Low Prioritization in the Banking System: The Magna Carta for MSMEs as a ‟Symbolic Law‟

 

An ever-weaker private sector, weak real wages, declining productivity growth, and the currency’s diminishing purchasing power all indicate the unsustainability of debt levels. It becomes increasingly difficult for families and small businesses to make ends meet and pay for essential goods and services, while those who already have access to debt and the public sector smile in contentment. Why? Because the accumulation of public debt is printing money artificially—Daniel Lacalle 

Nota Bene: Unless some interesting developments turn up, this blog may be the last for 2024. 

In this issue 

Low Prioritization in the Banking System: The Magna Carta for MSMEs as a ‟Symbolic Law‟

I. MSMEs: The Key to Inclusive Growth

II. The Politicization of MSME Lending

III. Bank's MSME Loans: Low Compliance Rate as a Symptom of the BSP’s Prioritization of Banking Interests

IV. Suppressed MSME Lending and Thriving Shadow Banks: It’s Not About Risk Aversion, but Politics

V. Deepening Thrust Towards Banking Monopolization: Rising Risks to Financial System Stability  

VI. How PSEi 30's Debt Dynamics Affect MSME Struggles

VII. The Impact of Bank Borrowings and Government Debt Financing on MSMEs’ Challenges 

VIII. How Trickle-Down Economics and the Crowding Out Effect Stifle MSME Growth 

IX. Conclusion: The Magna Carta for MSMEs Represents a "Symbolic Law," Possible Solutions to Promote Inclusive MSME Growth 

Low Prioritization in the Banking System: The Magna Carta for MSMEs as a ‟Symbolic Law‟ 

Despite government mandates, bank lending to MSMEs reached its third-lowest rate in Q3 2024, reflecting the priorities of both the government and the BSP. This highlights why the Magna Carta is a symbolic law.

I. MSMEs: The Key to Inclusive Growth 

Inquirer.net December 10, 2024 (bold added): Local banks ramped up their lending to micro, small and medium enterprises (MSMEs) in the third quarter, but it remained below the prescribed credit allocation for the industry deemed as the backbone of the Philippine economy. Latest data from the Bangko Sentral ng Pilipinas (BSP) showed total loans of the Philippine banking sector to MSMEs amounted to P500.81 billion in the three months through September, up by 3 percent on a quarter-on-quarter basis. But that amount of loans only accounted for 4.6 percent of the industry’s P11-trillion lending portfolio as of end-September, well below the prescribed credit quota of 10 percent for MSMEs. Under the law, banks must set aside 10 percent of their total loan book as credit that can be extended to MSMEs. Of this mandated ratio, banks must allocate 8 percent of their lending portfolio for micro and small businesses, while 2 percent must be extended to medium-sized enterprises. But many banks have not been compliant and just opted to pay the penalties instead of assuming the risks that typically come with lending to MSMEs. 

Bank lending to the MSME sector, in my view, is one of the most critical indicators of economic development. After all, as quoted by the media, it is "deemed as the backbone of the Philippine economy." 

Why is it considered the backbone?

Figure 1

According to the Department of Trade and Industry (DTI), citing data from the Philippine Statistics Authority, in 2023, there were "1,246,373 business enterprises operating in the country. Of these, 1,241,733 (99.63%) are MSMEs and 4,640 (0.37%) are large enterprises. Micro enterprises constitute 90.43% (1,127,058) of total establishments, followed by small enterprises at 8.82% (109,912) and medium enterprises at 0.38% (4,763)." (Figure 1 upper chart) 

In terms of employment, the DTI noted that "MSMEs generated a total of 6,351,466 jobs or 66.97% of the country’s total employment. Micro enterprises produced the biggest share (33.95%), closely followed by small enterprises (26.26%), while medium enterprises lagged behind at 6.77%. Meanwhile, large enterprises generated a total of 3,132,499 jobs or 33.03% of the country’s overall employment." (Figure 1, lower graph) 

Long story short, MSMEs represent the "inclusive" dimension of economic progress or the grassroots economy—accounting for 99% of the nation’s entrepreneurs, and providing the vast majority of jobs. 

The prospective flourishing of MSMEs signifies that the genuine pathway toward an "upper middle-income" status is not solely through statistical benchmarks, such as the KPI-driven categorization of Gross National Income (GNI), but through grassroots-level economic empowerment. 

Except for a few occasions where certain MSMEs are featured for their products or services, or when bureaucrats use them to build political capital to enhance the administration’s image, mainstream media provides little coverage of their importance.

Why?

Media coverage, instead, tends to focus disproportionately on the elite.

Perhaps this is due to survivorship bias, where importance is equated with scale, or mostly due to principal-agent dynamics. That is, media organizations may prioritize advancing the interests of elite firms to secure advertising revenues, and or, maintain reporting privileges granted by the government or politically connected private institutions. 

II. The Politicization of MSME Lending 

Yet, bank lending to the sector remains subject to political directives—politicized through regulation. 

Even so, banks have essentially defied a public mandate, opting to pay a paltry penalty: "The Bangko Sentral ng Pilipinas shall impose administrative sanctions and other penalties on lending institutions for non-compliance with provisions of this Act, including a fine of not less than five hundred thousand pesos (P500,000.00)." (RA 9501, 2010)

Figure 2 

With total bank lending amounting to Php 10.99 trillion (net of exclusions) at the end of Q3, the compliance rate—or the share of bank lending to MSMEs—fell to 4.557%, effectively the third lowest on record after Q1’s 4.4%. (Figure 2, upper window) 

That’s primarily due to growth differentials in pesos and percentages. For instance, in Q3, the Total Loan Portfolio (net of exclusions) expanded by 9.4% YoY, compared to the MSME loan growth of 6.5%—a deeply entrenched trend.(Figure 2, lower image) 

Interestingly, "The Magna Carta for Micro, Small and Medium Enterprises (MSMEs)" was enacted in 1991 (RA 6977), amended in 1997 (RA 8289), and again in 2008 (RA 9501). The crux is that, as the statute ages, industry compliance has diminished 

Most notably, banks operate under cartel-like conditions. They are supervised by comprehensive regulations, with the BSP influencing interest rates through various channels—including policy rates, reserve requirement ratios (RRR), open market operations, inflation targeting, discount window lending, interest rate caps, and signaling channels or forward guidance. 

