The PSEi-ICTSI Show, Part III: The Fulcrum Cracks—Benchmark-ism Unravels

 

You can't do well in investments unless you think independently. And the truth is, you're neither right nor wrong because people agree with you. You're right because your facts and your reasoning are right. In the end, that's all that counts. And there wasn't any question about the facts or reasoning being correct—Warren Buffett 

In this issue: 

The PSEi-ICTSI Show, Part III: The Fulcrum Cracks—Benchmark-ism Unravels

I. Ghost Month, Real Losses

II. The ICTSI Fulcrum Cracks

III. Breadth Confirms the Divergence

IV. From Prop to Drag: The Mechanics of Concentration in Reverse

V. Rotation Without Broadening: Speculative Capital in Search of the Next Punt

VI. The Arrière-Pensée: Confidence Is the Cover Story, Collateral Is the Point

VII. Conclusion: Benchmark-ism Meets Its Own Arithmetic 

The PSEi-ICTSI Show, Part III: The Fulcrum Cracks—Benchmark-ism Unravels 

When one stock becomes the market, its reversal becomes the market's problem: August exposes the concentration, liquidity, and benchmark-ism beneath the PSEi's manufactured confidence 

In Part I we flagged ICTSI as the PSEi 30's single point of vulnerability. In Part II we showed how that vulnerability had metastasized into concentrated liquidity, shrinking participation, and outright benchmark-ism. August supplied the arithmetic Part II warned was coming. 

I. Ghost Month, Real Losses

Figure 1

August is conventionally excused as the market's "ghost month"—a superstition with Chinese roots, ironically applied by the establishment commentaries to a market that isn't Chinese. The historical record hardly justifies the fear: from 2010 through 2025, August produced gains in only six of sixteen years, with an average loss of a marginal -0.33%. Mostly noise. (Figure 1, upper window)  

This August wasn't noise. The PSEi 30 fell 4.49% month-on-month—the fourth-largest monthly loss since 2010—dragging the year-to-date return to roughly -1.60% and the year-on-year figure to -3.24%. (Figure 1, lower table)

Figure 2 

The damage was compressed: a single closing week's 4.52% plunge erased three months of the index's ICTSI-driven advance. (Figure 2, upper image) 

Ghost month or not, the mechanism behind the reversal is the one this series has tracked for some time, but which intensified last June: ICTSI had become the fulcrum propping up the PSEi 30, and a fulcrum that lifts a benchmark on the way up can just as easily accelerate its fall. 

The timing again matters. 

The final week's plunge did not arrive in isolation. 

On Friday, the USDPHP closed at Php 62.265, a record, extending Thursday's prior record-low close of Php 61.888. Markets were also absorbing the BSP's latest policy signals, and the 7-month record fiscal and trade deficits. (Figure 2, lower chart) 

The PSEi 30 fell in lockstep, down for a fourth consecutive session and closing below 6,000, erasing gains since June. 

A rate hike aimed at defending the currency and a benchmark sliding on the same day are not coincidences to be filed separately from the ICTSI story. They are another expression of the same "resistance to adjustment" pattern this (stagflation) series has tracked across fiscal, monetary, and FX-regime policy: administrative efforts to keep the peso, the yield curve, and the index from clearing at levels the underlying imbalances would otherwise dictate. 

When that resistance gives way on the currency side, it rarely leaves the equity side untouched—not when equity "confidence" was doing double duty as collateral support in the first place. 

II. The ICTSI Fulcrum Cracks 

The same stock that manufactured the June-July rally supplied most of August's decline. ICTSI fell 7.86% week-on-week and 8.1% month-on-month, accounting for roughly 46% and 48%, respectively, of the PSEi's weekly and monthly losses. 

This is simply capitalization-weighting running in reverse. The identical arithmetic that let one company's 57% first-half return mask a negative-6.8% average constituent return in Part II is now transmitting one company's reversal directly into the headline index. 

A benchmark built to amplify a single stock's ascent is, by the same construction, built to amplify its descent.

Figure 3

ICTSI's share of the PSEi's free-float market cap slipped to 25.58% by month's end, down from a peak of 27.37% in the first week of August. (Figure 3, upper pane)         

The combined weight of the top five constituents eased from July's peak of 56.12% to about 54.7%. 

