Philippines: Financial System Stability Assessment-Press Release and Statement by the Executive Director for the Philippines
Author: International Monetary Fund. Monetary and Capital Markets Department
Publication Date:
09 Apr 2021
eISBN:
9781513576763
Language:
English
Keywords:
bank-NFC liquidity linkage; bank solvency test; liquidity linkage analysis; limit bank dividend distribution; C. bank solvency stress test; Credit; Financial sector stability; Anti-money laundering and combating the financing of terrorism (AML/CFT); Global
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Financial System Stability Assessment-Press Release and Statement by the Executive Director for the Philippines

Abstract

Financial System Stability Assessment-Press Release and Statement by the Executive Director for the Philippines

Executive Summary

The financial system is dominated by banks. Banks are tightly interlinked with nonfinancial corporates (NFCs) through conglomerate ownerships and significant exposures.

The immediate risk to financial stability is from the impact of COVID-19. GDP contracted by 9½ percent in 2020—a much sharper decline than during the Asian Financial Crisis (AFC). The economy had solid macro-fundamentals before COVID-19 thanks to policy efforts, but the pandemic turned out to be an extreme tail shock. The authorities took various measures, including time-bound regulatory relief and forbearance measures, though the scale of loan moratoria and credit guarantees has been relatively limited. With policy support and easing of containment measures, the economy started to recover in the second half of 2020 and is expected to grow 6½ percent in 2021.

While banks can withstand the exceptionally severe shocks in the baseline, they could experience a systemic solvency impact if additional downside risks materialize. Distress to the corporate sector could be widespread even in the baseline and sharply rise in adverse scenarios, elevating credit risks to banks. In the baseline, banks’ total capital adequacy ratio (CAR) falls from 15.6 percent to 11.7 percent by 2022, still above the ten percent minimum requirement even without sectoral policy effects. However, CAR falls to 9.3 percent in the adverse scenario, and 4.9 percent in the severe adverse scenarios. The second-round effects from such distress might reduce the real GDP level by an additional 4 to 9 percentage points in adverse scenarios. However, CARs start to recover in 2022 as the economy recovers. The results should be interpreted cautiously given the economic and model uncertainties. Moreover, conservative behavioral assumptions (e.g., deleveraging among others) in FSAPs tend to yield larger solvency impacts during a severe crisis.

Given the significant downside risks, the authorities should limit bank dividend distributions, and be ready to take additional measures to strengthen banks’ capital if the risks materialize. Given the potential for large loan losses, the authorities should limit banks’ dividend distributions as a precautionary measure. If downside risks materialize, banks should recognize NPLs and restructure them promptly with additional capital as needed. This is supported by a counterfactual policy analysis and the experience after the AFC, which suggest that such actions could improve GDP with sustained credit provision.

The BSP should allow the forbearance measures to lapse as scheduled and avoid introducing new measures. Forbearance does not address the underlying issues in weak banks and hampers banks’ ability to continue providing credit and ultimately may even undermine financial stability. Instead, the authorities should continue to use the flexibility of the tools available in the accounting and Basel capital framework, and, looking at the future, further develop and use macroprudential tools and buffers.

The downside risks to the banking system also underscore the importance of further strengthening the bank resolution framework. The Philippine Deposit Insurance Corporation (PDIC) should be designated and given powers to act as the resolution authority. Also, the resolution toolkit should be broadened beyond liquidation and possibly with a statutory bail-in tool. Besides, the purchase and assumption (P&A) tool should be expanded. While implementing these structural reforms requires amendments to laws and will take time, some action can be undertaken immediately. The Prompt Corrective Action (PCA) framework could be further streamlined and made more specific to prevent critically deficient banks from operating for prolonged periods. The authorities should also start working on resolvability assessments and resolution plans for individual banks, starting with D-SIBs. The cross-sectoral coordination mechanisms to manage the potential failure of a D-SIB should be enhanced and tested. Finally, the central bank should provide Emergency Liquidity Assistance (ELA) only against collateral.

While significant progress has already been made, further strengthening the macroprudential framework will be beneficial for dealing with future economic challenges. Within the Bangko Sentral ng Pilipinas (BSP)—the central bank and bank regulator—the sectors and units should collaborate to enhance essential financial stability exercises, including macro scenario stress tests of banks. The decision-making processes should reflect monetary policy, supervisory, and macroprudential perspectives given their interlinkages. The macroprudential toolkit should be expanded beyond the countercyclical capital buffer (CCyB), and the BSP should establish operational procedures in setting macroprudential policies, including introducing thresholds of relevant systemic risk indicators that trigger discussion to activate tools. The influence of the inter-agency Financial Stability Coordination Council (FSCC) could be elevated with a comply-or-explain mechanism and by providing financial stability objectives to supervisors of nonbank financial institutions.

Since the last FSAP, the BSP has modernized the oversight framework for banks, but material gaps in powers and conglomerate supervision remain. The government should amend the unusually stringent bank secrecy law as it limits BSP’s legal powers for effective prudential supervision and could impair financial stability and development. The BSP should strengthen conglomerate supervision with additional powers to obtain information from banks’ affiliates and to bring and supervise all related financial institutions under a regulated financial holding company. Regulatory powers and standards for transferring significant ownership, controlling interest, and assessing beneficial owners’ suitability should be enhanced. Financial conglomerates should be supervised with closer cross-agency collaboration, led by the BSP as the lead supervisor, and strengthened requirements and monitoring of large exposure and related party transactions.

The effectiveness of the Anti-Money Laundering and Counter Financing of Terrorism (AML/CFT) regime needs to be substantially enhanced. The 2019 Asia Pacific Group on Money Laundering (APG) assessment gave low/moderate grades to the regime. Without major reforms by June 2021, the country could again be included in the Financial Action Task Force (FATF) list of jurisdictions with serious AML/CFT deficiencies and expose the financial system to significant risks.

