Sep 192014
Reference ID Created Released Classification Origin
2005-12-23 08:02
2011-08-30 01:44
Embassy Manila

This record is a partial extract of the original cable. The full text of the original cable is not available.

230802Z Dec 05




E.O. 12958: N/A
SUBJECT: Banking System More Stable But Still Vulnerable

Ref: a) Manila 5519 b) Manila 4639

Sensitive but Unclassified – Not for Internet – Protect


¶1. (SBU) The Philippine Government is working to
overcome the reputation of the banking sector as weak and
inefficient with insufficient oversight. Although it
remains fragmented, the central bank has successfully
encouraged consolidation and has introduced many reforms
to strengthen banks and compel them to clean up their non-
performing loans (ref a) while introducing more rigid
accounting standards and improving its own management
capability. The Central Bank is updating and expanding
banking regulations in line with international best
practices, strengthening banking sector oversight and
governance, and pushing for revisions to its charter that
will expand legal protection and authority. End Summary.

Banking System Overview

¶2. (U) Currently, there are 40 commercial banks in the
Philippines along with 83 thrift banks and 750 rural and
cooperative banks. The commercial banks control 91% of
total banking sector assets, amounting to 3.9 trillion
pesos ($72 billion). This is approximately 80% of
Philippine GDP in 2004, one of the lowest percentages in
the region. Bear Sterns noted in comparison that these
assets were $11 billion less than the total assets of
Singapore’s second-ranked bank, United Overseas Bank, at
end-2004. Only Indonesia and India have smaller
proportion of bank assets per GDP, though the Philippine
ratio compares favorably with many emerging market
banking systems outside of Asia.

¶3. (U) Fourteen of the 40 commercial banks are branches
of foreign banks that collectively own 14% of the total
assets in the banking system. The four biggest foreign
banks — Citibank N.A., Standard Chartered, Hong Kong
Shanghai Bank Corporation (HSBC), and Bank of America —
hold 65% of foreign bank assets. The GRP passed
legislation in 1994 (the Foreign Bank Liberalization Act)
opening up the banking sector to 10 more foreign-branch
banks, or to own up to 60 percent of a new or existing
local subsidiary. All ten slots have been filled. The
Philippines is, therefore, currently closed to banking
institutions seeking to operate as foreign branch banks
in the country. Foreign branch banks that were allowed
entry under the 1994 legislation are limited to putting
up six branch offices each. The four foreign banks that
had been operating in the Philippines prior to 1948 were
each allowed to open a maximum of six additional branch
offices. Current regulations mandate that majority
Filipino-owned domestic banks should at all times control
70 percent or more of total banking system assets. Rural
banking remains closed to foreigners.

Reigning in Excess Cash

¶4. (U) As one of its monetary policy measures, the
Central Bank (Bangko Sentral ng Pilipinas, or BSP)
adjusts the banking sector’s required reserve ratio of
deposits to loans to control the supply of pesos. It
increased the reserve ratio by 2 percentage points in
July 2005 to 21% because of the high volume of pesos in
the market. Each bank must now hold 10% of its pesos in
“regular” reserves with the BSP at zero or minimal
interest rates. Banks must hold another 11% in
“liquidity” reserves, which can be invested in market-
yield government securities. In addition, the BSP has
raised overnight policy rates by 0.75 percentage points
thus far in 2005.

¶5. (U) Even with the increase in reserves requirements
and policy rates, domestic liquidity has risen 14% for
the year through October. BSP Governor Tetangco
attributed the sustained expansion in the money supply to
the large amount of hard currency remitted from overseas
workers (ref b) and portfolio investments in the
resurgent stock market. The BSP reported November 30
that the speculative financing flows of $2.1 billion so
far in 2005 are already four times greater than all of
last year. The bulk of this hot money went into the
stock market, which closed near the 2100 level on
December 1. Bankers noted that the BSP has resisted
taking some of the pesos out of circulation by either
raising the reserve requirement or selling securities on
the open market because the BSP is already flush with
cash. As one indication, the BSP’s foreign assets have
increased year-on-year by 9.7% while its foreign
liabilities declined by 50%.

Neither a Borrower Nor a Lender Be

¶6. (SBU) One feature of the banking system since the
Asian financial crisis is its reluctance to make new
loans. Bankers commented to Econoff that the corporate
sector has few major expansion plans that require outside
funding and so are not interested in loans. “There is
little corporate appetite to expand because of political
uncertainties, weak infrastructure, and regulatory
uncertainty,” said one banker. Because of the huge
amount of cash chasing few customers, it is a borrower’s
market. The competition creates a low spread between
consumer deposit and loan interest rates, compelling
banks to chase after their elite customers to maximize
lending and reduce risk. Even so, the Philippines has
the lowest ratio of consumer loans to deposits among all
the countries in Southeast Asia – only 53% and falling.
Loans account for less than 40% of total assets and this
ratio is also on the decline. Deposits are growing more
rapidly than loans, to the detriment of economic recovery
and job creation, though it helps the government to issue
new bonds for financing the budget deficit.

