Financial System Stability Assessment, including Reports on the Observance of Standards and Codes on the following topics: Monetary and Financial Policy Transparency, Banking Supervision, Securities Regulation, Insurance Regulation, and Payment Systems

This paper presents key findings of the Financial System Stability Assessment for the Philippines, including Reports on the Observance of Standards and Codes on Monetary and Financial Policy Transparency, Banking Supervision, Securities Regulation, Insurance Regulation, and Payment Systems. The Philippine financial system has undergone substantial reform in recent years, but faces significant vulnerabilities. The regulatory and supervisory framework has improved, and through mergers, price liberalization, and opening the system to foreign competition, the system is now more modern. However, distortions in the incentive framework currently constrain effective supervision and resolution.


This paper presents key findings of the Financial System Stability Assessment for the Philippines, including Reports on the Observance of Standards and Codes on Monetary and Financial Policy Transparency, Banking Supervision, Securities Regulation, Insurance Regulation, and Payment Systems. The Philippine financial system has undergone substantial reform in recent years, but faces significant vulnerabilities. The regulatory and supervisory framework has improved, and through mergers, price liberalization, and opening the system to foreign competition, the system is now more modern. However, distortions in the incentive framework currently constrain effective supervision and resolution.

Section I: Staff Report on Financial Sector Issues

I. Overall Stability Assessment

1. The cumulative effects of substantial peso devaluation since 1997 and weakened economic performance have had a significant impact on all performance indicators in the Philippine financial system. These fundamentals combined with differentiated tax and regulatory arrangements have resulted in a financial system under stress, operating in a rather distorted incentive framework. While important reforms are underway, a comprehensive and pre-emptive strategy is needed to avoid systemic problems and to deepen financial markets as a basis for prospective resilience.

2. The Philippine financial sector has been progressively reformed from one primarily tasked with a developmental role in the 1970s, to a more modern market oriented system. This transformation, including a program of mergers, removal of price and interest rate restrictions and the opening of the banking and insurance sectors to foreign competition has been supported by major improvements in the framework for regulatory oversight. Most recently, the enactment of the General Banking Law (May 2000), adoption of the Securities Regulation Code (SRC) (July 2000), a Memorandum of Agreement (MOA) between the SEC and the BSP (June 2001), and an Anti-Money Laundering Act (October 2001), together provide a dramatically improved basis for market development, oversight and regulatory coordination.

3. Notwithstanding this impressive progress, the incentive framework for financial intermediation has some important distortions. The differing tax and prudential norms across sectors and instruments favors the establishment of conglomerate structures exploiting the possibility for supervisory and other types of arbitrage. Instruments, and intermediaries authorized to deal in these instruments, have also developed to circumvent certain taxes, and together these complicate resolution of troubled intermediaries. Further efforts are required to re-focus the incentives that are either preventing the development of a sound financial system or are encouraging inappropriate behavior on the part of the key market participants.

4. The interaction of this incentive framework with a weakened corporate sector has amplified the vulnerability of the financial system. The asset quality of the banking sector has declined significantly. The turnover of shares and commercial paper has diminshed and related intermediaries have been also experiencing a degree of financial difficulty. The resulting fragility in the financial system has added to the probability of a continuing sluggishness in credit expansion.

A. Financial System Soundness

5. Conditions in the banking system are extremely fragile. Indicators of asset quality show progressive weakening and profits are only marginally positive. While reported capital appears relatively high, provisions for nonperforming loans appear inadequate and adjustments to the aggregate capital for various factors—including increased provisioning for nonperforming assets and deductions for deferred charges and equity investments in allied and non-allied undertakings—could reduce the effective level of capitalization to about half the currently reported value. Conditions across the system vary and while the solvency of the weakest commercial banks is affected significantly by the simulations, capitalization ratios of systemically important banks are reduced substantially. Additionally, a comparison of performance indicators (CAEL1) of domestic private commercial banks, thrift and rural banks reveal that although all three groups are under stress, rural banks appear to be severely under-provisioned and excessively exposed to bad loans.

6. Nonbank intermediaries display varying levels of strength. The equity market, while sizable in terms of capitalization, is suffering from low liquidity. The insurance sector shows varying levels of financial strength, with a small number of general insurance underwriters having some difficulties meeting the new minimum capitalization requirements. Pension reforms underway are not yet sufficient to ensure the long-term sustainability of the social insurance institutions. The system is still actuarially imbalanced due mainly to the mismatch between contributions and benefits: contingent liabilities arising from the Government Service Insurance System (GSIS) and the Social Security System (SSS) alone are equivalent to 68 percent of GNP.

7. The pre-need industry, while small, could be a source of reputational risk. 2 The sector is distressed in aggregate. While not posing a systemic threat, approximately 4 million plans have been sold in the past 25 years and the industry maintains nearly 800 highly visible branches throughout the country and, therefore, has the potential of affecting public perception of the financial system’s health.

B. Oversight and Risk Management Infrastructure

8. The cross sectoral preconditions for effective oversight have improved considerably in recent years. The legislative and regulatory framework, notably the key framework laws comprising the BSP Act, the General banking Act and in the Securities Regulation Code, have been overhauled to adopt modern concepts and practices. Most recently, the Philippines passed an Anti-Money Laundering Act in September 2001. Since then, the authorities have established an Anti-Money Laundering Council, issued implementing regulations and encouraged financial institutions to introduce appropriate internal procedures for the reporting of suspicious transactions.3 These reforms, combined with a comprehensive albeit complex supervisory framework, staffed by highly professional and dedicated regulators supported by an active accounting and actuarial profession, have improved the preconditions for effective supervision.

9. There has also been important progress made towards broad observance of international standards and codes across all segments of the financial industry. The Bangkok Sentral ng Pilipinas (BSP) has been working toward the goal of strengthened supervision and an increased observance of the Basel Core Principles. The IOSCO Principles of Securities regulations are largely observed, as are the IAIS Principles of Insurance Supervision and Payments and settlement arrangements are broadly robust. Important legislative and institutional steps have been taken in all areas, including provisions to ensure a high degree of transparency in the conduct of monetary, banking and securities supervision. There is need however for further institutional rationalization to better define the oversight responsibilities for lending investors, pre-needs plans and moneychangers.4 While not covered by an international standard, further capacity building in public debt risk management could also contribute to the development of an efficient domestic capital market.

10. Notwithstanding this progress, critical cross-sectoral weaknesses in oversight and supervisory arrangements remain. Critical among these is the need for more effective oversight of financial conglomerates. The recently established Memorandum of Agreement between the BSP and the SEC that potentially impacts the review of the activities of certain financial groups is welcome. However, full recognition of the scale and potential impact of the conglomerate structure—that has evolved to exploit regulatory and tax differences— needs to be reflected in substantial strengthening of consolidated supervision, including through redefined prudential ratios (connected lending, large exposure limits and foreign currency exposures). A second deficiency relates to the lack of clear legal protection for the BSP and other regulatory and supervisory staff, including the staff of the Philippine Deposit Insurance Corporation (PDIC). The thoroughness of their examinations and supervisory actions tends to be compromised by litigation, or even just the threat of litigation, can have on their recommendations. Moreover, their inability to access deposit account information, because of the severe constraints of the bank secrecy law, prevents the preparation of comprehensive reports and compromises the ability of the authorities to take preventive measures to avoid bank failures.

11. These weaknesses contribute to inadequate problem identification—complicated by balance sheet obfuscation in conglomerates—and diminished enforcement capacity across the regulatory spectrum. Moreover, these weaknesses create conditions for problems banks to unduly access liquidity assistance from the BSP. Assessment of the banks’ qualifications to access these facilities is also made more difficult because of the conglomerate structure of the financial system and the strong bank secrecy law. The current arrangements are unsatisfactory, and could result in weak institutions being able to compete with better-managed institutions, with potential adverse effects of the system as a whole.

12. Policy responses that invariably include forbearance could ultimately increase bank resolution costs. Fragility as noted earlier is system-wide, though amplified in systemically important banks. Nonperforming assets5 that average 30 percent of portfolios are a strain on earnings, thereby limiting the capacity of banks to strengthen their eroding capital base. Moreover, liquidity support, though reduced in recent months, has averaged over 11 percent of reserve money since 1998. One element of the authorities’ response has been to grant forbearance in capital adequacy and provisioning requirements. In this regard, current efforts to resolve the NPL issue through the establishment of private sector special purpose asset vehicles (SPAV) though welcome need to be carefully coordinated. The BSP should be closely involved in the monitoring of the process of transferring the assets from the banks’ books to the SPAVs and how the SPAVs value those assets. The transfer price of the assets and what type of assets the banks will receive in return are critical in determining whether these transactions serve to mask the true solvency position of the banks.

C. Directions for Reform6

13. Viewed from the standpoint of financial stability, the fragility and oversight weaknesses noted in the financial sector act as a constraint on the intermediation capacity of the system, and inhibits the role it can play in promoting balanced economic recovery. This has the potential of adversely impacting bank earning and thus diminishing the capacity for recovery and resulting in reduced credit availability. While progress to date has been impressive, there is an urgent need to strengthen the reform process—notwithstanding recent developments (see Box 1)—in the following areas.

  • Strengthen the supervision and resolution framework, especially in light of conglomerate structures, by:

    • overhauling prudential regulations to underpin effective consolidated supervision;

    • strengthening the prompt corrective action framework to clarify the BSP’s and the Philippine Deposit Insurance Corporation’s (PDIC) authority to implement timely enforcement actions (including temporary administration, closure, and liquidation);

    • providing supervisory authorities with adequate powers to take full control of a bank, once capital adequacy (or other triggers) has fallen below the threshold defined by the prompt corrective action (PCA) regime, so as to allow the supervisor to supercede shareholder rights and restructure, sell, merge, or liquidate the financial institution in a timely manner.

  • A more defined and explicit PCA should replace the strategy of forbearance and liquidity support as a principle. Notwithstanding, transparent forbearance in the context of full rehabilitation plan may be warranted for certain institutions, under strict conditions, to address the probable losses arising from the sale of the overhang of distressed assets to AMCs.

  • Legal reform is needed to: (i) Relax the bank secrecy provisions to allow bank examiners to have full access to deposit account information (relaxation should also aim to provide the PDIC with the ability to structure resolution transactions as well as to improve its ability to make available insured deposits to depositors promptly); (ii) Provide all BSP and PDIC staff with adequate protection against litigation so as to encourage them to fulfill the mandates of their jobs without fear of preemptive and retaliatory litigation; and (iii) Provide supervisors with powers to enforce supervisory decisions without shareholder interference.7

  • Capital and Debt Market development should be accelerated to diversify risks away from the banking system. Taxes that favor particular instruments and BSP liquidity support to banks may be inhibiting money market development. Public debt operations that are currently focused on raising external financing may also be constraining the development of deep debt markets. Currently the domestic debt market is very fragmented and does not support the development of efficient domestic capital markets. A transparent strategy to develop the domestic securities market is needed. In this regard, an improved clearance and settlement infrastructure will be a precondition for the commercial viability of the prospective Fixed Income Exchange.

  • Reduce prospective reputational risks. Oversight of the pre-need industry could be improved by prescribing reserves based on an actuarial assessment. In addition, the permitted asset holdings of the trust funds of these institutions should be reviewed, to limit investments to high quality assets. Given the current product structures, the supervision of pre-needs now probably lies more appropriately with the Insurance Commission than with the BSP.

  • Non-bank development issues. The Philippines should consider reforming its current pay-as-you-go defined benefit pension system towards a more defined contribution system that incorporates all workers (and in some cases servicemen) into a more transparent, fair and financially sustainable system. This could involve the commercialization (including possible privatization) of the General Insurance Fund in GSIS, increased mandatory minimum contribution levels for full participation in any residual defined benefit arrangements and the development of investment policies for the funds which are entirely focused around meeting the expectations of members rather than subsidizing special interests and supporting political agendas. Insurance supervision could substantially be strengthened if the Insurance Commission would adopt a risk-based approach to its supervisory process. Gains could also be made by improving reporting systems and technical capacity of staff through removal of salary caps for certain skill classes.

Authorities’ Responses and Recent Developments

Authorities Response to the FSAP

  • The authorities provided detailed written comments on the draft FSAP report. They expressed broad agreement with the findings; however, they stressed their belief that problems in the banking sector were contained.

  • While noting that these were not new or previously unidentified issues, the authorities recognize the critical nature of existing vulnerabilities and have requested technical assistance: (i) to enhance bank supervision capacity; (ii) to reform the pension system; and (iii) to strengthen corporate governance.

Recent Developments1/

  • FATF undertook a formal review of the new AML Act, and deemed it insufficient to warrant the removal of the Philippines from the list of non-cooperative countries, primarily due to the high threshold for reporting suspicious transactions and concerns regarding limitations imposed by the deposit secrecy law.

  • The SPAV bill, central to the government’s primary plan for dealing with the large and increasing stock of nonperforming assets, remained locked in Congress at the commencement of its summer break. The version of the bill that emerged from Senate committee was so debtor-friendly and void of creditor rights enhancements that banks and the BSP considered it worse than the status quo. However, they were hopeful that remaining issues could be resolved in the bicameral discussions.

