Inflation does not shift wealth from rich to poor. It is the opposite. Inflation does not help the poor and middle classes as real wages stagnate, savings become worthless and access to housing and assets is more difficult—Daniel Lacalle
In this issue
1Q Bank Losses Ease From the Reverse Robin Hood Effect! With Deflation in Bank Lending, Banks Switch to Asset Speculation!
I. Financial Repression’s Reverse Robin Hood Effect Eases Bank Loses in 1Q 2021
II. The Interest Rate Fallacy Redux
III. Bank Operations Shift from Lending to Asset Speculations, Uneven Liquidity Conditions
IV. The Growth of Peso Deposits Fall, FX Deposits Contract as GIR Nears Record! How Reliable are Capital Buffers?
V. Summary
1Q Bank Losses Ease From the Reverse Robin Hood Effect! With Deflation in Bank Lending, Banks Switch to Asset Speculation!
I. Financial Repression’s Reverse Robin Hood Effect Eases Bank Loses in 1Q 2021
At a recent speech, the incumbent BSP Governor said: “First were measures to boost market confidence on availability of credit resources, such as cuts in the policy rate and the reserve requirement (RR). Lower policy rate was meant to influence banks to slash their own lending rates, thereby promote credit-taking activities.” (bold added)
Benjamin E Diokno: Speech - Sulong Pilipinas: Partners for Progress, April 25, 2021 BIS.org
Figure 1
In the 1Q, net income grew by 6.4% for all listed banks, 10.13% for member banks of the Financial Index, and 2.5% for the members of the elite PSEi 30. However, total profits of the banking system slid 3.06% in the same period. Bank profit growth has been declining since 2013!
The massive rate cuts by the BSP provided a huge subsidy that cushioned the earnings deficit of the bank industry in 1Q 2021.
Deposit liabilities plunged 59.5% for the listed banks, 60.2% for the Financial Index, and 63.34% for the PSEi members. For the entire banking system, including the rural and thrift sectors, it was 41.13%.
The subsidy was worth Php 18.96 billion for all listed banks, or about 35% of the total profits earned by the industry during the period. Without it, the earnings deficit of the industry would have been amplified. Moreover, the cost of lending would have swelled for bank borrowers.
As said last week…
Differently put, the implicit transfer from household and corporate savings to the banks through the interest channel meant that savers were penalized heavily for the mischiefs of balance sheet mismatching employed by the banking industry.
And as part of the cost of the financial repression package, households not only lost income, jobs, and wages but suffered steeply from diminished a share of the GDP.
1Q 2021 GDP: A Statistic of Government Spending, Debt, Bailouts, and the BSP’s Financial Repression May 16, 2021
The bank and the financial system benefited immensely from the implicit BSP subsidies by underpaying client deposits.
So, again, the erosion of household and corporate savings reduced incomes, and savings and consequently, spending capacity.
Importantly, since banks are owned and controlled by the elites, while the bulk of depositors comprise the average Pedro and Maria, such bailouts signify the "reverse Robin Hood" effect. Or, even without their consent, the poor and the middle class are forced to rescue the rich (as well as the government). Of course, a vast majority of people are unaware of the ramifications of such Financial Repression policies.
Said differently, the BSP hopes that once the financial institutions owned by the elites have recuperated, bank credit expansion from the industry can resume "spreading" the wealth around. The "Trickle-Down" effect.
II. The Interest Rate Fallacy Redux
But low rates are not exactly a boon to the banking system. Or, an easy money regime, contra the BSP, is not characterized by artificially suppressed interest rates. The late Nobel Laureate Milton Friedman coined this the "Interest Rate Fallacy".
After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.
Wall Street Journal, December 17, 1997, from an article entitled "Rx for Japan: Back to the Future." Hoover.org April 1998
A century before, one of the founders of macroeconomics, the Swedish economist Knut Wicksell, wrote:
The rate of interest is never high or low in itself, but only in relation to the profit which people can make with the money in their hands, and this, of course, varies. In good times, when trade is brisk, the rate of profit is high, and, what is of great consequence, is generally expected to remain high; in periods of depression it is low, and expected to remain low.
Knut Wicksell, "The Influence of the Rate of Interest on Prices", Econolib.org
The BSP resists the evidence before their eyes.
Figure 2
Interest rate revenues plummeted 16.7% YoY for both all listed banks and members of the Financial Index in the 1Q. Revenues for bank members of the PSYEi 30 plunged by a more significant 18.34%.
