BSP’s Aggressive RRR Cuts: A High-Stakes Gamble?

 

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 1

Meanwhile, 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 2

More 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 3

It 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 4

BSP’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 5

The 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?

 

 

 

Q3 2024: Philippine Real Estate Enters Deflationary Spiral Post-Pandemic Recession!

 

The total wealth of a country is the total value of goods and services it produces. When real estate prices rise much faster than this value, there has effectively been a large wealth transfer from those who don't own real estate to those who do—Michael Pettis 

In this issue: 

Q3 2024: Philippine Real Estate Enters Deflationary Spiral Post-Pandemic Recession!

I. Q3 2024: Philippine Real Estate Sees First Deflationary Spiral Since the Pandemic Recession! 

II. A Brief Insight into the Differences Between Pandemic-Recession Real Estate Deflation and Today’s Economic Landscape 

III. Despite Declines in New Housing Loans, Total Real Estate Consumer and Supply-Side Loans Surge, Unaffected by High Cap Rates 

IV. Real Estate’s Falling GDP Contribution and Increased Bank Lending Share Point to Heightened Concentration Risks 

V. Q3 2024 Real Estate Deflation Means Lower Sectoral and National GDP; Slower Retail Sales Amidst Greater Supply Side Expansion Translates to More Vacancies 

VI. Real Estate Deflation Amidst Near Full-Employment? What Happens When Unemployment Soars? 

VII. Property Sector Woes: From Price Deflation to Income Losses and Increased Debt Loads 

VIII. Property Sector Woes: From Liquidity Strains to Soaring Bank NPLs? 

IX. Will the BSP Launch QE 2.0 Soon? 

X. Conclusion: Two Ways to Bankruptcy: Gradually, then Suddenly

Q3 2024: Philippine Real Estate Enters Deflationary Spiral Post-Pandemic Recession! 

Philippine real estate prices experienced their first deflationary spiral in Q3 2024 since the pandemic recession, highlighting worsening imbalances in the sector. We explore the potential economic implications and possible policy responses. 

I. Q3 2024: Philippine Real Estate Sees First Deflationary Spiral Since the Pandemic Recession!

The Philippine consumer economy is hurting—and hurting badly. 

This pain is being reflected across several fronts, including the country’s most popular investment: real estate. 

Businessworld, December 30: HOUSING PRICES nationwide declined in the third quarter, the first contraction in over three years, data from the Bangko Sentral ng Pilipinas (BSP) showed. The Residential Real Estate Price Index (RREPI) fell by 2.3% year on year in the July-to-September period. This was a reversal of the 2.7% growth in the second quarter and 12.9% expansion in the same period a year ago. This was also the first time the RREPI posted a decline since the 9.4% drop recorded in the second quarter of 2021. (bold added)

And more news excerpts (all bold mine)

GMANews.com December 12, 2024: The oversupply of condominium units has shot up to an equivalent of 34 months as of November amid the sudden increase in availability of units, according to data released by Leechiu Property Consultants (LPC)… There were 4,971 new units launched in October and November, versus the 4,375 units sold during the period. Year-to-date, condominium take up was recorded at 25,565 units, equivalent to 63% of that recorded in the comparable period of 2023 while project launches stood at 13,226 or half of the previous year. Golez earlier also noted that the oversupply was due to a mix of high interest rates and external concerns, as well as a shift in preference to single-detached homes and properties in nearby provinces. 

Inquirer.net November 16, 2024: Vacancies in Metro Manila’s prime and grade A office market hit a 20-year high as of the end of the third quarter this year, with rental rates declining for the fourth straight quarter. A report from global commercial real estate services firm Cushman and Wakefield puts the average office vacancy rate at 18.2 percent, the highest since the second quarter of 2004. “The Metro Manila office market is exhibiting a slower-than-expected recovery in Q3 2024,” Cushman & Wakefield director and head of tenant advisory group Tetet Castro said in a statement.

Businessworld, November 12, 2024: DEMAND for office space outside Metro Manila has been “less robust” as office occupiers now have smaller space requirements, real estate services firm JLL Philippines said. “After the pandemic, I think the demand has weakened in general because for the key cities outside Metro Manila like Cebu and Iloilo, we’re still seeing a bit of takeup, but for the other peripheral areas, it’s not as robust anymore,” JLL Philippines Head of Research and Strategic Consulting Jan-Loven C. de los Reyes said at a briefing last week…

Businessworld, October 30, 2024: THE OFFICE VACANCY rate in Metro Manila is projected to reach 20.5% by the end of the year, driven by the influx of new office space and the departure of Philippine offshore gaming operators (POGOs), according to property consultancy firm Colliers Philippines…As of the end of the third quarter, Colliers data showed that office space vacancy rose to 18.6% from 18.3% the previous quarter due to space resulting from POGO lease terminations and non-renewal of pre-pandemic leases.

