Stagflation Part 18: Philippine Banks as Shock Absorber — Record Lending, Record Bonds, Record Hiding Places

  

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances—Ludwig von Mises 

In this issue: 

Stagflation Part 18: Philippine Banks as Shock Absorber — Record Lending, Record Bonds, Record Hiding Places

I. Introduction: Three Shocks, One Balance Sheet

II. The Seen: Record Bank Lending, Bailout Edition

III. The Unseen: Financial Wile E. Coyote Keeps Running

IV. Who Funds the Sovereign? Borrowed Money, Held to Maturity

V. The Wall: Corporate Maturities Join the Queue

VI. Whac-a-Mole: Every Fix Has a Forwarding Address

VII. The Bank–Sovereign Doom Loop: Who Rescues the Rescuers?

VIII. Conclusion: When the Coyote Looks Down 

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Stagflation Part 18: Philippine Banks as Shock Absorber — Record Lending, Record Bonds, Record Hiding Places 

How policy relief, sovereign borrowing, and hidden balance-sheet losses turn banks into shock absorbers—and shift the cost of each rescue to the next balance sheet. 

I. Introduction: Three Shocks, One Balance Sheet 

Every shock since 2020 has had the same first responder: the banking system. Every bailout has had the same last bearer: the banking system. In between sits the sovereign, whose paper the banks keep buying. 

Underneath runs the same operating framework: free-lunch politics rewards spending now and sends the bill later. Spending outruns real savings; the gap is financed through domestic and external credit, central-bank accommodation, and the printing press. Monetary aggregates duly celebrate. The underlying scarcity of real resources, meanwhile, receives no such memo. 

Following the Keynesian dogma that spending drives GDP, the political class gets its preferred scorecard: expenditure goes up, and measured output may follow. 

But debt-financed spending is not synonymous with sustainable production. Borrowing can pull expenditure forward; it cannot, by itself, manufacture the real savings and complementary capital needed to sustain production. GDP records the expenditure. The liabilities remain on the balance sheet. 

Emergencies amplify this dynamic. 

A banking system cannot manufacture real savings simply by creating money. It can create deposits and extend credit, generating claims on future income. Those claims then accumulate across the economy, and the banks become warehouses for a growing web of financial promises. 

The magnification began with the pandemic rescue: historic BSP injections of Php 2.3 trillion, an unprecedented combination of interest-rate and reserve-requirement ratio (RRR) cuts, regulatory relief, fiscal deficits, and a USD/PHP regime operating under an implicit Php 59 (soft peg) ceiling. 

The 2022 oil shock arrived on top of that liquidity. 

Now comes the second oil shock of 2026, catalyzed by the Iran/Middle East conflict, but into an economy carrying a very different set of vulnerabilities: record public debt, eight months of twin deficits, weaker GDP growth, a return to 7.2% inflation, sharply lower gross international reserves (GIR), and a bond market beginning to reprice sovereign risk. 

The rescue capacity that absorbed the earlier shocks has itself become part of the balance sheet. 

This is the operating environment behind EO 110, BSP relief, and the current foreign-exchange regime. The Php 61.75 soft ceiling has given way to a wider operating range of Php 62.465–Php 62.86, before the peso breached Php 63. 

In summary:

• The first rescue created the liquidity.
• The second shock tested it.
• The third arrives after the balance sheets have accumulated the consequences.

The bill now travels through a system whose capacity to absorb it can no longer be taken for granted. And the banks remain central to that transmission. 

Consider EO 110. When a price is held below the level required to clear a market under prevailing conditions, the gap does not vanish. Someone must absorb it. The power producer or transport operator may initially bear the shortfall; bank credit can finance the resulting cash-flow gap; subsidies or other government support may shift part of the burden to the sovereign. Depending on the contractual and institutional arrangements, losses can migrate from one balance sheet to another. 

That is balance-sheet transfer. Bank credit is one of its shadows in the ledger. 

This week's market tape put a price on the accumulated pressures.

Figure 1

In a follow-up to our latest outlook, Whac-a-Mole Economics: The Week the Philippine Financial Markets Cracked, the USD/PHP printed its 27th record low of the year, breaking through 63 to close at 63.06 on October 15, before ending the week slightly lower at 62.985—still a record on a weekly basis. 

The 10-year BVAL yield, after reaching 8.1115% on October 8, eased to 8.0184% at the week's close. That reprieve did little to erase the broader repricing: the yield remained above the May 2026 and November 2022 highs cited in our market comparison. The 20- and 25-year yields closed at multiyear highs of 8.3856% and 8.3846%, respectively. (Figure 1, topmost pane) 

Equities offered a different surface impression. The PSEi skidded toward 5,600, hit by ICTSI's 6.89% plunge on October 14. But gains concentrated in the top 5 heavyweight stocks, led by ICT during the final two sessions, subsequently lifted the index by 1.43% for the week, recovering earlier losses. 

For a short follow-up to last week's article, see this week's account of the splenetic Philippine markets in my Substack note, Another Whac-a-Mole Week: Three Markets, One Signal—Escalating Financial Stress. 

Still, the peso, bonds, and PSEi remain under stress. Three markets, one signal. 

They were not merely reacting to three separate stories. They were repricing claims and risks across three interconnected balance-sheet domains: the government's, the banks', and the conglomerates'. 

• The peso prices the external constraint.
• Equities price claims on private businesses.
• Sovereign yields price the terms on which the government can finance itself—and provide a benchmark that feeds into financing conditions across the economy.
• The banks sit in the middle, holding claims on the other two while depending on their own funding conditions, asset valuations, and borrowers' capacity to pay. 

This installment reads the middle balance sheet. We turn to the August banking data to examine how the transfer manifests itself in lending, asset allocation, and the accumulation of financial claims. 

II. The Seen: Record Bank Lending, Bailout Edition 

The news headline writes itself: total loan portfolio (TLP) hit a record Php 17.783 trillion in August, up 13.21% year-on-year. Production loans accelerated for a third consecutive month, reaching 10.57%. 

Now look at who borrowed more. (Figure 1, middle image) 

• Electricity, gas, and steam: +27.03% YoY, accelerating from 24.36% in July. Share of the loan book: 14.1%.
• Administrative and support services: +20.91%, up from 15.14% in July.
• Financials: +9.04%, up from 5.36%.
• Mining: +54.54%, up from 51.4%.
• Trade: +10.52%, up from 8.76%. 

And those whose borrowing growth slowed: 

• Manufacturing: +6.07%, decelerating from 7.2%—ironically, amid a chip-export boom.
• Real estate: +4.52%, down from 5.55%.
• Consumer loans: +16.19%, down from 17.07%. Credit-card growth was 23.34%, slowing for the fifth consecutive month; auto loans grew 5.83% from 6.97% in July. 

The headline is record lending. The more revealing story is its composition. 

The surge is concentrated in sectors where intervention, regulatory arrangements, or financing pressures has been shaping capital allocation. 

Start with electricity. 

The SMC-AEV-MER and Prime Infra-FGEN consolidations, the suspension of real-property taxes (RPT), the GEA-ALL transition layered on top of FIT-ALL, and an ERC that returns what it takes in one ruling and recovers it in the next. For instance, it orders Meralco to refund consumers in one ruling while approving increases in generation charges in another 

These forms part of the institutional landscape we've examined in previous installments in 2025 (see references below). 

The contradiction is hard to miss: regulate prices, redistribute costs, alter the terms of recovery, and then observe the financing demands generated by the resulting structure. 

