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Credit-driven boom-bust cycles are temporally asymmetrical. The buildup is slow and long, the collapse quick and sudden. In Hemingway’s The Sun Also Rises, one of the protagonists asks his friend: “How did you go bankrupt?” “Two ways,” went the answer, “gradually, then suddenly.” --Axel Leijonhufvud
In this issue
After BSP’s RRR and Policy Cuts: Savings Deflation in October, Cash Reserves Tumble as Foreign Deposits and Bank Lending Rate Falls to Multi-year Low!
-The Low Interest Rate Elixir Myth
-The Banking System’s Multi-year Credit Expansion Slowdown: Both a Demand and Supply Problem; First-Ever Savings Deposits Deflation!
-After 200 bps of RRR Cuts, Cash Reserves Shrunk Anew, Forex Deposits Growth Nears Deflation!
-The Low Interest Rate Induced Paradigm Shift of the Banking System’s Business Model, Bank Asset Growth at Multi-Year Lows
-As Loans Stagnate, Investment Returns May Have Peaked
-Bonds Remain as The Primary Source of Bank Financing
-Conclusion: The ‘Shock and Awe’ Crisis Resolution Template
After BSP’s RRR and Policy Cuts: Savings Deflation in October, Cash Reserves Tumble as Foreign Deposits and Bank Lending Rate Falls to Multi-year Low!
The Low Interest Rate Elixir Myth
After declaring the end of the policy easing streak in early November, then changing its tune to consider a rate cut by the yearend depending on November’s inflation data, the BSP kept its policy rates (ON RRP) for the year last week. The BSP Governor has floated a fifty point rate cut in 2020 instead.
We’ve been told that "the quick to jump aboard the easing train and have a willingness to ease further" would "augur well to economic growth". If this assumption is true, then what's stopping the BSP from announcing ZERO policy rates, if not NEGATIVE interest rates, NOW????
Figure 1
With policy rates close to RECORD lows, why has the National Government’s GDP been declining with it? (figure 1, upmost pane) Interest Rate in the Philippines averaged 7.79 percent from 1985 until 2019, according to Tradingeconomics.com, reaching an all-time high of 31 percent in January of 1985 and a record low of 3 percent in June of 2016. (figure 1, middle pane)
Current policy rates have almost been half this average, and just 33% up at 4% from the 3% milepost low in June 2016.
And here’s a striking development: the cumulative 75 bps cuts in the BSP’s ON RRPs in May, August and September has failed to arrest the free-falling growth rate of the banking system’s loan portfolio in October! The banking system’s NET Total Loan Portfolio or TLP (inclusive of Interbank Loans and Repos) grew by 7.33% in October, sharply lower than 8.91% in September. Rates of such level had been seen last in 2009 to 2010! Following a spike that set an apogee in May 2018, October’s declining growth rate only reinforced the 17-month downtrend.
From a broader perspective, the banking system’s total loan portfolio growth rate has been plummeting even when the BSP’s policy rates are way below the 34- year average, and has been drifting near the June 2016 lows of 3%! (figure 1, lowest pane)
Although rates cuts from 2009 to 2013 did incite a growth spurt in the banking system’s loan portfolio, this growth paradigm has barely recurred since. Or, along with the launching of the QE in late 2015, the rate cuts of 2016 barely ignited a similar TLP growth spark. The combined easing measures only generated TLP growth rates that fluttered within a range, except for the May 2018 spike.
The 64-trillion peso question is WHY?
If such constitutes the baseline trend, HOW then and WHY will further “rate cuts” spur growth in the real economy? Despite BSP rates at historic lows in 2016, WHY did the TLP growth rates hit a plateau in 2016 to 2018? And WHY the floundering growth since? Or, WHY have banks been shy of expanding loans, at rates similar to 2009 to 2013, even when BSP policy rates during this period had generally been higher relative to the present (from 2016 to today)?
Most importantly, WHY have the banking system become increasingly LESS responsive to the BSP’s policies (QE, interest rates, and RRR cuts)?
The Banking System’s Multi-year Credit Expansion Slowdown: Both a Demand and Supply Problem; First-Ever Savings Deposits Deflation!
