Showing posts with label inflationism. Show all posts
Showing posts with label inflationism. Show all posts

Sunday, December 03, 2023

Why the BSP will be Slashing its Policy Interest Rates Soon

 

Every inflation must eventually be ended by government or it must "self‑destruct"—but not until after it has done untold harm—Henry Hazlitt 

 

In this short issue 


Why the BSP will be Slashing its Policy Interest Rates Soon 

I. Led by T-Bills, Yields of Treasury Curve Crashed: "Bullish Steepener" 

II. BVAL Treasure Rates Below the BSP’s Policy Rates; The Erosion of Inflation Tax 

III. BSP’s Asymmetric Monetary Policies 

IV. BSP’s Possible Rationalizations: Expected US Fed Rate Cuts and Escalating Streak of Global Central Bank Easing 

V. BSP’s Zero Bound Policies and the PSEi 30’s Diminishing Returns 

 

Why the BSP will be Slashing its Policy Interest Rates Soon 

 

The recent crash in the yields of the Philippine treasury curve has strongly signaled the BSP’s coming rate cuts.  

 

I. Led by T-Bills, Yields of Treasury Curve Crashed: "Bullish Steepener" 

 

Will the streak of BSP rate cuts start this December or early 2024?  Why? Because these have been communicated to the public by the local treasury market.  

  


Figure 1 

 

The reliable but unheralded treasury traders—via demonstrated preference (action speaks louder than words)—have been on a Treasury panic buying spree that sent yields collapsing across the curve. (Figure 1, upper window) 

  

Treasury traders appear to be expecting a (possibly a "surprise") sharp decline in inflation. If so, a disinflationary environment entails a weaker private sector economic performance this Q4.  

  

Since its peak last November 16th, the recent tailspin of the 1-month T-bill yield hallmarked the performance of various Treasury maturities across the curve.  

 

Yet, the scale of the decline (1- and 3-month T-bills) has been substantially deeper compared to the Q2 2019 episode when the BSP began its credit easing campaign. (Figure 1, lower graph)   

 

And this may be pressing enough to force the BSP to act. 

 


Figure 2 

 

Furthermore, since yields of short-term or T-bills have plunged the most, this reshaped the slope into a "Bullish Steepener"—frequently pointing to rate cuts. 

 

Treasury curve abruptly steepened from a relatively "flat" slope last September and October. (Figure 2, upper chart) 

 

II. BVAL Treasure Rates Below the BSP’s Policy Rates; The Erosion of Inflation Tax 

 

What’s more, the across-the-curve plunge in treasury yields has resulted in a sharp tightening—BSP overnight interbank rates have become HIGHER than treasuries! (Figure 2, lower graph)  

 

Figure 3 

 

On top of this, BSP rates have been higher than the CPI and the headline GDP, reinforcing this financial "tightening" phase on an economy heavily dependent on leverage and liquidity. 

 

Crucially, higher BSP rates than the CPI—theoretically—translate to positive "real" rates, which implies that this has eroded the government's seignorage fee or the inflation tax.  

 

The BSP embarked on rate cuts when "real" rates turned positive in Q2 2019.    (Figure 3, upper graph) 

 

III. BSP’s Asymmetric Monetary Policies 

 

But, of course, monetary authorities have recently engaged in asymmetric policies.   

  

Sure enough, it has raised headline rates to multi-decade highs, which reduced credit transaction growth mainly to the supply side.  

  

But its interest rate cap on credit cards or subsidies to consumer credit has also resulted in a textbook response of fueling excess demand for consumer credit.  (Figure 3, lower chart)   

  

Such extensive build-up of leverage in the consumer's balance sheets has driven the indulgent demand for vehicles, luxury-related spending activities, and magnified property speculations. 

  

The other ramification is the transformation of bank lending operations towards consumers at the expense of industry. 

 

Other behind-the-scene operations have marked the BSP's liquidity operations.  

  

Banks and non-bank financials have been directly financing the National Government’s deficit spending via Net claims on the Central Government (NCoCG) or indirect QE—injecting liquidity into the government and the financial system.  

  

These off-kilter operations afforded the BSP to raise headline rates and paint an impression of a "sound" macro-environment. 

