Attempts to carry out economic reforms from the monetary side can never amount to anything but an artificial stimulation of economic activity by an expansion of the circulation, and this, as must constantly be emphasized, must necessarily lead to crisis and depression. Recurring economic crises are nothing but the consequence of attempts, despite all the teachings of experience and all the warnings of the economists, to stimulate economic activity by means of additional credit—Ludwig von Mises
In this issue
January Banking Woes: Cash Reserves Loss Accelerates! Loan and Deposit Liabilities Growth Plunged! FX Deposits Halve!
-The Establishment’s Denial of Banking System’s Woes Won’t Alter Reality
-The Sharp Fall in the Banking System’s Cash Reserves Accelerates in January!
-Exploding Growth of HTMs and Investment Losses Contribute to the Liquidity Drain of the Banking System!
-January Woes: Loan and Deposit Liabilities Growth Plunged! FX Deposits Halve!
-LTNCDs, Bonds and Bills as Insufficient Substitute For Deposit Growth Reduction
-As Liquidity Shortages Spread to the Economy, The BSP is Trapped!
January Banking Woes: Cash Reserves Loss Accelerates! Loan and Deposit Liabilities Growth Plunged! FX Deposits Halve!
The Establishment’s Denial of Banking System’s Woes Won’t Alter Reality
Before instituting more easing, BSP Governor Ben Diokno will have his hands full with the banking system.
Struggles by the banking system have found little relief in the first month of 2019. To the contrary, the banking system has only immersed itself into a DEEPER quagmire.
First, the banking system’s balance sheet and selected performance indicators data have been published at the BSP site, hereand here. One can reconstruct the published data first-hand, to see and validate what I have been pointing out.
Yet, what has been striking has been the total blindness or the adamant refusal to acknowledge, by the establishment, of such published statistical facts. It is as if denying their existence would change reality.
By raising the public’s consciousness, it is understandable, that such would inhibit the establishment’s access to credit, escalating the tightening of the system. Why would people subscribe to bonds, bills, LTNCDs and stock rights issuance when they know that risks abound in the sector?
And should escalating risks in the system catch the awareness of the public, would that not heighten the possibility of a panic?
"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."
Given the public’s awesome glorification of the incumbent political institutions, denials predicated on the BSP’s data have been soiled, and subsequently rendered unreliable, can’t be possible.
The Sharp Fall in the Banking System’s Cash Reserves Accelerates in January!
But here’s the thing. Banks continue to draw money from the public. The question is WHY?
The first answer is obviously about liquidity.
Figure 1
Whatever gains the banking system recorded last December on their most liquid asset, the “cash and due banks” account, had been more than nullified this January.
The banking system’s cash portfolio shrank by 9.18% year-on-year, or double the rate of December 2018’s decline of 4.0%. Cash reserves shriveled for the fourteenth consecutive month in January.
Or, January’s contraction represents an extension of the series of deep monthly declines (9% to 12%) that have plagued the industry since the 2H of 2018.
Even more, the current rate of shrinkage has reached 2012 levels. And yet, the significant decline in 2012 was an anomaly, since it occurred in a single month, as contrasted to, again, the current string of sharp monthly decreases. (see figure 1, upper window).
The current extended stretch of crashing cash reserves has signified a relatively new adverse development, which has not transpired even during the near recession episode of 2009! Yes, this time must be DIFFERENT!
On a month-on-month and nominal peso basis, January’s cash reserves contracted by a precipitous Php 239.7 billion overshadowing the gains of Php 173.7 billion a month ago, the latter was brought about by the enormous borrowings from bond and bills issuance. (see below)
At Php 2.365 trillion, the banking system’s most liquid reserve assets have plunged to November 2015 lows of Php 2.313 trillion! (see figure 1, upper window).
And the most striking part of the current development has been that as the banking system continue to throw so much money to the economy, instead of generating liquidity, the oxymoron has been liquidity continues to deplete drastically!