Small retreats in percentage terms—large in what they signal: the "national team" support that Part II documented in the daily trading choreography appears to be losing its grip on the tape. 

III. Breadth Confirms the Divergence 

Beneath the headline, the market's breadth told a different story from the index. 

Only 10 of the PSEi's 30 constituents rose in August; the average constituent decline was roughly -2.92%—materially less than the benchmark's -4.49%, as ICTSI's outsized free-float market-cap weight amplified its decline in the headline index. (Figure 3, lower visual)

Figure 4

The divergence was even more pronounced during the final week's meltdown: only 7 of the 23 constituents that traded that week rose, while the average change was -2.78%—another example of how free-float market-cap weighting magnified the impact of ICTSI's decline on the benchmark. (Figure 4, upper diagram) 

Exchange-wide breadth stayed only marginally negative—1,783 advances against 1,818 declines—a spread nowhere near as lopsided as the ICTSI-driven index move would suggest. (Figure 4, lower image) 

That gap between a nearly even advance-decline line and a sharply negative benchmark is itself the tell: the index and the market it purports to summarize are increasingly telling two different stories, exactly as Part II's mid-year data showed in reverse. 

IV. From Prop to Drag: The Mechanics of Concentration in Reverse

Figure 5 

The unraveling wasn't confined to price. It showed up in the plumbing of trading activity too. ICTSI's % share of Main Board volume fell sharply from 28.23% in July to 21.91% in August as foreign flows shifted from net buying (Php 5.265B in July) to net selling (Php 1.59B in August). (Figure 5, upper graph) 

The same expansion in ICTSI's trading dominance that Part II attributed to both rising ICTSI activity and shrinking activity elsewhere is now reversing on both counts at once: as ICTSI volume recedes, there is no offsetting pickup in the rest of the market to cushion the loss of liquidity. 

The pattern increasingly resembles South Korea's KOSPI, where Samsung and SK Hynix now function as the index in practice. The difference is that Korea's concentration rides a global AI-hardware cycle with real earnings behind it; ICTSI's had no comparable confirmation from global port-operator peers, a point already established in Part II. (Figure 5, lower chart) 

Main Board volume fell 17.24% year-on-year to about Php 113.108 billion; aggregate turnover fell 4.5% to Php 142.976 billion. Cross trades made up 18.74% of Main Board volume, a four-month high—more of the exchange's already-shrinking activity conducted off the central order book, away from open price discovery. 

V. Rotation Without Broadening: Speculative Capital in Search of the Next Punt 

As the dominant ICTSI trade weakened, the other big caps failed to fill the gap—or the expected ‘rotation’ didn’t happen. Instead, trading activity shifted toward smaller, more speculative names—restructuring rumors, backdoor-listing chatter, M&A gossip—even as overall volume contracted. 

Near-even breadth on falling volume is not a healthy broadening of participation. It looks more like speculative capital searching for the next short-term story once the previous market leader loses momentum, not new capital entering the market on improved fundamentals. 

The extraordinary ICTSI ascent that carried the PSEi through June and July appears to have reached its inflection point. What follows this kind of top is rarely a broad-based handoff to the rest of the index; it's usually a scramble among smaller, thinner names while the index itself searches for a new prop. 

The progression is telling: from speculation to outright gambling, as capital searches less for value than for the next trade capable of replacing the momentum it has lost—more recipe for capital consumption. 

VI. The Arrière-Pensée: Confidence Is the Cover Story, Collateral Is the Point 

In Part II, we named this dynamic “benchmark-ism”: political and institutional narrative management that uses market and economic statistics to manufacture the appearance of stability—or to keep the Overton window of acceptable economic outcomes from shifting toward adjustment. 

August is the moment that narrative met its own arithmetic. 

Gains have always been projected as "confidence"—a rising PSEi as evidence of "resilience," useful for a leadership with sagging approval ratings and an economy absorbing the mounting tensions from the aftershocks of the Iran-war oil shock, EO 110's price-suppression architecture, and a cascade of BSP relief measures already tracked in this series. But confidence was never the only objective, and arguably not the primary one. 

