But increases in the quantity of money and fiduciary media will not enrich the world or build up what destructionism has torn down. Expansion of credit does lead to a boom at first, it is true, but sooner or later this boom is bound to crash and bring about a new depression. Only apparent and temporary relief can be won by tricks of banking and currency. In the long run they must land the nation in profounder catastrophe. For the damage such methods inflict on national well-being is all the heavier, the longer people have managed to deceive themselves with the illusion of prosperity which the continuous creation of credit has conjured up.—Ludwig von Mises
In this issue
The Banking System in Panic Borrowing Last December as 4Q NPLs Soar and Profit Growth Declined!
-The BSP’s Split Personality: Dr. Jekyll and Mr. Hyde
-December NET NPLs Surge by 90% as Bank Cash Reserves Jump in December!
-Banking System’s Profit Growth Decreased in the 4Q, Depositors Punished for Bank’s Bad Behavior From Easy Money Policies!
-Bank Income: Spiking Funding Costs, Flat Yield Curve Offset Revenue Spurts! The BSP-Banking System’s Increasing Embrace of Concentration Risks!
-Exploding HTMs, Downtrend in Deposit Liability Growth Continues Led by Peso Deposits!
-Banking System in Panic Borrowing! December Bank Bonds and Bills Payables Skyrocket!
-Not Just Banks, But Escalating Systemic Risks!
The Banking System in Panic Borrowing Last December as 4Q NPLs Soar and Profit Growth Declined!
The BSP’s Split Personality: Dr. Jekyll and Mr. Hyde
During the reception for the banking community hosted by the Bangko Sentral ng Pilipinas (BSP) last January 25, Governor Nestor A. Espenilla, Jr. acclaimed the banking system as "sound and stable and remains a key anchor of the growing economy”.
How I wish it were so!
The BSP bifurcates. In front of domestic audiences, the BSP projects a roseate outlook. However, when relating to their central bank peers, they publish a veneer of truth.
Here’s an example. (bold added)
The concern on the sustainability of debt is magnified by the increasing level of delinquent loans. The non-performing loans (NPLs) level of the banking system was generally declining at the onset of the GFC but has increased since late 2015 (Figure 3.9). The rising amount of NPLs does not, however, suggest that the credit market is already at the point of imminent collapse. Instead, it is simply pointing out that classifying an account as “non-performing” is already an ex post facto indicator of a borrower’s payment capacity which could eventually weigh on the balance sheet of lending banks, the magnitude of which is unknown in advance. [p.24]
In the BSP-led Financial Stability Coordinating Council’s 2017 Financial Stability Report, while admitting to the fact that NPLs have been rising, the BSP denies that it has reached “a point of imminent collapse”. Of course, admitting so would send depositors scampering away from the banking system! No official would want to see a run on banks in his/her tenure!
But it gets better.
While the BSP understands the impact of NPLs, as ‘an ex post facto indicator’ on the balance sheet of lending banks, it makes aforthright confession of their deficiencies in identifying the specifics for this to occur. Hence the statement “the magnitude of which is unknown in advance”.
This stunning revelation embodies the great Austrian Economist Nobel Laureate Friedrich von Hayek’s Knowledge Problem or the “problem of the utilization of knowledge which is not given to anyone in its totality”.
Sure enough, because the BSP inflated a grand credit bubble in the banking system by tinkering with interest rates, the asymmetric distribution of the banking system’s massive loan portfolio deprives them of the dimension of the mounting credit risks embedded into the system.
That said, with the Hanjin default, the BSP last week imposed “enhancements to the required reports on interest rates on loans and deposits being submitted by universal/commercial banks (UBs/KBs).” The reportorial requirements involve the disclosure of “interest rates on actual loans granted and deposits generated classified as to product types, maturity period/terms, and size (of deposits) as of a given reference period.”
The BSP hopes that the banking system will be candid on disclosing the true state of their respective balance sheets.
Good luck to them!
December NET NPLs Surge by 90% as Bank Cash Reserves Jump in December!
