Philippines
Financial Sector Assessment Program-Detailed Assessment of Observance-Basel Core Principles for Effective Banking Supervision

The BSP’s regulatory framework is broadly effective for the size and complexity of the Philippine banking system, but legislative gaps continue to hinder effective supervision of banks. The BSP has a well-resourced, experienced and highly committed staffing complement, but there is an ongoing need to develop and maintain adequate expertise in certain complex areas (e.g., risk modelling). Since the FSAP in 2002, and the assessment update in 2010, the BSP has made significant progress in enhancing the regulatory framework in a number of areas. But significant weaknesses in the legislative framework, arising notably from the bank secrecy laws and the lack of power for the BSP to supervise the parent companies and their affiliates of banking groups, present a material hindrance to effective supervision.

Abstract

The BSP’s regulatory framework is broadly effective for the size and complexity of the Philippine banking system, but legislative gaps continue to hinder effective supervision of banks. The BSP has a well-resourced, experienced and highly committed staffing complement, but there is an ongoing need to develop and maintain adequate expertise in certain complex areas (e.g., risk modelling). Since the FSAP in 2002, and the assessment update in 2010, the BSP has made significant progress in enhancing the regulatory framework in a number of areas. But significant weaknesses in the legislative framework, arising notably from the bank secrecy laws and the lack of power for the BSP to supervise the parent companies and their affiliates of banking groups, present a material hindrance to effective supervision.

Introduction1

1. The BSP’s regulatory framework is broadly effective for the size and complexity of the Philippine banking system, but legislative gaps continue to hinder effective supervision of banks. The BSP has a well-resourced, experienced and highly committed staffing complement, but there is an ongoing need to develop and maintain adequate expertise in certain complex areas (e.g., risk modelling). Since the FSAP in 2002, and the assessment update in 2010, the BSP has made significant progress in enhancing the regulatory framework in a number of areas. But significant weaknesses in the legislative framework, arising notably from the bank secrecy laws and the lack of power for the BSP to supervise the parent companies and their affiliates of banking groups, present a material hindrance to effective supervision.

2. Several initiatives undertaken by BSP have strengthened the overall regulatory and supervisory framework. BSP’s recently updated Charter (February 2019), among other things, formalizes its financial stability mandate, extends the scope of supervised entities, and grants additional authority to force banks to hold capital beyond the minimum regulatory requirement when needed. The BSP aims to implement the full Basel framework and is in the process of doing so. A number of core Basel III elements have been introduced by the BSP since the most recent assessment (e.g., capital definition amendments; higher capital minima requirements; Liquidity Coverage Ratio (LCR); Net Stable Funding Ratio (NSFR); leverage ratio; and the framework for D-SIBs), in addition to amendments to core banking supervision legislation and numerous guidelines.

3. A number of new initiatives are in train which, when implemented, will align the BSP regulatory framework more closely to applicable Basel standards. Assessors noted that the BSP is in the process of updating guidelines pertaining to large exposures, interest rate risk in the banking book, market risk management, model risk management, country and transfer risk capturing the investment side, and Pillar 3 disclosure requirements2. BSP needs to develop guidance in the areas of bank’s internal credit risk models and intra-day liquidity reporting. Liquidity monitoring tools, specifically in respect of cash flow mismatch reporting, need to be reviewed and aligned with Basel standards.

4. Bank secrecy laws in the Philippines restrict the BSP’s ability to undertake effective supervision. The Bank Secrecy laws state that all bank deposits with banking institutions in the Philippines are considered to be of an absolutely confidential nature and may not be examined, inquired or looked into by any person, including the BSP, except in defined circumstances. BSP should be granted unimpaired access to information on all customer accounts, and the ability, without constraints, to employ and share depositor information for any prudential purpose (e.g., funding concentrations from related parties, intra-group dependencies, cash flow analysis, related-party transactions (RPT) and off-site anti-money laundering (AML) data and analysis) in order to fulfill its supervisory mandate to address safety and soundness concerns.

5. BSP’s ability to assess the impact of mixed conglomerate structures on D-SIB banking groups needs to be strengthened. The BSP has to rely to a large extent on public information for assessing risks in the wider conglomerates as it does not have the power to supervise a bank’s parent or the wider group, or to review their activities to determine their impact on the safety and soundness of the bank and the bank groups within the conglomerates. The recent Charter amendment gave the BSP an additional power to obtain data and information from entities including parent and affiliate companies for “statistical and policy development purposes”, but the limited scope of this new authority does not provide the BSP with sufficient powers to assess any potential negative impact the activities of those companies may have on the safety and soundness of the banking group. Limitations on BSP’s enforcement powers also impair its ability to fully protect the bank from the actions of parent companies and affiliates.

6. More work is needed to strengthen BSP’s oversight on the assessment of ultimate beneficial ownership (UBO) of banks operating in the Philippines. BSP is able to govern transfers of greater than 10 percent of voting shares of a bank, however current laws and regulations do not enable BSP to address transfers by or assess suitability of UBO or significant indirect controlling interests of banks.

7. BSP’s ability to assess the resolvability of banks, especially D-SIBs, and support the orderly resolution of a problem bank, including the preparedness for effectively dealing with a major bank failure needs to be developed. BSP should continue ongoing improvements to its Prompt Corrective Action (PCA) framework and ensure that failed or failing banks are resolved in a prompt and timely fashion. BSP should incorporate an assessment of resolvability into its supervisory framework, especially for D-SIBs, in conjunction with the PDIC. BSP should continue its ongoing efforts to ensure that the PCA framework effectively operates to require firms to be placed into resolution at an early stage and before equity has been exhausted, and that the supporting legal and regulatory framework ensures the transition of problem banks to the PDIC is on a timely basis to avoid losses to the deposit insurance fund and mitigate moral hazard risks.