Elevated equity prices are collateral. They support asset values on bank and corporate balance sheets, cushioning a financial system already leaning on the BSP's regulatory relief and foreign-exchange interventions to keep the credit cycle turning. 

Put bluntly: a rising PSEi, and specifically a rising ICTSI, was never just about optics. It was about propping up the collateral base that a decaying credit cycle depends on to keep rolling over. That is the arrière-pensée behind the applause Part II described—the second, unstated motive sitting behind the first. 

The trouble with using one stock as collateral infrastructure for an entire financial system is that the mechanism is symmetric. 

What inflates the collateral on the way up can deplete it on the way down, potentially at a leveraged pace 

August didn't just cost the PSEi 4.49%. It cost the system a slice of the very collateral cushion the whole exercise was designed to build. 

VII. Conclusion: Benchmark-ism Meets Its Own Arithmetic 

This isn't the first time a single Philippine equity story has been mistaken for—or dressed up as—a market. The DigiPlus [PSE: PLUS] gaming-stock bubble of 2025 ran on the same logic: a policy-fueled speculative vehicle inflated past any relationship to its fundamentals, celebrated rather than examined, until the arithmetic of momentum reversed on its own. 

We called that top in real time and traced its roots back to the same boom-bust pattern that took down BW Resources in 1999. 

ICTSI is a larger, more systemically consequential version of the same mechanism—dressed in blue-chip legitimacy instead of casino-stock notoriety, but running on identical fuel: concentrated, momentum-driven flows mistaken for confidence. 

• Part I called ICTSI the PSEi's single point of vulnerability. 
• Part II showed that vulnerability metastasizing into concentrated liquidity and narrative management.
• Part III shows what happens when the fulcrum that was doing the lifting starts doing the dropping instead. 

The PSEi was supposed to represent the market. But once the representation itself becomes something to be managed—because it communicates confidence and supports financial conditions—it begins to substitute for the reality it was meant to represent. That is the simulacrum. 

The episode reconfirms why the PSEi is becoming an increasingly unreliable gauge of the broader Philippine equity market—and, equally, a more fragile one: susceptible to substantial mispricing, disproportionate liquidity exposure, asset-bubble formation, rising concentration risk, and hidden leverage. 

Benchmark-ism can manufacture confidence for a while. It cannot repeal the arithmetic of the index it's built on.

___

References:

Prudent Investor Newsletters, The PSEi-ICTSI Show, Part II: When One Stock Becomes the Market, July 19,2026 

Prudent Investor Newsletters, PSEi 30: The ICTSI Show, June 7, 2026

 

PSEi 30’s 1Q Non-Financials Borrowing Swelled by Php 528 Billion as Earnings Fell by Php 49 Billion! BSP’s Real Estate Index Boomed as GDP Contracted in 1Q!

The essence of the this-time-is-different syndrome is simple. It is rooted in the firmly held belief that financial crises are things that happen to other people in other countries at other times; crises do not happen to us, here and now. We are doing things better, we are smarter, we have learned from past mistakes. The old rules of valuation no longer apply. Unfortunately, a highly leveraged economy can unwittingly be sitting with its back at the edge of a financial cliff for many years before chance and circumstance provoke a crisis of confidence that pushes it off—Carmen Reinhart and Kenneth Rogoff

 In this issue:

PSEi 30’s 1Q Non-Financials Borrowing Swelled by Php 528 Billion as Earnings Fell by Php 49 Billion! BSP’s Real Estate Index Boomed as GDP Contracted in 1Q!

I. PSEi 30’s 1Q Borrowing Swells by Php 528 Billion as Net Income Decreased by Php 49 Billion!

II. Why the Massive Bailouts?

III. Rising Asset Prices from Low Rates Aren’t Signs of Stability But Disguising Risks Through Liquidity Injections

IV. Debt Crisis Represents an Outcome of the Dynamic Process of Excessive Leveraging

V. Malinvestments: Effects of Credit Easing: BSP’s Real Estate Index Boomed as the GDP Contracted!

PSEi 30’s 1Q Non-Financials Borrowing Swelled by Php 528 Billion as Earnings Fell by Php 49 Billion! BSP’s Real Estate Index Boomed as GDP Contracted in 1Q!

