‘RESILIENCE’ best describes the Philippine banking sector’s performance over the last 12 years — a period marred by external shocks of varying magnitudes.

When Bangko Sentral ng Pilipinas (BSP) Gov. Amando M. Tetangco, Jr. hands over the reins by the end of next month, his successor will inherit a banking system that has joined the ranks of the strongest — albeit still among the smallest — in developing Asia.
The capital adequacy ratio (CAR) of the Philippine banking system has kept well above the international minimum standard of 8% throughout those 12 years, even staying in the double-digit territory at the depths of the Global Financial Crisis (GFC).
Banks’ asset quality has improved substantially, with non-performing loan (NPL) ratios settling in the low single-digits in recent years.

Financial intermediation in the Philippines however remains middling, even as the financial sector’s share of domestic credit has risen close to 60% of the economy. In contrast, domestic credit provided by the financial sector in neighboring Malaysia, Singapore, Thailand and Vietnam has exceeded their respective gross domestic products (GDP) by at least a fifth.

Ambreesh Srivastava, head of Fitch Ratings’ South & Southeast Asian Financial Institutions team, said the Philippine banking sector improved over the last few years, adding that it used to be in the lower BB (BB-) level. At present, it is within the BBB category, the lowest for investment-grade debtors.

“[I]f we were to look at the major banks in the Philippines, their ratings also used to be in the low BB (BB-) range. Now, we can see that the largest banks’ ratings in Philippines (BPI, BDO and Metrobank) are already in our investment grade range while the rest of the banking system has also become a lot stronger,” Mr. Srivastava said.

He said the local banking sector will “stand out a lot better” compared with less developed countries like Vietnam, but “not be as strong” as Singapore and Malaysia.

Simon Chen, vice-president and senior analyst at Moody’s Investors Service agreed: “The banking system has benefited from the robust growth of the Philippine economy in recent years, which has supported the domestic demand for credit among businesses and individuals.”
“At the same time, the regulatory environment has kept pace with global developments and broadly ensured that the sector as a whole remains resilient to both external headwinds and domestic pressures,” he added.

ASIAN FINANCIAL CRISIS
Philippine banks have come a long way since Mr. Tetangco first took on the job of BSP governor in 2005. Eight years after the Asian Financial Crisis struck, lenders were still sifting through their books to identify more soured assets they could unload.
The Special Purpose Vehicle (SPV) Act was expiring, but disposals at mid-2005 comprised only less than a fifth of the P520-billion worth of unproductive assets logged when the law came into effect three years before. When the SPV law expired that year, the stock of non-earning assets comprised under a tenth of the industry’s combined P4.5-trillion in gross assets.

Consequently, the banking industry was pushing for a two-year extension of the tax breaks for bad asset sales. While the SPV law cut NPL levels to the high single-digits in 2005 from double-digits just the year before, the BSP was hoping an extension would allow the industry to shed at least P100 billion more of toxic loans and unproductive real and other properties owned or acquired (ROPOA).
“If you look at credit growth, we can see that back in 2005, the loan expansion was weak amid the sector’s restructuring effort,” Fitch’s Mr. Srivastava said.

A high level of NPLs has an insidious effect on credit, making it less affordable, thus less available. At the depths of the Asian crisis, the banking industry’s loan portfolio contracted, as bank lending rates hit the high-teens.

Banks naturally are more averse to lending, especially in the absence of a credit information system, a law establishing which was passed only in 2008 in the Philippines. Bad assets are a drag on earnings because banks would have to set aside provisions that otherwise could have been used to earn money.

Even creditworthy borrowers are penalized, as the credit crunch meant that they would find it more difficult to take out a loan. The Asian crisis was the worst possible time for all of these to happen, as it makes it harder for an economy that is financed largely by bank credit to claw back from a recession.

When the law extending the SPV tax perks expired in 2008, bad asset disposals fell short of the BSP’s target. Despite the underperformance, the banking industry’s NPL ratio was more than halved to 3.5%, or at levels seen before the Asian crisis.

Bank lending rates likewise had gone down to the high single-digits, whereas the industry’s total loan portfolio grew at double the pace of the previous year. Outside financial intermediation, credit was channeled to real estate, construction and manufacturing.
But barely had Philippine banks recovered from the Asian contagion, when another crisis loomed around the corner.

GLOBAL FINANCIAL CRISIS
US banks’ over-lending to subprime borrowers came home to roost, dealing a mortal blow to American icons such as Lehman Brothers and Bear Stearns. As the dust settled, it became clear that the damage was not restricted to the US, as European financial behemoths also took a hit, weighing down their governments. Credit markets froze, sending ripples across the globe.

BSP’s Mr. Tetangco recalls that he was in Washington, DC, leading a delegation to the annual IMF-World Bank (IMF-WB) meeting when news broke about the US’ subprime crisis: “The general environment there was very bleak. Financial market indices were falling each day. You watch the late news in the US, and wake up to find out Asia had reacted overnight, and US markets would again be lower from where they closed the day before.”