THE United States is currently experiencing a banking crisis, triggered by the collapse of a regional lender, Silicon Valley Bank (SVB), and subsequently another middle-sized bank, Signature Bank. A banking crisis is significant because it can spread to the entire economy and drive the latter into recession.
Does the current US banking crisis hold any lessons for us, especially on the creation of the Maharlika Investment Fund (MIF)?
Firstly, we need to understand that the banking industry is a special industry. It’s special on a number of counts.
One is that it uses OPM — “Other People’s Money.” Unless it is heavily regulated, which it is, the industry is prone to risk-taking behavior.
Second, through the magic of fractional banking, one peso can multiply into several pesos. The reason is that not everybody uses their deposits at the same time. Therefore, a bank can just keep a fraction of the deposits in reserves (as cash or a deposit with the Central Bank) and lend the rest. The rest then get loaned out and deposited in other banks, which then use fractional banking, to lend and the cycle goes on with a multiplier effect.
Third, it is characterized by maturity mismatch since deposits are often withdrawable on demand but lent on longer maturities.
Fourth, it is characterized by asymmetric information. The depositor doesn’t often know how the bank uses his money but relies on the fact that he can withdraw when he wants to, even though there is often a maturity mismatch.
Precisely because of the asymmetry, the industry is very vulnerable to human psychology and contagion. Negative rumors can easily spread and infect other institutions. Panic withdrawals also tend to be self-fulling and trigger the domino-like collapse of similar institutions.
Fifth, it is a key industry, a strategically important part of the economy, if not the most important part. Banking matches savers and users, channeling savings toward users who are expected to make the most productive use of the money. Bankers earn income from this important process of intermediation.
LESSONS TO BE LEARNED
Having gotten that little lecture about banking out of the way, can we say that there are lessons we can draw on from the US banking crisis that can be applied in the creation of the Maharlika Investment Fund? After all, our own domestic banking system is supposedly very sound, right? And healthy despite the economic scars caused by the pandemic?
However, the MIF exposes our banking system to a risk of a crisis more than what SVB was perceived to trigger in the US. SVB was a regional bank, not classified as “TBTF” or Too Big To Fail, yet its failure triggered a collapse. On the other hand, Land Bank and the Development Bank of the Philippines (DBP) are separately, already TBTF. Land Bank is the second biggest bank in the country in terms of assets. DBP is the country’s eighth-largest bank.
However, under the Maharlika Investment Fund bill, P25 billion or 50% of the capital of DBP and P50 billion or 25% of the capital of Land Bank is committed to a single investment (MIF) — a startup lacking a business plan at that, breaching prudential ratios on a single investment. Under the MIF bill, the Bangko Sentral ng Pilipinas (BSP) is mandated to give these banks “regulatory relief” when they invest in the MIF.
There’s more. Under the MIF bill, the MIF can get as big as it wants because it has access to the full liquidity of the government financial institutions with the full guarantee of the National Government.
If the collapse of specialized banks like SVB and Signature Bank, which weren’t classified as TBTF by the US Fed and whose collapse wasn’t due to fraud or faulty loan decisions, could threaten the robust and gigantic US financial system, how much more DBP and Land Bank investing in a startup with no track record and no business plan?
Yes, it’s true. The exposures of DBP and Land Bank enjoy a sovereign guarantee under the bill. However, can the Philippine government make DBP and Land Bank whole in case the investment in the MIF tanks with the same speed with which the US Fed reacted to a bank failure? If not with the same speed, confidence can easily evaporate and fear and panic would have decimated the financial markets.
However, in the end, even with a sovereign guarantee, the banking crisis may yet spill into a fiscal crisis. Filipino taxpayers will end up paying the tab with those responsible getting away with it.
WEAKENING THE BSP
Another lesson from the current banking crisis is that the US Fed acted quickly and used its balance sheet to backstop the failed banks and all other banks. By coming in and guaranteeing all deposits, it hopes to stem the contagion. (Whether it will work is another matter given the fact that it is still rapidly increasing interest rates.)
