The USD-PHP Breaks 59: BSP’s Soft Peg Unravels, Exposing Economic Fragility

 

Devaluing is a de facto default and the manifestation of the insolvency of a nation—Daniel Lacalle 

In this Issue

The USD-PHP Breaks 59: BSP’s Soft Peg Unravels, Exposing Economic Fragility 

Part I: The USD-Philippine peso Breach at Php59

IA. The Soft Peg’s Strain Finally Shows

IB. "Market Forces" or Managed Retreat?

IC. Gold, GIR, and the Mirage of Strength

ID. Historical Context: Peso Spikes and Economic Stress

Part II: The Savings–Investment Gap (SIG) Illusion

IIA. Savings–Investment Gap—a Flawed Metric and Free Lunch Spending

IIB. Misclassified Investment, ICOR and the Productivity mirage

Part III: Soft Peg Unravels: Systemic Fragility Surfaces, Confidence Breakdown

IIIA. The Keynesian Hangover: How "Spending Drives Growth" Became National Pathology

IIIB. Credit-Fueled Consumption and Fiscal Excess: Twin Deficits

IIIC. CMEPA and the Deepening of Financial Repression: How the State Institutionalized Capital Flight

IIID. Corruption as Symptom, Not Cause: The Flood Control Scandal and Malinvestment Crisis

IIIE. The Soft Peg's Hidden Costs: FX Regime as Subsidy Machine and Flight Accelerant

IIIF. Gold Sales Redux: The 2020–2021 Playbook Returns

IIIG. GIR Theater: Borrowed Reserves and Accounting Opacity, Slowing NFA and Widening BOP Gap

IIIH. Soft Peg Lessons: Where From Here? Historical Patterns and the Road to 62—or 67?

IV. Conclusion: Why This Time May Be Worse, the BSP is Whistling Past the Graveyard 

The USD-PHP Breaks 59: BSP’s Soft Peg Unravels, Exposing Economic Fragility 

How the BSP’s widening savings–investment gap, soft peg, flood control response left the peso exposed—and what it reveals about the Philippine economy.

Part I: The USD-Philippine peso Breach at Php59 

IA. The Soft Peg’s Strain Finally Shows 

This is what we posted at X.com 

After three years, $USDPHP breaks the BSP’s 59 Maginot line. What cracked it?

• 👉 Record savings–investment gap (BSP easing, deficit spending, CMEPA)
• 👉 BSP soft peg (gold sales)
• 👉 Capital controls fueling flight
• 👉 Weak economy + high debt 

The soft peg’s strain finally shows. 

After three years of tacit defense, the BSP’s 59.00 line cracked on October 28. Yet it closed the week—and the month—at 58.85, just below what we’ve long called the BSP’s ‘Maginot line.’ 

IB. "Market Forces" or Managed Retreat? 

The BSP and media attributed the breach to “market forces.” But if the peso’s rate is truly market-determined, why issue a press release at all? To reassure the public? Why the need for reassurance? And if the breakout were merely “temporary,” why frame it at all—unless the goal is to condition perception before the markets interpret the breach as systemic or draw their own conclusions?

Figure 1

Another dead giveaway lies in the BSP’s phrasing: it “allows the exchange rate to be determined by market forces.” (Figure 1, upper image)

That single word—allows—is revealing. 

It presupposes BSP supremacy over the market, implying that exchange rate movements occur only at the central bank’s discretion. FX determination, in this framing, is not a spontaneous process but a managed performance. Market forces operate only within the parameters permitted by the BSP. “Allowing” or “disallowing” thus reflects not market discipline, but bureaucratic control masquerading as market freedom. 

Yet, the irony is striking: they cite “resilient remittance inflows” as a stabilizer—even as the peso weakens. If OFW remittances, BPO earnings, and tourism inflows are as strong as claimed, what explains the breakdown? 

Beneath the surface, the pressures are unmistakable: thinning FX buffers, rising debt service, and the mounting cost of defending a soft peg that was never officially admitted.

IC. Gold, GIR, and the Mirage of Strength

Then there’s the gold angle. 

In 2024, the BSP was the world’s largest central bank seller of gold—offloading reserves to raise usable dollars. (Figure 1, lower chart)

Figure 2

Now, higher gold prices inflate its GIRs on paper—an accounting comfort masking liquidity strain. It’s the same irony we saw in 2021–22, when the BSP sold gold amid a pandemic recession and the peso still plunged. (Figure 2, upper graph) 

Adding to the drama, the government announced a price freeze on basic goods just a day before the peso broke Php 59. Coincidence—or coordination to suppress the impact? 

And there was no “strong dollar” to blame. The breakout came as ASEAN peers—the Thai baht, Indonesian rupiah, Singapore dollar, and Malaysian ringgit—strengthened. This was a PHP-specific fracture, not a USD-driven move. (Figure 2, lower table) 

ID. Historical Context: Peso Spikes and Economic Stress

Figure 3

Historically, sharp spikes in USDPHP have coincided with economic strain:

• 1983 debt restructuring
• 1997 Asian Financial Crisis
• 2000 dotcom bubble bust
• 2008–2010 Global Financial Crisis
• 2020 pandemic recession (Figure 3, upper window)

The BSP even admitted “potential moderation in economic growth due in part to the infra spending controversy” for this historic event. That makes reassurance an even more potent motive. 

Remember: USDPHP made seven attempts to breach 59.00—four in October 2022 (3, 10, 13, 17), three from November 21 and 26 to December 19, 2024. That ceiling revealed the BSP’s implicit soft peg. The communique doesn’t explain why the eighth breach succeeded—except to say it was “market determined.” But that’s just another way of saying the market has abandoned the illusion of BSP control. (Figure 3, lower diagram)

As I’ve discussed in earlier Substack notes, this moment was years in the making: 

• The widening savings–investment gap
• CMEPA’s distortions
• Asset bubbles, the creeping financial repression and fiscal extraction that eroded domestic liquidity 

The peso’s breach of 59 isn’t just a technical move. It’s the culmination of structural stress that monetary theater can no longer hide. 

Part II: The Savings–Investment Gap (SIG) Illusion

IIA. Savings–Investment Gap—a Flawed Metric and Free Lunch Spending 

Spending drives the economy.  That ideology underpins Philippine economic policy—from the BSP’s inflation targeting and deficit spending to its regulatory, tax, and FX regimes—and it has culminated in a record savings–investment (SIG) gap. 

This is the Keynesian hangover institutionalized in Philippine policy—confusing short-term demand management with sustainable capital formation 

But this is not merely technocratic doctrine; the obsession with spending anchors the free-lunch politics of ochlocratic social democracy. 

Yet even the SIG is a flawed metric. 

As previously discussed, “savings” in national accounts is a residual GDP-derived figure riddled with distortions, not an empirical aggregation of household or corporate saving. It even counts government savings—retained surpluses and depreciation allowances—when, in truth, fiscal deficits represent outright dissaving. (see reference) 

Worse, the inclusion of non-cash items such as depreciation and retained earnings inflates measured savings, masking the erosion of actual household liquidity.

