If there is one common
theme to the vast range of the world’s financial crises, it is that excessive
debt accumulation, whether by the government, banks, corporations, or
consumers, often poses greater systemic risks than it seems during a boom. Infusions
of cash can make a government look like it is providing greater growth to its
economy than it really is. Private sector borrowing binges can inflate housing
and stock prices far beyond their long-run sustainable levels and make banks
seem more stable and profitable than they really are. Such large-scale debt
buildups pose risks because they make an economy vulnerable to crises of
confidence, particularly when debt is short term and needs to be constantly
refinanced—Carmen Reinhart and Kenneth Rogoff
In this issue
BSP’s Aggressive RRR
Cuts: A High-Stakes Gamble?
I. Decline
in 2024 Bank Non-Performing Loans Amidst Record-High Debt Levels and a Slowing
Economy
II. Deepening Financialization: Financial Assets Surge in 2024
as Banks Drive Industry Monopolization
III. Viewing Bank’s Asset Growth Through the Lens of the PSE
IV. March 2025 RRR Cuts and the Liquidity Conundrum: Unraveling
the Banking System’s Pressure Points
V. Liquidity Drain: Record Investment Risks and Elevated
Marked-to-Market Losses
VI. Despite Falling Rates, Bank’s Held-to-Maturity Assets Remain
Near Record High
VII. Moral Hazard and the "COVID Bailout Playbook"
VIII. The Bigger Picture: Are We Headed for a Full-Blown Crisis?
IX. Conclusion: RRR Cuts
a High-Risk Strategy?
BSP’s Aggressive RRR
Cuts: A High-Stakes Gamble?
The BSP announced another round of RRR cuts
in March amid mounting liquidity constraints. Yet, the reduction from 20% in
2018 to 7% in 2024 has barely improved conditions. Will this time be different?
I. Decline in 2024 Bank
Non-Performing Loans Amidst Record-High Debt Levels and a Slowing Economy
Inquirer.net,
February 14, 2025: Soured loans held by Philippine banks as a ratio of total
credit eased to their lowest level in a year by the end of 2024 as declining
interest rates and softer inflation helped borrowers settle their debts on
time. However, a shallower easing cycle might keep financial conditions still
somewhat tight, which could prevent a big decline in bad debts this year. Preliminary
data from the Bangko Sentral ng Pilipinas (BSP) showed the gross amount of
nonperforming loans (NPLs)—or credit that is 90 days late on a payment and at
risk of default—had cornered 3.27 percent of the local banking industry’s total
lending portfolio as of December, down from November’s 3.54 percent. That
figure—also known as the gross NPL ratio—was the lowest since December 2023,
when bad loans accounted for 3.24 percent of banks’ total loan book.
An overview of the operating environment
In any analysis, it is crucial to understand
the operating environment that provides context to the relevance of a statistic
in discussion.
The Bangko Sentral ng Pilipinas (BSP)
initiated its ‘easing cycle’ in the second half of 2024, which included three
rate cuts and a reduction in the reserve requirement ratio (RRR). Meanwhile,
inflation (CPI) rebounded from a low of 1.9% in September to 2.9% in December.
Additionally, the BSP tightened its cap on the USDPHP exchange rate. Fiscal
spending over the first 11 months of the year reached an all-time high.
Yet, there are notable contradictions.
Despite record-high
bank lending—driven largely by real estate and consumer loans—GDP growth
slowed to 5.2% in the second half of 2024 primarily due to the weak
consumer spending. The employment rate was also near an all-time high.
Figure 1Meanwhile, real estate prices entered deflationary
territory in Q3, with the sector’s real GDP growth falling to its lowest
level since the pandemic-induced recession. Its share of total GDP also dropped
to an all-time low.
Notably, the real estate sector remains the
largest borrower within the banking system (encompassing universal, commercial,
thrift, and rural/cooperative banks). (Figure 1, topmost chart) This data
depends on the accuracy of the loans reported by banks.
