The Political Economy of Corruption: How Social Democracy Became the Engine of Decay

 

In a world of uncertainty, no one knows the correct answer to the problems we confront and no one therefore can, in effect, maximize profits.  The society that permits the maximum generation of trials will be the most likely to solve problems through time (a familiar argument of Hayek, 1960).  Adaptive efficiency, therefore, provides the incentives to encourage the development of decentralized decision-making processes that will allow societies to maximize the efforts required to explore alternative ways of solving problems—Douglass North 

In this issue

The Political Economy of Corruption: How Social Democracy Became the Engine of Decay 

Part I: How Social Democracy Sows the Seeds of Corruption

IA. Corruption Starts with the Electoral Process

IB. Public Choice Theory and Barangay Projects: Microcosm of the National Rent Machine

IC. A Caveat: Between System and Choice

ID. Dynasties, and the Patron–Client Trap, From Adaptive to Extractive Efficiency

IE. Goodhart’s Law and the Metric Illusion: Governance by the Numbers

IF. The Limited Access Orders: Elite Stability Through Controlled Competition

IG. The Financialization of Patronage

IH. Ochlocratic Democracy and the Squid Game Parable

II. The Tragic Paradox of Philippine Social Democracy

Part II: The Political Economy of Corruption

IIA. The Pandora’s Box of Public Spending

IIB. The Fiscal Mirage: Bigger Budgets, Shrinking Revenues

IIC. The Economic Undercurrent: A Slowdown Beneath the Noise

IID. The Policy Backlash: Easy Money Meets Fiscal Decay

IIE. The Mirage of Deficit-to-GDP Ratio: When Optics Replace Substance

IIF. The Mirage of Prudence: Debt, Deception, and the Ochlocratic State

Part III: Conclusion: The Final Drift: From Rent-Seeking to Crisis 

The Political Economy of Corruption: How Social Democracy Became the Engine of Decay 

From ballot to budget, the Philippine political economy drifted from progress to patronage—where fiscal populism and elite collusion sustain the illusion of democracy 

Part I: How Social Democracy Sows the Seeds of Corruption 

IA. Corruption Starts with the Electoral Process

Figure 1

Corruption begins not in backroom deals—but at the ballot box. 

How much does a candidate spend to get elected? 

While formal spending limits exist under law, field estimates and media-monitoring data reveal that actual campaign expenditures, especially at the national level, reach hundreds of millions to billions of pesos. In urban settings, Barangay officials reportedly spend upwards of Php 500,000, city councilors tens of millions, and candidates for national seats billions. (Figure 1) (see reference) 

Given their modest stipends, what motivates them and their backers to pour in such vast sums? Patriotism? Or the expectation of returns—through power, access, and extraction? 

IB. Public Choice Theory and Barangay Projects: Microcosm of the National Rent Machine 

Here, Public Choice Theory—or as the late Economist James Buchanan artfully defined it—"politics without romance," strips away the illusion of altruistic politics. (see reference) 

Elections, far from being contests of ideals, are investments in rent-seeking. Politicians rationally pursue interventions—public works, subsidies, welfare programs—that expand budgets and open opportunities for returns. 

Barangay officials, for instance, may build health centers or basketball courts to tout “accomplishments,” while pocketing funds through overpricing, commissions, or other channels within their networks. 

At the grassroots, popular barangay projects—covered courts, health stations, road repairs—serve dual purposes: visible service and invisible extraction. These projects justify budget allocations while enabling leakage through padded contracts and favored suppliers. The barangay becomes a microcosm of the national rent machine. 

That is, the larger the government’s footprint, the larger the potential rents.

Fiscal expansion is often framed as developmental necessity. In reality, it’s a mechanism for rent distribution. More projects mean more contracts, more intermediaries, more leakage—and most importantly, more VOTES.

Politicians push for interventions not to solve problems, but to create extractive opportunities and extend their tenure.

IC. A Caveat: Between System and Choice

As a caveat, while the seeds of corruption are sown in the electoral system—where incentives reward control, manipulation, and extraction through patron–client ties and dependency-building programs—individual agency still matters. Not all who enter the system succumb to its temptations.

We must resist the fallacy of division: the idea that because the system is corrupt, every actor within it must be. While many—or even most—may exploit the structure, others attempt to navigate it with integrity, often at great personal and political cost.

