When Free Lunch Politics Meets Fiscal Reality: Lessons from the DPWH Flood Control Scandal

 

Democratic socialism—thereby fusing populist authorization with bureaucratic command—inverts civil society’s logic: spontaneous coordination yields to electoral control, property, and precedent to administrative discretion. The quest for legibility breeds discretion, opacity, colonizing associations, and politicizing provision. The polity grows more ceremonially majoritarian as its structure turns illiberal. Human relations become increasingly politicized. The space for autonomous and dissenting freedom steadily recedes—Vibhu Vikramaditya 

In this issue: 

When Free Lunch Politics Meets Fiscal Reality: Lessons from the DPWH Flood Control Scandal

I. Selective Framing: The "Smallest Deficit" Headline

II. Bigger Picture: Weak Revenues, Sluggish Spending, Cumulative Deficit Near Record Highs

III. Quietly Moving the Goalposts, Budget Gaps: Enacted vs. Revised

IV. Interventionist Mindset: The Root of the Fiscal Imbalance

V. The Economics of "Free Lunch" Politics: The Law of Scarcity Meets the Welfare State

VI. Debt Dynamics and the Savings–Investment Gap

VII Corruption as Symptom, Not Cause

VIII. Public Spending at Historic Highs and the DPWH Flood Control Scandal

IX. The DPWH Scandal: A Systemic Threat

X. A Policy Dilemma: The Impossible Choice 

When Free Lunch Politics Meets Fiscal Reality: Lessons from the DPWH Flood Control Scandal 

What the DPWH scandal reveals about the fragility of a spending‑driven political economic order

I. Selective Framing: The "Smallest Deficit" Headline 

Inquirer.net, August 29, 2025: A modest increase in government spending narrowed the Philippines’ budget deficit in July to its smallest level in nearly five years, keeping the shortfall within the Marcos administration’s target. The state continued to spend more than it collected after recording a fiscal deficit of P18.9 billion, albeit smaller by 34.42 percent compared with a year ago, latest data from the Bureau of the Treasury showed.

Figure 1

The July budget deficit headline—“smallest in nearly five years”—is a textbook case of selective framing. 

While technically accurate, it obscures deeper fiscal concerns by exploiting the optics of quarterly VAT reporting, which front-loads revenue at the start of each quarter. Since 2023, firms have filed VAT returns quarterly instead of monthly, so revenues at the start of each quarter appear inflated, producing artificial “surpluses” or unusually slim deficits. (as discussed last year, see reference) [Figure 1, upper image] 

This makes July look exceptional, but it is little more than a timing quirk—not a sign of genuine fiscal improvement.

II. Bigger Picture: Weak Revenues, Sluggish Spending, Cumulative Deficit Near Record Highs 

In reality, the cumulative January–July shortfall has ballooned to Php 784.4 billion, the second-largest on record. [Figure 1, lower chart] 

Revenues grew by only 3.26% while expenditures posted a meager 1.02% increase. The Bureau of the Treasury itself attributed the spending slowdown to the "timing of big-ticket disbursements of the Department of Public Works and Highways, Department of Social Welfare and Development, and Department of National Defense for their respective banner programs." 

Year-to-July, expenditures are up 8.2%, slower than 13.2% in 2024, but the bigger story lies in revenue weakness: collections grew just 4.8% this year compared with 14.75% in 2024. The 24.9% contraction in non-tax intake and the sharp deceleration in Bureau of Customs growth (1.5% vs. 5.8% in 2024) dragged overall revenues down. 

III. Quietly Moving the Goalposts, Budget Gaps: Enacted vs. Revised 

July’s Php 491.2 billion in expenditures also fell sharply below the Php 561 billion monthly average needed to meet the Php 6.326 trillion enacted budget. 

Figure 2

Compounding this, the Bureau of the Treasury reported that 2025 fiscal targets had been revised downward (by the DBCC) for both revenue and spending, now pegged at Php 6.08 trillion. [Figure 2, upper table] 

Authorities attributed the adjustment to "heightened global uncertainties," but the subtext is clear: the government is quietly recalibrating expectations to preserve its 5.5% deficit ceiling, even as structural weaknesses deepen. The headline may offer comfort, but the underlying trajectory points to fragility, not fiscal strength. 

The enacted budget sets the ceiling—what government aims to spend—while the revised budget marks the floor, revealing what it can realistically afford as conditions shift. 

Yet the jury is still out on whether the current administration will break its six-year trend of exceeding the enacted budget—or whether this implicit admission of slower growth will instead spur even more spending in the second half of the year. 

IV. Interventionist Mindset: The Root of the Fiscal Imbalance 

Of course, the fiscal imbalance is merely a symptom. 

As previously discussed, it is driven by behavioral factors—such as the heuristics of recency bias and overconfidence—combined with an overreliance on a technocratic bureaucracy fixated on flawed econometrics as the fountainhead of interventions. (see reference on our previous post dealing with the rising risks of a Fiscal Shock) 

Most importantly, it is fueled by a populace increasingly dependent on social democracy’s "free lunch" politics, anchored in a deepening interventionist mindset. 

As Mises Institute’s Joshua Mawhorter lucidly describes, "by living under a modern, highly interventionist modern nation-state, the default paradigm of political elites and the general public is that, whenever a problem arises, the government must do something, that not doing something would be irresponsible and disastrous, that it can only help, and that the worst possible option would be doing nothing. This might be called the interventionist mindset or interventionist paradigm." (bold added)

V. The Economics of "Free Lunch" Politics: The Law of Scarcity Meets the Welfare State 

This mindset lays the policy framework for trickle-down Keynesian spending programs financed by the BSP’s easy money. 

