All governments, however, are firmly resolved not to relinquish inflation and credit expansion. They have all sold their souls to the devil of easy money. It is a great comfort to every administration to be able to make its citizens happy by spending. For public opinion will then attribute the resulting boom to its current rulers. The inevitable slump will occur later and burden their successors. It is the typical policy of après nous le déluge. Lord Keynes, the champion of this policy, says: "In the long run we are all dead." But unfortunately nearly all of us outlive the short run. We are destined to spend decades paying for the easy money orgy of a few years—Ludwig von Mises
In this issue
The BSP’s 2H Financial Stability Report: Inflate Asset Bubbles to Restore Confidence!
I. The BSP’s Financial Stability Report: Bailout Policies Signify a Gamble with the Economy!
II. The Questionable Benefits of Artificially Low Rates
III. By Lowering Funding Costs: BSP Cut Rates to Save Banks
IV. Bailouts are Not Necessarily Stimulus: Credit Easing Haven’t Boosted Profits of Banks
V. Short Term Fixes (via Financial Repression), Long Term Pain
VI. BSP-FSR: To Reduce Risk Aversion, Inflate Asset Bubbles!
The BSP’s 2H Financial Stability Report: Inflate Asset Bubbles to Restore Confidence!
I The BSP’s Financial Stability Report: Bailout Policies Signify a Gamble with the Economy!
Like the lockdown, the citizenry is once again a guinea pig of the BSP’s gambit.
Inflating the PSE’s Bubble: The Bid-en Global Financial Assets Boom Compounds on the BSP’s Php 1.9 Trillion Liquidity Infusions, November 8, 2020
From the BSP-led Financial Stability Coordinating Council’s latest Financial Stability Report (p.14): [All bold added]
For financial authorities, this presents unique challenges. Unlike the Asian Financial Crisis (AFC) and GFC, the ongoing global recession is rooted in the public health issue, not in financial markets. However, uncertainties breed risk aversion and so the financial markets will certainly be affected, either in fund flows or in risk prices. Since the expectation is that the likely dislocations come close to that of the Great Depression, then no current policymaker would have direct experience on what it was like then in a manner that can help with the handling of the COVID-19 pandemic-cum-recession. These points imply that there is no ready-made policy playbook for this evolving crisis, forcing the authorities to introduce out-of-the-box interventions.
This can be seen as a call for pre-emptive and collective action, the very point that the GFC raised about the perils of systemic risks. Yet, collective action will always be a challenge as authorities face idiosyncratic risks whose handling may have cross-border consequences. As to the pre-emptive policy stance, the authorities have taken strong action on expansionary fiscal, monetary and economic policies, supplemented by various regulatory relief measures to cushion the ill-effects of the income shock. But operating within a fluid environment that is subject to “epidemiological waves” and financial spillovers, establishing either a definitive exit strategy or a change in policy course (where warranted by evolving data) would be a challenge.
Financial Stability and Coordinating Council, 2nd SEMESTER 2020 FINANCIAL STABILITY REPORT, bsp.org.ph
Though we part ways from the claim that the current global recession has been allegedly rooted in the “public health issue, not in financial markets”, presenting the evidence of the US repo shock in 2019 and the local yield curve inversion in the 1Q 2019, the FSCC validates our observation through the admission that “there is no ready-made policy playbook for this evolving crisis, forcing the authorities to introduce out-of-the-box interventions”!
Out. Of. The. Box.
Bullseye!
Furthermore, because of their unprecedented approach towards the crisis, mainly representing a string of responses from the unintended consequences of the lockdown socialism, having built on the economic foundations of a credit bubble, the thrust of their ‘pre-emptive and collective’ response has been anchored only on attaining immediate financial stability, while simultaneously ignoring the complexity of the feedback loop mechanisms from such actions, which should eventually translate to a series of unforeseen aggregate outcomes over the longer time frame.
Stunningly, they even confess to such a knowledge problem! From the FSR: (p.11-13)
But there is also that component where the damage may amplify because the state of any agent will impact the conditions of other agents with whom the former has natural economic linkages. This is the point of looking at the system as intertwined chains of related and sequenced transactions. Each chain branches off to other transactions, effectively creating a network where the shocks can amplify or dampen depending on how the chains are structured…
Hence, these linkages raise the possibility of follow-through effects. This is simply reflective of the reality of spillover effects, the magnitude of which will then depend on running through the linkages. Coupled with the income effects in the previous section, future business arrangements should consider how the links may adopt and adapt.