In a nutshell, despite stringent regulations, the cartelized industry is able to elude the goal of promoting MSMEs. 

III. Bank's MSME Loans: Low Compliance Rate as a Symptom of the BSP’s Prioritization of Banking Interests 

Yet, the record-low compliance rate with the Magna Carta for MSMEs points to several underlying factors: 

First, banks appear to exploit regulatory technicalities or loopholes to circumvent compliance—such as opting to pay negligible penalties—which highlights potential conflicts of interest. 

Though not a fan of arbitrary regulations, such lapses arguably demonstrate the essence of regulatory capture, as defined by Investopedia.com, "process by which regulatory agencies may come to be dominated by the industries or interests they are charged with regulating" 

A compelling indication of this is the revolving-door relationship between banks and the BSP, with recent appointments of top banking executives to the BSP’s monetary board. 

Revolving door politics, according to Investopedia.com, involves the "movement of high-level employees from public-sector jobs to private-sector jobs and vice versa" 

The gist: The persistently low compliance rate suggests that the BSP has prioritized safeguarding the banking sector's interests over promoting the political-economic objectives of the Magna Carta legislation for MSMEs.

IV. Suppressed MSME Lending and Thriving Shadow Banks: It’s Not About Risk Aversion, but Politics

Two, with its reduced lending to MSMEs, banks purportedly refrain from taking risk. 

But that’s hardly the truth.

Even with little direct access to formal or bank credit, MSME’s are still borrowers, but they source it from the informal sector. 

Due to the difficulty of accessing bank loans, MSMEs in the Philippines are borrowing from informal sources such as the so-called 5-6 money lending scheme. According to an estimate, 5-6 money lending is now a Php 30 billion industry in the Philippines. These lenders charge at least 20% monthly interest rate, well above the 2.5% rate of the government’s MSME credit program. The same study by Flaminiano and Francisco (2019) showed that 47% of small and medium sized enterprises in their sample obtained loans from informal sources. 

...

An estimate by the International finance Corporation (2017) showed that MSMEs in the Philippines are facing a financing gap of USD 221.8 billion. This figure is equivalent to 76% of the country’s GDP, the largest gap among the 128 countries surveyed in the IFC report. (Nomura, 2020)

The informal lenders don’t print money, that’s the role of the banks, and the BSP.

Simply, the Nomura study didn’t say where creditors of the informal market obtained their resources: Our supposition: aside from personal savings, 5-6 operators and their ilk may be engaged in credit arbitrage or borrow (low interest) from the banking system, and lend (high interest) to the MSMEs—virtually a bank business model—except that they don’t take in deposits.

The fact that despite the intensive policy challenges, a thriving MSME translates a resilient informal credit arbitrage market—yes, these are part of the shadow banking system.

As an aside, uncollateralized 5-6 lending is indeed a very risky business: collections from borrowers through staggered payments occur daily, accompanied by high default rates, which explains the elevated interest rates.

Figure 3

That is to say, the shadow banks or black markets in credit, fill the vacuum or the humungous financing gap posed by the inadequacy of the formal financial sector. (Figure 3, upper diagram)

The financing gap may be smaller today—partly due to digitalization of transactional platforms—but it still remains significant. 

This also indicates that published leverage understates the actual leverage in both the financial system and the economy. 

Intriguingly, unlike the pre-2019 era, there has been barely any media coverage of the shadow banking system—as if it no longer exists.

As a caveat, shadow banking "involves financial activities, mainly lending, undertaken by non-banks and entities not regulated by the BSP," which implies that even formal institutions may be engaged in "unregulated activities." 

Remember when the former President expressed his desire to crack down on 5-6 lending, vowing to "kill the loan sharks," in 2019? 

If such a crackdown had succeeded, it could have collapsed the economy. So, it’s no surprise that the attempt to crush the informal economy eventually faded into oblivion. 

The fact that informal credit survived and has grown despite the unfavorable political circumstances indicates that the suppressed lending to MSMEs has barely been about the trade-off between risk and reward. 

It wasn’t risk that has stymied bank lending to MSMEs, but politics (for example, the artificial suppression of interest rates to reflect risk profiles). 

More below. 

Has the media and its experts informed you about this?

Still, this highlights the chronic distributional flaws of GDP: it doesn’t reflect the average experience but is instead skewed toward those who benefit from the skewed political policies. 

In any case, mainstream media and its experts tend to focus on benchmarks like GDP rather than reporting on the deeper structural dynamics of the economy.

V. Deepening Thrust Towards Banking Monopolization: Rising Risks to Financial System Stability

Three, if banks have lent less to MSMEs, then who constituted the core of borrowers?

Naturally, these were the firms of elites (including bank borrowings), the consumers from the "banked" middle and upper classes, and the government.

Total Financial Resources (TFR) reached an all-time high of Php 32.8 trillion as of October, accounting for about 147% and 123% of the estimated real and headline GDP for 2024, respectively. (Figure 3, lower pane)

TFR represents gross assets based on the Financial Reporting Package (FRP) of banking and non-bank financial institutions, which includes their loan portfolios.

The banking system’s share of TFR stood at 83.2% last October, marking the second-highest level, slightly below September’s record of 83.3%. Meanwhile, Universal-Commercial banks accounted for 77.8% of the banking system’s share in October, marginally down from their record 78% in September.