Public spending on an ever-widening scope of social services—including the proposed "universal healthcare" for all Filipinos—illustrates this. [Figure 2, lower left image] 

In simple terms, while such programs may appear ideal, the law of scarcity dictates that there must be sufficient savings to sustain a welfare state. 

If the rate of redistribution exceeds the growth of savings, funding must come from elsewhere—either by borrowing from future taxpayers or through the inflation tax, via financial repression and fiscal dominance enabled and facilitated by central bank accommodation. 

Yet a persistent reliance on borrowing or inflation is not sustainable. Both are subject to ‘reversion to the mean’ and will eventually face a reckoning through crisis.

VI. Debt Dynamics and the Savings–Investment Gap 

The thing is, while some authorities acknowledge the burden of public debt—"every Filipino now owes P142,000"—most attribute it to "corruption," a convenient strawman. [Figure 2, lower right picture]

Figure 3

Alongside rising expenditures, public debt surged to a record Php 17.56 trillion last July, sustaining its upward trajectory and accelerating in both scale and velocity! MoM changes depict this uptrend. [Figure 3, topmost and center graphs] 

All told, the Philippines suffers from a record savings–investment gap, which hit a new high in Q2 2025. [Figure 3, lowest chart] 

But "savings" in national accounts is a residual GDP-derived figure that is deeply flawed; it even includes government "savings" such as retained surpluses and depreciation, when in reality, the fiscal deficit reflects dissaving (as discussed during CMEPA last July; see reference). 

With public debt up Php 296.2 billion month-on-month, Php 1.873 trillion year-on-year, and Php 1.512 trillion year-to-date, the government is suggesting a forthcoming decline in public debt by the end of 2025. 

Technically, while a ‘slowdown’ may occur, this is a red herring—it omits the fact that soaring deficit spending inevitably translates into higher debt, higher inflation, or both.

VII Corruption as Symptom, Not Cause 

Social democrats fail to heed the lessons of EDSA I and EDSA II: corruption is a legacy of big government. 

What is often forgotten is that corruption is not the disease but a symptom of vote-buying politics—of a system built on free-lunch populism, where political spending buys loyalty, entrenches dependence, transfers wealth, consumes savings, and simultaneously erodes institutions through ever-deepening interventions. 

Per the great Frédéric Bastiat, 

"When plunder has become a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that glorifies it." (Bastiat, 1848) 

Still, social democrats cling to the illusion that electing an "angel" leader can deliver an ideal command-and-control economy. They overlook that forced redistribution—or legalized plunder—breeds societal tensions and unintended consequences, triggering a vicious cycle of interventions and power concentration —exactly what Tocqueville warned against when he said absolute power corrupts absolutely. 

Again, Bastiat reminds us: 

"legal plunder may be exercised in an infinite multitude of ways. Hence come an infinite multitude of plans for organization; tariffs, protection, perquisites, gratuities, encouragements, progressive taxation, free public education, right to work, right to profit, right to wages, right to assistance, right to instruments of labor, gratuity of credit, etc., etc. And it is all these plans, taken as a whole, with what they have in common, legal plunder, that takes the name of socialism." (Bastiat, 1850) 

The bigger the government, the greater the corruption. 

VIII. Public Spending at Historic Highs and the DPWH Flood Control Scandal

Figure 4

Today, public spending as a share of GDP is at its highest level (!!) compared to pre-EDSA I and pre-EDSA II—and that’s counting only direct public expenditures, excluding construction and private sector participation in government projects such as PPPs and other ancillary ventures. [Figure 4, upper diagram] 

From this perspective, the ongoing flood control scandal is merely the tip of the iceberg, with contractors and select authorities in the “hot chair” serving as convenient fall guys for a much larger, systemic issue. 

IX. The DPWH Scandal: A Systemic Threat 

These X.com headlines provide a stark clue as to how public spending and GDP might be affected: [Figure 4, lower images]

• DPWH, DBM set 2-week deadline to review DPWH budget
• Palace says review of DPWH’s 2026 budget could expand to other agencies
• DPWH Secretary Vince Dizon suspends bidding for locally funded projects amid massive corruption scandal 

The unfolding DPWH scandal threatens more than reputational damage—it risks triggering a contractionary spiral that could expose the fragility of the Philippine top-down heavy economic development model. 

With Php 1.033 trillion allotted to DPWH alone (16.3% of the 2025 budget)—which was lowered to Php 900 billion (14.2% of total budget)—and Php 1.507 trillion for infrastructure overall (23.8% and estimated 5.2% of the GDP), any slowdown in disbursements could reverberate across sectors. 

Many large firms are structurally tied to public projects, and the economy’s current momentum leans heavily on credit-fueled activity rather than organic productivity. 

Curtailing infrastructure outlays, even temporarily, risks puncturing GDP optics and exposing the private sector’s underlying weakness. 

Or if infrastructure spending is curtailed or delayed, growth slows and tax revenues fall—VAT, corporate, and income tax collections all weaken when economic activity contracts. 

This means the deficit doesn’t necessarily shrink despite spending restraint; the “fiscal hole” may, in fact, widen—imperiling fiscal stability and setting the stage for a potential fiscal shock. 

The irony is stark: efforts to contain corruption by tightening spending could deepen the very gap they aim to close.

To be clear, this is not a defense of corruption but rather a reminder of how dependent GDP growth has become on public spending, leaving it vulnerable to the vagaries of political oscillation—including the ongoing flood control corruption scandal.

X. A Policy Dilemma: The Impossible Choice

Figure 5

With debt servicing already absorbing a growing share of the budget (7-month interest payment accounted for 14.8% share of expenditure), and revenue buoyancy dependent on infra-led growth, the administration faces a dilemma—either sustain spending through a compromised political pipeline or risk a broader economic and fiscal unraveling. 