Institutional and Market Structure—Overview

A. Institutional Structure

8. The BSP is responsible for the prudential regulation and supervision of banks, nonbanking entities,3 money service businesses, credit granting entities and payment system operators. BSP is the central monetary authority responsible for providing policy directions in the area of money, banking and credit It also oversees the payment and settlement systems in the Philippines, including overseeing the critical financial market infrastructure.

9. The Philippines regulatory framework includes other financial sector authorities responsible for financial regulation:

  • Securities and Exchange Commission (SEC) is the national government regulatory agency charged with supervision over the corporate sector, capital market participants and the securities and investment instruments markets. In addition to its regulatory functions, the SEC also maintains the country’s company register.

  • The Insurance Commission (IC) is a national government regulatory agency which supervises and regulates the operations of life and non-life companies, mutual benefit associations, and trusts for charitable uses. It issues licenses to insurance agents, general agents, resident agents, underwriters, brokers, adjusters and actuaries. It has also the authority to suspend or revoke such licenses.

  • Philippine Deposit Insurance Corporation (PDIC) is a government run corporation providing deposit insurance coverage to member banks. PDIC serves as the principal resolution authority for insured institutions. Membership of banks is mandatory and provides protection up to PhP 500,000 to depositors.

10. The regulators, together with the Department of Finance (DOF), form the Financial Stability Co-ordination Council (FSCC), a voluntary body chaired by the Governor of the BSP, which meets quarterly to discuss industry wide perspectives in identifying financial issues and contemplating macroprudential regulation to mitigate systemic risk. FSCC members signed a Memorandum of Agreement (MOA) in January 2014 to formalize representation of the FSCC, streamline its working groups and to clarify communication initiatives. In addition, the Financial Sector Forum (FSF), made up of the BSP, SEC, IC and PDIC, meet six times per year to exchange information and to coordinate regulatory and supervisory policies where appropriate of its members.

B. Overview of the Banking Sector

11. The banking sector accounted for approximately 76 percent of the financial system’s total resources,4 or 98 percent of the nominal Gross Domestic Product (GDP), as of end-June 2019. As outlined in Table 1, BSP’s supervised financial institutions consist of 554 banks, 1,214 nonbank financial institutions and 2 off-shore banking units. Banking sector assets are broken down by: 46 universal and commercial banks representing 91.3 percent of total bank assets, 3 government banks5 (14.4 percent of total bank assets), 51 thrift banks (7.2 percent of total bank assets), and 457 rural and cooperative banks (1.5 percent of total bank assets). Although 30 foreign banks were approved and authorized to operate by the BSP in the Philippines, this represented only 7.2 percent of the total banking system assets as at end of June 2019.6 Domestic banks have minimal overseas activities.

Table 1.

Philippines: Financial Sector Structure

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Sources: National authorities

Number of institutions is as at end-June 2019.

Data on NBFIs is as of end-March 2019, except Insurance Mutual which is as of end-June 2019.

Includes Investment Houses, Finance Companies, Investment Companies, Securities Dealers/Brokers, Pawnshops, Lending Investors, Non-Stock Savings and Loan Assns., Venture Capital Corps., and Credit Card Companies which are under BSP supervision; also includes Private and Government Insurance Companies (i.e., SSS and GSIS). Data as of end-March 2019.

12. Banking sector risks stem primarily from global macro-financial developments, which could be amplified by several vulnerabilities in the corporate sector and the real estate markets. The Philippine is a small open economy well-integrated with the global supply chain, and its macro-financial performance—the key drivers of bank health—is highly dependent on global conditions. Some corporate vulnerability indicators started to deteriorate in the past couple of years despite their strong levels. Risks from the corporate sector could be further amplified by the complex mixed conglomerate structures. Loans to booming real estate market is close to the regulatory cap of 20 percent of total loans.

13. BSP has identified a number of D-SIBs, an important part of which belong to larger Philippine conglomerate groups and some of which are foreign bank branches. The conglomerates are mixed activity, with a wide range of commercial activities across the various groups, including real estate, breweries, petrochemical companies etc. BSP requires D-SIBs to hold additional capital, including a capital conservation buffer (2.5 percent). The BSP has introduced a countercyclical capital buffer, but it is currently set at 0 percent.

14. Overall, the banking sector has strong capital and liquidity levels. The Basel III capital adequacy ratio (CAR), adopted effective January 2014, for universal and commercial banks stood at 15.9 percent on a consolidated basis, well above the BSP (10 percent) and BIS prescribed minimum requirements. Common equity tier 1 capital (CET1) stood at 14.5 percent on a consolidated basis. Data as of end-October 2018 indicated the liquidity coverage ratio (LCR) of the universal and commercial banks7 recorded at 173.1 percent (on a solo basis).

15. Gross loans contribute to 60 percent of assets and have been driving banking sector growth, with real estate lending comprising the largest share of the loan portfolio at about 17 percent. Although the average non-performing loan (NPL) ratio was reported at 2.1 percent at end of June 2019, thrift banks reported NPLs at 5.9 percent and rural/cooperative banks at 11.4 percent respectively. NPL coverage ratio is reported at 93.3 percent, which includes the general allowance provision of 100 basis points, end of June 2019. Following the implementation of PFRS 9, the BSP has required universal and commercial banks to maintain a minimum general allowance of 100 basis points, as a floor to the expected credit loss provisioning required in the new standard.