Figure 2
We also read that the BSP has purportedly been running a victory lap in claiming “Mission Accomplished” in its campaign against inflation. From the Inquirer (December 12, 2019): “The central bank on Thursday declared victory in its war against inflation — which it had been waging for two years now — saying prices of consumer goods and services for next year and beyond will likely be “benign.””
Yet, the most important force responsible for containing, both statistical and real economy inflation, has been the ongoing liquidity strains in the financial system. (figure 2 upmost window)
That’s aside from the National Government’s record amounts of cash stash, the panic imports in response to the 2018 rice crisis that led to a supply glut which depressed the food CPI; the most substantial component of the headline CPI, 2019's global bond boom, and the statistical juggling by official statisticians.
If policies have increasingly become ineffective in influencing the banking system’s loan portfolio, then how did the BSP slay the inflation monster, when the CPI has been shaped critically by money supply conditions, which are derivative from the rate of banking credit expansion?
Another remarkable development, experts believe in free lunches! They seem to forget that bank loans require funding! From the BSP-led FSCC’s Financial Stability Report (p.15): “The rising LDR suggests that the maturity mismatch is likewise increasing. Funds sourced by banks are largely savings deposits which are then used to fund longer-term credits.” (bold original, bold italics mine)
The banking system has officially announced through the BSP that savings deposits have entered the deflationary zone. Despite the 200 bps RRR and 75 bps ON RRP cuts, savings deposits CONTRACTED by .54% in October, the first-ever since at least 2008! October’s deflation validates the BSP’s M2’s savings deposits shrinkages in August and September and reinforces 1Q’s inverted yield curve.
Has it been so difficult to see and comprehend that the decaying rate of bank expansion accounts for a demand and supply juncture for the banking system?
On the supply side, the declining trend in the rate of change of savings deposits translates to the decreased funding for bank credit expansion? (figure 2, middle window)
On the demand side, the diminishing need for bank credit have been ventilated in the treasury and fixed income markets. (figure 2, lowest pane) Or, people would rather acquire fixed income securities than borrow to spend in the economy!
Of course, distortions brought about NG’s cash hoarding, the historic deficit spending, the fidgeting with the CPI, as well as, the BSP’s 200 bps RRR adjustments in November and December and the 25 bps policy cut in November have yet to reveal its intertemporal effects on the banking system’s balance sheet.
Without understanding the mechanics behind the WHY in the shortfall of bank credit demand, and the WHY in the downtrend of bank credit funding or supply through savings deposits, how can further easing or rate cuts “boost” the economy?
By magic? Or have these been intended to delude the public with a constant barrage of propaganda?
After 200 bps of RRR Cuts, Cash Reserves Shrunk Anew, Forex Deposits Growth Nears Deflation!
Or how about the perspective that years of artificially depressed interest rates are the PRIMARY CAUSE of banking’s problems?
Aside from the watershed downfall in bank credit expansion and savings deposit deflation, other symptoms have emerged elsewhere.
In spite of the estimated Php 200 billion funds released from the 200 bps RRR cuts from May to July, and again, the 75 bps ON RRP cuts, the banking system’s cash and due banks reserves resumed its downside pressures anew last October!
Figure 3
The banking system’s Cash and due banks contracted by .45% or Php 10.923 billion YoY and shrunk by Php 90.27 billion Month-on-Month. (figure 3, upmost pane)
From the BSP’s liquidity KPI, declining cash and deposits pushed the Cash to Deposits ratio to slip anew to 18.56%, the second-lowest level after June 2019’s 18.34%. Importantly, the Liquid Assets to Deposits ratio weakened anew to 47.58% in October from 48.28% in September. (figure 3, middle window) The bank’s booming treasury assets have started to lose ground relative to changes in deposits.
The cheapest and most fundamental source of funding for bank lending, total deposit growth dropped to 5.5% the second-lowest this year after August 5.4%, and a level last reached in September 2012.
The 11.58% increase in demand deposits, which corroborated the M2 data for the period, as well as, time deposits which surged 16.13% partially offset the deflation in savings deposits. As such, total peso deposits growth fell to 6.47% in October from 6.57% a month ago. Again, this rate of growth resonates with 2012. Savings deposits accounted for 44.6% share of peso deposit liabilities while demand and time deposits accounted for 28.7% and 24.7%.