Moreover, corruption is not monolithic. Its degree, visibility, and method vary:

• At the barangay level, corruption may be more modest—petty overpricing, padded logistics, or informal commissions.
• At the national level, it scales. Many officials may not directly pocket funds from projects. Instead, some exploit indirect mechanisms—through layered corporate networks, proxy ownerships, and business interests within their jurisdictions.

In such cases, transparency tools like the SALN (Statement of Assets, Liabilities, and Net Worth)—while symbolically important—often remain cosmetic. They measure disclosure, not control. As such, they are easily gamed, rarely enforced, and structurally blind to the artifice of legally structured beneficial ownership. 

ID. Dynasties, and the Patron–Client Trap, From Adaptive to Extractive Efficiency

Over time, this incentive structure breeds dynastic entrenchment. Voters become dependent on welfare, contracts, and subsidies—reinforcing the very system that sustains them.

Political families consolidate control over access to state resources, while bureaucracies serve as vehicles for loyalty rather than performance.

Here, Douglass North’s concept of adaptive efficiency becomes central. In healthy societies, innovation and problem-solving emerge through decentralized experimentation—allowing multiple actors to test ideas and learn over time.

But in a captured social democracy, decision-making becomes centralized, risk-averse, and politically motivated.

Instead of adaptive efficiency, the system evolves toward extractive efficiency—maximizing rent extraction rather than problem-solving. Every “reform” becomes another opportunity for patronage. 

IE. Goodhart’s Law and the Metric Illusion: Governance by the Numbers 

When a measure becomes a target, it ceases to be a good measure. 

Goodhart’s Law explains why governance quality erodes: once developmental indicators—poverty reduction, infrastructure spending, digitalization—become political targets, they cease to measure real progress.

Politicians and bureaucracies chase metrics, not meaning. Budgets swell to create the optics of success, even as institutional capacity stagnates. 

Despite headline growth, nearly half of Filipino families still identify as poor, and hunger rates remain stubbornly high—underscoring the dissonance between GDP triumphalism and lived reality. 

The logic of numbers has replaced the logic of outcomes. For instance, infrastructure becomes a scoreboard; social amelioration, a campaign metric. 

What cannot be measured—quality of life—disappears from governance priorities. 

IF. The Limited Access Orders: Elite Stability Through Controlled Competition 

North, Wallis, and Weingast’s framework of Limited Access Orders capture this equilibrium. In such systems, elites maintain stability by controlling access to political and economic privileges. Violence is contained not through rule of law, but through negotiated rents among dominant coalitions. 

Competition—whether electoral or market—is not eliminated, but managed to prevent instability. 

In the Philippine context, the political economy resembles a cartel: quasi-competition among elites crowds out MSMEs through the BSP’s easy-money regime and the regulatory state. 

Access to capital, permits, and protection is rationed—not by merit, but by proximity to power. 

The ruling oligarchy—masquerading as democratic elites—justifies this concentration through the promise of trickle-down prosperity. Anchored on a record-high savings-investment gap, the benefits rarely diffuse. They consolidate, reinforcing privilege and power. 

Corruption, then, is not a malfunction. It is the stabilizing mechanism of the political order. Public works and welfare programs distribute rents downward to maintain consent, and upward to preserve privilege. 

IG. The Financialization of Patronage 

The BSP’s easy-money regime acts as the lubricant of this system. Cheap credit, monetized deficits, and liquidity injections sustain the illusion of prosperity. Fiscal populism flourishes, financing both vote-buying and elite projects under the banner of “inclusive growth.”

Figure 2

Yet as public debt expands (Php 17.468 trillion in August) and private credit is crowded out (Bank compliance of MSME lending share 4.59%), efficiency dissipates, innovation recedes, and systemic risk mounts. (Figure 2, upper image)

The same elites who dominate politics now dominate finance—transforming competition into collusion. What began as political capture of budgets has evolved into financial capture of capital. Bank’s net claims on central government (NCoCG) reached Php 5.445 trillion or 31% of public debt, last August. (Figure 2, lower graph)

However, elite finance no longer thrives on production, but on asset transfers anchored in debt—rent extraction by other means.

IH. Ochlocratic Democracy and the Squid Game Parable

Social democracy becomes a shell—democratic in ritual, oligarchic in practice. Elections legitimize extraction. The state grows as both employer and benefactor. Bureaucracies serve dynasties. Welfare becomes vote collateral.