These figures reveal that the banking system has been outpacing the asset growth of the non-banking sector, thereby increasing its share and deepening its concentration.

Simultaneously, Universal-Commercial banks have been driving the banking system’s growing dominance in TFR. 

The significance of this lies in the current supply-side dynamic, which points towards a trajectory of virtual monopolization within the financial system. As a result, this trend also magnifies concentration risk. 

VI. How PSEi 30's Debt Dynamics Affect MSME Struggles

From the demand side, the 9-month debt of the non-financial components of the PSEi 30 reached Php 5.52 trillion, the second-highest level, trailing only the all-time high in 2022. However, its share of TFR and nominal GDP has declined from 17.7% and 30.8% in 2023 to 16.7% and 29.3% in 2024.

Figure 4

Over the past two years, the PSEi 30's share of debt relative to TFR and nominal GDP has steadily decreased. (Figure 4, upper chart) 

It is worth noting that the 9-month PSEi 30 revenues-to-nominal GDP ratio remained nearly unchanged from 2023 at 27.9%, representing the second-highest level since at least 2020. (Figure 4, lower image) 

Thus, the activities of PSEi 30 composite members alone account for a substantial share of economic and financial activity, a figure that would be further amplified by the broader universe of listed stocks on the PSE. 

Nevertheless, their declining share, alongside rising TFR, indicates an increase in credit absorption by ex-PSEi and unlisted firms. 

VII. The Impact of Bank Borrowings and Government Debt Financing on MSMEs’ Challenges

Figure 5

On the other hand, bank borrowings declined from a record high of Php 1.7 trillion (49.7% YoY) in September to Php 1.6 trillion (41.34% YoY) in October. Due to liquidity concerns, most of these borrowings have been concentrated in T-bills. (Figure 5, topmost visual) 

As it happens, Philippine lenders, as borrowers, also compete with their clients for the public’s savings. 

Meanwhile, the banking system’s net claims on the central government (NCoCG) expanded by 8.3% to Php 5.13 trillion as of October. 

The BSP defines Net Claims on Central Government as including "domestic securities issued by and loans and advances extended to the CG, net of liabilities to the CG such as deposits." 

In October, the banks' NCoCG accounted for approximately 23% of nominal GDP (NGDP), 18% of headline GDP, and 15.6% of the period’s TFR. 

Furthermore, bank consumer lending, including real estate loans, reached a record high of Php 2.92 trillion in Q3, supported by an unprecedented 22% share of the sector’s record loan portfolio, which totaled Php 13.24 trillion. (Figure 4, middle graph) 

Concomitantly, the banking system’s Held-to-Maturity (HTM) assets stood at nearly Php 3.99 trillion in October, just shy of the all-time high of Php 4.02 trillion recorded in December 2023. Notably, NCoCG accounted for 128.6% of HTM assets. HTM assets also represented 15.1% of the banking system’s total asset base of Php 26.41 trillion. (Figure 4, bottom chart) 

This means the bank’s portfolio has been brimming with loans to the government, which have been concealed through their HTM holdings.

Figure 6

Alongside non-performing loans (NPLs), these factors have contributed to the draining of the industry’s liquidity.  Despite the June 2023 RRR cuts and the 2024 easing cycle (interest rate cuts), the BSP's measures of liquidity—cash-to-deposits and liquid assets-to-deposits—remain on a downward trend. (Figure 6, upper window)

VIII. How Trickle-Down Economics and the Crowding Out Effect Stifle MSME Growth 

It is not just the banking system; the government has also been absorbing financial resources from non-banking institutions (Other Financial Corporations), which amounted to Php 2.34 trillion in Q2 (+11.1% YoY)—the second highest on record. (Figure 6, lower graph)

These figures reveal a fundamental political dimension behind the lagging bank lending performance to MSMEs: the "trickle-down" theory of economic development and the "crowding-out" syndrome affecting credit distribution. 

The banking industry not only lends heavily to the government—reducing credit availability for MSMEs—but also allocates massive amounts of financial resources to institutions closely tied to the government. 

This is evident by capital market borrowings by the banking system, as well as bank lending and capital market financing and bank borrowings by PSE firms. 

A clear example is San Miguel Corporation's staggering Q3 2024 debt of Php 1.477 trillion, where it is reasonable to assume that local banks hold a significant portion of the credit exposure. 

The repercussions, as noted, are significant: 

Its opportunity costs translate into either productive lending to the broader economy or financing competitiveness among SMEs (Prudent Investor, December 2024)

Finally, in addition to the above, MSMEs face further challenges from the "inflation tax," an increasing number of administrative regulations (such as minimum wage policies that disproportionately disadvantage MSMEs while favoring elites), and burdensome (direct) taxes.

IX. Conclusion: The Magna Carta for MSMEs Represents a "Symbolic Law," Possible Solutions to Promote Inclusive MSME Growth 

Ultimately, the ideology-driven "trickle-down" theory has underpinned the political-economic framework, where government spending, in tandem with elite interests, anchors economic development. 

Within this context, the Magna Carta for MSMEs stands as a "Symbolic Law" or "Unenforced Law"—where legislation "exists primarily for symbolic purposes, with little to no intention of actual enforcement." 

Politically, a likely short-term populist response would be to demand substantial increases in penalty rates for non-compliance (to punitive levels, perhaps tied to a fraction of total bank assets). However, this approach would likely trigger numerous unintended consequences, including heightened corruption, reduced transparency, higher lending rates, and more. 

Moreover, with the top hierarchy of the BSP populated by banking officials, this scenario is unlikely to materialize. There will be no demand for such measures because only a few are aware of the underlying issues. 

While the solution to this problem is undoubtedly complex, we suggest the following:

1 Reduce government spending: Roll back government expenditures to pre-pandemic levels and ensure minimal growth in spending.