IIB. Misclassified Investment, ICOR and the Productivity mirage 

Even the “investment” side is overstated. Much of it is public consumption misclassified as capital formation. Because politics—not markets—dictate pricing and returns, the viability of monopolistic political projects cannot be credibly established. 

Consider infrastructure. Despite record outlays, the Incremental Capital-Output Ratio (ICOR) has worsened—proof that spending does not equal productivity.

Figure 4

According to BSP estimates, the Philippines’ ICOR has fallen from around 8.3 in the 1989-92 period to approximately 4.1 in 2017-19, contracted by 12.7% and recovered to around 3.0 by 2022 (see reference) (Figure 4, topmost visual) 

While the ICOR trend suggests some efficiency gains since the 1990s, it remains a blunt and often misleading proxy—distorted by GDP rebasing, project misclassification, and delayed returns. What it does reveal, however, is the widening gap between spending and sustainable productivity 

Listed PPP firms, meanwhile, sustain appearances through leverage, regulatory capture and forbearance, and mark-to-model accounting. The result is concealed fragility, reinforced by the hidden costs of various acts of malfeasance, conveniently euphemized as by the public as “corruption.” 

In the end, the SIG tells a simple truth: domestic savings are too scarce to fund both public and private investment. The gap is bridged by FX borrowing. 

But this is not a sign of strength—it’s a symptom of deepening structural dependence, masked by monetary theater and fiscal illusion, thus amplifying peso vulnerability. Every fiscal impulse now imports external leverage, entrenching the illusion of growth at the expense of stability. 

Part III: Soft Peg Unravels: Systemic Fragility Surfaces, Confidence Breakdown 

IIIA. The Keynesian Hangover: How "Spending Drives Growth" Became National Pathology 

Spending-as-growth isn’t just policy—it’s pathology.

While the BSP’s mandate is "to promote price stability conducive to balanced and sustainable growth," its inflation-targeting framework—tilted toward persistent monetary easing—has effectively become a GDP-boosting machine to finance free-lunch political projects. 

Banks have realigned their balance sheets accordingly. Consumer loans by universal and commercial banks rose from 8.2% of total lending in December 2018 to 13.5% in August 2025—a 64% surge—while the share of industry loans declined from 91.7% to 86.5% over the same period. (Figure 4, middle pane) 

Fueled by interest rate subsidies and real income erosion, households are leveraging aggressively to sustain consumption. Yet as GDP growth slows, the marginal productivity of credit collapses—meaning every new peso of debt generates less output and more fragility for both banks and borrowers. 

Production credit’s stagnation also forces greater import dependence to meet domestic demand.

IIIB. Credit-Fueled Consumption and Fiscal Excess: Twin Deficits 

Meanwhile, deficit spending—now nearing 2021 pandemic levels—artificially props up consumption at the expense of productivity gains. (See reference for last week’s Substack.) 

Together, credit-fueled consumption and fiscal excess have produced record "twin deficits." (Figure 4, lowest chart) 

The fiscal deficit widened from Php 319.5 billion in Q2 to Php 351.8 billion in Q3, while the trade deficit expanded from USD 12.0 billion to USD 12.76 billion—levels last seen in 2020. 

Historically, fiscal deficits lead trade gaps—it raises import demand. If the budget shortfall hits fresh records by year-end, the external imbalance will likely push the trade deficit back to its 2022 peak.

Figure 5

These deficits are not funded by real savings but by credit—domestic and external. The apparent slowdown in approved public foreign borrowings in Q3 likely masks rescheduling (with Q4 FX borrowings set to spike?), delayed recognition, shift to BSP-led financing (to reduce scrutiny) or accounting prestidigitation (Figure 5, topmost diagram) 

Public external debt accounted for roughly 60% of the record USD 148.87 billion in Q2. Even if Q3 slows, the trajectory remains upward. (Figure 5, middle graph) 

In short, widening twin deficits mean more—not less—debt. 

Slowing consumer sales growth, coupled with rising real estate vacancies, signals that private consumption is already being crowded out—a deepening symptom of structural strain in the economy.

IIIC. CMEPA and the Deepening of Financial Repression: How the State Institutionalized Capital Flight

Yet the newly enacted CMEPA (Capital Market Efficiency Promotion Act, R.A. 12214) deepens the financial repression: it taxes savings, institutionalizes these by redirecting or diverting household savings into state-controlled channels or equity speculation, and discriminates against private-sector financing. By weakening the deposit base, it also amplifies systemic fragility. The doubling of deposit insurance last March, following RRR cuts, appears preemptive—an implicit admission of the risk CMEPA introduces. 

Authorities embraced a false choice. Savers are not confined to pesos—they can shift to dollars or move capital abroad entirely. Capital flight is not theoretical; for the monied class, it can be a reflexive response. 

IIID. Corruption as Symptom, Not Cause: The Flood Control Scandal and Malinvestment Crisis 

The recent “flood control” corruption scandal has merely exposed the deeper rot. 

Consensus recently blames the peso’s fall and stock market weakness on “exposed corruption.” But this is post hoc reasoning: both the peso and PSEi 30 peaked in May 2025—months before the scandal broke. (Figure 5, lowest image)

Corruption, as argued last week, is not an aberration—it’s embedded or a natural expression of free-lunch social democracy 

It begins at the ballot box and metastasizes through centralization, cheap money, financial repression, the gaming of the system and rent-seeking. It explains the entrenchment of political dynasties and the extraction economy they operate on. 

What media and the pundits call “corruption” is merely the visible tip. The deeper pathology is malinvestment—surfacing across: 

• Bank liquidity strains
• Wile E. Coyote NPLs
• Record real estate vacancies
• Slowing consumer spending despite record debt
• Cracks in employment data
• Persistently elevated self-rated poverty ratings (50% + 12% borderline as of September).
• Stubborn price pressures and more… 

The BSP’s populist response to visible corruption? 

Capital controls, withdrawal caps, probes, and virtue signaling. These have worsened the erosion of confidence, potentially accelerating the flight to foreign currency—and escalating malinvestments in the process. (see reference) 

What emerges is not just structural decay, but a slow-motion confidence collapse. 

IIIE. The Soft Peg's Hidden Costs: FX Regime as Subsidy Machine and Flight Accelerant 

And there is more. The BSP also operates a de facto FX soft-peg regime. 

By keeping a lid on its tacit thrust to devalue, its implicit goal is not merely to project macro stability, but to subsidize the USD and manage the CPI within its target band. Unfortunately, this policy overvalues the peso, encouraging USD-denominated borrowing and external savings while providing the behavioral incentive for capital flight.

Figure 6

Including public borrowing, the weak peso has prompted intensified growth in the banking system’s FX deposits. In August 2025, FX deposits rose 11.96%—the second straight month above 10%—reaching 15.07% of total bank liabilities, the highest since November 2017. (Figure 6, topmost window) 

The BSP’s FX regime also includes its reserves management—Gross International Reserves (GIR).

IIIF. Gold Sales Redux: The 2020–2021 Playbook Returns 

As noted above, similar to 2020–2021, the BSP embarked on massive gold sales to defend the USDPHP soft peg. Yet the peso still soared 22.97% from 47.90 in May 2021 to 58.9 in September 2022. That pandemic-era devaluation coincided with a CPI spike—peaking at 8.7% in January 2023. The 2024 gold sales echo this pattern, offering a blueprint for where USDPHP could be heading. 