Under the MIF bill, however, the BSP, instead of being strengthened, will be weakened. Under the New Central Bank Charter, the BSP’s capital was supposed to be raised to P200 billion from P50 billion as soon as possible by reinvesting its earnings into its capitalization. Under the MIF bill, however, the increase in capitalization will be delayed for as long as seven years, as BSP’s earnings in the first two years will be used to fund MIF and 50% of its profits perpetually.
Instead of bulking up the BSP to handle the possible crises in an uncertain and volatile world, the government is emasculating the only institution that can put out fires during a banking crisis. More so since the Philippine capital market is very thin. A few big players dominate the market and they can’t sell without hurting themselves. The BSP has an important market-making function, which could be emasculated by its involvement in the MIF.
There’s another more important point about the weakening of the BSP under the MIF: it’s not only about degrading its financial muscle but about degrading its integrity and moral standing.
By leaning on the BSP to fund the MIF from the former’s earnings, the government will turn the BSP’s mission from maintaining price and financial system stability, into profit-making because it will be the principal and perpetual source of MIF funding.
The BSP will also lose its moral standing, especially if it gives regulatory relief to DBP and Land Bank, while imposing stiff fines and penalties on the private banking sector. Worse, the BSP will have no moral standing if a banking crisis involves DBP and Land Bank because it was a participant in the violation of its own rules.
But wait, why are we talking intangibles here — integrity and moral standing — when banking is supposed to be about money? Wrong. Banking is ultimately about trust and confidence. Trust that the bankers will handle your money well. Trust that the regulators will do what is right. Banking is built not on the foundation of concrete but of trust and confidence.
Furthermore, because of the political nature of the MIF, doubts, negative rumors, wild speculations, and malign gossip could easily be seeded and spread by social media. Since the banking system will be used to fund the MIF, it becomes more vulnerable to these types of destabilizing influences that authorities would find hard to dispute or control.
Worse, these days, rumors and panic can be spread with a few clicks of a button. Nakedness can get exposed to the entire universe in a nanosecond.
INFLATION AND TARIFFS
The US banking crisis should also provide us an opportunity for a broader reflection of inflation and the cost of hiking interest rates to contain inflation. In the US, the rapid rate increases by the Fed to fight inflation is inflicting huge costs on the financial markets, especially on those sectors that were used to the low-interest rate regime in the past.
In the Philippines, the BSP is similarly seeking to dampen inflation through interest rate increases. Like the Fed, the BSP has also rapidly increased interest rates since the pandemic. The last quarterly increase to 6% in February 2023 hasn’t been enough to quell surging inflation, which rose to 8.6% in February.
However, its monetary tightening may not do much to contain inflation or will do so at great cost to the entire economy because inadequate supply rather than demand is driving Philippine inflation.
There’s a simple solution to food inflation: abolish quantitative quotas on imported food and other agricultural commodities, impose tariffs, and remove those non-tariff barriers without scientific basis.
Liberalizing importation and adding tariffs on imported products worked for rice, then why not do so for all other agricultural commodities? Not doing this and relying on the corruption-ridden system imposes a heavy cost to the economy, largely unhidden, by the high-interest rate increases that BSP has no choice but to impose. The homeowner has to pay a higher mortgage rate through no fault of his own. The MSME owner must pay higher interest charges even if he hasn’t become less efficient. The prudent bank is also paying through its mark-to-market losses. The entire system becomes more brittle and more stressed just because we refuse to allow food imports to come in.
Instead of railroading the MIF bill, the Senate should pause and reflect on what the current US banking crisis means for the Philippine financial system, the capability and resilience of its regulators, the overreliance on monetary tools to solve supply-side problems, and reform measures to address the real economy.
Calixto V. Chikiamco is a member of the board of IDEA (Institute for Development and Econometric Analysis).
totivchiki@yahoo.com