As such, operating income for the entire banking system slipped 5.4% YoY in the 1Q to a five-year low. In that respect, revenue declines partially counteracted against the BSP subsidies that pulled down expenses. Or, the operating interest margin was positive only because interest expenses fell more than revenues.
Why the decline in interest revenues?
Well, the banking system’s lending portfolio (ex-Interbank loans and repos) sunk further (-4.19%) in March. The deflationary quagmire plaguing the core operations of the banking system has only deepened.
You can lead a horse to the water, but you cannot make it drink. As forewarned, the BSP's low rates policies have only tightened money conditions.
And as pointed out by the charts, the performance of the 1Q 2021 was not an anomaly but rather signified an acceleration of a trend that existed before the pandemic.
After peaking in March 2019, interest income growth headed downhill. Bank lending growth also climaxed in May 2018 then was southbound. Total operating income reached its zenith in 2013, bounced in 2017-2019 before the June 2020 dive. (Figure 2, upmost and middle windows)
And that’s not all.
According to the BSP, while bank headline earnings are improving or suffering lesser declines, the other KPI metrics reveal faster deterioration. The Return on Asset (RoA) and Return on Equity (RoE) are at the lowest level since at least March 2013! (Figure 2, lowest pane)
Low rates have not done the magic it was supposed to do.
III. Bank Operations Shift from Lending to Asset Speculations, Uneven Liquidity Conditions
As a reminder, statistics make it appear that bank conditions operate under similar conditions of the past. They don't.
Again, from the BSP Chief’s Sulong Pilipinas speech: Second were extraordinary liquidity measures. These include provisional advances to the National Government to help fund COVID-response measures. After previous ones were settled, the latest loan from the BSP was the P540 billion granted last January. The loan has been extended, following its original maturity dated end-March. Another extraordinary liquidity measure is the BSP's purchases of government securities in the secondary market, which helped financial markets run smoothly despite the crisis.
Sure, the BSP's purchases of government securities in the secondary market primarily boosted the cash reserves of the banking system.
Figure 3
But the bounce in Cash and due banks to deposit ratio appears to have stalled in the 1Q.
On the other hand, the liquid assets to deposit ratio continue to improve significantly. But liquid assets comprise not only cash but also financial assets (except equity investments). (Figure 3 upmost pane)
Aside from cash, the other component of liquid assets are financial assets (excluding equity investments).
On this score, the BSP has implicitly encouraged banks to shift activities towards asset speculation.
Financial Assets (net) jumped 19.13% in March to Php 4.604 trillion accounting for 23.75% of Total Assets, the highest since May 2012. Cumulative gains jumped 176% to Php 5.8 billion but sharply down from Php 15.7 billion a month ago. (Figure 3 middle window)
On the other hand, the share of bank lending (ex Interbank loans and Repos) to total assets plunged to 51.39%, a 51-month low over the same period. (Figure 3, lowest pane)
Importantly, asset speculation, fueled by the digital press, appears to anchor the BSP’s policy fix for the recovery of the banking system.
Of course, asset speculation by the industry and public institutions from the BSP’s monetary inflation does not exist in a vacuum. Disguising risks has unintended intertemporal consequences.
First, the stoking of excess demand fuels the mispricing of financial assets. Second, true, the elevation of asset prices supports collateral values used for credit transactions. Temporarily.
But it creates false signals to the real economy about the conditions of real savings, driving misallocations, which represents the third factor. Such imbalances surface or are vented in the real economy through prices, production and distribution of resources. Rising statistical inflation is a consequence of these maladjustments (apart from supply shocks from the lockdown socialism and the ASF).
Third, by becoming dependent on BSP support, liquidity injections amplify the various risks embedded in the banking system’s balance sheets.
Increased volatility in the returns from financial investments exemplifies this. Further, the abrupt rise in the growth of the total investments as a share of total assets are manifestations of the increasing fragility of the banking system to market meltdowns or pronounced downside market volatility. The charts from the BSP demonstrate these risks.
This tactical approach to disguise risk to boost the "animal spirits" is no free lunch. The disproportionate focus on the policy panacea by redistribution has risks unforeseen by the establishment.
Figure 4
Fourth, such an episode of rampant speculations supported by the diversion of resources erode capital, thereby magnifying systemic risks with banks at its center.