This outlook deals with the following:

How can there be a robust recovery when borrowings of the component members of the PSYEi 30 continue to outgrow net income?

Bailout upon bailout measures, if the economy is sound, why the need to institute a culture of bailouts?

Are surging assets signs of stability, or are they symptoms of policies designed to conceal risks?

Understanding the debt crisis cycle through its dynamic process.

Philippine property prices boomed in the 1Q as the GDP reeled, is this sustainable?

I. PSEi 30’s 1Q Borrowing Swells by Php 528 Billion as Net Income Decreased by Php 49 Billion!

In the Bangko Sentral ng Pilipinas’ latest Financial Stability Report (April 2020), one of its principal concerns has been the excess leveraging of PSE firms. (bold mine)

Moreover, the outstanding corporate debt among 200 listed companies stood at PHP9.3 trillion, 28.4 percent of which is denominated in foreign currency (FCY). This year, USD3.46 billion of FCY debt will mature, while PHP553 billion in local currency is likewise due (Figure 2.16). The latter will be tested by any impairment in revenues, and thus capacity to pay, while the former will add pressure on USD liquidity, on top of income capacity.

It should be pointed out that the debt repayment capacity of some PSE-listed non-financial corporates (NFCs) was already declining before the emergence of COVID-19. The interest coverage ratio (ICR), which is a measure of the firm’s ability to service the interest obligations of their debt, has been decreasing in recent periods as interest expense has grown by an annualized rate of 20.9 percent, while earnings before interest and taxes (EBIT) has only grown by 9.0 percent over the past three years (Figure 2.17). Stress test estimates suggest that the ICR declines from 6.44 in Q4 2019 to 4.01 (at 10 percent EBIT decline) or further to 2.23 (at 50 percent EBIT drop). Although the policy rate has been reduced starting April 2019, the impact of lower rates on existing bank debts would not be felt until the repricing of those loans usually a year later.

Php 9.3 trillion of outstanding corporate debt accounts for a remarkable 40.7% of the total resources of the financial system as of the close of 2019.

In the 1Q 2020, even as revenues and net income tumbled, indebtedness of the principal equity benchmark’s 26 nonfinancial issues expanded by an incredible 12.9% or by Php 528.237 billion to Php 4.624 trillion!

Figure 1

Some statistics first.

Net income of the PSYEi 30 plummeted 27.7% to Php 127.92 billion from Php 176.88 billion a year ago or a Php 48.96 billion decrease. Excluding banks, nonfinancial firms posted a 31.42% net income plunged to Php 103.581 billion from Php 151.031 billion or down by Php 47.5 billion.

Total revenues of the index firms slipped by 5.18%, excluding bank revenues have been lower by 6%. 

Since the National Government imposed the rigorous social distancing measure of the Enhanced Community Quarantine (ECQ) covering the Luzon island, which essentially shut down most of the economy starting March 17, these firms declared about two-and-a-half months of normal operations in their 1Q Financial Statements.

Even then, the damage to their bottom line has been substantial. Yet, given the likely tendency for firms to look good, the extent of published losses may not have been an accurate depiction of real conditions.

As such, plugging the actual financial deficits may have been one of the reasons for the fantastic debt surge.

Led by holding companies and the property sector, PSEi non-financial firms borrowed a staggering Php 528.24 billion even as earnings dropped by 47.5 billion. Or PSEi borrowings in 1Q accounted for an astonishing over 4x their published net income!

Please note that the low debt growth rate signifies a function of a high baseline figure.

Moreover, some of the debt acquired may have been used for either bridge financing or raising liquidity under the duration of Community Quarantine.

And with most of the economy in suspended animation in the 2Q, expect index firms to post significant losses rather than reduced income.

II. Why the Massive Bailouts?

Because the Bayanihan law shielded liability collections or sanctioned moratorium on debt repayments, aside from other regulatory easing measures implemented, expect distortions on the reporting of Financial Statements over the interim.