The 27.03% lending growth’s mechanism is the Averch-Johnson effect: When allowable returns are tied to a regulated capital base, firms can have an incentive to expand that base beyond what an unregulated profit-maximizing firm would choose. 

The bank finances the enlargement. The regulator helps determine the returns. 

Bluntly, the Averch-Johnson effect needs no ideology:  the regulator's formula pays you to borrow. 

Now consider financials. 

Financial-sector lending accelerated from 5.36% to 9.04%. Essentially, financials are the BSP relief regime finding its own counterparty. The system lends to the system, providing liquidity and bridge financing within the very structure the interventions are intended to stabilize. Credit circulates; the question is how much new productive activity it creates and how much of the existing financial structure it keeps afloat. 

Then comes trade. 

Trade is where the money illusion becomes relevant. Retailers see nominal sales growth against Q2 inflation of 6.5%, interpret the plus signs as stronger demand, and borrow to replenish inventories. But nominal turnover is not real volume, and rising sales values do not necessarily mean consumers are buying more goods. 

The goods arrive. The inventory has to move. 

Yet consumer-credit growth is decelerating. Household purchasing power is under pressure. If inventories were accumulated on the assumption that nominal sales growth represented stronger real demand, retailers could find themselves financing goods that turn over more slowly than expected. 

That is how a credit expansion becomes an inventory problem, then a cash-flow problem, and eventually a delinquency problem. It is a causal sequence to test, not an automatic consequence of the lending figures. 

The employment data add another contradiction. 

Trade employment increased by 227,000 in August even as trade lending growth reached 10.52%. Construction employment rose by 389,500, while construction lending contracted 11.73% year-on-year. (Figure 1, lowest graph) 

Employment, credit, and output need not move together in the short run. But when lending expands rapidly without a corresponding improvement in real activity—or contracts while employment rises—we need to look beneath the headline indicators to understand what is financing production, what is sustaining existing operations, and where adjustment may be accumulating. 

Record lending is not record value-added. 

Our Part 14 already documented the broader disconnect: Q2 GDP growth of 2.3%, first-half growth of 2.6%, a 13.9% contraction in construction, and a 9.2% decline in gross capital formation. Universal and commercial (U/KB) bank credit grew 10.3% against an economy expanding at roughly 2%. 

The difference was not productive expansion. Credit was financing refinancing, liquidity support, and the cost of keeping an intervention-distorted structure viable. 

Credit expanding while investment contracts is not a boom. It is a financial system extending claims while the real economy's capacity to generate returns deteriorates. The lending figures celebrate expansion; the underlying economic signals reveal its failure to translate into productive growth. 

III. The Unseen: Financial Wile E. Coyote Keeps Running 

Chased by the Road Runner, Wile E. Coyote runs off a cliff and hangs in midair. Everything appears fine until he looks down and realizes there is no ground beneath him. 

The gross NPL ratio is that coyote. 

Figure 2 

It is a fraction: nonperforming loans over total loans. While the denominator sprints, the ratio can remain perfectly composed, even as the numerator climbs. The trick is not that bad loans disappear. It is that the loan book grows faster than they do. 

August's gross NPL ratio held at 3.35%, unchanged from July. Look beneath the calm. 

Gross NPLs reached Php 596 billion, up 8.4% year-on-year and the second-highest level on record, just below May's Php 601 billion. Meanwhile, the total loan portfolio hit a record Php 17.783 trillion, expanding 13.21%—all under relief measures. (Figure 2, topmost window) 

The denominator is running faster than the numerator. 

Then the other financial coyotes. 

• Allowances for credit losses reached a record Php 555 billion, up 6.99% year-on-year and equivalent to 3.12% of loans—roughly 93% of gross NPLs. 
• Distressed assets climbed to Php 1.008 trillion, up 10.66%. (Figure 2, middle diagram) 

The reported NPL ratio looks stable because the loan book is expanding faster than the stock of recognized bad loans. That is the arithmetic. It is not evidence that underlying credit quality is improving. 

The ratio does not tell us how quickly the system is accumulating risk. It tells us how much recognized bad debt sits inside an expanding pool of loans. When the pool grows fast enough, the ratio can hold steady while the underlying burden rises. 

The coyote keeps running. The ground has not returned. 

Now go one level down, where the aggregate cannot hide the pattern. 

The consumer is already slowing 

In Q2 2026 consumer lending, loan growth decelerated across every category, while NPL growth outran loan growth in nearly all of them: (Figure 2, lowest chart) 

• Consumer loans: lending grew 14.42%, against NPL growth of 19.64%.
• Motor vehicle loans: lending grew 6.2%, while NPLs surged 16.6%. Vehicle sales slid by about 11.4% in August YTD; risibly, the weather is the alibi.
• Credit-card receivables: lending grew 25.28%, but NPLs jumped 46.53%—nearly twice as fast.
• Salary loans: NPLs grew 24.56%, even after the maturity extension under Circular 1239. 

The pattern is straightforward: recognized distress is growing faster than the underlying credit categories in which it is accumulating. Credit-card NPLs are expanding at nearly twice the pace of receivables. Motor-vehicle NPLs are rising while sales contract. Salary-loan distress continues despite extended repayment periods. 

Extending maturities can ease immediate payment pressure. It can also push the recognition of distress further down the road. The calendar changes; the obligation does not vanish. 

Real estate: the conspicuous exception 

Real-estate NPLs rose by only 2.74%, despite the known vacancy overhang. 

That is the outlier. While consumer-credit deterioration shows up clearly in the numbers, real-estate distress appears far more contained. Sustained refinancing, relief-enabled reporting, inaccurate data and delayed recognition offer possible explanations. The available figures do not establish which mechanism dominates. 

But the contrast is worth watching. A subdued NPL figure is not the same thing as a healthy underlying asset market, particularly when vacancies and refinancing needs remain part of the picture. 

The sectoral bailout 

Now return to the system-wide ratio. 

The aggregate remains stable while consumer-credit quality deteriorates and lending expands rapidly in electricity, financials, and administrative and support services. These are precisely the sectors in which regulatory arrangements, policy relief, and institutional financing needs shape the demand for credit. 

The point being: asset quality is being held up by the bailout sectors. 

The composition of lending matters because rapid expansion in one part of the loan book can dilute the reported deterioration elsewhere. Remove the denominator growth contributed by the expanding sectors, and that cushioning effect weakens—or the rot gets exposed. 

The aggregate ratio conceals the divergence: consumer distress is accelerating, while policy-sensitive sectors continue to expand the pool of outstanding credit. 

This is why record lending and a stable NPL ratio can coexist with deteriorating underlying economic conditions. The banking system can continue extending claims even as the capacity of households and businesses to service those claims comes under pressure. 

When the measurement rules move 

And the measurement institutions have been moved. 

NPL grace periods under Monetary Board Resolution 296, intragroup credit reforms, the release of previously required capital buffers (BSP Circular No. 1235, Series of 2026), and mark-to-market relief (BSP Memorandum No. 2026-027) alter the terms under which financial stress is recognized, absorbed, or reported. 

A reclassified loan is not a repaid loan. It is a loan given more time before it is called what it is. 

A maturity extension can postpone a missed payment. A reporting accommodation can change when a loan is classified as distressed. A capital-buffer release can create additional room to absorb losses. A mark-to-market waiver can defer the recognition of valuation changes. 

These measures are not identical, but they share a consequence: they can buy time between the emergence of financial pressure and its full recognition in reported indicators. 

And time changes incentives. 

When institutions are under pressure to preserve capital, maintain reported solvency, and avoid recognizing losses, the temptation to postpone bad news grows. Relief can provide breathing room for a genuine recovery. It can also prolong the appearance of stability when the underlying problem remains unresolved. 

