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

 

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

In this Issue 

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

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

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

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

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

V. Treasury Market Plumbing: Who Really Benefits?

VI. Crowding Out: Corporate Issuers in Retreat

VII. The Free Lunch Illusion: Debt and Servicing Costs

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

IX. Q2 2025 Bank Profit Plummets on Credit Loss Provisions

X. Conclusion: Goldilocks Faces the Three Bad Bears 

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

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

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

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

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

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

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

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

Figure 1

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

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

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

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

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

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

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

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

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

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

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

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

Figure 2

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

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

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

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

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

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

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

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

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

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

V. Treasury Market Plumbing: Who Really Benefits? 

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

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

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

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

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

Figure 3

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

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

This wasn’t retail exuberance—it was plumbing. 

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

VI. Crowding Out: Corporate Issuers in Retreat 

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

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

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

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

VII. The Free Lunch Illusion: Debt and Servicing Costs

Figure 4

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

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

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

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

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

Crowding out isn’t just theoretical. 

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

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

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

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

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

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

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

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

Figure 5 

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

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

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

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

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

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

Goldilocks, eh? 

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

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

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

IX. Q2 2025 Bank Profit Plummets on Credit Loss Provisions

Figure 6 

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

The culprit? 

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

X. Conclusion: Goldilocks Faces the Three Bad Bears 

The cat is out of the bag. 

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

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

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

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

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

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

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

___

references 

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

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

 

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

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

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

In this issue: 

Part 1: Earnings Erosion and the Mask of Stability

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

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

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

1.D Income Breakdown: Lending Boom Masks Structural Risk

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

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

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

1.H The NPL Illusion: Velocity Masks Vulnerability

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

Part 2: Liquidity Strains and the Architecture of Intervention

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

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

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

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

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

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

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

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

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

Part 1: Earnings Erosion and the Mask of Stability 

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

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

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

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

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

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

Figure 1

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

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

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

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

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

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

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

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

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

1.D Income Breakdown: Lending Boom Masks Structural Risk 

What explains the sharp profit downturn?

Figure 2

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Figure 3

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

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

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

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

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

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

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

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

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

1.H The NPL Illusion: Velocity Masks Vulnerability

Figure 4

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

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

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

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

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

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

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

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

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

Part 2: Liquidity Strains and the Architecture of Intervention

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

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

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

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

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

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

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

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

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

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

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

Figure 5

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

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

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

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

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

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

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

Figure 6

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

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

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

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

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

Figure 7

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

As the saying goes: we live in interesting times. 

____

Prudent Investor Newsletter Archives: 

1 San Miguel

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

Just among the many…

2 CMEPA

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

The CMEPA Delusion: How Fallacious Arguments Conceal the Risk of Systemic Blowback

As the cycle nears its end, a country is typically beset by chronic fiscal deficits. Low domestic savings and current account deficits render it dependent on foreign lenders. As lenders become wary, the average maturity of the public debt shortens. The central bank finds it impossible to set interest rates at the level which balances the needs of both creditors and borrowers. Once interest rates rise, governments’ debt servicing costs become increasingly onerous. Government finances come to resemble a Ponzi scheme, with new debt being issued to service old borrowing—Edward Chancellor 

In this issue

The CMEPA Delusion: How Fallacious Arguments Conceal the Risk of Systemic Blowback

I. Introduction: Evading the Real Issue

II. The Fallacies Behind the CMEPA’s Defense

A. False Equivalence

B. Red Herring

C. Categorical Error

D. Begging the Question

E. Ignoring Second-Order Effects (Bastiat’s “Seen and Unseen”)

F. Appeal to the General (Overgeneralization)

III. The Diminishing Role of Time and Savings Deposits in M2 and Bank Liabilities

IV. Defective Gross Domestic Savings, Near Record Savings-Investment Gap

V. Financing the ‘Twin Deficits’ with Record Systemic Leverage

VI. State-Driven Financial Repression: Time Deposits vs. RTBs & Pag-IBIG MP2

VII. Inflating Stock Market Bubbles: CMEPA’s Savers Lion’s Den

VIII. Conclusion: Sovereignty over Speculation, Economic Blowback 

The CMEPA Delusion: How Fallacious Arguments Conceal the Risk of Systemic Blowback 

Logical fallacies aren’t harmless—they shape policy narratives. In CMEPA’s case, they obscure financial repression and pave the way for systemic economic backlash. 

This is a follow-up on my original piece: The Seen, the Unseen, and the Taxed: CMEPA as Financial Repression by Design 

I. Introduction: Evading the Real Issue 

The Capital Market Efficiency Promotion Act (CMEPA) has stirred significant debate, not merely because of its tax provisions but because of what it signals about the evolving relationship between the state and citizen savings. 