Furthermore, the BSP’s regulatory relief on financial institutions may also help conceal the actual conditions of banks.

The FSR enumerates the measures the BSP has undertaken in its FSR (p21-25)

Aside from the reduction of policy rates, reserve requirements, and direct support of the Bureau of Treasury through a Php 300 billion direct repo arrangement, the BSP will also be scaling down the Overnight Reverse Repurchase volume offering, it will be purchasing government securities (GS) in the secondary market, and it will be temporarily reducing the term spread on the peso rediscounting loans relative to the overnight lending rate to zero.

The BSP extended 1) operational relief measures for FX transactions, implemented regulatory relief measures for banks to encourage the supervised financial institutions to provide financial relief to their customers, clients, and employees, 2) Prudential accounting relief measures to reduce the impact of mark-to-market losses and 3) Relaxed Know Your Customer requirements for both over the counter and electronic or online transactions.

The easing up of regulations applied to the other agencies as well. 1) The PDIC announced the grant of payment relief for corporate and closed banks' clients whose payments for loans, real property purchases, and lease fall due during the community quarantine period. 2) The IC extended the coverage of insurance policies and Health Maintenance Organization agreements about to expire during the quarantine, and 3) the SEC extended the filing of annual reports and suspended the payment of cumulative penalties for covered companies.

Add this to the panoply of redistributive policies, from the Inquirer (July 4): “In its bid to make available loans to small businesses badly hit by the COVID-19 crisis, the state-run Philippine Guarantee Corp. (Philguarantee) has green-lit P37.5 billion in credit guarantees as of end-June. Philguarantee said the total credit guarantee facilities it approved during the second quarter covered 22 accredited banks serving micro, small and medium enterprise (MSME) borrowers.”

Debt repayment capacity of many PSE firms, which was already declining before the emergence of COVID-19, as the FSR pointed out, further deteriorated in the 1Q. And the amount of debt raised, Php 528.24 billion, accounts for about 95.5% of the local currency debt due this year.

And the over Php 9.3 trillion of corporate debt outstanding, which represents about 40% of the financial resources, highlights the mounting concentration risks in the financial system.

A 50% drop in EBIT earnings appears to be the maximum input the BSP used for its stress test model. What if the rate of decline in EBIT earnings will be more? What if losses occurred? How will these impact liquidity, solvency, and transactional flows in the system?

For instance, the 19.76% jump in San Miguel’s debt by Php 160.25 billion to a staggering Php 971 billion accounts for 30.34% of the overall debt increases. Yet, the firm suffered a 91.5% crash in earnings. That’s just the 1Q. How about the 2Q?

 San Miguel’s Stunning Race to Reach Php 1 Trillion Debt! June 8, 2020

Figure 2

Interestingly, the BSP vows to unwind these emergency measures once the crisis has passed.

From the Inquirer (July 2): In a press briefing, Bangko Sentral ng Pilipinas Governor Benjamin Diokno assured his stakeholders that, once the crisis abates, the unwinding of COVID-19 relief measures will be data-driven, done gradually and prudently, and communicated correctly to all stakeholders.

When has the BSP withdrawn the emergency measures it implemented? ON RRP rates, presently at a record low, have barely returned to its base levels, after being used to support the economy from the Global Financial Crisis (GFC) almost 13-years ago!

The BSP’s debt monetization policies have barely regressed to its original levels, after being ramped up from 2007 to 2009 likewise as a shield against the GFC. Instead, it began to climb in 2015, and the rate of increases accelerated even before 2020!

If the economy, as presented by the mainstream, has been robust, why the need for such a massive 'stimulus' or policy support?

What would the financial system and the economy look like with the withdrawal of such policy steroids?  Can it even withstand its absence?

And has it not been a wonder, why an economy or financial system ever so dependent on policy support, would require even greater interventions? Interventions beget interventions.

At the end of the day, BSP’s policies reinforce the ratchet effect or in Milton Friedman’s perspective, “nothing is so permanent as a temporary government program”!

As previously noted, the enactment of the controversial Anti-Terrorism bill represents part of dynamic of the ratchet effect.

