When moral hazard becomes so widespread, magical thinking inevitably follows, because market participants no longer believe that they are responsible for their commitments, or that calculated risks are genuine. This general mood not only distorts the trade-offs between risks and returns, but also prevents major markets from providing the right signals to investors and government decision-makers. If left unchecked, moral hazard will inflict high social costs through long-run efficiency losses, misallocated investment and higher systemic risk (and thus vulnerability to crises)—Mario I.Blejer and Piroska Nagy-Mohacsi
In this issue:
BSP Exit Measures: More About Rhetoric Than Action; Bank Profit Zooms in 2021 Even as Core Operations Suffer Deficits!
I. PSA’s Labor Data Defies a Consumption Boom 4Q GDP
II. BSP Exit Measures: If there is any, it will be a Milquetoast Tightening!
III. While Core Operations Suffer Deficits, Bank Profits Zoom in 2021!
IV. Wealth Transfer Policies and Why Bank Funding Cost Will Rise
V. Bank Lending Increases: Signs of Survival Rather than Growth
VII. 2021 Bank Profits Are About Accounting Magic from Reduced Loan Loss Reserves
BSP Exit Measures: More About Rhetoric Than Action; Bank Profit Zooms in 2021 Even as Core Operations Suffer Deficits!
I. PSA’s Labor Data Defies a Consumption Boom 4Q GDP
From CNN, February 10: December saw slightly more Filipinos without jobs despite more relaxed COVID-19 restrictions in time for the holidays, leading to a full-year tally still higher than pre-pandemic levels. The Philippine Statistics Authority estimates 3.27 million people aged 15 and up were unemployed during the month — more than November's 3.16 million. This means the national joblessness rate stood at 6.6% in December, slightly up from 6.5% in the previous month.
Let us grant that the PSA survey represents an accurate estimate of reality. Why were jobs shed at the peak of retail season? Christmas!
Weren’t we told that consumers fueled the 4Q 7.7% GDP?
But there is more.
From the Businessworld, February 10: AVERAGE MONTHLY WAGE rate of selected occupations decreased by almost a tenth in 2020, reflecting the economy’s record contraction due to the coronavirus pandemic. The Philippine Statistics Authority (PSA) on Wednesday said the average monthly wages of time-rated workers across 190 monitored jobs in the country declined by 9% to P16,486 in 2020 from P18,108 in 2018, citing the Occupational Wages Survey (OWS).
Assuming the sanctity of the data anew, if the average monthly wages fell by almost 10% in 2020, then it means that for consumption to have boomed in Q4 2021, wage growth would have not only recovered lost ground but would have generated a premium.
So how can significant job losses produce wage growth enough to spur a consumption boom?
Ah yes, it was about the elites and the wealth effect!
See 4Q and 2021 GDP: Consumer "Revenge" Spending Boom in a Metaverse Economy! Reality Check: Revenge Public Spending, Debt and BSP Interventions, January 30, 2022
Incredible logical inconsistencies have plagued government data just to promote an embellished political statistic.
II. BSP Exit Measures: If there is any, it will be a Milquetoast Tightening!
Moving on to the banks.
The domestic banking system is supposedly sound.
Yet, aside from extending Php 300 billion of direct loans by the BSP to the central government, why all these?
From the Businessworld, January 19: THE BANGKO SENTRAL ng Pilipinas (BSP) has further extended the effectivity of relief measures for financial institutions to sustain lending recovery and support the economy amid the pandemic. Memorandum No. M-2022-024 signed by BSP Deputy Governor Chuchi G. Fonacier said the extension for the implementation of the measures was approved by the Monetary Board on Jan. 13. “[This will]…sustain momentum of bank lending and ensure continued access to financial services by the public, including vulnerable sectors of the economy,” the memorandum said.
Here is an excerpt from a speech by the BSP Chief last January*: And to provide relief to beleaguered borrowers, we excluded some loans from being tagged as past due or non-performing and allowed a grace period for loan settlement and restructuring of rediscounted loans.
*Benjamin E Diokno: The COVID-19 pandemic and the economy, BIS.org, January 5, 2022
From Philstar.com, February 2: The Securities and Exchange Commission (SEC) is set to implement the Bangko Sentral ng Pilipinas (BSP) circular, which imposes a cap on interest rates and other fees charged by financing and lending companies. In a notice, the SEC gave financing and lending companies 15 days to submit their comments on a draft memorandum circular implementing the BSP’s new regulation, which sets caps on lending rates.
