Philippine Markets Daily

MONDAY MACRO: In this time of crisis, Philippine banks are more than ready with their own war chest

April 27, 2020

The 2008 financial crisis opened the public’s eyes to the lack of regulation on complex financial instruments and reckless lending by banks.

In response, the international financial institution for central banks required banks to maintain the appropriate leverage ratio in order to strengthen banks’ balance sheets and their ability to mitigate risk.

Now that the international community is on the verge of another financial crisis, this chart should further show the Philippine banks’ capabilities to mitigate the economic impact of the pandemic.

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The Bank of International Settlements (BIS) was established in 1930 to serve as a bank for central banks, and facilitate collaboration among them in the pursuit of monetary and fiscal stability.

In 2018, the Bangko Sentral ng Pilipinas (BSP) joined this elite group of banks, which currently has 62 members across the globe that, combined, accounts for 95% of world GDP.

The BIS issued the Basel Accords in 1988, which focused on the capital adequacy of financial institutions, or their capital adequacy ratio (CAR). Their third accord (Basel III) was established in 2010 in response to the 2008 financial crisis.

Banks’ CAR is determined by taking the percentage of capital that the bank has relative to its assets.

In Basel III reforms, the qualifying capital consists of three tiers that could absorb operational losses:

  1. Common Equity Tier-1, which are their common shares and retained earnings
  2. Tier-2 Capital, which are their subordinated debt and general loan-loss reserves
  3. Additional Tier-1, their other capital instruments with no fixed maturity

Meanwhile, their assets include the banks’ cash, securities, and loans made to clients and businesses.

Basel III requires banks to a specified minimum CAR level of 8%. The higher the ratio, the safer a bank is from insolvency, as it indicates that the bank has a higher capacity to absorb potential losses. This also implies lesser chances of bankruptcy in the event of a debt crisis.

The capital adequacy ratio, therefore, promotes financial stability since it serves as the basis for banks’ capital and financial strength globally.

In the Philippines, the 10% minimum requirement prescribed by the BSP is above Basel III requirements. Even then, the Philippine banks capitalized well above what is necessary.

Philippine banks have upheld this high standard during the 2008 recession, and even before the admission of the BSP into the BIS community.

In the chart above, the CAR for Philippine banks in aggregate remained stable at 14%-15% levels in Q1 2008 to Q2 2010. It expanded 16% in Q3 2010, and rose further to peak levels of 18% in Q3 2012 and Q2 2013.

However, the CAR dropped to 15% in Q1 2014 as the BSP adopted the Basel III framework where it excluded Basel II-compliant capital instruments that did not have the feature of loss absorbency such as intangible assets.

After the Basel III adoption, the CAR experienced volatility, fading to 14% levels in Q4 2016 and rebounding to 15% to 16% levels since Q2 2018.

At 15% levels, Philippine banks are highly prepared with enough loss-absorption and liquidity buffers to withstand moderate stresses in the system before the enhanced community quarantine (ECQ) in Luzon took place.

Furthermore, the government has been active in providing the necessary economic assistance to soften the pandemic’s impact.

The BSP is now lowering the maximum penalty for bank reserve deficiencies. By lowering this penalty, the BSP is enticing banks to use their reserved capital to support the liquidity requirements of their clients during the ECQ.

In addition, the Department of Finance plans to borrow more debt from international institutions such as the World Bank and the Asian Development Bank to fund the government’s budget deficit from their program to help the poorest families, small and medium enterprises (SME), and larger companies.

As our Monday Macro Report on the Philippines’ interest coverage ratio a month ago shows, the larger Philippine companies are still generating enough earnings before interest, taxes, amortization, and pension expense to service their interest expense. It is still at a comfortable level for firms to continue operations without defaulting on their loans.

Together with healthy fundamental profiles from firms, ample fiscal and monetary assistance, and above global standard liquidity buffers that would support banks’ losses, the Philippines has the financial capability to minimize the pandemic’s impact, and restore investors’ confidence.

About the Philippine Market Daily
“The Monday Macro Report”

When just about anyone can post just about anything online, it gets increasingly difficult for an individual investor to sift through the plethora of information available.

Investors need a tool that will help them cut through any biased or misleading information and dive straight into reliable and useful data.

Every Monday, we publish an interesting chart on the Philippine economy and stock market. We highlight data that investors would normally look at, but through the lens of Uniform Accounting, a powerful tool that gets investors closer to understanding the economic reality of firms.

Understanding what kind of market we are in, what leading indicators we should be looking at, and what market expectations are, will make investing a less monumental task than finding a needle in a haystack.

Hope you’ve found this week’s macro chart interesting and insightful.

Stay tuned for next week’s Monday Macro report!

Regards,

Angelica Lim
Research Director
Philippine Markets Daily
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