Key Issues

Risks: GDP contracted by 9½ percent in 2020—a much steeper decline than during the Asian Financial Crisis (AFC)—but it is now recovering with the easing of containment measures and economic policy support. Banks are closely connected to the corporate sector through high credit exposures and conglomerate ownership linkages. The Financial Action Task Force (FATF) may list the Philippines as a jurisdiction with serious Anti-Money Laundering and Combatting the Financing of Terrorism (AML/CFT) deficiencies in 2021. The country is also vulnerable to climate change (physical) risks, especially the destruction of physical capital from typhoons.

Findings: The economic contraction is elevating credit risks, especially from the corporate sector. While banks can withstand the severe baseline scenario, they could experience systemic solvency distress in a much more severe adverse scenario. The second-round effects from such distress might reduce GDP even more. Regulatory forbearance that delays loss recognition could harm economic recovery by limiting credit growth, as observed after the AFC. However, prompt loss recognition and non-performing loan (NPL) restructuring can prevent sharp deleveraging and boost GDP. Physical risks from climate change are relevant for financial stability, though they are not systemic unless extreme tail events materialize.

Recommendations: Given the significant downside risks, the authorities should limit bank dividend distributions and be ready to take additional measures to strengthen banks’ capital if downside risks materialize. The central bank should allow forbearance measures to lapse as scheduled and avoid introducing new measures, as delayed loss recognition and NPL restructuring could limit credit growth. The authorities should further enhance the effectiveness of the AML/CFT framework. The government should also amend the unusually stringent bank secrecy laws, which are limiting effective prudential supervision and impairing financial stability, financial integrity, and development. Given the downside risks to bank health, strengthening the resolution framework is urgent. While legislative changes will take time, the authorities should immediately start streamlining the prompt corrective action (PCA) framework and working on resolvability assessments and resolution planning. Over the medium-term, the authorities should expand their macroprudential toolkit, strengthen the supervision of financial conglomerates, and enhance the monitoring of climate change risks.

Approved by

James Morsink and Odd Per Brekk

Prepared by

Monetary and Capital Markets Department

• The team was led by Hiroko Oura (IMF) and Ilias Skamnelos (WB), and included Dirk Jan Grolleman (IMF) and Valeriya Goffe (WB) as Deputy Mission Chiefs, Paola Morales-Acevedo, Peter Lohmus, Minsuk Kim, Jiri Podpiera, and Jonathan Pampolina (IMF staff), Geraldine Low, Adhi Nur, and Irman Robinson (IMF experts), Serap Oguz Gonulal, Karol Karpinski, Keith Alan Ligon, Nilima Chhabilal Ramteke, Martijn Gert Jan Regelink, and Luz Maria Salamina (WB staff), Alan Ball, Eddy Rodriguez Cespedes and Yavar Moini (WB experts).

• The mission met the Governor of the Bangko Sentral ng Pilipinas, the Secretary of the Department of Finance (Ministry of Finance), the Chairman of the Securities and Exchange Commission, the Commissioner of the Insurance Commission, the Executive Director of the Anti-Money Laundering Council, senior staff of Philippines Deposit Insurance Corporation, many staff in their agencies, and held many helpful meetings with other official agencies, financial sector representatives, and other stakeholders.

• FSAPs assess the stability of the financial system, not that of individual institutions. They are intended to help countries identify key sources of systemic risk in the financial sector and implement policies to enhance their resilience to shocks and contagion. Certain categories of risk affecting financial institutions, such as operational or legal risk, or risk related to fraud, are not covered in FSAPs.

• This report was prepared by Hiroko Oura and Dirk Jan Grolleman, with contributions from the members of the FSAP team.