  • In the absence of a workable SPAV bill, BSP has been considering further forbearance with regard to loan loss provisioning; losses on loans sold to the SPAVs could be spread out (staggered booking) over as many as 10 years. BSP maintains that banks electing to avail themselves of this forbearance would be required to disclose the total amount of loss in their financial statements; in addition, capital equivalent to the amount of losses would be segregated and unavailable for dividends or bonuses. Banks could also be subject to restrictions on their operations.

  • Progress was made in the resolution of PNB through an agreement with the majority owner to renationalize the bank through a debt/equity swap that would offset much of the emergency credit outstanding and give the government an ownership stake comparable to the existing majority shareholder. Both parties agree to a joint sale of their holdings once the bank has been rehabilitated.

  • In the Urban Bank cases, the Ombudsman ruled that four senior BSP supervision officers should be suspended without pay for “neglect of duty,” despite his rulings in related cases that exonerated both the Governor and the General Counsel, and that the BSP’s closing of the bank was justified.

  • In December 2001, BSP issued a circular reducing the provisioning requirement on pass loans to 1 percent, from the previous requirement of 2 percent. While this relaxation was to be “offset” by stricter provisioning on ROPOA, that requirement will not come into full effect until next year. Furthermore, given that there are no established guidelines for appraisers and no industry accreditation program, the accuracy of the appraisals in the current market conditions is uncertain; the market is highly illiquid despite a substantial stock of repossessed real estate which is weighing on bank earnings.

1/ Provided for information. The quantitative bank-by-bank analysis of the health of the banking system is largely based on information available at mid-year 2001. Where available aggregate updates are provided through March 2002 and the underlying conclusions on the health of the system remain valid.

II. Macroprudential Environment and Overview of Financial System

A. Macroprudential and Incentive Issues that Affect the Financial Sector

14. Over the course of the last three decades, the Philippine financial sector has progressively been transformed from a banking sector characterized by high state directed lending to priority sectors, interest rate controls and subsidies in the 1970s, to a more market oriented one. A first wave of reforms in the early 1980’s liberalized interest rate controls, relaxed directed lending and led to some consolidation in the sector. The failure of several banks in the 1980s led the monetary authorities to strengthen prudential regulations in the latter part of the decade. DOSRI8 connected lending regulations and limits on single borrower exposures were introduced, capital requirements were modified and the launching of a program to rehabilitate the two state-owned banks (PNB and DBP), and building the capital base of rural banks were put into place.

15. A second major wave of deregulation occurred in the mid-1990s, with the liberalization of branch banking and the entry of foreign banks, which was allowed in 1995. Foreign exchange markets were also liberalized in the early 1990s and by 1992, exporters could retain 100 percent of foreign exchange earnings and restrictions on purchase of foreign exchange were lifted. In June 1997, the BSP tightened regulations on real estate lending, and in 1998, further measures were introduced, tightening minimum capital and loan loss provisioning requirements. Moreover, regulatory standards in a number of areas, notably marking to market requirements of securities portfolios, disclosure requirements for banks listed on the PSE, stricter licensing requirements and an enhanced role for external auditors, were all introduced during this period. The evolution of these reforms in response to different stages of market development and economic challenges unfortunately have produced a peculiar incentive environment that favors the establishment of conglomerate structures, that takes advantage of differences in tax and capital requirements between some intermediaries. It has also resulted in a bias towards particular instruments, resulting in a great deal of balance sheet obfuscation and may have contributed to the slow development of the domestic debt market (Box 2).

B. Structure of the Financial System

16. The financial system in the Philippines is dominated by the banking sector that accounts for 78.8 percent of the system’s assets (Table 1). This sector is comprised of 925 banking institutions of which there are 44 commercial banks (including the three specialize government banks), 100 thrift banks and 781 rural and cooperative banks. Excluding pawn shops, of which there are 5018 institutions, there are a range of non-banking intermediaries such as investment houses and financing companies (78)—of which 12 operate with quasi-banking licenses; 9 investment companies, 91 savings and loan and building societies, and 150 private insurance companies. The intermediaries are supported by an infrastructure of broker/dealers (26), credit card companies (7), venture capital firms (9) and a stock exchange. Transactions are done on a payments and settlement platform that is comprised of the Enhanced Multi-Transaction Inter-bank Payment system, the Peso Check Automated Clearing System and the Philippines Domestic Dollar Transfer system. Oversight of the financial system is affected through the BSP for all banking institutions and nonbank financial institutions with quasi-banking functions.9 The SEC supervises broker dealers, investment houses, investment companies, and pre-needs financing companies. The Insurance Commission oversees insurance companies and pensions.

Incentive Framework Affecting Intermediation

The structure of the Philippine financial system and financial intermediation has developed over the years in response to different regulatory and tax incentives. In addition, the existence of different regulators and supervisory bodies with differing capabilities has led to some arbitrage activity that has facilitated the development of financial conglomerates.

Low and differential minimum capital requirements have been an important factor in encouraging the development of financial conglomerates. Another factor is that until the implementation of the new capital adequacy requirements in July 2001, following the Basel guidelines, equity investments in allied and non-allied subsidiaries were not deducted from capital to measure compliance. The fact that limits on loans to large single borrowers and on connected lending are not measured on a consolidated basis may have also favored the development of financial conglomerates.

The differential statutory and liquidity reserve requirements on peso deposits also favored the establishment of institutions with lower requirements or the development of new financial instruments to circumvent those requirements. The BSP has taken steps to diminish the financial cost of statutory reserve requirements. In 1997, however, statutory reserve requirements represented 13 percent of commercial banks’ deposits. Since then, they have been reduced to 9 percent, and the percentage of reserves remunerated has increased from 25 percent to 40 percent, while the rate of remuneration has also increased from 4 percent to 4.5 percent. At the same time, authorities have relied more on liquidity requirements, which are remunerated at market interest rates, to mop up excess liquidity (from 2 percent in 1997 to 11 percent till December 2001 when it was reduced to 9 percent).

Non-bank financial intermediaries without quasi-banking functions have been subject to limited supervision by the BSP: no minimum capital-to-assets ratio, or statutory and liquidity reserve requirements on deposits and deposit substitutes, or loan ceilings, or required credit allocation, or branching requirements. The market share of investment houses and financing companies without quasi-banking functions exceeds that of investment houses and financing companies with quasi-banking functions.

The tax system has also facilitated the development of financial conglomerates. Thrift and rural banks were exempted from paying any taxes, fees, and charges, except income tax, for a period of five years after initiating operations, or after passage of the Thrift Bank Act and the Rural Bank Act, respectively, for operating banks. Income tax policy favored intermediation in foreign currency and the development of off-shore banks and foreign currency deposit units operated by domestic banks and branches and subsidiaries of foreign banks operating in the Philippines, by taxing net income from peso operations at a higher rate than income from foreign currency operations.

Foreign currency intermediation was also favored by the withholding tax on interest income, the differential statutory and liquidity reserve requirements, and different treatment under the bank secrecy law. Initially at zero percent, the withholding tax on interest income from foreign currency denominated instruments was increased to 7.5 percent, still below the 20 percent rate applicable on interest income on pesos deposits. Foreign currency deposits are not subject to statutory and liquidity reserve requirements, although foreign currency deposits must have 100 percent coverage in foreign currency assets. Before the Anti-Money Laundering Law was enacted in October 2001, foreign currency deposits could be disclosed or looked into only upon written permission of the depositor, or a court order. Peso deposits, on the other hand, could be disclosed upon written permission of the depositor, in cases of impeachment, upon order of a competent court in cases of bribery or dereliction of duty, or in cases where the money deposited was the subject matter of litigation.

The gross receipt tax (GRT) and the documentary stamp tax (DST) also facilitated the development of financial instruments and, consequently, of financial intermediaries authorized to deal in these instruments. The GRT favored the development of trust and other fiduciary accounts. In the case of other financial instruments, the main sources of income are commissions, fees, or spreads, which result in a reduced taxable base. Because instruments with longer maturities were taxed at a lower rate, the practice of instruments with pre-termination clauses developed. The DST facilitated the instruments taxed at lower rates, such as policies supporting pre-need plans. Because the DST applies on every transfer or renewal of instruments, it has effectively prevented the development of secondary markets.

Table 1.

The Philippines: Financial System Structure

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Excludes Foreign Banks with EKB license

Inclusive of Foreign Banks with EKB license and subsidiaries of Foreign Banks

EKBs are universal banks which can conduct securities underwriting & invest in the equity of allied & non-allied undertakings and perform regular commercial banking functions. Allied undertakings refer to activities considered allied to banks, such as activities of finance, insurance companies, etc.

Non-expanded commercial banks which can conduct only commercial banking activites.

Includes only NBFIs without quasi-banking functions and/or with trust or IMA license and/or are subsidiaries/affiliates of banks/quasi-banks

Presently it includes Government Service Insurance System (GSIS), Social Security System (SSS), Small Business Guarantee & Finance Corp (SBGFC), National Development Corp (NDC), Phil Veterans Investment Development Corp (PVIDC)-still exists with one staff but no longer operating since June 2000, National Home Mortgage Finance Corp. (NHMFC) & Phil. Export & Phil Export & Foreign Loan Guarantee Corp. (Philguarantee now Trade & Investment Development Corp. of the Phils.)

Total Assets is Net of “Due from/to HO /Branches/Other Agencies” account of foreign banks

Peliminary Data

Substituted Data, as of December 31, 2001

Does not include data for MBF

Does not include data for MBF and Equitable Credit Card

Does not include data for Small Business Guarantee & Finance Corp. (SBGFC), National Development Corporation (NDC) and Philippine Veterans Investment Development Corp (PVIDC)

Conglomerates and interconnectedness

17. Notwithstanding the range of institutions, the financial system is dominated by banks that form part of larger corporate conglomerates.10 These appear to have evolved to arbitrage the differential reserve, capital, and tax requirements impacting the financial system. The conglomerates own trust, investment, securities, and insurance companies, as well as foreign currency deposit units and thrift subsidiaries.11 These subsidiaries are mostly used to book transactions to minimize the costs associated with raising different classes of deposits and to exploit regulatory differences across the institutions. The conglomerates have assumed greater systemic importance, as these are invariably the dominant clearing banks in the Philippine payments system. While profit efficient from the standpoint of the conglomerate, the interconnectedness of the conglomerate makes the banks vulnerable to problems in their subsidiaries—as evidenced in the recent episodes of banking problems.12

18. The conglomerate structure often complicates the ability of the regulator to measure the degree of the interconnectedness and/or concentration of the financial system (Table 2). While DOSRI exposures in the banking system appear low, this is in part due to the fact that DOSRI measures exclude corporations that are subsidiaries or associates of the banks themselves. In measuring financial flows across the financial sector, bank lending to non-bank and non-financial intermediaries appears high while insurance company deposits in the banking system appear low; however, these flows may be understated by the fact that the funds may be booked in the trust accounts of banks or managed through other subsidiaries.

19. Beyond this feature of a bank dominated financial sector, the capacity for resource mobilization by corporates and risk mitigation through non-bank financial institutions is currently small. Securities markets are currently very illiquid despite relatively high market capitalization. Equity and bond market capitalization stood at P2.429 billion at August 2001 (or close to 80 percent of GDP). Market turnover that averaged 40 percent in 1999 has fallen to 7.1 percent as of August 2001. The debt securities market is dominated by government paper. The insurance sector appears to be under-developed when compared to other countries in the region. Private sector gross life insurance premiums amounted to P26.9 billion in 2000 (0.82 percent of GDP, up from 0.47 percent of GDP in 1990) and for non-life premiums, P18.8 billion (0.36 percent of GDP, down from 0.42 percent in 1990). The total penetration of 1.18 percent compares with a South and East Asia average of 3.52 percent.

Table 2.

The Philippines: Measures of Financial System Interconnectedness

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Source: Bangko Sentral ng Pilipinas

DOSRI (director, officer, stockholder, and their related interests) Excludes rural banks.

Based on credit exposures to top borrowers of the financial system

Includes: Deferred LCs, Standby LCs - FX and Domestic. O/S Guarantees Issued, Committed CL for CPs issued and Export LCs Confirmed.

Thrift banks’ data for March 2002 not yet available.

III. Financial System Vulnerabilities

20. The analysis below focuses only on the resilience of the banking system to credit risk. Notwithstanding some dollarization of the Philippine financial system, portfolio positions are regulated and where banks borrow abroad to sell dollars in the market, as part of the BSP’s intervention arrangements, their exchange rate risk is covered by a contractual forward with the BSP. With respect to other market risks, supervisory oversight is only evolving, however portfolio exposures appear minimal. For these reasons standard stress tests on such exposures were not conducted. Moreover, the system’s exposure to credit risk (including risks arising from banks transferring foreign exchange risks to customers) is substantial and asset quality, its prospect and resolution are at the heart of the current distress in the banking sector.

A. Stylized Conditions in the Corporate Sector

21. The sustained weakening in macroeconomic performance and, more recently, the decline in exports dependent on world demand conditions has adversely affected the corporate sector in the Philippines. Cross-country analysis of data on corporate sector performance13 before the Asian crisis suggests that corporations in the Philippines were profitable and better able to withstand interest rate and exchange rate shocks. Although debt levels were increasing before the crisis, leverage never reached the same high levels as in other Asian countries.

