The Bangko Sentral ng Pilipinas (BSP) deserves a lot of credit for diligently aiming for financial inclusion in the Philippines. The BSP defines financial inclusion as the process of providing access to financial services for all — savings, credit, investment, money transfers, and other products. The financial inclusion agenda revolves around three pillars: (1) access to financial products and services; (2) financial education and literacy; and (3) financial consumer protection. These objectives are especially critical to the underbanked and unbanked, people who struggle in an uncertain world of financial exclusion and insecurity. The BSP has been at the forefront of developing the National Strategy for Financial Inclusion, which involves private and public sector stakeholders.
We have to remember though that the BSP is also at the center of efforts to promote stability and efficiency in the financial system. In fact, this is the primary reason for being of any country’s central bank. The BSP promotes price stability so that the country’s financial system is conducive to balanced and sustainable growth of the economy. Its monetary policy is conducted using inflation targeting as a primary tool. It exercises effective regulation and supervision over financial institutions under its jurisdiction. The approach is through a risk-based capital adequacy framework using Basel II/III and compliance with best practice financial reporting standards.
Basel III, for example, will provide regulations by way of stricter standards on banks on the levels of capital they maintain. The regulations will improve the quantity and quality of bank capital through mandated capital ratios. It will also redefine what constitutes core (or Tier 1) bank capital and redefine bank liabilities and risk management standards. Liquidity coverage and funding ratios are tweaked to increase capital and improve liquidity, problems that were encountered in previous financial crises.
While stability is enhanced, the cost of raising capital for small business could be affected. The higher capital ratios and compliance costs, together with the higher cost of capital, will impact the viability of smaller banks. Small banks are more inclined to serve and lend to small business entrepreneurs. This is attested to by the banking community’s compliance with the mandatory lending provisions of the Magna Carta for SMEs, where the thrift banks and rural banks are reported to be most compliant in the micro and small business segment. Regulations that will require banks to assign higher risk weights to small businesses will serve as a disincentive to servicing this sector. Customization of loans to a small business’ unique needs also suffers in the process because of the higher costs of doing business. In general, Basel III effects on lending to small businesses are generally expected to be disproportionally negative.
Let’s look at the situation from the other side. A liberal approach to financial inclusion by way of relaxation of credit standards, especially for the underbanked, can backfire. The reason for being underbanked or unbanked is not a simple supply problem, and may be an issue of borrower creditworthiness, the character and capacity to pay external debt. The sub-prime mortgage lending situation in America that led to the global financial crisis is a recent example of an aggressive foray into the underbanked gone awry. This is a classic moral hazard, where both lenders and borrowers behave in accordance with the incentive structure of the liberalized credit environment.
The policy dilemma is clear. These two policy objectives — financial inclusion and financial stability — are both important, but they demand actions that may lead to consequences at cross purposes with each other. And these outcomes may even be totally unintended. The behavioral effects are not necessarily consistent and in harmony.
This is precisely the focus of a recent study by Cihak, Mare, and Malecky. The authors conclude that “on average, financial inclusion and financial stability are negatively correlated, and thus linked more through tradeoffs than synergies… While tradeoffs could dominate the inclusion-stability nexus, synergies could arise with almost equally high probability.” They add, “rapid increases in credit to previously informal firms that enter the formal sector should be monitored for potential threats to financial stability.”
The bottom line here is the need for greater policy coordination and astute management by our BSP leaders in achieving the right balance. In which areas can synergies be achieved? What are the risks and tradeoffs when one objective is pursued at the sacrifice of another?
Aiming for both inclusion and stability is a responsibility in which the BSP, a constitutionally independent body, needs support from a number of other government agencies for effective policy coordination. But since the BSP has assumed a mantle of leadership here, its efforts must be lauded, encouraged, and sustained. The next BSP leader must be cognizant of these tradeoffs and the potential synergies.
Benel D. Lagua is executive vice-president at the Development Bank of the Philippines. With an AIM-MBM and a Harvard-MPA. He is a part-time faculty of the College of Business, De La Salle University.