However, despite recent rate cuts and
significant reductions in RRR, the sector remains under pressure. Additionally,
sluggish GDP growth suggests mounting risks associated with record levels of
consumer leverage.
Upon initial analysis, the decline in non-performing
loans (NPLs) appears inconsistent with these economic
developments. Gross NPLs dropped to one-year lows, while net NPLs reached
levels last seen in June 2020. (Figure 1, middle window)
Ironically, the BSP also announced another
round of RRR cuts this March.
II. Deepening
Financialization: Financial Assets Surge in 2024 as Banks Drive Industry
Monopolization
Let's now turn to the gross assets of the
financial system, also known as Total
Financial Resources (TFR).
The BSP maintained its policy
rate this February.
Ironically, BSP rates appear to have had
little influence on the assets of the bank-financial industry.
In 2024, TFR surged by 7.8% YoY, while bank
resources jumped 8.9%, reaching record highs of Php 33.78 trillion and Php
28.255 trillion, respectively.
Why does this matter?
Since the BSP started hiking rates in April
2022, TFR and bank financial resources have posted a 9.7% and 10.9% compound
annual growth rate (CAGR), respectively. In short, the growth of financial
assets has accelerated despite the BSP’s rate hikes.
Or, the series of rate hikes have barely
affected bank and financial market operations.
By the end of 2024, TFR stood at 128% of
headline GDP and 152% of nominal GDP, while bank resources accounted
for 107% and 127%, respectively. This reflects the
increasing financialization of the Philippine economy—a growing reliance
on credit and liquidity—as confirmed by the Money Supply (M series) relative
to GDP. (Figure 1, lowest image)
Banking Sector Consolidation
Figure 2More importantly, the rate hikes catapulted
the bank's share of the TFR from 82.3% in 2023 to an all-time high of 83.64% in
2024, powered by universal and commercial banks, whose share jumped from 77.6%
to 78.3%! (Figure 2, topmost diagram)
Effectively, the banking
industry—particularly UCBs—has been monopolizing finance, leading to greater
market concentration, which translates to a build-up in systemic
concentration risk.
As of December 2024, bank assets were
allocated as follows: cash, 10%; total loan portfolio (inclusive of interbank
loans and reverse repurchase agreements), 54%; investments, 28.3%; real and
other properties acquired, 0.43%; and other assets, 7.14%.
In 2024, the banking system’s cash reserves
deflated 6.01% YoY, while total loans and investments surged by 10.74% and
10.72%, respectively.
Yet over the years, cash holdings have
declined (since 2013), loan growth has been recovering (post-2018 hikes), and
investments have surged, partially replacing both. (Figure 2, middle image)
Notably, despite the BSP’s historic
liquidity injections, banks' cash reserves have continued to erode.
The catch-22 is that if banks were
profitable, why would they have shed cash reserves over the years?
Why the series of RRR cuts?
III. Viewing Bank’s
Asset Growth Through the Lens of the PSE
During the Philippine Stock Exchange Index
(PSEi) 30’s run-up to 7,500, Other Financial Corporations (OFCs)—potentially
key players in the so-called "national team"—were substantial net
buyers of both bank and non-bank equities.
BSP,
January 31, 2025: "The q-o-q rise in the other financial corporations’
domestic claims was attributable to the increase in its claims on the
depository corporations, the other sectors, and the central government. In
particular, the other financial corporations’ claims on the depository
corporations grew as its holdings of bank-issued debt securities and equity
shares increased. Likewise, the sector’s claims on the other
sectors grew as its investments in equity shares issued by other
nonfinancial corporations and loans extended to households expanded. The
growth in the OFCs’ domestic claims was further supported by the rise in the
sector’s investments in government-issued debt securities" (bold added)
The OFCs consist of non-money market
investment funds, other financial intermediaries (excluding insurance
corporations and pension funds), financial auxiliaries, captive financial
institutions and money lenders, insurance corporations, and pension funds.
In Q3 2024, claims on depository corporations
surged 12% YoY, while claims on the private sector jumped 8%, both reaching
record highs in nominal peso terms.