22. However, the capacity of companies to service their debt appears to have weakened since the crisis. This measure of corporate performance has a direct impact on the quality of bank portfolios and thus to the financial system’s asset quality. The high and rising share of interest expenses, vis-a-vis earnings, indicates that corporations are now even more vulnerable to rising interest rates (or drop in earnings) than at the time of the Asian crisis.

B. Overview of Sectoral Indicators of the Health of the Banking System

23. The stress in the corporate sector has impacted on performance indicators in the banking sector—reviewed using the CAMELS approach, i.e., comprising indicators of capital adequacy, asset quality, management quality, earnings, liquidity and sensitivity to market risk. In aggregate, banking performance is marked by an escalating portfolio of nonperforming assets (NPAs) and plummeting profitability (see Figure 1).

24. The interaction between slow growth and decline in performance of the real sector with fragile conditions in the banking sector is self-reinforcing. Increasing distress in the banking assets leads to a weakening in private credit growth and diminishing lending-deposit margins as banks compete for credit-worthy borrowers (Figure 1). This iteration and the consequential adverse impact on bank earnings diminish the capacity of the banking system to recover and reduce the availability of credit that is essential for the recovery of the real sector. A slower recovery of the real sector adversely impacts the asset quality of banks, thus completing the vicious cycle of a slowdown in the economy and the deteriorating position of the banking system.

Capital adequacy

25. Reported capital adequacy ratios may overstate the real capitalization of the banking system. Banks have reported considerable increase in the amount of deferred charges during the last two years, in part due to staggered booking of loan loss provisions. Moreover, capital reporting as of June 2001 did not deduct from the definition of capital all the investments in affiliates and subsidiaries of banks. In this regard, the implementation of the capital subsidiaries must be deducted from capital. The net worth-to-risk assets ratio, which on June 30, 2001 stood at around 16.4 percent for the commercial banking system, declined to around 13 percent at December 2001, when the capital adequacy ratio is measured on a solo basis under the rules that follow the Basel guidelines.14

Asset quality

26. The asset quality of banks has progressively declined. Nonperforming loans (NPLs) of the banking system have continuously risen from 3.6 percent of the total loan portfolio at end-1996 to 15.8 percent at June 2001.15 In the case of the Philippines, the evolution of the level of NPLs alone does not tell the full story about the underlying and growing stress in the asset portfolio of the banking system. Concurrent with the growth in NPLs, banks have also continued to assist troubled borrowers by exhausting all “extra-judicial “means of settling accounts to avoid the lengthy process of litigation. As of June 2001, the restructured loans of the commercial banking system amounted to PI 06 billion, or 6.7 percent of the loan portfolio. In addition, the level of real and other properties owned or acquired (ROPOA) by commercial banks through dacion-en-pago or foreclosure amounted to PI46 billion, bringing up the ratio of nonperforming assets to 24 percent.16 Provisioning to cover bad loans that had increased significantly up to 1999, following the introduction of new provisioning requirements by the BSP, has, however, stagnated thereafter. The coverage of bad loans amounts to approximately 45 percent of NPLs as of June 30, 2001. The provisions for ROPOA, however, are very small, which brings the coverage of nonperforming assets (NPAs) to only about 30 percent.17

Figure 1.
Figure 1.

Philippine Banking Sector

Citation: IMF Staff Country Reports 2002, 222; 10.5089/9781451831283.002.A001

Source: Philippine authorities.1/ Excludes special government banks and foreign banks and subsidiaries.2/Total loan portfolio (TLP) is inclusive of interbank loan receivables.3/ Ratio of NPA (NPL and gross ROPOA) to TLP and gross ROPOA. ROPOA indicates real and other properties owned or acquired.4/ Ratio of loan loss reserves (for both loans and ROPOA) to NPAs (NPL plus gross ROPOA).5/ Return on average asset and average equity. 6/ Net income adjusted for extraordinary gains.

Earning indicators

27. The impact of distressed assets on bank income has been significant. Return on equity and assets indicators show progressive decline. After a sharp fall in 1998, with the loss on net interest income due to the impairment of assets, there has been a steady decline in these indicators. From ROA and ROE levels of 2.2 percent and 15.9 percent in 1996 these have fallen to 0.6 percent and 4.3 percent, respectively, at June 2001. This decline in profitability is more marked if other elements are taken into consideration. Net income has been largely supported by extraordinary gains in recent years; if these gains are deducted the return on normal banking business is close to zero.18 With profitability being as low as it is, the likelihood of banks augmenting capital through earnings is therefore very small.

Sensitivity of financial indicators

28. The impact of the operating environment on the banking system has been differential (Table 3). In particular, as of March 2002, the private domestic commercial banks report the lowest capital adequacy ratio (15.4 percent), the highest proportion of nonperforming loans (20.9 percent), and the lowest interest margins as a proportion of gross income (23.9 percent). The thrift banks report the largest exposure to the real estate sector (29.0 percent of total loans) and negative returns, while the rural banks report the highest ratio of nonperforming loans net of provisions to capital (42.2 percent).19

Table 3.

The Philippines: Macroprudential Indicators of the Banking System, March 2002

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Source: Bangko Sentral ng Pilipinas.

DOSRI (director, officer, stockholder and their related interests).

29. Furthermore, systemically important and ailing banks have suffered more than others. A peer group analysis was conducted with data as of June 2001 for 13 commercial banks covering 73 percent of banking sector assets and the top five thrift banks. The banks were ranked according to seven performance indicators, and a weakness in a bank was identified if the value of the indicator was below or above the median for the group, depending on the indicator.20 For each criterion, the median value was used to assign banks a penalty of 1 if the performance was worse than the median value and 0 otherwise. Banks were then assigned a consolidated rank by adding up the number of penalty points across all seven criteria. The median of weaknesses for the sample was 3 indicators; however, three of the commercial banks, accounting for 13.1 percent of the banking sector assets, had weaknesses in all the indicators (Figure 2). Seven out of the 13 commercial banks accounting for 42.1 percent of banking sector assets showed weaknesses in five or more indicators, and only four banks accounting for 26.7 percent of the assets showed weakness in one indicator. Of the top five thrifts, only one showed weakness in more than three indicators.

30. Under provisioning for nonperforming loans and strapped profitability stand out as the most critical issues facing the key commercial banks included in the sample. The NPLs net of provisions to capital ratio in the three worst banks was above 100 percent; that is, if those banks had to recognize as a loss the full value of the currently reported net NPLs, the additional losses they would have to absorb would exceed the value of reported capital. In the weakness bank, the additional losses would be 4.5 times the reported capital.21 In addition, the credit portfolio of the three weakness banks was poorly diversified with the exposure to the top three borrowers ranging from 66 percent to 220 percent of own capital base; they were highly exposed to bad loans, ranging from 18 percent to 42 percent of total loans. Moreover, earnings net of extraordinary gains were reported as negative for five of the 13 banks.

Figure 2.
Figure 2.

Peer Group Analysis Using CAMELs1/

(As of June 30, 2001)

Citation: IMF Staff Country Reports 2002, 222; 10.5089/9781451831283.002.A001

Source: Compiled from data provided by the Bangko Sentral ng Pilipinas.1/ A consolidated rank of one implies that an individual bank received only one penalty point out of 7. Lower value of consolidated rank thus means lo wer penalty points and better performance. The top panel of Figure 2 reports, by each consolidated rank category (1-7), the number of banks (height of the bar chart) that received the respective rank (e.g. the figure indicates that while four of the top thirteen banks received only one penalty point, three received 7 penalty points). The bottom panel of the chart then reports the corresponding market shares (height of the bar chart) of the banks for each consolidated rank category.

31. Adjusting the aggregate capital of the commercial banks for various factors, the effective level of capitalization would reduce to about half the currently reported values (Table 4). Adjusting for the under-provisioning for ROPOA leads to shrinkage in the capital stock and CAR ratio of the banking system of between 1.7 to 3.8 percentage points (see Table 4 column “current”).22 The rules governing ROPOA loss provisioning have not kept up with the existing stock and growing volume of ROPOA held by banks in the face of declining property prices. Commercial land value has depreciated between 55-60 percent outside and within the Makati (main business) area, and residential rentals have fallen by 22 percent since 1996. Therefore, ROPOA are likely to be overstated in banks’ books and under-provisioning for these assets may mask the true capital of the bank. In addition, the capital stock and CAR could fall substantially when adjusted for deferred charges and equity investment in allied and non-allied undertakings. The estimated sensitivity of the capital adequacy ratio to deducting the equity investments in subsidiaries is between 2.9 to 3.1 percentage points of CAR.23 This reduction in the CAR is consistent with the reduction observed in the reported CAR of June to July 2001, when the new calculation methodology was introduced. If the reported deferred charges were to be amortized all at once, then the impact on capital would be a decline in CAR between 1.0 to 1.2 percentage points.

C. Contractual Savings

32. The contractual savings sector comprises mandatory and voluntary savings organizations and insurance companies. The total assets of the sector are approximately P380 billion. The sector is small when compared to commercial banks, but comparable in size to the mandatory savings organizations (SSS, GSIS, AFP-SBI, and Pag- IBIG)24 (P360.3 billion), and would be considerably larger if GSIS’s genuine insurance activities were privatized.

33. The insurance and contractual savings sector shows varying levels of financial strength. The life insurance industry is relatively strong and is dominated by major international groups. Disclosed solvency as of December 2000 was P52 billion, or 76 percent of mathematical reserves. This compares with general implied rules of 5 percent under the EU model and 10 percent under the North American risk based capital model. However, the investment policies of local life insurers, which have 59.5 percent of assets invested in stock and real property is much riskier than that of the internationals and if equity values continue to deteriorate some life insurers could, become financially distressed. The major general insurers are also relatively strong, but a number of smaller local underwriters are having some difficulties meeting the new minimum capitalization requirements.

Table 4.

The Philippines: Commercial Banking System Sensitivity

(In percent; as of June 30, 2001)

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Source: Based on stressing testing data provided by the Bangko Sentral Ng Pilipinas.

Assumes that existing stock of ROPOA with the commercial banks is subject to 33 percent provisioning assuming depreciation of original collateral value by 60 percent given a loan-to-value ratio of 60 percent.

Assumes that existing stock of ROPOA with the commercial banks is subject to 75 percent provisioning assuming average market/AMC price of 15 cents to a dollar on collateral original value and given a loan-to-value ratio of 60 percent.

34. The pre-need industry is distressed in aggregate. The overall deficit in its trust funds (held to meet plan holder obligations) as of June 30, 2001 was PI.7 billion This compares to P3.9 billion six months earlier, before regulatory action was taken; however much of the improvement arises from somewhat tenuous allocations of interests in property held by the pre-need companies to the trust funds. Of 82 trust funds managed by 46 reporting pre-need companies, 33 were in deficit at June 30, 2001. The bulk of the deficit arises from the six largest pre-need companies. It seems likely that at least one major pre-need company will need to go through some form of resolution in the next year, particularly if necessary prudential and consumer rights regulations are introduced. In addition, a number of trust funds are unlikely to be able to comply with a newly imposed limit on real property holdings.

35. The three largest mandatory social insurance funds (SSS, GSIS, and AFP-RSBS) show various levels of financial strength and long-term solvency. The largest of the three, the SSS is showing signs of financial distress despite its PI 81.7 billion in assets and may soon face liquidity problems. Up to December 2000, benefit payments were equal to 81 percent of total revenue and it is estimated that by the year 2003, if not before, benefit payments will exceed revenues for the first time in history. With the current levels of reserves and the estimated negative cash flow balances in the years to come, the fund may run out of money by the year 2011.25 The problem is caused mainly by the mismatch between contributions and benefits (but aggravated by the poor performance of its investment portfolio26 and the high level of operating expenses27).

36. While the situation at GSIS is not as critical, the system will eventually face the same problems of SSS but at a later date. Projections (based on 1999 data) show that at current levels of revenue and benefit payments the system will report its first cash flow deficit by the year 2025 and faces the possibility of depleting its reserves by the year 2040. Both SSS and GSIS are two of the largest investors in the stock market. The current downturn in the market has translated into a liquidity problem for the stock market as neither of the two institutions can divest large amounts of stock without negatively affecting their value and the market itself.

37. GSIS has a contingent exposure to its general insurance operation, which has allegedly been subjected to questionable reinsurance practices, and which was running bare of reinsurance on major infrastructure exposures at the date of the mission. GSIS needs to exit the general insurance business, and steps need to be taken to remove the government’s contingent fiscal exposures to major infrastructure loss.

38. For AFP-RSBS the situation is somewhat different but equally of concern. AFP-RSBS contributions plus interest (currently at 6 percent compounded annually) are returned to each member upon retirement and the pension benefits are paid out from the current Personnel Service (PS) budget.28 In theory, pension payments will continue to be paid from the PS budget until the date that the pension fund becomes self-sufficient.29 The return on investments (ROI) has deteriorated considerably over the last six years and, at present, it is not large enough to cover the 6 percent interest rate the fund has to pay on contributions.

