In a healthy economy, savings are channeled to productive investment, and the new securities that are issued in the process are evidence of that transfer. In an unhealthy economy, and particularly one with very large wealth disparities, a large volume of securities may be created, but they are often simply a way of supporting debt-financed consumption. As a result, no productive investment occurs, and no national “wealth” is created. All that occurs is a wealth transfer from savers to dis-savers—John P Hussman
In this issue
What has the BSP’s RRR Cuts Accomplished? August NPLs Spikes to Multi-Year Highs as Savings Deposits Growth Plummets!
-The BSP’s Moving Goalpost for Reserve Requirement Ratio Cuts!
-200 Basis Points of RRR Cuts Barely Improved the Banking System’s Cash Reserves
-Held to Maturity Investments are Symptoms of a Credit Driven Liquidity Blackhole
-August NET NPLs Hit Fresh Multi-Year High!
-Confirming M2, Plunging Savings Deposits Growth Pulls Peso Deposit Growth to Multi-year Lows!
-Has 400 BPS of RRR Cuts Lowered Intermediation Costs?
-Plummeting Savings Deposits are Signs of General Malinvestments
-Summary and Conclusion
What has the BSP’s RRR Cuts Accomplished? August NPLs Spikes to Multi-Year Highs as Savings Deposits Growth Plummets!
The BSP’s Moving Goalpost for Reserve Requirement Ratio Cuts!
When the Bangko Sentral ng Pilipinas reduced the banking system’s reserve requirement ratio (RRR) by 200 bps in two installments 2018 in March and June, operational enhancements were justified for these: (bold added)
These operational adjustments are part of the BSP’s shift toward a more market-based implementation of monetary policy that aims to gradually reduce the BSP’s reliance on reserve requirements for managing liquidity in the financial system. The shift to the auction-based monetary operations under the interest rate corridor (IRC) framework has allowed the BSP to provide more effective guidance to short-term market interest rates, which should help facilitate healthy price discovery on the cost of funds in the financial system.
The reduction in reserve requirements is also part of the BSP’s broad financial sector reform agenda to promote a more efficient financial system by lowering intermediation costs.
The BSP added that this was not about policy easing: “Moreover, the Monetary Board reiterates that the calibrated reductions in reserve requirement ratios are not intended to signal any change in the prevailing monetary policy stance, as the BSP continues to have the scope to offset their potential liquidity impact via an expansion in auction-based monetary operations.” (italics added)
In his August 2018 speech, the late BSP Governor Nestor Espenilla, Jr. affirmed this view: “I reiterate that the RRR cuts are not intended to be expansionary. Data suggest we were able to neutralize the immediate liquidity impact through open market and FX operations. Following the cuts, the level of domestic liquidity actually grew at a slower rate. M3 expanded by 11.7 percent year-on-year (y-o-y) in June 2018, slower than the 14.3-percent growth rate in the previous month.” (bold mine)
Though the BSP repeated the goal that RRR cuts were about “broad financial sector reform agenda to promote a more efficient financial system by lowering financial intermediation costs”, in the next three-pronged 200 bps downside adjustments in May to July 2019, it included another objective, “to help mitigate any tightness in domestic liquidity conditions due to limited public expenditure following the budget impasse in the first quarter of the year.” (bold mine)
In the forthcoming lowering of another 100 bps in November, which would total 300 bps for 2019, aside from repeating the mantra “to promote a more efficient financial system by lowering financial intermediation costs”, included at present was something the BSP had earlier denied, “the adjustment in reserve requirement ratios is aimed at increasing domestic liquidity in support of credit activity”.
Put this way: the BSP has been moving its goalposts!
It proposed reforms to attain efficiency in operations, due to the imposition of the Interest Rate Corridor (IRC), by lowering financial intermediation costs while denying these had been about easing. However, the BSP made a volte-face in the Diokno regime. Moreover, blaming the budget impasse, the BSP also confessed that recalibration of the RRR had been intended “to help mitigate any tightness in domestic liquidity”.