16. Deposits are mainly from resident individuals and private corporations. At the end of June 2019, savings accounted for 46 percent of deposits.

17. The system has been recording annualized returns on assets and equity of 1.2 percent and 9.8 percent respectively. The net interest margin (NIM) is on an upward trend and stands at 3.6 percent.

Preconditions for Effective Banking Supervision8

18. Although the Philippine economy continues to demonstrate strong growth of over 6.3 percent between 2010–2018, in 2018 the country faced some challenging issues including rising inflation of 5.2 percent (above target) and some volatility in the Philippine Peso. Monetary policy response has since addressed these issues. As of June 2019, year-on-year inflation eased to 3.4 percent (within target). The overall debt-to-GDP ratio stood at 43.7 percent.

19. BSP recently amended its Charter to formalize its statutory mandate of promoting and maintaining financial stability. The BSP continues to work in close coordination with other relevant agencies on the FSCC to promote financial stability. On matters of systemic importance, BSP has worked closely with the DOF in the past, including on the drafting or formulation of any legislation pertaining to financial institutions and financial stability measures. Further, the DOF, together with the Bureau of the Treasury, has primary responsibility for all fiscal matters.

20. The Philippines’ public infrastructure, including its legal system, oversight of professionals, accounting standards, and governance and supervision of other financial markets appears strong, as follows:

  • The legal system of business laws, including corporate, bankruptcy, contract, consumer protection and private property laws exist

  • Professionals (e.g., accountants, auditors and lawyers) are subject to transparent and ethical standards with oversight by their respective regulatory boards. National accounting and auditing standards are substantially equivalent to international principles and many elements of international good practice are in place to foster reliable and efficient corporate financial reporting. Further, the external auditors of supervised entities of the BSP, SEC and IC are all subject to a stringent accreditation standards program overseen by the SEC.

  • The banking sector, financial market and insurance sector have well defined rules to govern and supervise entities by the BSP, SEC and IC respectively.

  • The Credit Information System Act, enacted in 2008, provided for the creation of a central credit bureau and the establishment of the Credit Information Corporation which provides credit information to the country.

  • Basic economic, financial and social statistics are made available to the public through various government websites.

21. BSP has the primary regulatory responsibility for the Philippines’ payments system, including the systemically important payment systems and financial market infrastructures. The newly enacted National Payment Systems Act, effective October 2018, lays out a comprehensive legal and regulatory framework for the payment system related to BSP’s oversight role of the Philippine Real Time Gross Settlement System or the “PhilPaSS” and the National Retail Payment System.

22. The framework for crisis management, recovery and resolution is currently under development in the Philippines. Although the FSCC recently approved the Financial Crisis Management and Resolution (FCMR) Framework, much more work is needed to develop additional legislative resolution tools as well as strengthening the jurisdiction’s crisis preparedness measures for the potential failure of a major bank. Each agency, including the BSP, is currently creating FCMR handbooks to develop individual agency crisis preparedness plans.

23. The PDIC provides some degree of protection in its current role as liquidator for smaller member financial institutions. PDIC’s charter provides for the authority to conduct special examinations and take prescriptive action when and if needed. PDIC, with the BSP, carries out joint examinations of member institutions that the BSP has designated as firms in the resolution phase and generally acts in conjunction with the BSP at all times. BSP’s Monetary Board (MB) makes the final decision on whether a bank will be liquidated by the PDIC. The PDIC does not currently play a role in the review of D-SIB recovery plans, nor the assessment of resolvability of a major bank.

24. BSP has authority to provide emergency liquidity assistance. In periods of national and/or local financial panic and during normal periods (so long as the bank is not insolvent), the BSP provides emergency loans and advances to banks within prescribed limits and conditions as outlined in the Republic Act.9

25. Transparent information is provided by banks to the public. Philippine Financial Reporting Standards (PFRS), which are substantially equivalent to the International Financial Reporting Standards (IFRS), were adopted in 2005. Meanwhile, PFRS 9 was adopted effective January 1, 2018. Although not Pillar 3 compliant, major banks are required to disclose their financial statements to enable users to evaluate the nature and extent of risks arising from financial instruments to which the entity is exposed and its management of those risks. In addition, publicly-traded domestic banks are also subject to disclosure requirements imposed by the SEC of the Philippines.

Main Findings

A. Responsibilities, Objectives, Powers, Independence (CP 1–2)

26. A significant weakness in the legislative and regulatory framework arises from bank secrecy laws, which prevent the BSP from identifying the names of a bank depositor other than in defined circumstances, thereby constraining the BSP’s ability to conduct effective supervision of banks. The constraints imposed by these two Acts hinder effective supervision (e.g., identifying funding concentrations from related parties, intra-group dependencies, cash flow analysis, RPT and off-site AML data and analysis).

27. Although independence of the BSP is clearly prescribed in law, the BSP’s Charter specifies the composition of the MB, which includes a member of the Cabinet. Although the Cabinet member has only one vote and there is no evidence of any past political interference in the supervisory decisions taken by the MB, the presence of a senior political appointee to the MB, by definition, gives rise to a concern that the operational independence of the BSP is compromised.

28. The BSP does not have the power to regulate and examine the parent or other affiliate companies of BSP supervised firms. Recently passed legislation provides the BSP with the authority to obtain data from a bank’s parent and their related parties outside the banking group for “statistical and policy development purposes in relation to the proper discharge of its functions and responsibilities.” However, the BSP has not had cause to use this authority to date, and the scope of the new authority to collect data is limited. It does not provide the BSP with full powers to review the activities of parent companies and of companies affiliated with parent companies.