From the Businessworld, February 8: THE TIMING of the Bangko Sentral ng Pilipinas’ (BSP) exit strategy remains clouded by the uncertainty over the coronavirus pandemic, BSP Governor Benjamin E. Diokno said. “Under current circumstances, the timing and pace of the BSP’s exit plans remain uncertain. While recent indicators point to a recovery in economic activity, the recent new coronavirus disease 2019 (COVID-19) cases while receding are still high and could represent a downside risk to the outlook for growth and inflation,” Mr. Diokno told Global Source Partners in a report released on Feb. 4….“Even as we have begun looking toward the eventual withdrawal of policy support, the timing of the exit could still be contingent on how prevailing conditions evolve,” Mr. Diokno said. He previously signaled the central bank may consider adjusting policy rates when it sees four to six quarters of economic growth.
Here is our conjecture.
Aside from path dependency, moral hazard issues play a significant role in the policy choices of the BSP.
Further, since 'whatever it takes' represents a free lunch, vested interest groups benefiting from it will lobby, at the very least, to hold on to such privilege, and they could even demand more, signifying the moral hazard at work.
See How to Chop the CPI? Change the Baseline Rates! T-Bill Yields Plunge to All-Time Lows as Credit Spreads Tighten! February 6, 2022
And there is no other evidence than this.
Figure 1
The proof of the pudding is in the eating.
When has the BSP exited or withdrawn from its emergency policies? Or, have they ever embraced a policy of normalization in the aftermath of a crisis?
Take for instance the BSP policy rates.
In response to the Great Recession (2007-2009), monetary authorities dramatically slashed policy interest rates from 7.5% in 2006 to 4% in 2009. (Figure 1, top window)
Today, the BSP ON-RRP rates, at 2%, have remained at a historic low for the last sixteen months!
That is to say, from 2006 to the present, the BSP's policy rate has been headed south!
Yes, there were sporadic instances the BSP raised rates, but the scale of increases had been minimal, inconsequential, and symbolic. Milquetoast tightening, in short.
For instance, the rice crisis fueled inflation of 2018 pushed the BSP to abruptly raise its rates in five months, from 3% in April to 4.75% in November 2018! That didn't last long, though. From April 2019, these rates cascaded down. The pandemic reinforced and justified the downside spiral.
Remember this warning from the late BSP Governor Nestor Espenilla Jr’s 2017 Financial Stability Report?
While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise. What is not debatable is that repricing, refinancing and repayment risks (3Rs) are escalated versus last year and this could result in systemic risk if not properly addressed in a timely manner.
Needless to say, the BSP had to desist from raising rates because the system couldn't afford it.
So, from that point, aside from policy rates, the BSP also chopped the reserve requirement ratio (RRR) of the banking system. (Figure 1, middle pane)
In 2019, the BSP rationalized this move as an operational rather than a crisis-prevention response measure; "to promote a more efficient financial system by lowering financial intermediation costs."
The media further justified this reserve ratio as "among the highest in the world," implying its alignment with international standards.
Since 1990, like policy rates, it has also been a downtrend for the RRR.
The BSP increased RRR rates from an all-time low of 12% in 1999, the aftermath of the Asian Crisis, to 20% in 2001. But RRR rates never returned to their original levels.
Instead, RRR rates today at 12% have reverted to the post-Asian Crisis 1999 levels!
But there’s more.
The monetization of the public sector debt by BSP indirectly through financial institutions continues to scale to all-time highs, accelerating to the present levels from 2019. (Figure 1, top pane)
"Exit" here translates to a slowing pace of interventions than a withdrawal.
In contrast, it is only from the BSP's direct monetization of public debt where reversals in interventions transpired. (Figure 1, lowest pane)
So the only channel that could see a reversal may be in the BSP's debt monetization.
But with the mounting scale of public debt, wouldn't inflating it away be on the BSP's menu of options?
And it is critical to understand why. As stated in my latest CPI outlook,
The more financialized the economy, the greater is its sensitivity to changes in interest rates.
From the premise of the increasing systemic dependence on leverage, measured by the money supply to the inflated GDP, there seems hardly any substantial exit or normalization program for the BSP.
In essence, the ideological biases, path dependence, and the current financial and economic structure and conditions restrain bureaucrats from undertaking these.
To be clear, this is not to say that there would not be any attempt to normalize.