Meanwhile, the PSEi and Financial Index
surged 15.1% and 23.4%, respectively. The Financial Index hit an all-time high
of 2,423.37 on October 21st, and as of this writing, remains less than 10%
below that peak. The Financial
Index, which includes seven banks (AUB, BDO, BPI, MBT, CBC, SECB) and the
Philippine Stock Exchange (PSE) as the sole non-bank component, has cushioned
the PSEi 30 from a collapse. (Figure 2, lowest chart)
Figure 3It has also supported the PSEi 30 and the PSE
through the private sector claims. (Figure 3, topmost pane)
The irony is that OFCs continued purchasing
bank shares even as the banking
sector’s profit growth (across universal-commercial, thrift, and
rural/cooperative banks) materially slowed (as BSP’s official rates rose)
In 2024, the banking system’s net profit
growth fell to 9.8%, the lowest in four years. (Figure 3, middle chart)
Meanwhile, trading income—despite making up
just 2.2% share of total operating income—soared 78.3% YoY.
The crux is that the
support provided to the Financial Index by the OFCs may have enabled banks to
increase their asset base via their ‘investment’ accounts, while simultaneously
propping up the PSEi 30.
Yet, this also appears to mask the
deteriorating internal fundamentals of Philippine banks. (Figure 3, lowest graph)
There are several possibilities at play:
1. The BSP’s influence could be a
factor;
2. Banks may have acted like a cartel
in coordinating their actions
3. The limited depth of Philippine capital
markets may have forced the industry’s equity placements into a narrow set
of options.
But in my humble view, the most telling
indicator? Those coordinated intraday pumps—post-recess "afternoon delight"
rallies and pre-closing floats—strongly suggest synchronized or coordinated
activities.
The point of this explanation is that
Philippine banks and non-bank institutions appear to be relying on asset
inflation to boost their balance sheets.
Aside from shielding banks through
liquidity support for the real estate industry, have the BSP's RRR cuts also
been designed to boost the PSEi 30?
IV. March 2025 RRR Cuts
and the Liquidity Conundrum: Unraveling the Banking System’s Pressure Points
Philstarnews.com,
February 22, 2025: The Bangko Sentral ng Pilipinas (BSP) surprised markets
yesterday as it announced another major reduction in the amount of deposit
banks are required to keep with the central bank. The BSP said it would reduce
the reserve requirement ratios (RRR) of local banks, effective March 28, to
free up more funds to boost the economy. “The BSP reiterates its long-run
goal of enabling banks to channel their funds more effectively toward
productive loans and investments. Reducing RRRs will lessen frictions that
hinder financial intermediation,” the central bank said…The regulator slashed
the RRR for universal and commercial banks, as well as non-bank financial
institutions with quasi-banking functions (NBQBs) by 200 basis points, to five
percent from the current level of seven percent.
The BSP last reduced the reserve requirement
ratio (RRR) on October
25, 2024. With the next cut taking effect on March 28, 2025, this marks the
fastest and largest RRR reduction in recent
history.
In contrast, the BSP previously
cut RRR rates from 18% to 14% over an eight-month period between May and
December 2019.
Why the RRR Cuts if NPLs Are Not a Concern?
Figure 4BSP’s
balance sheet data from end-September to November 2024 shows that the RRR
reduction led to a Php 124.5 billion decline in Reserve Deposits of Other
Depository Corporations (RDoDC)—an estimate of the liquidity injected into the
system. The downtrend in bank reserves since 2018 reflects the cumulative
effect of these RRR cuts. (Figure 4, topmost image)
Yet, despite the liquidity injection, the
banking system’s cash
and due-from-bank deposits continued to decline through December. It
has been in a downtrend since 2013. (Figure 4, middle pane)
Cash
reserves dropped 6% in 2024, marking the third consecutive annual
decline. The BSP’s 2020-21 historic Php 2.3 trillion injection has largely
dissipated.