And not content with the proposed November 2019 modification, quoting Governor Diokno, “the BSP could still cut banks’ reserve requirement ratio (RRR) further towards December after a cumulative 300-basis-point reduction this year so far should relevant data warrant such move”, reported the Businessworld, but also added that they are “likely done for 2019 with cuts in benchmark interest rates that have totaled 75 bp, through 25bp equal cuts on May 9, Aug. 8 and Sept. 26.”
So another reduction in the RRR is in the BSP’s pipeline! Another 100 bps perhaps, for a total of 400 bps in 2019, designed to release from regulatory shackles some Php 300 to 350 billion to the banks? Why hurry?
And seemingly dissatisfied with just bank reserves, the BSP this week expanded its scope to cover bonds issued by banks and quasi-banks: “The Monetary Board approved the reduction in the reserve requirement rate for bonds issued by banks/QBs to three (3) percent as part of its commitment to contribute to deepening of the local debt market. This rate is lower than the required reserves of other debt instruments issued by banks such as long-term negotiable certificates of time deposits which is currently at four (4) percent. The lower bank reserves on bond issuances is expected to reduce the bond issuers’ intermediation cost that could be passed on to the holders of such securities.”
Yet, have the BSP achieved any of the enumerated goals, namely, to mitigate tightness in liquidity, to support credit activity, and to lower intermediation costs?
The August data on the banking system’s balance sheet should reflect fully on the impact of the 200 bps of RRR cuts from May to July, which should have made available some Php 200 billion for the banks.
But here’s the rub. Exactly, what has such monetary reform agenda accomplished?
200 Basis Points of RRR Cuts Barely Improved the Banking System’s Cash Reserves
Has the cutback of the first 200 bps of RRRs mitigated the tightness in domestic liquidity conditions?
Figure 1
Ever since shrinking by as much as 12.33% in July 2018, the rate of contraction of cash and due banks have partially been recovering.
The year-on-year rate of cash deflation was at -1.99% in August 2019, or a drawdown of Php 49.45 billion, from -.39% in July, or a decrease of Php 9.53 billion. (figure 1, upmost pane)
Since December 2017, August marked the 21st consecutive month of the banking system’s cash deflation! When the BSP initiated its first 200 bps RRR adjustments in two stages (March and June 2018), the banking system’s rate of cash contraction was at its acme (March -9.23% and June -12.55%).
Four hundred (400) bps later since its launch, the banking system’s cash reserves continue to shrink in 2019, but at a lesser pace than in 2018.
On a month on month basis, cash and due banks registered a Php 23.5 billion increase in August that followed an inflow of Php 49.7 billion in July. From May to August or when the 200 bps of RRR cuts took place, banks saw an increase of Php 65.5 billion from increases in three out of the four months.
Despite falling deposit growth, the Cash and due Banks to Deposits (CBD) ratio has barely moved higher since its June 2019 low. It was 18.79% in August slightly higher from 18.57% in July and 18.34% in June, the lowest since at least 2013. On the other hand, the drop in deposits had magnified the Liquid assets to deposits (LAD) ratio coming from the boom in treasury securities. The LAD increased to 48.33% from 47.74% over the same period. The LAD reached a low of 45.7% in September 2018. (figure 1, middle window)
That is to say, the BSP’s implemented the RRR cuts, in response to the deflationary trend in liquidity, expressed by its tumbling cash reserves, that has been plaguing the banking system. The IRC, which was implemented two years ago or in June 2016, was merely used as a politically convenient smokescreen.
To be sure, the release of banking funds from the regulatory rein from the BSP’s RRR mandate was just a factor, among the many, influencing changes in the cash reserves.
Held to Maturity Investments are Symptoms of a Credit Driven Liquidity Blackhole
The escalation in liquidity strains had been, in Governor Ben Diokno’s 2018 Financial Stability Report (FSR), attributed to the banking system’s funding of investments. (p.16)
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 have been growing at an exponential pace, which has been driven by the growth of securities classified as held-to-maturity (HTM). These developments have implications on maintaining the balance between profitability and liquidity
The reality has been that the ‘exponential pace’ of ‘growth of securities classified as held-to-maturity’ was just another symptom of an internal vortex engulfing the bank’s liquidity.