The Hanjin default occurred in January 2019.
Figure 1
But the BSP’s Net NPLs or “Gross NPLs less specific allowance for credit losses on NPL” rocketed by 91% from .93% in November to 1.77% last December! So even before the surfacing of the Hanjin event, tremors have rocked the banking system!
How will the Hanjin debacle affect the banking system’s real health conditions versus statistics?
The good news was that BSP’s cash reserves exhibited considerable improvements in December.
Cash and due from banks jumped by Php 173.7 billion to clip the year-on-year decline from -9.87% in November to 4% in December. With this, the BSP’s liquidity ratio of the banking system improved: the cash and due from banks to deposits ratio increased from 19.45% in November to 20.41% in December while liquid assets to deposits ratio increased from 46.15% to 47.3% over the same period.
Banking System’s Profit Growth Decreased in the 4Q, Depositors Punished for Bank’s Bad Behavior From Easy Money Policies!
But the Php 21.5 trillion question is: how was such improvement attained?
Was the banking system that tremendously profitable in the 4Q?
The straightforward answer is NO.
Figure 2
The BSP’s bank lending statistics supposedly declined to 15.8% in December from 17.2% a month before.
But the banking system’s interest income spiked to record highs, not only in the 4Q but has been in a streak since the 3Q of 2017! Interest income jumped 22%, 20.6% and 18.9% in the 4Q, 3Q and 2Q, respectively.
In a different lens, banks continue to recklessly throw money into the system just to wangle ‘profits’ or ‘earnings’!
Despite this, bank profits have steadily been in a downtrend. In the 4Q, the banking system registered a net profit growth of 6.4%, lower significantly than the 3Q’s 7.92% and 4Q 2017’s 8.92%. Universal and commercial banks comprised 89.43% of the industry’s profit growth in the 4Q 2018.
The two major profit centers of the banking system, the interest income, and non-interest income, registered lower growth in 4Q 2018. (figure 2 middle window)
Net interest income growth was down from 14.87% in the 3Q18 and from 15.92% in the 4Q 2017 to 13.93% in the 4Q18. The non-interest income component plunged from 11.49% in 3Q 2018 to 4.95% in 4Q 2018. Dividend income, trading income, and other income were lower down, namely, 1.34%, 3.02% and -.32% in 4Q18 from 26.15%, 23.57% and 6.42% in 3Q18, respectively. Only fees and commission income gained from 6.68% to 6.94% over the same period.
Does this not explain why banks have been raising transaction costs on their clients?
From GMA News (January 25): “Clients are decrying the fees charged by banks for inter-regional transactions…Apart from inter-regional deposits which are usually charged a service fee of P50 and inter-regional over-the-counter withdrawal fee of around P100, several banks also charge an additional P100 for encashment of checks if the transaction is not in the same branch where a client opened his or her account. According to the Bangko Sentral ng Pilipinas, banks have the liberty to charge fees and other transaction charges.” (bold added)
So instead of market-based competition to serve consumers, the banking system has evolved into adapting internal policies which engage in the strip mining of bank clients (thru exorbitant transaction fees) to subsidize the banking system’s increasingly fragile balance sheets, which are ramifications from the BSP’s bubble policies!
A bank even charges fees on USD deposits!
Woe to bank depositors who must shoulder the brunt from the sins of brashness and avarice of the banking system as a result of the BSP’s easy money policies!
Are these supposed to be signs of soundness and stability or escalating fragilities?
And have these not been related to brazen manipulation that has plagued the Philippine stock market?
Easy money policies foster unethical behavior.
In Australia, a gamut of mischiefs has embroiled the four biggest banks in a historic scandal! From the Strait Times/Bloomberg(February 8, 2019): [bold added] “The departures of NAB chief executive Andrew Thorburn and chairman Ken Henry show the slow-burn pressure the inquiry has had on the country's biggest firms. Mr Thorburn had ruffled shareholders by planning two months of leave on either side of the Royal Commission's delivery of its final report, which was hotly anticipated as a watershed moment for the country's banking industry. The year-long inquiry uncovered a litany of wrongdoing across the industry - from charging dead people fees to advisers pushing customers into bad investments to meet bonus targets. NAB staff accepted cash bribes to approve fraudulent mortgages and misled the regulator over a fees-for-no-service scandal.
