A woman sits with a pro-Brexit placard as a group of people set up a counter demonstration to a group taking part in a picnic against Brexit organized by the General Assembly in Green Park in London in July 2016. The British government on Saturday formally rejected a petition signed by more than 4.125 million people calling for a second referendum on Britain’s membership of the EU. (AFP)

by Imee Charlee C. Delavin, Reporter 

The next few years will be more challenging for Philippine banks amid headwinds from overseas, but the country’s sound macroeconomic fundamentals are seen fueling the local financial sector’s expansion, drawing in more foreign banks that want a piece of Asia’s rising star.

Since the start of the year, local financial markets have been buffeted by the divergence in the fortunes of the world’s biggest economies. In recent weeks, Britain’s decision to pull out of the European Union added to this uncertainty.

“With the exit of Britain from the European Union, investors right now are on a wait-and-see mode, assessing the repercussions of Britain’s decision on the health of the world economy,” Land Bank of the Philippines market economist Guian Angelo S. Dumalagan said.

“Britain could potentially undermine global growth by dampening consumer and business sentiment. Although another worldwide recession is unlikely given the steady pace of the US economy, the separation of Britain could definitely aggravate global economic divergence, resulting in increased volatility in financial markets,” he said.

The divergence among the world’s advanced economies has the US on the one hand raising interest rates to sustain its recovery from the Global Financial Crisis of 2008-2009. Japan and the Eurozone on the other hand are easing monetary policy to prevent their economies from sliding back.

Add to the mix China, which has slowed down in recent years, pulling along with it some emerging economies in Asia that rode on the export boom of the world’s second largest economy.

“Added stimulus would mean that interest rates may remain low, but very volatile, in the next few years,” Mr. Dumalagan said.

“Amid this global economic environment, Philippine banks might find themselves frequently adjusting their portfolios in response to mixed signals from abroad. Volatility offers profit opportunities, although market timing is critical. This could also mean that loan growth might remain strong, as relatively low interest rates could entice firms and households to borrow more,” he added.

Despite global headwinds, Philippine banks remain well-capitalized, the Bangko Sentral ng Pilipinas said. (AFP)

Local lenders remain well-capitalized

Despite the external headwinds, Philippine banks remained well-capitalized, with a 14.91% capital adequacy ratio (CAR) at the end of last year, or well above 10% minimum set by the Bangko Sentral ng Pilipinas’ (BSP) and the 8% floor under Basel III.

Capital buffers also were of high quality, mainly composed of common equity tier 1 (CET1) instruments, which represented 12.37% and 13.33% of risk-weighted assets on solo and consolidated bases, or more than double the minimum 6% share set by the BSP. The share of Tier 1 capital — composed of common equity and qualified capital instruments — also stood at 12.55% and 13.48% at end-2015, higher than the 7.5% requirement.

The banking sector’s total resources stood at P12.52 trillion at end-March 2016, up from the year-ago level of P11.37 trillion, as the public continued to place their savings in banks, thus supporting the industry’s expansion.

Universal and commercial banks’ total resources stood at P11.25 trillion, up from the P10.24 trillion at end-March 2015. Thrift banks had P1.05 trillion at end-December, while rural banks held P213 billion.

This was despite a drop in the number of banks operating in the country. At end-December, the number of lenders declined to 632 from 648 in 2014. However, total bank branches rose to 10,124 from just 9,713the previous year.

Big banks remained profitable in 2015, posting a combined net income of P120.275 billion.

According to the BSP’s assessment, “the Philippine banking system remains resilient as it continued to support long-term economic growth, [adding that] banks’ balance sheets were marked by sustained growth in assets and deposits.”

International credit raters have said the Philippine banking system remains sound and stable, as banks remained well-capitalized against any financial shocks, having been supported by the country’s strong fundamentals and rapid economic growth.

Bangko Sentral Governor Amando Tetangco Jr: ““The projection is that the Philippine economy will continue to grow at a rate above trend over the next few years.” (AFP)

Positive economic outlook

BSP Governor Amando M. Tetangco, Jr. agrees that the country’s solid macroeconomic fundamentals underpin the banking industry’s strength, adding that the positive outlook for the Philippine economy lends support to lenders’ resilience in the near- to medium-term.