Charles Kindleberger understood the darker side of financial distress. In Manias, Panics, and Crashes, he describes the sauve qui peut mentality—the scramble for individual survival that takes hold during crashes and panics. As institutions and individuals attempt to escape mounting losses, swindling, fraud, embezzlement, and other forms of misconduct can become part of the unraveling. 

The connection is institutional, not merely moral. When losses threaten survival and the incentives favor preserving appearances, desperation can turn deferred recognition into deliberate concealment. 

First, the numbers are softened. Then the incentives deteriorate. Eventually, someone has to absorb the loss. 

The coyote keeps running because the denominator is still growing, relief is still buying time, and the accounting has not yet forced the adjustment into view. 

But the balance sheet is accumulating the bill. 

A stable ratio is not a stable system. It may simply be a system that has not yet looked down. 

IV. Who Funds the Sovereign? Borrowed Money, Held to Maturity 

The loan book is half the balance sheet. The other half is paper. Yet another Coyote.

Figure 3 

• Net claims on the central government (NCoCG): Php 6.345 trillion, +16.6% YoY, a seventh consecutive month of double-digit growth, equivalent to roughly a fifth of bank assets. 
• Debt securities at amortized cost, formerly held-to-maturity (HTM): Php 4.493 trillion, +11.5%, a record. Growth accelerated from 3.17% in March to 11.5% in August. (Figure 3, topmost image) 
• Available-for-sale (AFS) securities: growth of 14.19%, with accumulated losses of Php 145.65 billion, the third-highest on record. 

AFS shows the losses recognized in the books. HTM is an accounting choice: hold the bond to maturity, and market-price fluctuations generally do not flow through its carrying value. The price still exists; it simply does not appear in the accounts in the same way. Add a mark-to-market waiver, and more of the sovereign's repricing stays outside reported valuations. 

When a bank's loan portfolio grows 13% while deposits rise 9.44%, the funding gap has to come from somewhere. It came increasingly from borrowing: 

• Bills and bonds payable: Php 2.312 trillion, the second-highest level, +51.84%.
• Interbank loans: Php 484 billion, +20.44%.
• Repos: Php 648 billion, +54.55%, following June's record Php 983 billion. (Figure 3, middle and lowest charts) 

Borrow short, hold long, hope the rollover keeps rolling. 

That is transitional Ponzi finance in the Minskyan sense: a position increasingly dependent on continued refinancing. Here, the position is the sovereign's own paper.

Figure 4

The cushion is thinning from the other side. Cash to deposits fell to 9.24%, tying its all-time low; liquid assets to deposits stood at 47.64%, trending downward. (Figure 4, upper window) 

But what counts as liquid? A substantial share is government paper that may have to be sold into the same market, during the same squeeze, as other holders seek liquidity. A liquid asset is one you can sell without taking a damaging loss—not merely one for which a market exists. PDS data already show the strain: September trading volume was the lowest of 2026 as yields rose. 

The fourth balance sheet: captive savings 

The Commission on Audit recently flagged Php 40 billion in SSS equity-paper losses. That is what is seen. 

Beneath the other three balance sheets sits one whose contributors cannot simply leave. SSS coverage is compulsory, the state shapes the institutional framework, and members have no direct say over individual investment decisions. Contributions reached Php 373.6 billion in 2025, up 14.8%. (Figure 4, lower SSS table)

About Php 572 billion—46% of its Php 1.254 trillion in assets—is invested in government paper. Another parallel with the banks: Php 531.8 billion in bonds, more than 80% of non-current financial assets and up 45% in 2025, sits at amortized cost. The books record carrying value, not what those bonds would fetch in the market today. 

When yields rise, bond prices fall. The carrying value need not follow. Temporary is a forecast, not an accounting category. 

The sovereign is also the borrower, so rising yields pressure government financing and the market value of SSS's bond holdings simultaneously: correlation, not diversification. 

Foreign money can exit, and the peso reflects part of that repricing. Captive savings cannot exit as freely; the consequences emerge through investment returns, fund sustainability, and the capacity to meet future pension obligations. 

The channel into stagflation runs through the paycheck. The compulsory contribution rate rose to 15% as September 2026 CPI reached 7.2%, including 9.0% for the bottom 30%. 

Take-home pay is squeezed to fund a pool that finances the sovereign. Pension disbursements rose 12.3% to Php 237.7 billion; retiree pensions are scheduled to rise 10% annually through 2027, while contribution rates remain frozen. 

In 2025, contributions exceeded benefit payments by Php 68 billion in cash. But that is an ex-post result, not proof of long-term sustainability. There was no forced selling in 2025. 

The trigger is net cash outflow that forces the sale of cost-carried bonds below carrying value. The investment portfolio carries market risk; cash flows carry demographic and economic risk. They can deteriorate together. 

The money supply: credit finds another route

Figure 5

Meanwhile, M3 grew 11.2% in August, its seventh consecutive month of double-digit growth. Deposit substitutes surged 75.9% YoY and have remained above 50% growth since March. M1 & M2 growth also accelerated from 7.4% and 9% in July to 8.6% and 9.8% in August. (Figure 5, upper diagram) 

The banks are funding the state partly by issuing their own paper. The sovereign borrows; banks acquire the claims; financial institutions expand their funding. Credit expansion feeds the sovereign-financing loop. 

This is where the Cantillon effect enters. New money does not reach everyone simultaneously. The first recipients—the sovereign and the sectors receiving the initial financing—gain purchasing power before the resulting price adjustments spread through the economy. Those further down the chain encounter the adjustment after relative prices have already moved. It is no coincidence that the oil-shock CPI surge (third wave of the cycle) has been accompanied by pandemic-era money-supply growth. September CPI hit 7.2%—returning to April 2026 high. (Figure 5, lower image) 

The sovereign gets its financing. Banks accumulate the claims. Captive savers supply funds they cannot freely redirect. Households absorb the pressure through reduced purchasing power and compulsory contributions. 

The same system that finances the sovereign transmits the cost of financing it. 

V. The Wall: Corporate Maturities Join the Queue 

The BSP has already identified the next claimant. Its Financial Stability Report (2025) p.30, warns of a sizeable maturity wall among large conglomerates: approximately Php 1.6 trillion, or 22.7% of conglomerate debt, falls due between 2027 and 2029 . US-dollar debt averages 37.6% of conglomerate debt over the next five years. Refinancing has so far relied on bonds, bank funding, and internal liquidity. The BSP's prescription: “close monitoring.” 

That warning predates the second oil shock. Since then, the peso has broken through its previous soft ceiling, reserves have fallen to a three-year low, and the 10-year BVAL yield has climbed above 8%. The wall did not move. The ground in front of it did. 

The stock market repriced the risk first. On October 15, the PSEi fell 2.2%, with index heavyweights doing the damage. Equity markets price conglomerate balance sheets daily; the maturity schedule brings the reckoning more slowly, then all at once. 

Refinancing is not repayment. It is a fresh claim on loanable funds. Banks can create nominal credit; they cannot manufacture the real savings, labor, materials, and capital goods needed to sustain every project that credit finances or it cannot mint the real savings behind it. 

The arithmetic puts the wall in perspective. The BSP's figures imply roughly Php 7 trillion in conglomerate debt. The Php 1.6 trillion due over 2027–2029 equals about 9% of today's bank loan book. Spread evenly across three years, it amounts to approximately Php 533 billion annually—about a quarter of last year's Php 2.08 trillion increase in bank loans. 