Wells Fargo, Australian Edition?
Bank Income: Spiking Funding Costs, Flat Yield Curve Offset Revenue Spurts! The BSP-Banking System’s Increasing Embrace of Concentration Risks!
And as I pointed out in the past, by inflating interest rate margins, the BSP implicitly pushed the Philippine banking system to ‘back up the truck’ to rely on interest income. The industry complied. However, instead of a subsidy, the erosion of the industry’s profits, since 2013, persists.
Even from the BSP’s profitability ratio, the banking system’s financial entropy appears to be escalating. The banking system’s return of assets (ROA) plunged from 3Q18’s 1.16% and from 4Q17’s 1.17% to 4Q18’s 1.12%. Return on equities ROE) also showed a similar decay; 4Q18’s 9.38% was lower significantly from 3Q18’s 9.47% and from 4Q17’s 10.17%. (figure 2, lower window)
Today, interest margins have been falling as the industry offsets such margin shortfall with aggressive credit issuance! Gross interest margins have decreased to 72.9% in 4Q18 from 74.42% in 3Q18 and 77.92% in 4Q17. (figure 2, upper window)
Figure 3
Spiking funding costs or interest rate liabilities of the banking system have been one of the principal factors behind the erosion of margins. (figure 3, upper window)
Despite falling rates in the 4Q due to lower inflation, funding cost soared to 1.42% in 4Q2018 from 1.28% in the 3Q18 and 1.05% a year ago.
Part of this has been due to flattening/ partly inverted yield curve. Despite the yield curve management by the BSP, the sovereign curve has been partially inverted or flat. (figure 3, middle window). The other part will be discussed below.
As noted above, banks have structurally shifted their business model, since 2013, by putting the increasing weight of their income generation to interest income at the expense of non-interest income. As such, as of the 4Q 2018, bank dependency on interest income from loan issuance hit the highest level ever! (figure 3, lower window)
The % share of interest income to total operating income surged from 76.91% in the 3Q and from 75.73% in the 4Q of 2017 to 77.21% in 4Q 2018. In contrast, the % share of non-interest income shriveled from 23.1% and from 24.27% to 22.79% over the same period, respectively.
As time goes by, systemic fragility has only been mounting due to the overreliance of the banking system from the BSP’s borrow and spend free lunch policies.
Banks have increasingly been embracing concentration risks!
Exploding HTMs, Downtrend in Deposit Liability Growth Continues Led by Peso Deposits!
Was the improvement in liquidity due to the industry’s reduced exposure on ‘Hold-Until-Maturity’ (HTM) assets?
Figure 4
Well, that’s not the case either.
Despite lower rates, the banking system continues to frantically shovel their fixed income securities into their HTMs category. HTM growth have exploded by over 50% in the past four months, in particular, September (+53.0%), October (+53.59%), November (+57.36%) and December (+56.54%)!
Remember this from the FSCC’s FSR?
Banks face marked-to-market (MtM) losses from rising interest rates. Higher market rates affect trading since existing holders of tradable securities are taking MtM losses as a result. While some banks have resorted to reclassifying their available-for-sale (AFS) securities into held-to-maturity (HTM), some PHP845.8 billion in AFS (as of end-March 2018) are still subject to MtMlosses (Figure 3.8). Furthermore, the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity [p.24]
The share of HTMs to Financial assets gross has soared from 48.4% in 2016, 52.92% in 2017 and 69.73% last year. As a share of total assets, HTMs accounted for 9.23%, 10.17% and 14.3% over the same period.
To interpret the panic stashing of AFS into HTMs differently, accounting gymnastics has been artificially bloating the industry’s earnings.