The lesson is, the real danger lies not in the scandal itself, but in the systemic exposure it threatens to reveal: 

• A growth model overly reliant on state-led spending
• A fiscal framework vulnerable to both political shocks and bureaucratic paralysis
• A debt trajectory that leaves little room for error when revenues falter 

In short, the interventionist mindset at the core of social democracy’s "free lunch" political economy entrenches structural fragility, as shown by the mounting fiscal imbalance. 

The DPWH scandal crystallizes a deeper tension—forcing the political economy to weigh popular demands for ‘good governance’ against the imperatives of a development model structurally reliant on public spending. 

As Roman historian Tacitus warned (The Annals of Imperial Rome): 

"The more corrupt the state, the more numerous the laws."

____

References 

Vibhu Vikramaditya How Democratic Socialism Inverts the Logic of Civil Society Mises.org, September 3, 2025 

Prudent Investor Newsletter, Philippine Government’s July Deficit "Narrowed" from Changes in VAT Reporting Schedule, Raised USD 2.5 Billion Plus $500 Million Climate Financing September 1, 2024 Substack 

Prudent Investor Newsletter, June 2025 Deficit: A Countdown to Fiscal Shock, August 3, 2025 Substack 

Joshua Mawhorter Interventionist Non-Interventionism Mises.org, September 5, 2025 

Prudent Investor Newsletter, The CMEPA Delusion: How Fallacious Arguments Conceal the Risk of Systemic Blowback, July 27, 2025 Substack 

Frédéric Bastiat Economic sophisms, 2nd series (1848), ch. 1 Physiology of plunder ("Sophismes économiques", 2ème série (1848), chap. 1 "Physiologie de la spoliation"). Econolib 

Frédéric Bastiat, The Law (1850), Ludwig von Mises Institute 2007 Mises.org

 

Goldilocks Meets the Three Bad Bears: BSP’s Sixth Rate Cut and the Late-Cycle Reckoning

 

Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence—especially in cases in which large short-term debts need to be rolled over continuously—is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang!, confidence collapses, lenders disappear, and a crisis hits—Carmen Reinhart and Kenneth Rogoff 

In this Issue 

Goldilocks Meets the Three Bad Bears: BSP’s Sixth Rate Cut and the Late-Cycle Reckoning

I. The BSP’s Sixth Cut and the Goldilocks-Sweet Spot Illusion

II. Data-Driven or Dogma-Driven? The Myth of Low-Rate Growth

III. The Pandemic Rescue Template Returns, The MSME Credit Gap

IV. Fintech’s Limits, Financial Concentration: Banking Cartel by Design

V. Treasury Market Plumbing: Who Really Benefits?

VI. Crowding Out: Corporate Issuers in Retreat

VII. The Free Lunch Illusion: Debt and Servicing Costs

VIII. Banks as the Heart of the Economy: Palpitations in the Plumbing

IX. Q2 2025 Bank Profit Plummets on Credit Loss Provisions

X. Conclusion: Goldilocks Faces the Three Bad Bears 

Goldilocks Meets the Three Bad Bears: BSP’s Sixth Rate Cut and the Late-Cycle Reckoning 

The Bangko Sentral ng Pilipinas’ latest rate cut is a "Goldilocks" illusion masking a late-cycle reckoning driven by crowding out, surging leverage, and mounting stress in the financial system 

I. The BSP’s Sixth Cut and the Goldilocks-Sweet Spot Illusion 

Reinforcing its "easing cycle," the Bangko Sentral ng Pilipinas (BSP) cut policy rates last week—the sixth reduction since August 2024. Officials claimed they had reached a “sweet spot” or “Goldilocks level”—a rate neither inflationary nor restrictive to growth, as the Inquirer reported. 

We’ve used “sweet spot” before, but not as a compliment. In our framing, it signals ultra-loose monetary policy—part of a broader “Marcos-nomics stimulus” package that fuses fiscal, monetary, and FX regimes into a GDP-boosting mirage. A rescue narrative sold as reform. 

II. Data-Driven or Dogma-Driven? The Myth of Low-Rate Growth 

The idea that “low rates equal growth” has calcified into public gospel. 

But if that logic holds, why stop at 5%? Why not abolish interest rates altogether—and for good measure, tax 100% of interest income? By that theory, we’d borrow and spend our way to economic utopia. In short: Such (reductio ad absurdum) logic reduces policy to absurdity: prohibit savings, unleash debt, and expect utopia.

Figure 1

The BSP insists its decisions are data-driven. But have they been? Since the 1998 Asian Crisis, rate cuts have been the default posture. 

And since the 2007–2009 Global Financial Crisis, each successive cut has coincided with slowing headline GDP—through the pandemic recession and beyond. The decline was marginal at first, barely noticed. But post-pandemic, the illusion cracked. (Figure 1 upper pane)

A historic rescue package—Php2.3 trillion in injections, rate cuts, RRR reductions, a USD-PHP soft peg, and sweeping relief measures—combined with unprecedented deficit spending, triggered a temporary growth spike. This extraordinary intervention, combined with global reopening, briefly masked structural weaknesses. 

But since 2021, GDP has resumed its downward drift, with the deceleration becoming conspicuous through Q2 2025. Inflation forced the BSP to hike rates, only to restart its easing cycle in 2024. 

So where is the evidence that low rates boost the economy?

III. The Pandemic Rescue Template Returns, The MSME Credit Gap 

Today’s “sweet spot” eerily mirrors the pandemic-era rescue template—minus the direct injections and relief measures. For now. 

Meanwhile, over half the population still self-identifies as borderline or poor (self-rated poverty surveys—SWS and OCTA). 

GDP, as a measure, fails to capture this disconnect—possibly built on flawed inputs, questionable categorization and assumptions, as well as politically convenient calculations. 