2 Let markets set interest rates: Allow interest rates to reflect actual risks rather than artificially suppressing them.

3 Address the debt overhang through market mechanisms: Let markets resolve the current debt burden instead of propping it up with unsustainable liquidity injections and credit expansions by both the banking system and the BSP.

4 Liberalize the economy: Enable greater economic and market liberalization to reflect true economic conditions.

5 Adopt a combination of the above approaches.

The mainstream approach to resolving the current economic dilemma, however, remains rooted in a consequentialist political scheme—where "the end justifies the means."

This mindset often prioritizes benchmarks and virtue signaling in the supposed pursuit of MSME welfare. For example, the establishment of a credit risk database for MSMEs is presently touted as a solution.

While such measures may yield marginal gains, they are unlikely to address the root issues for the reasons outlined above.

_____

References 

Republic Act 5901: Guide to the Magna Carta for Micro, Small and Medium Enterprises (RA 6977, as amended by RA 8289, and further amended by RA 9501), p.17 SME Finance Forum 

Margarito Teves and Griselda Santos, MSME Financing in the Philippines: Status, Challenges and Opportunities, 2020 p.16 Nomura Foundation 

Prudent Investor, Is San Miguel’s Ever-Growing Debt the "Sword of Damocles" Hanging over the Philippine Economy and the PSE? December 02, 2024

 

 

PSE Craters as Financials’ Share of the PSEi 30 Hits All-Time Highs; A Growing Mismatch Between Financial Index Performance and Bank Fundamentals

 

History will not be kind to central bankers fixated on financial economy and who created serial speculative booms to sustain the illusion of prosperity. It will also be critical of governments unwilling to address weaknesses, who deflected shifting hard policymaking to independent, unelected and largely unaccountable central banks—Satyajit Das 

In this issue 

PSE Craters as Financials’ Share of the PSEi 30 Hits All-Time Highs; A Growing Mismatch Between Financial Index Performance and Bank Fundamentals

I. PSEi 30 Craters on Signs of Re-Tightening Amid Rising Dollar and Higher UST Yields

II. Despite the Market Carnage: Financials Share of the PSEi 30 Zoom to All-time High!

III. Financialization: The Expanding Role of Banks in Achieving Political Goals

IV. "National Team?" In Q2, Other Financials Corporations Sold, the PSEi 30 Plunged

V. In Q3, Mismatch Between Financial Index-Bank Fundamentals Reached a Blow-off Phase!

VI. Worsening Bank Liquidity Conditions as Cash-to-Deposits Hit Milestone Low

VII. Liquidity and Collateral Crunch? Bank Borrowings, Focused on Bills, Zoomed to Record Highs in September, as Repos also Hit All-time Highs!

VIII. Despite Lower Rates Held to Maturity Assets Near All-time Highs, Record Bank QE

IX. A Snapshot of Q3 and 9-Month Performance of PSE Listed Banks

X. Highlights, Summary and Conclusion

PSE Craters as Financials’ Share of the PSEi 30 Hits All-Time Highs; A Growing Mismatch Between Financial Index Performance and Bank Fundamentals

Even as the PSEi plummeted due to signs of global and local re-tightening, the Financials outperformed, widening the mismatch between share prices and fundamentals. Will a reckoning come soon?

I. PSEi 30 Craters on Signs of Re-Tightening Amid Rising Dollar and Higher UST Yields"

Figure 1

The Sage of Omaha, Warren Buffett, once said, "Only when the tide goes out do you discover who's been swimming naked."

Have the signs of tightening upended the dream of easy money’s "goldilocks" economy, or have they exposed those who have been "swimming naked?"

The surging US dollar index, coupled with rising 10-year Treasury yields—both largely attributed to Trump's policies— has sent global risk assets tumbling. Yet, these developments took shape two months before the US elections. (Figure 1, topmost graph)

This includes the Philippine PSEi 30, which plunged by 4.31%, marking its largest weekly decline in 2024 and the steepest drop since the week of September 30, 2022, when it fell by 8.3%.

As of Thursday, November 14, the headline index broke below the 6,600 level, closing at 6,557.09.

A notable oversold rebound in industrials, led by Meralco (up by 7.78%) and Monde (up by 7.52%), along with financials from BPI (up by 3.7%) and CBC (up by 4.58%), contributed to a low-volume rally of 1.82% on Friday.

Year-to-date, the PSEi 30 is struggling to maintain its narrowing return of 3.5%.

II. Despite the Market Carnage: Financials Share of the PSEi 30 Zoom to All-time High!

The Financial Index, down by only 1.86%, was the least affected in this week’s market carnage. BPI was the only member of the PSEi 30 component to withstand the foreign-driven selloff, while Jollibee ended the week unchanged. (Figure 1, middle pane)

Interestingly, this outperformance has propelled the aggregate free-float market capitalization weighting of the three major banks of the headline index to an all-time high. (Figure 1, lowest chart)

Figure 2

Furthermore, financials accounted for 41.7% of the mainboard's volume on Friday—the third-highest share since October. (Figure 2, topmost diagram)

Meanwhile, October’s cumulative 29.92% accounts for the sector’s highest share since July 2023, which also translates to a 2017 high.

In a related note, the Bangko Sentral ng Pilipinas (BSP) has suspended its free publication of non-BSP-generated data, including PSE data on monthly price-earnings ratios (PER), market capitalization by sector, index data, and volume distribution by sector. This suspension hampers our ability to track critical developments in market internals. (Yes, I wrote them)

The point being, the increasing share of mainboard volume by the financial sector has pillared the rising share of the sector’s market cap share of the PSEi 30.

However, this dynamic also implies growing concentration risk in the stock market.

