BSP’s Aggressive RRR Cuts: A High-Stakes Gamble?

 

If there is one common theme to the vast range of the world’s financial crises, it is that excessive debt accumulation, whether by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels and make banks seem more stable and profitable than they re­ally are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced—Carmen Reinhart and Kenneth Rogoff 

In this issue

BSP’s Aggressive RRR Cuts: A High-Stakes Gamble?

I. Decline in 2024 Bank Non-Performing Loans Amidst Record-High Debt Levels and a Slowing Economy

II. Deepening Financialization: Financial Assets Surge in 2024 as Banks Drive Industry Monopolization

III. Viewing Bank’s Asset Growth Through the Lens of the PSE

IV. March 2025 RRR Cuts and the Liquidity Conundrum: Unraveling the Banking System’s Pressure Points

V. Liquidity Drain: Record Investment Risks and Elevated Marked-to-Market Losses

VI. Despite Falling Rates, Bank’s Held-to-Maturity Assets Remain Near Record High

VII. Moral Hazard and the "COVID Bailout Playbook"

VIII. The Bigger Picture: Are We Headed for a Full-Blown Crisis?

IX. Conclusion: RRR Cuts a High-Risk Strategy? 

BSP’s Aggressive RRR Cuts: A High-Stakes Gamble?

The BSP announced another round of RRR cuts in March amid mounting liquidity constraints. Yet, the reduction from 20% in 2018 to 7% in 2024 has barely improved conditions. Will this time be different?

I. Decline in 2024 Bank Non-Performing Loans Amidst Record-High Debt Levels and a Slowing Economy

Inquirer.net, February 14, 2025: Soured loans held by Philippine banks as a ratio of total credit eased to their lowest level in a year by the end of 2024 as declining interest rates and softer inflation helped borrowers settle their debts on time. However, a shallower easing cycle might keep financial conditions still somewhat tight, which could prevent a big decline in bad debts this year. Preliminary data from the Bangko Sentral ng Pilipinas (BSP) showed the gross amount of nonperforming loans (NPLs)—or credit that is 90 days late on a payment and at risk of default—had cornered 3.27 percent of the local banking industry’s total lending portfolio as of December, down from November’s 3.54 percent. That figure—also known as the gross NPL ratio—was the lowest since December 2023, when bad loans accounted for 3.24 percent of banks’ total loan book.

An overview of the operating environment 

In any analysis, it is crucial to understand the operating environment that provides context to the relevance of a statistic in discussion.

The Bangko Sentral ng Pilipinas (BSP) initiated its ‘easing cycle’ in the second half of 2024, which included three rate cuts and a reduction in the reserve requirement ratio (RRR). Meanwhile, inflation (CPI) rebounded from a low of 1.9% in September to 2.9% in December. Additionally, the BSP tightened its cap on the USDPHP exchange rate. Fiscal spending over the first 11 months of the year reached an all-time high.

Yet, there are notable contradictions.

Despite record-high bank lending—driven largely by real estate and consumer loans—GDP growth slowed to 5.2% in the second half of 2024 primarily due to the weak consumer spending. The employment rate was also near an all-time high.

Figure 1

Meanwhile, real estate prices entered deflationary territory in Q3, with the sector’s real GDP growth falling to its lowest level since the pandemic-induced recession. Its share of total GDP also dropped to an all-time low. 

Notably, the real estate sector remains the largest borrower within the banking system (encompassing universal, commercial, thrift, and rural/cooperative banks). (Figure 1, topmost chart) This data depends on the accuracy of the loans reported by banks. 

However, despite recent rate cuts and significant reductions in RRR, the sector remains under pressure. Additionally, sluggish GDP growth suggests mounting risks associated with record levels of consumer leverage. 

Upon initial analysis, the decline in non-performing loans (NPLs) appears inconsistent with these economic developments. Gross NPLs dropped to one-year lows, while net NPLs reached levels last seen in June 2020. (Figure 1, middle window) 

Ironically, the BSP also announced another round of RRR cuts this March.

II. Deepening Financialization: Financial Assets Surge in 2024 as Banks Drive Industry Monopolization

Let's now turn to the gross assets of the financial system, also known as Total Financial Resources (TFR).

The BSP maintained its policy rate this February.

Ironically, BSP rates appear to have had little influence on the assets of the bank-financial industry. 

In 2024, TFR surged by 7.8% YoY, while bank resources jumped 8.9%, reaching record highs of Php 33.78 trillion and Php 28.255 trillion, respectively. 

Why does this matter? 

Since the BSP started hiking rates in April 2022, TFR and bank financial resources have posted a 9.7% and 10.9% compound annual growth rate (CAGR), respectively. In short, the growth of financial assets has accelerated despite the BSP’s rate hikes. 

Or, the series of rate hikes have barely affected bank and financial market operations. 