And conglomerates are not refinancing in a vacuum. 

The sovereign is borrowing, with banks' net claims on government at Php 6.345 trillion, up 16.6%, as the 10-year BVAL yield exceeds 8%. 

Utilities and other policy-supported sectors are absorbing credit: electricity lending grew 27%, while financial and administrative lending accelerated. 

Banks themselves are increasingly reliant on bills and bonds payable, interbank loans, and repos. 

Now the conglomerates arrive at the refinancing window with Php 1.6 trillion in maturities due over 2027–2029, 37.6% of their debt in dollars. 

Meanwhile, consumers face slowing loan growth, and MSMEs are already being squeezed out, as discussed in our Magna Carta installment. 

Everyone wants the same pool of savings and liquidity. Not everyone gets access on equal terms. 

Four stagflation channels follow. 

1. Crowding out. Funds are rationed by access, not by productivity. Those with sovereign standing or a conglomerate crest get financed; others face higher rates or a rejected application. Credit that rolls over old projects does not build new capacity. That is how credit can grow 13% while gross capital formation contracts 9.2%. Rolled-over debt keeps yesterday's projects from liquidating. That is not capital allocation. It is capital preservation for the already-allocated. 

2. Gearing. Roll over at 8% what was borrowed at lower coupons, and the interest burden rises even if the principal does not. Rolling over is not deleveraging; it is gearing with extra steps. These groups are simultaneously borrowers, bond issuers and, in many cases, owners of the banks that lend to them. Their exposures are not independent bets. They are tied to the same policy regime and financing conditions. 

3. Dollars. With 37.6% of conglomerate debt denominated in dollars, the maturity wall competes for foreign currency with sovereign external debt service and the oil import bill. All three draw on a reserve stock that has just fallen by $4.85 billion. A wider peso trading range does not create dollars. It reprices their scarcity. 

4. Money. If real savings cannot meet the queue, adjustment must come through some combination of higher rates, asset sales, defaults, project cancellations, or credit rationing. 

But if the political system refuses to accept that adjustment, monetary accommodation becomes the escape route. Section IV has already shown the direction: seven consecutive months of double-digit M3 growth, alongside CPI inflation of 7.2%. When financing sustains claims without expanding productive capacity, the economy gets more nominal demand competing for constrained real resources. That is how the same process can feed both sides of stagflation. 

The BSP calls it a wall. Walls are what you hit when you keep driving. The 2027 maturities begin in a few months. The 2026 data already show the system's preferred response: relief, rollover, and more of the same paper. 

VI. Whac-a-Mole: Every Fix Has a Forwarding Address 

The September–October data are not a new story. They are the old story at new addresses. 

Years of spending ahead of real savings (or the record savings-investment gap) created the underlying imbalances; emergency interventions postponed adjustment by drawing down reserves, bank capital, and fiscal room. The oil shock was the trigger, not the cause. Each fix suppresses pressure in one place, only for it to surface in the next least-controlled price.

Figure 6 

The pressure surfaces in goods, dollars, and yields because the underlying constraint is real savings. What Austrian economist Eugen von Böhm-Bawerk called the subsistence fund or real savings is the stock of goods and resources that sustains workers and projects until production yields output. Credit can create competing claims on that fund; it cannot conjure the real resources themselves. When claims outrun available resources, the adjustment surfaces in prices: consumer goods, foreign exchange, and the price of time—interest rates. 

In each case, the fix moved the problem; none removed it. The hammer shrinks with every swing: defending the peso spent reserves, the peso broke anyway, and the bond market is the next mole. A currency can be managed. A yield curve can only be managed so far. (Figure/Table 6) 

Figure 7

The rate channel shows the same blockage. The BSP cut its policy rate nine times, by a cumulative 225 basis points, from August 2024. Average bank lending rates peaked at 8.234% that month and bottomed at 7.125% in February 2026—a decline of just 110.9 bps, less than half the policy-rate reduction. By July, lending rates had climbed back to 7.883%, up 75.8 bps from the low. (Figure 7, upper graph) 

Banks price loans according to their own funding costs and risk, not simply the BSP's policy corridor. Both are being reshaped by the imbalances already discussed: wholesale funding costs are rising, with bills and bonds payable up 51.8% and repos up 54.6% (August 2026); sovereign yields near 8% raise the opportunity cost of private lending; and deteriorating asset quality requires provisions against potential losses. 

The policy rate is a nudge. The balance sheet is the answer. 

Interest is supposed to coordinate saving and investment. Here, there are two prices: the BSP's policy rate and the rate banks actually charge. The first can be cut by decree. The second must contend with funding costs, credit risk, and the government's demand for financing. 

A supply shock makes the contradiction worse. Higher rates cannot produce more rice or oil. They work through credit conditions instead, tightening financing for consumers and MSMEs while policy-supported borrowers continue to absorb credit. 

That is the asymmetry: the sectors bearing the shock face tighter constraints, while the sectors sustained by intervention retain access to financing. 

Whac-a-mole economics is the diagnosis. The bank is the mallet's table. Each strike lands on the same surface. 

VII. The Bank–Sovereign Doom Loop: Who Rescues the Rescuers? 

Name the loop plainly:

1. The sovereign runs deficits larger than revenue—Php 1.054 trillion in eight months—and needs banks to absorb its paper.
2. Banks hold that paper, fund it short, and park much of it at amortized cost. Regulatory relief can obscure market losses without eliminating them.
3. Rising yields, driven by the oil shock, peso weakness, and global bond repricing, reduce the market value of those holdings. Accounting rules determine how much of the loss is reported, not whether it occurred.
4. Capital relief and forbearance soften the immediate consequences, prolonging the system's dependence on sovereign paper.
5. The sovereign is a major asset of the banking system and cannot reprice without transmitting losses back to its creditors. The BSP is pulled toward the familiar response: suppress, subsidize, transfer, borrow.
6. A weaker peso raises the peso value of external debt—about Php 90 billion in August alone (Part 17)—widening the next deficit and returning the process to step one.

The sovereign and the banks are one balance sheet in two names. The crisis is not simply that either is weak. It is that each can be rescued only at the risk of weakening the other. 

Who rescues the rescuer? 

The last time developing-world sovereigns and their banks hit this wall, the Baker and Brady Plans offered successive responses. The Baker Plan (1985) sought to sustain debtors through structural adjustment, multilateral support, and fresh commercial-bank lending. It failed to resolve the debt overhang. The Brady Plan (1989) shifted toward debt reduction, exchanging commercial bank loans for bonds, some backed by US Treasury collateral, with IMF and World Bank support. The mechanism changed from extending credit to restructuring claims. 

Both approaches depended on coordinated creditors and access to external financing. 

This time the donors have their own queue: record public debt in the advanced economies, Fed hike bets after hot US inflation, and an AI financing trade that imploded this week (Nasdaq −4.5%, the worst week since June; the Semiconductor (SOX) index −11.4%; more than $1T off the top 20 AI and chip names). South Korea’s KOSPI plunged 14.5% this week and 18.3% over seven sessions, leaving it nearly 40% below its June 19 high. Samsung fell 17.7% this week and 43% from its June high, while SK Hynix dropped 24.3% and 57%, respectively. Japan’s Nikkei bushwhacked, plunging 5.4% (Figure 7, lowest chart) 

Bond vigilantes, investors who sell a government's bonds when they distrust its finances, are already repricing here and abroad. 