Analysis of climate change risks shows the importance of improving data and building capacity. The Philippines is highly exposed to physical (typhoon) risks. The FSAP developed an innovative tool that combines climate science and catastrophe risk models to build long-term bank solvency test scenarios. The analysis indicated the relevance of physical risks for financial stability, though they are not systemic unless extreme tail events—once in 250–500 years—materialize.

Table 1.

Philippines: Key Recommendations

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Short-term (ST) = within one year; medium-term (MT) = one to three years

Background

A. Financial System Structure

1. The size of the financial system is broadly in line with the economy’s level of development (Figure 1). The total assets of the system amount to 126 percent of GDP (Table 2). The banking system holds about 94 percent of the system’s assets, but bank credit is just over 50 percent of GDP as banks hold substantial liquid assets. Access to finance for individuals is significantly lower than in other Asian emerging market economies (EMs), with only a third of adults having formal accounts.

Figure 1.
Figure 1.

Financial Sector Development: Philippines and Selected Economies

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Table 2.

Philippines: Financial System Structure

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Sources: National authorities

Number of institutions is as of end-June 2019.

Data on NBFIs is end-March 2019, except insurers and mutual funds, which is end-June 2019.

Including investment houses, finance companies, investment companies, securities dealers/brokers, pawnshops, lending investors, non-stock savings and loan associations, venture capital corporationss., and credit card companies, which are under BSP’s supervision. The line also includes private and government insurance companies. Data is end-March 2019.

2. The banking sector is dominated by several large domestic banks. Forty-six universal and commercial banks (UKBs) hold over 94 percent of bank assets, of which 60 percent are held by the top five banks (all domestic). Foreign bank subsidiaries and branches hold seven percent of bank assets. Also, there are about 500 small thrift banks (TBs) and rural and cooperative banks (RCBs).

Financial Development

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Sources: IMF Financial Development IndexNote: The index is based on a composite of financial institution and market development (depth, access, and efficiency).

Bank Business Model

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Source: BIS, BSP, and IMF staff calculations.

3. Overall, banks follow a traditional commercial banking business model, relying on deposits and lending mostly to large NFCs (Figure 2). Eighty percent of the loans go to NFCs, which is unusually high, partly because of underdeveloped corporate bond markets. The exposure to real estate loans is relatively low under a regulatory limit of 20 percent of total loans applicable to UKBs (raised to 25 percent upon COVID-19). These loans are largely commercial. The exception is TBs, providing one-third of their loans to residential properties. TBs and RCBs are more exposed to household consumption and agriculture loans. A quarter of assets are securities (mostly sovereign bonds). Overall, banks are liquid, with nearly 40 percent of their assets in securities and central bank reserves, the highest level among Asian EM peers.

Figure 2.
Figure 2.

Business Model of the Banking System

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

1/ The law, introduced in 2009, requires banks to invest 25 percent of the increase of funding since 2009 (about 10 percent of UKB borrowing) to the broad agricultural sector (wider than the standard industry classification). At end-2019, UKBs provide about half of the required amounts and pay fines for shortfalls. The draft bill to expand the scope of qualifying investments is at the Senate.

4. The banking sector is subject to bank secrecy laws that undermine financial stability, financial integrity, and development and expose the banking system to reputational risk (Table 6). The past two FSAPs, recent Article IVs, the 2020 Basel Core Principle (BCP) assessment, and the 2019 mutual evaluation report on AML/CFT by the APG—a FATF-style regional body—all emphasized challenges to supervisory effectiveness from these laws. Unlike most other countries with strict secrecy laws, the Philippine laws do not allow banks to share depositor information directly with supervisors for prudential purposes.1 They reduce supervisors’ ability to monitor liquidity risk and make banks vulnerable to reputational risk. The secrecy laws also slow down the payouts by the Philippine Deposit Insurance Corporation (PDIC) and reduce the effectiveness of misconduct investigations by the Securities Exchange Commission (SEC). Furthermore, the laws prevent the Philippines from joining some regional capital market initiatives.

Table 3.

Philippines: Selected Economic Indicators

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Sources: Philippine authorities; World Bank; and IMF staff estimates and projections.

In National Capital Region.

Latest observation as of 2019:Q4.

Benchmark rate for the peso floating leg of a 3-month interest rate swap.

IMF definition. Excludes privatization receipts and includes deficit from restructuring of the previous Central Bank-Board of Liquidators.

Table 4.

Philippines: Financial Soundness Indicators

(In percent)

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Source: Philippines authorities; IMF, Financial Soundness Indicators; and IMF staff estimates. *As of September 2020.
Table 5.

Philippines: Main Policy Measures to Mitigate the Impact of COVID-19

(as of October 2020)

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Table 6.

Philippines: Risk Assessment Matrix

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5. NFCs are deeply interconnected with the financial system through “mixed” conglomerate structures that include NFCs and financial institutions (Figure 3). Seven out of the ten largest banks (holding about 60 percent of total bank assets) are related to local-family-owned mixed conglomerates. The network analysis by the BSP and the FSAP suggest that the primary source of contagion among banks is common exposures to large conglomerates.

Figure 3.
Figure 3.

Financial Linkage Among Banks and Conglomerates

(Inner circle = conglomerate groups, outer circle = banks)

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Sources: BSP and IMF staff visualization.Note: The sample includes 20 large conglomerates. Out of all UKBs and thrift banks, those with more than one connection (lending counterparts among the 20 conglomerates) are included in the figure Based on banks’ large exposure data. Bank deposit data are not available due to the secrecy law.Node size represents the degree of the network. Nodes color codes: light pink = thrift banks that are not part of any conglomerate; light green = foreign banks; dark grey = government-owned banks; light grey = conglomerates and banks in a conglomerate with a relatively smaller group total exposures; and other colors = other conglomerates—for instance, the three red nodes indicate a conglomerate groups and two banks that belong to the conglomerate.