Since peaking at Php 3.572 trillion in
December 2021, cash levels have fallen by Php 828 billion to Php 2.743 trillion
in December 2024—essentially returning to 2019 levels. (Figure 4, lowest chart)
Figure 5The BSP’s other key liquidity indicator, the liquid
assets-to-deposits ratio has also weakened, resonating with the cash reserve
trend. This decline, which began in 2013, was briefly offset by the BSP’s
historic Php 2.3 trillion liquidity injection but has now resumed its downward
trajectory. (Figure 5, topmost diagram)
Other Factors Beyond Cash and Reserves
The slowdown isn’t limited to cash reserves.
Deposit
growth has also decelerated since 2013, despite reaching record highs in peso
terms. Ironically, a robust 12.7% rebound in bank lending growth (excluding
interbank loans and repos) in 2024, which should have spurred deposit growth,
failed to translate into meaningful gains. Peso deposits grew by just 7% in
2024. (Figure 5, middle pane)
The question arises: where did all this
money go?
This brings attention back onto the BSP’s
stated goal of "enabling banks to channel funds more effectively toward
productive loans and investments." This growing divergence between total
loan portfolio growth and peso deposit expansion in the face of RRR cuts—20%
before March 2018, now down to just 7% last October—raises further questions
about its effectiveness in boosting productive lending and
investment.
A Deeper Liquidity Strain: Rising Borrowings
Adding to signs of the increasing liquidity
stress, bank borrowings hit an all-time high in 2024, both in gross and
net terms. (Figure 5, lowest graph)
Figure 6 Total borrowings surged by Php 394.5 billion,
pushing outstanding bank debt to a record Php 1.671 trillion.
More importantly, the focus of borrowing
was in bill issuance, which accounted for 65% of total bank
borrowings in 2024 (!)—a strong indicator of tightening liquidity. (Figure 6,
topmost image)
If banks are highly profitable and
NPLs are not a major issue, why are they borrowing so aggressively and
requiring additional RRR cuts?
The liquidity squeeze cannot be attributed
solely to RRR levels alone—otherwise, the 2018–2020 cut from 20% to 12%
should have stemmed the tide.
V. Liquidity Drain: Record
Investment Risks and Elevated Marked-to-Market Losses
There’s more to consider.
Beyond lending, bank investments—another key
bank asset class—also hit a record high in peso terms in 2024.
Yet, despite lower fixed-income rates,
banks continued to suffer heavy losses on their investment portfolios: Accumulated
investment losses stood at Php 42.4 billion in 2024, after peaking at Php
122.85 billion in 2022. (Figure 6, middle diagram)
Banks have now reported four
consecutive years of investment losses.
These losses undoubtedly strain liquidity,
but what’s driving them?
The two primary investment
categories—Available-for-Sale (AFS) and Held-to-Maturity (HTM)
securities—accounted for 40% and 52.6% of total bank investments, respectively.
Accumulated losses likely stem from AFS
positions, reflecting volatility in equity, fixed-income, foreign exchange,
and other trading activities.
VI. Despite Falling
Rates, Bank’s Held-to-Maturity Assets Remain Near Record High
Interestingly, despite easing fixed-income
rates, HTM assets remained close to their all-time high at Php 3.95 trillion
in December 2024, barely below the December 2023 peak of Php 4.02
trillion.
Since January 2023, HTM holdings have hovered
tightly between Php 3.9 trillion and Php 4 trillion.
Government Financing and Liquidity Risks
Yet, this plateau may not persist.
Beyond RRR cuts, the banking system’s Net
Claims on Central Government (NCoCG) surged 7% to a new high of Php 5.541
trillion in December 2024.
Per
BSP: "Net Claims on CG include domestic securities issued by, and
loans extended to, the central government, net of liabilities such as
deposits."
While this is often justified under Basel
III capital
adequacy measures, in reality, it functions as a quasi-quantitative
easing (QE) mechanism—banks injecting liquidity into the financial system
by financing the government.
The likely impact?
The losses in government securities are
categorized as HTMs, effectively locking away liquidity.