“The projection is that the Philippine economy will continue to grow at a rate above trend over the next few years, which would indicate that there would be a need for funding increased economic activity during that period. That would augur well for the banking system,” Mr. Tetangco said.

Despite the global uncertainty, the Philippines’ gross domestic product (GDP) growth has averaged 6.3% annually since 2010. At 1.8 percentage points more than in the previous six years, the recent growth record is a bigger improvement than in any other country in the region, Capital Economics Ltd. earlier said.

Last year, GDP grew by 5.8% on the back of robust domestic demand and private investments, albeit missing a 7-8% target for 2015.

GDP grew by 6.9% in the first quarter of 2016, driven by an uptick in public disbursements, a surge in investments, and robust household consumption, which historically has contributed up to 70% of GDP. This year, the country is seen expanding by 6-7%, down from the initial target of 6.8-7.8%, but still above trend.

Workers stay onsite to fix a flood control project in Metro Manila. Big-ticket projects are expected to boost the expansion of Philippine banks further. (AFP)

Boost infrastructure spending

Seen boosting economic growth in the medium term is increased infrastructure spending — by at least 5% of GDP, going by what President Rodrigo R. Duterte’s economic managers have been saying. This in turn will be a boon to the banking industry.

“It helps that the new economic team has announced that they will ratchet up infrastructure spending. This would create the conditions for more future growth,” EastWest Banking Corp. President and CEO Antonio C. Moncupa, Jr. said.

“And if the campaign against criminality starts to bear fruits and the peace processes take off, these could unleash more upbeat mood and eventually investments and hopefully translate to more job opportunities for our workers,” he said.

Ildemarc C. Bautista, assistant vice-president and head of research at Metropolitan Bank & Trust Co., described as “unprecedented” the Duterte administration’s plan to ramp up infrastructure spending to as much as 7% of GDP.

“[C]onsumer and business loans should pick up on the back of these government stimulus programs and strong consumer spending,” he said, adding that, coupled with low global inflation and high domestic liquidity, “this should prove positive for the demand side.”

Maybank ATR Kim Eng banking sector analyst Katherine Tan said the government’s emphasis on infrastructure, particularly public-private partnership (PPP) projects can address banks’ compressing margins.

“[T]hey are term loans… they are considered as project financing and project financing usually gives you higher rates so more PPPs then that should also help the banks’ margin in the long-term,” Ms. Tan said. “There would be more room for growth for the banking sector in the next six years [as] more PPPs, more project-financing type of loans then that would probably help improve your margins.”

Back to basics

Patrick D. Cheng, first vice-president at China Banking Corp., said banks “should do reasonably well” during the next few years.The government’s PPP projects will boost the expansion of banks as “more conglomerates team up and share the risks and rewards” of such projects, giving local lenders “more capital market deals to attend to,” he said.

“If the country continues to grow by around 6% to 7% per year for the duration of the Duterte administration, then we should expect bank earnings to gain somewhere between 1 and 1.50 times GDP growth,” Mr. Cheng said.

“With interest rates much lower, bank’s trading gains will definitely be muted compared to where they were four to five years ago. It will really be a back to basics for banking. Making good loans… keeping within their respective bank’s risk appetite and generating a good balance of fee income,” he said.

Branch expansion “may be tapering off as banks and clients adapt better to technology and digital banking — non-branch banking — channels,” Mr. Cheng said, adding that this should give banks “some breathing space on operating expenses.”

“These actions if properly executed should allow banks to generate and rebuild net income levels to offset the generally lower trading gains environment,” he added.

A woman walks in front of a signboard of Japan’s Sumitomo Mitsui Banking Corp in Tokyo in this photo taken in 2013. The bank was one of eight that secured approval to operate in the Philippines (AFP).

Entry of more foreign banks

And as success attracts rivals, the Philippine banking industry will be witness to more players from abroad, aided in no small way by the government’s move to liberalize foreign ownership, and by the envisioned ASEAN Banking Integration come 2020.

“An expanding economy is always positive for the banking system,” Mr. Tetangco said, adding that the country’s “strong macroeconomic fundamentals and good economic performance” is luring more foreign banks into the system.