 

IV. BSP’s Possible Rationalizations: Expected US Fed Rate Cuts and Escalating Streak of Global Central Bank Easing 

Figure 4 

 

Aside from inflation, the BSP could rationalize its actions with the widely expected rate cuts by the US Federal Reserve in early 2024 and use the appeal to the majority—the growing streak of rate cuts by global central banks. (Figure 4, upper chart) 

 

 

Figure 5 

 

Previously, changes in the BSP policy rates have coincided with the gyrations in the yield differentials of the Philippines and the US (proxied by the 10-year).   BSP rate cuts in 2019 narrowed the spread between the 10-year Philippines and the US. (Figure 4, lower diagram) 

 

Today, since the US Fed has adopted a more hawkish stance than the dithering BSP, this broke the previous correlations—the rate spread has compressed even as the BSP held on its rates at multi-decade highs.  

 

Put this way, domestic developments determine the BSP policies.  

  

Of course, since current developments in the treasury markets have anchored our anticipation of the possible changes in the BSP's policy stance, this is also conditional on the sustainment of this unfolding trend. 

 

V. BSP’s Zero Bound Policies and the PSEi 30’s Diminishing Returns 

 

Finally, the establishment experts have been whetting the speculative impulses of the disenchanted public starved of easy money gains with the prospects of a stock market boom from "rate cuts."    

 

True, "rate cuts" have had ephemeral amplifying effects on the YoY returns from 2009-2018, but this relationship broke in 2019 (pre-pandemic).  (Figure 5, top chart) 

 

But "rate cuts" had to be bolstered with the BSP's historic Php 2 trillion liquidity injections to spur a momentary rally in 2H 2020 to 1H 2021. 

  

Worst, the BSP’s zero bound (ZIRP) policies have been associated with the PSEi 30’s diminishing monthly long-term returns. 

  

It is no coincidence that the rate cuts have fueled spikes in the CPI and contributed to the attenuation of the Philippine peso, which are all interrelated with the PSEi 30’s return. (Figure 5, lower graph) 

  

Artificial speculative booms from free-lunch monetary policies only induce capital consumption and a lower standard of living. 

Sunday, October 22, 2023

Three Critical Forces Influencing the Structural Shift in the Philippine Banking Industry’s Business Model, Four Reasons for the Drain in Bank Cash Reserves

 

We can call this monetary hedonism: a combination of low rates and ever-growing money supply designed to create an illusion of real wealthMonetary hedonism is an arrangement which encourages our whole society to live beyond its means, using monetary policy rather than direct tax-and-spend policy. It directly benefits both the Beltway and the banking classes, who enjoy an exorbitant political privilege due to their proximity to newly created cheap money—Jeff Deist 

 

In this issue:

 

Three Critical Forces Influencing the Structural Shift in the Philippine Banking Industry’s Business Model, Four Reasons for the Drain in Bank Cash Reserves 

I. Depressed Shares of Most Listed Banks Defy Sanguine Mainstream Outlook 

II. Three Critical Forces Influencing the Structural Shift in the Banking Industry’s Business Model  

III. Four Reasons for the Drain in Bank Cash Reserves 

IV. Strengthening of Stagflationary Forces Amplifies Bank Balance Sheet Risks With Real Estate Loans as its Core  

V. Increased Bank Funding from Borrowings, and Repos as Deposit Growth on a Downtrend 

VI. As Risks Mount, Banks Centralize and Cartelize Financial Resources 

 

Three Critical Forces Influencing the Structural Shift in Philippine Banking Industry’s Business Model, Four Reasons for the Drain in Bank Cash Reserves 

 

The public seems unaware of the evolving transformation of the Philippine banking system in response to policies. A developing liquidity drain has been one of its prominent effects. 


I. Depressed Shares of Most Listed Banks Defy Sanguine Mainstream Outlook 

 

Businessworld, October 11: THE TOTAL ASSETS of the Philippine banking industry continued to rise year on year at end-August amid a sustained growth in loans and deposits. Preliminary data from the Bangko Sentral ng Pilipinas (BSP) showed banks’ assets grew by 8.6% to P23.46 trillion as of August from P21.59 trillion in the same period a year ago. Banks’ assets are mainly supported by deposits, loans, and investments. These include cash and due from banks as well as interbank loans receivable (IBL) and reverse repurchase (RRP), net of allowances for credit losses. “The latest asset growth of banks is largely consistent with the growth in loans,” Rizal Commercial Banking Corp. Chief Economist Michael L. Ricafort said in a Viber message. 

 

The Halo effect.  The public deems every "plus" sign as signifying positive developments or "growth." 