The BSP insists that benchmarks like the GIR assure the public of sufficient reserves. Yet it has never disclosed the composition in detail. Gold—which the BSP remains averse to—accounts for only ~15% of the GIR (September). A former BSP governor even advocates selling gold "to profit” from it." (2020 gold sales and devaluation occurred in his tenure) 

But since the BSP doesn’t operate for profit-and-loss, but for political objectives such as "price stability," this logic misrepresents intent.

IIIG. GIR Theater: Borrowed Reserves and Accounting Opacity, Slowing NFA and Widening BOP Gap 

A significant portion of GIR—around 5%—consists of repos, derivatives, and other short-term instruments classified as Other Reserve Assets (ORA), introduced during the 2018 peso appreciation. Not only that: national government borrowings deposited with the BSP are also counted as GIR. Hence, “borrowed reserves” make up a substantial share. (Figure 6, middle graph) 

If reserves are truly as strong as officially claimed, why the peso breakout—and the need for a press release? 

All this is reflected in the stagnating growth of BSP net foreign assets (NFA) since 2025, reinforcing a downtrend that began in 2013. While nominally at Php 6.355 trillion, NFA is down 2.1% from the record Php 6.398 trillion in November 2024. (Figure 6, lowest diagram)

Figure 7

This fragility is also evident in the balance of payments (BOP) gap. Though narrowing in recent months, it reached USD 5.315 billion year-to-date—its highest since the post-pandemic recession of 2022. That’s 67% of the November 2022 peak. (Figure 7, topmost graph) 

The apparent improvement merely reflects deferred pressure—delayed borrowings and import compression. 

Despite BSP claims, net outflows reflect more than trade gaps. They signal external debt servicing amid rising leverage, capital flight, and systemic strain.

IIIH. Soft Peg Lessons: Where From Here? Historical Patterns and the Road to 62—or 67? 

Last March, we wrote: 

The USDPHP exchange rate operates under a ‘soft peg’ regime, meaning the BSP will likely determine the next upper band or ceiling. In the previous adjustment, the ceiling rose from 56.48 in 2004 to 59 in 2022, representing a 4.5% increase. If history rhymes, the next likely cap could be in the 61–62 range. (see reference) 

At the time, our lens was historical—measuring breakout levels from 2004 to 2022 and projecting forward to 2025. 

But as noted above, USDPHP spikes rarely occur in a vacuum. They tend to coincide with economic stress. Using BSP’s end-of-quarter data, we find: (Figure 7, middle table) 

• 1983 debt restructuring: +121% over 12 quarters (Q1 1982–Q1 1985)
• 1997 Asian Financial Crisis: +66.15% over 6 quarters (Q1 1997–Q3 1998)
• 1999–2004 dotcom bust: +30.6% over 20 quarters (Q2 1999–Q1 2004)
• 2007–2009 Global Financial Crisis: +16.95% over 5 quarters (Q4 2007–Q1 2009)
• 2020–2022 pandemic recession: +22.64% over 7 quarters (Q4 2020–Q3 2022) 

While the USDPHP also rose from 2013–2018, this episode was largely driven by the Fed’s Taper Tantrum, China’s 2015 devaluation, and Trump-era fiscal stimulus—with no comparable economic event.

IV. Conclusion: Why This Time May Be Worse, the BSP is Whistling Past the Graveyard 

The current moment is different. 

Using the post-2022 low—Q2 2025 at 56.581—as a base, a 10% devaluation implies a target of 62.24. But with the late-cycle unraveling, a weakening domestic economy, and rising debt burdens, the odds tilt towards a deepening of stagflation—or worse. If the peso mirrors its pandemic-era response, a 20% devaluation to 67.90 is not far-fetched. 

Even the BSP now concedes "potential moderation in economic growth." 

Yet it continues to cite “resilient inflows” like tourism. The Department of Tourism data tells another story: as of September 2025, foreign arrivals were down 3.5% year-on-year—hardly a sign of strength. (Figure 7, lowest chart) 

Otto von Bismarck’s maxim applies: 

Never believe anything in politics until it has been officially denied. 

Hounded by diminishing returns and Goodhart’s Law—where every target becomes a distortion—the BSP clings to benchmarks that no longer signal strength. From the USDPHP to GIR composition, Net Foreign Assets, and FX deposit ratios, the metrics have become theater. The more they’re defended, the less they reflect reality.

In the face of unraveling malinvestments, deepening institutional opacity, and accelerating behavioral flight, the BSP is whistling past the graveyard. 

Caveat emptor. The illusion is priced in.  

____ 

References 

Bangko Sentral ng Pilipinas, Discussion Paper Series No. 2024-10: Estimating the Incremental Capital Output Ratio (ICOR) for the Philippines, Towards Greater Efficiency: Estimating the Philippines’ Total Factor Productivity Growth and its Determinants BSP Research Academy, June 2024. 

Prudent Investor Newsletters: 

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

The CMEPA Delusion: How Fallacious Arguments Conceal the Risk of Systemic Blowback, Substack, July 27, 2025 

The Seen, the Unseen, and the Taxed: CMEPA as Financial Repression by Design, Substack, July 27, 2025 

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

The Political Economy of Corruption: How Social Democracy Became the Engine of Decay, Substack, October 26, 2025 

BSP’s Gold Reserves Policy: A Precursor to a Higher USD-PHP Exchange Rate? Substack, March 03, 2025 

How the BSP's Soft Peg will Contribute to the Weakening of the US Dollar-Philippine Peso Exchange Rate, Substack, January 02, 2025 

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

The Philippine Flood Control Scandal: Systemic Failure and Central Bank Complicity

 

Today the fashionable philosophy of Statolatry has obfuscated the issue. The political conflicts are no longer seen as struggles between groups of men. They are considered a war between two principles, the good and the bad. The good is embodied in the great god State, the materialization of the eternal idea of morality, and the bad in the "rugged individualism" of selfish men. In this antagonism the State is always right and the individual always wrong. The State is the representative of the commonweal, of justice, civilization, and superior wisdom. The individual is a poor wretch, a vicious fool—Ludwig von Mises 

In this issue

The Philippine Flood Control Scandal: Systemic Failure and Central Bank Complicity

I. ‘Shocked’ or Complicit? The Nexus of Policy and Corruption

II. A Financial System in Cartel’s Grip

III. Structural Failure, Not Just Regulatory Lapse; Virtue-Signaling Over Solution

IV. BSP Withdrawal Caps as Capital Controls: Six Dangers

V. Liquidity Theater and the Politics of Survival

VI. Systemic Risks on the Horizon

VII. Political Survival via Institutional Sacrifice; The Kabuki Commission

VIII. The Political Playbook: Delay, Distract, Dissolve

IX. Historical Parallels: When Economics Ignite Revolutions

X. The Strawman of Fiscal Stability and Revenue Realities

XI. Expenditure Retrenchment and the Infrastructure Dependency Trap

XII. The Keynesian Paradox, Liquidity Trap and Deposit Flight

XIII. PSE’s Sleight of Hand on CMEPA

X. The Horizon Has Arrived

XI. Statolatry and the Endgame 

The Philippine Flood Control Scandal: Systemic Failure and Central Bank Complicity 

What looks like an infrastructure scam is really a mirror of the Philippines’ deeper malaise: politicized finance, central bank accommodation, and a brittle economy propped by debt. 