Philippine politics drifts toward ochlocracy—where collective dependency replaces civic reason, and politics becomes an auction of favors.

In the popular Korean drama Squid Game, participants vote democratically on whether to continue the deadly contest. It’s a grim parody of ochlocratic democracy—where the masses “choose” within a system they cannot change, while elites watch from above, entertained by their struggle.

Philippine politics mirrors this cruel symmetry: voters play the game of elections, but the rules—and the rewards—belong to the few who own the arena.

This is the tragedy of ochlocratic democracy: people mistake participation for power, and choice for change.

II. The Tragic Paradox of Philippine Social Democracy

The paradox is tragic. Social democracy began as an ideal of empowerment, but its penchant for populist collectivism and institutional capture devolved into systemic dependency. It rewards extraction over experimentation, and loyalty over learning and entrepreneurship.

As North warned, prosperity depends not on good intentions or efficient markets, but on institutions that foster experimentation, decentralization, and accountability. When these vanish, societies lose their adaptive capacity—and settle into the stability of decay. 

That decay now finds fiscal expression. 

The controversial 2025 national budget, packed with pork-laden projects, confidential allocations, and populist welfare programs, does not represent governance—it exposes social democracy’s rent-distribution paradigm.

It is the modern stage of our own Squid Game democracy: grand spending justified by social ideals, yet orchestrated to consolidate power. The next step forward is not reform in name, but reckoning in structure.

Part II: The Political Economy of Corruption

IIA. The Pandora’s Box of Public Spending 

The opening of the public spending Pandora’s Box exposes the government’s MIDAS touch—except that what it touches doesn’t turn into gold but corruption. From overpricing to kickbacks, bribery to ghost projects, and more, allegations of improprieties have emerged not only in flood control programs but also across farm-to-market roads, election platforms, healthcare centers, the DICT’s WiFi subscription services, LTO license plates, and more yet to come. 

The iceberg unravels. 

We recently wrote: 

Authorities hope for three things: 

• That time will dull public anger
• That the probe’s outcome satisfies public appetite
• That new controversies bury the scandal

But history warns us: corruption follows a Whac-a-Mole dynamic—until it hits a tipping point.

Here is what we missed. 

In a striking inversion of democratic logic, the Philippine Navy’s recent warning—that public outrage over flood control failures may expose the nation to foreign propaganda—reveals a deeper institutional reflex: the impulse to reframe civic dissent as geopolitical vulnerability. 

The narrative is shifting: from corruption to propaganda, from domestic failure to foreign destabilization. In this alchemy of blame, scandal becomes sovereignty, and criticism becomes treason. 

The Thirty-Six Stratagems offer an apt lens: “Let the enemy’s own spy sow discord in his own camp.” When power is cornered, it conjures enemies to restore cohesion—sowing the seeds of conflict, via diversion, to preserve its own survival. 

By invoking the specter of foreign interference, the regime deflects attention from systemic rot to imagined threats, weaponizing patriotism against dissent. 

Yet one must ask: is the Philippine military also attempting to obscure internal corruption within its own agency? 

IIB. The Fiscal Mirage: Bigger Budgets, Shrinking Revenues

Figure 3

Despite the domino trail of corruption being exposed, political authorities recently passed the 2026 budget of Php 6.793 trillion—up from this year’s enacted Php 6.326 trillion. Though this marks a 7.4% increase, it rose by Php 467 billion from last year, the fourth highest ever. (Figure 3, topmost chart) 

The House of Representatives even increased its allocation by Php 10 billion. 

However, the Bureau of the Treasury quietly revised the 2025 expenditure target downward—from Php 6.326 trillion to Php 6.082 trillion—likely after realizing it had overestimated non-tax revenue projections. 

All things equal, this translates to an 11.7% increase or ₱711 billion, the largest peso expansion in Philippine fiscal history. 

While actual spending this year may fall below the enacted budget, history suggests it will still exceed the revised target. 

In any case, because corruption is often framed in binary terms—black or white, good or evil—the 2026 budget signals that the establishment expects the scandal to breeze over and the good times to continue. 

This echoes Aldous Huxley’s warning:

That men do not learn very much from the lessons of history is the most important of all the lessons of history. 