By the end of 2024, TFR stood at 128% of headline GDP and 152% of nominal GDP, while bank resources accounted for 107% and 127%, respectively. This reflects the increasing financialization of the Philippine economy—a growing reliance on credit and liquidity—as confirmed by the Money Supply (M series) relative to GDP. (Figure 1, lowest image)

Banking Sector Consolidation

Figure 2

More importantly, the rate hikes catapulted the bank's share of the TFR from 82.3% in 2023 to an all-time high of 83.64% in 2024, powered by universal and commercial banks, whose share jumped from 77.6% to 78.3%! (Figure 2, topmost diagram) 

Effectively, the banking industry—particularly UCBs—has been monopolizing finance, leading to greater market concentration, which translates to a build-up in systemic concentration risk. 

As of December 2024, bank assets were allocated as follows: cash, 10%; total loan portfolio (inclusive of interbank loans and reverse repurchase agreements), 54%; investments, 28.3%; real and other properties acquired, 0.43%; and other assets, 7.14%. 

In 2024, the banking system’s cash reserves deflated 6.01% YoY, while total loans and investments surged by 10.74% and 10.72%, respectively. 

Yet over the years, cash holdings have declined (since 2013), loan growth has been recovering (post-2018 hikes), and investments have surged, partially replacing both. (Figure 2, middle image) 

Notably, despite the BSP’s historic liquidity injections, banks' cash reserves have continued to erode. 

The catch-22 is that if banks were profitable, why would they have shed cash reserves over the years? 

Why the series of RRR cuts? 

III. Viewing Bank’s Asset Growth Through the Lens of the PSE 

During the Philippine Stock Exchange Index (PSEi) 30’s run-up to 7,500, Other Financial Corporations (OFCs)—potentially key players in the so-called "national team"—were substantial net buyers of both bank and non-bank equities. 

BSP, January 31, 2025: "The q-o-q rise in the other financial corporations’ domestic claims was attributable to the increase in its claims on the depository corporations, the other sectors, and the central government. In particular, the other financial corporations’ claims on the depository corporations grew as its holdings of bank-issued debt securities and equity shares increased.  Likewise, the sector’s claims on the other sectors grew as its investments in equity shares issued by other nonfinancial corporations and loans extended to households expanded. The growth in the OFCs’ domestic claims was further supported by the rise in the sector’s investments in government-issued debt securities" (bold added)

The OFCs consist 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.

In Q3 2024, claims on depository corporations surged 12% YoY, while claims on the private sector jumped 8%, both reaching record highs in nominal peso terms.

Meanwhile, the PSEi and Financial Index surged 15.1% and 23.4%, respectively. The Financial Index hit an all-time high of 2,423.37 on October 21st, and as of this writing, remains less than 10% below that peak. The Financial Index, which includes seven banks (AUB, BDO, BPI, MBT, CBC, SECB) and the Philippine Stock Exchange (PSE) as the sole non-bank component, has cushioned the PSEi 30 from a collapse. (Figure 2, lowest chart)

Figure 3

It has also supported the PSEi 30 and the PSE through the private sector claims. (Figure 3, topmost pane)

The irony is that OFCs continued purchasing bank shares even as the banking sector’s profit growth (across universal-commercial, thrift, and rural/cooperative banks) materially slowed (as BSP’s official rates rose)

In 2024, the banking system’s net profit growth fell to 9.8%, the lowest in four years. (Figure 3, middle chart)

Meanwhile, trading income—despite making up just 2.2% share of total operating income—soared 78.3% YoY. 

The crux is that the support provided to the Financial Index by the OFCs may have enabled banks to increase their asset base via their ‘investment’ accounts, while simultaneously propping up the PSEi 30. 

Yet, this also appears to mask the deteriorating internal fundamentals of Philippine banks. (Figure 3, lowest graph) 

There are several possibilities at play: 

1. The BSP’s influence could be a factor;

2. Banks may have acted like a cartel in coordinating their actions

3. The limited depth of Philippine capital markets may have forced the industry’s equity placements into a narrow set of options.

But in my humble view, the most telling indicator? Those coordinated intraday pumps—post-recess "afternoon delight" rallies and pre-closing floats—strongly suggest synchronized or coordinated activities.

The point of this explanation is that Philippine banks and non-bank institutions appear to be relying on asset inflation to boost their balance sheets. 

Aside from shielding banks through liquidity support for the real estate industry, have the BSP's RRR cuts also been designed to boost the PSEi 30?

IV. March 2025 RRR Cuts and the Liquidity Conundrum: Unraveling the Banking System’s Pressure Points 

Philstarnews.com, February 22, 2025: The Bangko Sentral ng Pilipinas (BSP) surprised markets yesterday as it announced another major reduction in the amount of deposit banks are required to keep with the central bank. The BSP said it would reduce the reserve requirement ratios (RRR) of local banks, effective March 28, to free up more funds to boost the economy.  “The BSP reiterates its long-run goal of enabling banks to channel their funds more effectively toward productive loans and investments. Reducing RRRs will lessen frictions that hinder financial intermediation,” the central bank said…The regulator slashed the RRR for universal and commercial banks, as well as non-bank financial institutions with quasi-banking functions (NBQBs) by 200 basis points, to five percent from the current level of seven percent. 