While defenders of CMEPA claim it merely modernizes financial taxation and expands savings options, these arguments often rest on flawed logic and misleading equivalencies that mask the deeper issues: the erosion of true savings, the rise of speculation, and creeping state control over private capital.

Besides, in classical economic thought, savings is deferred consumption—a temporal anchor against uncertainty, a moral wager on future stability. Time-bound, low-risk instruments like term deposits have long served this function. They do not aspire; they buffer. When the state flattens the tax incentives protecting this buffer, it doesn’t merely tweak an equation—it alters the meaning of saving. 

II. The Fallacies Behind the CMEPA’s Defense 

CMEPA's defenders lean on several logical fallacies to support their case: 

A. False Equivalence: By equating time-bound savings with speculative financial assets such as stocks or REITs, proponents confuse two fundamentally different financial behaviors. Savings are deferred consumption; risk assets are bets on volatility. 

B. Red Herring: Arguments pointing to alternative investment vehicles like Pag-IBIG MP2 or Retail Treasury Bonds distract from the core concern: CMEPA disincentivizes bank-based, low-risk savings that traditionally fund long-term development. 

C. Categorical Error: To assume that financial markets can substitute for savings systems ignores the institutional role of savings in capital formation, stability, and intermediation. 

D. Begging the Question: CMEPA defenders assume what they must prove: that taxed savings instruments still count as savings (tax = savings or 1-1=2), or that savings will simply shift outside time deposits without consequence. This begs the question. 

It presumes that risk assets and government-managed schemes are natural substitutes for time deposits. It conflates taxation with neutrality, ignoring how incentives shape behavior.

In reality, aside from extraction, tax is a signal, not a passive overlay. And when the signal penalizes duration, it redefines savings itself. 

Worst, it also treats financial repression as benign without examining its structural damage to intermediation, capital formation, and systemic liquidity.

E. Ignoring Second-Order Effects (Bastiat’s “Seen and Unseen”) 

Defenders highlight only the seen—that capital might shift to “alternative” instruments like stocks or Pag-IBIG MP2. 

What is seen:

1. Lower taxes on REITs and stocks = more investment.

2. Flat tax on deposits = not new, fairness 

But they ignore the unseen: 

1. weakening of bank intermediation via the erosion of long-term bank funding,

2. The crowding out of private credit channels, and

3. The behavioral shift toward liquidity-chasing speculation, which gives rise to

4. increased market and economic volatility 

Policy must be judged not just by its immediate effects, but by its downstream damage. This is the classic Bastiat fallacy—what is unseen—the fragility, the distortion, the systemic cost—often matters more. 

F. Appeal to the General (Overgeneralization) 

CMEPA’s defenders argue that because some financial instruments like stocks, REITs, or Pag-IBIG MP2 exist, they can generally serve as adequate substitutes for traditional savings. 

But this overlooks key details: liquidity risk, volatility, transitional frictions or tensions, accessibility, ceilings, investor profile and behavioral inertia that constrain real-world reallocation. 

Not all instruments serve the same function—especially for households that need capital preservation over yield. 

This fallacy blurs crucial distinctions between risk assets and true savings vehicles. By appealing to broad categories, it sidesteps the very real limitations and risks of reallocating savings. In policy, the details are the difference between resilience and fragility. 

Policy design and evaluation demands specificity: Without disaggregated data on household savings patterns, bank funding structures, and instrument uptake, differentiating between resilience and fragility, the defense becomes narrative and rhetoric, not analysis. 

III. The Diminishing Role of Time and Savings Deposits in M2 and Bank Liabilities 

Since the BSP’s structural easing cycle began in the early 2000s, both the savings and time deposit shares of M2 have steadily declined. 

This erosion has profound implications for the liquidity foundations of the Philippine financial system. 

Figure 1 

Notably, time deposits briefly surged during two critical junctures: first, when the BSP’s policy rates hit record lows during the pandemic, and again when aggressive rate hikes resumed in 2022. Yet this rebound proved short-lived. (Figure 1, topmost pane) 

Subsequent M2 growth increasingly leaned on more liquid components—such as demand deposits and currency in circulation—rather than long-term savings. 

In effect, liquidity transformation has shifted away from stable deposits toward more volatile sources: demand-driven credit expansion and the banking system’s financing of government liabilities, as evidenced by the surge in net claims on the central government (NCoCG). (Figure 1, middle graph) 

The CMEPA tax will likely accelerate this liquidity vacuum by further penalizing traditional savings vehicles. 

This structural shift presents a systemic challenge. As deposits decline, credit expansion becomes increasingly unanchored from genuine savings. In tandem with both implicit liquidity support (via bank balance sheets) and direct quantitative easing (via the BSP), this dynamic becomes inherently inflationary and destabilizing. 