6. The other segments of the financial system are underdeveloped. Nonbank financial institutions (NBFIs) are much smaller than several Asian peers. Informal financing among family members is more significant to households than retail bank loans. The domestic stock market capitalization and bond outstanding are roughly 90 percent and 30 percent of GDP, respectively, but government securities dominate the debt market.

7. The Fintech ecosystem is nascent. Digital payments are used much less than in Asian EM peers. The 2017 Global Findex results indicate that only a quarter of the adult population made or received at least one digital payment in the preceding year. Some of the constraints include expensive bank charges and barriers to establishing IT and communication infrastructure for the archipelago of over 7,000 islands.

8. The financial system is indirectly exposed to international spillovers (Figure 4). Banks’ direct cross-border exposure is low at about 10 percent of bank assets and liabilities, mostly to service overseas Philippine workers. Dollarization is also moderate (15 percent of deposits and 11 percent of loans are in Foreign Exchange, FX). Exposures to FX risks are tightly regulated, with separate licensing requirements to conduct FX transactions and strict limits to open FX positions. Most international spillovers are likely to stem indirectly from NFCs and market contagion effects. International remittance inflows are significant (about eight percent of GDP annually). However, they may have little impact on banks’ FX deposits because they can be credited to banks only in pesos in most cases.2

Figure 4.
Figure 4.

Financial Linkage Map

(Network of Financial Claims, all instruments and currencies, March 2019)

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Sources: BSP and IMF staff visualization.NBFI = non-bank financial instituitons, NFC = non-financial corporation. Yellow lines=liabilities to foreign investors, blue lines = bank assets, and red lines = NFC assets. Bubble size represents relative financial footprint of the sector (sum of financial assets and liabilities). Financial exposure data among NFCs and between households and NFCs are missing.

9. The financial system faces risks from climate change. As indicated in the 2019 Article IV report, the Philippines is highly exposed to climate-related natural disasters (i.e., physical risks such as typhoons, landslides, floods, droughts). Transition risks for the Philippines appear to be closely related to the coal-based power generation industry.3 The BSP is building up capacity to assess climate risks and joined the Central Banks and Supervisors Network for Greening the Financial System (NGFS) in 2020.

B. Macrofinancial Developments

10. The Philippines was severely hit by COVID-19 (Figure 5 and Table 3) but is now recovering. Real 2020 GDP contracted by 9.5 percent. The government imposed stringent quarantine measures, resulting in 12 percent (H/H, s.a.) real GDP contraction in the first half of 2020. The recovery started in the third quarter, mainly driven by easing containment measures and economic policy support with real GDP increasing by 8.0 percent in the third quarter and 5.6 percent in the fourth quarter (q/q, s.a.). The Fund projects 2021 real GDP growth to be 6.6. percent (January 2021 World Economic Outlook, WEO).

Figure 5.
Figure 5.

Macro-Financial Indicators

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Sources: Haver Analytics, Moody’s Analytics, Bloomberg, Datastream, national authorities, and IMF staff estimates.

The Magnitude of the COVID-19 Shock to GDP

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

The worst ten hit countries include Libya, Guyana, Macao SAR, Lebanon, Venezuela, and Caribbean Islands.

11. However, the economy went into the pandemic with better macro-financial fundamentals than before the AFC, as a result of bold structural reforms and prudent macroeconomic policies (Figures 5–6). Annual economic growth has been over 6 percent during 2013–19, with moderate inflation. Public debt steadily declined in the past 20 years, reducing the country’s risk premiums. External debt and international reserves have improved. Pre-COVID financial indicators of NFCs were healthier than the pre-AFC time. While property prices doubled in the past ten years, they are broadly in line with income growth, and residential mortgages are only four percent of GDP.

Figure 6.
Figure 6.

Risks from Non-Financial Sectors

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

IDN = Indonesia, MYS = Malaysia, PHL = Philippines, SGP = Singapore, THA = Thailand, and VNM = Vietnum.

12. Before the pandemic, banks’ health appeared comparable to other EMs despite some deteriorations since the mid-2010s (Table 4 and Figure 7). By historical standards and among key EM comparators, the NPL ratio was low at end-2019. The CAR was stable at about 15 percent in the past ten years, and the quality of capital is high. Return on assets (ROA) has been about 1½ percent—at the median among EMs—supported by high interest margins. TBs and RCBs tend to have higher NPL ratios (around 6 and 11 percent, respectively) than UKBs (about 1½ percent), but they also have higher capital ratios and cure rates back to performing.

Figure 7.
Figure 7.

Financial Soundness Indicators

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

PBS = Philippines banking system.

13. So far, the financial system has broadly withstood the COVID-19 shock (Figure 5 and Table 5).

  • Financial markets: Markets recovered well after a brief period of increased volatility in March 2020. The exchange rate appreciated slightly against the USD for 2020 as a whole, and gross international reserves recovered by nearly US$20 billion to US$110 billion between end-April and end-year (11 months of import coverage). The BSP cut policy rates and reserve requirements in contrast to the AFC.

  • NFCs: Market analysts forecast significant earnings shocks, especially in retail, tourism, transportation, and construction industries. The authorities launched a small (0.6 percent of GDP) credit guarantee program for loans to small- and medium-sized enterprises (SMEs) and the agricultural sector. Moratoria (total of five months) expired at the end of 2020.

  • Banks: Lending standards have tightened, and credit is contracting though the credit gap remains positive as GDP contracts. The NPL ratio rose from 2.1 at the end-2019 to 3.4 percent in September 2020, so has the share of past-due loans and restructured loans. However, the CAR rose over one percentage point since end-2019 (Table 4). However, these figures may have optimistic bias under moratoria and forbearance measures. At the same time, banks continued to receive new deposits, reducing the loan-to-deposit ratio noticeably.