III. Financialization: The Expanding Role of Banks in Achieving Political Goals

Businessworld, November 13: THE PHILIPPINE banking system’s net profit jumped by 6.4% at end-September as both net interest and non-interest income grew, data from the Bangko Sentral ng Pilipinas (BSP) showed. The combined net income of the banking industry rose to P290 billion in the first nine months of 2024 from P272.6 billion in the same period a year ago.

The PHP 290 billion profit and a 6.4% growth rate represent the Q3 figures year-over-year (YoY).

Continuing from last week’s discussion, the diverging dynamics in the Philippine Stock Exchange (PSE) have also been reflected in the GDP figures. 

Although the financial sector has been on an upward trajectory since the new millennium, its share of the real GDP has rapidly deepened during the BSP’s historic rescue of the sector. 

This was notably influenced by the BSP historic intervention to rescue the sector, which included an unprecedented PHP 2.3 trillion quantitative easing package, historic cuts in official and reserve ratios, as well as unparalleled subsidies and relief measures. 

In line with the rising share of money supply-to-GDP, the financial sector's share of GDP reached its third highest level at 10.8% in Q3. (Figure 2, middle image) 

It even hit an all-time high of 10.9% when considering the 9-month real GDP data. 

While this evolution may be labeled as "financialization," the essential message is clear: BSP policies have led to an economy increasingly immersed (or heavily reliant) in credit and liquidity, primarily channeled through an elite-owned and controlled banking system. 

This deepening dependence comes at the expense of the development of other competing financial conduits, such as capital markets. 

The underlying reason for this is political: the bank-led financial sector serves as the primary non-BSP financier of the government’s deficit spending. 

As a result, the government's calls for improvements in the capital markets appear to be mere lip service. 

However, judging by their "demonstrated preference" in policy choices, it appears that inflating bank shares may serve to camouflage the adverse consequences of this deepening and complex political-economic arrangement. 

IV. "National Team?" In Q2, Other Financials Corporations Sold, the PSEi 30 Plunged

The developments in Other Financial Corporations (OFCs) provide valuable insights. 

In Q2, OFCs eased their holdings of equities.  According to the BSP, "The other financial corporations’ claims on the other sectors dropped as their holdings of equity shares issued by other nonfinancial corporations fell." 

The Non-bank financial institutions and OFCs "includes the private and public insurance companies, other financial institutions that are either affiliates or subsidiaries of the banks that are supervised by the BSP (i.e., investment houses, financing companies, credit card companies, securities dealer/broker and trust institutions), pawnshops, government financial institutions and the rest of private other financial institutions (not regulated by the BSP) that are supervised by the Securities and Exchange Commission (SEC)" (Armas, 2014) 

In the same quarter, OFC claims on the private sector decreased by 0.5% quarter-over-quarter (QoQ), while the PSEi 30 index plunged by 7.1%. (Figure 2, lowest visual) 

My guess is that some of these OFCs are part of what could be considered the Philippine version of the "national team." 

V. In Q3, Mismatch Between Financial Index-Bank Fundamentals Reached a Blow-off Phase!

Nevertheless, the deviation between the fundamentals of banks and their share prices has reached "blow-off" proportions!

Figure 3 

In Q3, the banking system reported a modest growth of 6.4%, slightly higher than Q2’s 4.1%. However, the financial index skyrocketed by 19.4% quarter-over-quarter (QoQ). 

From another angle, 9-month profit growth was up by 5.07%, even as the financial index surged by a stunning 23.4% year-on-year in Q3.

Worst of all, profit trends and the financial index have moved in opposite directions. 

Since profit growth peaked in Q3 2022 and subsequently eased, shares of the seven-member bank stocks (excluding the eighth member: PSE) within the financial index have continued to accelerate. (Figure 3, topmost window) 

Meanwhile, given that universal and commercial banks account for 93.9% of total bank assets, their profit growth largely mirrors the entire banking system. In Q3, profit growth was 7.03%, and on a 9-month basis, it stood at 6%. 

These figures underscore the increasing monopolization of the financial industry by banks validated by the BSP’s Total Financial Resources (TFR) data. 

Total financial resources grew by 10.07% to a record PHP 33.08 trillion. 

The banking sector’s share surged to an all-time high of 83.3%, driven mainly by universal and commercial banks, whose contribution reached a record 78.1%. (Figure 3, middle image) 

So let us get this straight: banks have increased their share of trading activities in the PSE, as well as their slice of both the PSEi 30 and the GDP pie. They now command 83.3% of total financial resources and are continuing to rise. 

This dominance doesn’t even account for their substantial role in the local bond markets, where they act as issuers, intermediaries, and holders. 

Even without the BSP acknowledging this, what we are witnessing is the intensifying risks within the Philippine financial-economic system. 

VI. Worsening Bank Liquidity Conditions as Cash-to-Deposits Hit Milestone Low

Have you ever seen any experts or establishment analysts address the developing contradiction between the banks' reported profits and their liquidity conditions? 

Cash and due from banks, or bank cash reserves, plummeted by 13.6% in September 2024, following a brief 4% rebound in August. This decline brought cash reserves to their lowest level since 2019. (Figure 3, lowest graph) 

To address the emerging liquidity shortfall, the BSP previously reduced the bank reserve requirement ratio (RRR) from 19% to 14%, implemented in seven installments from March 2018 to December 2019. 

Cash reserves saw a temporary spike in 2020 when the BSP injected Php 2.3 trillion into the system, accompanied by an RRR cut from 14% to 12% in April 2020. 

However, facing diminishing returns, cash reserves resumed their downward trend. 

Once again, doing the same thing and expecting different results, the BSP reduced the RRR by a larger margin than in 2020, lowering it from 12% to 9.5% in June 2023. 

Despite these efforts, the challenges within the banking system's cash reserve position have persisted.

