Severe slump may amplify risks for Philippine banks – IMF

By Luz Wendy T. Noble, Reporter

PHILIPPINE banks may experience “systemic solvency distress” if the economic impact of the coronavirus disease 2019 (COVID-19) turns out to be worse than initially expected, the International Monetary Fund (IMF) said.

“While banks can withstand the exceptionally severe shocks in the baseline, they could experience a systemic solvency impact if additional downside risks materialize,” the IMF said in its Financial System Stability Assessment on the Philippines.

“The economic shock would weigh on corporate earnings and then spill over to banks. Bank stress could limit credit supply, reducing economic growth noticeably even more,” it added, noting the Philippines’ recession last year was worse than what it had experienced during the Asian Financial Crisis.

The IMF report was finalized on March 9 after virtual missions were conducted on Oct. 20 last year. ​However, the IMF said the Philippines​, at that time,​ was already recovering and that its macroeconomic fundamentals are more solid than its standing in the late 1990s. Gross domestic product (GDP) contracted by a record 9.6% in 2020, and is expected to grow by 6.5% to 7.5% this year.​

In its baseline scenario, the IMF said banks’ total capital adequacy ratio (CAR) will drop from 15.6% to 11.7% by 2022, still above the 10% minimum requirement.

“However, CAR falls to 9.3% in the adverse scenario, and 4.9% in the severe adverse scenarios. The second-round effects from such distress might reduce the real GDP level by an additional 4 to 9 percentage points in adverse scenarios. However, CARs start to recover in 2022 as the economy recovers,” the IMF said, adding these should be interpreted cautiously given heightened uncertainty.

Sought for comment, Bangko Sentral ng Pilipinas (BSP) Governor Benjamin E. Diokno said the IMF stress tests consider a scenario where it would take longer to contain the COVID-19 pandemic.

“This will affect people, the companies they work at, and the financial market. To address possible financial stability complications, we have invested a great deal of effort into mapping the business connections between firms, between industries and between economic activities. This gives us a network view of what we have referred to before as the possibility of ‘slow burn contagion.’ This network is a very important tool for preemptive surveillance,” he said in a Viber message to BusinessWorld.

Mr. Diokno noted servicing of debt is a major focus for now, as many households and companies lost income during the pandemic.

“We have to give those who are temporarily distressed the opportunity to get back on track. Part of that is making sure there is liquidity and that we are flexible enough in handling debts as they fall due. We think of the needs of borrowers, but also be fair to those who lent money. Of course, it is natural for uncertainties to get reflected in the financial market and so calming markets with information and policy direction is as important,” he said.

Separately, BSP Deputy Governor Chuchi G. Fonacier said the central bank has been conducting stress tests in light of how assumed scenarios could impact banks’ capital.

“Based on our assessment, the banking system remains healthy and has maintained solid footing as evidenced by the sustained growth in assets, deposits, and capital, as well as positive net profit, adequate capital and liquidity buffers and ample loan loss reserves,” Ms. Fonacier said in a text message to BusinessWorld.

Despite pressures caused by the pandemic on banks’ performance and asset quality, Ms. Fonacier said the CAR of the industry both on solo and consolidated bases remain well above the minimum threshold of 10% set by the BSP.

The Philippine banking system’s cumulative net income dropped by nearly a third (32.6%) to P155.218 billion in 2020 from P230.671 billion as lenders hiked their loan loss provisions due to the crisis, based on BSP data. Allowance for credit losses in January stood at P371.102 billion, surging by 72% from the P215.204 billion a year earlier.

Central bank data also showed the banking industry’s bad loan ratio stood at 3.7% in January, picking up from the 3.61% in December and the 2.16% a year earlier. This, as gross nonperforming loans (NPL) jumped by 67% to P392.256 billion from a year earlier.

NO DIVIDENDS?
Faced with these significant downside risks, the IMF said authorities should limit Philippine banks from distributing dividends as a precautionary measure.

“If downside risks materialize, banks should recognize NPLs and restructure them promptly with additional capital as needed. This is supported by a counterfactual policy analysis and the experience after the AFC, which suggest that such actions could improve GDP with sustained credit provision,” the IMF said.

The central bank should also allow forbearance measures to lapse as scheduled and avoid introducing new measures.

“Forbearance does not address the underlying issues in weak banks and hampers banks’ ability to continue providing credit and ultimately may even undermine financial stability. Instead, the authorities should continue to use the flexibility of the tools available in the accounting and Basel capital framework, and, looking at the future, further develop and use macroprudential tools and buffers,” the IMF said.

A 60-day mandatory loan moratorium lapsed at the end of 2020.

REGULATORY GAPS
The multilateral lender also identified reforms needed to strengthen the central bank’s supervision to maintain financial stability.

“Material gaps remain on BSP’s legal powers related to conglomerate supervision, and bank secrecy laws are limiting the effectiveness of supervision, but also have wider financial sector implications,” the IMF said.

Mr. Diokno said the Financial Sector Forum which includes the BSP, the Securities and Exchange Commission, the Insurance Commission, and the Philippine Deposit Insurance Corp., are working together with a mandate to “have a better and holistic view of market institutions” while abiding within laws.

“If we believe that the risk decisions of financial institutions, either individually or collectively, pose a threat to the health of the whole financial system, then these matters are discussed at the Financial Stability Coordination Council,” Mr. Diokno said.

Meanwhile, Quirino Representative Junie E. Cua, who also heads the House Committee on Banks and Financial Intermediaries, said IMF’s concern is over the BSP’s lack of supervisory power in terms of looking into how transactions by affiliates of a conglomerate affects banks also within the group.

“We have big banks that are owned by conglomerates and these banks of course will lend to other affiliates of their parent firm,” Mr. Cua said in Filipino over a phone call on Sunday.

“We have tasked the BSP to propose what measures can be done to address possible situations wherein the failure of a conglomerate’s affiliate can affect the soundness of the conglomerate-owned bank,” he added.

Pending at the House of Representatives is House Bill 8991, which seeks to allow the central bank to look into accounts of bank officials provided there is “reasonable ground” that fraud, serious irregularity or unlawful activity has been committed by said officials.

“What it [the bill] can prove is that we are serious in providing sufficient authority to the BSP to regulate the banking industry for the protection of the general depositing public,” Mr. Cua said.

In its assessment, the IMF also said the country is still at risk of being included in the “gray list” of the Financial Action Task Force, or countries that are found to have lax regulations against “dirty money” and terrorism financing.

The Philippines has addressed its deficiencies in terms of technical compliance through the passage of the Republic Act No. 11521 in January which amended the Anti-Money Laundering Act and Republic Act No. 11479 or the controversial Anti-Terror Act of 2020 in July.

Anti-Money Laundering Council Executive Director Mel Georgie B. Racela has told BusinessWorld last week the next step is to prove the country can demonstrate “effective implementation” of its tighter rules against money laundering and terrorism financing.