14. The BSP also issued time-bound regulatory relief and forbearance measures (Appendix IV). Measures included unusually strong forms of forbearance to delay NPL recognition and allow banks to provision over a maximum period of five years subject to the BSP’s approval. The uptake appears to be limited so far, given the BSP’s tight approval criteria. We welcome BSP’s effort to keep track of credit quality information without policy measures to maintain transparency.

Systemic Risk Assessment

A. Key Risks, Assessment Methods, and Scenarios

15. The key risks to financial stability stem from the COVID-19 crisis and bank-corporate linkages. The economic impact of COVID-19 is already much worse than the AFC. Uncertainty surrounding the growth outlook is larger than usual, mainly stemming from the uncertainty about the pandemic and the timing of the vaccine rollout. But the economy may recover faster, especially if reinforced with a quick vaccine rollout. Containment measures will depress NFC earnings, and they could spill over to bank health through direct exposures and ownership linkages of mixed conglomerates.

Quantitative Risk Analyses and Their Linkages

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

DSGE = Dynamic Stochastic General Equilibrium, ICR = interest coverage ratio, SVAR = Structural Vector AutoregressiveSee Appendix I, stress testing matrix for more details.1/ Moratoria (Table 5) could reduce NFC liquidity stress and, therefore, drawdowns of NFC’s liquid assets, including bank deposits. While it reduces cash inflows to banks from loan repayments, banks may experience lower deposit withdrawal from NFCs. It will reduce bank capital if banks eventually need to write off moratoria-related restructured loans.2/ Bank solvency test does not examine additional effects from interbank exposures as such links are negligible (Figure 3).

16. The FSAP mission conducted bank stress tests and applied new tools to better understand bank-NFC and bank-economic linkages (Appendix I). NFC tests assess the effects of earnings shocks on their capacity to repay bank loans. The bank solvency test covers all banks, and liquidity tests examine UKBs. Both use end-2019 data, as reported 2020 data are likely to be biased upward due to temporary policy effects. Solvency test results are then used to estimate the second-round effects on GDP through credit growth channels. The model is applied to analyze counterfactual policy to restructure NPLs promptly. Cashflow stress tests of banks and NFCs are linked to assess their liquidity contagion. The mission also developed a new approach to assessing physical risk from climate change (Appendix I and VI). Except for bank-NFC liquidity linkage analysis, all exercises do not incorporate the effects of sectoral support measures. The guarantee program is limited to SMEs and the agricultural sector and small (0.6 percent of GDP). Moratoria expired at the end of 2020. Forbearance measures that are not compatible with Basel III should not be incorporated.

17. The macroeconomic scenarios assume different directions and degrees of risks from COVID-19. The real GDP paths of all four scenarios (baseline, upside, adverse, and severe adverse) are more severe than the AFC but less than the political turmoil experienced in the mid-1980s. The baseline is unusually weak, a nearly three standard deviation shock to GDP compared to the pre-COVID forecast. The unlikely severe adverse includes an additional 3.8 standard deviation shock to the baseline due to tighter containment measures and severer scarring effects. However, unlike the AFC, policy rates are assumed to remain low in all scenarios given the development. Still, financial conditions tighten slightly with higher risk premiums.

Macro Scenarios: GDP Assumption

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Note: See Appendix I for more details, including paths of other macrofinancial variables.WEO forecast (Table 3, real GDP growth rate is -9.6 percent for 2020 and 6.6 percent for 2021) is slightly revised down from October WEO (-8.3 percent for 2020 and 7.4 percent for 2021) but still above the adverse scenario.

B. Nonfinancial Corporations

18. The mission assessed the NFC risks with a macro-scenario approach. The work in 2019 Article IV has been expanded to evaluate the impact of the COVID-19 pandemic on corporate earnings, interest coverage ratio (ICR), and cash positions. The sample is mostly limited to listed firms due to data availability, but it covers nearly half of bank loans.

19. Philippine firms are likely to experience substantial distress even in the baseline (Figure 8). The GDP shocks are expected to reduce corporate earnings across different sectors, especially in the energy, consumer discretionary, and industrial sectors. As a result, the debt weighted average ICR would decline from 4.9 percent at end-2019 to 1.3, below one, and 0.2 in the baseline, adverse, and severe adverse scenarios, respectively. Debt-at-Risk (the share of debt issued by firms with ICR below one) would jump from five percent at end-2019 to about 45 percent even in the upside scenario and reach 80 percent in the severe adverse scenario. However, the contribution from other macroeconomic shocks, such as the exchange rate shock, appears to be relatively small.

Figure 8.
Figure 8.

Non-financial Corporate Stress Test Results

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

IDN = Indonesia, MYS = Malaysia, PHL = Philippines, SGP = Singapore, THA = Thailand, and VNM = Vietnam.

20. The NFC distress could significantly elevate credit risks to banks if the crisis persists. Support from wealthy owner families of large conglomerates and policy support for SMEs could mitigate contagion from NFC distress to bank solvency. Loan moratoria, which do not automatically classify loans as NPL immediately, could help firms survive liquidity shocks. However, it might only delay eventual bankruptcy if the crisis incurs persistent impact.

C. Bank Solvency Stress Test and Second-Round Effects Bank Solvency Stress Test

21. While banks can withstand the severe baseline scenario, they could experience systemic solvency stress in a much more severe adverse scenario. By 2022, the CAR falls from 15.6 percent to 11.7 percent in the baseline, 9.3 percent in the adverse scenario, and 4.9 percent in severe adverse scenarios compared to the 10 percent minimum CAR requirement. UKBs are more likely to meet the Common Equity Tier 1 Ratio (CET1) requirement (6 percent minimum requirement) as the quality of capital is high. Nonetheless, capital ratios start to recover in 2022 in adverse scenarios in line with the assumed economic turnaround.