Figure 4

Moreover, while the growth in peso deposit rates increased from 6.9% in August to 7.07% in September—the slowest growth rate since July 2023—the BSP’s cash-to-deposit ratio plummeted to 12.44%, its lowest ratio since at least 2013! (Figure 4, topmost and second to the highest graphs) 

Yet, with the record bank credit expansion, why the sluggish growth in deposits? Where did the money flow into? 

Even with the recent decline in inflation rates, have a minority of "banked" households continue to draw from their savings? 

Furthermore, the banks' liquid asset-to-deposit ratio, which includes both cash reserves and financial assets, fell to 50.34%, reverting to levels seen during the BSP's rescue efforts in July 2020. 

Incredible. 

And this is just one facet of the mounting liquidity challenges that banks seem to be facing. 

VII. Liquidity and Collateral Crunch? Bank Borrowings, Focused on Bills, Zoomed to Record Highs in September, as Repos also Hit All-time Highs! 

More eye-catching data emerged last September. 

Bank borrowings—primarily in short-term bills—skyrocketed to an all-time high! Borrowings surged by 49.7%, reaching a record PHP 1.7 trillion, with their share of total liabilities climbing to 7.3%, the highest since 2021. (Figure 4, second to the lowest and lowest charts) 

The liquidity shortfall is most pronounced over the short-term, this is why bank’s bills payable zoomed to unscaled heights.

Figure 5

Not only that, bank short-term repo (repurchase agreements) or RRP (reverse repurchase) operations with the BSP and other banks have also launched into the stratosphere!

With record repo operations, the RRP’s 3.72% share of the bank’s total assets surged to the highest level since at least 2015! (Figure 5, upper image) 

Could this rampant use of repurchase agreements (repos) be underlying growing collateral issues in the financial system? As banks increasingly depend on repos for short-term liquidity, are we witnessing a decline in the quality of collateral or a shortage of high-quality assets available for these transactions? 

These developments likely explain the BSP's abrupt announcement of the latest series of RRR cuts, which took effect last October. 

However, such actions resemble a Hail Mary pass, with RRR ratios now headed toward zero. 

VIII. Despite Lower Rates Held to Maturity Assets Near All-time Highs, Record Bank QE

Another paradox: banks reported that credit delinquencies—across the board—marginally declined in September. (Figure 5, lower diagram) 

If this is true, then higher profits combined with lower non-performing loans (NPLs) should result in more, not less liquidity 

Figure 6

Additionally, the easing of interest rates, as indicated by declining treasury yields, should have reduced banks' held-to-maturity (HTM) assets. As noted repeatedly, HTM assets drain liquidity because they lock up funds. (Figure 6, topmost graph)

Yet, there hasn’t been significant improvement in this area. 

Moreover, since authorities aim to meet year-end spending targets, boost GDP, and finance the upcoming elections, it is expected that the government will ramp up its deficit spending in Q4. 

This increase in public spending will likely lead to a rise in banks' and the financial sector’s net claims on central government (NCoCG), which may translate to higher HTM assets. (Figure 6, middle chart) 

Furthermore, if the current trend of declining inflation reverses, or we experience a third wave of rising inflation, banks might resort to accounting maneuvers to shield themselves from potential mark-to-market losses by shifting these assets into HTMs. 

That is to say, increases in debt-financed government spending and rising inflation rates could therefore result in higher levels of HTM assets.

Above all, banks are not standalone institutions; they have deep exposure to counterparties. As noted last week, 

Led by banks, the financial sector is the most interconnected with the local economy.  Its health is contingent or dependent upon the activities of its non-

financial counterparties. 

Alternatively, the sector’s outgrowth relies on political subsidies and is subject to diminishing returns. 

Yet ultimately, this should reflect on its core operational fundamentals of lending and investing. (Prudent Investor, October 2024) 

The transformational shift in the banking system’s business model—from production and consumption—could be ominous. Part of this shift has been motivated by pandemic-era subsidies and relief measures, as well as a move away from unproductive industry loans. 

As a result, the consumer share of total bank loans (excluding real estate) reached an all-time high of 14.9% in September 2024, while the share of production loans declined to 82.7%. The remaining 2.4% comes from non-resident loans. (Figure 6, lowest image) 

Banks have embraced the government’s belief that spending drives the economy, neglecting the balance sheet health of individuals, as well as the potential misallocations as a result of artificially low rates. 

But what happens to the consumer economy once their balance sheets have been tapped out? 

This should not surprise to our readers, given that the "inverted belly" of the Treasury yield curve has already been signaling these concerns.

IX. A Snapshot of Q3 and 9-Month Performance of PSE Listed Banks

Finally, here is a snapshot of the micro aspects of the financials.

Table 7

The performance of PSE-listed banks indicates that while all-bank profits grew by 14% to Php 226 billion in the first nine months of 2024, bills payable jumped by 79%, or Php 579 billion, reaching Php 1.31 trillion. This increase in bills payable signifies more than double the net profits generated over the same period. The data excludes the small-scale Citystate Savings Bank [PSE: CSB]. [Table 7]

PSEi banks accounted for 84% of the nine-month increase in bills, relative to their 73% share of net income growth. Metrobank [PSE: MBT] represented the most aggressive borrower, with a 61% share. 

We have yet to reconcile the stark divergence between the reported BSP bank performance and the aggregate activities of listed firms. 

Nonetheless, through aggressive lending, banks boosted their top and bottom lines in Q3, positively impacting the nine-month performance. 

Fueled by a 29.7% growth in non-PSEi banks, the net income growth of all banks soared by 22%. 