39. The current allocation of assets does not follow the principles of safety, good yield and liquidity to ensure the actuarial solvency of the funds in order to meet the fund’s future obligations. The funds have been primarily placed in investments that do not provide a return that is adequate to meet the fund’s obligations. Funds at SSS and GSIS have historically been used to provide subsidy loans to its members. With approximately 40 percent of the funds lent to members at below market rates and an increasing rate of NPLs, the ROI will continue to deteriorate.

D. Capital Markets—Including Debt and Securities Markets

40. The Philippines has made significant progress in reforming the securities market and its regulatory framework in the recent years. The SRC redefined the scope of the SEC’s regulatory responsibility to eliminate its judiciary function thereby enabling a greater focus on supervision of the securities market industry. The SRC also established the basis for the demutualization of the PSE but the final step towards demutualization—going public and listing—which is expected to improve business incentives, has been delayed due partly to the slumped equity market.

41. Concurrent with the rationalization of the regulatory environment, focused efforts are needed to develop capital markets that are able to offer alternative sources of financing and a place for risk diversification and management. Any likely pension reform, when it materializes, is likely to generate significant portfolio investment demand. The domestic market needs to be able to offer instruments to meet this demand. Moreover, the debt market needs to be developed to provide alternative sources of financing for both the public and the private sectors and to permit them to diversify risks—especially important for the public sector in light of observed currency risks in the public debt portfolio—and manage liquidity.

42. If the above reform measures are to be successful, improved coordination between the efforts of the BTr to enhance the primary debt markets and those of the Bankers’ Association to enhance the secondary market will be required.30 For example, the effort of the BTr to enhance the Government Securities Eligible Dealers (GSED) system and the architectural design of the planned FIE need to be consistent with each other. Primary issue and debt management practices of the BTr should also be conducive to activation of trading in the secondary market. Currently, there is a multiplicity of instruments issued without reopening and the weekly T-bill auction may be too frequent to provide standardized instruments with adequate lot sizes to facilitate the secondary market. Such issue practices fragment the market and stifle liquidity.

43. Development of the debt market is also likely to require further rationalization of the institutional framework of the financial sector. While the GSEDs are licensed by the SEC, all banks are likely to become direct participants in the proposed debt market. The primary instruments traded will be government securities that are exempted from registration with the SEC. However, the FIE will need to be licensed and regulated under the SRC by the SEC. It will also have to build a self-regulatory capacity by establishing conduct rules for its members, a mechanism and capacity for market surveillance to monitor compliance with those rules and a system of member examination. The emergence of the second exchange is likely to call for upgrading and an architectural reform of the settlement infrastructure. The BSP may need to become the central custodian for government securities while the Philippine Central Depository (PCD) may provide a clearance and settlement platform based on which the BSP can operate its central custodian functions.

IV. Legal and Supervisory Framework for Risk Management

A. Prudential Oversight

44. The framework for prudential supervision in the financial sector in the Philippines has undergone significant reform in the past decade. Key framework laws comprising the BSP Act, the General Banking Law, and the SRC are now supplemented by a plethora of other laws dealing with bank secrecy, anti-money laundering, electronic commerce and specific laws covering the activities of universal banks, thrift banks, rural banks, cooperative banks, Islamic banks, development banks, investment houses, investment companies, financing companies, and a host of other financial and quasi-financial institutions.

45. Most of the internationally recognized standards are adhered to, and the level of compliance is generally high. The Philippines’ regulatory and supervisory framework is comprehensive in coverage but quite complex. The complexity is due to the fact that the financial industry and services are increasingly conglomerated and universalized with functional regulation while the regulatory authorities remain fragmented. Section II of this report provides summary assessments of the compliance with international standards. The Philippines complies or largely complies with 16 of the 25 Basel Core Principles; satisfies 11 of 17 IAIS Core Principles; implements 20 of 30 IOSCO Core Principles and observes on average 6 of the 10 Core Principles across the 3 systemically important payment systems. The authorities also maintain a high degree of transparency in Monetary and financial policies as well as in supervision arrangements.

46. Notwithstanding this regulatory and institutional platform, gaps where they exist are in critical areas. Market participants have complained of the inefficiency of the Judiciary and that the system is biased against creditor’s rights, thereby undermining the development of a strong credit culture. Actions can take many years to be resolved through the current legal processes and supervisory actions can potentially be held at bay almost indefinitely. The recently introduced Action Program for Judicial Reform 2001-2006 is an excellent initiative. This program needs to be implemented fully and quickly if the courts are to reclaim the trust and confidence of the banking community and the public at large. More rigorous application of the rules governing the use of Temporary Restraining Orders and the possible creation of a bankruptcy court to specialize in corporate recovery issues are other matters that merit consideration. Moreover, and as discussed below crucial issues relating to the excessive levels of bank secrecy, inadequate protection for bank supervisors and weaknesses in the power of the regulatory authorities to intervene in distressed bank situations or close banks need early legislative attention.

47. In banking, effective consolidated supervision is urgent. The complex financial sector framework, and the extensive interlinkages with the corporate sector, necessitate a strong consolidated supervisory framework incorporating risk-focused surveillance and examination techniques. The BSP has made progress in redesigning its supervisory program in line with these principles, and further important enhancements are in train. However, much more remains to be implemented. There is a need to expand the scope to incorporate all risks to regulated (and especially insured) institutions that result from control—either direct or indirect—by mixed activity conglomerates or groups. At present, BSP’s consolidated supervision extends only to the parent bank and its direct financial subsidiaries, excluding potential vulnerabilities from upstream or lateral affiliates.

48. Another concern is the lack of adequate legal protection for BSP staff especially given the very litigious nature of market participants. Liberal recourse to the judicial system has introduced temporary restraining orders and injunctions as extremely effective delaying tactics in the exercise of enforcement actions by the BSP. The threat of litigation has a moderating effect on strong and comprehensive enforcement of prudential regulations. A stronger, more prescriptive prompt corrective action framework that better underpins the BSP’s enforcement actions is an important priority.

49. In insurance, capacity and the design of prudential rules need to be addressed. The organizational structure of the Insurance Commission is in place but would benefit from a codified process for the appointment of the Commissioner, the reinstatement of independent funding and improvements in computerization and recruitment of high-level technical staff. Its licensing process including all changes in control at insurance companies should be accompanied by fit and proper tests for directors and managers and by mandatory business plans. As for corporate governance and internal controls in the industry, the insurance commission should follow the actions of the BSP in strengthening the relevant regulations. Prudential rules should be revamped to address asset-liability management issues and statistical reporting upgraded to enable double-checking of technical provisions.

50. Conglomeration in the financial system will need closer BSP and SEC coordination. Stand alone, the SRC and the regulations issued by the SEC provide a comprehensive regulatory framework and detailed standards for the Philippine securities market. However, given the increasingly conglomerated nature of the financial sector, further rationalization of the regulatory framework and a more strategic approach to more appropriately and effectively address the prevalence of such conglomerates, is needed. It is noteworthy that most of the NBFIs are owned by or affiliated with commercial banks. In fact, seven commercial banks have been licensed as universal banks under the Universal Banking Act. By law, they are permitted to conduct securities business directly under one roof. However, most of them have conducted this business through subsidiary broker dealers and/or investment houses. The BSP has some degree of supervision over many NBFIs because of (i) their ownership links to or affiliation with banks; (ii) the quasi-banking function and/or trust operations permitted for some of them based on licenses granted by the BSP; or (iii) their offerings of financial products and services involving foreign exchange transactions.

51. The BSP, the clearing house and the banking industry as a whole have, in recent years, taken advantage of technological improvements and opportunities to enhance the payment processes and infrastructure. Although the individual initiatives are good, seen from an overall perspective the reforms have been piece-meal and fragmented across different parties. This has resulted in some vulnerabilities and specific weaknesses, particularly (i) the concentration risk within certain entities; (ii) oversight responsibilities and the powers of the BSP over payment system operators are not clear-cut, particularly in the case of private-sector established interbank clearing and/or foreign currency systems (e.g., the Philippine Domestic Dollar Transfer system or PDDTS). The unwinding procedures for clearing and appropriate protection from systemic risk can be improved upon as well; and (iii) the general criteria for participation in the different payment systems are not explicit, although there is an implicit understanding among the parties involved, and the BSP provides a high-level of regulatory safeguard through its banking supervision role.

52. The individual weaknesses identified in payment and settlement arrangements are generally minor, and can be addressed through short- to medium-term reforms. However, taken altogether, the weaknesses reflect the key vulnerability—lack of strategic and operational planning on a national level and between the public and private sectors. Although the BSP has a cross-departmental committee managing the Real Time Gross Settlement (RTGS) project, a group looking at the wider infrastructure, which includes, for example, the legal foundation, securities settlement and low-value payments, is nonexistent. This may cause future deficiencies to surface, or result in missed opportunities to consolidate certain systems, especially if the issue is across different domains of the parties involved. A National Payment System Council may thus be a possible solution, and this idea has been floated among the BSP and key industry people. A first step could be the establishment of a group of payment system specialists in the BSP, and incrementally involve all the relevant stakeholders.

53. Some progress has been made in anti-money laundering reform.31 In accordance with the worldwide move in the late 1990s to strengthen anti-money laundering laws and procedures the BSP introduced a number of measures on the basis of its existing legislative and supervisory authority. Major achievements in this respect were the prohibition on anonymous accounts and the introduction of a customer identification and reporting requirement. However, attempts at real reform were frustrated by the very strict bank secrecy provisions which forbade bank examiners from accessing customer account information except under very limited conditions.

54. Strong international pressure, culminating in the threat of sanctions, eventually led the authorities to enact an Anti-Money Laundering Act (AML Act) in late September 2001. The AML Act criminalized money laundering for the first time and provided measures to be taken by financial institutions and supervisory authorities to combat money laundering, such as making customer identification and record keeping mandatory, and introducing a very limited suspicious transaction reporting system. The AML Law also established an Anti-Money Laundering Council (AMLC), which will function essentially as a financial intelligence unit to facilitate the detection and investigation of money laundering offences and information sharing between domestic and foreign authorities.

55. The adoption of the AML Law is a first step, but significant deficiencies in its scope and in a number of its provisions will limit its effectiveness. Institutions covered by the AML Law basically include all entities that are subject to regulatory oversight by the BSP, the SEC or the Insurance Commission. Not included are accountants, auditors, lawyers, casinos and gaming houses—all of which are or can be major players in the movement of wealth. The AML Act creates a very limited exception to the Bank Secrecy Law. It obligates the covered institutions to report to the AMLC “covered transactions” which include the following types of transactions involving in each case an amount in excess of P4,000,000 (approximately US$77,000).

56. The scope of this reporting requirement is narrower than typical suspicious transaction reporting systems and the threshold of $77,000 equivalent defeats the effectiveness of the reporting requirement. Suspicious transactions could well occur that involve amounts that are less than this figure. The authorities have sought to broaden the scope of reporting, via the implementing rules, to include any activity that engenders reasonable belief that any money laundering offence is about to be committed; however, there are substantial questions about the enforceability of these regulations, which should be remedied by amending the current law.

B. Resolution Capacity and Safety Nets

57. Financial fragility when combined with the noted weaknesses in oversight has continuously tested safety net arrangements. The actions of the PDIC have been limited mainly to the small insolvent thrift and rural banks. During the period 1998-2000, the PDIC has taken under receivership or put under liquidation 97 banking institutions, of which only two were commercial banks. The other institutions included 12 thrift banks and 83 rural banks. During the first 9 months of 2001, another 10 rural banks were closed.

58. There are a number of impediments to effective resolution of failed banks in the Philippines. PDIC does not have the ability to independently access detailed information on the insured banks and must rely on the BSP for data concerning banks. The real problem, however, lies in the current legislation that places such a degree of secrecy on deposit records that PDIC does not have access to deposit records until after the failure of the bank. Not only does this impact its ability to craft an effective resolution of the failing institution, but it severely hampers the PDIC’s ability to pay the insured depositors in a timely manner. The combination of deposit secrecy, the apparent right of owners to submit a rehabilitation plan post-receivership (90-day opportunity), and the opportunity for owners to judicially challenge actions can significantly delay effective resolution. Furthermore, the appointment of the receiver can itself be met with resistance from the owners which also adds to the delay and thus the cost of the receivership, leading to a lower recovery for depositors and other creditors. Finally, the ability of staff to perform the functions of their jobs without concern for personal liability is weak. Bank owners have been able to block or delay resolution actions by seeking court injunctions or suing staff members for negligence. For effective bank failure resolution, these impediments that hamper the operations of PDIC need to be removed.

59. These weaknesses have in part forced the BSP into a strategy of merger promotion and liquidity support to handle stresses in the system. The package of incentives offered by the BSP to facilitate the process of mergers and acquisitions include forbearance on compliance with several prudential regulations and relief of liquidity pressures.32 It is important that the BSP cautiously monitor the process of mergers and acquisitions, and require additional capital as needed to guarantee the medium- and long-term soundness of the new or surviving institutions participating in the process. Otherwise, it will delay the recognition of problems and the final costs to society will most probably increase.