My Initial Insights: 

1. Polls indicate that the challenges faced in Q3 are likely to extend throughout the rest of 2024 and beyond. 

2. Mounting mismatches between weakening demand and rising supply have led to either increasing vacancies or a glut. 

3. Even the most bullish industry advisors have been forced to admit or confront the harsh reality facing the sector. However, they often put on a cosmetic face or a polished façade, promoting hope of recovery with little explanation beyond reliance on GDP growth. 

4. While real estate prices may seem "sticky," they are actually sensitive to liquidity and interest rates. Consequently, price declines reflect intensifying liquidity strains. In other words, vacancies have drained liquidity from many leveraged landlords and real estate owners, forcing them to sell properties at lower prices. 

5. The inflationary boom has morphed into a deflationary bust, where fear has replaced greed. 

6. Mainstream thinking has consistently overlooked the root of the issue: trickle-down policies that foster a "build-and-they-will-come" ideology, relying on the assumption of perpetual credit-driven demand fueled by low inflation and interest rates-or an everlasting regime of easy money.

Although we have been addressing this topic for some time, I will be quoting extensively from my May 2023 article: (bold and italics original)

There has been little realization that the industry has invested primarily in the foundation of the so-called "integrated community structure," anchored on urbanization and its extension of "satellite communities." 

Espousing the contortion of Say's Law, "supply creates its own demand," through "build and they will come," the race to build became the industry’s bedrock. 

Yet, the dynamic preference of consumers became one of the challenges of this model. 

And so, influenced by digitalization and pandemic policies, the transformation to hybrid/remote work has rendered a massive "sunk cost" or capital decumulation—signified by oversupply.  

… 

The thing is, though office spaces are the concern here, all other segments of the property sector constitute part of such "integrated communities," which therefore extrapolates to interconnection.  

By extension, it also means that the paradigm of "integrated community" is codependent not only on the vibrancy of the office properties but also residential, shopping malls, hotels, logistics and commercial hubs, and other related structures.   

Indeed, the dilemma of the office segment, the weakest link of the commercial real estate sector (CRE), should spread to other areas. 

Aside from the misallocation of capital, financing these imbalances through debt signifies a double whammy or the acceleration of capital consumption. 

The point having been made, these clusters of entrepreneurial errors are products of the distortion of money via the BSP's easy money regime. 

II. A Brief Insight into the Differences Between Pandemic-Recession Real Estate Deflation and Today’s Economic Landscape

Here’s a deeper dive into this developing seismic event.

The first article noted: "This was also the first time the RREPI posted a decline since the 9.4% drop recorded in the second quarter of 2021."

Figure 1

The last time deflation plagued the BSP’s Real Estate Price Index was in Q3 2020 (-0.4%), Q1 2021 (-4.2%), and Q2 2021 (-9.4%).  (Figure 1, upper window)

However, the difference between then and now is that policymakers responded to the pandemic-induced economic shutdown that led to five consecutive quarters of GDP contraction—a full-blown recession with aggressive measures.

Authorities reacted to this unprecedented disruption with a record fiscal deficit. Simultaneously, the BSP flooded the banking system with a historic Php 2.3 trillion of liquidity, aggressively cut interest rates to historic lows (2% from November 2020 to April 2022), significantly reduced the banking system’s Reserve Requirement Ratio (RRR) from 14% to 12%, implemented unprecedented capital, operational, and regulatory relief measures and subsidies, and placed a cap on the US dollar-Philippine peso exchange rate. The Finance Chief even ordered the SSS and GSIS to buy stocks and support the PSEi 30. 

All these collective actions were taken to prevent credit deflation and support collateral values—which back bank-issued loans—by reflating the bank-dominated financial system.

Fast forward to today, there has been no recession yet. Despite elevated interest rates, bank credit flows have been oozing.