The BSP last reduced the reserve requirement ratio (RRR) on October 25, 2024. With the next cut taking effect on March 28, 2025, this marks the fastest and largest RRR reduction in recent history.

In contrast, the BSP previously cut RRR rates from 18% to 14% over an eight-month period between May and December 2019.

Why the RRR Cuts if NPLs Are Not a Concern?

Figure 4

BSP’s balance sheet data from end-September to November 2024 shows that the RRR reduction led to a Php 124.5 billion decline in Reserve Deposits of Other Depository Corporations (RDoDC)—an estimate of the liquidity injected into the system. The downtrend in bank reserves since 2018 reflects the cumulative effect of these RRR cuts.  (Figure 4, topmost image)

Yet, despite the liquidity injection, the banking system’s cash and due-from-bank deposits continued to decline through December. It has been in a downtrend since 2013. (Figure 4, middle pane)

Cash reserves dropped 6% in 2024, marking the third consecutive annual decline. The BSP’s 2020-21 historic Php 2.3 trillion injection has largely dissipated.

Since peaking at Php 3.572 trillion in December 2021, cash levels have fallen by Php 828 billion to Php 2.743 trillion in December 2024—essentially returning to 2019 levels.  (Figure 4, lowest chart)

Figure 5

The BSP’s other key liquidity indicator, the liquid assets-to-deposits ratio has also weakened, resonating with the cash reserve trend. This decline, which began in 2013, was briefly offset by the BSP’s historic Php 2.3 trillion liquidity injection but has now resumed its downward trajectory. (Figure 5, topmost diagram) 

Other Factors Beyond Cash and Reserves

The slowdown isn’t limited to cash reserves. 

Deposit growth has also decelerated since 2013, despite reaching record highs in peso terms. Ironically, a robust 12.7% rebound in bank lending growth (excluding interbank loans and repos) in 2024, which should have spurred deposit growth, failed to translate into meaningful gains. Peso deposits grew by just 7% in 2024. (Figure 5, middle pane) 

The question arises: where did all this money go? 

This brings attention back onto the BSP’s stated goal of "enabling banks to channel funds more effectively toward productive loans and investments." This growing divergence between total loan portfolio growth and peso deposit expansion in the face of RRR cuts—20% before March 2018, now down to just 7% last October—raises further questions about its effectiveness in boosting productive lending and investment.

A Deeper Liquidity Strain: Rising Borrowings

Adding to signs of the increasing liquidity stress, bank borrowings hit an all-time high in 2024, both in gross and net terms. (Figure 5, lowest graph)

Figure 6

Total borrowings surged by Php 394.5 billion, pushing outstanding bank debt to a record Php 1.671 trillion.

More importantly, the focus of borrowing was in bill issuance, which accounted for 65% of total bank borrowings in 2024 (!)—a strong indicator of tightening liquidity. (Figure 6, topmost image)

If banks are highly profitable and NPLs are not a major issue, why are they borrowing so aggressively and requiring additional RRR cuts?

The liquidity squeeze cannot be attributed solely to RRR levels alone—otherwise, the 2018–2020 cut from 20% to 12% should have stemmed the tide.

V. Liquidity Drain: Record Investment Risks and Elevated Marked-to-Market Losses

There’s more to consider.

Beyond lending, bank investments—another key bank asset class—also hit a record high in peso terms in 2024.

Yet, despite lower fixed-income rates, banks continued to suffer heavy losses on their investment portfolios: Accumulated investment losses stood at Php 42.4 billion in 2024, after peaking at Php 122.85 billion in 2022. (Figure 6, middle diagram)

Banks have now reported four consecutive years of investment losses.

These losses undoubtedly strain liquidity, but what’s driving them?

The two primary investment categories—Available-for-Sale (AFS) and Held-to-Maturity (HTM) securities—accounted for 40% and 52.6% of total bank investments, respectively.

Accumulated losses likely stem from AFS positions, reflecting volatility in equity, fixed-income, foreign exchange, and other trading activities.

VI. Despite Falling Rates, Bank’s Held-to-Maturity Assets Remain Near Record High

Interestingly, despite easing fixed-income rates, HTM assets remained close to their all-time high at Php 3.95 trillion in December 2024, barely below the December 2023 peak of Php 4.02 trillion.

Since January 2023, HTM holdings have hovered tightly between Php 3.9 trillion and Php 4 trillion.

Government Financing and Liquidity Risks

Yet, this plateau may not persist.

Beyond RRR cuts, the banking system’s Net Claims on Central Government (NCoCG) surged 7% to a new high of Php 5.541 trillion in December 2024.

Per BSP: "Net Claims on CG include domestic securities issued by, and loans extended to, the central government, net of liabilities such as deposits."

