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The debt moratorium

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FINEX Folio

One of the pressing issues of the day is the plan of Congress to provide a two-month moratorium or grace period on loan payments. It was originally a one-year debt moratorium under the house version of the Bayanihan II. The time frame  was criticized for its possible impact on the banking industry in terms of risk and liquidity.

A moratorium is intended to prevent the cash crunch induced by the enhanced community quarantine or lockdown. Revenue and customer starved companies shall be given enough time to pay back their debts. Small and medium enterprises are unlikely to have huge cash buffers and have little recourse but to defer loan payments.  The moratorium reduces the burden on companies adversely affected by the business disruptions.

The devastating effect on the economy is clear as the country enters one of its worse GDP decline in decades. With the virus still to depart, the medium-term economic scars will be palpable. Resumption of ordinary life does not seem to be within easy reach and a 60-day moratorium may not be sufficient to build up cash to settle debts. The long quarantine has definitely disrupted trade and commerce. With the Philippine economy largely consumption led, the pandemic has altered the landscape that has defined the country’s growth.

Some say that 60 days will not be enough. On the other hand, the original 1 year proposal seems too oppressive. It is a delicate balancing act.  Whatever final action is taken on the length of the moratorium, it is of course still speculative if the loans and interest obligations will be fully paid once it ends.  The banking sector nonperforming assets as a share of total could rise by a big number. Banks will be under pressure to proactively augment capital soon. But weaker banks will find it difficult to attract investors’ interest unless the economy finds a way to rebound.

The moratorium is intended to help debt-exposed borrowers.  But it also has an effect on the current lending activities of the banks.  With growth prospects weak and uncertain, only the brave entrepreneurs will invest in new ideas, premises,  machineries and ventures.  Jack Ma was even quoted to say that the objective of businesses in 2020 is simply to survive. But for those willing to move forward, invest and borrow, will the risk averse banks be ready to respond?

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In response to many financial crises in the past, regulations have been forcing banks to be more risk averse. In the past, many of banks held only a fraction of their assets as reserves and they borrowed short term to make long-term loans or hold long term securities. This exposed banks to runs and forced the hand of regulators to impose stricter rules.

National and international regulations such as the Basel framework have required banks to fund themselves with more capital and encouraged them to take less risk. Core capital in balance sheets have to be increased radically. The risk weights supervisors attach to bank assets which is a measure of how uncertain the underlying loans and securities are have become stringent. And this makes the assets stronger, albeit leading to bankers claiming that their balance sheet has become a scarce resource.

The moratorium therefore represents a double-edged sword. Yes it helps our enterprises for now, but is it just postponing an eventual negative consequence? And with the banks burdened as they are, how will they confront the forthcoming past due debacle. Will the regulators, lawmakers and policy makers provide some kind of relief?  The future will especially be a concern for the smaller banks.

Another anticipated consequence here is the effect on shadow banking. As banks have become less competitive, nonbanks who are often tech savvy will fill in the gaps. Payments and other bank-like activities outside of the banking system will find greater traction.

The term shadow banking could apply to many financial institutions and activities. Anything that provides a vehicle for savers to deposit cash as well as for borrowers to access needed funds is considered within the ambit of shadow banking. For borrowers and savers, it is not necessary that the funds are intermediated through a formal bank. The financial system will evolve to accommodate innovators who will provide this service.

Shadow banking as term is rather pejorative and the players prefer the euphemism “market-based finance.” More notable is that this collection of nonbank financial institutions provide service, outside of normal banking regulations.  Will the rules on the moratorium cover these institutions? The financial system will naturally evolve and some institutions will take advantage of regulatory arbitrage when the rules are not able to catch up.

The moratorium is a necessary policy tool for now but policy makers should anticipate its medium to long term effects. The players behave according to the incentive mechanisms put in place.  There should be a think group calibrating effects of actions taken today.  Stress tests on the macroeconomy must be developed so that counter measures can be instituted when the red flags are seen, not only when the crisis is already in place.

 

Benel Dela Paz Lagua was previously Executive Vice-President and Chief Development Officer at the Development Bank of the Philippines.  He is an active FINEX member and a long time advocate of risk-based lending for SMEs.  The views expressed herein are his own and does not necessarily reflect the opinion of his office as well as FINEX.

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