Yes, despite the BSP’s massive injections, the growth in cash in circulation plummeted to 15.9% in March from 24.7% a month ago. (Figure 4, upmost pane)
Reduced cash flows to the economy diminished the growth rate of the benchmark money supply M3 from 9.44% in February to 8.31% in March.
So while the BSP successfully put cash in the pockets of the banks, that is not true for the economy.
IV. The Growth of Peso Deposits Fall, FX Deposits Contract as GIR Nears Record! How Reliable are Capital Buffers?
Even more striking are the conditions of bank deposit liabilities.
Since 2013, the banking system’s main source of funding, deposits, continues to decline.
Growth of total deposits dropped to 7.82% in March from 9% in February. Peso liabilities growth decreased to 9.44% from 10.6% over the same period. (Figure 4, lowest window)
Incredibly, FX deposits posted an -.8% contraction, the first time since December 2019. Gross International Reserves are adrift at record highs at USD 107.25 last April, right? But why are FX deposits in the banking system shrinking? (Figure 4, middle window)
Where have all the recent public FX borrowings, amounting to USD 15.5 billion (as of May 20), touted as pandemic financing, flowed to?
With the BSP’s Financial Repression policy of penalizing depositors for the benefit of the banks, why should this trend of falling deposits be a surprise?
Again, from the incumbent BSP Governors recent speech at the Sulong Pilipinas: Third were regulatory and operational relief measures to maintain stability of the financial system and ensure public access to financial services. We counted loans to MSMEs as compliance to the reserve requirement, increased the single borrower's limit (or the limit on loans a bank may extend to a single borrower), and raised the ceiling for real-estate loans. We excluded some loans from the "past-due" and "non-performing" classification, and allowed grace period for loan settlement and restructuring of rediscounted loans. Such moves provided relief to banks and their borrowers. The BSP's interventions helped calm the market and ease domestic liquidity conditions.
Again, with substantially different bank conditions today than from the pre-pandemic era, why should current bank statistics be any relevant?
Figure 5
For instance, the BSP admits to relaxing delinquent loans, so naturally, statistics would mechanically exhibit reduced incidences of souring loans. Yes, it continues to rise but at a milder rate, palatable to the authorities. Net NPLs, Gross NPLs, Distressed Assets and past due are at multi-year highs last March.
And how much of the actual incidences of delinquencies and insolvencies have been cloaked by the many other relief measures in place?
And what about the credit "skeletons in the closet" channeled through possible misdeclarations or the probability of some banks gaming the system?
After all, there exists a phenomenon called regulatory capture, which is defined by Investopedia as “regulatory agencies may come to be dominated by the industries or interests they are charged with regulating”.
Or, instead of promoting the welfare of the public, authorities uphold the interest of special interest groups.
By this definition, the BSP’s subsidies to the banks through deposit expenses (for instance) can be characterized as one.
And there’s more.
Since the BSP constantly tweaks its rules in governing banks to accommodate more credit impairments, how reliable is its stand on the bank’s capital buffer?
For example, back in December 2018, to make capital monitoring more flexible, the BSP announced the countercyclical capital buffer (CCyB) rule. This rule, like Keynesian deficit spending theory, can be subject to abuse.
Besides, since public debt comprises a substantial base of assets for banks, surging debt loads are not only a threat to access to cheap savings but also the bank’s buffers.
The thing is: if banks have been as strong and healthy as acclaimed, why the need for the unprecedented bailouts in the form of historic liquidity injections, record monetary policies, and unseen operational and regulatory reliefs?
V. Summary
In the 1Q, the deficit of headline earnings of banks was reduced, mainly from the BSP’s monetary policy of rate cuts, which significantly slashed deposit or interest rate expense.
However, with banks pulling back from their core operation of lending, other profitability metrics like RoA and RoE continued to fall to multi-year lows.
That said, using the deluge of liquidity, banks shifted operations towards speculations exhibited bythe surge of investments. Asset speculations only magnify the balance sheet risks of the banking system.
Will a policy of transferring resources from savers to the banks restore the bank’s health?
Despite the evidence before them, the policy of low rates has failed to jump-start bank lending because of the obstacles on their balance sheets. They either forgot or disregard the tacit rule that low rates are not the same as an easy money regime.
Or, will the BSP’s financial repression instead further erode savings, which consequently, increases the burden on investments and consumption that aggravates the deterioration in credit condition magnifying the bank's maladies?