As significant and, thus far, as protracted the effects are of COVID-19, the likely outcome is that there is some degree of amplified vulnerabilities that is percolating without evident data at this juncture. This is the notion of slow-burn contagion.
First, they admit that they have little understanding of the workings of a living and breathing economy operating under the complexity of a spontaneous order.
Importantly, they have NO idea of HOW their so-called pre-emptive and collective actions will affect or disrupt the overlapping lattice adaptive-reactive network of the millions of simultaneously moving socio-economic nodes!
No. Idea.
At worst, the FSCC appears even lost on the scale, and the intensity, as well as the limitations of their approach to the crisis, which had been highlighted by an undefined or ambiguous blueprint for an exit, particularly “establishing either a definitive exit strategy or a change in policy course (where warranted by evolving data) would be a challenge”!
As I have been saying here, the BSP insiders have been publishing a rather forthright report to their peers at the Bank for International Settlements, which barely gets an audience here (or which reports have been deliberately buried) that has contrasted the public relations assertions made by the leading authorities.
And yet after failing dramatically to foresee the outcomes of their variable measures justified on the supposed menace of a pandemic that has affected less than .5% of the 109 million population, so far, the same authorities keep blabbering about recovery by showing either cherry-picked or inflated statistics!
The point being, how can their goals to centrally plan the economy work when the BSP’s econometric formulations can’t even capture the human dimensions in their models?
At the end of the day, the National Government/BSP’s approach, like their global peers, has been to bail-out the (mostly the banking) system by basically throwing an immense amount of money into the system through a mishmash of inflationary actions such as policy rate and RRR cuts and QE expansion, as well as to politicize credit distribution to various sectors of the economy.
They also dramatically expanded public borrowings to finance these political undertakings, suspended the implementation of regulatory, operational, and capital requirements regime, and applied forbearances justifying the emergency of the pandemic, as well as tweaked statistics to brandish the supposed strength of the economy and game prices of financial assets.
Again, these represent a tactical reaction, a band-aid approach, to stabilize the financial system and the economy with little comprehension of its consequences.
II. The Questionable Benefits of Artificially Low Rates
Let us use the recent rate cuts as an example.
From CNN(November 19): The Bangko Sentral ng Pilipinas on Thursday unleashed a fresh interest rate cut to an all-time low of 2%, hoping lower borrowing costs will support an economic rebound. The Monetary Board slashed the key policy rate by 25 basis points, now the lowest on record as the Philippine economy remains in recession due to earlier lockdowns amid the COVID-19 pandemic. The last rate cut was in June. Banks and other lending firms rely on the BSP's rates as their benchmark in pricing loans, credit card, and deposit rates. The central bank cumulatively brought the key yield down by 2% so far this year.The overnight deposit and lending rates were also slashed to 1.5% and 2.5%, respectively. BSP Governor Benjamin Diokno said authorities took note of "elevated uncertainty" as COVID-19 infections surge anew in parts of the world, as well as moderating global economic prospects.
Ever since the Great Recession in 2007-2009, the BSP has followed its global contemporaries of serially chopping rates to supposedly ‘boost’ the economy. And each time strains economic emerge, the BSP uses this as a pretext to reduce interest rates. However, when low rates fuel a rapid increase in the money supply growth that eventually spurs surges in the CPI, the BSP has been forced to raise rates as has been the case in 2014 and 2018.
Nevertheless, from the Great Recession, the BSP has, like its global peers, never seen the normalization of policy rates, as well as a major pullback on the stealth deficit-financing used to inject liquidity into the financial system.
The point is, emergency measures became a PERMANENT feature of the BSP’s policy landscape.
Yet, while the spillover effect may be partly true, artificially lowered rates have benefited both the banking system and their elite clients most, since the financial inclusion numbers say that the banked population represents only less than two-fifths of the adult population, and since only less than one-fifth of adults have loan exposure with a formal institution.
Or, even when MSMEs account for the largest share of the distribution and employment of the economy, bank loans to the sector has been grossly underrepresented.
In fact, the allocations of bank lending to the sector have emanated from a legal mandate.
As of March 2020, total loans to the MSMEs amounted to Php 535 billion or accounting for 6.343% of the banking system’s Php 8.434 trillion Total Loan Portfolio (TLP net of exclusions).