IIC. The Economic Undercurrent: A Slowdown Beneath the Noise 

While the September Php 248.1 billion deficit was reported as having narrowed from last year—due to a 7.5% decline in expenditures amid DPWH embroilment— few noted that public revenues also fell by 5.99%. 

Yes, tax revenues grew: BIR up 4.74% YoY, BoC up 5.25%. But non-tax revenues collapsed by 65.8%. 

The quarterly and year-to-date numbers reveal a broader slowdown: (Figure and Table 3, middle and lower windows) 

Q3 2025: -3.22% revenues, +4.47% tax revenues (BIR +4.87%, BoC +3.297%), non-tax -48.24%

Q3 2024: +16.95% revenues, +11.7% tax revenues (BIR +14.7%, BoC +3.61%), non-tax +61.7%

9M 2025: +2.2% revenues, +8.6% tax revenues (BIR +10.9%, BoC +1.6%), non-tax -34.7%

9M 2024: +16.04% revenues, +10.6% tax revenues (BIR +12.73%, BoC +4.6%), non-tax +62.85% 

The bottom line: where revenues are conditioned on economic performance and administrative capacity, the Q3 slowdown signals deeper economic weakening—dragging down the 9M performance. The GDP leads tax collections. 

Yet, the public barely realizes that the economy is tacitly emaciating, while the corruption scandal, which partly curtailed spending, exacerbates the decline.

Figure 4

Despite the September contraction in public spending, 9M YoY growth slipped from 11.6% in 2024 to 5.2% in 2025. Still, public spending hit an all-time high of Php 4.484 trillion. Figure 4, topmost visual) 

As a result, the 9-month deficit swelled to Php 1.117 trillion—just 1.92% or Php 21.85 billion shy of the historic Php 1.139 trillion budget gap during the pandemic recession year of 2021 —an astounding fiscal gap without a recession. (Figure 4, middle diagram) 

A massive pandemic-sized fiscal backstop without a crisis—what is the government not telling the public? 

IID. The Policy Backlash: Easy Money Meets Fiscal Decay 

One might add: all this unfolds amid the BSP’s easing cycle—marked by interest rate and RRR cuts, plus a doubling of deposit insurance. 

All told, the economy now reels from the unintended consequences of overlapping policies:

• Bank-financed asset bubbles,
• Crowding-out of private credit,
• The soft USD-peg, and
• Implicit backstops for bank balance sheets. 

Together, these reinforce malinvestments that distort both fiscal and monetary stability. 

Once again, from our September post (bold original): 

Many large firms are structurally tied to public projects, and the economy’s current momentum leans heavily on credit-fueled activity rather than organic productivity. 

Curtailing infrastructure outlays, even temporarily, risks puncturing GDP optics and exposing the private sector’s underlying weakness. 

Or if infrastructure spending is curtailed or delayed, growth slows and tax revenues fall—VAT, corporate, and income tax collections all weaken when economic activity contracts. 

This means the deficit doesn’t necessarily shrink despite spending restraint; the “fiscal hole” may, in fact, widen—imperiling fiscal stability and setting the stage for a potential fiscal shock. 

The irony is stark: efforts to contain corruption by tightening spending could deepen the very gap they aim to close.

This means that an extended softening of GDP entails a much higher deficit-to-GDP ratio—recently adjusted to 5.5% for 2025.

Crucially, few realize that further slippage in this ratio amplifies the risk of a fiscal shock—a scenario no longer theoretical but increasingly imminent.

IIE. The Mirage of Deficit-to-GDP Ratio: When Optics Replace Substance 

Yet what policymakers increasingly celebrate as "fiscal discipline" may in fact be a statistical mirage. 

The narrowing of the deficit-to-GDP ratio, often paraded as proof of resilience, conceals deeper structural decay beneath the surface. (Figure 4, lowest chart) 

For while nominal figures appear stable, the underlying engine of growth—real production, capital formation, and household income—has been hollowing out. The economy’s apparent balance is not born of strength, but of accounting illusion. 

The obsession with deficit-to-GDP optics reveals how politicians and bureaucrats chase statistical benchmarks—or what I call as ‘benchmark-ism’—over structural integrity. As the ratio falls—even while real GDP softens—authorities infer that deeper deficits carry little cost. 