This matters to the Philippines. The same global repricing that threatens AI financing also competes with sovereign borrowing and corporate refinancing for investor capital. A sustained unwind would tighten credit, weaken collateral, and compete with sovereigns and conglomerates for a shrinking pool of risk-bearing capital. The Philippines' refinancing problem is therefore arriving as the capacity of external markets to absorb risk is itself under pressure. 

The central bank faces two broad paths: let yields, the peso, and asset valuations adjust, forcing losses into the open; or extend liquidity and relief, postponing recognition while deepening dependence on continued accommodation. The first is politically painful. The second feeds the loop. 

The system rewards the second until it breaks. 

One reserve stock, three claimants: the currency, the banks, and the sovereign. 

The textbook version is the Mundell–Fleming trilemma or the Impossible Trinity: a country cannot simultaneously maintain a managed exchange rate, free capital flows, and independent monetary policy. Something has to give. The BSP has sought to manage the peso while domestic monetary conditions lag behind inflation. The exchange rate has absorbed much of the resulting pressure. 

The structural problem is the deepening fiscal dominance. 

When the deficit path remains fixed, the central bank becomes the residual financier. Tight money today can simply mean more money creation tomorrow—the unpleasant monetarist arithmetic of Thomas Sargent and Neil Wallace. Their 1981 analysis explains how persistent fiscal financing needs can ultimately constrain monetary policy and shift the burden into future monetary expansion. 

That closes the loop. Deficits create the need for financing; banks absorb the sovereign's paper; repricing threatens bank balance sheets; relief postpones recognition; and monetary accommodation sustains the financing structure. The cost returns through the economy then the peso, yields, and prices. 

The AI trade adds an external vulnerability: the very global capital markets expected to absorb more borrowing are reassessing the returns on one of their largest investment booms. 

The sovereign borrows from the banks, the banks depend on the sovereign, and the central bank is expected to keep both standing. The rescuers are inside the loop—and the outside rescuer is busy putting out fires of its own. 

VIII. Conclusion: When the Coyote Looks Down 

The banking system has become the shock absorber for a political economy that spends beyond its real savings. Credit expands, sovereign paper accumulates, losses are deferred, and liquidity is consumed to keep the structure running. Each intervention transfers the pressure without removing its cause. 

This is the bank–sovereign doom loop: the sovereign depends on banks to finance its deficits; banks depend on the sovereign's paper to sustain their balance sheets; and the BSP is expected to keep both afloat. The same rescue that postpones adjustment deepens the system's dependence on the next rescue. 

The tipping point comes when the chain breaks—when refinancing fails, sovereign repricing forces losses into bank capital, or pressure on the peso exhausts the room for intervention. These are not independent risks. Each can trigger the others. 

The 2027–2029 corporate maturity wall adds another claimant to a financing system already stretched between the sovereign, policy-supported borrowers, and banks' own funding needs. 

The Coyote does not fall because he looks down. He falls when he realizes there is no ground beneath him. Looking down is the recognition; the fall is the adjustment that can no longer be deferred. 

The balance sheets are still running. The ground beneath them is already giving way. 

---

References: 

Stagflation Part 17: Eight Months of Twin Deficits, Record Debt, and the Bill for Deferred Adjustment, October 4, 2026 

Stagflation Part 14: Q2 GDP at 2.3% and Falling — A GDP Built on Suppression and Debt, August 9, 2026 

USD-PHP at Record Highs: The Three Philippine Fault Lines—Energy Fragility, Fiscal Bailouts, Bank Stress, December 21,2025 

The Oligarchic Bailout Everyone Missed: How the Energy Fragility Now Threatens the Philippine Peso and the Economy, December 7, 2025 

Inside the SMC–Meralco–AEV Energy Deal: Asset Transfers That Mask a Systemic Fragility Loop, November 23, 2025

 

 

Stagflation Part 11: The Intervention Ecosystem Behind Moody's and Fitch's Banking Warnings

  

This is the same mentality that drives every sovereign debt crisis. Governments become disconnected from the source of their funding. They begin treating taxpayer money as an unlimited resource rather than the product of someone else’s labor. Every expenditure can be justified. Every program becomes essential. Every privilege becomes a necessity. Meanwhile, the national debt continues to rise—Martin Armstrong 

In this issue

Stagflation Part 11: The Intervention Ecosystem Behind Moody's and Fitch's Banking Warnings

Part 1: The Ratings Agencies Finally Catch Up

Part 2: The Political Economy of the Intervention Ecosystem

2A. Basel, Sovereign Debt, and the Savings-Investment Gap

2B. Five Relief Measures, One Intervention Regime

2C. Confidence Management: BSP Rebuts Fitch

2D. Policies Are Never Neutral

2E. The Feedback Mechanism Begins to Fail

Part 3: Wile E. Coyote Begins to Lose Altitude

3A. Sovereign-Bank Doom Loop: Financing the State Before Financing the Economy

3B. The Hidden Losses Continue to Grow

3C. Liquidity Reveals What Capital Ratios Conceal

3D. Deposits Rise—But Why?

3E. Funding Conditions Become Increasingly Demanding

Part 4: Conclusion: The Balance Sheet Speaks 

Stagflation Part 11: The Intervention Ecosystem Behind Moody's and Fitch's Banking Warnings

Moody's and Fitch have finally caught up. The balance sheet explains why. 

Part 1: The Ratings Agencies Finally Catch Up 

Within days, the world's two largest credit-rating agencies issued successive warnings on the Philippine banking system. 

Moody's first revised its outlook on Philippine banks to ‘Negative’, citing weakening household consumption, softer loan demand, rising credit impairments, and slowing government spending. 

Days later, the agency issued a second warning, describing the BSP's latest capital-relief measure as ‘credit negative’, arguing that excluding unrealized losses on government securities from regulatory capital calculations reflected increasing balance-sheet pressures rather than genuine strengthening. 

Notably, the warning represented a marked shift from Moody's assessment only months earlier, when the agency viewed the BSP's capital-relief measures more favorably. The reversal illustrates how rapidly external assessments can change once balance-sheet vulnerabilities become more difficult to ignore. 

Fitch Ratings soon followed. 

It downgraded its outlook on Philippine banks from ‘Neutral’ to ‘Deteriorating,’ warning that slower economic activity, rising credit costs, rapid unsecured consumer lending, and weakening profitability would increasingly pressure the sector. Earlier, Fitch had also revised the Philippine sovereign outlook to Negative, citing slower public spending, fiscal deterioration, and the inflationary consequences of higher oil prices. 

Both agencies have finally acknowledged stresses that balance-sheet data, market behavior, and this series have documented for years. 

Ironically, neither Moody's nor Fitch identified the gradual deterioration while it was unfolding. Instead, both reacted only after a series of highly visible developments—including the Middle East oil shock, concerns over public spending associated with the corruption investigation, the persistent rise in Philippine Treasury yields, and the deterioration in bank share prices—made the underlying fragilities increasingly difficult to ignore. 

This pattern is not an isolated shortcoming. It reflects the institutional character of modern credit-rating agencies. 

Major rating agencies—Moody's, Fitch, and S&P—operate under an issuer-pays business model that embeds a persistent principal-agent problem. They are compensated by the very institutions whose creditworthiness they evaluate, making their commercial incentives structurally dependent on maintaining long-term issuer relationships. At the same time, their reputations depend on avoiding assessments that diverge too sharply from prevailing market consensus before the evidence becomes widely accepted. Ratings that prove prematurely pessimistic risk damaging institutional credibility, while ratings that move alongside emerging market consensus are considerably easier to defend ex post. The resulting incentive structure favors gradual convergence rather than early diagnosis of structural deterioration. 