60. An assessment of the banks’ qualifications to get access to emergency credit facilities is complicated by conglomerate structures. The solvency of the bank can be masked through intergroup transactions.33 Similarly, the liquidity assistance provided to a bank may be directed to cover the withdrawals suffered from other members of the same group.

61. The Monetary Board has had to make use of these facilities, due in part to BSP’s inability to effectively intervene or close large banks. The amount of liquidity support increased substantially at the time of the crisis surrounding the Urban Bank case in April 2000, and escalated further with the political crisis in October 2000 and the deposit runs affecting certain banks. Additionally, since late 1999, the PDIC has been used as another vehicle to provide financial assistance to problem banks, although the funding comes mainly from the BSP. In the PDIC case, the assistance takes the form of purchase of nonperforming loans or assets with buyback, or direct loans. Although the solvency of the BSP and of the PDIC seems not to have been affected due to the collateral received, the monetary impact of these operations has been considerable. In January 2001, at the peak of the liquidity support, the amount provided amounted to the equivalent of about US$2 billion, or 34 percent of reserve money, which has forced the BSP to increase liquidity requirements to mop up the excess liquidity provided to the market.

62. These approaches however have been inadequate to address the large overhang of distressed assets in the system. As the prospect for public sector support to resolution efforts is limited by current fiscal stresses, the authorities’ primary strategy for resolving the NPL issue has involved the establishment of private sector special purpose asset vehicles (SPAVs) to purchase the loans and dispose of them. However, several pieces of legislation that are integral to this strategy have been mired in congressional hearings and negotiations, the outcomes of which have not been encouraging. Both the House and Senate bills have emerged from Committee hearings not only seriously weakened, but with provisions which overly favor debtors and introduce significant moral hazard risk to the process. The transferring of assets from the banks’ books to the SPAVs, and how the SPAVs value those assets, will be need to be closely monitored to prevent abuse of the process. The transfer price of the assets, the type of assets the banks will receive in return, and the accounting for those assets are critical in determining whether these transactions mask the true solvency position of the banks.

63. Given concerns expressed about the inability of SPAVs to strike deals with banks given wide variances in perceived asset values and the difficulties in passing the necessary legislation, as well as the fact that banks may have not written many assets down to their true values, other options for addressing NPLs must be closely evaluated. Innovative solutions to deal with this increasingly serious problem are urgently required, and could include an easing of friction costs for banks when disposing of nonperforming assets through other vehicles than SPAVs and mechanisms for the banks to sell ROPOA to third parties, on an arms-length basis, subject to appropriate servicing and buyback agreements. The BSP has acknowledged that, either with or without SPAVs, regulatory relief in the form of staggered bookings of losses on NPA sales is under consideration. It is expected that conditions will be attached to the availment of this relief, and that full disclosure of the capital impact will be required.

Summary Assessment of the Observance of Financial Sector Standards and Codes

I. Introduction and Summary

64. This section contains summaries of the reviews of compliance and consistency with key principles and standards applicable to the financial sector. Specifically, it reviews compliance with (a) the Basel Core Principles for Effective Banking Supervision; (b) the Committee on Payment and Settlement Systems’ (CPSS) Core Principles for Systemically Important Payment Systems; (d) the International Organization of Securities Commissions’ (IOSCO) Objectives and Principles of Securities Regulations; (e) the International Association of Insurance Supervisors’ (IAIS) Supervisory Principles; and the Code of Good Practices in Transparency in Monetary and Financial Policies. The detailed assessments for each of the standards and codes formed an integral part of the FSAP and an input into the Financial System Stability Assessment (FSSA).

65. The assessment confirms that the infrastructure for effective supervision has improved considerably in recent years and that while important gaps exist, compliance is overall quite high. The weaknesses that exist are however critical and derive in part from a supervisory structure and its enforcement capacities being out of line with key challenges. Among these are the needs to reprient the framework away from forbearance and liquidity support to on that is based on early problem identification, prompt corrective action and resolution.

66. The supervisory authorities are well aware of the concerns raised and have requested technical assistance to develop a comprehensive action plan to deal with the specific concerns as well as to ensure even higher levels of compliance with the relevant standards and codes.

67. The assessments were coordinated by Mr. Masayuki Tamagawa and prepared by:

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II. Compliance of Basel Core Principles for Effective Banking Supervision

A. General

68. This assessment of the current state of the Philippines’ compliance with the Basel Core Principles for Effective Banking supervision has been completed as part of the IMF-World Bank Financial Sector Assessment Program (FSAP). Completion of a formal assessment serves several purposes. This assessment of the effectiveness of banking supervision was based on an examination of the legal framework, both generally and as specifically related to the financial sector, the self-assessment of the Core Principles, and extensive discussions with the staff of the BSP, the Philippine Deposit Insurance Corporation (PDIC), the Capital Market Development Council (CMDC), the ODG-SES, the Bankers Association of the Philippines (BAP), the external auditors and the management of commercial banks.

B. General Preconditions and Macroprudential Setting

69. The operating environment for Philippine banks has been difficult. In this context nonperforming loans (NPLs) have been increasing and profitability has been declining. Around half of the banks’ NPL volume is held on a limited number of important groups and individuals and the NPL distribution pattern illustrates the existence of unacceptable concentrations in a handful of individual banks with systemic importance.

70. There have been a number of changes to the regulatory and supervisory framework. The BSP is progressively introducing supervisory approaches inspired by the Basel Committee on Banking Supervision and the best practices of the leading banks in the local market. The banking industry itself has developed, in conjunction with the BSP, a number of best practice manuals covering various topics. The Philippine accounting system is progressively evolving in the direction of international standards. On the other hand, developments in the judiciary sphere have led banks to rely more systematically on contractual arbitrage mechanisms and settlement practices outside the courts.

71. Enhanced transparency in the banking sector has been made mandatory and corporate governance has been promoted recently through a number of regulatory changes. However, the effective implementation of these changes will have to be closely monitored and evaluated in the future. The concentration of bank shareholding in a few shareholders, some very closely linked to business conglomerates, is an important feature of the Philippine economic fabric.. The low level of domestic savings and a poorly developed domestic corporate bond market are other structural weakness that add to the reliance of these conglomerates on bank financing.

72. A number of procedures for the resolution of problems in banks, particularly in the case of financially distressed banks, do exist but experience has shown that their application can be severely hampered by the absence of some coercive legal instruments, a certain degree of prudential forbearance and the possibility of judiciary interventions. BSP and PDIC are authorized to grant credits to banks in order to overcome temporary liquidity problems. In that event, conditions are being attached to the credits and both BSP and PDIC join efforts in monitoring the condition of the banks and searching for the best resolution mechanism.

73. According to Section 83 of the RA No. 7653, also known as the New Central Bank Act (NCBA), the BSP is also allowed to extend loans and advances to banks for a period that should not exceed 7 days without any collateral for the purpose of providing liquidity in times of need. Furthermore, Section 84 allows the BSP to extend emergency loans and advances in periods of national and/or local emergency or of imminent financial panic which directly threaten monetary and banking stability. However, these loans or advances must be secured by assets. The BSP may also grant emergency loans or advances to banks, even during normal periods for the purpose of assisting a bank in precarious condition or under serious financial pressures, provided however that the bank is not insolvent and has the required assets to secure the advances.

C. Main Findings—Summary

74. Objectives, autonomy, powers and resources, CP 1. Taken collectively, the central bank and banking laws and the secondary regulations provided by the supervisor constitute an appropriate legal framework. Concerns about the calibration of the business process of banking supervision and the adequacy of the BSP’s human resources have to be voiced in this connection. The supervisor has recognized this and the assessment team commends the BSP on the efforts that have already been made to address the issue.

75. Licensing and structure, CPs 2-5. Permissible activities, the licensing process and the investment criteria are well defined (CP 2, 3, and 5). As to the ownership of banks substantial regulatory changes have to be undertaken in order to allow the supervisor to address the transfer of voting shares adequately. To that end the control test approach is preferable to a simple focusing on ownership percentages. Note that such regulations have already been drafted.

76. Prudential regulations and requirements, CPs 6-15. Although the BSP has set capital requirements for credit risks on both a solo and a consolidated basis, it has not to date introduced capital requirements for market risk, which is admittedly relatively insignificant at the moment, is not fully addressed either. Although large exposure limits have to be observed on a solo basis, banks are not yet required to observe them on a consolidated basis. An identical major loophole in the regulatory system affects the connected lending issue. The BSP is making efforts to introduce a consolidated supervisory approach in both areas. This particular situation draws attention to the more general issue of corporate governance that is not adequately dealt with in supervision. The BSP will have to more systematically apply qualitative standards for banks’ risk management systems, including an explicit assessment of the adequacy of relevant internal policies. Existing standards on internal control should be enhanced and best practices regarding internal audit should be elaborated. The BSP requires banks to adopt some measures that prevent them becoming inadvertently involved in money laundering. The situation is expected to improve as a result of the recent enactment of an anti-money laundering law, which provides immunity for the reporting of suspicions relating to bank deposits, and the introduction in the near future of detailed implementing regulations.34 These developments will require the BSP to extend its examination procedures to monitor banks’ compliance with the new regulations. The BSP is planning to formalize enhanced examination procedures in the near future and is already actively training its examiners.

77. Methods of ongoing supervision, CPs 16-20. The Philippines has just begun to conduct consolidated supervision on a comprehensive basis.. The shortcomings in consolidated reporting and analysis is a significant weakness because of the high level of connectivity in the banking system. Although BSP’s supervisory framework is largely compliant with the four other CPs in this group, the current supervisory process is largely compliance based and has to be drastically reoriented towards a more risk-based approach. The BSP recognizes this and has set in train a change process to that effect, but much remains to be done. Supervisory efforts should address the necessity for banks to have in place effective systems, procedures and administrative tools to monitor and control their activities, and supervisory guidance and recommendations should be developed in these areas.

78. Accounting, CP 21. The legislation and secondary regulations that govern bank accounting represent a valid basis for the supervisory authority. However, there is evidence that all aspects are not consistently enforced, possibly leading to banks issuing financial statements that do not transparently reflect their true risk profile. Of particular concern at present is the reporting of provisioning requirements; valuation of assets, especially if sold to Asset Management Companies (AMCs) as anticipated in the near future, will need to be closely monitored. The assessment of this principle does not mitigate the concerns previously cited regarding consolidated supervision, as it focuses only on bank accounting and record keeping practices. Events in the past also lead to the conclusion that synergy with the external auditors should be enhanced and the BSP’s ongoing efforts in that direction are commended.

79. Remedial measures, CP 22. The implementation periods and the required corrective actions should be significantly reviewed and enhanced. The Prompt Corrective Action framework should be strengthened to give the BSP clearer authority to implement timely enforcement actions.

80. Cross-border banking, CPs 23-25. T f Comprehensive and proactive information sharing and cooperation arrangements between the BSP and its international counterparts (formal and or informal) are not well developed. This in addition to the weaknesses in consolidated supervision can lead to incomplete assessments of the full group network.

D. Recommended Action Plan

Table 5.

Recommended Action Plan to Improve Compliance of the Basel Core Principles

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III. Assessment of IOSCO Objectives and Principles for Securities Regulation Summary Assessment

A. Institutional and Macroprudential Setting, Market Structure—Overview

Supervisory framework

81. The SEC is the primary regulatory authority over the capital markets and their participants. The BSP also supervises NBFIs to the extent that they have ownership links with banks, and are permitted to have quasi-banking function and trust operations and offer foreign exchange products and services. The Securities Regulation Code (SRC) is the main legal basis for the regulation of the markets. The SRC narrowed and redefined the scope of responsibilities of the SEC to enable the regulator to focus on regulation of the securities market and its enforcement in particular. The SRC also provided for demutualization of the Philippine Stock Exchange (PSE) which addressed, among other things, the PSE’s conflicts of interest as a self-regulatory organization (SRO).

82. In addition to the SRC, the Corporation Code provides basic rules for establishment and governance of companies. There are also laws dedicated to governing each type of non-bank financial institutions (NBFIs) and universal banks participating in the market. Those include the Presidential Decree 129 on Investment Houses, the Financing Company Act of 1998 and the Investment Company Act of 1960. For each law, the SEC provides Implementing Rules and Regulations (IRR) to substantiate the laws with detailed provisions. Among the laws, the Investment Company Act is due to be amended, which is expected to bring investment advisers under the supervision by the SEC. The General Banking Law of 2000 and the BSP Manual of Regulations for NBFIs further provide rules for quasi-banking and trust functions of NBFIs and rules for universal banks and commercial banks to be engaged in the securities business and to own NBFIs subsidiaries. The BSP supervises NBFIs on the basis of this law and the regulations.

Market structure

83. The equity market is built around the Philippine Stock Exchange (PSE). It is supported by the Philippine Central Depository (PCD) and the Securities Clearing Corporation of the Philippines (SCCP) for clearance and settlement of trades. Key market intermediaries include: 44 Investment Houses 44, 174 Financing Companies, 176 Broker-Dealer firms, 19 Mutual Funds and 15 Investment Management Companies.