Instead, as history has shown, any moves by the BSP to exit will be minimal, inconsequential, and most importantly, symbolic. Or, if there should be one, it would be a token tightening.
But all these mistakenly assume a restoration of pre-pandemic conditions for the BSP to act on it.
Our bet, instead of an exit strategy, the BSP will ease by more!
Submission by the BSP will only occur after the market and economic forces reassert their dominance.
III. While Core Operations Suffer Deficits, Bank Profits Zoom in 2021!
Figure 2
The good news is that the banking system posted a significant jump in income growth in 2021.
The politically incorrect fact is that neither interest income nor non-interest income, representing the core operations, delivered the goodies.
Despite deficits posted by core operations of Net Interest Income (-2.88%) and Net Non-Interest Income (-6.1%), profits of the banking system surged 44.1% in 2021, the highest rate since 2009! (Figure 2, topmost pane)
But operating Income also contracted by 3.7%.
Yet, such profit metric represents a false equivalence compared to the past, as massive distortions from relief measures have muddied bank performance in the context of statistics.
Net interest income fell despite the BSP subsidy of low policy rates, principally transmitted through a massive reduction in deposit expenditures. Interest expense plunged by 35.21% for the second straight year in 2021 after the 37.21% dive in 2020. (Figure 2, second to the highest window)
As expected, despite the historic low in overnight policy rates, ascendant treasury yields have begun to gnaw at the implicit subsidies to the banking system. The quarterly changes of interest expense, the BSP ON RRP rate, and treasury yields exhibit this relationship. (Figure 2, second to the lowest window)
This seminal divergence seems to be the principal reason behind the BSP's uncompromising stance in pushing for the retention of its policy rates despite the intensifying pushback from the treasury markets.
IV. Wealth Transfer Policies and Why Bank Funding Cost Will Rise
Yet, why the need for sustained transfer from savers to the banks if the industry is resilient as claimed?
Again, the BSP appears to prioritize banks over consumers and savers, reflecting their priorities of pushing for a trickle-down mechanism from wealth effect policies.
Despite the massive injections of the BSP and the record borrowing binge of the National Government, the growth rate in bank deposit liabilities continued to decline since 2013. (Figure 2, lowest pane)
Yes, FX deposit growth rallied in Q4 following the 15.7% surge in external debt in Q3 primarily from FX borrowings of the central government.
See External Debt Growth Accelerates in Q3! Why This Uptrend Will Continue December 19, 2021
Sadly, reduced deposits extrapolate to diminished potentials for investments.
Figure 3
Here is the thing. Aside from reduced potential investments from low savings rates, client deposits are the principal and cheapest source of bank funding.
So with reduced support from the BSP, banks have started to tap public savings, which again will compete with borrowings from the government and non-financial corporations.
BDO and BPI announced nearly Php 80 billion of funding from bond sales last January. RCBC also announced a plan to raise Php 3 billion in bonds, its 7th tranche of the Php 100 billion commercial paper program.
That said, competition for funds will likely fuel more upside on Treasury yields that should likely aggravate the higher financing cost of banks and the economy.
This means too that the cost of bank funding will most likely increase from bond financing.
V. Bank Lending Increases: Signs of Survival Rather than Growth
With higher funding costs, the inducement for banks to lend grows too.
Also, it is interesting to note that widening interest spreads, reflecting the spreads of Treasury yields, have barely encouraged bank lending. (Figure 3, topmost pane)
Bank lending growth started to ascend in 2H of 2021, but this hardly contributed to the profits of the banking industry and the liquidity of the financial system.
So what did the banking system do with the historic liquidity infusions by the BSP?
As previously noted here, they shifted from lending to speculation.
However, even with increased positioning on investments or speculations, volatile markets have inflicted losses on trading. Banks accumulated Php 4.326 billion in investment losses in 2021. (Figure 3, middle pane)
And that’s not all.
Held-to-maturity (HTM) assets seem to be generating growth momentum in the industry’s investment portfolio.
HTMs in peso soared to fresh records in 2021! (Figure 3, lowest window)
In 2018, the BSP admitted that banks camouflaged mark-to-market losses by reclassifying affected assets into HTMs.
From the BSP’s 2017 Financial Stability Report (p.24) [bold original]: 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.
As of 2021, about half of the bank’s investment portfolio are HTMs. About 12.6% of the industry's total assets are HTMs.