So, based on credit distribution alone, it is arguable that low rates benefit the economy in general.
III. By Lowering Funding Costs: BSP Cut Rates to Save Banks
The 2020 rate ON RRP cuts underscore this dynamic.
Figure 1
When the BSP cuts its policy rates, the banking system benefits directly from the lowering of funding costs on deposits. That is, such lowered funding costs enlarge the net interest rate margins of banks that support its earnings.
Ever since peaking at 4.75% in December 2018 to March 2019, the BSP’s official rates have trended lower, pulling with it 1-year Philippine Treasury yields, and more importantly, the interest expense of the banking system. (Figure 1, top)
To wit, while deposit liabilities of all listed banks, the PSEi 30 banks, and banks comprising the Financial Index grew by 6.8%, 7.3%, and 7.2% in the 9-months of 2020, respectively, the aggregate interest expenses dropped by 41.94%, 42.3% and 42.4% over the same period, dragged by the sharp decline of funding cost in the 3Q, particularly, 53.9%, 54.34%, and 54.84%, correspondingly. (Figure 1, middle)
The rate cuts, in essence, are tied with the bailout of the banks.
And while media tirelessly blare about how low rates are supposedly designed to help the economy, bank lending continues to slide. Growth of the Total Lending Portfolio TLP (net of Reverse Repurchase and Interbank Loans) decreased to 2.13% in September 2020, its lowest level since 2009. Bank lending growth peaked in May 2018 at 23.53% and proceeded downhill since, and have become apparently immune to the BSP’s series of rate cuts from 4.75% in April 2019 to the 2.25% level as of September 2020.
A balance sheet problem has been plaguing the banking system for the past years for it to diminish substantially lending transactions with the public. And the current recession has only aggravated such pre-existing conditions.
When credit easing measures implemented by a central bank fail to fire up bank lending to support the economy, in the mainstream vernacular, such is called pushing on a string. So the lack of traction from lending has prompted the FSCC/Department of Finance to call for expanded actions in the fiscal space. (p.36)
The recent extraordinary events triggered by the COVID-19 epidemic called for yet another heavy lifting by both monetary and fiscal authorities. Fiscal policy has and henceforth will continue to play a decisive role in helping recover lost household incomes and reviving the economy, while being mindful of stability implications of such actions thereby keeping its powder dry to maintain the multi-strike capability in the event of a prolonged battle against the pandemic.
In any event, as repeatedly pointed out here, from this standpoint, the BSP has been bogged by the interest rate fallacy, viz., low rates, as popularly embraced by authorities and the consensus, are NOT stimulus.
The Medical Gulag Experiment: PSYEi Revenue and Income Crashed in 2Q as Debt Zoomed! COVID-19 Death Toll Mounts! Say’s Law In Action August 23, 2020
IV. Bailouts are Not Necessarily Stimulus: Credit Easing Haven’t Boosted Profits of Banks
Figure 2
In the meantime, despite the massive bailouts, bank earnings suffered its second quarterly loss.
With core operations of banks hampered by the tightening of credit standards, or the reluctance to lend, the banking system’s earnings tumbled 25.93% in the 3Q, which was larger than the 22.64% loss in the 2Q and barely posted a profit in the 1Q with a 2.01% growth. Ironically, such 3Q losses emerged as a greater part of the economy have been released from the lockdown socialism. (Figure 2, top)
Meanwhile, member banks of the PSEi, the financial index and the total suffered income contractions of 24.4%, 35.08%, and 26.11% in the 3Q, respectively.
Following the reporting of steeper losses endured by the banking system in the 3Q, the BSP responded by “unexpectedly” chopping rates.
As demonstrated above, the BSP’s rate cuts were barely designed to inspire bank lending directly, but primarily, to serve as a floor to the losses or stanch the bleeding of the banks and the financial system.
Bailouts are not necessarily stimulus.
Figure 3
In any case, facilitated by the same low-interest rate regime, a boom in Philippine treasuries, as yields plummeted, powered the surge in the profits in the banking system last year.
Though profits surged, Return on Assets (RoA) and Return on Equity (RoE) comprising the BSP’s Key Profit Indicators (KPI) metrics, barely showed significant improvements then. Worst, exacerbated by recent developments, the same indicators were dragged to multi-year lows in the 3Q 2020. (Figure 3, top)
However, record low yields at the front end amidst the widening of treasury spreads are indicative of higher street prices over time. With rates creeping higher, this suggests that the BSP subsidy through the treasury market may be coming to an end. (Figure 2, lowest pane)
And so another downward bump, via the latest rate cut, to keep it low.