I. ‘Shocked’ or Complicit? The Nexus of Policy and Corruption 

Media reported that BSP was “shocked” by the scale of corruption. The Philstar quoted the BSP Chief, who also chairs the AMLC: “It was worse than we thought… We knew there was corruption all along, but not on this scale… as much of a shock to the central bank as to the public.” 

“Shocked” at the scale of corruption? Or at their own complicity?

Figure 1

Easy-money ‘trickle-down’ policies didn’t just enable anomalies—they fostered and accommodated them. Banks, under BSP’s watch, have financed the government’s ever-expanding debt-financed deficit spending binge—including flood control projects—through net claims on central government (NCoCG), which hit Php 5.547 trillion last July, the third highest on record. Public debt slipped from July’s record high to Php 17.468 trillion in August. (Figure 1, upper window) 

II. A Financial System in Cartel’s Grip 

Meanwhile, operating like a cartel, bank control of the financial system has surged to a staggering 82.7% of total financial resources/assets, with universal commercial banks alone commanding 77.1% (as of July 2025). (Figure 1, lower chart) 

This mounting concentration is no mere market feature—the scandal exposes the financial system’s structural vulnerability. The scale of transactions, personalities, and institutional fingerprints involved in the scandal was never invisible. It was ignored. 

III. Structural Failure, Not Just Regulatory Lapse; Virtue-Signaling Over Solution 

This isn’t just a regulatory lapse. 

It is structural, systemic, and political—failure implicating not only the heads of finance and monetary agencies, but extends up to political leadership past and present. The iceberg runs deep. 

Worse, the economy’s deepening dependence on deficit spending to prop up the GDP kabuki only enshrines the “gaming” of the system—a choreography sustained by a network of national and local politicians, bureaucrats, financiers, media, and their cronies. 

Corruption scandals of this kind are therefore not confined to infrastructure—it permeates every domain tethered to policy-driven redistribution 

Yet instead of accountability, the BSP hides behind virtue-signaling optics. It flaunts probes and caps withdrawals, likely oblivious to the systemic damage it may inflict on beleaguered banks, stained liquidity, and an already fragile economy. 

The predictable ramifications: lingering uncertainties lead to a potential tightening of credit, and erodes confidence in Philippine assets and the peso. 

Ironically, this impulse response risks amplifying the very imbalances the BSP aims to contain—Wile E. Coyote dynamics in motion. 

Banks attempt to camouflage record NPLs via ‘denominator effects’ from a growth sprint on credit expansion while simultaneously scrambling to mask asset losses via intensifying exposure to Available for Sale Securities (AFS)—a desperate sprint toward the cliff’s edge—as previously discussed. (see reference section for previous discussion) 

IV. BSP Withdrawal Caps as Capital Controls: Six Dangers 

As part of its histrionics to contain the flood-control scandal, the BSP imposed a daily withdrawal cap of Php 500,000. 

First, these sweeping limits target an errant minority while penalizing the wider economy. Payroll financing for firms with dozens of employees, capital expenditures, and cash-intensive investments and many more aspects of commerce all depend on such flows. The economy bears the cost of institutional failure. 

Second, withdrawal caps are a form of capital control—another step in the state’s creeping centralization of the economy. Price controls (MSRP and "20 rice" rollouts), wage controls (minimum wages), and exchange-rate controls (the USDPHP soft peg) are already in place. Capital controls, by nature, bleed into trade restrictions and signal deeper interventionist intent. 

Third, with strains in the banking system worsening, the caps effectively lock in liquidity—an indirect rescue effort for banks at the expense of depositors. This is moral hazard in action: prudence is punished while recklessness is protected. But locking liquidity in stressed institutions risks triggering a velocity collapse, where money exists but refuses to circulate—amplifying systemic fragility. 

Fourth, once the public realizes that siloed money can be unilaterally withheld at will, the credibility of financial inclusion erodes, risking a collapse in confidence. Combined with CMEPA’s assault on savings, these measures push households and firms toward informal channels, further eroding trust in the banking system itself. The behavioral signal is chilling: your money is conditional; your trust is optional. 

Fifth, such public assurance measures expose the banking system’s inherent weakness. Rather than calming markets, they sow doubt over BSP’s capacity to safeguard stability—risking a surge in cash hoarding outside the formal system and spur credit tightening. 

Sixth, international investors may interpret this as mission creep in financial repression—adding pressure on Philippine risk premiums and the peso. Capital flight doesn’t need a headline—it just needs a signal. 

Finally, history warns us: Argentina’s 2001 corralito, Greece in 2015, and Lebanon in 2019 all saw withdrawal limits destroy trust in banks for a generation. The Philippines now flirts with the same danger. 

What begins as optics may end as rupture. 

V. Liquidity Theater 

Efforts to win public approval by “doing something” haven’t stopped at withdrawal caps or capital controls. The BSP has widened its response to include probes into the industry’s legal, administrative, and compliance frameworks—an escalation designed more for optics than systemic repair. 

While the BSP chief admitted that freezing bank funds tied to the flood control scandal could affect liquidity, he downplayed broader risks, claiming: “Our banks are very, very liquid at this point... No bank runs.” (italics added) 

Figure 2

But BSP’s own metrics tell a different story (as of July 2025): (Figure 2, topmost graph) 

-Cash-to-deposit ratio is at all-time lows

-Liquidity-to-deposit ratio has fallen to 2020 levels 

This isn’t stability—it’s strain. 

VI. Systemic Risks on the Horizon 

Beyond tighter liquidity and credit conditions, several systemic risks loom: 

1) Funding Stigma: Banks under investigation face counterparty distrust. Interbank markets may shrink access or charge higher spreads, amplifying liquidity stress. 

2) Reputational Contagion: Even unaffected banks risk depositor anxiety, particularly if they share infrastructure or counterparties with implicated institutions. Concentration risk thus becomes contagion risk. 

3) Depositor Anxiety: The public often interprets targeted probes as systemic signals. Precautionary withdrawals may accelerate, caps notwithstanding. Was BSP anticipating this when it chopped RRR rates last March and doubled deposit insurance? 

4) Regulatory Overreach: To signal credibility, BSP may impose stricter KYC/AML protocols—slowing onboarding, increasing balance sheet friction, and chilling transaction flows. 

5) Market Pricing of Risk: Equity prices, bond spreads, interbank rates, and FX volatility may rise—exposing incumbent fragilities and financial skeletons in the closet. Philippine assets have been the worst performers per BBG. (Figure 2, middle image) 

6) Earnings Pressure and Capital Hit: Sanctions, fines, and reputational damage translate to earnings erosion and capital buffer depletion—weakening the very liquidity BSP claims is “ample.” 

7) AML Fallout: The probe exposes systemic AML blind spots, risking FATF graylisting. Compliance costs may rise, deterring foreign capital. This episode reveals how the statistical criteria behind AMLA and credit ratings are fundamentally flawed. 