The Ratchet Effect: Anti-Terrorism Bill, Bayanihan Law Extension; Reopening in Name Only: Regime Uncertainty, June 8, 2020

III. Rising Asset Prices from Low Rates Aren’t Signs of Stability But Disguising Risks Through Liquidity Injections

Resonating global developments, the massive liquidity injections by global central banks, including the BSP, have been boosting risk assets.

The domestic equity benchmark surged by a stunning 6.32% last June and an astonishing 16.66% return in the 2Q.

While most of the media tend to rationalize this optimism over either expectation of a vaccine discovery or continued publication of next year’s economic ‘recovery’, in reality, asset markets have been diverging against fundamentals. Again, massive easing measures, or liquidity injections, by the BSP have been responsible for these.

The Price Earnings Ratios (PER) published at the PSE’s website reflects on 2018 earnings per share (eps). Given that the completion of the 2019 annual performance last week, these changes have yet to be reflected.

As an aside, because the headline index comprises the holding firms and their subsidiaries, this distorts or double counts its price performance, through market cap share ranking, as well as the average eps and other fundamental data as debt.

Nonetheless, based on a 20% and 50% discount of 2018 eps, the heavily distorted equity index manifests an average PERs of 17.9 and 28.7, as of July 4, assuming the impact of the latest economic freeze on the company’s earnings. But the 27.9% plunge in 1Q net income may be a sign of things to come for the year.  In short, markets have priced the index for perfection!

The distribution of the weight share of its components is a manifestation of the Power law.

And given the massive disruptions in demand and supply, and the dislocations of credit flows and quality, as well as the imposition of political walls of mostly social-distancing regulations, and a possible change in consumer behavior, a recovery back to the pre-COVID, ECQ performance would likely represent wishful thinking.

Add to this the second and third-order consequences from the multitude of interventions on the marketplace.

And not just been the equity market, but the BSP's bailout of the banking system has benefited Philippine assets. The peso rallied 1.71% in the 1Q. Media admits that an avalanche of foreign borrowing has been boosting the Philippine forex reserves, thereby, the peso. Foreign borrowings have reached $7.76 billion

Yields of Philippine treasuries dropped to record lows across the curve. Again, such milepost reflects global trends, and importantly, the BSP’s policy actions of reducing its policy rates to levels unseen in history. 

Figure 3

Yields of US and ASEAN 10-year bonds likewise have been drifting in historic low levels. For instance, since USTs recently plumbed to new lows, US mortgage rates have followed last week. This record-breaking streak has spilled over to the yields of corporate bond investment grades, which has been benefiting from the US Federal Reserve’s acquiring US corporate debt ETF as part of the bailout of the US financial system.

Again, such historic lows have hardly been signs of stability but about central bank interventions of disguising risks with massive infusions of liquidity.

Since all actions have consequences, the repercussions from such interventions will surface in the fullness of time.

IV. Debt Crisis Represents an Outcome of the Dynamic Process of Excessive Leveraging

Artificially low rates sow the seeds of bubble cycles.

First of all, instead of stimulus, low rates signify monetary tightening. The Interest rate fallacy as described by the Nobel Prize winner, Milton Friedman*, runs in contrast to popular wisdom.

Initially, higher monetary growth would reduce short-term interest rates even further. As the economy revives, however, interest rates would start to rise. That is the standard pattern and explains why it is so misleading to judge monetary policy by interest rates. Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

*Milton Friedman, Reviving Japan, April 30, 1998

Tightening money suggests slow growth.

Meanwhile, the risks of booming risks assets in the face of the marked deterioration of fundamentals have likewise caught the eye of the establishment institutions.

From the CNBC (June 25): The International Monetary Fund has warned that the ongoing disconnect between financial markets and the real economy could lead to a correction in asset prices. 

Such IMF’s warnings represent a follow-through from their April 2020 Global Financial Stability Report: (Chapter 3)

Lower-for-longer yields may prompt institutional investors to seek riskier and more illiquid investments to earn their targeted return. This increased risk-taking may lead to a further buildup of vulnerabilities among investment funds, pension funds, and life insurers, with grim implications for financial stability. Furthermore, institutional investors’ strategies to search for yield may introduce additional risks. Low yields promote an increase in portfolio similarities among investment funds, which may amplify market sell-offs in the event of adverse shocks. The need to satisfy contingent calls arising from pension funds’ illiquid investments could constrain the traditional role they play in stabilizing markets during periods of stress. High-return guarantees and duration mismatches are driving an increase in cross-border investments by some life insurers, which could facilitate the spillover of shocks across borders. The underlying vulnerabilities could amplify shocks and should therefore be closely monitored and carefully managed.