As of January, the banking system’s (gross) loans to deposit ratio has surged to a staggering 79.05% while cash to deposit ratio plummeted to 18.85%! (see figure 1, middle window). That is, even when the rate of loan growth had been subsiding!
The banking system has lost a stunning 44.7% of cash buffer from the peak of November 2013 when the cash to deposit ratio accounted for a hefty 34.1%! In the meantime, the banking system loaded up significantly on portfolio risk by a whopping 25.1% to bloat its loans to deposit from 63.2% to the present rate of 79.05%. Talk about a massive buildup of CONCENTRATION RISK!
Cash reserves as a share of total assets as of January 2019 at 14.25% hit a December 2009 level of 14.18%. Back then the share of gross loans and total investments to total assets were at 51.35% and 27.54%, respectively, in contrast to January 2019’s 59.76% and 23%. The share of gross loans to total assets, thus, jumped by 16.38% while total investments dwindled by 16.5% in January 2019 compared to December 2009. And the cash reserve lows of 2009 represented a nadir, as it zoomed to a high of 26.01% in November 2013.
The point here is the forces influencing the banking system’s assets in 2009 has been immensely different from that today!
From March 2008, the lowest level of cash reserve to total assets recorded was on November 2008 at 13.47%. So if present cash levels were to decline by more, or reach levels seen from 2008 to 2009, such should be a paramount source of concern. Remember, back then, the share of the loan portfolio to total assets (range of 49.33% to 52.88%) had been very much smaller than today’s 59% to 60%.
And come to think of it, the BSP implemented two Reserve Requirement Ratio (RRR) cuts in 2018 (in March and June). Contra popular thinking, such RRR cuts were NOT intended for "easing" but were meant, instead, to PLUG the rapidly expanding liquidity black hole. And as the data above demonstrates, these RRR cuts have barely been of help at all!
Nevertheless, the intensifying decay in the cash conditions of the banking system will prompt the BSP to implement MORE RRR cuts in the pretext of adopting global standards.
Exploding Growth of HTMs and Investment Losses Contribute to the Liquidity Drain of the Banking System!
Because of diminishing cash reserves, the rate of total asset growth has been rapidly falling. January 2019’s 10.04% hit a 2015 low level. (see figure 1, lowest window). Reported total asset growth was at 11.5% in December 2018. It climaxed in January 2014 at 25.53%.
While the banking system continues to amass loans as its principal contributor, total investments have been the other area contributing to the growth in total assets.
January 2019 registered total investment growth of 18.65% from 18.98% a month ago. As such, total investment’s share to total assets grew to 23.06% from 22.06% over the same period.
And the Held to Maturity (HTM) Financial Assets represents the biggest share contributor to the total investment category with 63.8% in January 2019. The next is Available For Sale (AFS) Financial Assets at 21.54%, Financial Assets Held for Trading (HFT) at 6.56% and Equity Investment in Subsidiaries at 8.08%.
As I had been pounding the table here, one of the principal sources of the banking system’s liquidity drain has been from HTMs. That is because banks have sheltered their losses, via HTMs, from the markets, through accounting maneuvers. Even the late governor Espenilla led Financial Stability Coordinating Council (FSCC) admitted to this in their FSC report (p.24).
Figure 2
In 2018, the banks went into a panic stashing of their investment holdings into the HTMs, most especially in the 4Q. HTM growth spiked to 30%, then to over 50% in the last four months of 2018. So 2018 ended with relatively high levels of HTMs. (figure 2, upper and middle window)
But it doesn’t stop here.
Such panic hoarding continued in 2019, HTM growth vaulted by 32.74% in January!
The sharp drop in Treasury yields hasn’t mitigated the industry’s imperative of stacking up their investment assets into HTMs. The explosive growth of HTMs explains one of the sources of the leakage of liquidity in the banking system.