While this is often justified under Basel III capital adequacy measures, in reality, it functions as a quasi-quantitative easing (QE) mechanism—banks injecting liquidity into the financial system by financing the government.

The likely impact?

The losses in government securities are categorized as HTMs, effectively locking away liquidity.

BSP led Financial Stability Coordination Council (FSCC) noted in their 2017 Financial Stability Report in 2018 that: "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. Furthermore, the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity" (bold mine) 

Curiously, discussions of HTM risks vanished from BSP-FSCC Financial Stability Reports after the 2017 and 2018 H1–2019 H1 issues.

VII. Moral Hazard and the "COVID Bailout Playbook"

Although NCoCG has been growing since 2015, banks accelerated their accumulation of government securities as part of the BSP’s 2020 pandemic rescue package. 

Are banks aggressively lending to generate liquidity solely to finance the government? Are they also using government debt to expand the collateral universe for increased lending? Government debt is also used as collateral for interbank loans and repo transactions. 

Have accounting regulations—such as HTM—transformed into a silo that shields Mark-to-Market losses? 

The growth of HTM has aligned with NCoCG. (Figure 6, lowest chart)

While this may satisfy Basel capital adequacy requirements, ironically, it also exposes the banking system to investment concentration risk, sovereign risk, and liquidity risk.

This suggests that reported bank "profits"—likely inflated by subsidies and relief measures—are overshadowed by a toxic mix of trading losses, HTM burdens, and potentially undeclared or hidden NPLs. 

These pressures have likely forced the BSP to aggressively cut RRR rates.

As anticipated, authorities appear poised to replicate the COVID-era bailout playbook, which they view as a success in averting a crisis.

The likely policy trajectory template includes DIRECT BSP infusions via NCoCG, record fiscal deficits, further RRR and policy rate cuts, accelerated bank infusions NCoCG, a higher cap on the USD/PHP exchange rate, and additional subsidies and relief measures for banks.

This is unfolding before us, one step at a time.

VIII. The Bigger Picture: Are We Headed for a Full-Blown Crisis?

Given the moral hazard embedded in this bailout mindset, banks may take on excessive risks, exacerbating "frictions in financial intermediation". Debt will beget more unproductive debt. "Ponzi finance" risks will intensify heightening liquidity constraints that could escalate into a full-blown crisis. 

Further, given the banking system’s fractional reserve operating framework, riskier bank behavior, whetted by reduced cash buffers, heightens the risks of lower consumer confidence in the banking system—which translates to a higher risk of a bank run. 

The Philippine Deposit Insurance Corporation (PDIC) reportedly has funds to cover 18.5% of insured deposits, or P3.53 trillion, as of 2023. 

So, with the RRR cuts, is the BSP gambling with this?

IX. Conclusion: RRR Cuts a High-Risk Strategy?

BSP’s statistics cannot be fully relied upon to assess the true health of the banking system.

1. The decline in non-performing loans (NPLs) is inconsistent with slowing economic growth and the deflationary spiral in the real estate sector. Likewise, falling NPLs contradict the ongoing liquidity pressures faced by banks.

2. Evidence of these liquidity strains is clear: bank borrowings have surged to record levels, with bill issuances dominating the market. The BSP’s RRR cuts only reinforce the mounting liquidity constraints. 

3. Beyond lending, banks have turned to investments to strengthen their balance sheets—including supporting the Philippine Stock Exchange (PSE), even as asset prices have become increasingly misaligned with corporate earnings.

4. In a bid to further boost systemic liquidity, implied quantitative easing (QE) spiked to an all-time high in December, which will likely translate into a higher volume of Held-to-Maturity (HTM) assets.

Through aggressive RRR cuts, is the BSP taking a high-risk approach merely to uphold its statistical narrative?

 

 

 

Quote of the Day: Monetary Policy Cannot Solve All Economic Problems That May Ail Our Economies; What happens When The Fed Stops Distorting Prices?

The authority of monetary policymakers to intervene in financial markets has come to be accepted and expected. Whether the purpose is to change the relative price of various assets, such as long vs. short dated Treasuries, or to alter the allocation of credit, such as Treasuries vs. mortgage-backed securities, the result has been a much more interventionist central bank. The belief is, of course, that central bankers know enough to control relative asset prices with sufficient precision and that the transmission mechanisms and consequences are sufficiently predictable that policymakers can better control real economic growth and employment, and now, financial stability.

I find this a dubious proposition at best. For central banks to act as if these conditions exist suggests to the public that monetary policy has great ability to fine tune economic outcomes. That means monetary policy makers may well be accepting more responsibility for managing economic outcomes than they, in fact, can deliver. This is a recipe for failure and can undermine the public’s trust and confidence in the central bank. So maybe a little more humility on the part of central bankers and the public regarding what they monetary policy can accomplish is in order and a little less intervening just because it can, or has the power or authority, may be prudent. Monetary policy simply cannot solve all economic problems that may ail our economies.