The dilemma is mirrored in bank balance sheets. 

The time deposit share of total bank liabilities has collapsed—from over 32% in 2008 to just 17.5% by mid-2022, before rebounding modestly in response to BSP’s tightening cycle. (Figure 1, lowest diagram) 

This plunge coincides with a decade of financial repression: persistently low real rates, high inflation, and the rise of state-directed instruments like RTBs, MP2, and PERA accounts. 

As traditional deposits dwindled, banks turned increasingly to borrowings to fill the liability gap. 

The share of bank borrowings from capital markets has been rising since 2015, ironically peaking just before the pandemic recession in 2019. This share temporarily declined to 5.4% by Q3 2023, as ‘tighter’ policy conditions set in. 

Yet as liquidity stress intensified, bank borrowing surged anew—hitting 7.9% in March 2025—before moderating after the BSP’s second leg of RRR cuts. 

In this context, what CMEPA promotes as capital market reform in practice amounts to an escalation of the erosion of the deposit base. It trades long-term stability for short-term borrowing, redirecting household savings away from private financial intermediation and into state debt. 

The result? A more fragile banking system, less private capital formation, and greater macro-financial risk. 

Moreover, these bank borrowings now compete directly with government financing needs and private sector credit demand—exacerbating the crowding-out effect and tightening liquidity conditions for the broader economy. 

This fragility is amplified by the growing concentration of liquidity within a handful of dominant players.

Figure 2

As of May, Philippine banks controlled 82% of total financial resources or assets, with universal-commercial banks accounting for 76%. (Figure 2, topmost image) 

Meanwhile, even as the M2-to-GDP ratio soared from 63% in 2019 to a pandemic-era peak of 76.2% in 2021, it dropped sharply to 66.3% by Q1 2025—a sign that not only has GDP become dependent on liquidity, but, importantly, money creation is no longer translating into real economic or savings growth. (Figure 2, middle chart) 

Taken together, as banks increasingly monopolize liquidity while time deposits diminish, the financial system becomes more fragile. It is precisely this growing instability that forced the BSP to roll out confidence-boosting measures—including the doubling of deposit insurance coverage and the second phase of the RRR cut. These are not signs of strength. They are signs of deepening systemic stress.

IV. Defective Gross Domestic Savings, Near Record Savings-Investment Gap 

At first glance, gross domestic savings (GDS) might seem useful for assessing national savings conditions, but its use to account for real savings conditions is generally misleading. 

First, as a derived indicator—not a strict accounting identity—it suffers from definitional inconsistency. 

For instance, the World Bank reports it at 9.3% in 2024, while Trading Economics, citing the same source, shows 29.24%. Same source, vastly different realities. (Figure 2, lowest window) 

Second, it is calculated as: 

GDS = GDP – Total Consumption (private + public). 

But GDP itself is indifferent to distributional nuances. As we always ask here: Cui bono or Who benefits? 

Is the savings outcome driven primarily by genuine productivity gains—or by increasing dependence on leverage? What is the quality of the growth? What ratios of cost, allocation, and extraction were involved? 

Third, the GDS measure masks household savings weakness—especially during capital flight or high profit repatriation. 

Fourth, how are these "savings" reflected in the banking system? 

Even when elevated GDS suggests high aggregate capacity, the reality is that available savings for productive intermediation—such as long-term deposits and investible capital—are scarce. CMEPA threatens to worsen this distortion by tilting incentives toward consumption and speculation. 

Put differently: while 2024 GDS appears deceptively high at over 29% of GDP, net national savings—after accounting for income and transfer leakages—is a mere 9.3%, per World Bank estimates. 

This reveals a deep structural fragility in the country's true capacity to accumulate capital. By penalizing savings and redirecting flows into speculative capital markets, CMEPA threatens to widen this gap and exacerbate the very vulnerabilities it claims to address.

Figure 3

Yet—and this is key—BusinessWorld recently produced a chart based on Philippine Statistics Authority (PSA) data showing the second widest gap between saving rates (apparently from the World Bank) and investment rates —which we discussed last March. (Figure 3, topmost visual) 

If savings were truly robust, why does this gap persist? What finances this chasm? 

V. Financing the ‘Twin Deficits’ with Record Systemic Leverage 

Cherry-picking numbers to defend the law ignores that the savings-investment gap has been manifested through ‘twin deficits’—fiscal and external trade. Despite supposed normalization post-pandemic, the Philippine economy remains at pandemic-level dependency on credit. (Figure 3, middle graph) 

Here’s the key: public spending is part of those investment rates. 

Bureau of the Treasury data revealed that the 2025 first-half fiscal deficit hit a record Php 765.49 billion—even without a recession! This confirms earlier warnings, which we’ll expand on in another post. (Figure 3, lowest diagram) 

So, who finances this? Domestic banks and foreign lenders are now absorbing this growing imbalance. 