The 2008 Global Financial Crisis remains the clearest illustration. Rating agencies assigned investment-grade ratings to mortgage-backed securities even as the quality of their underlying collateral deteriorated. Subsequent investigations concluded that the combination of the originate-to-distribute model and issuer-paid ratings systematically weakened independent credit assessment, allowing confidence to persist until the financial system itself became unstable. 

The Philippine experience exhibits similar characteristics. 

For years, Philippine bank profitability had already begun slowing. Profit growth peaked around the second quarter of 2021 before entering a prolonged deceleration. Yet the PSE Financial Index continued advancing, reaching its cyclical peak only in March 2025. The divergence between weakening earnings momentum and rising market valuations reflected an expanding disconnect between underlying fundamentals and market expectations.

Figure 1 

The eventual reversal should not have been surprising. 

Today, both profit growth and the Financial Index are declining as market valuations gradually converge toward balance-sheet realities that had long been obscured by abundant liquidity, optimistic narratives, expectations of continued policy accommodation, and price support originating from large financial institutions. (Figure 1, topmost pane) 

The phenomenal rise in the Financial Index from September 2020 to March 2025, largely reflected appreciation in its dominant constituents. As of late June 2026, BDO, BPI, and Metrobank accounted for nearly four-fifths of the index's market capitalization, making movements in a handful of banks sufficient to sustain the appearance of sectoral strength. Although they comprised less than one-fifth of the PSEi 30 (also as of late June), their size and influence made them likewise important contributors to the performance of the headline index. 

During much of the previous bull market, other financial corporations (OFCs) also played a material role in supporting banking share prices, further weakening the informational content of market prices. 

OFC claims on depository corporations rose broadly in tandem with the Financial Index, suggesting that expanding OFC financing helped support bank share prices. However, after reaching a record high in the fourth quarter of 2025, OFC claims began to diverge from the Financial Index beginning in the first quarter of 2025, indicating that this source of support had begun to weaken. (Figure 1, middle image) 

With the Financial Index declining throughout 2025, however, market valuations began adjusting before the rating agencies revised their assessments. 

Their recent actions therefore represent confirmation rather than discovery. The warnings validate developments that had already become evident in BSP statistics, in the progressive deterioration of bank profitability, in weakening banking-equity/Financial Index performance, and in the increasingly frequent policy accommodations undertaken by the BSP. 

This distinction is fundamental because it separates empirical description from causal explanation. Rating agencies describe conditions once they become sufficiently visible. They do not explain why those conditions emerged. 

The factors emphasized in the recent downgrades—higher oil prices, slower government spending, weaker household demand, and rising credit costs—are undoubtedly relevant. But they function primarily as catalysts rather than causes. 

Philippine banking-sector fragility did not originate with the latest geopolitical shock, nor did it suddenly emerge because of corruption investigations or weaker fiscal spending. Those developments merely exposed vulnerabilities that had accumulated over many years through policy choices, regulatory incentives, and increasingly interventionist financial arrangements. 

Understanding that process requires moving beyond current events toward the institutional framework governing Philippine finance. The common thread connecting slowing profitability, declining liquidity buffers, record sovereign exposures, repeated BSP capital-relief measures, and successive rating-agency warnings is not the latest external shock. 

It is the cumulative consequence of a policy regime that has increasingly substituted intervention for adjustment. 

Modern central-bank intervention is no longer a collection of isolated policies. It has become an ecosystem. Understanding that ecosystem—not merely its latest manifestations—is the central objective of this essay. 

Part 2: The Political Economy of the Intervention Ecosystem 

If Part 1 established that Moody's and Fitch merely recognized Philippine banking stress after it had become increasingly visible, the more important question remains unanswered. 

Why has the banking system become progressively dependent on successive regulatory accommodations in the first place? 

The answer cannot be found in the recent oil shock, the corruption investigation, or slowing GDP growth. Those developments merely exposed vulnerabilities that had accumulated over many years. 

The deeper explanation is institutional. 

The Philippine banking system has gradually evolved into an intervention ecosystem in which fiscal policy, monetary policy, prudential regulation, and financial markets increasingly reinforce one another. The result is a self-reinforcing sovereign-bank nexus, where interventions introduced to alleviate one problem progressively create the conditions requiring the next. 

2A. Basel, Sovereign Debt, and the Savings-Investment Gap 

The BSP's latest relief measures did not emerge in isolation. 

Their foundations were laid years earlier. 

Modern prudential regulation under the Basel framework assigns highly preferential regulatory treatment to sovereign obligations. Government securities generally receive lower regulatory capital charges while simultaneously qualifying as high-quality liquid assets for liquidity requirements. 

Banks responded accordingly. 

As fiscal deficits widened and the domestic savings-investment gap persisted, government borrowing increasingly flowed through the banking system. Philippine banks accumulated record holdings of government securities, which now comprise roughly one-third of total banking assets—the highest in Asia, while debt securities classified under amortized cost likewise reached unprecedented levels. (Figure 1, lowest graph) 

Note: The share reported here differs from the roughly 30% figure cited elsewhere because of differences in measurement. This chart uses net claims on the central government as a share of total banking-system assets, whereas other sources often report total holdings of government securities (or include broader public-sector claims) as a share of assets. Although the definitions differ, both measures point to the same underlying trend: Philippine banks have become increasingly exposed to sovereign debt. 

The arrangement appeared mutually beneficial while interest rates remained exceptionally low. Governments obtained inexpensive financing. Banks benefited from favorable regulatory treatment. Reported capital ratios remained strong. Expanding sovereign portfolios came to be viewed as evidence of prudence rather than concentration. 

Yet policies are never neutral. 

The same incentives that encouraged banks to finance government deficits also concentrated duration risk on bank balance sheets. Once long-term interest rates began rising, unrealized losses accumulated almost inevitably. 

The present mark-to-market problem therefore did not originate with the recent rise in Treasury yields. Higher yields merely exposed vulnerabilities embedded years earlier through regulatory incentives and reinforced by persistent fiscal dependence on the banking system. 

Viewed through this lens, today's banking pressures are not an isolated financial event. They are the institutional consequence of a prolonged policy regime. 

2B. Five Relief Measures, One Intervention Regime 

Against this backdrop, the succession of recent BSP interventions becomes considerably more revealing. 

Figure/Table 2 

Within only a few months, regulators and the National Government implemented a remarkable sequence of accommodations. (Figure/Table 2) 

Following Executive Order No. 110 and the declaration of a National Energy Emergency, in April, banks received temporary regulatory relief allowing affected loans to avoid immediate non-performing classification while repayment schedules for agricultural borrowers were extended. 

The government subsequently lengthened salary-loan maturities to as much as seven years, reducing immediate repayment burdens while extending household leverage further into the future. 

The BSP introduced a Positive Neutral Countercyclical Capital Buffer framework, permitting banks to draw down previously accumulated capital during periods of stress. 

Regulators also revised rules governing intragroup guarantees and credit-risk transfers to provide greater flexibility in regulatory capital treatment. 

Finally, the BSP temporarily excluded unrealized losses on peso-denominated government securities from regulatory capital calculations, preventing mark-to-market losses from immediately reducing reported Common Equity Tier 1 ratios. 

The pattern of interventions is clear. As banking-sector pressures emerge, authorities increasingly respond through regulatory accommodation rather than balance-sheet adjustment. 

• Accommodation postpones adjustment.
• New pressures subsequently emerge.
• Additional accommodations follow. 

Intervention increasingly becomes the primary mechanism through which adjustment itself is managed. 

Intervention thus evolves from a temporary response into a self-reinforcing mechanism that perpetuates the need for further intervention. 