(bold added)

This quote is from Charles Plosser former President, Federal Reserve Bank of Philadelphia and former Dean, Graduate School of Business Administration, University of Rochester as interviewed by the Money and Banking blog

More juicy quotes (bold mine)

As I mentioned, no regulatory authority anywhere in the world, no central bank no financial supervisory agency, saw the crisis coming. What makes us think we will spot the next one? Whenever it arises it will surely come from somewhere the authorities were not looking.

We face a number of challenges. First we have the problem of defining financial stability. I know of no good definition. Without a definition how do we know if we have succeeded? How do we know if we have over compensated and reduced risks too much without some metric that tells us of the trade-offs? Implicit in the Dodd-Frank legislation is the view that if only we could write enough rules and prohibitions on the financial sector we could solve the problem. I believe this is a bit like the dog chasing its tail, and equally futile.

Second we should acknowledge that stability risks can move around. Where regulators look, those risks are unlikely to be found. The challenge is figuring out where they will show up next. Financial markets are adept at packaging and repackaging risks in forms that the market will buy. There is nothing inherently wrong with this except regulators will always be behind the market developments.

Finally, the central bank should be particularly vigilant in not artificially encouraging financial imbalances or stability risks through its monetary policy actions. Unfortunately, this may bring financial stability and the goals of monetary policy into stark conflict. There is an ongoing and important debate on this issue. That is, should monetary policy be used to address financial stability risks or not; what if it’s a source of the risks?

Today the stated goal of the interventions undertaken by the Fed such as the asset purchases or the maturity extension program have been intended to encourage risking-taking and alter the portfolio balances of economic agents. If successful, these actions distort market prices. One stability risk worth considering is: What happens when the Fed stops distorting prices?

Wow! Ambiguity in the definition of financial stability, stability risk in a state of perpetual flux (or also policy or political response as 'fighting the last war' or dealing with past rather then present evolving problems) and most importantly, treating symptoms while encouraging the disease (financial imbalances) seem as an implied rebuke on central banking's "macroprudential policies" and the Basel Standard!

Phisix 7,800: Peso Smashed, January Remittance Growth Rates Plunges, Short Term Treasury Yields Spike!

And as man cannot bear to be without the miraculous, he will create new miracles of his own for himself, and will worship deeds of sorcery and witchcraft, though he might be a hundred times over a rebel, heretic and infidel ― Fyodor Dostoyevsky, The Brothers Karamazov

In this issue:

Phisix 7,800: Peso Smashed, January Remittance Growth Rates Plunges, Short Term Treasury Yields Spike!

-US Dollar’s Domino Effect: Philippine Peso and Malaysian Ringgit Smoked!

-OFW Remittances: Growth Rates Crash in January! Structural Headwinds Compounded by Event Risks

-Short-Term Philippine Treasury Yields Spike as Yields Flatten! Basel Standards are No Guarantee of Adequate Risk Measurement

-Capital Flight from Local Elites? Asian Currencies and CDS Spreads Show Why This Time Won’t Be Different

-Sweden Cuts Rate Announces QE as BIS and OECD Warns on Low Interest Rates!

Phisix 7,800: Peso Smashed, January Remittance Growth Rates Plunges, Short Term Treasury Yields Spike!

Marking the close occurred in a stunning 4 out of the 5 trading days this week!

It’s just horrifying to see how the Philippine stock market has transmogrified into a broken system characterized by mass hysteria and rampant manipulation!

US Dollar’s Domino Effect: Philippine Peso and Malaysian Ringgit Smoked!

In noting of the Philippine pesos’ outperformance, last week I asked, “For now, the Philippine peso now takes on the leadership but for how long?”

The currency markets appeared to have answered my question.

Although the US Federal Reserve’s FOMC dropped the word “patient” from their recent policy meeting, a “surprisingly downbeat outlook” and Fed Chairwoman Ms. Janet Yellen’s implied assurances of stretching an interest rate hike via “doesn’t mean we are going to be impatient” sent the US dollar tumbling. The US dollar even experienced a flash crash! (see right window). Growing accounts of real time flash crashes represents another sign how fragile and vulnerable the current financial markets have been.

Compounding the US dollar’s plight has been reports that the Chinese government’s central bank, the PBOC, massively intervened in support of her currency, the yuan.

So these factors—the Fed’s dovish stance and PBOC intervention—sent Asian currencies rallying hard (see right also see JP Morgan Bloomberg’s Asian Currency Index ADXY). The same factors have likewise accommodated a risk ON environment.

Yet the Philippine peso and the Malaysian ringgit defied the general regional sentiment. Against the US dollar, the peso plummeted 1.19% while the ringgit has been once again crushed, down by 1.3%. 

This week’s meltdown has not only erased the gains of the year, but has dragged down the peso to a year to date loss of .2%. Current momentum suggests that the USD-peso may break the 45 levels soon (see right)

Meanwhile, the ringgit’s sustained losses have brought the USD MYR pair to the peak of 2008! (see left)

Aside from the US dollar’s relative strength over most currencies, there are likely internal factors that have led to the pesos’ decline.