 

However, financial markets have continually demonstrated substantial deviations from statistics and the mainstream narrative. 

 

For instance, despite heavy buying from Other Financial Corporations (OFC) on bank shares in Q4 2022 and Q1 2023, share prices of ex-PSEi members Security Bank [PSE: SECB] and Union Bank [PSE: UBP] have come under pressure.  

Figure 1 


Surprise, SECB shares have dropped below the March 2020 panic level lows! (Figure 1, topmost chart) 

 

The PSE replaced the SECB and UBP in the PSEi 30 on August 8, 2022, and September 28, 2023, as a consequence of their share price selloffs. 

 

Conversely, the principal market beneficiaries have been the top two banks, BDO and BPI, which cushioned the PSEi 30 from further devastation by the bear market.  

 

In so doing, market actions catapulted their ranks to the third and fourth-largest market capitalization! 

 

So, likely interventions have resulted in deviances in share price performances favoring PSEi 30 issues even when the general industry breadth has stagnated. 

 

II. Three Critical Forces Influencing the Structural Shift in the Banking Industry’s Business Model  

 

Indeed, bank assets continue to grow.  (Figure 1, middle window) 

 

As of August, it was at a record in pesos.  But growth rates continue to reflect its long-term downtrend.   

 

The banking system's total assets represent the sum of cash reserves, investments, loans, ROPA, and other assets.       

 

In support, deposits, other liabilities, bonds, and bills payable comprise the total liabilities. 

 

The share of cash, investments, and loans accounted for 93.8% last August. (Figure 1, lowest graph) 

 

Unknown to the public, the banking system has undertaken substantial structural changes, which come with attendant risks. 

 

The share distribution of assets reflects existing conditions.   

 

To wit, their underlying trend signifies a crucial stethoscope of the banking's health. 

 

The downtrend of cash reserves commenced in 2013 and has accelerated from 2022 to the present. 

 

boost in the investment pie, which filled the gap from the sharp drop in loans, was a response to the overall pandemic policies (economy's lockdown, BSP historic rate cuts, and Php 2.3 trillion injections) 

 

Yet, this shift towards investments represents the FIRST of the three critical changes in the banking system. 

 

The SECOND pivotal transformation is in the distribution of loans.  

Figure 2 

 

To reiterate, banks reconstituted the foundations of their loan portfolio to focus on consumers for four possible reasons (the first two I previously explained). (Figure 2, topmost graph) 

 

First.  The BSP's credit card subsidy through interest rate cap.  When you subsidize something, you get more of it. 

 

Second.  Consumers accelerated leveraging their balance sheets in response to the loss of purchasing power of their income and savings. 

 

Third.  The consumer market signified an underserved market. 

 

Fourth and last.  Credit impairments (Non-Performing Loans or NPLs) from production loans induced this pivotal shift.  The 175 bps rate hikes in response to the rice crisis 1.0 in eight months (May to December 2018) opened the floodgates of NPLs, which intensified during the pandemic.  (Figure 2, middle window) 

 

Production loans boomed ephemerally in the post-pandemic transition, mostly in response to the reopening.  However, consumer lending swiftly regained its predominance. 

 

The next big shift. 


In collaboration with the BSP, banks continually amassed government securities, which provided liquidity support to the government and financial system.  Sequentially, the inflationary nature of such liquidity operations amplified the loss of purchasing power of the peso.  Such operations are called "inflationism." 

 

The great Austrian economist Ludwig von Mises, 

 

Under an inflationary system, nothing is simpler for the politicians to do than to order the government printing office to provide as much money as they need for their projects. Under a gold standard, sound government has a much better chance; its leaders can say to the people and to the politicians, "We can't do it unless we increase taxes." 

 

But under inflationary conditions, people acquire the habit of looking upon the government as an institution with limitless means at its disposal: the state, the government, can do anything. If, for instance, the nation wants a new highway system, the government is expected to build it. But where will the government get the money? (Mises, 1958) 

 

This joint effort represented the third crucial bank business model makeover. 

 

III. Four Reasons for the Drain in Bank Cash Reserves 

 

But actions have intertemporal (time different) consequences.   

 

Inflationary pressures spurred rising rates, forcing banks to conceal mark-to-market losses through Held-to-Maturity (HTM) assets.  The BSP has admitted to this in the 2018 episode. 