B. Licensing, Changes in Control, and Acquisitions (CP 4–7)

29. BSP possesses authority to set prudential conditions upon the granting of banking licenses and major acquisitions, but regulations need to be updated in key areas and rendered consistent with prudential standards. Licensing standards should be updated to provide greater clarity regarding key elements, including especially the examination of the suitability of ultimate beneficial owners and setting objective criteria that ensures all applicants have adequate and consistent governance, internal controls and risk management systems ‘in place’ upon commencing operations. Internal procedures should mandate on-site examinations upon initiation and more frequent review of newly licensed banks.

30. BSP’s legal and regulatory authority and standards regarding transfer of significant ownership or controlling interest and to assess the suitability of beneficial owners need to be clearly established. Current standards requiring approval of transfers of significant ownership or controlling interest are fixed by the NCBA to a 10 percent direct interest in ‘voting shares in banks.’ Existing regulations lack a definition of ultimate beneficial owner, do not provide clarity in the definition of ‘control’ or ‘significant controlling interest,’ and are similarly tied to ownership or control of voting shares. The application of S. 25-A of the NCBA and the lack of regulatory clarity regarding the definition of ‘control’ or ‘significant controlling interest’ to include ultimate beneficial ownership, or indirect control of voting shares, impairs BSP’s ability to review and approve transfers of significant controlling interests and assess suitability of ultimate beneficial owners.

C. Supervisory Cooperation and Cross Border Supervision (CP 3, 12, 13)

31. BSP has MOAs in place to support information sharing as well as co-operation and coordination between both domestic and foreign regulatory authorities. The overseas activities of Philippine banks are not material to their overall operations, but the BSP has established MOAs and less formal information sharing arrangements with relevant host and home countries. Existing regulations and practical arrangements between the BSP and domestic and foreign regulators provide an effective framework for cooperation and collaboration.

32. The majority of D-SIBs are incorporated within conglomerate structures that include non-regulated parent companies and affiliates engaged in non-banking activities, but this ‘wider group’ is not captured within the BSP’s regulatory perimeter. The BSP’s on- and off-site supervisory regime assesses the adequacy of a consolidated banking groups’ capital and liquidity positions effectively and ensures that RPTs are conducted on an arms-length basis, but this framework does not capture the risks posed to the banking group by companies in the wider group. The BSP has to rely to a large extent on public information for assessing wider group risks as it does not have the power to supervise a bank’s parent or its affiliates.

33. As there are financial entities regulated by other domestic agencies outside the consolidated groups regulated by the BSP, the BSP should consider bringing those entities into the relevant consolidated banking groups to enable the BSP to capture the risks they pose to the banking group. In the interim, the BSP should strengthen its coordination with other domestic regulators through the establishment of formal colleges of supervisors to ensure that risks posed by other financial entities are assessed and mitigated adequately. BSP regulated banks within conglomerate structures should also specifically identify all risks arising from companies within their wider group structure in their ICAAP and describe fully the internal controls for reporting and managing such risks.

D. Supervisory Approach (CP 8–10)

34. BSP maintains an effective system of banking supervision that is evolving to enhance current abilities to develop a more forward-looking and risk-based approach to oversight of banks, bank groups and systemically important firms. BSP employs an effective range of examination techniques, tools and reporting requirements to support its supervisory processes and approach. BSP is reviewing its supervisory approach and moving to further refine its examination process to focus more directly on key risks, resiliency and systemic risks, and is working to gain better oversight of risks to safety and soundness that can be imposed upon banks that operate within a large, complex conglomerate structure.

35. BSP’s supervisory approach presently does not include an assessment of resolvability of supervised financial institutions, in conjunction with PDIC, to support planning for the orderly resolution of D-SIBs. The assessment of resolvability, in particular of D-SIBs that operate within a conglomerate group, necessarily depends upon an effective framework for early intervention and resolution, as well as the supervisory authority obtaining comprehensive information regarding the bank and banking group and the interconnections and inter-dependencies with the wider conglomerate that may present obstacles to orderly resolution.

E. Corrective and Sanctioning Powers of Supervisors (CP 11)

36. While BSP has an appropriate set of enforcement powers, the timeframes within which the remediation of significant supervisory issues are concluded or resolved can be extensive. BSP issues directives to banks upon completion of the Report of Examination (ROE) and requires bank management to submit an acceptable remediation plan. The bank is required to submit quarterly updates on remediation efforts, and will be assessed for compliance with open directives at the next annual (or greater) examination. Matters can be elevated to require banks to issue written letters of commitment, and such remediation commitments can be revised or amended. Banks with continuing and significant supervisory concerns are placed into PCA and can linger in such status for prolonged periods (years), during which time the banks can remain capital deficient; and firms are not placed into resolution at an early stage and before equity has been exhausted. While BSP has worked to improve the effectiveness of its PCA framework, further work is needed to ensure that unhealthy and poorly managed banks are addressed in a prompt and timely fashion.

37. Limitations on BSP’s enforcement powers impair its ability to fully protect the bank from the actions of parent companies and affiliates. Since parent companies and their affiliates fall outside of BSP’s regulatory perimeter, direct action against non-regulated entities within the conglomerate group cannot be taken. Available information on conglomerate structure is updated only periodically and there is no requirement that the bank or banking group regularly provide a comprehensive and current view of group-wide interconnections and inter-dependencies; thereby impairing BSP’s ability to ring-fence the bank from the actions of parent companies that would be detrimental to the safety and soundness of a bank or banking group operating within the conglomerate structure.