X. Highlights, Summary and Conclusion 

In the end, we can summarize the banking sector as having the following attributes: (as of September or Q3) 

1. all-time highs in:

-Financial Index

-market cap share of the PSEi 30 (3 biggest banks)

-turnover of financial sector to mainboard volume (near)

-nominal or Philippine peso and % share of total financial resources

-nominal net claims on central government

-nominal Held-to-Maturity assets

-total bank lending in Philippine pesos

-percentage share of consumer bank lending

-nominal bank borrowing (mainly Bills)

-nominal repo operations

- nominal net financial assets

2. Historical lows in:

-cash-to-deposits

-production pie of total bank lending

-reserve requirement ratio

3. Declining trend in:

-cash reserves

-profit growth

-deposit growth

-liquid asset-to-deposit ratio

How is it that the supposedly "profitable" financial institutions, supported by the recent slowdown in non-performing loans, have been accompanied by sustained declines in deposit and savings rates, as well as a massive hemorrhage in liquidity that compelled them to rapidly access short-term financing via bills and repos?

Have profits been overstated? Have NPLs been understated?

To what extent have the BSP’s relief measures and subsidies caused distortions in banks’ reporting of their health conditions?

Why the flagrant disconnect between stock prices and the actual conditions of the banks?

Could the "national team" have been tasked with camouflaging recent developments through a panicked pumping of the sector’s shares?

Does the ongoing shortfall in liquidity portend higher rates ahead?

Given all these factors, what could possibly go wrong?

As we recently pointed out,

To be clear, we aren’t suggesting that CBC and other record-setting bank shares, such as BPI, are a simulacrum of Lehman; rather, we are pointing to the distortive behavior of speculative derbies that may hide impending problems in the sector. (Prudent Investor, October 2024)

____

References 

Satyajit Das, Central banks: The legacy of monetary mandarins, New Indian Express, November 15, 2024 

Jean Christine A. Armas, Other Financial Corporations Survey (OFCS): Framework, Policy Implications and Preliminary Groundwork, BSP-Economic Newsletter, July-August 2014, bsp.gov.ph 

Prudent Investor, Q3 2024 5.2% GDP: Consumers Struggle Amid Financial Loosening, PSEi 30 Deviates from the GDP’s Trajectory, November 10, 2024 

Prudent Investor, Important Insights from the Philippine PSEi 30’s Melt-Up! October 7, 2024

  

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion!

 

The short end of the UST curve is highly influenced by the Federal Reserve’s monetary policies while the long end clarifies those policies through the prism of risk/return. A steep yield curve…is one that suggests a low rate, accommodative monetary policy that is likely to work over time. This accounts for the curve’s steepness. A flat and inverted curve is the opposite. Whatever monetary policy is being conducted, the long end is interpreting that policy as well as other conditions as being highly suspect—Jeffrey P Snider 

In this issue:

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion!

I. 2024 Reserve Requirement Ratio Cuts to Designed to Plug the Banking System’s Worsening Illiquidity

II. Bank Liquidity Drain from Held to Maturity (HTM) and Growing Non-Performing Loans (NPL)

III. Philippine Yield Curve Shifts from an Inverted Belly to a Full Inversion!

IV. Was San Miguel’s September 20th Pre-Closing Dump Related to the Liquidity Strained Yield-Curve Inversion? 

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion! 

The Philippine yield curve inverts as the BSP significantly reduces the Bank RRR, while the US Fed embarks on a "Not in Crisis" 50-bps rate cut. 

The BSP has been telegraphing cuts to the banking system’s Reserve Requirement Ratio (RRR) since its last reduction in June 2023. 

For instance, Philstar.com, May 18, 2024: The Bangko Sentral ng Pilipinas (BSP) is looking at a significant reduction in the level of deposits banks are required to keep with the central bank after it starts cutting interest rates this year, its top official said. BSP Governor Eli Remolona Jr. said the Monetary Board is planning to cut the reserve requirement ratio (RRR) of universal and commercial banks by 450 basis points to five percent from the existing 9.5 percent, the highest in the region. 

Four months later. 

GMANews.com, September 18, 2024: The Bangko Sentral ng Pilipinas (BSP) is looking to cut the reserve requirement ratio, the amount of cash a bank must hold in its reserves against deposits, “substantially” this year and reduce it further in 2025. BSP Governor Eli Remolona Jr. said on Wednesday that the cut in the reserve requirement is being considered, with the timing being discussed. He earlier said this can be reduced to 5% from the present 9.5% for big banks. 

Two days after. 

ABSCBNNews.com, September 20, 2024: The Bangko Sentral ng Pilipinas is reducing the reserve requirement ratio (RRR) for universal and commercial banks by 250 basis points (bps).  This RRR reduction will also apply to non-bank financial institutions with quasi-banking functions, the BSP said… The reduction shall bring the RRRs of universal and commercial banks to 7 percent; digital banks to 4 percent; thrift banks to 1 percent; and rural and cooperative banks to zero percent, the central bank said. The new ratios take effect on October 25 and shall apply to the local currency deposits and deposit substitute liabilities of banks and NBQBs. (bold mine) 

I. 2024 Reserve Requirement Ratio Cuts to Designed to Plug the Banking System’s Worsening Illiquidity 

Bank lending growth has been accelerating, while broad economic liquidity measures have been rising, so why would the BSP opt to inject more liquidity through Reserve Requirement Ratio (RRR) cuts? 

The following data set may provide some answers.

Figure 1

Although lending by Universal and Commercial Banks is at a record high in nominal peso terms, the growth rate remains far below pre-pandemic levels. (Figure 1, topmost image) 

The RRR cuts from 2018 to 2020 appeared to have worked, as the loans-to-deposit ratio rose to an all-time high in February 2020 but the pandemic-induced recession eroded these gains. (Figure 1, middle graph) 

It took a combination of historic BSP policies—record rate cuts, an unprecedented Php 2.3 trillion liquidity injection, and extraordinary relief measures—to reignite the loans-to-deposits ratio. Nonetheless, it still falls short of the 2020 highs. 

A likely, though unpublished, explanation is that bank liquidity continues to decline. 