BSP led Financial Stability Coordination
Council (FSCC) noted in their 2017 Financial
Stability Report in 2018 that: "Banks face marked-to-market (MtM)
losses from rising interest rates. Higher market rates affect trading since
existing holders of tradable securities are taking MtM losses as a result.
While some banks have resorted to reclassifying their available-for-sale
(AFS) securities into held-to-maturity (HTM), some PHP845.8 billion in AFS
(as of end-March 2018) are still subject to MtMlosses. Furthermore, the shift
to HTM would take away market liquidity since these securities could no
longer be traded prior to their maturity" (bold mine)
Curiously, discussions of HTM risks vanished
from BSP-FSCC Financial Stability Reports after the 2017 and 2018 H1–2019
H1 issues.
VII. Moral Hazard and
the "COVID Bailout Playbook"
Although NCoCG has been growing since 2015,
banks accelerated their accumulation of government securities as part of the
BSP’s 2020 pandemic rescue package.
Are banks aggressively lending to
generate liquidity solely to finance the government? Are they also using
government debt to expand the collateral universe for increased lending?
Government debt is also used as collateral for interbank loans and repo transactions.
Have accounting regulations—such as
HTM—transformed into a silo that shields Mark-to-Market losses?
The growth of HTM has aligned with NCoCG.
(Figure 6, lowest chart)
While this may satisfy Basel capital adequacy
requirements, ironically, it also exposes the banking system to
investment concentration risk, sovereign risk, and liquidity risk.
This suggests that reported bank
"profits"—likely inflated by subsidies and relief measures—are
overshadowed by a toxic mix of trading losses, HTM burdens, and potentially
undeclared or hidden NPLs.
These pressures have likely forced the BSP to
aggressively cut RRR rates.
As anticipated,
authorities appear poised to replicate the COVID-era bailout playbook, which
they view as a success in averting a crisis.
The likely policy trajectory template
includes DIRECT BSP infusions via NCoCG, record fiscal deficits, further RRR
and policy rate cuts, accelerated bank infusions NCoCG, a higher cap on the
USD/PHP exchange rate, and additional subsidies and relief measures for banks.
This is unfolding before us, one step
at a time.
VIII. The Bigger
Picture: Are We Headed for a Full-Blown Crisis?
Given the moral hazard embedded in this
bailout mindset, banks may take on excessive risks, exacerbating "frictions
in financial intermediation". Debt will beget more unproductive debt. "Ponzi
finance" risks will intensify heightening liquidity constraints that could
escalate into a full-blown crisis.
Further, given the banking system’s fractional
reserve operating framework, riskier bank behavior, whetted by reduced cash
buffers, heightens the risks of lower consumer confidence in the banking
system—which translates to a higher risk of a bank run.
The Philippine Deposit Insurance Corporation
(PDIC) reportedly has funds to cover 18.5% of
insured deposits, or P3.53 trillion, as of 2023.
So, with the RRR cuts, is the BSP gambling
with this?
IX. Conclusion: RRR Cuts
a High-Risk Strategy?
BSP’s statistics cannot be fully relied upon
to assess the true health of the banking system.
1. The decline in non-performing loans (NPLs)
is inconsistent with slowing economic growth and the deflationary spiral in the
real estate sector. Likewise, falling NPLs contradict the ongoing liquidity
pressures faced by banks.
2. Evidence of these liquidity strains is
clear: bank borrowings have surged to record levels, with bill issuances
dominating the market. The BSP’s RRR cuts only reinforce the mounting liquidity
constraints.
3. Beyond lending, banks have turned to
investments to strengthen their balance sheets—including supporting the
Philippine Stock Exchange (PSE), even as asset prices have become increasingly
misaligned with corporate earnings.
4. In a bid to further boost systemic
liquidity, implied quantitative easing (QE) spiked to an all-time high in
December, which will likely translate into a higher volume of Held-to-Maturity
(HTM) assets.
Through aggressive RRR cuts, is the BSP
taking a high-risk approach merely to uphold its statistical narrative?