F. Corporate Governance and Internal Audit (CP 14, 26)

38. Corporate governance regulations have been strengthened by the BSP together with a more direct area of on-site supervisory focus, in line with the updated Basel Core Principles. Current supervisory practice of assessing governance is carried out not only during on-site examinations, but through other initiatives such as the working group conducting interviews on corporate culture and conduct. Regulations clearly articulate and hold accountable those with key responsibilities within the bank, placing primary responsibility for ensuring the establishment of an effective risk management framework and controls with boards of directors while ensuring management operates within board approved policies. BSP recognizes the need for proportionality and thereby has set appropriate minimum requirements for less complex banks.

39. BSP’s regulations set expectations for banks to demonstrate a strong internal control environment and internal audit function. BSP amended its regulations to address the need for banks to have a strong compliance function and recognizes the importance to review the overall strength of the internal audit program through its on-site examination framework.

G. Capital (CP 16)

40. An appropriate capital framework is in place for the major banks in the Philippine banking sector, with minimum capital ratios and a leverage ratio set at more conservative levels than applicable Basel standards. The capital framework for stand-alone rural, thrift and cooperative banks is in the process of being revised to align more closely with Basel III. The BSP does not directly vary individual banks’ capital requirements to reflect their risk profile. The BSP should consider setting individual capital ratios for banks based on their risk profile and introduce a simplified ICAAP for the rural, thrift and cooperative banks.

H. Credit Risk and Problems Assets, Provisions and Reserves (CP 17–18)

41. BSP should develop a center of technical credit risk expertise to ensure it keeps pace with bank’s likely progression to more sophisticated credit products/facilities. It will be key for BSP to develop guidance to communicate its expectations on bank’s management of internal credit risk models. Further, BSP should contemplate horizontal deep dive credit reviews to ensure it has a deep understanding of bank’s credit risk management practices, especially across the D-SIBs.

42. BSP has released adequate guidance on its expectations with respect to banks’ asset classification and provisioning requirements. In general, BSP’s guidance is in line with IFRS 9 requirements (with the implementation of PFRS 9), however, it will be important for BSP to reassess the adequacy of its guidance pertaining to expected loss provisioning requirements once the SEC has released its guidance. In addition, the BSP will need to update its provisioning requirements for less sophisticated banks to ensure adequate collateral valuation write-off requirements are in line with PFRS 9.

I. Risk Management (CP 19–25)

43. Aspects of banks’ risk management practices pertaining to contingency planning will need to be addressed. As BSP moves towards a view on the adequate level of minimum prudential capital and liquidity requirements on a bank-by-bank basis, it will be critical for BSP to update its ICAAP guidance and introduce an ILAAP to ensure it is aligned with current international practices. Further, BSP should separate out the D-SIB recovery plans from the ICAAP to ensure not only that adequate assessments by banks are carried out, but BSP cross D-SIB assessments are carried out. Further, BSP should share these recovery plans with the resolution authority to ensure that it is adequately prepared to effectively deal with a major bank problem or failure.

44. BSP does not impose a single borrower limit on banks at a consolidated level. Assessors note that BSP is currently working on the update of its large exposure guideline that will include the tracking of single borrower and aggregate large exposures on both a solo and consolidated basis. It will also expand the definition of interdependence, among other things. The large exposure limits for banks, especially banking groups with a conglomerate group structure, is essential in BSP’s ability to effectively supervise and assess the level of interconnectedness risk impacting the bank.

45. An appropriate regulatory framework is in place to ensure banks comply with minimum requirements for liquidity and funding. The BSP has introduced the LCR and NSFR frameworks for the D-SIBs and other major banks and has a simplified liquidity regime for smaller banks. There are weaknesses in the monitoring tools for the LCR, which should be reviewed and aligned more closely with applicable Basel standards, and consideration should be given to introducing an ILAAP framework to enable the BSP to set individual minimum liquidity and funding requirements for the major banks. A monitoring regime for intraday liquidity has recently been introduced.

46. The regulatory framework and supervisory practice for market risk and interest rate risk in the banking book (IRRBB) are appropriate given the level of complexity of the risks being run by banks. The BSP is resourced in terms of both numbers and levels of expertise to supervise banks’ market risk functions effectively. There are proposals in hand to update both the market risk and IRRBB frameworks.10 When in place, both regimes will be better aligned to applicable Basel standards.

J. Disclosures and Transparency (CP 27–28)

47. The BSP prescribes detailed public disclosure requirements for banks on both a consolidated and solo basis and verifies that these requirements are met. The disclosure regime is not as comprehensive as the current BCBS Pillar 3 framework in terms of the scope and detail of coverage required across a number of risk elements (e.g., for NSFR, market risk, IRRBB and remuneration), but the current disclosure regime is in the process of being revised to align it more closely to the Basel Pillar 3 regime. Banks’ financial reporting requirements are in accordance with international standards.

K. Abuse of Financial Services (CP 29)

48. Although BSP’s supervisory oversight of bank’s compliance with AML/CFT requirements remains strong, certain components of the regulatory framework need to be strengthened. BSP has made a concerted effort to effectively utilize its contingent of AML experts, however, it must ensure adequate resources are available to cover all banking institutions and other entities (e.g., MSBs) under its mandate. Further, although BSP makes use of its enforcement tools (issuing directives, letters of commitment, etc.), it needs to ensure it is effectively utilizing its monetary penalty regime for AML/CFT non-compliance issues on a consistent basis.