Numerically, the ratio implies GDP is outperforming the deficit, either through faster nominal growth or slower deficit expansion. But this dissonance masks a dangerous illusion: debt-financed deficits now comprise a substantial and growing share of GDP. 

The economy’s rising dependency on public spending, funded by mounting debt, creates a fragile equilibrium. 

Once the extraction and redistribution mechanism weakens—manifesting as a sharp GDP decline—the ratio could spike violently. 

In all, the falling deficit-to-GDP ratio conceals the economy’s eroding capacity to absorb and repay debt. It’s not a sign of resilience, but a warning of latent fragility. 

IIF. The Mirage of Prudence: Debt, Deception, and the Ochlocratic State 

This leads us to debt. 

Media and authorities entertain us with a dramatic 71.1% plunge in BSP-approved FX borrowings in Q3 2025, projecting an image of fiscal prudence and stability. 

Officials attribute the slowdown to the “frontloading” of offshore financing earlier in the year. 

Yet BSP approved $12.28 billion in the first 9 months of 2025—up 16.1% from $10.58 billion in the same period last year. For context, BSP approved $13.8 billion for the full year 2024. 

What they fail to highlight is that the Q3 deficit—among the largest on record—pushed the 9-month shortfall to 2021 levels. This demands financing. The data suggests BSP either shifted operations through banks, reclassified borrowings via accounting gymnastics, or pivoted to peso-denominated debt.

Figure 5

What BSP’s data shows supports this view. In August, banks’ net foreign assets surged 45% year-on-year, while the BSP’s claims rose by a mere 0.7%. This divergence indicates a clear shift in FX borrowing and asset buildup from the BSP and national government toward the banking sector. (Figure 5, topmost graph) 

In effect, external leverage didn’t disappear—it was privatized, migrating into bank balance sheets where it escapes fiscal scrutiny but magnifies systemic risk. 

However, financing did slow in September, marking a second consecutive decline. This pulled 9-month financing back to 2024 levels, implying a slowdown in national debt growth—even as deficits soared past last year’s. Again, this hints at rescheduling maneuvers or creative fiscal accounting. (Figure 5, middle pane) 

We saw a similar pattern with amortization. Media and consensus proudly cited a debt financing slowdown in 1H 2025. But analyzing the June deficit, we surmised in August that this reflected one or more of the following: Scheduling choices, prepayments in 2024 and political aversion to public backlash 

Amortizations resurfaced by August, and September data reinforced the rebound. 

More strikingly, interest payments surged 15.4% in September, pushing their 9-month share of expenditures to 14.85%—the highest since 2009. (Figure 5, lowest graph)

Figure 6

Combined, amortization and interest payments in the first 9 months of 2025 already exceed 2023’s annual totals and sit just 7.5% below 2024’s all-time high— with a full quarter remaining! (Figure 6, upper chart) 

Meanwhile, foreign-denominated debt servicing fell 35% in September—its fourth straight monthly decline and the largest yet. This pulled its 9-month share of total debt servicing down from 21.04% in 2024 to 19.7% in 2025. (Figure 6, lower image) 

What’s apparent is a deliberate effort to paint macro stability by suppressing FX loan exposure. 

But in doing so, even if a fiscal shock doesn’t erupt in 2025, its shadow has: the pullback in FX loans weakens BSP’s structural defenses for its ‘soft peg’ regime. 

Finally, while we view the deficit-to-GDP ratio as a flawed metric, its relevance to consensus sentiment remains. A shock could send USD/PHP soaring, stocks plummeting, inflation spiking, rates rocketing and the economy stumbling—a chain reaction born of fiscal manipulation disguised as discipline. 

Part III: Conclusion: The Final Drift: From Rent-Seeking to Crisis 

The current flood control scandal reaffirms the lessons of the EDSA I and II Revolutions: corruption is not a binary, black-and-white event underwritten by good or bad ethics, but a symptom of a broader, deeper, and entrenched political-economic pathology called social democracy—where elections are treated as opportunities to gain both political capital and economic power through tenure-based rent-seeking. 

Thus, the systemic drift deepens toward free lunch policies—protecting the interests of a privileged few, while masking them as welfare interventions for the many. These “trickle-down” redistributions, in practice, breed dependence and disincentivize productivity. 

Intervention begets intervention, as every maladjustment and distortion calls forth another. 