¶7. (SBU) BSP Deputy Governor Espenilla admitted that
Philippine industry growth is primarily in the service
sector, not in manufacturing where the country needs it.
Instead of corporate lending, it is consumer lending that
is growing rapidly, fueled by the massive growth in
overseas remittances. There has been double-digit growth
in credit card issuance and use, he said, as well as auto
loans. The BSP is developing credit information system
legislation that will force credit providers to submit
customer accounts and transaction history into a central
data bureau that will help ensure individuals do not take
on excessive amounts of lending.

¶8. (SBU) As a result of the low loan rate, the
Philippine banking system’s role as an investor in fixed
income securities is almost as important as its role as
provider of loans. Thus, around one-quarter of RP bank
assets consist of securities – largely bonds – issued
primarily by the GRP, though RP banks and corporations
have begun to issue their own smaller dollar-denominated
bonds as well. Citibank Vice-President for Debt and
Capital Markets Cheli Tabuena said the private banking
sector issues only 5% of the bonds in the Philippines by
value, but this number is growing quickly.

Consolidation, Not Expansion

¶9. (SBU) Another structural aspect of the Philippine
banking system is its fragmentation, with 40 banks in a
roughly $100 billion economy, compounding a severe
concentration of assets in a small number of banks.
Twenty-four of the banks accounted for less than 1% of
banking system assets. The top five individual banks
(Metrobank, Bank of the Philippine Islands, EPCI,
Landbank, and Citibank) account for 48% of the assets and
the top ten banks account for 71%. According to Bear
Sterns, this ownership concentration is growing after
recent consolidations of banks within the Sy family
(Equitable and PCI which will likely merge with Banco de
Oro) and by Lucio Tan, who owns Allied Bank and bought
out the government shares in Philippine National Bank.

¶10. (SBU) The BSP is encouraging the banking industry
to merge or stand on its own feet. Espenilla said he
hoped the number of banks would eventually dwindle to
less than a dozen. The General Banking Law of 2000
created a seven-year window during which foreign banks
may own up to 100 percent of one locally incorporated
commercial or thrift bank. However, these investments
can be made only in existing and not new banks; since
1999, the BSP has imposed a complete moratorium on new
bank licenses, except for those engaged in micro-finance.
Already several banks have merged (down from 42
commercial banks in 2004 to 40 at present) and others are
in various stages of takeover by larger banks. Citibank,
for example, is taking over the 53 branch offices of
Insular Bank and JP Morgan may be taking over a small
bank chain soon as well. The BSP announced in November a
partial liberalization of its branch moratorium for
domestic banks outside of seven core cities, including
Manila, where branching will remain frozen. The BSP also
announced relaxation of rules to give bank automatic
extension of special licenses for certain banking
activities unless revoked for cause.

Other Banking Sector Reforms

¶11. (SBU) Espenilla told econoff that the GRP has
drafted a law creating independent retirement accounts
with tax incentives. It has also promoted revisions to
the investment competency act to develop mutual fund
standards, and a fixed income exchange to encourage more
transparent trading and clearing systems for fixed income
recipients. The GRP has finalized its rules for third
party custodianship, which will require a separate bank
to sell securities from an account-holder’s regular bank.
This boosts consumer protection, prudential standards,
and capital market development, he said.

¶12. (SBU) Otherwise, the BSP is updating and expanding
banking regulations in line with international best
practices, using the standards and codes of the Basel II
conference. Espenilla said he hopes to strengthen risk-
based management and impose risk-based capital, improve
corporate governance, and strengthen the appraisal
process through USAID to evaluate the banking system
assets. (Note: The BSP is advocating for the passage of
a credit bureau bill, now pending before the Senate and
Congress, that will mandate all banks and other major
credit providers to submit customer credit accounts and
transaction history into a central credit bureau that
will guide credit providers in screening prospective
borrowers. USAID assisted the BSP in developing the bill
and studying credit bureau operations. End Note.) He
said the BSP needs an amendment to its charter,
especially parts related to legal protection and
authority. For example, there have been many suits
against individuals in the BSP, including a number
against the former Deputy Governor, because the laws are
unclear or weak regarding the ability to close down or
restrict lending from banks in jeopardy. Recently,
Espenilla commented, the BSP has been winning its cases
since the Monetary Board granted them more leeway to hire
better lawyers.


¶13. (SBU) Based on the positive developments listed
above, the banking sector’s reputation and impact on the
investment climate deserve reconsideration. The BSP has
had a series of strong leaders with acumen and foresight.
Their efforts have resulted in a banking sector that is
more stable, efficient, and transparent than at any time
in the past and could, provided reforms continue,
eventually rise to rival the effectiveness of financial
systems in the region.




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