8) Political Pressure: The scandal’s reach into lawmakers and officials may trigger clampdowns on regulators, budget delays, and a slowdown in infrastructure spending. 

VII. Political Survival via Institutional Sacrifice; The Kabuki Commission 

One thing is clear: Diversionary policies—from the war on drugs to POGO crackdowns to nationalism via territorial disputes—have boomeranged. Now, the political war is being waged on governing institutions themselves. 

The BSP’s trifecta—capital controls, signaling channels, and probes—is part of a tactical framework to defend the administration’s survival. It sanitizes executive involvement while letting the hammer fall on a few “fall guys.” This is textbook social democratic conflict resolution: high-profile investigations and figurehead resignations to appease public clamor. 

Case in point: the Independent Commission for Infrastructure (ICI), reportedly funded by the Office of the President. How “independent” can it be if the OP bankrolls and decides on its output? 

As I noted on X: (Figure 2, lowest picture)

“That’s like asking the bartender to audit his own till. This ‘commission’ smells more like kabuki.” 

After a week, an ICI member linked to the scandal’s villain resigned. 

VIII. The Political Playbook: Delay, Distract, Dissolve 

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. 

IX. Historical Parallels: When Economics Ignite Revolutions 

Two EDSA uprisings were preceded by financial-economic upheavals:

1983 Philippine debt crisis → 1986 EDSA I

1997 Asian crisis → 2000 EDSA II 

The lesson is stark: Economic distress breeds political crisis. Or vice versa. 

X. The Strawman of Fiscal Stability and Revenue Realities 

The fiscal health of the Philippine government has been splattered with piecemeal evidence of the flood control scandal’s impact on the political economy. 

Authorities may headline that “Tax Revenues Sustain Growth; Budget Deficit Well-Managed and On Track with Full-Year Target”—but this is a strawman, built on selective perception masking structural deterioration. 

In reality, August 2025 revenues fell -8.8%. The Bureau of Internal Revenue’s (BIR) growth slowed to 5.04%, barely above July’s 4.8%, and far below 11.5% in August 2024. Bureau of Customs (BoC) collections slipped from +6% in July to -1.4% in August, versus +4.7% a year ago. Non-tax revenues collapsed -67.8%, deepening from July’s -9.7%, in stark contrast to the +281.6% surge a year earlier.

Figure 3

For January–August, revenue growth has decelerated sharply from 15.9% in 2024 to just 3.1% in 2025. BIR collections slowed to 11.44% (from 12.6%) and BoC to 1.14% (from 5.67%). Non-tax revenues plunged -31.41%, against +58.9% a year earlier. (Figure 3, topmost diagram)

XI. Expenditure Retrenchment and the Infrastructure Dependency Trap 

Meanwhile, August expenditures fell -0.74% YoY, with National Government disbursement contracting 11.8% for the second straight month. It shrank by 11.4% in July. 

Eight-month expenditures slowed from 11.32% in 2024 to 7.15% in 2025, driven by a sharp decline in NG spending from 10.6% to 3.98%. (Figure 3, middle and lowest graphs) 

Infrastructure spending dropped 25% in July, per BusinessWorld. The deeper August slump reflects political pressure restraining disbursements—pulling down the eight-month deficit. 

Though nominal revenues and expenditures hit record highs, the 2025 eight-month deficit of Php 784 billion is the second widest since the pandemic-era Php 837.25 billion in 2021 Ironically, today’s deficit remains at pandemic-recession levels even without a recession—yet. 

As we noted back in early September: 

"The unfolding DPWH scandal threatens more than reputational damage—it risks triggering a contractionary spiral that could expose the fragility of the Philippine top-down heavy economic development model.  

"With Php 1.033 trillion allotted to DPWH alone (16.3% of the 2025 budget)—which was lowered to Php 900 billion (14.2% of total budget)—and Php 1.507 trillion for infrastructure overall (23.8% and estimated 5.2% of the GDP), any slowdown in disbursements could reverberate across sectors.  

"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. " 

And it’s not just infrastructure. Political pressure has spread to cash aid distribution. ABS-CBN reported that DSWD is preparing rules “to insulate social protection programs from political influence.” Good luck with that. 

For now, rising political pressure points to a drastic slowdown in spending. 

XII. The Keynesian Paradox, Liquidity Trap and Deposit Flight

Figure 4

Remember: the government’s share of national GDP hit an all-time high of 16.7% in 1H 2025. (Figure 4, upper chart) 

This excludes government construction GDP and private sector participation in political projects (PPPs, suppliers, contractors etc.). Yet instead of a Keynesian multiplier, higher government spending has yielded slower GDP—thanks to malinvestments from the crowding out dynamic. 

The BSP is already floating further policy easing this October. BusinessWorld quotes the BSP Chief: “If we see [economic] output slowing down because of the lack of demand, then we would step in, easing policy rates [to] strengthen demand.”

The irony is stark. What can rate cuts achieve in “spurring demand” when the BSP is simultaneously probing banks and imposing withdrawal caps?

And more: what can they do when authorities themselves admit that CMEPA triggered a “dramatic” 95-percent drop in long-term deposits, or when households are hoarding liquidity in response to new tax rules—feeding banks’ liquidity trap?

XIII. PSE’s Sleight of Hand on CMEPA

Meanwhile, the PSE pulled a rabbit from the hat, claiming CMEPA attracted foreign investors from July to September 23. As I posted on X.com: The PSE cherry-picks its data. PSEi is significantly down, volume is sliding. The foreign flows came from a one-day, huge cross (negotiated) sale from Metrobank (PSE:MBT) and/or RL Commercial (PSE: RCR)—untruth does not a bull market make.” (Figure 4, lower picture)

What this really signals is that banks will scale up borrowing from the public to patch widening balance sheet imbalances—our Wile E. Coyote moment (see reference to our previous discussion). Banks, not the public, stand to benefit.

IX. The Debt Spiral Tightens

The bigger issue behind policy easing is government financing. 

As we’ve repeatedly said, the recent slowdown in debt servicing may stem from: “Scheduling choices or prepayments in 2024—or political aversion to public backlash—may explain the recent lull in debt servicing. But the record and growing deficit ensures borrowing and servicing will keep rising.” (see reference)

Figure 5

August 2025 proved the point: Php 601.6 billion in amortization pushed eight-month debt service to Php 1.54 trillion—just shy of last year’s Php 1.55 trillion, and already near the full-year 2023 total (Php 1.572 trillion). (Figure 5, topmost and middle graphs)

Foreign debt servicing’s share rose from 19.86% to 22.3%. 

Eight-month interest payments hit a record Php 584 billion, raising their share of expenditures from 13.8% to 14.8%—the highest since 2009.  (Figure 5, lowest chart) 

All this confirms: BSP’s rate cuts serve the government, banks, and politically connected elite—not the public. (see reference) 

X. The Horizon Has Arrived 

As we noted last August: (See reference) 

-More debt → more servicing → less for everything else

-Crowding out hits both public and private spending

-Revenue gains won’t keep up with servicing

-Inflation and peso depreciation risks climb

-Higher taxes are on the horizon 

That horizon is here. Higher debt, more servicing, more crowding out, faltering revenue gains, and higher taxes in motion (new digital taxes, DOH’s push for sin tax expansion…). 