As a share of gross financial assets, Held for Trading (HFT) increased to 7.1% in January from 6.11% in December 2018, as the HTM’s tapered to 69.03% from 69.73%. Available For Sale (AFS) investments has sustained its downward trend with a 23.3% share from 23.6% in December. (figure 2, middle window)
And there’s more.
While banks have been piling into net equity investments in subsidiaries, joint ventures or associates, financial assets continue to register investment losses in January. (figure 2, lower window) January 2019’s investment losses of Php 2.7 billion signified an ‘improvement’ from the Php 12.3 billion loss a month back.
Banks have been bleeding from their investment assets since November 2017, with profits recorded only a single month in 2018! Whether direct investments have eased or worsened the banking system’s investment position is not clear. Its share of the total assets was a paltry 8.08%.
The hemorrhaging of the industry’s liquidity has partly emanated from unprofitable banks investments.
Since cheap money has signified the source of the swelling mountain of bad investments, more easing as would hardly alleviate the banking system’s losing investments
January Woes: Loan and Deposit Liabilities Growth Plunged! FX Deposits Halve!
Figure 3
The principal source of the system’s total asset has been its loan portfolio. Hence, changes in their loan portfolio should influence the banking system’s liquidity conditions.
Guess what? The rate of total loan growth in January dived to 12.6% from 13.9% a month ago. After peaking in May 2018 at 23.5%, the industry’s total loan portfolio (inclusive of Interbank loans and Reverse Repos) growth turned sharply lower. January 2019’s growth rate was seen last in 2015! (figure 3)
If loans have served as the principal source of liquidity in the past, how will the scaling back of bank loans affect the industry’s overall financial conditions?
More importantly, if banks have been pulling back from providing loans to the real economy, how will credit-dependent industries like real estate, construction, and shopping malls, which comprise the largest segment of the GDP, thrive?
The irony is that, as mentioned above, even as loan growth fell, its % share of total assets continues to grow!
Changes in the asset side get reflected on the liability side too.
Figure 4
Deposit liabilities account for 86.6% of the banking system’s total liabilities (as of January 2019).
And here’s the shocker. Deposit liability growth plunged to 6.89% in January from 8.82% in December 2018, a stunning 22% dive in the growth rate! (figure 4, upper window)
Why?
Foreign currency deposits more than halved! January foreign deposits clocked in at 3.02% in January from 7.26% in December! Though the BSP screams about the recovery in its GIRs, the horrific drop in the banking system FX holdings reveals the true state of affairs. Foreign currency deposits may have been used to fund the BSP’s GIR. Foreign currency deposits constitute 16.85% of total deposit liabilities.
On the other hand, Peso liabilities, which account for the largest share of total deposits at 83.15%, registered a steep decline in its growth rate of 7.71% in January from 9.13% a month ago, a 15% decrease.
The following represents the distribution % share of peso liabilities as of January 2019: Savings deposit 46.6%, Demand and NOW deposits 27.2%, time deposits 23.93% and Long Term Negotiable Certificate of Deposits 2.26%.
The three most significant segments of peso deposits posted considerable growth losses: Savings deposits: 7.58% in January from 7.9% in December (-4.0%). Demand (checking) and NOW deposits: 6.33% from 8.57% (-26.14%). Time deposits: 8.37% from 11.21% (-25.3%). (figure 4, middle window)
The sharp declines in Demand deposits are manifestations of the plummeting growth rate of bank credit expansion!
The NG raised Php 236 billion from 5-year retail bond issuance last week. What was the source of such fund raising in favor of government? Or where did the money originate?
So the government took deposits from the banking system to fund its consumption activities (record deficits).
As such, with the NG competing intensely with the banks and financials (as well as non-financials) for access to savings, this would only aggravate the banks’ worsening liquidity conditions.
Banks will have to offer significantly higher yields to win back savers. But if they do so, they would sap lending activities, slowing an economy that breathes on credit.
As one would note, this would be a perfect example of the crowding out syndrome at work here.