Buy. More. Time.
If income from core operations through lending have been down, and the subsidy effect from the bond markets may be climaxing, where will banks find their earnings juice?
V. Short Term Fixes (via Financial Repression), Long Term Pain
Figure 4
Authorities are inherently fixated with immediate consequences.
With the elections on the near horizon, to maintain a popular approval rating, the propensity to apply more short-term fixes shall most likely determine the incumbent leadership’s policy landscape. After all, authorities are driven by incentives too.
Pushing interest rates below the CPI represents financial repression via negative real rates, which effectively represents an implicit transfer of paying debts, benefiting the governments, and borrowers (mainly the elites), at the expense of savers. (Figure 3, middle pane)
Why raise taxes when the inflation tax seems the most convenient? Besides, with almost every central banker in the world doing it, wouldn’t it be a vogue policy?
“A ‘sound’ banker, alas, wrote John Maynard Keynes, is not one who sees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.”
But again, there are costs to these.
Not only have bank lending been trending down, but the policy of driving rates lower has coincided with the downturn of the growth of peso deposit liabilities (figure 3, lowest pane), and likewise, the banking system’s core liquidity indicators, cash and due banks-to-deposits, and liquid assets-to-deposits. The Php 1.9 trillion injections by the BSP has partly reversed the trend in 2020. (Figure 4, top)
Why stash money on banks when returns have been so low? Or, when higher street inflation easily negates the returns from traditional deposits?
In theory, banks would compete by raising rates to acquire deposits or people’s savings. But because of the cartelized arrangement, rates haven’t been reflected on the supply and demand of savings and credit but from the BSP’s monetary stance.
Instead of raising rates to acquire more deposits, which could be used for funding lending in the cheapest manner, banks have instead relied on the capital markets, the priciest source, and more recently from the BSP’s operations.
The shortfall in deposits has, thus, in part led to the challenges in the banking system’s liquidity conditions, which partially reveal the health of the banking system’s balance sheet.
But the BSP previously sees it from funding mismatches**, which represents a likely euphemism for the camouflaged buildup of delinquent accounts, which represents the primary source of liquidity drain.
**Financial Stability Report, 2018 H1–2019 H1 FINANCIAL STABILITY REPORT, bsp.org.ph (p16-17)
Current events reinforce this concern.
The swift passage of the FIST at both houses of Congress is a testament to the urgency of addressing the rapidly deteriorating health conditions of banks.
Furthermore, because the main source of financial liquidity—mainly bank lending—has been decelerating fast, the entire weight of the expanding money supply has been taken over by the BSP in 2020.
So, with a corresponding slowdown in the BSP’s QE last September, the growth of bank cash reserves, as well as the popular measure of money supply growth M3, has exhibited signs of rolling over. (Figure 4, middle window)
As been said here, like all central bankers, the BSP will fight signs of credit and liquidity deflation with more monetary inflation.
Needless to say, last week's rate cut and the expanded QE announced in early October signifies no coincidence. They were responses to the current developments.
That said, following the March 200 bps reduction, expect the BSP to use its final allocated share of the 400 bps cuts in Reserve Requirements Ratio before 2020 ends.
The reduction of the RRR will likely coincide with the expiration of the 60-day debt moratorium at the end of December.
The pandemic gave the BSP a convenient excuse to implement a deeper bailout of banks.
VI. BSP-FSR: To Reduce Risk Aversion, Inflate Asset Bubbles!
Moving from mismatches, risk aversion, for the BSP, has signified the main force for the reluctance of banks to lend.
Again, the great experiment with denizens acting as guinea pigs… [p.15]
First, previous financial crises required a healthy dose of liquidity to address the difficulties. Getting to a state of illiquidity would be the fastest way to complicate things in the financial markets. The caveat though is that this crisis is precisely not rooted in the financial market, so the calibration of liquidity injections is a learning process for the authorities. As shown below, financial markets are prone to non-linearities in risk behavior so that the price of liquidity may not induce the movement of funding liquidity if a threshold of risk aversion is reached.