 

From the 2017 FSR (all bold mine)  

 

Banks face marked-to-market (MtM) losses from rising interest rates. Higher market rates affect trading since existing holders of tradable securities are taking MtM losses as a result. While some banks have resorted to reclassifying their available-for-sale (AFS) securities into held-to-maturity (HTM), some PHP845.8 billion in AFS (as of end-March 2018) are still subject to MtM losses. Furthermore, the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity (FSCC, 2018)  

  

From the H1 2018-H1 2019 FSR   

 

While one can take comfort that the formal LCR regime has started at high levels, one should also appreciate that taking out securities booked as HTM will reduce the LCR. As of end-2018, majority of the HQLA stock of Philippine banks are in the form of holdings of government and non-government debt securities and bank reserves. The former securities include those that are HTM and thus, not intended to generate cash flows from trade. Deducting the HTM debt securities from the HQLA will lower the LCR. (FSCC, 2019)  

 

Also  

There is some evidence that incremental funding has been sourced from the banks’ liquid assets. We can see from Figure 2.18 that cash and due from banks had been rising until August 2017 after which it has followed a downward trajectory. In contrast, investments (Figure 2.19) have been growing at an exponential pace, which has been driven by the growth of securities classified as held-to-maturity (HTM) (Figure 2.20). These developments have implications on maintaining the balance between profitability and liquidity(FSCC, 2019)  

 

Therefore, the record bank holdings of Net Claims on Central Government (NCoCG) have coincided with its unprecedented holdings HTMs. (Figure 2, lowest chart) 

 

Figure 3  

 

The repercussion?  


Bank liquid assets, in particular, cash reserves, have come under pressure.  (Figure 3, topmost graph) It has also lowered the Liquidity Coverage Ratio (LCR).  

 

Again, elevated Non-Performing Loans (NPLs) are another source of liquidity drain.  

 

Though NPLs have dropped from their 2021 pinnacle, primarily from the various relief measures extended by the BSP, they remain above the pre-pandemic highs.  Ironically, banks continue to raise their loan loss provisions. (Figure 3 second to the highest window) 

 

Both activities reduce bank liquidity. 

 

Mark-to-market losses from trading positions represent a third source of drain to bank liquidity.  Though losses have eased from the low of Q3 2022, they remain elevated through August. (Figure 3, second to the lowest chart) 

 

The BSP's slowing of the monetization of public debt (Quantitative Easing/NCoCG) signifies a fourth factor of the bank's decaying liquidity conditions.  (Figure 3, lowest diagram) 

 

But again, banks have offset BSP's pullback. The design of this action could be for public consumption: to exhibit tightening via the BSP's balance sheet (aside from rate hikes).  

Figure 4 

 

Despite the massive June Reserve Requirement Ratio (RRR) cut, bank cash reserves continue to bleed through August 2023.    

 

Cash and due banks sunk 7.5% YoY in August but increased by 2.6% over the month.  This increase signified a bounce from July's 10.4% YoY and 13.5% MoM plunge.  Cash reserves in peso have retraced to 2019 levels, revealing the negation of BSP's unparalleled injections. (Figure 4, topmost graph) 

 

In the meantime, the BSP's liquidity KPI metrics, cash-to-deposits, and liquid assets-to-deposits ratio continue to sag through August. (Figure 4, middle pane) 

 

The thing is, growing tensions in bank liquidity conditions are found in all corners of their balance sheet. 

 

IV. Strengthening of Stagflationary Forces Amplifies Bank Balance Sheet Risks With Real Estate Loans as its Core  

 

Despite the rabid denial of the financial punditry, the economy's maladaptive responses to (monetary and administrative) policies have increased the clout of stagflationary forces (elevated inflation & diminishing output).   

 

Bank conditions are exhibiting this process.  Though at record highs in peso levels, the YoY change in bank loan operations and investments has been rolling over.  (Figure 4, lowest graph) 

 

For an economy breathing on credit, diminishing liquidity reinforces a feedback loop of a growth slowdown, higher risks of unemployment, amplified credit risks or rising NPLs, and the increased hazards of liquidations.   

 

It is not a surprise that the NEDA has pushed back on the prospects of another rate hike. 

Figure 5 

 

And reduced liquidity would no less have a magnified impact on the real estate sector.   