This is precisely why Moody's second warning deserves closer attention. 

Ironically, while the BSP presented its latest capital-relief measure as supporting financial stability, Moody's characterized the same measure as ‘credit negative.’ 

The significance lies not in Moody's opinion itself. Rather, the rating agency inadvertently acknowledged what the policy implicitly reveals. If Philippine banks were genuinely as “resilient” as official narratives repeatedly suggest, successive relief measures would be unnecessary. 

The interventions themselves become evidence of the underlying condition they are intended to manage.

2C. Confidence Management: BSP Rebuts Fitch 

The same pattern emerged following Fitch's decision to revise its outlook on the Philippine banking sector to "deteriorating." Rather than engaging the underlying balance-sheet concerns raised by Fitch—slowing profitability, rising credit costs, deteriorating consumer-credit quality, and mounting macroeconomic risks—the BSP issued an official rebuttal emphasizing the banking system's resilience, strong capitalization, and prudent supervision. 

The response illustrates another dimension of the intervention ecosystem: confidence management. 

Financial stability increasingly depends not only on liquidity facilities and regulatory accommodation but also on sustaining confidence through official communication, supervisory discretion, accounting treatment, statistical embellishments, market-price support, and managing information. 

Here one is reminded of Otto von Bismarck's famous observation: 

"Never believe anything in politics until it has been officially denied." 

The quotation need not be interpreted literally. Rather, it illustrates a broader principle: official denials often reveal where authorities perceive the greatest political or financial vulnerability. Communicative reassurance, when accompanied by repeated intervention, creates its own internal contradiction. 

Demonstrated preference in motion: Actions ultimately reveal more than statements. 

If the banking system is indeed as resilient as repeatedly claimed, the growing sequence of relief measures, accounting accommodations, capital waivers, repayment extensions, and supervisory flexibility becomes increasingly difficult to reconcile with that narrative. 

As a whole, Moody's first warning, Moody's second warning, Fitch's deteriorating outlook, and the BSP's official rebuttal are best understood not as separate news events but as different responses to the same underlying balance-sheet reality.

2D. Policies Are Never Neutral 

Modern intervention rarely operates through monetary policy alone. To remain effective, it increasingly extends into prudential regulation, accounting treatment, supervisory discretion, statistical presentation, market-price support, and official communication. The objective gradually shifts from correcting underlying imbalances toward preserving confidence despite those imbalances. 

Confidence, however, is not synonymous with resilience. 

Market prices, capital ratios, official statistics, and regulatory classifications increasingly become components of a broader architecture of confidence management. 

This recalls the argument developed in Stagflation Part 9 regarding statistical simulacra. Confidence management increasingly involves directing public attention toward officially presented indicators while managing information about underlying conditions. 

Policies are never neutral. 

Every policy accommodation redistributes costs and benefits while reshaping future incentives. Banks carrying substantial unrealized losses receive capital relief. Governments retain easier access to domestic financing. Institutions that managed liquidity and duration risk more conservatively receive comparatively fewer advantages. The public receives progressively less transparent balance sheets, while future taxpayers inherit greater contingent liabilities, capital is consumed, and the purchasing power of money erodes. 

Perhaps more importantly, repeated accommodation alters expectations. 

When losses repeatedly receive regulatory relief, incentives increasingly favor postponement over recognition. When accounting treatment becomes progressively more flexible, opportunities for accounting arbitrage naturally expand. When capital requirements become adjustable, pressure to raise fresh equity correspondingly diminishes. 

Policies influence behavior because they alter the expected rewards and penalties facing economic actors. 

As the great Ludwig von Mises argued, intervention possesses its own internal logic. Each intervention generates distortions that subsequently justify additional intervention. 

Historian Charles Kindleberger's sauve qui peut similarly reminds us that periods of financial stress intensify incentives to preserve appearances, transfer adjustment elsewhere, and ultimately culminate in what he famously described as the "emergence of swindles." 

Economist János Kornai's soft-budget constraint explains how repeated accommodation gradually conditions institutions to expect further accommodation, thereby entrenching dependence on future intervention. 

As one, these perspectives describe how policy reshapes the political economy. The intervention ecosystem does not merely postpone adjustment. It alters the adaptive behavior of the financial system itself. 

2E. The Feedback Mechanism Begins to Fail 

Perhaps the greatest cost of repeated intervention is not its immediate fiscal expense or temporary accounting opacity. 

It is the gradual deterioration of the market's feedback mechanism.

• Markets are increasingly managed to produce an optic of stability.
• Prices become less informative.
• Balance sheets become more difficult to manage and interpret.
• Statistics increasingly reflect administrative treatment more than the underlying economic reality.
• Capital allocation responds progressively more to regulation than entrepreneurship. 

Meanwhile, scarce domestic savings continue flowing toward sustaining existing politically induced structures rather than financing new productive investment. 

Austrian economist Frank Shostak's observation becomes increasingly relevant. Fiscal and monetary rescue measures appear effective only while supported by an adequate stock of genuine private savings. As real savings become progressively constrained, successive interventions generate diminishing economic benefits while simultaneously increasing distortions and fragility. 

In this sense, intervention gradually begins consuming the very foundation upon which it depends. 

If this diagnosis is correct, its consequences should already be visible in the Philippine banking system's balance sheet. 

The April and May BSP data suggest precisely that. 

Part 3: Wile E. Coyote Begins to Lose Altitude 

For several years, Philippine banking has what I have aptly described through the metaphor of Wile E. Coyote. 

The analogy remains instructive. 

A cartoon character running beyond the edge of a cliff continues forward motion until gravity is finally acknowledged. Momentum temporarily sustains the illusion of stability, even after structural support has disappeared. 

The same dynamic has characterized Philippine bank lending. 

For much of the previous cycle, rapid loan expansion repeatedly outpaced the growth of non-performing loans, producing the appearance of stable asset quality through what we previously described as a denominator effect. As long as total lending grew faster than impaired assets, reported ratios remained contained, masking underlying deterioration. 

Eventually, however, arithmetic reasserts itself. 

The May data suggest that this transition may now be underway.

Figure 3

Gross non-performing (NPL) loans rose 14.0 % year-on-year, outpacing total loan growth of approximately 11.9 %. As a result, the gross NPL ratio continued its steady ascent—from 3.29 % in March to 3.37 % in April and 3.44% in May. (Figure 3, topmost window) 

Gross NPLs (in pesos) also reached a new record for the second consecutive month. 

The denominator is no longer keeping pace. 

Wile E. Coyote is beginning to feel gravity. 

Loan-loss reserves likewise reached record levels in peso terms. However, provisioning continues to lag overall loan expansion, suggesting that while buffers are increasing, they are not rising fast enough to fully offset the growth of risk exposures. (Figure 3, middle diagram) 

The deterioration therefore extends beyond headline ratios. It is increasingly embedded in the structure of the balance sheet itself.

3A. Sovereign-Bank Doom Loop: Financing the State Before Financing the Economy 

The asset side of bank balance sheets reinforces the same structural shift. 

Net claims on the central government (NCoCG) reached another record in April, while holdings of debt securities (mostly government) under amortized-cost classifications (formerly Held-to-Maturity or HTM) also hit a milestone last May. (Figure 3, lowest chart) 

This is not incidental. 

Under Basel-aligned prudential frameworks, sovereign obligations receive preferential regulatory treatment through lower capital charges and favorable liquidity classification. Banks responded exactly as incentives dictated. 

Over time, this has resulted in a gradual but persistent reallocation of bank balance sheets toward sovereign financing. 