Because of volatile markets, mounting investment losses, and the need to sustain rollover of credit of critical industries to avoid defaults, higher funding costs, as well as diminishing returns on BSP subsidies, must have likely induced banks to lend despite a climate of heightened uncertainty.
That said, it is not necessarily true that growing bank lending is a sign of recovery. Bank lending growth seems more a sign of survival.
With ascendant treasury yields defying the BSP, to take advantage of the arbitrage opportunities (difference between bank lending rates and Treasury yields), demand for loans by bank borrowers may also increase.
But this would represent a front-loading of credit demand in expectation of rising rates.
VI. BSP’s Gamble on Low Rates: Liquidity Pressures Emerge
Figure 4
Aside from undeclared credit distress, competition for funding may have compounded the draining of liquidity in the system.
Although in the BSP’s data, liquid assets-to-deposits have risen that may be more about the HTMs or accounting mirage in the face of slower deposit growth.
In any case, the decline in the cash-to-deposits ratio exhibits more of the diminishment of cash in the financial system than deposits. It also reveals the law of diminishing returns at work. That is, the corrosion of the record liquidity injections of the BSP on the banking system. (Figure 4, upper window)
And the Treasury markets have manifested mounting signs of liquidity pressures: Yield spreads of the belly (5y) and bonds (20y) have plunged since September 2021. The noteworthy development is how the equity markets may respond to such strains. (Figure 4, middle window)
An inversion has even emerged between the BVAL 10y (5.367%) and the 20y (5.2418%)/25y (5.2384%) bonds last Friday! One day may not be a trend, but we should see if this is an anomaly partly influenced by rising US Treasuries.
Also, the deviation between the BSP ON RRP (official policy rates) and BVAL benchmark 10y yield trend continues to widen, exhibiting the accrual of imbalances in the financial system from the mispricing of credit. (Figure 4, lowest pane)
And at this time, by insisting on its current stance, zero-bound policies of the BSP magnify the window of policy errors, exacerbating the fragility of the financial system.
VII. 2021 Bank Profits Are About Accounting Magic from Reduced Loan Loss Reserves
Figure 5
In any case, one should not overlook the relationship between NPLs and the CPI (2012 base). (Figure 5, upmost pane)
The relief measures designed to boost confidence through statistical magic may have led to the interim peak in NPLs in the 4Q 2021.
However, NPLs emerged from the surge of CPI of 2017-2018, which spurred rising yields. With banks weaker today than in 2018, it would be alarming if NPLs regain their momentum.
In sum, the remarkable surge of the bank profits in 2021 signifies accounting profits from the unprecedented rescue measures instituted by the BSP to sugarcoat or deodorize the balance sheet of the banking system.
The drop in loan loss provisions provided the bulk of profits even as deficits engulfed the core operation of the industry: interest and non-interest income. (Figure 5, second to the highest pane)
Despite the profit surge, this has barely improved the BSP's profitability KPIs of RoA and RoE, which remain on respective downtrends. (Figure 5, second to the lowest window)
Yet, what awe to see the industry's real GDP growth dive in 2021 in the face of a multi-year high in profit growth! (Figure 5, lowest pane)
Positive growth will turn to contraction if it excludes statistical distorting measures.
For what it is worth, here is an interesting take of the BSP on the current economic and financial condition before the 2021 GDP was released.
From the BSP-led Financial Stability Coordinating Council’s 2021 Financial Stability Report (p.9): Systemic risks matter but there is much that is unclear about it. They matter because the effects are not limited to targeted constituents but eventually affect the rest of the economy. They matter regardless of whether the risks originate from the financial market or the real economy. And they matter because the dislocations feed off each other. The large effects that we typically associate with systemic-ness are the result of these cascading effects where small (even private) shocks can get passed on, magnified and eventually become a problem to all. They matter because there will always be a next occurrence, and we need to prepare for them, ideally, before these systemic risks come to fruition.
It is nice to hear them admit to the daunting complexity of the situation. The irony is, however, authorities presume that they will have the adequacy of knowledge from the past data on how to address this. Unfortunately, economic theory provides the necessary signposts for such a process, only validated or falsified by data.
As the great Ludwig von Mises explained
Experience of economic history is always experience of complex phenomena. It can never convey knowledge of the kind the experimenter abstracts from a laboratory experiment. statistics is a method for the presentation of historical facts concerning prices and other relevant data of human action. It is not economics and cannot produce economic theorems and theories.
Good luck to those who think that authorities have a handle on this.
Yours in liberty,
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