OFW Remittances: Growth Rates Crash in January! Structural Headwinds Compounded by Event Risks

This week the BSP came out with a report on personal and cash remittances for the month of January. 

Strikingly, personal and cash remittances inched up by ONLY .2% and .5% respectively! This marks the second below 2% growth rate in 3 months!

January’s growth rate crash represents the worst level since January 2009!

Yet the trends of the rate of growth of personal and cash remittances have been on a downhill as noted above.

It would be facile to blame seasonality for this. I can also add the Dodd-Frank ACT 1073 remittance-transfer as potential obstacle to remittance flows as previously discussed.

But a showcase of the January activities since 1990 reinforce the downside trend of growth rates in remittance flows. As one would note from the left graph, since 1998, remittance growth rates have been on a steady decline.

It would appear that the law of compounding and diminishing returns likewise affects remittance trends. Nominal remittance levels have reached size and scale where growth rates have become incremental.

Yet January’s nominal remittance trend may have even broken its long term trend.

While seasonality and Dodd Frank may have contributed, they are likely to be secondary (epiphenomena) or aggravating factors. But January activities show that seasonal dynamic appear as minor events.

And current conditions like crashing oil prices may have likely been another more significant contributing cause too. As I warned last December[1]

And yet how will the blowing up of the Middle East bubble extrapolate to Philippine OFW remittances? More than half or about 56% of OFWs according to the Philippine Overseas Employment Administration (POEA) have been deployed to this region. Will OFWs (and their employers) be immune from an economic or financial crisis? This isn’t 2008 where the epicenter of the crisis was in the US, hence remittances had been spared from retrenchment. For this crisis, there will be multiple hotbeds. The ongoing crashes in oil-commodity spectrum have already been showing the way.

So the above suggests that the structural declining trend in remittance growth rates seems as being reinforced by secondary causes such as oil prices and possibly the Dodd-Frank statute.

What is the implication of the remittance slowdown?

Well, as I wrote this week[2]:

This partly explains the ongoing pressures in retail activities and the weakening of the consumer household activities (HFCE) as revealed by the 4Q 2014 GDP data provided by the government, as explained here.

The rising account of store vacancies at shopping malls appear as real world (not statistical) symptoms of this.

Yet ironically, the supply side (housing, shopping malls, hotel and related industries) continues to project consumer trends as perpetually headed to the sky for them to borrow and build with ferocity. For instance, the daughter of the Philippines' richest tycoon anchors her firm's expansion projects largely on remittances as posted here

The end result from the widely divergent expectations and activities will be a huge or massive excess capacity mostly financed by debt!

And yet the sellside industry, expects earnings growth rate for the Phisix in 2015 to be at the mid teens. If current trends continue, then they will not only miss by a mile or by an ocean but by a galaxy!

And whatever strength by the peso, or its outperformance in the region, will be further exposed if such trends continue.

Is it a wonder why the BSP chief adamantly insists of deflationary risks in his latest speeches?

Short-Term Philippine Treasury Yields Spike as Yields Flatten! Basel Standards are No Guarantee of Adequate Risk Measurement

There could have been another factor to last week’s peso meltdown. 

Yes symptoms of funding pressures have reappeared in the Philippine treasury markets. Short term rates have massively spiked to return to December levels! That’s just two months after the Philippine government raised $2 billion overseas. The $2 billion loans may have helped temporarily improve February Gross International Reserves now at $81.3 billion.

Yet to apply the BSP chief’s splendid advice to journalists (whom I previously quoted[3]):

Economic numbers rarely tell the complete story when taken at face value. Therefore, a responsible journalist who seeks to offer readers a fuller appreciation of the information will examine the figures within a broader context or against an array of other relevant indicators.

So even if the BSP declares that the Philippine banking system as having “adequate capital levels against risks” for commercial and universal bank and for rural and coop banks, “figures within a broader context or against an array of other relevant indicators” in the prism of the treasury markets suggests that the alleged diminished risk outlook has been inconsistent or incompatible. Said differently, what statistics say and what the treasury markets have signaled have diverged.

Further, the obsession towards statistical or quant models as measures of risks as to declare the system safe has been vastly misplaced. 

Proposed changes at the Basel standards or ‘Basel IV’ have already been raising a hubbub at the international banking world.

An officer from the American Bankers Association exposes on the flaws of the Basel standards (as excerpted by Euromoney)[4]. [bold mine]

"As Basel III was an admission that Basel II got things wrong, Basel IV is a clear recognition that there is much that is wrong with Basel III," he says. "Yet the folks at Basel have not yet looked in the mirror and asked whether what is mostly wrong might be happening in Basel, that the simple concept of Basel I, to have some basic global capital standards, has been lost in an effort to over-engineer and micromanage at the global level the fine details of capital standards."