Aside from peso savings, another worrisome aspect would be foreign deposits. While the BSP crows about its Gross International Reserves, the banking system’s total foreign deposit liabilities have trended towards deflation. That’s because of the sharp 6.7% contraction or deflation in demand deposits, and the crawling growth of savings and time deposits, which clocked in at 2% and .15%. (figure 3, lowest pane)
Aside from swelling credit transactions with US banks, has the BSP been puffing up its reserves by absorbing the banking system’s foreign deposit liabilities?
Put differently, the erosion of the Php 200 billion freed by the BSP through reserve requirements to the banking system had been swift. Not only is the banking system being plagued by cascading cash reserves, but the rapidly corroding deposit base has been contributing immensely to the shortfall in bank credit expansion.
The Low Interest Rate Induced Paradigm Shift of the Banking System’s Business Model, Bank Asset Growth at Multi-Year Lows
To shield the Philippines from the Great Recession, aside from the fiscal stimulus worth Php 330 billion, or 4.1% of the GDP, called the Economic Resiliency Plan (ADB Doraisami 2011 p.30), the BSP went into a rate-cutting spree. The series of cuts impelled a structural transformation of the banking system’s model, which leaned towards bank credit expansion to boost its asset base. At the close of 2008, the BSP’s policy rate was 5.5%.
In June 2009, the % share of the banking system’s total loan portfolio was at 49.04%, while total investments recorded at 27.74%. As of October 2019, the proportions shifted to 58.67% and 23.5%. Total bank assets almost tripled to Php 17.25 trillion in June 2019 from Php 5.78 trillion in June 2009 for a CAGR of 11.56%. So not only did the bank assets grew briskly, but the gist of its growth emanated from bank credit expansion! (figure 4, upmost pane)
Figure 4
With the banking system’s deepening its reliance on loans for its income and asset growth, and with bank borrowers chasing faddish investments made profitable by the façade of artificially low interest rates, the BSP tightening of 2014, which slowed economic growth began to affect the credit quality.
So even as QE was launched in late 2015, which had been supported by the adjustment to a record low BSP policy rates in June 2016, banks begun to admit by publishing increases in credit impairments.
Again despite 200 bps RRR cuts in 2018, and another 200 bps reduction in May to July of 2019, October Net Non-Performing Loans at 1.15% are knocking at the door of August 2019’s 1.18%, a multi-year high. (figure 4, middle window)
And these are the published ones, how about the undeclared impairments?
And as loans, cash and deposits simultaneously stumble, growth in the banking system’s total asset have slowed to 7.72% in October, marking a 7-year low rate! (figure 4, lowest window)
As Loans Stagnate, Investment Returns May Have Peaked
Figure 5
And if banks’ core operations have barely been vibrant, what’s elevating their asset base? The short answer: speculation on financial assets. Banks have been piling on Available for Sale (AFS) and Held for Trading (HFT) financial assets. AFS, with a 29.7% share of gross financial assets, jumped 50.5% in October, while HFT, with a 6.6% share, increased 28.9%. Growth of Held to Maturity assets, with 63.6% share, the accounting sanctuary from losses, moderated to 3.04%. (figure 5, upmost window)
Interestingly, as banks chase returns from the treasury boom, growth of net investments have begun to subside. Net Investments recorded a 15.13% increase in October down from 15.6% a month ago and from April’s peak at 20%. (figure 5, middle window)
And even as the investment category’s accumulated market gains soared by 211% YoY, in nominal or peso terms, this has begun to moderate. October’s gains recorded at Php 22.016 billion was down from 23.968 billion a month ago and from the recent high of Php 30.75 in August. (figure 5, lowest pane)
If widening treasury spreads helped produce recent profits, would a likely narrowing undermine them? Well, the trend of 10-and 1-year spread has been southbound since 2011, and so has the nominal or peso accumulated gains since 2013.
If lending operations continue to stagnate while investments lose its luster, wouldn’t that be a toxic mix for the banking system’s profits and liquidity?
Maybe the last batch of 200 bps in RRR cuts may do the trick?
Bonds Remain as The Primary Source of Bank Financing
Figure 6
With deposits under pressure, this leaves the capital markets as the primary funding source for banks.