 

As we have consistently been pointing out, although its "value added share" of the GDP has been on a long-term downtrend, its portion of the banking system's (supply side) lending portfolio, after hitting a peak in March and April 2021, remains elevated.  In August, total banking's supply-side real estate loans had a 19.5% share.  It peaked at 21.1% in March 2022. (Figure 5, topmost graph) 

 

Bank consumer loans have gradually been displacing the role of the property sector.  That is to say, slowing GDP contribution in the face of a disproportionate share of bank loans translates to heightened credit risks from malinvestments—overspending afflicted by diminishing returns.  And to keep "risk at bay" requires constant feeding of inflationary credit and liquidity.  

 

The sectoral stock market performance highlights this massive disparity: bank contribution to the PSEi 30 has drifted to a record high (as of September), while the real estate sector's share has slumped to 2015 levels.  (Figure 5, second to the highest window) 

 

Again, ironically, real estate remains the biggest client of banks.  For this reason, the PSE booted out Robinsons’ Land and Megaworld from the PSEi 30 last February.  

 

V. Increased Bank Funding from Borrowings, and Repos as Deposit Growth on a Downtrend 

 

How have banks funded their assets? 

 

The long-term trend of deposit growth rate continues to head south. (Figure 5, second to the lowest graph) 

 

Total deposits grew from 6.6% to 8.1% in August, primarily due to a spike in foreign deposits from 6.07% to 11%.  The growth of peso deposits from 6.7% to 7.5% also helped. 

 

The recent increases in government external or internal FX borrowings must have contributed to this.  

 

Despite the recent increase in lending, the decadent growth rate implies liquidity-consuming activities affecting deposit conditions.  

 

Instead of inducing an increase in savings from the recent rate hikes, peso savings growth remains languid, suggesting a drawdown by account holders to fill the purchasing power gap. (Figure 5, lowest chart) 

Figure 6 


Banks fill this liquidity chasm through the capital markets, issuing bonds and bills.  Never have banks borrowed from the capital markets at this scale. (Figure 6, topmost graph) 


Enhanced short-term borrowings have signified a symptom of the developing immediate liquidity strains.  Banks are borrowing at a higher cost than deposits.  

 

It is no wonder we are seeing a re-flattening of the Treasury curve.  

 

Repos have spiked, too.  The BSP has been providing short-term liquidity to the banks via repos, which surged to all-time highs last August. (Figure 6, second to the highest chart) 

 

Decaying cash reserves, record HTMs, elevated mark-to-market losses, slowing bank lending in the face of expanded bank borrowings to fund operations, a downtrend in savings growth, and a shift to repos point toward escalating maturity mismatches in the banking system's balance sheet.  

 

VI. As Risks Mount, Banks Centralize and Cartelize Financial Resources 

 

And this development has coincided with banks almost monopolizing the nation's financial resources.   The total bank share of the nation's aggregate financial resources climbed to a milestone 82.7% high last August.  Universal banks reached 77.7%, its second highest on record. (Figure 6, second to the lowest graph) 

 

Over a decade of the BSP's easy money regime has empowered Universal-Commercial banks to command more of the economy's finances and resources.  

 

This centralization process essentially cements the cartelization of the industry. 

 

Ultimately, mounting maturity mismatches in the face of the centralization of finance is hardly a comforting scenario for risk appetite and should signify a wake-up call to any serious investors. 

 

Unsurprisingly, the PSEi 30's returns have closely tracked the bank’s cash-to-deposit ratio. (Figure 6, lowest diagram) 

 

Or the capital consumption process playing out on bank and financial market conditions. 

 

When the economy stumbles, we can expect torrents of political interventions:  The BSP will likely open the dams of liquidity via (a combination of) rapid rate and RRR cuts, boost QE, and expand relief measures alongside another record round of deficit spending by the government—at the risk of unleashing a more powerful third wave of inflation. 

 

As it happens, increasing systemic fragility from the intensifying interventions heightens the risks of a financial/currency crisis. 


Coming up: Part 2 expounds on the PSE's financial share performance.  

____ 

References 

 

Ludwig von Mises, InflationEconomic Policy: Thoughts for Today and Tomorrow (1979), transcription of Lecture 4 (1958), Mises.org 

 

Financial Stability Coordination Council, 2017 FINANCIAL STABILITY REPORT, Bangko Sentral ng Pilipinas, June 2018 p.24  

  

Financial Stability Coordination Council 2018 H1–2019 H1 FINANCIAL STABILITY REPORT Bangko Sentral ng Pilipinas September 2019 p.45 and p.17