Yet why have some bankers been pushing back on Basel Committee on Banking Supervision’s (BCBS) proposals?

BCBS wants to end the practice of risk-weighting lenders’ exposures by reference to external credit ratings and instead suggests using measures such as capital adequacy and asset-quality metrics on exposures to other banks, for example. For corporates, the BCBS argues a given borrower’s revenue and leverage should determine credit risk weights rather than ratings, with the latter typically discriminating between industries and local-accounting standards. 

Bankers see plenty of problems. Since this way of risk-weighting exposure to other banks is determined by common tangible equity ratios and the non-performing assets ratio, it does not adequately take into account divergent liquidity and business-risk profiles, nor differences in supervisory processes under Pillar 2 of the Basel regime, says a senior regulatory adviser to the CEO of a large European universal bank.

The adviser adds: "Credit rating agencies look at a multitude of factors and these metrics are always richer, incorporating thorough timely reviews, and engagement with counterparties and agencies. You can also never empirically replace these qualitative assessments. 

The answer to the push back; because there is no uniformity in the risk profile of each loan portfolio.

To repeat “You can also never empirically replace these qualitative assessments”. Hmmm

Doesn’t this resonate with what I wrote back in October 2014[5]?

Because the BSP doesn’t really know of the viability or credit worthiness of each of the loans that have been extended throughout the system. And this lack of knowledge is what they admit as “uncertainty” and thus the warning “risks that could challenge… financial stability pressures from repricing of credit; sharp downward adjustments in prices of real and financial assets; and, capital flow volatility”.

They have practically NO idea what happens when there will be a “repricing of credit” and or how intense and scalable will “sharp downward adjustments in prices” and or how volatile capital flow will be.

Even bankers and regulators see Basel standards as inadequate measures of risk. So the citation of accounting metrics or statistics does nothing to uphold the supposed soundness of the system.

Going back to the Philippine treasury markets, the spike in short term yields has once again steepened the yield curve flattening dynamics.

Such flattening dynamic posits for an implied tightening of the liquidity environment as banks has less incentives to lend in an economy that has become increasingly dependent on debt.

Again considering that the Philippine treasury markets have been tightly held or controlled by the Philippine government and their banking sector vassals, those short term yield spikes signify as signs of growing fissures in the system.

And could the peso selloff have been also prompted by increasing concerns over risks build up despite the government and media’s attempt to whitewash them?

Capital Flight from Local Elites? Asian Currencies and CDS Spreads Show Why This Time Won’t Be Different

Two more items.

Has the local elites been seeking refuge away from the peso and domestic equities?

The BSP’s Balance of Payment report[6] says that in 4Q 2014 and in the entire 2014, the financial accounts registered net outflows.

I quote below the BSP’s explanation per category and put an emphasis on the activities of residents

4Q Direct investments (bold added): The direct investments account yielded higher net outflows of US$977 million in Q4 2014, more than double the net outflows of US$471 million in Q4 2013. Residents’ net acquisition of financial assets of US$2.4 billion exceeded their net incurrence of liabilities (foreign direct investments in the Philippines or FDI) of US$1.4 billion. This developed as equity capital placement abroad by resident non-banks surged to US$1.7 billion from US$226 million.

4Q Portfolio investment holdings: The portfolio investments account posted net outflows of US$1.2 billion in Q4 2014, 7.5 percent higher than the net outflows in Q4 2013. This development was reflective of the prevailing volatility in financial markets amid lingering uncertainty over the global growth prospects. Residents’ net acquisition of financial assets amounted to US$930 million, a reversal of the US$81 net disposal of financial assets in Q4 last year on account of net placements by domestic deposit-taking corporations (US$777 million) and the central bank (US$171 million) in debt securities issued by non-residents.

4Q Other investment accounts: The other investment account recorded net outflows amounting to US$2.3 billion in Q4 2014, more than five times the US$426 million registered in the comparable quarter last year. Net outflows stemmed mainly from higher net acquisition of financial assets which reached US$4 billion from US$1.2 billion in Q4 2013, due largely to higher residents’ deposit placements (US$2.7 billion) and net lending (US$1.4 billion) abroad.

The same Balance of Payment report for 2014 reveals the same dynamics.

Direct investments: The direct investment account reversed to net outflows of US$789 million from net inflows of US$90 million a year ago. This developed on account of the 91.7 percent rise in residents’ net acquisition of financial assets to US$7 billion from US$3.6 billion due to resident corporations’ net placements in both equity capital (US$2.9 billion) and debt instruments (US$4 billion) abroad.

Portfolio Investments: Portfolio investment account recorded net outflows of US$2.5 billion during the period, a reversal of last year’s net inflows of US$1 billion. This was due to residents’ net acquisition of financial assets of US$2.5 billion, from a net disposal of assets amounting to US$638 million combined with non-residents’ net withdrawal of investments amounting to US$3 million, a reversal from the net placements of US$363 million in 2013.