Inflation and peso depreciation are coming. 

XI. Statolatry and the Endgame 

The paradox is sobering: Reduced public spending may slow diversion from wealth consumption and unproductive activities to a gradual build-up in savings—offering a brief window for capital formation. 

The bad news? Most still believe political angels exist, and that governance can only be solved through statism—a cult which the great economist Ludwig von Mises called statolatry. 

For the historic imbalances this ideology has built, the endgame can only be crisis. 

____

References 

Banks and Fiscal Issues 

Prudent Investor Newsletters, Minsky's Fragility Cycle Meets Wile E. Coyote: The Philippine Banking System’s Velocity Trap, Substack, September 14, 2025 

Prudent Investor Newsletters, When Free Lunch Politics Meets Fiscal Reality: Lessons from the DPWH Flood Control Scandal, Substack, September 7, 2025 

Prudent Investor Newsletters, June 2025 Deficit: A Countdown to Fiscal Shock, Substack, Substack, August 3, 2025 

Prudent Investor Newsletters, The Philippines’ May and 5-Month 2025 Budget Deficit: Can Political Signaling Mask a Looming Fiscal Shock?, Substack, July 7, 2025 

Prudent Investor Newsletters, Goldilocks Meets the Three Bad Bears: BSP’s Sixth Rate Cut and the Late-Cycle Reckoning, Substack, August 31, 2025 

CMEPA 

Prudent Investor Newsletters, The CMEPA Delusion: How Fallacious Arguments Conceal the Risk of Systemic Blowback July 27, 2025 (substack) 

Prudent Investor Newsletters, The Seen, the Unseen, and the Taxed: CMEPA as Financial Repression by Design July 20,2025 (substack)  

Ludwig von Mises, Bureaucracy, NEW HAVEN YALE UNIVERSITY PRESS 1944. p.74  Mises.org

 

 

Minsky's Fragility Cycle Meets Wile E. Coyote: The Philippine Banking System’s Velocity Trap

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances—Ludwig von Mises 

In this issue

Minsky's Fragility Cycle Meets Wile E. Coyote: The Philippine Banking System’s Velocity Trap

I. Introduction: The Banking System’s Wile E. Coyote Moment

II. NPL Benchmarks Unveil Minskyan Fragility and the Wile E. Coyote Moment

III. Diminishing Returns: Policy Stimulus-Backstop Backlash

IV. Banks’ Drift Toward Consumers: Credit Cards and Salary Loans Power NPLs Higher

V. Stagflation Signals and the Death Knell of Benchmark-ism: Labor Frailty Meets Inflation’s Third Leg

VI. The Wile E. Coyote Dynamic in Bank Investments via Available For Sale (AFS) Assets

VII. AFS Surge and Recession-Grade Financial Losses

VIII. Benchmark-ism and the Illusion of Confidence

IX. Velocity or Collapse: The Wile E. Coyote Reckoning

X. BSP’s Tacit Pivot: From Sovereign Risk to Banking Backstop

XI. Conclusion: The Velocity Charade Meets Its Limits 

Minsky's Fragility Cycle Meets Wile E. Coyote: The Philippine Banking System’s Velocity Trap

The Wile E Coyote velocity game—credit expansion, AFS bets, and central bank lifelines—keeps Philippine banks afloat, but the stability it projects is an illusion

I. Introduction: The Banking System’s Wile E. Coyote Moment 

Inquirer.net, September 06, 2025: Bad debts held by the Philippine banking system rose to their highest level in eight months in July, as lenders—facing slimmer margins from declining interest rates—may have leaned more on riskier retail borrowers in search of yield. Latest data from the Bangko Sentral ng Pilipinas showed that nonperforming loans (NPL), or debts overdue by at least 90 days and at risk of default, accounted for 3.40 percent of the industry’s total loan portfolio. That marked the highest share since November 2024, when the NPL ratio stood at 3.54 percent. 

Time and again, we’ve detailed the escalating challenges facing the Philippine banking system—chief among them, its role in financing the government deficit amid elevated rates. 

This has led to record levels of held-to-maturity (HTM) securities, mounting investment losses from mark-to-market exposures, and potentially unpublished credit delinquencies buried in loan accounts. 

Together, these forces have contributed to the system’s entropic liquidity conditions: a slow, grinding erosion of institutional health masked by policy choreography. 

But recent developments take the proverbial cake. While NPLs remain elevated, their apparent ‘containment’ has served as public reassurance—an illusion of stability. 

Beneath that veneer, banks have shifted into a "velocity game" to preserve KPI optics: record-high credit expansion running in tandem with record-high NPLs. 

This statistical kabuki masks growing stress but sets the system on a path to its own Wile E. Coyote moment. 

While this sustains confidence in the short term, the moment loan growth slows, the cliff edge becomes visible—and the entire charade unravels. 

II. NPL Benchmarks Unveil Minskyan Fragility and the Wile E. Coyote Moment

Figure 1

Since the second half of 2022, Philippine banks have seen a structural uptrend in gross nonperforming loans (NPLs), with nominal levels breaching all-time highs by April 2024 and reaching a record Php 535 billion in July 2025. (Figure 1, topmost chart) 

Though the industry’s NPL ratio remains at a deceptively flat at 3.4 percent, this apparent stability is largely the effect of the ‘denominator illusion’: total loan growth (+11 percent) has been fast enough to offset the rise in bad loans.  (Figure 1, middle window) 

This accelerates procyclical risk-taking—banks extend more credit, often to riskier retail borrowers, to maintain headline ratios. 

Neo-Keynesian economist Hyman Minsky famously proposed that financial instability evolves in stages—from hedge finance to speculative finance, and finally to Ponzi finance—where borrowers can no longer generate sufficient cash flows to service debt and must rely on refinancing, rollovers, or asset sales to stay afloat (see references) 

But Minsky’s framework has a counterparty: the lender. 

In the Philippine case, banks have become enablers of this drift. To keep overleveraged firms and households solvent, they must sustain ever-faster credit expansion—rolling over weak loans, extending new ones, and deferring recognition of losses. 

This is the Minskyan drift on the supply side: not just borrower pathology, but lender complicity. 

A banking system whose apparent stability depends on pyramiding credit to increasingly marginal borrowers, refinancing delinquent accounts, and chasing yield into riskier consumer segments—exacerbating the very fragility it was meant to manage. 

The result is a velocity-dependent equilibrium—one that demands constant motion to avoid collapse. 

When the sprint falters or bad debts surge, the NPL ratio will spike—mechanically, inevitably—unveiling the proverbial skeletons long buried beneath the benchmark gloss. 

The system confronts its Wile E. Coyote moment: suspended mid-air, legs still spinning, gravity imminent. Once credit growth slows, the ground disappears—and the fragility long masked by velocity is fully revealed. 

III. Diminishing Returns: Policy Stimulus-Backstop Backlash 

This Minskyan drift is unfolding despite a full-spectrum easing cycle from the Bangko Sentral ng Pilipinas: reserve requirement cuts, interest rate reductions, the USDPHP softpeg regime, doubled deposit insurance, and lingering regulatory relief. 