Meanwhile, the BSP’s easy money regime and regulatory bias have allowed banks to monopolize the financial system, now accounting for 83% of total financial assets as of Q2 2025. (Figure 1, lower graph) 

Yet MSMEs—the backbone of employment at 67% (as of 2023, DTI)—remain sidelined. 

Ironically, Republic Act No. 9501 mandates banks to lend 10% of their portfolio to MSMEs (8% to micro and small, 2% to medium enterprises).

Figure 2

But compliance has collapsed—from 8.5% in 2010 to just 4.63% in Q1 2025. (Figure 2, topmost image) 

Banks, unable to price risk appropriately, prefer paying penalties over lending to the sector. The result: the credit boom inflating GDP primarily benefits 0.37% of firms—the large enterprises that employ only a third of workers. 

While RA 9501 mandates banks to allocate 10% of their loan portfolio to MSMEs, BSP regulations restrict risk-based pricing—directly through caps on consumer and financing loans (BSP Circular 1133) and indirectly in MSME lending through microfinance rules (Circulars 272, 364, 409, and related issuances).   

Again, unable to fully price in higher default risks, banks often find it cheaper to pay penalties than to comply. 

IV. Fintech’s Limits, Financial Concentration: Banking Cartel by Design 

At the same time, banks are aggressively expanding into consumer credit, while the unbanked majority continues to rely on the informal sector at usurious or punitive rates. 

Fintech e-wallets have gained traction, but they remain mostly transactional platforms. Banks, by contrast, are custodial institutions. Even if convergence is inevitable, bridging the informal credit gap will remain elusive unless rates reflect real distribution and collection risks.

This convergence may democratize leverage—but banks still dominate credit usage, reinforcing a top-heavy system. 

Deepening concentration, paired with price restrictions, resembles a cartel. A BSP-led cartel. 

And the first beneficiaries of this low-rate regime? Large enterprises and monied consumers. 

V. Treasury Market Plumbing: Who Really Benefits? 

And like any cartel, it relies not only on market power but also on control of the pipes—the very plumbing of the financial system, now evident in the Treasury market 

The Bangko Sentral ng Pilipinas has dressed up its latest rate cut as part of a “Goldilocks easing cycle,” but the bond market tells a different story.

Even before the policy shift, the Philippine BVAL Treasury yield curve had been flattening month after month, with long rates falling faster than the front end.  (Figure 2, middle and lower charts) 

That is not a picture of renewed growth but of markets bracing for a slowdown and disinflation. 

The rate cut simply ratified what the curve had preemptively declared: that the economy was softening, and liquidity needed to be recalibrated.

Figure 3

From the Treasury market’s perspective, the real beneficiaries weren’t households or corporates—they were institutional actors navigating a crowded, distorted market. 

Trading volumes at the Philippine Treasury market raced to all-time highs in August, just before and during the cut! (Figure 3, topmost diagram) 

This wasn’t retail exuberance—it was plumbing. 

BSP’s direct and indirect liquidity injections, coupled with foreign inflows chasing carry (data from ADB Online) amid global easing and macro hedges created a bid-heavy environment. The rate cut amplified this dynamic, lubricating government borrowing while sidelining private credit. (Figure 3, middle visual) 

VI. Crowding Out: Corporate Issuers in Retreat 

Meanwhile, the collateral damage is clear: corporate bond issuance has been trending downward, regardless of interest rate levels—both in nominal terms and as a share of local currency debt. (Figure 3, lowest window) 

This is evidence of the crowding-out syndrome, which suggests that BSP easing isn’t reviving private investment—it’s merely accommodating fiscal expansion. 

In the cui bono calculus, the winners of rate cuts are clear: the state, the banks, and foreign macro hedgers. 

The losers? Domestic firms, left behind in a market—where easing no longer means access. 

VII. The Free Lunch Illusion: Debt and Servicing Costs

Figure 4

The deeper reason behind the BSP’s ongoing financial plumbing lies in social democracy’s favorite illusion: the free lunch politics. 

Pandemic-era deficit spending has pushed public debt to historic highs (Php 17.27 trillion in June), and with it, the burden of debt servicing. (Figure 4, topmost chart) 

July’s figures—due next week—may breach Php 17.4 trillion. 

Even with slower amortizations temporarily easing the burden in 2025, interest payments for the first seven months have already set a record.

Rising debt means rising servicing obligations—even at the zero bound. The illusion of cheap debt is just that: an illusion. 

Crowding out isn’t just theoretical. 

It’s visible in the real economy—where MSMEs and half the population (per self-poverty surveys) are squeezed—and in the capital markets, where even the largest firms are feeling the pinch. 

The entropy in financial performance among PSE-listed firms, especially the PSEi 30, underscores that the spillover has reached even the politically privileged class. (see previous discussion—references) 

Monthly returns of the PSEi 30 similarly reflect the waning impact of the BSP’s cumulative easing measures since 2009. (Figure 4, middle image) 

In a world of scarcity, there is no such thing as a permanent free lunch. 

VIII. Banks as the Heart of the Economy: Palpitations in the Plumbing 

If the government is the brain of the political economy, banks are its heart. And the pulse is showing increasing signs of palpitations.

The banking system’s books reveal the scale of the plumbing, most visible in the record-high net claims on central government (NCoCG) held by the banking system and Other Financial Corporations (OFCs). 

Bank NCoCG surged 7.5% YoY to an all-time high Php 5.591 trillion in Q2 2025, pushing Held-to-Maturity (HTM) assets up 1.8% YoY to a milestone Php 4.075 trillion. (Figure 4, lowest graph)

Figure 5 

OFCs saw an even sharper jump—14.7% in Q1 to a record Php 2.7 trillion! (Figure 5, topmost diagram) 

According to the BSP, OFCs are composed of non-money market investment funds, other financial intermediaries (excluding insurance corporations and pension funds), financial auxiliaries, captive financial institutions and money lenders, insurance corporations, and pension funds. 