III. Despite Declines in New Housing Loans, Total Real Estate Consumer and Supply-Side Loans Surge, Unaffected by High Cap Rates

Still, the RREPI fell into deflationary territory, led by properties in Metro Manila, which posted a 14.6% contraction—the second-largest decline since the 18.3% shrinkage in Q2 2021. (Figure 1, lower chart)

Areas outside the National Capital Region (AONCR) have experienced a sharp slowdown but remain on a growth path. 

Importantly, AONCR was barely affected by deflation during the pandemic era. Given the recent dynamics, it might not be exempt this time.

Figure 2

The BSP tacitly attributed this turn of events to the shrinking demand for new housing loans. (Figure 2, topmost table)  

In Q3 2024, the number of residential real estate loans (RRELs) granted for all types of new housing units in the Philippines contracted by 15.7 percent y-o-y. Specifically, loans granted in the NCR and AONCR decreased by 20.3 percent and 13.0 percent, respectively. Notably, the double-digit y-o-y contraction in RRELs in the Philippines, NCR, and AONCR in Q3 2024 was significant, yet not as severe as the decline in housing loan availment observed during the pandemic, which began in Q2 2020. (BSP, 2025) [bold added] 

However, a mere lack of demand for new loans is insufficient to cause a contraction. 

Nevertheless, theoretically, since real estate prices are duration-sensitive and influenced by changes in long-term interest rates, these shifts also impact capitalization rates (cap rates), which in turn affect property values.

Rising interest rates typically lead to higher cap rates, as investors demand a higher return to compensate for the increased cost of borrowing and the higher risk associated with interest rate changes. 

Consequently, higher cap rates generally lead to lower property values, as expected returns must adjust to match the new rates. Therefore, the adverse impact of higher cap rates on property values translates to diminished demand from investors. 

Notwithstanding the contraction in new property consumer loans, aggregate real estate consumer loans hit a record high of Php 1.061 trillion in Q3, although its growth rate fell from 13.5% in Q2 2024 to 8.07%. (Figure 2, middle graph) 

On the supply side, real estate bank loans reached a record Php 2.686 trillion in Q3 2024, with quarterly YoY growth accelerating from 3.86% in Q2 2023 to 13.9% in Q3 2024. 

In aggregate, total bank loans (net of interbank lending) rose to a record Php 13.24 trillion, with quarterly YoY growth also accelerating over the past five quarters. 

Thus, higher cap rates were hardly a factor; instead, the vibrant growth in supply-side bank lending likely contributed to more "build-and-they-will-come" supply. 

IV. Real Estate’s Falling GDP Contribution and Increased Bank Lending Share Point to Heightened Concentration Risks 

Furthermore, reports like this can be misleading: "Banks’ real estate exposure ratio dropped to 19.55% at end-September from 19.92% at end-June and from 20.55% at the end of September 2023—the lowest real estate exposure ratio recorded in five years, or since the 19.5% level as of September 2019." 

This is because the data on Real Estate Loans (REL) as a share of the Total Loan Portfolio (TLP) can signify many things. In this instance, the decline in REL/TLP is not primarily due to banks lending less to the sector or becoming more judicious or cautious. Rather, banks have been lending more aggressively to other sectors, particularly consumer credit cards and salary loans. 

In the realm of consumer loans, the share of real estate loans fell from a record high of 45.06% in Q4 2021 to 36.4% in Q3 2024, despite record peso real estate consumer loans. The 8.6% gap was filled by credit cards, which increased their share from 22.3% in Q4 2021 to 29% in Q3 2024. (Figure 2, lowest diagram) 

Meanwhile, the share of salary loans jumped from 8.3% to 13.22% over the same time frame. 

In statistics, there are many ways to "skin a cat." 

Unless funds are designated through escrow accounts, banks have virtually no control over how loan proceeds are spent. Some of the credit card and salary loans—or even loans declared for production purposes—could have been diverted to real estate mortgage payments, property purchases, or even stock investments. 

The fact that real estate credit growth remains buoyant suggests that most of the borrowed money may have been used for refinancing, with modest amounts allocated to acquiring second-hand properties (for consumer loans) and for property development expansion (supply-side loans). 

This also tells us that while new buyers played a smaller role in borrowings, more experienced buyers and property developers significantly contributed to the sector’s bank borrowings. 

On this note, despite lackluster growth, the real estate sector’s relative strength—compared to the overall weaker performance of other sectors—prompted a surge in its share of GDP in Q3 2024. 

The value-added contribution of the sector, which posted a 5.4% real GDP growth, amounted to 5.9% of national GDP. 