84. The PSE lists 231 companies and one series of Small Denomination Government bonds. The market capitalization at the end of August 2001 was P2,429 billion (US$47 billion), representing nearly 80 percent of the GDP, a high figure for a country with per capita income of about US$1,000. On the other hand, the annualized market turnover drastically declined to PI73 billion (7.1 percent turnover) in 2001 from the peak of P781 billion (40 percent turnover) in 1999. Given the substantial level of capitalization, this represents low liquidity. An important attribute to the low liquidity is the small free float portion of corporate shares (about 15 percent) due to the holding of controlling shares by founding families of the companies.

85. The debt market is dominated by the government securities which are traded in the over-the-counter (OTC) market except for the one series of Small Denomination Bonds. T he total capitalization of the government securities including those issued by government-owned and -controlled companies (GOCCs) and local government units (LGUs) stood at PI, 128 billion, about 30 percent of GDP, as of July 2001. General Preconditions for Effective Securities Regulation.

86. Legislative bills currently being read in the congress is expected to address a need to rationalize taxation of financial instruments and services from various angles. In particular, elimination of Documentary Stamp Tax on the secondary market trading and securities lending and borrowing transactions is expected to have a significant positive impact on the market liquidity. The rationalization is also expected to provide more equal treatment and fairer market access for both domestic and foreign investors and market participants to stimulate competition.

87. The SEC and the PSE are in the process of implementing the reforms mandated by the SRC. The SEC has restructured its organization and renewing its staffing with a focus on strengthening the enforcement capacity of the SEC. These new organizational changes and capacity building need to be reasonably completed before the SEC starts functioning at its full capacity under the SRC. The PSE also corporatized itself, reformed its board and is now due to go public to restructure its ownership structure.

B. Main Findings—Summary

88. The Regulator (Ps 1-5). The SRC made the SEC a more enforcement-oriented, operationally independent regulator with clear objective and procedures. It has been better empowered to enforce the law and given adequate budgetary resources relative to the narrowed responsibilities. Computerization of the data administration has recently achieved significant progress. It needs to continue to work on enhancing enforcement skills of the staff. Its accountability also can be simplified and clarified.

89. Self-regulation (Ps 6-7). Against the SRC, the PSE has been corporatized and its Board of Governors has been reformed to become more independent of its member broker dealers. The PSE now needs to go public to diversify away from the excessive broker dealer dominance in ownership. It needs to enhance its market surveillance system and Net Capital reporting system. The PSE, together with the SEC, is considering spinning out of its Compliance and Surveillance Group to make it a dedicated self-regulator.

90. Enforcement (Ps 8-10). The SRC provided comprehensive inspection, investigation, surveillance and enforcement powers for the SEC. The SEC needs to continue to enhance the staff skill in using the comprehensive powers. Its electronic information management capacity needs to be further enhanced to avail more human resources for enforcement activities while readily availing accurate, updated information for inspection, investigation and surveillance.

91. Regulatory Cooperation (Ps 11-13). The SEC has authority to share public and non-public information with both domestic and foreign counterparts. The rules of confidentiality of information are sound. It only needs to agree on MOUs with willing counterparts. The Anti-Money Laundering Act (AMLA) also facilitates to overcome obstacles created by the Bank Secrecy Law.

92. Issuers (Ps 14-16) The disclosure regime is up to a high standards. The SEC still plays significant role to ensure that minority shareholders’ interest is protected. However, the strong founder family ownerships generally make it a difficult environment to defend interest of minority shareholders. The SEC is committed to completing the adoption of the International Accounting Standards by 2005.

93. Collective Investment Schemes (Ps 17-20). The existing Investment Company Act, while providing core elements needed for CIS regulation, is outdated and requires clarification and rationalization for its various parts. In addition, it does not accept foreigners as members of the boards of directors, discouraging foreign investment. It also leaves investment advisors unregulated. The passage of the Revised Investment Company Act is awaited.

94. Market Intermediaries (Ps 21-24) The eligibility criteria and procedures of registration are clear and sound. Capital and other prudential requirements are clearly established. Model Internal Supervision, Control and Compliance Procedures as well as SRC Rules are sound. The procedures to deal with failure of market intermediaries are clearly established. The system to monitor Net Capital may be computerized to achieve daily monitoring.

95. Secondary Market (Ps 25-30). The PSE is a highly autonomous market operator. With the demutualization, it has become a for-profit corporation which is self-regulating. At the same time, the Fixed Income Exchange and/or the Commodity Futures Exchange will likely be introduced soon. Competition emerging among these markets may raise doubt about credibility of their self-regulatory functions. The SEC is encouraged to provide key benchmarks through the SRC Rules and/or SEC Orders to show what it envisages as a ground design of the Philippine capital markets in which various exchanges can compete as a for-profit businesses.

D. Recommended Action Plan

Table 6.

Recommended Actions to Improve Compliance wit the IOSCO Objectives and Principles of Securities Regulation

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IV. IAIS Insurance Supervisory Principles Summary Assessment

A. Institutional and Macroprudential Setting, Market Structure—Overview

96. Insurance is supervised in the Philippines by the Insurance Commission (IC), an arm of the Ministry of Finance. This assessment has been based on the Insurance Core Principles Methodology (ICP) of the International Association of Insurance Supervisors dated October 2000. Given the relatively undeveloped stage of the Philippine insurance market, the stability of the market and the lack of exposure to international activities this assessment has been carried out on the basis of the essential criteria underpinning each Core Principle.

97. The private insurance sector in the Philippines is underdeveloped with total private sector penetration (premium divided by GDP) of 1.18 percent comparing to a South and East Asian average of 3.52 percent. GSIS, the main government insurer, is of comparable size to the entire private insurance sector reflecting its constituency, which comprises approximately 20 percent of all employees in the formal economy. Some social insurance is also handled by the Social Security System.

98. The private life insurance sector has continued to show healthy growth (47 percent real growth of premium income over the last five years), has achieved a ‘no failures’ history. The bulk of the life sector profit accrues to the few long established market leaders and barriers to entry are high, largely reflecting the costs of establishing a viable distribution system. Real growth rates have been negative in the non-life sector due to excessive capacity in a relatively static economy and reducing costs of reinsurance (typically between 35 percent and 40 percent of non-life premium is ceded to reinsurers and many smaller companies are effectively fronting operations). There are ongoing concerns about the solvency of a number of smaller non-life insurers and the Insurance Commissioner recently imposed a price freeze, through a formal tariff, to limit the potential negative consequences of excessive competition.35

99. Despite weak solvency requirements the Philippine private sector insurers have maintained a relatively high-risk asset structure and the current portfolio would require a substantially strengthened solvency margin under a risk based capital regime. In practice the industry appears to be well capitalized in aggregate, partly due to the requirement that unrealized capital gains are held in a fluctuation reserve and the exercising of strong controls over the introduction of new and riskier product/ pricing structures.

B. General Preconditions for Effective Insurance Supervision

100. The Philippines satisfies sufficient preconditions to justify a full IAIS Core Principles Assessment. After including public sector insurers it is not markedly out of line with regional penetration levels. Macro economic settings which are important for the growth of the insurance sector, while not particularly positive (slow economic growth), are also not inimical to development (inflation is falling). In addition the life insurance industry has significant potential for faster growth if a number of environmental matters such as discriminatory taxes and regulatory arbitrage favoring other savings mechanisms are dealt with.

101. There are active accounting and actuarial professions in place, although again further work is needed to ensure that appropriate standards are produced and capable of being enforced. Work is currently underway on some initiatives in this regard.

102. The insurance supervisor has a strong law to work with and the potential for independent funding, but firm action often requires the backing of his superiors and can be blunted through the courts. While the judicial system is well developed and relatively transparent, it needs to be refined to deal with administrative matters. Under the current regulatory regime some necessary supervisory actions can potentially be held at bay almost indefinitely.

C. Main Findings—Summary

103. Organization of an insurance supervisor (CP 1). The appointment process of the Insurance Commissioner needs to be codified and the independent funding of the Commission needs to be re established as originally intended by the law. Computerization is urgently required as is the capacity to recruit high-level technical staff.

104. Licensing and changes in control (CPs 2-3). Fit and proper tests for directors and managers need to be strengthened and business plans should be mandatory at the time of licensing.

105. Corporate governance (CP 4). A reform program is being introduced.

106. Internal controls (CP 5). Examinations are infrequent and tend to be very audit focused rather than risk focused. Although current enforcement is problematic, change is possible.

107. Prudential rules (CPs 6-10). Asset and Liability guidelines need to be addressed in an updated set of standards.

108. Market conduct (CPs 11). To be updated with an improved set of standards.

109. Monitoring, inspection, and sanctions (CPs 12-14). Statistical reporting needs to be upgraded to enable double-checking of technical provisions. More efficient use of resources would be achieved through computerization and the adoption of a risk based approach to inspection.

110. Cross-border business operations (CP 15). Strong arrangement exists.

111. Supervisory coordination and cooperation, and confidentiality (CPs 16-17). The law is outdated in this regard and should be updated.

C. Recommended Action Plan

Table 7.

Recommended Actions to Improve Observance of IAIS Insurance Supervisory Principles

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V. Observance of CPSS Core Principles for Systemically Important Payment Systems Summary Assessment

A. General

112. The assessment has been based on the report “Core Principles for Systemically Important Payment Systems” (Jan. 2001) by CPSS and the FSAP Guidance Note (Aug. 2001) by the IMF, the World Bank, and the CPSS. Discussions were held with the central bank, bankers association, clearing house, key banks and service providers, and documents pertaining to the laws, regulations, rules and procedures, contractual agreements, system descriptions, published reports and responses to FSAP questionnaires were reviewed to assess the level of compliance. As a self-assessment exercise against the CPSIPS was not conducted prior to the FSAP mission, such a review has not been factored into this report.

Institutional arrangements and market structure

113. The Bangko Sentral ng Pilipinas (BSP), clearing house and major banks play important roles in the Philippines payment systems. The BSP takes a leading role in establishing interbank clearing facilities and their relevant policies and regulations. It is the primary settlement agent for Peso funds transfers, while the PCHC provides the infrastructure for the clearing, communications network and software for the transmission of settlement instructions between participating banks and BSP. For U.S. dollar payments, Citibank serves as the settlement bank, while PCD and PCHC are the system operators for the real-time and batch transactions of PDDTS.

114. As shown in the table below, the major interbank clearing systems are the cheque clearing, MIPS2-IBCL and the PDDTS-U.S. dollar Gross. Over 92 percent of all interbank funds transfers are transmitted through these systems. The daily funds settlement (net) of securities transactions averaged PHP 176.5 million, and these are settled via the cheque clearing system.

115. The main means of consumer payments are still via paper cheques and cash. Electronic transactions involving ATMs (~1,250 transactions a day in 1999), credit cards (2.8 percent of population in 1997) and EFTPOS (~1,600 transactions a day in 2000) are relatively small on a per capita basis. Multi-purpose pre-paid card instruments were only recently introduced, like the BPI express cash and smart money card, by a bank and cellular phone company respectively.36

Table 8.

The Philippines: Comparative Table of Interbank Payment Systems

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Estimated figures from PCHC (Jan.-Sep. 2001).

BSP figures (until Oct. 2001).

Citibank figures (until Aug. 2001), using US$1=PHP50.8134 (BSP, Oct. 2001).

PCHC figures for Y2000.

PCD Annual Report 2000 (gross trades).

116. The most significant payment system developments are the enhancement of MIPS to MIPS2 from a net to a gross settlement system in July 2001 and the on-going RTGS project spearheaded by BSP. The RTGS project was initiated in Jan. 2001, and at the time of assessment, BSP was evaluating the submitted proposals from four companies for such a solution. In October 2001, the PCHC assumed the responsibility to clear inter-regional cheques, while BSP continued to clear the 27 local regional ones.

117. The core interbank payment systems are either in place or would be established soon. With the future RTGS system, more securities transactions can be settled on a gross delivery-vs. -payment basis via electronic means, which will significantly improve the processing efficiency and reduce settlement risk. The recent enactment of the Electronic Commerce Act (RA No. 8792) and Rules on Electronic Evidence (July 17, 2001) will also support future developments of the electronic payment systems. There have been several fraudulent cases involving cheques, and the arbitration procedures recently established by PCHC would be helpful as a mechanism for resolving cases amicably and not through the courts. It will take some time before clear trends are observed on the effectiveness of arbitration. Although PCHC has made many improvements on the processing of paper cheques, the predominance of paper-based instruments in the consumer payment space might limit the efficiency gains in the future. The Peso-Netting system, an electronic funds transfer facility similar in concept to a GIRO system, is apparently under-utilized as a means to settle low-value interbank payments.

B. Main Findings—Summary

118. The identified Systemically Important Payment Systems (SIPS) are MIPS2, cheque clearing and the PDDTS-U.S. dollar gross systems. As most of the issues identified across the three systems are similar, the findings are presented in a general way, while issues that are specific to a particular system are highlighted.

Legal foundation (CP I)

119. The legal and regulatory framework for the establishment of interbank clearing facilities by BSP is in place, but the finality of settlement for both public and private systems is inferred through contractual obligations and does not have as strong a legal underpinning as compared to a central bank law or directive. This may make the enforceability tied to the judicial processes, which may complicate the effectiveness of systemic risk reduction. Absolute clarity on this matter is especially needed when there is an insolvency of a major payment system participant.