Layered atop record fiscal stimulus, these measures were designed to cushion the system—but they now reveal diminishing returns. 

The irony is sharp: instead of stabilizing credit dynamics, these policies have parlayed into rising risks—encouraging yield-chasing behavior and masking stress through refinancing. 

And to maintain the illusion of stability, authorities have upped the ante on benchmark-ism—using statistical bellwethers to project ‘resilience’ while embellishing markets to fit the narrative. 

As nominal NPLs climb and consumer credit deepens, the central bank faces an unenviable dilemma: tighten policy and risk triggering defaults, or deploy unprecedented, pandemic-style liquidity injections to preserve appearances even as the system runs out of runway. At the same time, banks themselves may be compelled to conserve liquidity and pull back on credit expansion, exposing the system’s velocity game for what it is. 

Needless to say, whether in response to BSP policy or escalating balance sheet stress, banks may begin pulling back on credit—unveiling the Wile E. Coyote moment, where velocity stalls and gravity takes hold. 

IV. Banks’ Drift Toward Consumers: Credit Cards and Salary Loans Power NPLs Higher 

This fragility is no longer confined to institutional (supply side) exposures—it’s now bleeding into the household sector. 

The banking system’s transformational pivot toward consumer credit—particularly credit card loans—has deepened latent risks, building a larger stock of eventual loan portfolio losses. 

While aggregate nominal consumer loans (including real estate) hit a record high in Q2 2025, non-performing loans also sprinted higher from their December 2022 bottom. Gross consumer NPLs now sit just 4.7% below their Q2 2021 peak. (Figure 1, lowest graph) 

Though recent increases have been broad-based, the lag in consumer credit delinquencies reflects delayed stress transmission—especially in motor vehicle and real estate segments.

Figure 2

Crucially, the share of consumer loans to banks’ total loan portfolio (net of interbank) reached an all-time high of 22.34% in Q2 2025. Year-on-year growth in consumer NPLs has accelerated from single digits in 2024 to double digits in the last two quarters. (Figure 2 topmost pane)  

As noted earlier, surging NPLs have accompanied blistering growth in credit card loans—both hitting record highs in Q2. (Figure 2, middle image) 

But it’s not just credit cards: salary loan NPLs also spiked to a record, juxtaposed against all-time high disbursements. (Figure 2, lowest graph)

Figure 3

Strikingly, even as bank lending hits new highs, consumer real estate NPLs have climbed over the past two quarters. This uptick comes despite previously stable delinquency rates—a counterintuitive anomaly given the record and near-record vacancy levels observed in Q1 and Q2 2025, potentially a product of sustained refinancing. (Figure 3, topmost diagram)  

These pressures are permeating into the demand side of the economy—further evidence of a consumer squeezed by inflation, debt, and the slow erosion of repayment capacity. 

Taken together, weak household balance sheets, rising camouflaged NPLs, and a slowing economy raise systemic risks that extend well beyond macro fundamentals—threatening institutional health and reaching deep into the financial sector’s core, even as headline growth continues to mask the underlying fragility. 

V. Stagflation Signals and the Death Knell of Benchmark-ism: Labor Frailty Meets Inflation’s Third Leg 

Credit risk pressures should intensify with the July labor market data, which unexpectedly exposes the labor market’s underlying frailty. 

The unemployment rate (5.33%) and unemployed population (2.59 million) surged to pandemic-era highs (August 2022: 5.3%, 2.681 million), while the labor participation rate fell to 60.7%—slightly above July 2023’s 60.1%. (Figure 3 middle and lowest images) 

Stunningly, despite a 1.51% YoY increase in population, the non-labor force swelled to 31.45 million, the highest level since at least 2021. 

Combined, the unemployed and non-labor force accounted for a staggering 42.5% of the 15-and-above population in July 2025—a July 2023 high. 

Ironically, authorities amusingly blamed the weather. 

For banks, a looming storm is brewing: fragile household balance sheets, concealed loan delinquencies, and a deteriorating labor market set the stage for increased NPL formation in Q3 2025, with potentially systemic consequences

Figure 4

There’s more. 

Authorities also reported that despite rice price controls and the 20-peso rollout, headline CPI jumped to 1.5% in August—exposing the likely anomalous 0.9% dip in July. More concerning is the CORE CPI breakout, rising from 2.3% to 2.7%, the highest since December 2024. (Figure 4, topmost visual) 

Historically, a negative spread—where CORE CPI exceeds headline—has signaled cyclical bottoms for headline inflation. 

History rhymes. Peak CPI in October 2018 marked the launchpad for the record run in gross NPLs, which climaxed in October 2021 before slowing. (Figure 4, second to the highest image) 

Likewise, February 2023’s peak CPI became the springboard for the recent all-time highs in gross NPLs—records now eclipsed or obscured by the Wile E. Coyote velocity game. 

The pattern is clear: Each cycle shows how households use credit to bridge spending power losses during inflation surges, only to leave borrowers delinquent in its wake. 

The fatal cocktail of surging unemployment and a potential third leg of the inflation cycle—stagflation—could be the coup de grâce for NPL benchmark-ism. The illusion of resilience may not survive the next impact. 

VI. The Wile E. Coyote Dynamic in Bank Investments via Available For Sale (AFS) Assets 

There’s another aspect we’ve barely touched—yet it has become a critical factor in the banking system’s health challenges, now showing symptoms of the Wile E. Coyote dynamic: investment assets. 

First, the distribution of bank assets reveals a transformational shift—from safeguarding liquidity to an entrenched addiction to leverage. This seismic rebalancing is evident in the rising share of investments and, more recently, the rebound in loan activity, both at the expense of cash reserves. (Figure 4, second to the lowest graph) 

Since the BSP’s historic rescue during the pandemic recession, the cash share of bank assets has plunged to an all-time low of 6.93% as of July 2025. 

Second, as we’ve repeatedly noted, the pandemic-level fiscal deficit has driven the banking system’s net claim on central government (NCoCG) to a record Php 5.547 trillion (up 7.12% last July). This is mirrored in Held-to-Maturity (HTM) assets, which rose 2.15% to a record Php 4.1 trillion. Today’s deficit is not just a macro concern—it’s manifesting as a liquidity squeeze across the banking system. And that’s before accounting for the adverse effects of crowding out. (Figure 4 lowest graph) 

Third, the very investments that carried the banking system through the pandemic—buoyed by the historic BSP cash injections—have now become a source of friction. 

The need for sustained liquidity from the BSP to keep asset prices afloat has morphed into a Trojan Horse for inflation and a fuel source for increasingly speculative risk-taking engagements. 

To stave off asset deflation, the BSP must inject liquidity—primarily via bank credit expansion—yet this comes at the cost of spiking inflation risk.

Figure 5

This dynamic is most evident in Available-for-Sale (AFS) assets, which now constitute 41% of gross financial assets, fast catching up to HTMs at 52%. (Figure 5, topmost window) 

VII. AFS Surge and Recession-Grade Financial Losses 

The record build-up of AFS assets has heightened exposure to mark-to-market shocks, transmitting valuation swings directly into capital accounts and investor sentiment. 