As previously noted: 

"A shrinking domestic savings pool limits capital accumulation, increases dependence on external financing, and exposes the economy to risks such as debt distress and currency fluctuations."— Prudent Investor, March 2025

Figure 4

As of May, public debt hit a record Php 16.918 trillion, with June data expected to breach Php 17 trillion —the all-time high deficit will accelerate its increase. Didn’t the administration hint at pushing up the debt-to-GDP corridor from 60% to 70%? (Figure 4, upper graph) 

Meanwhile, combined with total bank credit expansion, systemic leverage reached a new record of Php 31.225 trillion, or 118% of 2024 nominal GDP. (Figure 4, lower chart) 

And that figure excludes: 

• Capital market debt issuance (corporate bonds, CMBS)
• FDI-linked intercompany loans
• Informal debt (pawnshops, personal lending, unregulated finance)

Think of the costs: this credit buildup means rising debt servicing burdens, declining real incomes, and growing risks of delinquencies and defaults. 

More importantly, in the absence of productivity-led savings growth, the Philippine economy is running on borrowed money—and borrowed time.

VI. State-Driven Financial Repression: Time Deposits vs. RTBs & Pag-IBIG MP2 

Defenders of CMEPA point to alternatives like RTBs or Pag-IBIG’s MP2 as substitutes for taxed time deposits. 

But these are neither comprehensive nor scalable: 

MP2 has annual ceilings and requires Pag-IBIG membership. 

RTBs are state-managed, episodic, and offer limited liquidity.

Figure 5 

Latest BSP data: (Figure/Table 5) 

• Total time deposits in the PH banking system: Over Php 5 trillion
• Long-term deposits (>5 years): ~Php 500–Php 700 billion
• RTB retail uptake: ~Php 175 billion
• MP2 inflows: ~Php 30–Php 50 billion/year 

Combined, RTBs + MP2 absorb just 5–10% of the capital displaced by CMEPA’s flattening of tax incentives. The rest sits idle, chases risk, or exits the formal system. 

More critically, these instruments are not substitutes for a diverse, open savings ecosystem. They represent state-controlled pipelines—a form of financial repression where household capital is diverted into funding public consumption, and paid for by the diminishing purchasing power of the peso. And this is supposed to ‘encourage’ savings growth? Really?

This contradicts the narrative that these flows remain as ‘savings outside’ time deposits. On the contrary, it is a narrowing of financial autonomy. 

VII. Inflating Stock Market Bubbles: CMEPA’s Savers Lion’s Den 

As previously discussed, the policy-induced gambling mentality has migrated to the equity markets. Instead of encouraging true savings, CMEPA will foster boom-bust cycles that further erode wealth and fuel capital consumption. 

This week’s coordinated pre-closing and afternoon pumps illustrate how institution-dominated markets manage the main index for optics—what we might call "benchmark-ism." (Figure 5, lower graph)

Though it escapes the Overton Window, this behavior—like CMEPA—distorts the price signal function of capital markets, leading to the misallocation of capital goods in the economy. 

By stoking gambling instincts, markets become casinos where savings and credit—someone else’s savings or bank-issued liquidity—is converted into house profits. 

When capital markets are manipulated for non-market goals, the effect is the same: momentum cloaking a wealth transfer. 

CMEPA leads savers straight into the lion’s den. 

VIII. Conclusion: Sovereignty over Speculation, Economic Blowback 

In an age where reform rewards liquidity and penalizes patience, true saving becomes a philosophical—and revolutionary—act. It’s no longer just economic prudence. It’s resistance to engineered ephemerality. 

The ideology driving CMEPA whispers: Be fast. Be fluid. Be speculative. Be extravagant. Be taxable. Be subservient to the state. 

The public must reply: Be steady. Be real. Be cautious. And above all—be sovereign. 

This is not academic critique—it’s a warning. When incentives distort prudence, the fallout is material, not theoretical. 

CMEPA does not act alone. It fuses with a wider architecture of distortion:

• BSP’s redistributionist easing cycle
• Record deficit spending
• An implicit USDPHP soft peg
• Accelerating bureaucratization and economic centralization 

Together, they form the scaffolding of financial and social maladjustment. 

And when crises surface—households hemorrhaging stability, banks scrambling for duration, systems unraveling under engineered fragility—the reckoning will be felt everywhere. 

In that moment, accountability will matter. 

We must remember: Who authored this distortion? Who rationalized it as progress? 

And we must prepare—for its backlash. 

___

References

Prudent Investor Newsletter, 2024’s Savings-Investment Gap Reaches Second-Widest Level as Fiscal Deficit Shrinks on Non-Tax Windfalls March 9, 2025, Substack