Detailed Assessment

49. This assessment is based on the current state of the implementation of the Basel Core Principles for Effective Banking Supervision (BCP) in the Philippines. The BCP assessment mission took place from June 19 to July 9, 2019. Regulatory initiatives after the assessment date have not been taken into account.

50. The ratings assigned during this assessment are not directly comparable to those from the previous assessment. The methodology issued by the Basel Committee on Banking Supervision (BCBS) September 2012 was used for the current assessment and the authorities have opted to be assessed and graded on the essential criteria (EC) only. The 2002 BCP assessment, prepared in the context of the 2002 FSAP, as well as the focused follow-up report prepared in 2010 was based on the previous methodology. Since then, the methodology has been revised leading to some substantive changes.

51. The 2012 methodology reflects lessons from the global financial crisis (GFC) and emerging supervisory best practices. New principles have been added to the methodology along with new EC for each principle that provide more detail. Altogether, the revised Basel Core Principles (BCPs) now contain 247 separate essential and additional criteria against which a supervisory agency may be assessed. In particular, the revised BCPs strengthen the requirements for supervisors, the approaches to supervision and supervisors’ expectations of banks. While the BCPs set out the powers that supervisors should have to address safety and soundness concerns, there is a heightened focus on the actual use of the powers, in a forward-looking approach through early intervention.

52. The assessment team reviewed the framework of laws, rules, and guidance and held extensive meetings with authorities and market participants. The assessment team met officials of the BSP, the DOF, Bureau of the Treasury, PDIC, auditing firms, Board of Accountancy and SEC Oversight Assurance Committee and banking sector participants. The authorities provided a comprehensive self-assessment of the BCPs, as well as detailed responses to additional questionnaires, and facilitated access to staff and to supervisory documents and files on a confidential basis.

53. The standards were evaluated in the context of the sophistication and complexity of the financial system of the Philippines. The BCPs must be capable of application to a wide range of jurisdictions whose banking sectors will inevitably include a broad spectrum of banks. To accommodate this breadth of application, a proportionate approach is adopted within the BCP, both in terms of the expectations on supervisors for the discharge of their own functions and in terms of the standards that supervisors impose on banks. An assessment of a country against the BCPs must, therefore, recognize that its supervisory practices should be commensurate with the complexity, interconnectedness, size, and risk profile and cross-border operation of the banks being supervised. In other words, the assessment must consider the context in which the supervisory practices are applied. The concept of proportionality underpins all assessment criteria. For these reasons, an assessment of one jurisdiction will not be directly comparable to that of another.

54. An assessment of compliance with the BCPs is not, and is not intended to be, an exact science. Reaching conclusions required judgments by the assessment team. Banking systems differ from one country to another, as do their domestic circumstances. Furthermore, banking activities are undergoing rapid change after the GFC, prompting the evolution of thinking on, and practices for, supervision. Nevertheless, by adhering to a common, agreed methodology, the assessment should provide the authorities with an internationally consistent measure of the quality of their banking supervision in relation to the revised BCPs, which are internationally acknowledged as minimum standards.

55. The team appreciated the very high quality of cooperation received from the authorities. The team extends its warm thanks to staff of the authorities, who provided excellent cooperation, including provision of documentation and technical support.

Table 2.

Philippines: Supervisory Powers, Responsibilities and Functions

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In this document, “banking group” includes the holding company, the bank and its offices, subsidiaries, affiliates and joint ventures, both domestic and foreign. Risks from other entities in the wider group, for example non-bank (including non-financial) entities, may also be relevant. This group-wide approach to supervision goes beyond accounting consolidation.

The activities of authorising banks, ongoing supervision and corrective actions are elaborated in the subsequent Principles.

Such authority is called “the supervisor” throughout this paper, except where the longer form “the banking supervisor” has been necessary for clarification.

In this document, “risk profile” refers to the nature and scale of the risk exposures undertaken by a bank.

In this document, “systemic importance” is determined by the size, interconnectedness, substitutability, global or cross-jurisdictional activity (if any), and complexity of the bank, as set out in the BCBS paper on Global systemically important banks: assessment methodology and the additional loss absorbency requirement, November 2011.

Please refer to Principle 1, Essential Criterion 1.

Principle 3 is developed further in the Principles dealing with “Consolidated supervision” (12), “Home-host relationships” (13) and “Abuse of financial services” (29).

An amendment to the FSF multilateral MOA on Information Exchange was signed in February 2020.

A MOA establishing college arrangements to share information between domestic regulators was signed in February 2020.

The Committee recognizes the presence in some countries of non-banking financial institutions that take deposits but may be regulated differently from banks. These institutions should be subject to a form of regulation commensurate to the type and size of their business and, collectively, should not hold a significant proportion of deposits in the financial system.

This document refers to a governance structure composed of a board and senior management. The Committee recognizes that there are significant differences in the legislative and regulatory frameworks across countries regarding these functions. Some countries use a two-tier board structure, where the supervisory function of the board is performed by a separate entity known as a supervisory board, which has no executive functions. Other countries, in contrast, use a one-tier board structure in which the board has a broader role. Owing to these differences, this document does not advocate a specific board structure. Consequently, in this document, the terms “board” and “senior management” are only used as a way to refer to the oversight function and the management function in general and should be interpreted throughout the document in accordance with the applicable law within each jurisdiction.

Therefore, shell banks shall not be licensed (reference document: BCBS paper on shell banks, January 2003).

Please refer to Principle 14, Essential Criterion 8.

Please refer to Principle 29.

While the term “supervisor” is used throughout Principle 6, the Committee recognizes that in a few countries these issues might be addressed by a separate licensing authority.