The impact is already visible: In Q2, Philippine banks suffered an income contraction of (-) 1.96%, driven largely by a surge in losses on financial assets totaling Php 43.782 billion—the largest since December 2020, at the height of the pandemic recession. Let it be clear, these are recession-grade losses. (Figure 5, middle chart) 

With fixed income rates falling and bond prices rallying, the source of these losses becomes clear by elimination: deteriorating equity positions and bad debt. This is reinforced by the all-time high in banks’ allowance for credit losses (ACL)—a supposed buffer against rising delinquencies that signals institutional awareness of latent stress. (Figure 5, lowest diagram) 

Yet, like NPLs, these record ACLs are statistically suppressed by spitfire loan growth.

VIII. Benchmark-ism and the Illusion of Confidence

Figure 6

Nonetheless, this structural shift helps explain the growing correlation between AFS trends and the PSE Financial Index. (Figure 6, topmost window) 

In this light, banks—alongside Other Financial Corporations (OFCs)—may well represent a Philippine version of the stock market “National Team”: pursuing benchmark-ism or, perhaps, reticently tasked with pumping member-bank share prices within the Financial Index to choreograph market confidence. 

Patterns of coordinated price actions—post-lunch ‘afternoon delight’ rallies and pre-closing pumps—can often be traced back to these actors. 

Whether by design or silent coordination, the optics are unmistakable. 

IX. Velocity or Collapse: The Wile E. Coyote Reckoning 

The implication is stark: even as banks expanded their AFS portfolios —ostensibly for liquidity and yield, they deepened their exposure to volatility and credit deterioration. 

Equity-linked losses began bleeding into financial statements, and provisioning behavior revealed a system bracing for impact. 

The liquidity strain was hiding in plain sight—concealed by statistical optics and benchmark histrionics.

Compounding this is the shadow of large corporate exposures—most notably San Miguel Corporation, whose Q2 profits were largely driven by asset transfers, shielding its Minskyan Ponzi-finance model of fragility 

For instance, if banks hold AFS equity stakes or debt instruments linked to SMC, any deterioration in valuation or repayment capacity would surface as mark-to-market losses or provisioning spikes. 

Alas, like Wile E. Coyote, banks now require another velocity game—pumping financial assets higher to sustain investment optics. 

Without it, they risk compounding their liquidity dilemma into a full-blown solvency issue.

X. BSP’s Tacit Pivot: From Sovereign Risk to Banking Backstop 

The drain in the banking system’s cash reserves appears to be accelerating. 

Following June’s 11.35% jump (+Php 224.78 billion), July posted a 12.8% contraction (–Php 281.87 billion), fully offsetting gains of June, and partly last May (+Php 66.11 billion). Nonetheless, cash and due from banks at Php 1.923 trillion fell to its lowest level since at least 2014. 

And July’s slump signifies a continuum of long-term trend. However, from the slomo erosion, the depletion appears to be intensifying. 

So, despite interim growth bounce of deposits and financial assets, net (excluding equities), the cash-due banks to deposit and liquid-assets-to-deposit ratios resume their respective waterfalls.  In July, cash to deposit ratio slipped to all-time lows, while liquid assets-to-deposit fell to pre-pandemic March 2020 lows! (Figure 6, middle chart) 

Ironically, July’s massive cash drain coincided with the implementation of CMEPA. 

Importantly, banks drew a massive Php 189 billion from the central bank’s coffers as shown by the BSP’s claims on other depository corporations (ODC). (Figure 6, lowest diagram) 

This wasn’t a routine liquidity operation—it was a balance sheet pivot, redirecting support away from direct government exposure and toward the banking sector itself. The implication is clear: the system is leaning harder on central bank liquidity to offset deepening reserve depletion.

Figure 7

By shrinking its net claims on the central government (NCoCG) while expanding its claims on ODCs, the central bank has effectively told the Treasury to park its funds at BSP, while opening its own balance sheet wider to banks. This reduces BSP’s exposure to sovereign credit, but leaves banks more dependent on central bank lifelines to cover liquidity shortfalls. (Figure 7, topmost visual)  

In practice, this means banks are now forced into a double bind. On one hand, they must absorb more government securities and expand credit to keep up the optics of balance-sheet strength. 

On the other, they rely more heavily on BSP’s injections to plug holes in cash reserves. This rebalancing masks systemic strain—liquidity looks managed on paper, but the underlying dependence on continuous velocity (credit growth, AFS positioning, and central bank drawdowns) signals fragility. 

Far more crucial, what emerges is a structural shift: the BSP’s balance sheet is less about backstopping fiscal deficits and more about propping up the banking system. Yet this is not a permanent fix—if banks stumble in their velocity game or government borrowing intensifies, the pressure could quickly return in the form of crowding-out, valuation losses, and even solvency fears. In short, the pivot may buy time, but it also deepens the Wile E. Coyote dilemma: run faster, or fall.

With the BSP pivoting towards a backstop, bank borrowing growth decelerated to 8.9% YoY or fell by 14% MoM in July to Php Php 1.58 trillion—about 17% down from the record Php 1.907 trillion last March 2025. (Figure 7, middle image) 

This deceleration underscores the limits of the velocity game: even with central bank support, banks are struggling to sustain credit expansion without exposing themselves to deeper asset and funding risks. 

XI. Conclusion: The Velocity Charade Meets Its Limits 

The deepening Wile E. Coyote dynamic—where velocity props up optics of loans and investments—is unsustainable. (Figure 7, lowest cartoon) 

Surging NPLs and rising latent loan losses belie the façade of credit expansion. 

Accelerated exposure to AFS assets injects mark-to-market volatility, while HTMs tie banks to the unsparing race of public debt. 

There is no free lunch. Policy-induced fragility is no longer theoretical—it is compounding and irreducible to benchmark-ism or statistical optics. 

The illusion of managed liquidity is cracking. Each policy lifeline buys time—but only deepens the fall if velocity fails. 

Yet banks and the political economy have locked themselves in a fatal trap:

• Deposit rebuilding is punished by state policy,
• Recapitalization is constrained by fiscal exhaustion,
• Capital markets are dominated by overleveraged elites,
•  Hedge finance is crowded out by Ponzi rollovers,
• Tax and savings reform is politically dead under “free lunch” populism 

In short: a trap within an inescapable trap. 

___

References: 

Hyman P. Minsky, The Financial Instability Hypothesis, The Jerome Levy Economics Institute of Bard College, May 1992 

Prudent Investor Newsletter Substack Archives: 

-Goldilocks Meets the Three Bad Bears: BSP’s Sixth Rate Cut and the Late-Cycle Reckoning August 31, 2025 (substack) 

-Philippine Banks: June’s Financial Losses and Liquidity Strains Expose Late-Cycle Fragility August 7, 2025 (substack) 

-Liquidity Under Pressure: Philippine Banks Struggle in Q1 2025 Amid a Looming Fiscal Storm May 18, 2025 (substack) 

-BSP’s Fourth Rate Cut: Who Benefits, and at What Cost? April 13, 2025 (substack) 

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)