Mismatches! Sounds familiar?

Though I am no fan of the IMF, the fact that they recognize the inherent buildup of risks underscores mounting apprehension even from the establishment.

Low rates negatively impact the banks of advanced economies, wrote the IMF. (Chapter 4)

Profitability has been a persistent challenge for banks in several advanced economies since the global financial crisis. While monetary policy accommodation has helped sustain economic growth during this period and has provided some support for bank profits, very low interest rates have compressed banks’ net interest margins (the difference between interest earned on assets and interest paid on liabilities). Looking beyond the immediate challenges faced by banks as a result of the coronavirus (COVID-19) outbreak, a persistent period of low interest rates is likely to put further pressure on bank profitability over the medium term. A simulation exercise conducted for a group of nine advanced economies indicates that a large fraction of their banking sectors, by assets, may fail to generate profits above their cost of equity in 2025. Once immediate challenges recede, banks could take steps to mitigate pressures on profits, including by increasing fee income or cutting costs, but it may be challenging to fully mitigate profitability pressures. Over the medium term, banks may seek to recoup lost profits by taking excessive risks. If so, vulnerabilities could build in the banking system, sowing the seeds of future problems. 

A Working Paper for the Bank for International Settlements sees other impact of low rates on banks**.

Low interest rates tend to boost stock and bond markets (Bernanke and Kuttner (2005)). Searching for yield, banks are expected to rebalance their asset portfolio from the loan to the trading book, which should generate higher yields and fee-based income (Rajan (2005)). Likewise, at low rates, there is greater demand from retail depositors for professional portfolio management services (Albertazzi and Gambacorta (2009)). Bank managers may thus be inclined to shift their business lines towards capital market activities and raise their corresponding exposures.

Banks will also have incentives to rebalance the composition of funding. For a given risk profile, funding costs decline when interest rates are low. This includes the cost of bond issues, if term premia are compressed, and that of retail deposits. Banks may have incentives to rely more on deposits and fixed-rate long-term debt at the expense of short-term variable-rate funding.

Michael Brei, Claudio Borio and Leonardo Gambacorta Bank intermediation activity in a low interest rate environment, August 2019, BIS.org

Figure 4

Haven’t domestic banks become increasingly reliant “fixed-rate long-term debt at the expense of short-term variable-rate funding”?

That is, emerging market banks are prone to the same vulnerabilities.

Importantly, a debt crisis is a product of artificially low-interest rates.

The stages of a debt crisis according to Harvard’s Carmen Reinhart and Ken Rogoff***:

Newly developed long historical time series on public debt, along with modern data on external debts, allow a deeper analysis of the cycles underlying serial debt and banking crises. The evidence confirms a strong link between banking crises and sovereign default across the economic history of great many countries, advanced and emerging alike. The focus of the analysis is on three related hypotheses tested with both “world” aggregate levels and on an individual country basis. First, private debt surges are a recurring antecedent to banking crises; governments quite contribute to this stage of the borrowing boom. Second, banking crises (both domestic ones and those emanating from international financial centers) often precede or accompany sovereign debt crises. Indeed, we find they help predict them. Third, public borrowing accelerates markedly ahead of a sovereign debt crisis; governments often have “hidden debts” that far exceed the better documented levels of external debt. These hidden debts encompass domestic public debts (which prior to our data were largely undocumented). P.2

Consistent with Diamond and Dybvig’s (1983) famous model of banking crises, short-term debts escalate on the eve of banking crisis; the ratio of shortterm to total debt about doubles from 12 to 24 percent. A similar pattern emerges in the runup to sovereign defaults (which in this particular exercise immediately follows banking crises).