Other accounts: The net outflows in the other investment account doubled to US$6.9 billion from US$3.4 billion in 2013 on account of increased net placements in currency and deposits abroad by resident banks and non-bank corporations, amounting to US$2.7 billion and US$1.4 billion, respectively), and to higher resident banks’ net lending of US$2.7 billion.

Have domestic elites been bullish on the outside, but bearish in the inside? Have they been engaged in ‘do as I say, but not as I do’? So why the seeming outgrowth in capital exodus?

Finally, a lot of people from the formal sector have come to believe that the Philippines have become invincible to exogenous factors as to price domestic financial assets to perfection.

This week’s peso activity shows why this won’t be true, and add to this the above, the cost of insuring government debt via ASEAN 5 year CDS spread from Deutsche Bank.

While so far the Philippines has outperformed, the seeming near synchronized movements of CDS spreads shows of the relevance of the region’s influence.

The above only shows that this time won’t be different.

Sweden Cuts Rate Announces QE as BIS and OECD Warns on Low Interest Rates!

As I have been saying, central banks have aggressively embarked on crisis resolution measures even as global stock markets have run amuck.

The Swedish central bank cut rates into negative territory last week, as well as, announced the Swedish version of QE. 

From the New York Times[7]:

The executive board of the Swedish Riksbank said that it had cut its main rate target by 0.15 percentage point to minus 0.25 percent, and that it would buy government bonds valued at 30 billion kronor, or about $3.5 billion, over the next few months.

The bank said in a statement that it saw signs “that inflation has bottomed out and is beginning to rise,” but that the strength of the currency “risks breaking this trend.” The measures on Wednesday were intended “to support the upturn in inflation,” said the Riksbank, which signaled its “readiness to do more at short notice.”

The actions of the Swedish Riksbank marks the seventh rate cut by global central banks for the month of March and 25th for the year based on the tabulation of the CentralBankRates.com. This has been a count for rate cuts alone and excludes other non interest rate actions.

Central banks seem as in a panic mode in the face of abruptly falling economic indicators as financial markets party! 

It is as if we exist in two different worlds

Yet when the crisis emerges, global central banks would have little or no ammunition left to mount rescues as they have been desperately frontloading them.

Yet in a follow up to their September call, the OECD once again issues a brief warning on low interest rates[8].

“Lower oil prices and widespread monetary easing have brought the world economy to a turning point, with the potential for the acceleration of growth that has been needed in many countries,” said OECD Chief Economist Catherine L. Mann. “There is no room for complacency, however, as excessive reliance on monetary policy alone is building-up financial risks, while not yet reviving business investment. A more balanced policy approach is needed, making full use of fiscal and structural reforms, as well as monetary policy, to ensure sustainable growth and public finances over the longer term.”

The Bank for International Settlements has been consistently, persistently determined to warn of a risk buildup since 2014.

In the media briefing for the BIS Quarterly Review[9], Mr Claudio Borio, Head of the Monetary & Economic Department, goes on the record to caution the world from current set of policies. (bold mine)

In the process, central banks have shown that the so-called zero lower bound on interest rates is quite porous. Negative policy rates at the short end, coupled in some cases with large-scale asset purchases at the longer end, have pushed both term premia and nominal yields firmly and farther into negative territory. If this unprecedented journey continues, technical, economic, legal and even political boundaries may well be tested. The consequences should be watched closely, as the repercussions are bound to be significant, on the financial system and beyond.

The unforeseen technical, economic, legal and even political boundaries repercussions from inflationism reminds me of this majestic quote from the high priest of inflationism[10] (bold mine)

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.

Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

How so very relevant such quote have been today.

Has central banks implicitly functioned as communist Trojan horses whose policies could have been engineered to destroy the residual capitalist structure of the world?

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[1]See Phisix: The October Syndrome is Back! Philippine Casinos as the Causa Proxima? December 15, 2014

[2] See Wow, Philippine Remittance January Growth Rates Collapse to Near Zero or Post 2009 Crisis Levels! March 17, 2015

[3] See Phisix 7,800: Record Phisix as the BSP Continues with Deflation Spiel! March 9, 2015

[4] Euro Money Bank regulation: ‘Basel IV’ sparks banker fury March 2015

[5] See Phisix: 7,400 is not the Technical Hurdle, the BSP Governor Is October 6, 2014

[6] Bangko Sentral ng Pilipinas Q4 2014 BOP Position Yields US$574 Million Surplus; Full-Year 2014 Registers US$2.9 Billion Deficit March 20, 2014

[7] New York Times Sweden Cuts Key Interest Rate to Minus 0.25% March 18, 2015

[8] OECD Newsroom Low oil prices and monetary easing triggering modest acceleration of global recovery March 18, 2015

[9] Mr Claudio Borio BIS Quarterly Review March 2015 - media briefing BIS.org

[10] John Maynard Keynes The Economic Consequences of the Peace 1919. pp. 235-248. PBS.org