Bank Solvency Stress Test Results

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Note: See Appendix I for the details of stress testing methods and assumptions and Figure 8 for additional information about the results. All banks have to comply with the minimum CAR of 10 percent set by the BSP (Basel III 8 percent). The results with actual 2020 GDP sit somewhere between the October baseline and adverse scenairos.

22. The impact is particularly noticeable for UKBs and RCBs, but capital shortfalls vis-à-vis minimum requirements are moderate. Even in the baseline, 185 banks (mostly RCBs), which account for about a third of the system by assets, might not meet the 10 percent requirement. In the adverse scenario, 201 banks could have capital shortfalls. In the unlikely severe adverse scenario, 214 banks with three-quarters of the system’s assets miss the minimum CAR requirement. Nonetheless, capital shortfalls appear moderate—below four percent of GDP even in the severe adverse scenario.

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Figures at the end of the stress test horizon (2022).

Amount of money needed to bring CAR and CET1 to respective regulatory minimums. UKBs and TBs and RCBs that are subsidiaries of UKBs have to comply with the following minima (hurdle rate for the stress tests): CAR 10 percent (Basel III 8 percent), CET1 ratio 6 percent (Basel III 4.5 percent) and Tier 1 ratio 7.5 percent (Basel III 6 percent). Moreover, these banks are required to hold a 2.5 percent capital conservation buffer and, if applicable, a D-SIB buffer (of 1.5 or 2 percent). The minima for independent TBs and RCBs are: CAR 10 percent and Tier 1 ratio 6 percent. They are not subject to buffer and leverage ratio requirements either.

23. A jump in NPLs is the key driver of the results (Figure 9). PDs for UKBs jump to the level comparable to and higher than in the AFC episode in adverse and severe adverse scenarios. This increases NPLs sharply. As a result of the jump, loan-loss provisioning (LLP), lost interest income from NPLs, and lower margins drag capital ratios down.

Figure 9.
Figure 9.

Bank Solvency Stress Test Results

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

1/ Contribution is measured as the 2019 profit and loss multiplied by three minus 2020–22 cumulative profit and loss projection in each scenario.NII = net interest income; LL = loan loss (provision); Non-II = non-interest income; Non-IE = non-interest expense; NTI = net trading income; and OCI = other comprehensive income (valuation change of available-for-sales securities).

Second-Round Effects

24. The mission estimated the second-round effects focusing on the macro-financial linkage through credit growth. Bank-by-bank solvency test results are used as explanatory variables to project bank-level credit growth. After examining various model specifications, the final model includes changes of NPL ratios LLP ratio. Capital ratios were not significant in estimations, possibly because the past crisis-time regulatory responses reduced their risk-sensitivity. The aggregated credit growth projection is then fed into a structural-VAR that produces a change in real GDP growth rate in response to reduced credit growth.

25. Second-round effects through weaker credit growth may double the initial shock to GDP in adverse scenarios. In the adverse (severe adverse) scenario, the banking sector CAR declines by nearly 8 (12) percentage points, which could reduce the real GDP level by additional 4 (9) percentage points by 2021. The effect might persist for several years.

Second-Round Effects: Feedback from Bank Distress to the Real Economy

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Note: See Appendix I for the details of the model.

Counterfactual Policy Effects

26. The second-round effect models can be used to investigate the effects of counterfactual policy measures. Since the empirical credit growth model indicates NPL ratios and LLP ratios as significant predictors, we consider the effects of a one-time write-off of NPL worth (an arbitrary) 30 percent of LLP stock in 2021—which we assume will be financed by available excess capital.

Cost-Benefit Analysis of Counterfactual Policy

(2019 real GDP = 100)

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Note:Benefit 1: Maximum difference in the level of real GDP during 2020–22 Benefit 2: Sum of differences in the level of GDP from 2020 to 2022. Cost: 30 percent of loan-loss provision stock as of 2021 (one time).

27. The estimates appear to suggest net positive effects of timely loss recognition and NPL restructuring (Figure 10). The counterfactual policy’s costs (the necessary excess capital) ranges from 1½ percent to nearly 3 percent of GDP. While the single year benefits are about the same as the costs, the benefits last for multiple years. The total benefits from 2021 to 2022 are significantly above the costs.

Figure 10.
Figure 10.

Second-Round Effects and Policy Effects Simulation

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Note: See Appendix I for the details of counterfactual policy design.

Limitation of the Analysis

28. The results should be interpreted with caution, given the uncertainties amid the COVID-19 shock, as they could bias the results to both directions. Stress test results are sensitive to assumptions over cure rates for NPL (back to performing), the extent of deleveraging, and loss-given-default (LGD), which could all show atypical patterns during a crisis. FSAPs usually assume conservative parameters that increase the negative impact. Credit risk during a deep economic crisis may evolve differently from what historical patterns imply. Also, our exercise did not incorporate the effects of policy measures because guarantees and moratoria are limited, and forbearance should not be incorporated (Appendix I). As for the second-round effects, other approaches may deliver different views.

D. Bank Liquidity Stress Test

29. Banks have sufficient buffers to withstand severe liquidity shocks (Figure 11). High-quality liquid assets (HQLA) for calculating the liquidity coverage ratio (LCR) are mostly reserves and sovereign securities. The high (12 percent) reserve requirement significantly contributes to the buffer, making its usability a critical factor for banks’ survival. Banks rely mainly on retail and wholesale deposits. The system appears to be more resilient against FX liquidity shocks than local currency liquidity shocks. However, FX buffers are concentrated in a couple of Global-SIB branches. The net stable funding ratio and cash flow analysis show similar outcomes.

