BSP’s Actions Should Reflect Sound Money Policies, Philippine Banks Can Afford Tightening

``The whole policy . . . must be looked upon as a case of price-fixing by which the rate of interest . . . was kept artificially lower through an unsound use of government control over banking policy. The results were speculation, inflation of prices, and eventual disillusionment and loss to investors and to large numbers of other citizens.”-Frank A. Fetter Modern Economic Problems, The Century Company

For us, the BSP should continue to raise its policy rates even if the statistical inflation index diminishes in the near term.

Raising interest rates to positive real levels will relieve policymakers of the blame of unbecoming conduct and inducing an inflationary regime, aside from reducing imported inflationary pressures via currency appreciation.

Besides, we believe that the banking sector and the Philippine economy are resilient enough to withstand further tightening.

The pervasiveness of the informal economy stresses the point that LIQUIDITY is the more important variable, since informal financing has made the sector inured to high interest rates or “5-6” microlending schemes as discussed in Phisix: In The Eyes of Asia’s Bond Market, Deflation Phantom, Hedge Against Inflation.

Next is ACCESS TO FINANCING. As testament to the low penetration level of the banking sector, according to BSP chief Amando Tetangco Jr., ``Rural banks alone cover around 80% of the total municipalities in the Philippines with nearly 730 banks and over 2,000 branches nationwide.”

But of course, with the composition of investment patterns that are likely to shift towards resource or commodity oriented industries in the rural areas, the growth of rural banks according to our BSP chief has been ``faring equally or even better than its universal, commercial and thrift bank counterparts while remaining true to its core mission of serving the needs of the countryside.” And this trend is likely to get better.

Another, mainstream bank financing growth has improved modestly but has been concentrated to mostly consumer lending. The Philippine Daily Inquirer quotes BSP Deputy Governor for bank supervision BSP Deputy Governor for bank supervision Nestor Espenilla Jr. ``Loans to the corporate sector haven’t been growing too much. What’s driving growth is consumer loan and basically this mirrors the vibrance of the consumer sector of the economy. This has something to do with the [overseas Filipino] remittance story,” he said."

In short, the expanded rural income will probably be helped by remittances and will continue to find financial intermediation support from the banking sector, most especially from the rural areas.

Finally, in consideration of overall bank intermediation, this statement from the IMF ``Despite substantial progress in reducing NPAs, they remain large and depress bank profits. Bank lending remains low, well below funds raised in the capital market in 2007, as banks are willing to lend to only their best clients. The credit reporting system is poor, only 5½ percent of adults are currently covered, and an inefficient bankruptcy code extends recovery time to 5¾ years and reduces recovery rates to 4¼ percent.”

In other words, bank lending remains highly conservative, given the shortcomings of credit reporting or bankruptcy code as the IMF cites which indicates need for administrative reforms.

Moreover, the anguish from the Asian Financial crisis probably remains impressed on our bankers, hence the functioning hindrance in the access to credit.

These are some other banking highlights from researchandmarkets.com, which suggests of the vitality of our banking sector (highlight ours)

- Deposit mobilization is concentrated with universal and commercial banks, which account for the majority of the Philippine banking industry deposit.

- Financial Intermediation was the largest shareholder of the loan disbursal by banks during 2004-2007.

- Bancassurance will account for 65% of the total sales of insurance products by 2011.

- Increasing at a CAGR of 69.78%, microfinancing in the Philippines is expected to reach 56.5 Billion Pesos.

- Increasing mobile penetration will expand the mobile banking user base to more than 11 Million by 2011.

With reference to the Philippine Stock Exchange, some suggested that increasing rates will reduce the public’s incentive to invest in the stock exchange.

This premise will probably hold true if local participants dominate the trading activities. The fact is that only a scant segment of the Philippine society of approximately 1% has invested in the PSE directly and indirectly, which means that foreigners are likely to remain as main navigators of the Phisix. And our guess is appreciating currencies, controlled “inflation”, and improving balance sheets are more of an attraction once the financial chaos in the system settles than simply rising interest rates.

Bottom line: Interest rates are not the only variable that will determine capital flows. The BSP can afford to raise rates by responsibly closing the gap of the real interest rates and at the same time addressing regulatory reform issues, while the Philippine banking system given the present economic conditions can afford to withstand such tightening measures.