Yet despite these massive reallocations—and even with banks drawing a staggering Php 189 billion from their freed-up reserves (Claims on Other Depository Corporations) after March’s RRR cut—liquidity remains tight. (Also discussed last August, see references) (Figure 5, middle chart) 

Cash reserves continue to decline. Though cash-to-deposit ratios bounced in June from May’s all-time low, the trend remains downward—accelerating even as RRR rates fall to 5%. (Figure 5, lowest image) 

Liquid assets-to-deposit ratios have slumped to levels last seen in May 2020, effectively nullifying the supposed benefits of the BSP’s Php 2.3 trillion pandemic-era injections. 

This strain is now reflected in bank stocks and the financial index—dragging down the PSE and the PSEi 30. 

Goldilocks, eh? 

After the rate cut, the BSP immediately floated the possibility of a third RRR reduction—“probably not that soon.” Highly doubtful. Odds are it lands in Q4 2025 or Q1 2026. 

But even if the BSP dismantles the Reserve Requirement entirely, unless it confronts the root cause—the Keynesian dogma that credit-financed spending is a growth elixir—the downtrend will persist. 

At zero RRR, the central bank will run out of excuses. And the risk of bank runs will amplify.

IX. Q2 2025 Bank Profit Plummets on Credit Loss Provisions

Figure 6 

The toll on banks is already visible—profits are unraveling. From +10.96% in Q1 to -1.96% in Q2.  (Figure 6, upper visual) 

The culprit? 

Losses on financial assets—driven by surging provisions for credit losses, which ballooned 89.7% to Php 43.78 billion in Q2. That’s pandemic-recession territory—December 2020. (Figure 6, lower graph) 

X. Conclusion: Goldilocks Faces the Three Bad Bears 

The cat is out of the bag. 

The “stimulative effect” is a political smokescreen—designed to rescue banks and the elite network tethered to them. It’s also a justification for continued deficit spending and the rising debt service that comes with it. 

But “sweet spots” don’t last. They decay—subject to the law of diminishing returns. 

Paradoxically, under the Goldilocks fairy tale, there were three bears. In our case: three ‘bad’ bears:

• Crowding out and malinvestments
• Surging systemic leverage
• Benchmark-ism to sanitize worsening fundamentals 

Even the Bank for International Settlements has quietly replaced Philippine real estate pricing bellwethers with BSP’s version—one that paints booming prices over record vacancies. 

Nonetheless, the bears are already in the house. The porridge is cold. And the bedtime story is over. What remains is the reckoning—and the question of who’s prepared to face it without the comfort of fairy tales 

All signs point to a late-stage business cycle in motion. 

___

references 

Prudent Investor Newsletters, Q2–1H Debt-Fueled PSEi 30 Performance Disconnects from GDP—What Could Go Wrong, August 24, 2025 Substack 

Prudent Investor Newsletters, Philippine Banks: June’s Financial Losses and Liquidity Strains Expose Late-Cycle Fragility, August 17, 2025 Substack

 

Philippine Banks: June’s Financial Losses and Liquidity Strains Expose Late-Cycle Fragility

Debt-fueled booms all too often provide false affirmation of a government’s poli­cies, a financial institution’s ability to make outsized profits, or a country’s standard of living. Most of these booms end badly—Carmen Reinhart and Kenneth Rogoff 

Philippine Banks: June’s Financial Losses and Liquidity Strains Expose Late-Cycle Fragility 

In this issue: 

Part 1: Earnings Erosion and the Mask of Stability

1.A NPLs Fall, But Provisions Rise: A Tale of Two Signals

1.B Philippine Bank’s Profit Growth Falters: Q2 Deficit Breaks the Streak

1.C Universal and Commercial Banks Lead the Weakness; PSE Listed Banks Echo the Slowdown

1.D Income Breakdown: Lending Boom Masks Structural Risk

1.E CMEPA’s Gambit: Taxing Time Deposits to Diversify Bank Income

1.F The Real Culprit: Exploding Losses on Financial Assets

1.G San Miguel’s Share Plunge: A Canary in the Credit Mine? Beneath the Surface: Banks Signal Stress

1.H The NPL Illusion: Velocity Masks Vulnerability

1.I Benchmark Kabuki: When Benchmark-ism Meets Market Reality

Part 2: Liquidity Strains and the Architecture of Intervention

2.A Behind the RRR Cuts: Extraordinary Bank Dependence on BSP

2.B RRR Infusions: Liquidity Metrics Rebound; Weak Money Creation Amid Record Deficit Spending

2.C Rising Borrowings Reinforce Funding Strains, Crowding Out Intensifies, Record HTM Assets

2.D Divergence: Bank Profits, GDP and the PSE’s Financial Index; Market Concentration

2.E OFCs and the Financial Index: A Coordinated Lift?

2.F Triple Liquidity Drain; Rescue Template Risks: Inflation, Stagflation, Crisis; Fiscal Reflex: Keynesian Response Looms

2.G Finale: Classic Symptoms of Late-Cycle Fragility 

Philippine Banks: June’s Financial Losses and Liquidity Strains Expose Late-Cycle Fragility 

From earnings erosion to monetary theatrics, June’s data shows a banking system caught in late-cycle strain.

Part 1: Earnings Erosion and the Mask of Stability 

1.A NPLs Fall, But Provisions Rise: A Tale of Two Signals 

Inquirer.net August Bad loans in the Philippine banking system fell to a three-month low in June, helped by the central bank’s ongoing interest rate cuts, which could ease debt servicing burden. However, lenders remain cautious and have increased their provisions to cover possible credit losses. Latest data from the Bangko Sentral ng Pilipinas (BSP) showed nonperforming loans (NPL), or debts that are 90 days late on a payment and at risk of default, cornered 3.34 percent of the local banking industry’s total lending portfolio. That figure, called the gross NPL ratio, was the lowest since March 2025, when the ratio stood at 3.30 percent. 