Government borrowing increasingly absorbs domestic savings that might otherwise have supported private-sector credit formation. The banking system, in effect, has become a primary intermediary of fiscal financing. 

The result is not merely concentration risk. 

It is a structural transformation of intermediation itself—from financing entrepreneurial activity to financing the state. 

In this configuration, the savings–investment gap is increasingly mediated through public debt rather than private capital formation. 

The implication is straightforward: sovereign funding needs and bank balance-sheet structure become progressively intertwined, with each reinforcing the other over time. 

Or, this dynamic evolves into a sovereign-bank doom loop: banks’ balance sheets become increasingly saturated with sovereign risk, while the state becomes progressively dependent on domestic banks for financing. Each side reinforces the other, tightening the link between fiscal conditions and banking-sector stability. 

Sovereign risk becomes bank risk, and vice versa. 

3B. The Hidden Losses Continue to Grow 

The second channel of stress is less visible but equally important.

Figure 4

Available-for-sale (AFS) portfolios reached its second highest level in May, while unrealized losses rose to approximately Php 175 billion—exceeding the valuation losses recorded during the post-pandemic inflation shock following the Russia–Ukraine conflict. (Figure 4, upper graph) 

This unparalleled deterioration coincided with a sharp rise in Philippine Treasury yields. Yet, while 10-year yield spiked to the same level as 2022, the losses were much greater today. (Figure 4, lower image) 

The mechanism is direct. 

As yields rise, the market value of existing government securities declines. Given the unprecedented share of sovereign instruments on bank balance sheets, this translates into immediate valuation losses, reduced capital flexibility, and greater sensitivity to further rate movements. 

The BSP classifies these losses as temporary volatility. 

Economically, however, they are not temporary. They represent the opportunity cost of prior duration decisions shaped by the prevailing regulatory environment. 

Capital relief alters their regulatory treatment. 

It does not restore the lost economic value. It exacerbates them.

3C. Liquidity Reveals What Capital Ratios Conceal 

Asset quality and valuation effects are only part of the picture. Liquidity conditions provide an earlier signal of stress. 

Here, the evidence is increasingly consistent.

Figure 5

The cash-to-deposit ratio remains near historic lows despite modest improvement in April. Meanwhile, the liquid-assets-to-deposit ratio continued to weaken, falling to approximately 46.7 % in May—its lowest level since the pandemic period. (Figure 5 upper image) 

This is a notable weakening of liquidity buffers. 

During the pandemic, extraordinary BSP liquidity injections exceeding Php 2.3 trillion produced an unprecedented expansion in system-wide liquidity. That buffer has since unwound. 

Banks now face weakening liquidity conditions even as official narratives continue to emphasize systemic ‘resilience.’ 

The divergence between narrative and balance-sheet conditions is widening.

3D. Deposits Rise—But Why? 

At first glance, deposit growth appears supportive. 

Deposit liabilities continued expanding at double-digit rates through May. 

However, the source of this growth is crucial. 

Broad money (M3) continued to expand at more than 12% annually, even as currency in circulation slowed. At the same time, the BSP’s Monetary Authority Survey (MAS) shows a sharp increase in BSP net claims on the National Government (NCoCG), reaching approximately Php 663 billion last May, largely driven by declining government deposits at the BSP. (Figure 5, lower graph) 

In other words, liquidity increasingly entered the banking system through official channels rather than through underlying economic expansion. 

The composition of money creation therefore matters as much as its quantity. 

Deposit growth driven by public-sector liquidity operations is fundamentally different from deposit growth driven by rising productivity, voluntary savings, or private investment. 

One reflects economic activities. 

The other primarily reflects liquidity redistribution—wealth consumption concealed beneath a façade of sanguine statistics. 

3E. Funding Conditions Become Increasingly Demanding 

The liability side of bank balance sheets reinforces the same pattern.

Figure 6

Bonds and bills payable rose to nearly Php 2 trillion, the second highest levels on record. (Figure 6, upper visual) 

Banks have increasingly relied on wholesale funding, while interbank borrowing has remained volatile and reverse-repurchase activity has fluctuated sharply over the interim—though both are on an uptrend overtime. (Figure 6, lower chart) 

These developments indicate a gradual shift toward more expensive and less stable funding sources. 

Banks are increasingly competing with the National Government and the private sector for access to scarce domestic savings, placing upward pressure on funding costs. 

Like asset composition, funding structure reflects the evolving incentive environment facing the banking system.

Part 4: Conclusion: The Balance Sheet Speaks 

The evidence, viewed collectively, is difficult to dismiss. 

• Record sovereign exposure.
• All-time high amortized-cost securities.
• Biggest unrealized bond losses.
• Record non-performing loans in pesos.
• Milestone lows liquidity buffers.
• Increasing reliance on wholesale funding. 

In aggregate, they portray a banking system operating with progressively narrower margins of safety despite successive rounds of regulatory accommodation. 

This is why Moody's and Fitch should be understood as confirming rather than discovering emerging stress. 

The ratings agencies did not originate the signal. They merely acknowledged conditions that had already become visible in bank balance sheets, market prices, and the increasingly frequent interventions undertaken by policymakers. 

More fundamentally, the recent downgrades reveal the limits of confidence management. 

• Regulatory relief can postpone recognition.
• Accounting flexibility can soften reported capital ratios.
• Official reassurance can influence expectations.

But none can permanently suspend the underlying economics of deteriorating asset quality, mounting sovereign exposure, or tightening liquidity conditions. 

Policies are never neutral. They reshape incentives, redistribute risks, and influence how financial institutions adapt over time. Successive interventions may stabilize the system temporarily, but they also deepen institutional dependence on future intervention, reinforcing the very dynamics they seek to contain. 

The Philippine banking system did not arrive at its present condition because of a single oil shock, corruption investigation, or ratings downgrade. Those events merely exposed vulnerabilities that had accumulated over years through the interaction of fiscal policy, monetary accommodation, prudential regulation, and repeated financial intervention. 

Ultimately, the ratings agencies reacted to the symptoms. The balance sheet reveals the disease.

• Markets can postpone reality.
• Accounting can defer recognition.
• Regulation can delay adjustment.

But none can permanently suspend economic constraints. 

Eventually, the chickens come home to roost. 

____

References: 

Stagflation Part 10: The Politics of Contradiction—Rate Hikes, Liquidity Addiction, and External Constraint Under Balance-Sheet Stress 

Stagflation Part 9: The Good News Mirage — Statistical Stability Amid Structural Fragility 

Stagflation Part 8: Manufacturing Resilience — The PSEi 30 Under Stagflationary Pressure, BSP Accommodation, and the Financialization of Fragility 

Stagflation Part 7: The Return of Constraint—Oil Shock, Treasury Revolt, and the Politics of Inflation Suppression 

Stagflation Part 6: The Banking System Under Siege—Bond Selloffs, Liquidity Illusions, and the Coming Balance Sheet Reckoning 

Stagflation Part 5: The Q1 2026 GDP Illusion and the Gathering Recession Risk Beneath Price Suppression 

Stagflation Then and Now: Why Philippine Markets Are Repricing Like the 1970s (Part 4) 

The Anatomy of Philippine Stagflation: BSP Rate Hikes, Record External Deficits, and Fiscal Expansion (Part 3) 

Stagflation by Design: Policy Contradictions and the Return of the Pandemic Rescue Playbook 

Stagflation Is Already Here—Emergency Policies Are Now Entrenching It 

Seed Article 

EO-110 and the Politics of Price Suppression: How the Energy Emergency Is Becoming a Nationwide Economic Intervention