120. The specific oversight responsibilities and central bank powers over payment system operators (e.g., PCHC, PCD) is unclear, particularly in the case of private-sector established interbank clearing systems (PDDTS). The manual unwinding process for clearing items may pose some risk given the high overall values through the cheque clearing system, and this is compounded by the long float times for inter-regional clearing and incidences of fraudulent transactions.

Understanding and management of risks (CPs II–III)

121. The rules and procedures for all systems are comprehensive and clear, but their general encapsulation as contractual agreements may weaken their enforceability, although in practice, they are unlikely to be strongly contested. The tools and incentives to manage credit and liquidity risks are generally available, although limited, and the settlement banks (BSP and Citibank) may face certain exposures by implicitly guaranteeing settlement of transactions. For BSP, the current design specifications of the RTGS system would allow participants to manage their liquidity more effectively.

Settlement (CPs IV–VI)

122. The settlement of MIPS2 and cheque clearing transactions is achieved through central bank money in a real-time and end-of-day manner respectively. The move towards an actual RTGS system would strengthen these processes. In the case of PDDTS, U.S. dollar payments are settled in real-time but across the books of a commercial bank (Citibank). As mentioned in CP 1, the manual unwinding process for cheques raises some concerns, especially in the event of the inability to settle by the participant with the largest single settlement obligation.

Security and operational reliability, and contingency arrangements (CP VII)

123. The contingency plans are generally in place, but the resource capabilities and independent audit of the IT security and controls of BSP and PCHC systems, and particularly the offsite backup facilities and coordination of plans, would need to be improved to strengthen the operational robustness of MIPS2 and the cheque clearing systems. In the case of BSP, they had identified the deficiencies and have been actively addressing them. The remote backups for all three SIPS should ideally be in effectively distant but convenient locations, to minimize the concentration risks, especially after the events of September 11.

Efficiency and practicality of the system (CP VIII)

124. The systems are currently leveraging on existing infrastructures (MIPS2 on PCHC, PDDTS on PCD), which is a good sign of the practicality of all parties given the level of IT investments, pool of expertise and general readiness of participants. Except for PDDTS, the formal mechanisms to monitor operational cost-benefit trade-offs and efficiencies are only rudimentarily practiced. The efficiency aspects, of course, would require to be balanced by the cost and risk considerations, and this was generally observed.

Criteria for participation (CP IX)

125. The general criteria for participation in all three systems are not explicit, although there is an implicit understanding among the parties involved, and BSP provides the high-level regulatory safeguards through its banking supervision role. There are apparently no anti-competitive practices or methods that might compromise the safety, fairness or efficiency within the systems.

Governance of the payment system (CP X)

126. The availability of information, consultations among the various parties, communication of decisions and generally fine across all the systems. The governance structures were observed to be fairly effective, accountable and transparent, and could be strengthened by better clarity on the appropriate oversight authority and overlapping ownership/membership structures of the parties involved.

Central bank responsibilities in applying the CPs

127. The BSP’s specific objectives, major policies and oversight of SIPS are implied through legislation, contractual agreements and its powers over the participants, which are all banks. However, payment system oversight in practice, especially over PCHC and private sector systems and operators, is unclear. A self-assessment of the three SIPS by BSP would be useful, and developing the necessary expertise would enable it to encourage the design and operation of safe and efficient payment systems that form the cornerstone of Philippines’ financial sector and economy.

C. Recommended Action Plan

Table 9.

The Philippines: Recommended Actions to Improve Observance of CPSS Core Principles and Central Bank Responsibilities in Applying the CPS

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VI. Transparency in Monetary and Financial Policies

A. Banking Supervision


128. The banking supervision function of the Bangko Sentral ng Pilipinas (BSP) was assessed on its observance of the financial policies portions of the IMF Code of Good Practices on Transparency in Monetary and Financial Policies (MFP Transparency Code) as part of the joint Fund-World Bank Financial Sector Assessment Program (FSAP).

129. The assessment was based on 1) responses by the BSP staff to a pre-FSAP questionnaire; 2) review of The New Central Bank Act, The General Banking Law of 2000, and BSP publications; 3) review of information contained on the BSP website; and 4) discussions with BSP officials, including a member of the Monetary Board, and with staff of the Bankers Association of the Philippines.

130. BSP officials cooperated fully with the assessment and were readily forthcoming with information, publications, and clarifications.

Main findings—Summary37

131. With respect to transparency practices in the conduct of banking supervision policies, a number of provisions in The New Central Bank Act require transparency by, and accountability of, the BSP in its banking supervision function. This serves as an operational and directional guide to the BSP in the conduct of its banking supervision policies. In addition, transparency is viewed by the BSP as an ongoing process, and BSP officials are receptive and supportive to the transparency concept. The BSP resorts to a variety of means to disclose and explain information about its banking supervision policies and activities including several scheduled reports specified in The New Central Bank Act, including a semi-annual “review of the state of the financial system,” press releases, press conferences, public consultations, speeches by its officials, and its website. The Internet has dramatically widened the scope for disseminating information about the BSP’s banking supervision activities and policies, thereby facilitating efforts to practice more effective transparency.

132. With regard to clarity of roles, responsibilities, and objectives offinancial agencies most of these aspects of the BSP concerning banking supervision are specified in detail in The New Central Bank Act that took effect in 1993. These elements of the BSP’s mandate are further disclosed, described, and explained in a variety of reports issued by the BSP on a scheduled basis as prescribed by the Act, other BSP publications, and speeches by BSP officials. The principal objectives of the BSP’s banking supervision responsibilities are financial market stability and banking soundness, which are stressed in BSP reports and public pronouncements. Most of the BSP’s reports and public statements are posted on the BSP’s website. Although the relationship between financial agencies in the Philippines and the BSP’s role therein is disclosed, it would be desirable to report on this relationship, including new developments in these relationships over the past year.

133. Transparency practices related to open process for formulating and reporting of financial policies as they relate to the banking supervision function of the BSP are specified in The New Central Bank Act and the General Banking Law of 2000. The two-volume Manual of Regulations, which contain all the regulations dealing with bank examination and supervision, is available to the public on a subscription basis either in hard copy or on a CD. The regulations are also posted and updated on the BSP’s website. Speeches by members of the Monetary Board and other BSP officials and press releases periodically focus on new developments in the banking supervisory environment (for example, new emphasis on risk management, capital adequacy standards, role of Basel Core Principles, anti-money laundering and the like). The fee schedule for banks that are subject to examination by the BSP is publicly disclosed. Significant changes in banking supervision policies by the BSP are publicly announced and explained in a timely manner. For proposed substantive changes in the structure of banking supervision policies, the BSP typically conducts public hearings and the proposed changes are issued for public comment. Umbrella organizations of banks/nonbanks, such as the Bankers Association of the Philippines, are consulted when there are major reforms being considered that will affect the banking sectors.

134. With regard to public availability of information on financial policies. The BSP issues semi-annually a report, Status Report on the Philippine Financial System, which is mandated according by The New Central Bank Act, which is also posted on the BSP’s website. The Annual Report also contains a review of major developments of the banking sector. The BSP publishes aggregate data on banking and related matters in its publications, and data related to banking and related matters are posted and updated on the BSP’s website. The public has access to the BSP Statistical Center. Texts of regulations and any other generally applicable directives and guidelines issued by the BSP are readily available to the public.. Circulars, circular letters (containing nonregulatory issuances of the BSP addressed to particular entities or categories of institutions), and memoranda (containing guidelines or procedural requirements, clarifications, explanations, and interpretations of provisions of laws or of BSP circulars) are also posted on the BSP website. The information that the BSP discloses on its emergency support operations is limited and is provided in an ad hoc manner. The BSP does not disclose aggregate information on its emergency support operations.

135. Accountability and assurances of integrity by financial agencies as they relate to the banking supervision function of the BSP, where appropriate, appearances by BSP officials before congressional committees focus on the state of Philippine banking system and on matters closely related to banking supervision matters. The New Central Bank Act includes the provision that the Monetary Board is authorized to “indemnify its members and other officials of the Bangko Sentral, including personnel of the departments performing supervision and examination functions against all costs and expenses reasonably incurred by such persons in connection with any civil or criminal action, suit or proceedings to which he may be, or is, made a party by reason of the performance of his functions or duties, unless he is finally adjudged in such action or proceeding to be liable for negligence or misconduct.” Proposals to amend The New Central Bank Act currently under discussion include providing officials and staff of the BSP some form of immunity against civil lawsuits on acts or omissions committed by them in the exercise of their official duties in good faith, barring gross negligence. This might help deter legal actions against BSP officials and staff, which may be inhibiting BSP officials and staff from conducting their affairs effectively and efficiently, particularly in the bank supervision area. Should this sort of legal protection become law, the BSP should consider reporting this provision in the forthcoming Annual Report and posting it in an appropriate location on the BSP’s website.

Table 10.

The Philippines: Recommended Plan of Actions to Improve Observance of IMF’s MFP Transparency Code Practices—Banking Supervision

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B. Securities Regulation


136. The Securities and Exchange Commission of the Philippines (SEC) was assessed on its observance of the financial policies portions of the IMF Code of Good Practices on Transparency in Monetary and Financial Policies (MFP Transparency Code) as they relate to securities regulation as part of the joint Fund-World Bank Financial Sector Assessment Program (FSAP).

137. The assessment was based on 1) responses by the SEC staff to a pre-FSAP questionnaire; 2) review of the Securities Regulation Code (RA 8799) and SEC publications; 3) review of information contained on the SEC website; and 4) discussions with SEC officials, including one of the Commissioners.

138. The Securities Regulation Code (SRC) demands relatively little from the SEC in terms of public disclosure by the SEC and public accountability of the Commission’s affairs and policies. To that extent, transparency and accountability have to be more self-generated than in instances where public reporting requirements are mandated by law. The SEC resorts to a variety of means to disclose and explain information about its securities regulation policies and activities, including the Annual Report, press releases, press conferences, public consultations, speeches and interviews by its officials, and its website. The SEC’s website is in its early stages of development, and it could build on the progress achieved with it thus far to draw on this form of information dissemination to its full potential.

Main findings—Summary

139. Clarity of roles, responsibilities, and objectives offinancial agencies: Most of these aspects of the SEC are specified in the SRC that took effect in July 2000. These elements of the SEC’s mandate are further disclosed, described, and explained in the Annual Report, press conferences, and speeches and interviews by SEC officials. Most of the SEC’s reports and public statements are posted its website. The relationship between financial agencies in the Philippines and the SEC’s role therein, is disclosed, although it would be desirable to report on this relationship, including new developments in these relationships over the past year. The SEC’s oversight responsibilities for the Philippine Stock Exchange (PSE) and the relationship between the SEC and PSE are publicly disclosed. The PSE is guided by the SEC to follow the same good transparency practices specified for it in the MFP Transparency Code. The SEC is subject to limited objective accountability mechanisms.

140. Open process for formulating and reporting offinancial policies: The regulatory framework for securities regulation is specified in the SRC and SRC Rule 4 of its implementing rules and regulations, which were published in newspapers of general circulation and in the Official Gazette and posted on the SEC’s website. The regulations relating to the financial reporting by the securities industry and the regulations relating to organized markets are explained and disclosed to the public via press releases, publication in the SEC Bulletin, and posting of the regulations on the SEC’s website. Speeches and interviews by SEC Commissioners and other SEC officials and press releases periodically focus on new developments in the securities regulation environment (for example, new emphasis on risk management, IOSCO principles and standards, anti-money laundering, and the like). The SEC’s fee, fine and penalties structure is listed in SEC Memorandum Circular 6 that was released to the public and published in newspapers of general circulation and posted on the SEC’s website. Significant changes in securities regulation policies by the SEC are publicly announced and explained in a timely manner, including press conferences following the weekly meeting of the Commission. For proposed substantive changes in the structure of securities regulation policies, the SEC typically conducts public hearings, and the proposed substantive changes are issued for public comment. Umbrella organizations of security dealers and other affected parties are consulted when there are major reforms being considered that will affect the securities industry.

141. Public availability of information on financial policies. The Annual Report also contains a review of major developments of the banking sector. The SEC, in a joint project with the Credit Information Bureau Incorporated (CIBI), publishes an annual volume, Top 5000 Corporations, which contains data on the performance of the top 5000 corporations in the Philippines. Some selected data on the securities industry are also presented in the SEC’s Annual Report. The PSE, for which the SEC has oversight responsibilities, compiles data on the securities markets, which it publishes and posts on its website. Texts of regulations and any other generally applicable directives and guidelines issued by the SEC are readily available to the public. The SEC has a public information unit. The SEC has a limited publications program, including an Annual Report. Commissioners and staff are active in making public appearances, delivering speeches, and giving interviews on the radio and television explaining the SEC’s objectives and performance.. There is little information provided to the public on how the SEC handles investor protection issues in practice.