Figure 11.
Figure 11.

UKBs Liquidity Analysis

(Data as of end-2019)

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

ER = excess reserve; FX = foreign exchange; HQLA = high-quality liquid asset; LCR = liquidity coverage ratio; RR = required reserve; ST = stress test.

E. Loan Moratoria and Bank-NFC Liquidity Linkage

30. Liquidity stress to NFCs from lower earnings could spill over to banks, and loan moratoria could further complicate the linkages. As detailed in Figure 12, loan moratoria’s direct effects are to improve NFC cash balance while reducing bank cash inflows and liquid assets. Without moratoria, NFC cash balance declines for debt service while increasing bank liquidity balance. However, liquidity-strapped NFCs may withdraw bank deposits, weakening banks’ cash balance. Furthermore, if banks continue to roll over healthy maturing NFC loans, NFCs’ liquidity balance recovers with or without moratoria.

Figure 12.
Figure 12.

Bank-NFC Liquidity Linkages—Framework

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

The tool is based on the cash-flow analysis of banks and NFCs (see Appendix I for details). It incorporates three channels of liquidity contagion between banks and NFCs upon NFC earning shocks (step “0” in the figure) that reduce corporate liquid asset balance.1. NFCs may cash their liquid assets, including bank deposits, when their cash inflows from earnings are not enough to finance their operational expenditures and debt service obligation (indirect effect of moratoria). NFC deposit withdrawal rate is measured by (change of NFC cash balance between end-2020 and end-2019)/ (end-2019 cash balance), assuming NFCs liquidate all types of liquid assets proportionally. If they cash in assets other than bank deposits and find alternative financing (e.g., bonds), the withdrawal rate stays low.2. Loan moratoria help NFCs retain liquidity but reduce cash inflows to banks (direct effect of moratoria).3. Additional bank lending—rollover of repaid loans and new financing—also shifts liquidity from banks to NFCs.

31. The results show that certain policies, such as moratoria, may not achieve their intended results depending on the behavior of banks and NFCs (Figure 13). For NFCs, moratoria can substantially improve their liquidity balance when banks’ rollover rate is low but less so otherwise. So, the policy effectively support them with credit supply shocks but not much so without the shocks. For banks, overall moratoria effects on their liquidity balance critically depend on whether NFCs have alternative financing sources (e.g., liquidating other assets or issuing bonds). If NFCs withdraw deposits, banks might experience broadly the same cashflow effects irrespective of moratoria policy. The BSP could monitor banks and NFCs’ contingent financing plans to gauge the systemwide effects better.

Figure 13.
Figure 13.

Bank-NFC Liquidity Linkage—Results

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Note: The rollover rates of 90 percent are comparable to the distressed level observed during the past crises. During normal time, the rollover rates usually exceed 100 percent. Fifty percent is the assumption from Basel III LCR.

Bank-NFC Liquidity Linkage and Moratoria

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Source: IMF staff estimates.1/ During normal times, banks’ rollover rates for existing loans exceed 100 percent, reflecting normal time credit growth. Data shows they went down to about 90 percent during the past distress episodes across ASEAN. Negative figures indicate deposit inflows.

F. Climate Change Risk Analysis

32. The mission developed an innovative approach for analyzing banks’ solvency for physical risks from typhoons. We built climate change macroeconomic scenarios using climate science studies, a catastrophe (CAT) risk model, and a macro-financial model (Appendix I and VI).

33. The analysis indicated the relevance of typhoon risks, though they may not be necessarily systemic except for extreme tail events. Without other shocks, the destruction of physical capital from typhoons’ wind alone would reduce bank capital ratio only by one percentage point even in the once-in-500-year event in the future. However, the joint shock with pandemic intensifies the effects of climate change for extremely intense typhoons. For once in a 500-year events, the difference between current and future scenarios with the pandemic rises to 4½ percentage points.

34. At this stage, the BSP should continue enhancing data and building capacity. The BSP has started to integrate green finance and Environmental, Social and Corporate Governance principles (ESG) principles into its investment policy, joined the NGFS, and has initiated studies on rainfalls and bank performance. It has issued the circular for banks on environmental risk management, governance, and disclosure, which should be followed-up by more granular regulations and guidance on risk management, stress testing, and reporting and disclosure. Supervisory capacity should be built to monitor uptake in on-site and off-site supervision.

Climate Change Stress Test

Citation: IMF Staff Country Reports 2021, 074; 10.5089/9781513576763.002.A002

Notes: Bank capital ratio of UKB banks.See Appendix I for methodological details.1/ Bank capital rise in scenarios without pandemic over the short-period due to the valuation gains with securities (mostly sovereign) as the central bank cut policy rate.

Managing Risks from Covid-19

35. Given the significant downside risks, the authorities should limit bank dividend distributions and be ready to take additional measures to strengthen bank capital if downside risks materialize.4 Given the potential for large loan losses, the authorities should limit dividend distributions as a precautionary measure. If downside risks materialize, the BSP should consider broader policy options (e.g., support measures facilitating the sale and recovery of bad assets, raising additional capital starting with conglomerate owner families and private sector funding, and public funding only as a last resort). This is supported by the counterfactual policy analysis, which suggests that timely NPL restructuring and loss recognition, financed by adequate capital, can improve GDP with sustained credit provision, while the benefits of such a policy are higher than its cost. The experience during the AFC (detailed in Appendix IV) also shows credit-to-GDP contraction from over 50 percent to 25 percent in the ten years since 1997 while NPLs are recognized and restructured only slowly, supports the recommendation.