Reducing risk aversion as a policy priority… [p.18]
This is a classic case of a risk-off stance, but it is also a case of Fallacy of Composition. That is, the heightened risk aversion among banks has concentrated liquidity with them but these have not been redeployed to reboot economic activity, making the recovery a more difficult proposition. This suggests that unless the risk aversion is addressed, any economic forecast of future growth that rests on the premise that risk aversion can selfcorrect is contentious, particularly if the transition period is protracted.
The policy seeds towards inflating an asset bubble [p.38]
Above all, starting from a view of the New Economy presupposes that the current elevated levels of aversion towards risk can be addressed. There is an irony in circular reasoning: the shock to the economy has created uncertainties which has nurtured risk aversion, inducing banks to take a more defensive credit stance which then likely prolongs the recovery of the economy, creating another layer of uncertainty. The symbiosis between the real economy and financial markets is at one end and a Fallacy of Composition rests at the other. This impasse on risk aversion gets addressed only if the initial uncertainties are managed or if there is a collective rise in altruism.
Certainly, one can act on the former, without prejudice on the possibility of the latter. There is an appreciation on why lending institutions are averse to taking on additional credit risks at this juncture but there is also a recognition on the availability of liquidity. Thus, the objective is to re-deploy the liquidity as part of a general strategy for the lending institutions to get more comfortable in taking more calibrated risks.
There is now a need to enhance risk pricing and valuation in the capital market. The viability of any investment outlet depends on risk pricing (at initial issue) and valuation (in the secondary market). This ensures that risktakers are appropriately rewarded. However, current conditions suggest an uncertainty premium. While this is not unexpected and arguably rational for micro-agents, this add-on can be mitigated by enhancing the discovery of risk prices as a parallel to greater clarity of the future.
Let us get this straight: Resolving risk aversion, according to the BSP, must not be left to the markets, it equates to the BSP's redeployment of liquidity to enhance risk pricing and valuation in the markets, thereby ensuring current rewards for risk-takers. Thus, the animal spirits are back!
To be sure, the BSP hasn’t zeroed-in on stocks but on risk assets in general. [p.32]
Philippine regulators also provided a springboard for risk assets to rebound. The Securities and Exchange Commission (SEC) adjusted its disclosure requirements to promote transparency and accountability. It also enabled the creation of corporate debt vehicles to support liquidity requirements. These, and the stable outlook in the country’s credit ratings, are seen to restore investing public confidence and ease business pessimism.
Haven’t we been saying this?
The effects of the massive Php 1.9 trillion of liquidity infusions (and counting) will eventually manifest itself in the economy and the financial markets through prices (goods, services, and or assets), allocation of resources, and credit conditions.
Inflating the PSE’s Bubble: The Bid-en Global Financial Assets Boom Compounds on the BSP’s Php 1.9 Trillion Liquidity Infusions November 8, 2020
With the twilight of the treasury boom, and the reluctance by the banks to lend, which represents the core operations of the industry, wouldn't stoking a stock market bubble signify a desperate means to reduce risk-aversion?
Figure 5
Sure, a stock market bubble will help banks for now.
Fees and commission as a share of the banking system’s operating income has been oscillating with the flow and ebbs of the headline equity index. (Figure 4, lowest pane)
As of the 3Q, it has bounced up to 9.9% from a multi-year low of 9.24%, corresponding with the undulations of the equity benchmark, the PSYEi 30.
But how sustainable is this?
Spearheading this week’s continuing overbought rally, the financials rocketed by a marvelous 7.8% returns to buoy the headline index advance by 2.87%. Since the announcement of the expanded QE at the onset of October, the financial index has generated an amazing 21.97% advance! (Figure 5)
And strikingly, the published delinquent loans metrics have rocketed to multi-year highs in the 3Q, despite the unprecedented support provided by the BSP, including the regulatory and reporting reliefs! (Figure 5)
Interesting, isn’t it? Financial-Bank stocks rocketing amidst spiking (published) credit delinquencies? Which of the two is wrong?
Again, how will the economy and banks cope with the expiring debt moratoriums?
Will debt forbearances be prolonged until March through the possible extension of Bayanihan 2.0?
More importantly, while throwing money may disguise risks at the moment, increasing leverage of borrowers and financial institutions in the face of uncertainty and the diminution of capital amplifies it.
Will a surging stock market be sufficient to successfully reinvigorate the ‘animal spirits’ to the moribund economy through the normalization of bank lending, or will it inflate further a bubble, which eventually bursts?
Is this a ‘be careful of what you wish for’ moment for the BSP?