As of July, the cash and due-to-bank deposits ratio was at its lowest level since at least 2013. The BSP policies of 2020 and subsequent RRR cuts bumped up this ratio from 2020-21, but it resumed its downtrend, which has recently worsened. (Figure 1, lowest chart)

Figure 2

After a brief recovery from the RRR cuts of 2018-2020—further aided by the BSP’s historic rescue measures in 2020—the liquid assets-to-deposits ratio has started to deteriorate again. (Figure 2, topmost pane) 

Additionally, Q2 2024 total bank profit growth has receded to its second-lowest level since Q2 2021. (Figure 2, middle diagram) 

From this perspective, liquidity boost from increased bank lending, RRR cuts, and reported profit growth has been inadequate to stem the cascading trend of cash and liquid assets. 

Furthermore, despite subsidies, relief measures, and a slowing CPI, Non-Performing Loans (NPLs) and distressed assets appear to have bottomed out in the current cycle. (Figure 3, lowest visual) 

Increasing NPLs in the face of a slowing CPI is indicative of demand. Refinancing has taken a greater role in the latest bank credit expansion. 

To wit, rising NPLs contribute significantly to the ongoing drain on the banking system’s liquidity. 

II. Bank Liquidity Drain from Held to Maturity (HTM) and Growing Non-Performing Loans (NPL)

Figure 3

A primary source of the downtrend in the cash-to-deposits ratio has been the banking system's Held-to-Maturity (HTM) securities. (Figure 3 upper image)

Once again, the BSP has acknowledged this. 

Banks face marked-to-market (MtM) losses from rising interest rates. Higher market rates affect trading since existing holders of tradable securities are taking MtM losses as a result. While some banks have resorted to reclassifying their available-for-sale (AFS) securities into held-to-maturity (HTM), some PHP845.8 billion in AFS (as of end-March 2018) are still subject to MtM losses. Furthermore, the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity. [BSP, 2018] (bold mine) 

Even though rates have dropped, HTM (Held-to-Maturity) assets remain at record levels but appear to be plateauing. Falling rates in 2019-2020 barely made a dent in the elevated HTM levels at the time. 

Yet, a principal source of HTMs continues to be the bank's net claims on central government (NCoCG). (Figure 3, lower graph) 

That is, banks continue to finance a substantial portion of the government's deficit spending, which has represented an elementary and major contributor to the deterioration in bank liquidity. 

Why has the BSP been doing the same thing over and over again, expecting different results? Some call this "insanity." 

If the goal is to remove distortions—however ambiguously defined—why not eliminate the RRR entirely? 

It seems the BSP is merely buying time, hoping for a magical transformation of unproductive loans into productive lending. Besides, a complete phase-out of the RRR would leave the BSP with fewer "tools," or bluntly speaking, strip them of excuses. 

Thus, they’d rather have banks continue to accumulate unproductive loans in their portfolios and gradually subsidize them with relief from RRR cuts, rate cuts, various subsidies, and later direct injections—a palliative/band-aid treatment. 

III. Philippine Yield Curve Shifts from an Inverted Belly to a Full Inversion! 

Figure 4

Rather than steepening, the Fed's "not in a crisis" panic 50-basis-point cut also helped push the Philippine Treasury yield curve from an "inverted belly" to a "full inversion" on September 20! (Figure 4, tweet)

Figure 5

While yields across the entire curve plunged over the week, T-bill yields declined by a lesser degree relative to medium- and long-term Treasuries. (Figure 5, topmost window)

As a result, yields on Philippine notes and bonds have now fallen below T-bills!

Although one day doesn’t make a trend, this current inversion is the culmination of a process that began with a steep slope, then an inverted belly, and now a full inversion since June 2024. (Figure 5, middle chart)

The spreads between the 10-year bonds and their short-term counterparts are at the lowest level since March 2019! (Figure 5, lowest graph) 

And an inverted curve could serve as a warning signal/alarm bell for the economy.

From Investopedia: 

>An inverted yield curve forms when short-term debt instruments have higher yields than long-term instruments of the same credit risk profile.

>The inverted curve reflects bond investors’ expectations for a decline in longer-term interest rates, a view typically associated with recessions.

Further, it is a sign of tight liquidity: short-term borrowing costs rise or remain elevated, leading to higher yields on short-term debt instruments compared to long-term yields.

Moreover, expectations of slowing growth or economic recessions can also lead to decreased demand for riskier assets and increased demand for safer long-term bonds.

Again, the inverted curve must have resulted from the BSP’s announcement of a sharp reduction in the RRR in October, along with the Fed’s 50-basis point rate cuts.

Bottom line: cuts in the banks’ RRR were meant to address the banking system’s liquidity challenges as manifested in the Philippine treasury markets. The Fed’s 50-bps rate cut has exacerbated these distortions.

IV. Was San Miguel’s September 20th Pre-Closing Dump Related to the Liquidity Strained Yield-Curve Inversion?

Figure 6

Finally, it is interesting to observe that following the PSEi 30's intraday push above 7,300 last Friday, September 20, foreigners sold off or "dumped" SMC’s shares by 5% during the pre-closing five-minute float, contributing to the sharp decline in SMC’s share price and diminishing gains for the PSEi 30. (Figure 6, tweet) 

While we can’t directly attribute this to the inversion of the Philippine term structure of interest rates (yield curve), SMC’s intensifying liquidity challenges—evidenced by deteriorating cash reserves relative to soaring short-term debt in Q2 2024—should eventually influence its slope. (Figure 6, lower chart) 

In sum, as a "too big to fail" institution, SMC’s difficulties will inevitably reflect on the government’s fiscal and monetary health as well as the banks and the economy. 

____

references

FINANCIAL STABILITY COORDINATION COUNCIL, 2017 FINANCIAL STABILITY REPORT, p. 24 June 2018, bsp.gov.ph