36. The BSP should allow the forbearance measures to lapse as scheduled and avoid introducing new measures (Appendix IV). Forbearance does not address the underlying issues in weak banks and hampers banks’ ability to continue to support the economy and ultimately may even undermine financial stability. Instead, the authorities should continue to use the flexibility in the accounting and Basel capital frameworks, and, looking at the future, further develop and use macroprudential tools and buffers. While the BSP used some of these micro and macro-prudential tools during the current crisis, the preceding forbearance measures could undermine their effectiveness by reducing bank capital’s sensitivity to risks, as forbearance keeps bank capital at artificially high levels.

Macroprudential Framework and Oversight

A. Framework

37. The BSP plays a central role as the central bank, bank and payment system supervisor, macroprudential authority. The BSP is the only supervisor with financial stability mandate. The organization structure for macroprudential issues is different from that of monetary and supervision issues. A recently created financial stability “unit” (Office of Systemic Risk Management, OSRM) works on macroprudential issues, headed by an Assistant Governor (AG). In comparison, monetary policy and supervision are larger “sectors,” each headed by a Deputy Governor (DG). BSP’s Financial Stability Policy Committee (FSPC), a Monetary Board (MB) subcommittee comprising of all MB members, decides on macroprudential issues, while the MB makes monetary policy and supervision decisions.

38. The BSP should enhance collaboration and coordination within to conduct essential macroprudential analysis and assure a balanced decision-making process.

  • Financial stability analysis: Currently, the supervision sector implements all bank-related analysis and sets prudential tools except for CCyB, and OSRM focuses on non-financial sectors and their link to banks and CCyB. No units/sectors conduct macro-scenario stress testing—one of the essential tools for financial stability analysis—despite the staff’s strong capacity. The BSP should start such exercises. There is no single best practice about how to organize stress testing work. Several units and sectors could work jointly, or different sections could conduct distinct exercises depending on their objective.

  • Decision-making process: Monetary and supervision sectors and OSRM should enhance their coordination at technical and senior levels so that the BSP decides monetary, micro-prudential, and macro-prudential policies incorporating all the three perspectives with a clear mechanism to resolve any conflicting views. Multiple institutional arrangements could facilitate cooperation. For instance, an advisory committee could be added to the FSPC to facilitate technical-level cooperation, similar to the arrangement for monetary policy. Also, OSRM’s AG could be given the general right to attend MB meetings to participate in discussions on monetary policy and financial supervision (similar to the DGs, who are attending the FSPC meetings).

39. The Financial Stability Coordination Council (FSCC), a voluntary interagency body, is responsible for the cross-sectoral coordination of macroprudential policies and crisis management. It includes the BSP, SEC, Insurance Commission (IC), PDIC, and the Department of Finance (DoF) and is chaired by the BSP. The BSP also chairs the Financial Sector Forum (FSF) that coordinates microprudential policies and the supervision of financial conglomerates.

40. The influence of FSCC decisions should be enhanced. So far, the FSCC has been focusing on risk monitoring. To mitigate potential inaction bias, the FSCC should obtain powers (and a clear Charter or Terms of Reference) to make formal recommendations to its members with a comply-or-explain mechanism. Providing a financial stability objective to the IC, SEC, and PDIC could also strengthen the influence of FSCC’s recommendations.

B. Policy and Oversight

41. The BSP should expand its macroprudential policy toolkit and establish operational procedures to set them in a more systemic risk-sensitive manner. So far, CCyB is the only prudential tool explicitly recognized as a macroprudential toolkit. Nonetheless, other jurisdictions use many other prudential tools explicitly for macroprudential purposes (Table 7). While the BSP has many of these instruments (e.g., loan-to-value (LTV), liquidity, FX positions), these are not explicitly calibrated to counter systemic structural (e.g., the concentration of exposures) or countercyclical risks. Indeed, operational procedures—including introducing thresholds of relevant systemic risk indicators that trigger discussion to activate tools—are missing for CCyB as well.

Table 7.

Philippines: Key Macroprudential Policy Measures (MPMs): Selected Asian Economies

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Source: IMF Macroprudential Policy Database.

These broad-based tools are only applicable to the banking sector and, in some cases, to investment firms.

Note: In addition to these MPMs, the Philippines has extensive capital flow management (CFM) measures on FX transactions and borrowings—mostly to banks. For instance, banks have to obtain a separate license to handle FX transactions, and their access to non-deliverable forwards (NDFs) are constrained. However, many of the CFM measures do not apply for NBFIs and non-financial corporations as well as transactions in cash or foreign soil (that are not repatriated), which led to developing substantial and efficient informal FX and derivatives markets that are even larger than formal markets.

42. The data gap should be reduced to improve systemic risk monitoring and operationalize macroprudential tools. The quality of risk analysis is constrained by data gaps such as the lack of information on granular credit risk, including a comprehensive credit registry, LTV ratios, small and unlisted NFCs, and household indebtedness and survey, and detailed depositor information due to the bank secrecy. In this context, the new BSP power in the revised central bank charter to collect information from broader economic sectors for stability analysis and SEC’s initiatives to digitalize NFC data are welcome progress.

Microprudential Supervision

A. Bank Supervision

43. The BSP has modernized its oversight framework since the previous FSAP and shows reasonably good compliance with the BCPs as an EM (2020 BCP assessment). The 2019 amendments to the BSP charter (NCBA) formalized its financial stability mandate, extended the scope of supervised entities, and granted the legal power to ask banks to hold capital beyond minimum regulatory requirements (Pillar 2). The BSP has been making progress in implementing the full Basel III framework. It introduced several core Basel III requirements (e.g., capital definition; capital buffers; Pillar 2; leverage ratio; LCR and NSFR, and the supervisory framework for D-SIBs); and amended core banking supervision legislation and numerous guidelines.