Bills payable growth YoY materially slowed to 6.83% in October from 33.98%. On a month-on-month basis, bills payable decreased by Php 129.2 billion to Php 789.9 billion from Php 919.06 billion. However, bonds payable YoY rocketed by 149.12% from 143.16% a month ago. On an m-o-m basis, bonds payable expanded by Php 7.7 billion to Php 525.6 billion from Php 517.9 billion.
As a % share of the total, bond liabilities expanded to 3.45% in October from 3.36%. Meanwhile, bill payable decreased to 5.16% from 5.96% a month ago. (figure 6, upper and middle pane)
These imply that aside from steep competition with the government for access to the public’s funds, banks continue to tap higher-cost financing to fund its operations. Yet, higher-cost would translate to narrower interest margins that again would put pressure on banks. It’s a feedback loop of potential errors and risks.
Interestingly, while the growth rate of deposit liabilities have been decelerating substantially, its share of the total increased to 86.25% from 85.09%, which extrapolates to lackluster growth in the other categories.
The most interesting part has been the non-conversion to loans of the growth outperformance of peso demand deposit liabilities in September and October in both the bank’s report card to the BSP and the M2 accounts. What's the reason for this and why? Will loan growth surprise with a spike? (figure 6, lowest window)
Conclusion: The ‘Shock and Awe’ Crisis Resolution Template
From the Keynesian perspective embraced by the mainstream, everything is about aggregate demand. Thus, we’ve been told that cutting of interest rates or monetary easing, which should boost bank lending, and thus spending, would mechanically produce G-R-O-W-T-H.
Such heuristic masquerading as economics fails to account for significant correlations that establish the causal and transmission linkages of monetary policies to the economy through the banking system, the main source of the money supply.
And such fall short of explaining how the recent multi-year low rate of bank credit expansion has signified both a product of demand and supply.
For instance, subdued yields account for the liquidity preference of individuals to own fixed income securities than engage in investments through bank credit expansion.
On the other hand, dwindling savings deposits, the primary source of funding for bank credit expansion, implies reduced supply for lending.
And the near record low rates don’t elucidate the declining long-term GDP trend, the liquidity squeeze, tumbling deposits liabilities, which are at multi-year lows, alongside bank lending growth rates.
Despite the 200 bps RRR cuts and 75 bps policy rate cuts, cash reserves of the banking system fumbled anew as Net Non-Performing Loans rose to challenge the recent highs. It’s a sign that the BSP’s implicit bailout has become ineffectual.
Aside from savings deflation, another troublesome development has been the sharp deterioration of FX deposits, which had been weak in all categories, particularly the steep deflation in demand deposits.
The suppressed interest rate regime, which earlier boosted lending and the GDP, has met the law of diminishing returns. Importantly, since the banks' business model has shifted most of its weight towards lending, the industry became vulnerable to manifold risks, including interest, currency, inflation, market, and the economy.
As policy imposed low rates gave rise to projects that wouldn’t have existed without such subsidies, such in turn gave rise to credit impairments. Recent economic infirmities supported by the latest rate increases have magnified Net NPLs, which accelerated the liquidity strains in the financial system.
Recently, fixed income assets have boosted bank profits and assets. But factors that had brought about such bonanza indicate a turnaround.
If bank lending fails to pick up, and if bank investment falters, then the liquidity squeeze would amplify.
The BSP now prays that the next 200 bps RRR cuts plus the deposit substitute tweak would do the trick.
Moreover, banks have competed with the government for access to the public’s savings through the capital markets, which raises the cost of its lending operations. The rising cost of borrowing would reduce interest margins, compounding on pressures for banks to generate liquidity and profits.
As a final note, to the crises the incumbent administration faces, it uses a “shock and awe” template.
For instance, to subdue the rice crisis of 2018, a shift to a tariff system from the quota system was used. Because of the water crisis of 2019, the NG arbitrarily suspended the so-called onerous contracts with its existing concessionaires.
To help address the inflation scare of 2018, the BSP raised rates sharply and rapidly in seeming panic. Now it has gradually been trying to reverse this. And to address the liquidity strains, the BSP has been cutting RRR rates aggressively.
Shock and awe.
The measures undertaken as resolution towards such challenges are perceived and acted from a very short-term perspective, whereby unintended consequences from such drastic actions would surely surface over time.
And as one intervention begets another intervention, such leads to the general suffocation of economic and civil freedoms, and consequently, lower standards of living.