“Given the positive prospects of continued growth and manageable inflation, the entry of foreign investments is expected to increase further, including investments in the banking sector which has actually been liberalized through the passage of RA [Republic Act] 10641 and also the passage of the law allowing higher foreign participation in rural banks,” Mr. Tetangco said.

The BSP has approved the entry of eight foreign banks since the passage of the Act Allowing the Full Entry of Foreign Banks in July 2014. The foreign lenders that got the BSP’s green light to operate in the Philippines are Japan’s Sumitomo Mitsui Banking Corp., South Korea’s Industrial Bank of Korea and Shinhan Bank, Taiwan’s Cathay United Bank and Yuanta Commercial Bank Co. Ltd and the Singapore’s United Overseas Bank Ltd.

This year, Korea’s Woori Bank entered the local market by partnering with Gaisano-led Wealth Development Bank Corp., a thrift lender which targets to serve both Korean tourists and expats. In June, Taiwan’s First Commercial Bank also got the central bank’s approval to set up a branch in Manila.

“There are more applications that are being evaluated right now,” Mr. Tetangco said.

EastWest’s Mr. Moncupa said the outlook for the local banking industry in the next three to six years is “definitely bright,” notwithstanding greater competition.

“[M]ore intense competition… normally happens when the mood is upbeat. Everybody will try to get a piece of the action. While that puts some pressure on bank spreads, it will be good for households and businesses in terms of access to credit, better services, and more competitive pricing,” he said.

Mr. Moncupa said the lower spreads and intense competition would put pressure on mergers and acquisitions, which would create higher efficiencies and economies of scale.

“Overall, the industry will turn positive results although it could be tough for some banks.  We expect to see more interest from foreign banks to get into the country. In general, in the next few years we see retail banking to continue to be the realm of local banks.  Foreign banks will be mostly in corporate and wholesale banking. Foreign banks may try to get minority stakes in local banks,” he said.

Metrobank’s Mr. Bautista sees tighter competition playing out this way: “The big local banks will continue to leverage their national presence and create economies of scale while the smaller banks will focus on niche markets and consumer segments.”

“Although it looks like new entrants are more amenable to partnerships with local banks instead of going in solo… these foreign entrants will continue to seek partnerships with the mid-tier banks as they focus on niche markets and using technology solutions as a competitive tool,” he said.

Choice of next BSP chief

Lastly, any orderly adjustment by the banking industry to the new realities of broader competition and external volatility would require the steady hand of a central bank. Crucial to the financial sector, if not the entire economy’s mid-term prospects, is the appointment of a new BSP chief by next year when Mr. Tetangco steps down.

Nicholas Antonio T. Mapa, associate economist at Bank of the Philippine Islands (BPI) said one of Mr. Duterte’s most crucial appointees will be his choice for BSP Governor in 2017.

“President [Benigno S.C.] Aquino [III] did well in re-appointing the ace Governor who has earned international acclaim for his astute stewardship of the country’s financial system,” Mr. Mapa said.

“No doubt [Mr.] Tetangco helped keep the economy afloat in rough waters and ensured smooth and safe sailing in the times that the winds were full in our sails. Duterte would need to find a worthy successor to the outgoing Tetangco,” Mr. Mapa said.

The Philippine financial system is “one of the most resilient in the region, if not the world” as it “adheres to stringent standards of risk management to ensure that the business of public trust remains whole and viable for all stakeholders involved,” he said.

One of Mr. Tetangco’s legacies to the Philippine banking system is the implementation of an interest rate corridor system, “which is precisely the framework that can stave off financial market volatility,” Mr. Mapa said.

“Given how quickly global markets can turn from tempest to tranquil and back, the BSP’s investment in such a system affords them the flexibility to deal with rapid changes in market sentiment and to calm the waters when they do get roiled,” he said.

“Their ability to better get hold of liquidity will go a long way to deterring financial stress from the eventual [United Kingdom’s] exit from the European Union, imminent, albeit delayed Fed rate hike cycle and possible renewed concerns about crude oil prices and China’s economy,” Mr. Mapa added.

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Imee Charlee C. Delavin (@charleedelavin on Twitter) covers private banks for BusinessWorld. She loves to travel.