44. Nonetheless, material gaps remain with of BSP’s legal powers related to conglomerate supervision. The BSP lacks powers to regulate, obtain information for prudential purposes, and examine the parent or other affiliate companies of banks. It cannot require mixed conglomerates to establish a regulated financial holding company that includes all group financial institutions. Finally, regulatory powers and standards on transferring significant ownership or controlling interest and assessing beneficial owners’ suitability are not clear enough.

45. The BSP should strengthen conglomerate supervision by enhancing sectoral and group-wide supervision with closer cross-agency collaboration. At the group-level, the BSP should be appointed as the lead supervisor for FCs, given banks’ systemic importance. Then it should conduct a more frequent and comprehensive risk assessment of FCs. The BSP should enhance the large exposure requirements and reporting on both solo and consolidated bases and enhance related party transaction reporting and monitoring. Capital ratios for FCs should be set based on their specific risk profile as part of the Pillar 2 process. To support more effective conglomerate supervision, the IC and SEC should adopt a risk-based approach with appropriate resources.

B. Financial Integrity

46. The FATF may include the Philippines in the list of jurisdictions with serious AML/CFT deficiencies in 2021. The 2019 APG assessment gave low/moderate grades to the AML/CFT regime’s overall effectiveness, including supervision, preventive measures, and entity transparency. Absent sufficient progress by June 2021, the country could again be included in the FATF list and potentially face adverse effects on trade and remittances.

47. The authorities have started to take some actions. For example, the AMLC issued regulations expanding the definition of suspicious transaction reports and revised the reporting timelines. The BSP conducted thematic reviews and is enhancing its risk-based supervisory tools. Other AML/CFT supervisors (SEC, IC, and Philippine Amusement and Gaming Corporation, PAGCOR)5 are in various stages of assessing their sector’s ML/TF risks and strengthening their supervisory approaches. While SEC-registered companies are now required to disclose their beneficial owners, the framework to access the information by competent authorities and reporting entities is being finalized.

48. Yet, additional reforms will be needed to enhance the AML/CFT regime’s effectiveness more fully. Legislative amendments should be promptly approved to (i) give BSP, SEC, and IC direct and full access to individual depositor information covered by bank secrecy laws (Appendix V); (ii) designate tax crimes as predicate ML offenses; and (iii) establish a comprehensive legal framework for targeted financial sanctions against proliferation financing.6 AML/CFT supervisors should continue to build their supervisory capacities and ensure high-risk reporting entities understand key risks and fulfill their obligations. The AMLC should work with AML/CFT supervisors to establish more efficient rules to apply administrative sanctions. Ensuring accuracy of and timely access to beneficial ownership information should be prioritized. PAGCOR should effectively apply risk mitigation and risk-based supervision measures (i.e., targeting casino junket operators). The authorities should resolve PAGCOR’s conflict of interest from its responsibilities for operating casinos and AML/CFT supervision.

Financial Safety Net, Bank Resolution, and Crisis Management

49. The PDIC should be designated as and given comprehensive powers to act as resolution authority. The legislation in the Philippines does not explicitly single out the resolution authority. While banking institutions are subject to a blend of BSP and PDIC resolution powers, PDIC appears to serve as the de-facto principal resolution authority. Building on the existing framework, the logical next step would be to amend laws to formally designate the PDIC as the resolution authority.

50. Notwithstanding some progress in strengthening the resolution framework, the resolution toolkit should be further broadened. Bank resolution options are mainly limited to liquidation. In particular, the current P&A tool does not allow to leave uninsured creditors and bad assets behind. The law should provide for bridge banks and possibly for statutory bail-in tools along with increasing loss absorbing capacity requirements and strengthen the P&A tool to address potential D-SIB failures. The revised resolution framework should contain safeguards for bank stakeholders. In addition, the early intervention and remedial action framework could be further streamlined and include a clearer escalation process to avoid that severely deficient banks continue operating for long, as currently observed occasionally. The recent steps taken to clarify the preconditions for bank closures are welcome, but they could still leave weak banks operating for too long. Also, the PDIC should discontinue bailing out the shareholders of a weak bank by providing open bank assistance. Finally, the authorities should consider establishing a dedicated backstop for the Deposit Insurance Fund from the government/Treasury to ensure prompt access to the funds.

51. The authorities should immediately start working on resolvability assessments and resolution plans for individual banks, starting with D-SIBs. The assessments of resolvability should be incorporated into the supervisory and resolution framework, especially for D-SIBs. To complement the bank resolution framework, the authorities’ capacity and coordination need further attention. The authorities should consider establishing a platform that would bring together some of the competencies of the FSF and FSCC (for example, a joint committee) as both platforms have responsibilities for addressing the failure of D-SIB.

52. The legal framework for ELA should specify the conditions under which it can be provided more. Best practices suggest that a central bank should provide ELA only if a bank satisfies preconditions, such as exhausting all market-based and shareholder-sourced liquidity support and having adequate capital and sufficient collateral. The BSP should not provide uncollateralized loans. Nonetheless, for ELA to be effective, the BSP should consider taking a broader range of collateral. The BSP needs to establish internal guidance on determining bank’s capital position and general viability for ELA purposes.

Financial Inclusion

53. Promoting digital payments could increase access to formal finance deepen financial intermediation. Encouraging all financial institutions to participate in the core domestic retail transfer systems could encourage competition and reduce the cost of digital payments. As households shift to bank deposits from cash, the banking system could expand its credit provision.

54. Improving capital markets and credit information could also advance inclusion. Simplifying the registration and approval process for the issuance of corporate debt could deepen the market. The national credit registry should increase funding to enhance its technology standards and resolve the technical issues to make the registry functional.

Appendix I. Stress Testing Matrix

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Appendix II. Implementation of 2010 FSAP Recommendations

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Note: Based on both IMF and World Bank staff assessment.

Appendix III. Recommendations from Article IV Reports

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