But the NPL ratio masks a deeper tension: gross NPLs rose 5.5% year-on-year to Php 530.29 billion, while total loans expanded 10.93% to Php 15.88 trillion. The ratio fell not because bad loans shrank, but because credit growth outpaced them. 

Loan loss reserves rose 5.5% to Php 505.91 billion, and the NPL coverage ratio ticked up to 95.4%. Past due loans climbed 9.17% to Php 670.5 billion, and restructured loans rose 6.27%. Provisioning for credit losses ballooned to Php 84.19 billion in 1H 2025, with Php 43.78 billion booked in Q2 alone—the largest since Q4 2020’s pandemic-era spike. 

So, while the establishment cites falling NPL ratios to reassure the public, banks are quietly bracing for defaults and valuation hits—likely tied to large corporate exposures. The provisioning surge is a tacit admission: risk is rising, even if it hasn’t yet surfaced in headline metrics.

1.B Philippine Bank’s Profit Growth Falters: Q2 Deficit Breaks the Streak

Figure 1

Philippine banks posted their first quarterly profit contraction in Q2 2025, down -1.96% YoY—a sharp reversal from Q1’s 10.64% growth and Q2 2024’s 5.21%. This marks the first decline since Q3 2023’s -11.75%. (Figure 1, upper window) 

Even more telling, since the BSP’s historic rescue of the banking system in Q2 2021, net profit growth has been trending downward. Peso profits etched a record in Q1 2025, but fell in Q2. 

The Q2 slump dragged down 1H performance: bank profit growth slipped to 4.14%, compared to 2H 2024’s 9.77%, though slightly higher than 1H 2024’s 4.1%. 

1.C Universal and Commercial Banks Lead the Weakness; PSE Listed Banks Echo the Slowdown 

Earnings growth of universal-commercial (UC) banks sank from 8.6% in Q1 2025 to a -2.11% deficit in Q2. 

UC bank profits grew 6.33% in Q2 2024. Still, UC banks eked out a 3.1% gain in 1H 2025 versus 5.3% in the same period last year. UC banks accounted for 93.1% of total banking system profits in 1H 2025—underscoring their dominance or concentration but also their vulnerability. 

PSE listed banks partially echoed BSP data. (Figure 1, Lower Table) 

Aggregate earnings growth for all listed banks hit 6.08% in Q2 and 6.77% in 1H—down from 10.43% and 9.95% in the same periods last year. The top three banks in the PSEi 30 (BDO, BPI, MBT) reported combined earnings growth of 4.3% in Q2 and 5.31% in 1H 2025, substantially lower compared to 13.71% and 15.4% in 2024. 

The discrepancy between BSP and listed bank data likely stems from government, foreign, and unlisted UC banks—whose performance may be masking broader stress. 

1.D Income Breakdown: Lending Boom Masks Structural Risk 

What explains the sharp profit downturn?

Figure 2

Net interest income rose 11.74% in Q2, while non-interest income increased 14.7%—slightly higher than Q1’s 11.7% and 14.5%, respectively. However, net interest income was lower than Q2 2024’s 14.74%, while non-interest income rebounded from -5.71% in the same period. (Figure 2, topmost chart) 

In 1H 2025, net interest income grew 11.7%, and non-interest income rose 14.6%, compared to 15.53% and -8.83% in 1H 2024. Net interest income now accounts for 82.5% of total bank profits—a fresh high, reflecting the lending boom regardless of BSP’s rate levels. 

This share has reversed course since 2013, rising from ~60% to 77% by end-2024—driven by BSP’s easy money policy and historic pandemic-era rescue efforts. Banks’ income structure resembles a Pareto distribution: highly concentrated, and extremely susceptible to duration and credit risks. 

BSP’s easing cycle has not only failed to improve banks’ core business, but actively contributed to its decay.

1.E CMEPA’s Gambit: Taxing Time Deposits to Diversify Bank Income 

The government’s response has been the Capital Market Efficiency Promotion Act (CMEPA). CMEPA, effective July 2025, imposes a flat 20% final withholding tax on all deposit interest income, including long-term placements. 

By taxing time deposits, policymakers aim to push savers into capital markets, boosting bank non-interest income through fees, trading, and commissions. But in reality, this is financial engineering. (Figure 2, middle graph) 

With weak household savings and low financial literacy, deposit outflows will likely shrink banks’ funding base rather than diversify their revenues. 

It would increase time preferences, leading the public to needlessly take risks or gamble—further eroding savings. 

Or, instead of reducing fragility, CMEPA risks layering volatile market income on top of an already over-concentrated interest income model. 

We’ve previously addressed CMEPA—refer to earlier posts for context (see below) 

1.F The Real Culprit: Exploding Losses on Financial Assets 

Beyond this structural weakness, the real culprit behind the downturn was losses on financial assets. 

In Q2 2025, banks posted Php 43.78 billion in losses—the largest since the pandemic recession in Q4 2020—driven by Php 49.3 billion in provisions for credit losses!  (Figure 2, lowest image) 

For 1H 2025, losses ballooned 64% to Php 73.6 billion, with provisions reaching Php 84.19 billion. 

Once again, this provisioning surge is a tacit admission: while officials cite falling NPL ratios, banks themselves are bracing for valuation hits and potential defaults, likely tied to concentrated corporate exposures. 

1.G San Miguel’s Share Plunge: A Canary in the Credit Mine? Beneath the Surface: Banks Signal Stress

Figure 3

Could this be linked to the recent collapse in San Miguel [PSE: SMC] shares? 