In the case of major acquisitions, this determination may take into account whether the acquisition or investment creates obstacles to the orderly resolution of the bank.

On-site work is used as a tool to provide independent verification that adequate policies, procedures and controls exist at banks, determine that information reported by banks is reliable, obtain additional information on the bank and its related companies needed for the assessment of the condition of the bank, monitor the bank’s follow-up on supervisory concerns, etc.

Off-site work is used as a tool to regularly review and analyze the financial condition of banks, follow up on matters requiring further attention, identify and evaluate developing risks and help identify the priorities, scope of further off-site and on-site work, etc.

Please refer to Principle 10.

In the context of this Principle, “prudential reports and statistical returns” are distinct from and in addition to required accounting reports. The former are addressed by this Principle, and the latter are addressed in Principle 27.

Please refer to Principle 2.

Please refer to Principle 1, Essential Criterion 5.

Maybe external auditors or other qualified external parties, commissioned with an appropriate mandate, and subject to appropriate confidentiality restrictions.

Maybe external auditors or other qualified external parties, commissioned with an appropriate mandate, and subject to appropriate confidentiality restrictions. External experts may conduct reviews used by the supervisor, yet it is ultimately the supervisor that must be satisfied with the results of the reviews conducted by such external experts.

Please refer to Principle 1.

Please refer to footnote 11 under Principle 1.

Pertains to the reporting entity and its financial allied subsidiaries except insurance companies that are required to be consolidated on a line-by-line basis for the purpose of preparing consolidated financial statements.

Please refer to Principle 16, Additional Criterion 2.

See Illustrative example of information exchange in colleges of the October 2010 BCBS Good practice principles on supervisory colleges for further information on the extent of information sharing expected.

Please refer to footnote 21 under Principle 5.

The OECD (OECD glossary of corporate governance-related terms in “Experiences from the Regional Corporate Governance Roundtables,” 2003, www.oecd.org/dataoecd/19/26/23742340.pdf.) defines “duty of care” as “The duty of a board member to act on an informed and prudent basis in decisions with respect to the company. Often interpreted as requiring the board member to approach the affairs of the company in the same way that a ‘prudent man’ would approach their own affairs. Liability under the duty of care is frequently mitigated by the business judgment rule.” The OECD defines “duty of loyalty” as “The duty of the board member to act in the interest of the company and shareholders. The duty of loyalty should prevent individual board members from acting in their own interest, or the interest of another individual or group, at the expense of the company and all shareholders.”

“Risk appetite” reflects the level of aggregate risk that the bank’s Board is willing to assume and manage in the pursuit of the bank’s business objectives. Risk appetite may include both quantitative and qualitative elements, as appropriate, and encompass a range of measures. For the purposes of this document, the terms “risk appetite” and “risk tolerance” are treated synonymously.

For the purposes of assessing risk management by banks in the context of Principles 15 to 25, a bank’s risk management framework should take an integrated “bank-wide” perspective of the bank’s risk exposure, encompassing the bank’s individual business lines and business units. Where a bank is a member of a group of companies, the risk management framework should in addition cover the risk exposure across and within the “banking group” (see footnote 19 under Principle 1) and should also take account of risks posed to the bank or members of the banking group through other entities in the wider group.

To some extent the precise requirements may vary from risk type to risk type (Principles 15 to 25) as reflected by the underlying reference documents.

It should be noted that while, in this and other Principles, the supervisor is required to determine that banks’ risk management policies and processes are being adhered to, the responsibility for ensuring adherence remains with a bank’s Board and senior management.

New products include those developed by the bank or by a third party and purchased or distributed by the bank.

The Core Principles do not require a jurisdiction to comply with the capital adequacy regimes of Basel I, Basel II and/or Basel III. The Committee does not consider implementation of the Basel-based framework a prerequisite for compliance with the Core Principles, and compliance with one of the regimes is only required of those jurisdictions that have declared that they have voluntarily implemented it.

The Basel Capital Accord was designed to apply to internationally active banks, which must calculate and apply capital adequacy ratios on a consolidated basis, including subsidiaries undertaking banking and financial business. Jurisdictions adopting the Basel II and Basel III capital adequacy frameworks would apply such ratios on a fully consolidated basis to all internationally active banks and their holding companies; in addition, supervisors must test that banks are adequately capitalized on a stand-alone basis.

Reference documents: Enhancements to the Basel II framework, July 2009 and: International convergence of capital measurement and capital standards: a revised framework, comprehensive version, June 2006.

Approval for the implementation of SAFR in 2020 has been agreed subsequent to the BCP assessment.

In assessing the adequacy of a bank’s capital levels in light of its risk profile, the supervisor critically focuses, among other things, on (a) the potential loss absorbency of the instruments included in the bank’s capital base, (b) the appropriateness of risk weights as a proxy for the risk profile of its exposures, (c) the adequacy of provisions and reserves to cover loss expected on its exposures and (d) the quality of its risk management and controls. Consequently, capital requirements may vary from bank to bank to ensure that each bank is operating with the appropriate level of capital to support the risks it is running and the risks it poses.

“Stress testing” comprises a range of activities from simple sensitivity analysis to more complex scenario analyses and reverses stress testing.

Principle 17 covers the evaluation of assets in greater detail; Principle 18 covers the management of problem assets.

Credit risk may result from the following: on-balance sheet and off-balance sheet exposures, including loans and advances, investments, inter-bank lending, derivative transactions, securities financing transactions and trading activities.

Counterparty credit risk includes credit risk exposures arising from OTC derivative and other financial instruments.