In the meantime, the real estate sector’s share of Universal-Commercial bank portfolios amounted to 20.46% in Q3.

Figure 3

Thus, a sector contributing 5.9% of GDP holds a 20.5% share of UC bank portfolios—representing significant concentration risks. (Figure 3, topmost chart)

Notably, this is based on the official definition of the banks’ real estate portfolios, whose actual exposure may already be understated. 

V. Q3 2024 Real Estate Deflation Means Lower Sectoral and National GDP; Slower Retail Sales Amidst Greater Supply Side Expansion Translates to More Vacancies

Of course, we’d also argue that the price deflation in Q3’s RREPI, which indicates slower spending across the industry, means less than the advertised GDP. Again, the sector reported 8.8% nominal GDP and 5.4% real GDP. (Figure 3, middle image) 

A lower real estate GDP should shave off a few more percentage points from Q3’s GDP of 5.2%. 

But here’s another potential discrepancy: According to the BSP, buyers of new properties have been less influential in driving demand for real estate. 

In particular, condominium prices plummeted by 9.4% in Q3 2024—the third largest of the five quarterly contractions from 2020 to the present. 

However, as a proxy, the performance of the top five listed developers (SM Prime, Ayala Land, Megaworld, Robinsons Land, and Vista Land) tells a different story. Their Q3 2024 real estate sales surged by 19.76% YoY, suggesting no signs of retrenchment in new property sales. 

This raises a critical question: Were the BSP numbers inaccurate, or have property developers been overstating their real estate sales? (Figure 3 lowest graph) 

As a side note, the property sales of the top five developers are not limited to residential condos; however, the comparison provided is for estimation purposes only.

Figure 4

But there’s more. 

The slowing rental income growth of the top four developers (SM Prime, Megaworld, Robinsons Land, and Vista Land) appears to align with the moderating revenue growth of the top six non-construction retail chains (SM Retail, Puregold, Robinsons Retail, Metro Retail, SSI Group, and Philippine Seven).  (Figure 4, topmost diagram)

In Q3, rental income for developers increased by 7.12%, while retail chains saw 6% growth. Both figures peaked in 2022 (Q2 and Q3, respectively) and have been on a downtrend since. 

This slowdown also reflects the growing mismatch between sales growth rates and the expansion of selling areas for retail chains and shopping malls, which has resulted in increasing vacancies. 

VI. Real Estate Deflation Amidst Near Full-Employment? What Happens When Unemployment Soars?

Intriguingly, despite unprecedented consumer bank borrowing rates and levels, the data signals intensifying signs of strained consumers—despite the supposedly near-full employment rate. (Figure 4, middle window) 

This also suggests that either the government’s labor data has been significantly stretched, or that consumers are increasingly burdened by the sustained loss of purchasing power in their wages and incomes, or by escalating balance sheet leverage. 

Worst of all, it could be both. 

What happens when the employment rate falls? 

Even more important, what happens when consumer credit slows or even retreats?

VII. Property Sector Woes: From Price Deflation to Income Losses and Increased Debt Loads 

Of course, deflation in the industry translates to weakened demand.

While property firms may attempt to mask this through possible overstatements of sales, internal pressures—such as diminishing liquidity, rising debt burdens, and increasing servicing costs—are likely to result in the eventual emergence of losses. 

When deflation gripped the industry in 2020–2021, the top five developers recorded net income losses over four quarters.(Figure 4, lowest chart) 

Currently, while net incomes are at all-time highs, their growth rate has been eroding.

Figure 5

Furthermore, debt levels continue to climb to record highs, accompanied by rising interest rate expenses. On the other hand, cash reserves have recently dropped and stagnated. (Figure 5, topmost and middle graphs) 

Coming down the pike, the likelihood of income deficits combined with a drain in business liquidity may result in even greater reliance on debt financing to sustain operations—even as collateral values deteriorate. 

If these developments have already impacted the top five developers, what more for marginal industry players—the mom-and-pop operators? 

VIII. Property Sector Woes: From Liquidity Strains to Soaring Bank NPLs?

Considering that banks hold significant exposure to real estate, the next phase will likely result in a surge in non-performing loans (NPLs). 

When deflation engulfed the sector in 2020-2021, real estate consumer NPLs surged and continued to rise even when the RREPI index peaked at 14.1% in Q2 2023. (Figure 5, lowest chart) 

NPLs hit a record Php 21.7 billion in Q2 2024 but slightly declined to Php 21.28 billion in Q3 2024. 