Carmen M. Reinhart Kenneth S. Rogoff, FROM FINANCIAL CRASH TO DEBT CRISIS NBER WORKING PAPER SERIES, March 2010

From M. Ayhan Kose, Peter Nagle, Franziska Ohnsorge, and Naotaka Sugawara of the World Bank Group (Chapter 1, p 12)

The three previous waves displayed several significant similarities. They all began during prolonged periods of very low real interest rates, and were often facilitated by changes in financial markets that contributed to rapid borrowing. The three past waves all ended with widespread financial crises and coincided with global recessions (1982, 1991, and 2009) or downturns (1998, 2001). These crises were often triggered by shocks that resulted in a sharp increase in borrowing cost stemming from either an increase in investor risk aversion and risk premiums or a tightening of monetary policy in advanced economies. These crises typically featured sudden stops of capital flows. They usually led not only to economic downturns and recessions but also to reforms designed to lower external vulnerabilities and strengthen policy frameworks. In many EMDEs, inflation-targeting monetary policy frameworks and greater exchange rate flexibility were introduced, fiscal rules were adopted, and financial sector regulation and supervision were strengthened.

M. Ayhan Kose, Peter Nagle, Franziska Ohnsorge, and Naotaka Sugawara Global Waves of Debt Global Waves of Debt Causes and Consequences, December 2019

In short, a debt crisis is a product of cumulative actions, consequences, reactions and multiple feedback loops involving leveraging, therefore representing a complex and dynamic process.

Statistics, on the other hand, are data acquired from the past.

That said, the debt profile of banks and the public sector undergoes changes, especially the degree, depending on the conditions of a given time.

For instance, when the Asian crisis appeared, fiscal conditions seemed sound. From World Bank’s Global Waves of Debt (p.82)

While the fiscal positions of the Asian crisis economies were generally sound as they entered the crisis, government debt rose sharply in the ensuing deep recessions as a result of automatic stabilizers and counter-cyclical support for demand, as well as support of banks and corporates in distress. Government debt rose by more than 30 percentage points of GDP in Indonesia and Thailand during the late 1990s. While the Asian financial crisis did not lead to widespread sovereign debt crises as in LAC and SSA, several countries required official financial support during and after the crisis. IMF support included $23 billion for Indonesia, $58 billion for Korea, and $20 billion for Thailand (Fischer 1998; IMF 2000a)

Philippine public debt surged 15% year to date or by Php 1.159 trillion or by 12.2% year on year or Php 975 billion to Php 8.89 trillion last May.

Have we not been seeing similar patterns unfold?

The BSP is about to publish financial conditions of banks and its depository survey in the coming week or two.

V. Malinvestments: Effects of Credit Easing: BSP’s Real Estate Index Boomed as the GDP Contracted!

What’s wrong with this picture?

Figure 5

As the headline GDP plummeted to -.2%, the BSP’s real estate price index flew by a spectacular 12.4% in the 1Q. Booming prices of condominium (+23.6%) and duplex (+38.3%) have been responsible for most of the gains.

Have we not been told that real estate prices are supposed to manifest increases in wealth???

Banking loans to the real estate sector zoomed 22.4% in Q1 YoY along with surging property prices. And the loan figure represents the supply side of the real estate sector.

Paradoxically, the debt-fueled property mania comes in the face of soaring business closures, income cutbacks, and surging unemployment.

The real estate sector has signified the prime beneficiary from the BSP’s massive easing measure in the form of policy rate cuts and liquidity injections (aside from RRR cuts) that bolstered the growth of the industry’s loan portfolio, which subsequently diffused into prices.

According to the IMF’s Global Housing Watch, the Philippines topped the world’s housing property inflation in Q3 2019 and ranked 8th in the world in real credit growth.

With the stock market underperforming, the elites seemed to have converted property prices into a casino!

Let us see, slowing/contracting economy, booming property prices and surging loans are not signs of a colossal misdirection of resources?

As Carmen Reinhart and Kenneth Rogoff wrote in This Time is Different: Eight Centuries of Financial Folly: “What is certainly clear is that again and again, countries, banks, individuals, and firms take on excessive debt in good times without enough awareness of the risks that will follow when the inevitable recession hits.”