“Assuming” includes the assumption of all types of risk that give rise to credit risk, including credit risk or counterparty risk associated with various financial instruments.

Principle 17 covers the evaluation of assets in greater detail; Principle 18 covers the management of problem assets.

Reserves for the purposes of this Principle are “below the line” non-distributable appropriations of profit required by a supervisor in addition to provisions (“above the line” charges to profit).

It is recognized that there are two different types of off-balance sheet exposures: those that can be unilaterally cancelled by the bank (based on contractual arrangements and therefore may not be subject to provisioning), and those that cannot be unilaterally cancelled.

Connected counterparties may include natural persons as well as a group of companies related financially or by common ownership, management or any combination thereof.

This includes credit concentrations through exposure to: single counterparties and groups of connected counterparties both direct and indirect (such as through exposure to collateral or to credit protection provided by a single counterparty), counterparties in the same industry, economic sector or geographic region and counterparties whose financial performance is dependent on the same activity or commodity as well as off-balance sheet exposures (including guarantees and other commitments) and also market and other risk concentrations where a bank is overly exposed to particular asset classes, products, collateral, or currencies.

The measure of credit exposure, in the context of large exposures to single counterparties and groups of connected counterparties, should reflect the maximum possible loss from their failure (i.e., it should encompass actual claims and potential claims as well as contingent liabilities). The risk weighting concept adopted in the Basel capital standards should not be used in measuring credit exposure for this purpose as the relevant risk weights were devised as a measure of credit risk on a basket basis and their use for measuring credit concentrations could significantly underestimate potential losses (see “Measuring and controlling large credit exposures, January 1991).

See Footnote 2.

Such requirements should, at least for internationally active banks, reflect the applicable Basel standards. As of September 2012, a new Basel standard on large exposures is still under consideration.

Basel Committee Banking Supervision Standards, Supervisory framework for measuring and controlling large exposures, April 2014.

Related parties can include, among other things, the bank’s subsidiaries, affiliates, and any party (including their subsidiaries, affiliates and special purpose entities) that the bank exerts control over or that exerts control over the bank, the bank’s major shareholders, Board members, senior management and key staff, their direct and related interests, and their close family members, as well as corresponding persons in affiliated companies.

Related party transactions include on-balance sheet and off-balance sheet credit exposures and claims, as well as, dealings such as service contracts, asset purchases and sales, construction contracts, lease agreements, derivative transactions, borrowings, and writeoffs. The term transaction should be interpreted broadly to incorporate not only transactions that are entered into with related parties but also situations in which an unrelated party (with whom a bank has an existing exposure) subsequently becomes a related party.

An exception may be appropriate for beneficial terms that are part of overall remuneration packages (e.g., staff receiving credit at favorable rates).

Country risk is the risk of exposure to loss caused by events in a foreign country. The concept is broader than sovereign risk as all forms of lending or investment activity whether to/with individuals, corporate, banks or governments are covered.

Transfer risk is the risk that a borrower will not be able to convert local currency into foreign exchange and so will be unable to make debt service payments in foreign currency. The risk normally arises from exchange restrictions imposed by the government in the borrower’s country (reference document: IMF paper on External Debt Statistics—Guide for compilers and users, 2003).

See footnote 2.

Wherever “interest rate risk” is used in this Principle the term refers to interest rate risk in the banking book. Interest rate risk in the trading book is covered under Principle 22.

See footnote 2.

See footnote 2.

The Committee has defined operational risk as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. The definition includes legal risk but excludes strategic and reputational risk.

In assessing independence, supervisors give due regard to the control systems designed to avoid conflicts of interest in the performance measurement of staff in the compliance, control and internal audit functions. For example, the remuneration of such staff should be determined independently of the business lines that they oversee.

The term “compliance function” does not necessarily denote an organizational unit. Compliance staff may reside in operating business units or local subsidiaries and report up to operating business line management or local management, provided such staff also have a reporting line through to the head of compliance who should be independent from business lines.

The term “internal audit function” does not necessarily denote an organizational unit. Some countries allow small banks to implement a system of independent reviews, e.g., conducted by external experts, of key internal controls as an alternative.

In this Essential Criterion, the supervisor is not necessarily limited to the banking supervisor. The responsibility for ensuring that financial statements are prepared in accordance with accounting policies and practices may also be vested with securities and market supervisors.

For the purposes of this Essential Criterion, the disclosure requirement may be found in applicable accounting, stock exchange listing, or other similar rules, instead of or in addition to directives issued by the supervisor.

The Committee is aware that, in some jurisdictions, other authorities, such as a financial intelligence unit (FIU), rather than a banking supervisor, may have primary responsibility for assessing compliance with laws and regulations regarding criminal activities in banks, such as fraud, money laundering and the financing of terrorism. Thus, in the context of this Principle, “the supervisor” might refer to such other authorities, in particular in Essential Criteria 7, 8 and 10. In such jurisdictions, the banking supervisor cooperates with such authorities to achieve adherence with the criteria mentioned in this Principle.

Consistent with international standards, banks are to report suspicious activities involving cases of potential money laundering and the financing of terrorism to the relevant national centre, established either as an independent governmental authority or within an existing authority or authorities that serves as an FIU.

Recommendation 20.1 of the Asia/Pacific Group on Money Laundering’s Mutual Evaluation of the Philippines (MER) 2019 noted that s. 9(c) of the AMLA allows STRs to the AMLC to be filled within five working days, which is not considered to have met the requirement for “prompt” reporting.

These could be external auditors or other qualified parties, commissioned with an appropriate mandate, and subject to appropriate confidentiality restrictions.