LTNCDs, Bonds and Bills as Insufficient Substitute For Deposit Growth Reduction
And to partly fill the loss of momentum in the accumulation of main deposit accounts, banks have increasingly engaged in Long Term Negotiable Certificate of Deposits (LTNCD). LTNCDs have been booming. (figure 4, lower window)
In January 2019, LTNCDs grew by 21.63% from 21.62% a month ago. The explosive LTNCDs growth commenced in 2017 and continues today. If you read newspaper accounts stating that X bank will be raising Php Y billion of LTNCDs, such serves as a tacit admission that the Bank X has been losing growth momentum in its deposit portfolio.
LTNCD’s have been part of the banking system’s bundle of fund raising programs which includes stock rights, bond, bills, and hybrids.
Figure 5
Scorching banks borrowings from the public through Bills and Bonds issuance persisted in January 2019. Bonds registered a phenomenal 142.13% growth year-on-year though slightly lower from 150.42% a month ago. Meanwhile, bills issuance jumped 25.73% from 18.76% over the same period. (figure 5 upper window)
The % share to total liabilities of bonds spiked to 5.66% though marginally down from 6.29 in December. Bills increased to 1.38% from 1.35% a month ago.
Notice: as banks borrowed from the public, the rate of bank lending fell. More crowding out.
As Liquidity Shortages Spread to the Economy, The BSP is Trapped!
The tightening conditions in the banking system have begun to spread into the economy.
Aside from peso deposits and bank loans, M3 (money supply growth) have turned sharply lower in January. And as these happened, cash reserves of the banking system have been shrinking! (figure 4, middle window)
Won’t such an environment not incite negative feedback loops, such as reduced demand for credit, a sharp slowdown in the economy, margin calls on loans and surges in bad credit? Will these not be fertile grounds for more Hanjin events?
And the consensus expects a boom?!! These numbers are pointing to the heightened probability of a negative Black Swan!
As I said in the start, BSP governor Ben Diokno would have his hands full.
More easing (interest rates cuts or QE) will spur inflation that pressures interest rates upwards that should ripple adversely through the banking system’s loan and investment portfolios.
If the BSP pursues deleveraging, while this should be long term healthy, the unintended consequence would be the oscillation of pressures on profits of the credit-dependent unproductive and maladjusted (bubble) segments of the economy, thereby vitiating their creditworthiness.
The Diokno led BSP is, thus, caged.
Remember that the economy has been operating under emergency policy conditions: Diokno’s “expansionary fiscal policies”, interest rates at near historic lows and record QE.
Chronic addiction to these cheap money policies translates to lesser room or leverage for policies to deal with a downturn.
And yet, if credit is the blood of the economy, then the banking system is its heart. What happens when chronic illness consumes the sector? What happens to the flow of blood and its spillover effect on the organs?
If the banks have been burdened by unpublished or undeclared NPLs and/or distressed assets that have spilled over to investment losses and to the substantial reduction of cash reserves, what tools remain available to the BSP for use to arrest or even reverse such systemic entropy?
The BSP has been conducting regulatory bailouts such as Countercyclical Capital Buffers that eventually escalates the weakening of the sector’s balance sheets [Regulatory Bailout 2.0: BSP Launches Countercyclical Capital Buffer (CCyB) Intended to Ease Capital Reserves! December 16, 2018]
Last week, the BSP announced of the “extension of the observation period for the Basel III Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) compliance of subsidiary banks/quasi-banks (QBs) of universal and commercial banks (U/KBs) up to end-December 2019, moving the effectivity dates of said ratios to 1 January 2020.” Another implicit regulatory “easing” bailout.
Remember, bank cash reserves, capital, credit capacity, people’s savings and deposits are finite. Unless there will massive inflows of capital from external sources that may kick the proverbial can down the road, or unless the BSP’s Diokno can deliver magic via the printing press, current developments are unsustainable. That is, if current dynamics persist, thensomething is about to give.
The Austrians, through their business cycle theory, would be vindicated once again.
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