142. With regard to accountability and assurances of integrity by financial agencies, the SEC chairperson appears before congressional committees in connection with the SEC’s budget, which also provides some scope to report on SEC policies and activities. Although the SEC discloses information about standards for the conduct of personal financial affairs of its officials and staff and about legal protection for officials and staff in the conduct of their official duties, such information could be given wider exposure. The financial statements of the SEC are audited by the Commission of the Audit but are not released to the public. The SEC discloses information to the public on its operating expenses and revenues in a nonsystematic manner. The SEC collects fees, fines, and penalties but does not report on the revenues it collects and how these have been spent or disbursed. The SEC does not disclose its internal governance procedures.

Table 11.

The Philippines: Recommended Plan of Actions to Improve Observance of IMF’s MFP Transparency Code Practices—Securities Regulation

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C. Monetary Policy


143. The Bangko Sentral ng Pilipinas (BSP) was assessed on its observance of the monetary policy portions of the IMF Code of Good Practices on Transparency in Monetary and Financial Policies (MFP Transparency Code) as part of the joint Fund-World Bank Financial Sector Assessment Program (FSAP).

144. The assessment was based on 1) responses by the BSP staff to a pre-FSAP questionnaire; 2) review of The New Central Bank Act and BSP publications; 3) review of information contained on the BSP website; and 4) discussions with BSP officials, including a member of the Monetary Board, and with the professional staff of the Bankers Association of the Philippines.

145. BSP officials cooperated fully with the assessment and were readily forthcoming with information, publications, and clarifications.

Main findings—Summary

146. A number of provisions in The New Central Bank Act require transparency by, and accountability of, the BSP. This serves as an operational and directional guide to the BSP in the conduct of its activities and policies. In addition, transparency is viewed by the BSP as an ongoing process, and BSP officials are receptive and supportive to the transparency concept. The introduction of inflation targeting in early 2002, with its public reporting and monitoring requirements, will broaden and strengthen the practice of transparency at the BSP further. The BSP resorts to a variety of means to disclose and explain information about its policies and activities, including a number of scheduled reports specified in The New Central Bank Act, including the Annual Report, press releases, press conferences, public consultations, speeches by its officials, and its website.

147. There is considerable transparency practiced by the BSP with regard to clarity of roles, responsibilities, and objectives of monetary policies. Most of these aspects of the BSP concerning monetary policies are specified in detail in The New Central Bank Act that took effect in 1993. These elements of the BSP’s mandate are further disclosed, described, and explained in a variety of reports issued by the BSP on a scheduled basis as prescribed by the Act, other BSP publications, and speeches by BSP officials. Most of these publications and pronouncements are posted on the BSP’s website. The primary objective of monetary policy in the Philippines is price stability, and with the introduction of inflation targeting in early 2002, the commitment to this objective will be strengthened. The reporting and monitoring requirements associated with inflation targeting will also reinforce the transparency of policy. Public disclosure is incomplete concerning some aspects of the BSP’s relationship with the government, such as the terms of government deposits at the BSP, the allocation of responsibilities among government entities, including the BSP, for secondary debt market arrangements, and the procedures for BSP participation in government securities markets, as well as about the manner the BSP’s capital is maintained and the status of the BSP’s surplus account.

148. The BSP follows good transparency on nearly all of the transparency practices related to open process for formulating and reporting of monetary policies. With the introduction of inflation targeting, the framework used to pursue the objectives of the BSP’s monetary will be changing in early 2002. The move to inflation targeting has been well publicized and explained in a number of consultative and informational meetings in different regions of the country and in speeches by BSP officials. Changes in monetary policies approved by the Monetary Board are communicated to the public immediately following the weekly Board meeting through a press release, which at the same time is posted on the BSP’s website, supplemented by a press conference by the governor who also serves as chairman of the Monetary Board. The reasons for monetary policy decisions by the Monetary Board are offered in the press releases and press conferences and subsequently in BSP publications and in speeches by BSP officials. In the context of the adoption of inflation targeting, the Monetary Board is considering to release with a lag the minutes of relevant Monetary Board discussions on monetary policy. The periodic reports that the BSP issues cover the progress toward achieving its monetary policy objectives and on the evolving macroeconomic situation and their implications for monetary policy. With the introduction of inflation targeting, the BSP will publish a Quarterly Inflation Report, which will monitor and assess the progress in meeting the established inflation target.

149. The BSP meets most of the practices of the Code with regard to public availability of information on monetary policies. The Philippines subscribes to the IMF’s Special Data Dissemination Standards (SDDS). Information about foreign exchange reserve assets, liabilities and commitments by the monetary authorities are disclosed on a pre-announced schedule, consistent with the International Monetary Fund’s Data Dissemination Standards. The BSP has a special public information unit, and its website is well-structured and well-maintained. The BSP has a structured publications program. It issues a number of reports required by The New Central Bank Act to be submitted to the president and the congress (available to the public) by specific dates in the year, including an Annual Report. The Act also calls for a “version of the annual report in terms understandable to the layman.” In reaching out to a wider public, the BSP issues primers on a variety of topical subjects related to the functions and responsibilities of the BSP, and it also has issued two primers in comic-book form in the national dialect, Filipino/Tagalog. The information that the BSP discloses on its emergency support operations is limited and is provided in an ad hoc manner. The BSP does not disclose aggregate information on its emergency support operations.

150. With regard to accountability and assurances of integrity by the central bank, BSP officials make regular appearances before congressional committees to report on the conduct of monetary policy, explain its policy objectives, describe the performance in achieving its objectives, and, as appropriate, exchange views on the state of the economy and the financial system. Although the BSP discloses information about its operating expenses and revenues, about standards for the conduct of personal financial affairs of its officials and staff and about legal protection for officials and staff in the conduct of their official duties, such information could be given wider exposure. While the BSP releases its financial statements, at times the release of the statements do not meet the requirement that they have to be audited (as prescribed by The New Central Bank Act and called for by the MFP Transparency Code) and to contain information on accounting policies and any qualification to the statements (as called for by the Code). The BSP does not disclose its internal governance procedures.

Table 12.

The Philippines: Recommended Plan of Actions to Improve Observance of IMF’s MFP Transparency Code Practices—Monetary Policy

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These were capital adequacy ratio, connected lending to total capital ratio, nonperforming loan (NPL) ratio, and interest margin to gross income ratio. They performed better in terms of NPL net of provisioning to capital ratio and earnings—returns on assets and equity.


Pre-need companies are managers and guarantors of pre-funded contracts that provide a defined service. Pre-need plans have taken on many of the characteristics of traditional endowment life insurance. The most common pre-need plans include caskets and memorial services, education, and pensions.


Bank accounts in these cases have been frozen pending further investigation.


Lending Investors are consumer lenders which are large in number but mostly single proprietorships.


Non-performing assets are defined as non-performing loans (NPLs) plus real and other properties owned and acquired (ROPOA). These latter are in effect NPLs, but are subject to more lenient provisioning requirements.


Detailed sectoral recommendations were left with the authorities in the context of the FSAP mission reports.


Bank owners have been able to block or delay supervisory enforcement actions by securing temporary restraining orders or bringing court cases against supervisory staff for failing to exercise “extraordinary diligence.” This ill-defined and exceptional standard effectively invites litigation that undermines the BSP’s supervisory credibility.


Director, Officer, Stockholder and their Related Interests.


Quasi-banks are defined as entities that are engaged in the borrowing of funds through the issuance, endorsement, or assignment with recourse or acceptance of deposit substitutes for purposes of re-lending or purchasing of receivables and other obligations.


The four largest financial conglomerates on average account for 40 percent of total assets; intermediate 50 percent of payment and settlement transactions and account for 40 percent of loan and deposit markets.


The two largest conglomerates together own approximately 107 financial and non-financial subsidiaries.


In the case of Urban Bank, funding problems initially surfaced in the investment subsidiary. The bank had to provide liquidity to the affiliate and in return it acquired nonperforming assets. The liquidity problem eventually overwhelmed the bank and it was forced to declare a banking holiday, prompting BSP intervention.


Based on data from Worldscope Database for listed companies for 1995-2000.


On the basis of the data available at the time of the mission, six commercial banks accounting for 10.9 percent of total assets of all forty-four commercial banks reported capital adequacy ratios below 8 percent. Of these six, three small banks report negative capital adequacy ratios.


The NPL ratio for commercial banks increased to 18.4 percent by February 2002. However, at the time of the mission detailed data was available only up to June 30, 2001 for stress and sensitivity analysis.


The nonperforming assets (NPAs) ratio is defined as nonperforming loans plus ROPOA to total loans plus ROPOA. The NPA ratio for commercial banks increased to 26.6 percent by February 2002.


ROPOA are appraised at the time of foreclosure—wherein a one-off gain/loss is recognized on the income statement depending on how the appraisal compares with the book value. Banks have five years to dispose of those assets. They are not required to set up loss reserves against ROPOA, unless deterioration in the market value of the assets is assessed. At the time of this assessment, appraisals of the foreclosed assets were not conducted periodically; however, the BSP has since issued a regulation requiring reappraisal every other year.


Especially with the presence of financial conglomerates, the income statement of one member of the group could be inflated through operations/transactions made with other members of the same group.


The existence of financial conglomerates and the weaknesses in the regulatory and supervisory framework discussed in Section IV call for caution in the analyses of the data, as the real condition of the banking system could be worse than these indicators suggest.


The indicators selected were: capital adequacy ratio; past due loans to total loans; NPLs net of provisions to capital base; loan exposure to three largest borrowers as percent of capital base; pre-tax ROA (Return on Assets) excluding extraordinary gains; net interest income as share in average asset and ROE (Return on Equity).


If a new rule of a minimum 60 percent provision of NPLs were to be immediately passed, this bank would have a negative CAR, and three other banks, including one of the top five, would have CARs below 10 percent.


Assuming a loan to collateral value ratio of 60 percent at the time the loans were granted, and further assuming 60 percent depreciation in collateral value, a 33 percent provisioning for the existing ROPOA stock carried on the banks books would be needed. Furthermore, if the ROPOA value was to be marked-to-market—such as through an outright sale to an AMC, the required provisioning would be 75 percent if it is assumed that the recovery price could drop further, from 40 cents to 15 cents to a dollar (of collateral value).


Deducting from the capital base of a bank its equity investments in other affiliates or subsidiaries is justified because those funds are backing the risks incurred by the subsidiaries/affiliates.


Social Security System (SSS), Government Service Insurance System (GSIS), Armed Forces of the Philippines-Retirement and Separation Benefit System (AFP-SBI), and the Home Development Mutual Fund (Pag- IBIG).


According to the calculations of the Philippines Retirement Income Commission based on 1999 data.


The ROI for 2000 was 8.4 percent which is below the 91 day T-bill yield of 10.5 percent.


Operating Expenses for the year ended December 2001 were 9.9 percent of total revenue.


The 2000 budget allocated to Personnel Services constitutes 70 percent of the entire appropriation. An amount equivalent to P32.3 billion out of a total of P36.3 billion of the annual appropriation is being taken up by the personnel account.


The difference between he interest rate paid on contributions and the return on investments is kept in the fund with the future purpose of paying pension directly from the fund.


The rationalization of the documentary stamp tax regime (DST), in particular, elimination of DST on secondary market trading and securities lending and borrowing transactions is expected to have a significant positive impact on the liquidity of the securities market.


The discussion on AML practice was undertaken within the framework of the existing financial sector standard and not the enhanced methodology document.


Among the incentives banks and other financial intermediaries may avail, subject to BSP approval, are: (a) booking on staggered basis over a maximum period of five years of un-booked valuation reserves based upon BSP examination and other capital adjustments resulting from the merger or consolidation; (b) amortization of goodwill up to a maximum period of 40 years; (c) revaluation of bank premises; (d) temporary relief from full compliance with the net worth to risk assets ratio; (e) exemption from the 20 percent ceiling on commercial banks’ loan portfolio allocated to real estate loans for a period of one year; (f) exemption from the individual limits on voting rights in the new or surviving institutions; (g) restructuring/plan of payment of past due obligations with the BSP over a period not exceeding 10 years; (h) payment in installments over a period of one year of outstanding penalties in legal reserve deficiencies and interest on overdrafts with the BSP; and (i) rediscount ceiling of 150 percent of adjusted capital accounts for a period of one year.


As the Urban Bank case clearly indicates, substandard or doubtful receivables can be parked in the books of other affiliates of the bank, or bank borrowers may appear as performing because of their additional borrowings from other affiliates of the bank.


The authorities have released implementing rules and regulations relating to AMLA since the mission conducted its assessment.


Under S.s 357 and 358 the Commissioner has effective control of premium rates, and may allow rates in excess of the tariff to be charged on individual risks.


Source: PIDS discussion paper Nov. 2001 on Philippines Payment System.


The assessment of transparency with regard to banking supervision focused primarily on the functional aspects of banking supervision of the BSP. The transparency environment in the BPS for the institution as a whole, however, also impacts on the conduct of banking supervision policies. For a more complete picture of the state of transparency at the BSP as it affects banking supervision, therefore, the reader may want to take account of the separate assessment of transparency of BSP monetary policies and the recommendations to strengthen transparency further.

Philippines: Financial System Stability Assessment, including Reports on the Observance of Standards and Codes on the following topics: Monetary and Financial Policy Transparency, Banking Supervision, Securities Regulation, Insurance Regulation, and Payment Systems
Author: International Monetary Fund