SMC plunged 14.54% WoW (Week on Week) as of August 15th, compounding its YTD losses to 35.4%. (Figure 3, upper diagram) 

And this share waterfall happened before its Q2 17Q 2025 release, which showed debt slipping slightly from Php 1.511 trillion in Q1 to Php 1.504 trillion in 1H—suggesting that the intensifying selloff may have been driven by deeper concerns. (Figure 3, lower visual) 

SMC’s Q2 (17Q) report reveals increasingly opaque cash generation, aggressive financial engineering, and unclear asset quality and debt servicing capacity. 

Yet, paradoxically, Treasury yields softened across the curve—hinting at either covert BSP intervention through its institutional cartel, a dangerous underestimation of contagion risk, or market complacency—a lull before the credit repricing storm. 

If SMC’s debt is marked at par or held to maturity, deterioration in its credit profile wouldn’t show up as market losses—but would require provisioning. This provisioning surge is a tacit admission: banks are seeing heightened risk, even if it’s not yet reflected in NPL ratios or market pricing. 

We saw this coming. Prior breakdowns on SMC are archived below. 

Of course, this SMC–banking sector inference linkage still requires corroborating evidence or forensic validation—time will tell.

Still, one thing is clear: banks are exhibiting mounting stress—underscoring the BSP’s resolve to intensify its easing cycle through rate cuts, RRR reductions, deposit insurance hikes, and a soft USDPHP peg. The ‘Marcos-nomics’ debt-financed deficit spending adds fiscal fuel to this monetary response. 

1.H The NPL Illusion: Velocity Masks Vulnerability

Figure 4

NPLs can be a deceptive measure of bank health. Residual regulatory reliefs from the pandemic era may still distort classifications, and the ratio itself reflects the relative velocity of bad loans versus credit expansion. 

Both gross NPLs and total loans hit record highs in peso terms in June—Php 530.29 billion and Php 15.88 trillion, respectively—but credit growth outpaced defaults, keeping the NPL ratio artificially low at 3.34%. (Figure 4, topmost pane) 

The logic is simple: to suppress the NPL ratio, loan velocity must accelerate faster than the accumulation of bad debt. Once credit expansion stalls, the entire kabuki collapses—and latent systemic stress will surface. 

1.I Benchmark Kabuki: When Benchmark-ism Meets Market Reality 

This is where benchmark-ism hits the road—and skids. The system’s metrics, once propped up by interventionist theatrics, are now showing signs of exhaustion. 

These are not isolated anomalies, but worsening symptoms of prior rescues—now overrun by the law of diminishing returns. 

And yet, the response is more of the same: fresh interventions to mask the decay of earlier ones. Theatrics, once effective at shaping perception, are now being challenged by markets that no longer play along. 

The system’s health doesn’t hinge on ratios—it hinges on velocity. Velocity of credit, of confidence, of liquidity. When that velocity falters, the metrics unravel. 

And beneath the unraveling lies a fragility that no benchmark can disguise. 

Part 2: Liquidity Strains and the Architecture of Intervention

2.A Behind the RRR Cuts: Extraordinary Bank Dependence on BSP 

There are few signs that the public grasps the magnitude of developments unfolding in Philippine banks. 

The aggregate 450 basis point Reserve Requirement Ratio (RRR) cuts in October 2024 and March 2025 mark the most aggressive liquidity release in BSP history—surpassing even its pandemic-era response. (Figure 4, middle chart) 

Unlike previous easing cycles (2018–2019, 2020), where banks barely tapped BSP liquidity, the current drawdown has been dramatic. 

As of July, banks had pulled Php 463 billion since October 2024 from the BSP (Claims on Other Depository Corporations)—Php 84.6 billion since March and Php 189.2 billion in June. Notably, 40.9% of the Php 463 billion liquidity drawdown occurred in July alone. 

This surge coincides with mounting losses on financial assets and record peso NPLs—masked by rapid credit expansion, which may be a euphemism for refinancing deteriorating debt. Banks’ lending to bad borrowers to prevent NPL classification is a familiar maneuver. 

When banks incur significant financial losses—whether from rising NPLs, credit impairments, or mark-to-market declines—the immediate impact is not just weaker earnings but a widening hole in their funding structure. The December 2020 episode, when the system booked its largest financial losses, highlighted how such shocks create a liquidity vacuum: instead of recycling liquidity through lending and market channels, banks are forced to patch internal shortfalls, draining capital buffers and eroding interbank trust. 

Into this vacuum steps the BSP. Reserve requirement cuts, while framed as policy easing, have functioned less as a growth stimulus and more as a liquidity lifeline. By drawing on their balances with the BSP, banks convert regulatory reserves into working liquidity—filling gaps left by financial losses. The outcome is growing dependence on central bank support: what appears as easing is in fact the manifestation of extraordinary support, with liquidity migrating from market sources to the BSP’s balance sheet. 

This hidden dependence underscores how financial repression has hollowed out market-based liquidity, leaving the BSP as the primary lender of first resort 

2.B RRR Infusions: Liquidity Metrics Rebound; Weak Money Creation Amid Record Deficit Spending

The liquidity drawdown has filtered into banks’ cash positions. As of June, peso cash reserves rebounded—though still down 19.8% year-on-year. Cash-to-deposit ratios rose from 9.87% in May to 10.67% in June, while liquid assets-to-deposits climbed from 47.29% to 49.24%. (Figure 4, lowest image)

Figure 5

RRR-driven cash infusions also lifted deposits. Total deposit growth rebounded from 4.96% in May to 5.91% in June, led by peso deposits (3.96% to 6.3%) and supported by FX deposits (4.42% to 6.8%). (Figure 5, topmost graph) 

Yet paradoxically, despite a 10.9% expansion in Total Loan Portfolio and ODC drawdown, deposits only managed modest growth—suggesting a liquidity black hole. CMEPA’s impact may deepen this imbalance. 