As of this writing, the Philippine leadership has ordered a 50% cut in construction material prices while previously imposing both price ceilings on rice (MSRP and the “20-peso rollout”), and recently, price floors on palay farmgate prices.

Each measure deepens the drift toward centralization or socialism. 

The entropic consequences of the ochlocratic–social democratic regime are now manifesting even in embellished government data—suggesting that worsening conditions can no longer be shielded by the gaming and manipulation of marketplace and statistics (GDP, CPI, fiscal deficit, and debt among the most politically sensitive). 

The more the state intervenes to sustain the illusion of stability, the faster its underlying contradictions compound. 

The emergence of deeply seated corruption amid an ongoing economic slowdown exposes not only the late-cycle phase transition—but also Kindleberger’s drift toward the age of swindles, fraud, and defalcation. 

In the end, because both political and economic structures are ideological and self-reinforcing, reform from within is improbable. 

The deepening economic and financial imbalances will not resolve through policy, but will ventilate through a crisis—again the lessons of the post-1983 debt restructuring of EDSA I and the post-Asian Financial Crisis of EDSA II. 

____ 

References 

Based on legal caps under RA 8370 and RA 7166 and independent estimates (PCIJ, Inquirer, SunStar), actual campaign spending in competitive areas far exceeds statutory limits.

Prudent Investor Newsletters, The Philippine Flood Control Scandal: Systemic Failure and Central Bank Complicity, Substack, October 05, 2025 

Prudent Investor Newsletters, When Free Lunch Politics Meets Fiscal Reality: Lessons from the DPWH Flood Control Scandal, Substack, September 07, 2025 

Prudent Investor Newsletters, June 2025 Deficit: A Countdown to Fiscal Shock, Substack, August 03, 2025

 

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

 

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

In this Issue 

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

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

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

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

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

V. Treasury Market Plumbing: Who Really Benefits?

VI. Crowding Out: Corporate Issuers in Retreat

VII. The Free Lunch Illusion: Debt and Servicing Costs

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

IX. Q2 2025 Bank Profit Plummets on Credit Loss Provisions

X. Conclusion: Goldilocks Faces the Three Bad Bears 

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

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

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

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

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

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

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

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

Figure 1

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

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

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

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

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

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

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

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

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

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

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

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

Figure 2

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

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

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

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

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

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

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

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

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

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

V. Treasury Market Plumbing: Who Really Benefits? 

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

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

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

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

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

Figure 3

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

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

This wasn’t retail exuberance—it was plumbing. 

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

VI. Crowding Out: Corporate Issuers in Retreat 

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

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

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

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

VII. The Free Lunch Illusion: Debt and Servicing Costs

Figure 4

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

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

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

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

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

Crowding out isn’t just theoretical. 

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

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

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

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

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

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

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

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

Figure 5 

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

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

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

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

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

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

Goldilocks, eh? 

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

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

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

IX. Q2 2025 Bank Profit Plummets on Credit Loss Provisions

Figure 6 

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

The culprit? 

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

X. Conclusion: Goldilocks Faces the Three Bad Bears 

The cat is out of the bag. 

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

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

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

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

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

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

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

___

references 

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

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

 

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

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

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

In this issue: 

Part 1: Earnings Erosion and the Mask of Stability

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

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

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

1.D Income Breakdown: Lending Boom Masks Structural Risk

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

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

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

1.H The NPL Illusion: Velocity Masks Vulnerability

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

Part 2: Liquidity Strains and the Architecture of Intervention

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

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

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

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

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

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

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

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

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

Part 1: Earnings Erosion and the Mask of Stability 

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

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

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

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

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

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

Figure 1

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

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

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

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

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

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

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

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

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

1.D Income Breakdown: Lending Boom Masks Structural Risk 

What explains the sharp profit downturn?

Figure 2

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Figure 3

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

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

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

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

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

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

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

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

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

1.H The NPL Illusion: Velocity Masks Vulnerability

Figure 4

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

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

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

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

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

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

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

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

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

Part 2: Liquidity Strains and the Architecture of Intervention

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

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

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

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

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

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

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

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

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

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

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

Figure 5

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

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

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

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

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

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

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

Figure 6

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

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

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

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

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

Figure 7

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

As the saying goes: we live in interesting times. 

____

Prudent Investor Newsletter Archives: 

1 San Miguel

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

Just among the many…

2 CMEPA

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