Due to credit expansion outpacing NPL growth, these numbers have been obscured as a function of ratios. They will likely become more prominent once credit expansion materially slows. 

Or what is likely to follow, after mounting losses and the depletion of liquidity, is a rise in NPLs—starting with smaller players and gradually affecting larger industry participants, in a "periphery-to-core" dynamic. 

IX. Will the BSP Launch QE 2.0 Soon?

In addition to surging public debt, the RREPI Q3 2024 deflation provides context for the BSP’s recent actions, which mirror a shadow of the pandemic recession playbook. These include the reduction of the Reserve Requirement Ratio (RRR) from 9.5% to 7%, effective October 2024, and the ongoing easing cycle, marked by the second and third interest rate cuts in the ONRRP in Q4 2024.

Furthermore, it explains the record-high 11-month public expenditures, reflecting the "Marcos-nomics" fiscal stimulus aimed at offsetting the decline in private sector demand.

Figure 6 

These policies have combined to momentarily bolster liquidity, which had been eroding from 2021 to 2023, as reflected in the YoY changes in M1. (Figure 6, topmost visual) 

Lastly, the Php 2.3 trillion injections by the BSP were partly channeled through its net claims on the central government (NCoCG). 

Interestingly, despite the supposed economic normalization, the BSP’s NCoCG remains elevated, prompting the IMF to request that the BSP become more transparent about its "balance sheet strategy." 

For instance, notes Inquirer.net, "the IMF said the BSP may want to publish more information about the size of its portfolio of government securities (GS), which remains 'substantial' despite declining since the central bank’s large purchases of state bonds during the COVID-19 pandemic." 

The BSP’s NCoCG stood at Php 650 billion as of November 2024, which is vastly above its 2002-2019 monthly average of Php 32.7 billion. (Figure 6, middle chart)

The BSP also holds Php 1.178 trillion worth of domestic securities (as of September 2024), accounting for 14.6% of its total portfolio. (Figure 6, lowest graph) 

The essence here is that by partly maintaining its quantitative easing (QE), the BSP remains heavily involved in controlling liquidity conditions in the banking system, where the real estate industry represents a significant counterparty.

This signifies the 'ratchet effect theory' in action, where temporary solutions to address specific problems become a permanent part of the legal landscape. (Matulef, 2023)

The Php 64 trillion question is: should current developments in the real estate sector deteriorate, would the BSP launch QE 2.0?

X. Conclusion: Two Ways to Bankruptcy: Gradually, then Suddenly

All told, despite the profusion of liquidity and the embrace of easy money policies, deflation in the Philippine real estate industry has emerged and could worsen.

This highlights the widening mismatch between vigorous debt-financed supply-side growth and weakening consumer demand—primarily driven by the erosion of the peso's purchasing power and the extended balance sheet leverage resulting from trickle-down policies, including the crowding-out effect. 

Although the challenge for policymakers would be to allow market forces to take command—cleansing household, corporate, and government balance sheets while rebuilding savings through productive undertakings—this would translate to a vastly diminished GDP and, more importantly, reduced political boondoggles. As such, this route is unlikely to occur. 

Nonetheless, authorities are likely to "fight the last war" by pursuing path-dependent, free-money policies aimed at boosting aggregate demand and GDP, while ignoring all other factors. 

Lastly, because the consensus believes these trends represent a temporary phenomenon, isolated from the pandemic's events and previous easy money policies, the "build-and-they-will-come" mentality is likely to prevail, driving an even greater debt-financed "race-to-build supply"—thereby exacerbating existing imbalances. 

As American novelist Ernest Hemingway wrote in The Sun Also Rises:

"How did you go bankrupt? Two ways. Gradually, then suddenly."

___

References: 

Prudent Investor, Philippine Real Estate:Mainstream Expert Worried Over Increasing Demand-Supply Gap; Q1 2023 Data ofTop 5 Listed RE Firms and the Property Index, May 28, 2023  

Bangko Sentral ng Pilipinas, Residential Real Estate Prices Decline in Q3 2024, December 27, 2024, bsp.gov.ph  

Michael Matulef, Beyond Crisis: The Ratchet Effect and the Erosion of Liberty August 18, 2023, Mises.org  

Ernest Hemingway, The Sun also Rises Chapter 13, 1926 Project Gutenberg Canada