Despite record deficit spending in 1H 2025, BSP currency issuance/currency in circulation growth slowed from 9% in June to 8.1% in July, after peaking at 14.7% in May during election spending. Substantial money creation has not translated into higher CPI or GDP, and the slowdown suggests a growing demand problem. (Figure 5, middle diagram) 

Even with July’s massive ODC drawdown, BSP’s cash in circulation suggests a financial cesspool has been absorbing liquidity—offsetting whatever expansionary efforts are underway. 

2.C Rising Borrowings Reinforce Funding Strains, Crowding Out Intensifies, Record HTM Assets 

After a brief slowdown in May, bank borrowings surged anew by 24% in June to Php 1.85 trillion, nearing the March record of Php 1.91 trillion. Escalating liquidity strains are pushing banks to increase funding from capital markets. (Figure 5, lowest pane) 

This intensifies the crowding-out effect, as banks compete with the government and private sector for access to public savings.

Figure 6

Meanwhile, as predicted, record-high public debt has translated to greater bank financing of government via Net Claims on the Central Government, showing up in banks’ record-high Held-to-Maturity (HTM) assets. HTM assets have become a prime contributor to tightening liquidity strains in the banking system. (Figure 6, topmost graph) 

2.D Divergence: Bank Profits, GDP and the PSE’s Financial Index; Market Concentration 

Despite slowing profit growth, the PSE’s Financial Index—composed of 7 banks (BDO, BPI, MBT, CBC, AUB, PNB, SECB) plus the PSE—hit a historic high in Q1 2025, before dipping slightly in Q2. (Figure 6, middle visual)

Meanwhile, the sector’s real GDP partially echoed profits, reinforcing the case of a downturn. 

Financial GDP dropped sharply from 6.9% in Q1 2025 and 8% in Q2 2024 to 5.6% in Q2 2025. It accounted for 10.4% of national GDP in Q2, down from the all-time high of 11.7% in Q1—signaling deeper financialization of the economy. (Figure 6, lowest chart)

Figure 7

Bank GDP slowed to 3.7% in Q2 from 4.9% in Q1 2025, far below the 10.2% growth of Q2 2024. Since Q1 2015, bank GDP has averaged nearly half (49.9%) of the sector’s GDP. (Figure 7, topmost window) 

Thanks to the BSP’s historic rescue, the free-float market cap weight of the top three banks (BDO, BPI, MBT) in the PSEi 30 rose from 12.76% in August 2020 to 24.37% by mid-April 2025. As of August 15, their share stood at 21.8%, rising to 23.2% when CBC is included. (Figure 7, middle chart) 

This concentration has cushioned the PSEi 30 from broader declines—suggesting possible non-market interventions in bank share prices, while amplifying concentration risk. 

2.E OFCs and the Financial Index: A Coordinated Lift? 

BSP data on Other Financial Corporations (OFCs) reveals a dovetailing of ODC activity with the Financial Index. OFCs—comprising non-money market funds, financial auxiliaries, insurance firms, pension funds, and money lenders—appear to be accumulating bank shares, possibly at BSP’s implicit behest. 

In Q1 2024, BSP noted: "the sector’s claims on depository corporations rose amid the increase in its deposits with banks and holdings of bank-issued equity shares." 

This suggests a coordinated effort to prop up bank share prices—masking underlying stress. (Figure 7, lowest graph) 

Once a bear market strikes key bank shares and the financial index, losses will add to liquidity stress. Economic reality will eventually expose the choreography propping up both the PSEi 30 and banks. 

2.F Triple Liquidity Drain; Rescue Template Risks: Inflation, Stagflation, Crisis; Fiscal Reflex: Keynesian Response Looms 

In short, three sources of liquidity strain now pressure Philippine banks:

• Record holdings of Held-to-Maturity assets
• Rising Financial losses
• All-time high non-performing loans 

If BSP resorts to its 2020–2021 pandemic rescue template, expect the USDPHP to soar, inflation to spike, and rates to rise—ushering in stagflation or even possibly a debt crisis. 

With the private sector under duress from mounting bad credit, authorities—guided by top-down Keynesian ideology—are likely to resort to fiscal stimulus to boost GDP and ramp up revenue efforts. 

2.G Finale: Classic Symptoms of Late-Cycle Fragility 

The Philippine banking system is showing unmistakable signs of late-cycle fragility.

Velocity-dependent metrics are poised to unravel once credit growth stalls. Liquidity dependence is paraded as resilience. Market support mechanisms blur price discovery. Policy reflexes recycle past interventions while ignoring structural cracks. 

Losses are being papered over with liquidity, fiscal deficits are substituting for private demand, and the veneer of stability rests on central bank backstops. This choreography cannot hold indefinitely. If current trajectories persist, the risks are stark: stagflation, currency instability, and a potential debt spiral. 

The metrics are clear. The real story lies in the erosion of velocity and the quiet migration from market discipline to state lifelines. What appears resilient today may be revealed tomorrow as fragility sustained on borrowed time. 

As the saying goes: we live in interesting times. 

____

Prudent Investor Newsletter Archives: 

1 San Miguel

• Is San Miguel’s Ever-Growing Debt the "Sword of Damocles" Hanging over the Philippine Economy and the PSE? December 02, 2024 (substack)
• Escalating Systemic Risk: As Cash Reserves Plummeted, San Miguel’s 9M Debt Zoomed to an Astonishing Php 1.405 TRILLION! November 20, 2023 (substack)

Just among the many…

2 CMEPA

• The CMEPA Delusion: How Fallacious Arguments Conceal the Risk of Systemic Blowback July 27, 2025 (substack)
• The Seen, the Unseen, and the Taxed: CMEPA as Financial Repression by Design July 20,2025 (substack)