Deposit liabilities also tell us that liquidity continues to drain rather than improve. (figure 4, middle and lower window)
Growth deposit liabilities dropped to 8.82% in December from 8.87% a month ago and from 11.64% a year ago. Peso deposits had been mainly responsible for such erosion. Peso deposits grew by 9.13% in December down from 9.53% a month ago and 12.02% a year back. However, the rallying peso impelled a bounce on foreign currency deposits growth which jumped 7.26% in December from 5.75% in November but was lower from 9.79% in December 2017.
The decline in peso savings and demand and NOW accounts contributed most to decreasing growth rates in peso deposits. Savings and Demand deposits have a 33.63% and 19.63% share of the banking industry’s total liabilities.
In December, the bounce in the industry’s cash has dovetailed with the recent improvement in M3. On the other hand, bank loans and deposits continue to wobble. (figure 4, lower window)
The record monetization of the BSP of the National Government’s historic deficit can partly explain the improvements in the December M3. The publication of the 2018 fiscal balance has been long overdue. Why the procrastination?
Sinking liquidity tell us that the banking system has been bleeding rather than eking out published profits.
Banking System in Panic Borrowing! December Bank Bonds and Bills Payables Skyrocket!
So if profits were not the source of the improved liquidity of the banking system in December what has? The growth in cash and due bank reserves can’t be explained by either HTMs, which reduce liquidity, and the fall in peso deposits.
Cash reserves grew by Php 173.7 billion month-on-month last December.
Figure 5
If banks are indeed healthy, why have they been in a panic to raise funding from the capital markets?
Growth in the banking system’s bills payable vaulted by Php 180.92 month-on-month. Growth in bond payable skyrocketed by Php 54.29 billion also on a month-on-month basis.
Bills payable jumped 18.64% or Php 146.7 billion year-on-year which means December’s month on month borrowing contributed more than 100% of the year’s increase, whereas bonds payable zoomed by 150.42% to Php 162.232 billion with December’s monthly borrowing constituting 33.47% of the annual increase.
The growth in cash and due banks have fundamentally emanated from the bank borrowing through bonds and bills!
So aside from interest rates, increased leveraging by the LENDERs has contributed to the increasing cost of funding for the industry, thereby reducing margins, and pressuring profits. It is a vicious cycle.
Yet, banks continue to dig themselves into a hole!
Not Just Banks, But Escalating Systemic Risks!
So let us get this straight:
To fund another record deficit of Php 575.6 billion in 2019, the NATIONAL GOVERNMENT will be borrowing intensively from the capital markets. (The rest of the deficit will be funded by monetization of the BSP)
To fund CAPEX, operational expenditures and debt servicing, extensive borrowing from banks and from the capital markets will be the recourse for the NON-FINANCIALS COMMERCIAL entities.
To plug the escalating (NPL) vortex in the system, to inject liquidity, as well as, to intermediate lending, the capital markets will be tapped exhaustively by the BANKING system.
In the face of diminishing returns (GDP, earnings), crowding out (rising rates), deficit spending (simple inflation), the NG, banks, and non-financials will sizably increase the leveraging of their balance sheets!
How will these not end up with MORE Hanjins, no less higher NPLs?
This analyst gets it.
From the Inquirer (February 10, 2019): Higher interest rates—monetary authorities’ response to last year’s elevated inflation—may increase bad loans in the Philippines, UK-based Oxford Economics said. “Rising bad bank loans are a risk in several emerging markets (EM) where interest rates have risen steeply in the past year, such as Pakistan, Turkey, Argentina, the Philippines and Indonesia,” Oxford Economics lead economist Adam Slater said in a Feb. 7 report titled “EM debt: the bubble may already have burst.”
While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise. What is not debatable is that repricing, refinancing and repayment risks (3Rs) are escalated versus last year and this could result in systemic risk if not properly addressed in a timely manner.
So if the BSP can’t know the extent of NPLs or “the magnitude of which is unknown in advance”, that triggers the “point of imminent collapse”, then how can banks be “sound and stable”??!