As the late Espenilla’s 2017 FSR elaborated, since higher rates caused holders of securities to endure loses, some banks resorted to the reclassification of Available-For-Sale (AFS) to Held-to-Maturity (HTM) securities. But such accounting legerdemain came with a cost, “the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity”. (p.24) [bold italics added]
And despite the boom in the Treasury market, which has inflated their balance sheets, HTMs remain as the favored investment class for the banking system.
HTMs grew 16.29% in August 2019, down slightly from 16.34% in July. HTMs registered its fastest growth clip in November 2018 at 57.56%. HTMs expanded by a breakneck clip of over 50% in the four months of September until December 2018.
HTMs constituted the largest pie of the banking system’s gross Financial Assets with a 64.32% share in August, up from 64.1% in July 2019. HTMs had the biggest share of the bank’s investments in October 2018 at 70.87%.
However, since the Treasury market boomed at the onset of 2019, the growth rates of AFS and Financial Assets Held for Trading (HFT) outpaced HTMs in the 2Q. AFS grew 23.23% in August slightly lower from 26.5% in July, while HFT jumped 24.07% from 22.07% over the same period. (figure 1 lowest pane)
Nonetheless, the share contribution of such investment class remains inconsequential to the gross Financial Assets.
In short order, the artificially inflated treasury securities helped the banking system’s non-interest or trading income, as well as bloated their assets, yet in spite of this, pressures on liquidity continue to plague the industry.
The crux: How sustainable is the implicit subsidy, through the National Government’s massive amassment of financial liquidity, to the banking industry? And how lasting is the current deflation in food prices CPI?
August NET NPLs Hit Fresh Multi-Year High!
Figure 2
And it’s also no coincidence that Net Non-performing Loans (NPL) hit a multi-year high rate of 1.18% in August. This multi-year milestone comes in conjunction with the decline to multi-year lows, the banking system’s total loan portfolio, which had likewise been supported by the M3, also at a landmark (multi-year) low.
And the BSP data represents NPLs disclosed by the industry, how about the undeclared ones?
Surging NPLs have been raised by the 2018 FSR: “This rise may look minimal but a conservative approach requires that we monitor the NPL level which actually shows a V-shaped pattern. Since the inflection point in late 2015, the amount of NPLs has been increasing, reversing the previous positive trend of a decrease despite the rise in outstanding loans.” (p.13) [italics mine]
And since the BSP notes that “demand for credit remained the principal driver of money supply growth”, how exactly has the NPLs been driven by the material slowdown of both factors?
The growth rate of the banking system’s Total Loan Portfolio (TLP), Net of Interbank Loans and Repos, plumbed to 9.24% in August, a level reached in the 1Q of 2011. Since peaking in May 2018 at 23.5%, the growth rate of Net TPL has been plummeting. And the plunge in TLPs has likewise been manifested on the M3. The current 6-months streak of 6%+ M3 growth rates appears reminiscent of the performance of the 2H of 2012.
Why so?
Has the diving growth rate in bank lending been because of deficiencies in demand for credit? Since policy rates have been adrift in the proximity of uncharted low levels, why should borrowers retreat from such enticing offers?
Or, have banks been conserving loan issuance because of the shortages in funding? If the loan turnover remains healthy, why the worsening strain in the banking system’s funding? Aren’t banks benefiting from the Treasury boom in the 1H of 2019, which not only supposed to have contributed to the bulging of profits but also to enhancements of monetary liquidity?
What has been absorbing so much of the bank’s resources to have spurred a sharp slowdown in credit transaction activities and money supply conditions?
Figure 3
And if an increase in credit delinquencies on its record loan-to-deposit portfolio have hampered bank’s credit operations, wouldn’t a slowing economy, indicative of the deterioration in the borrower’s repayment and settlement ability, magnify its feedback loop and transmission effects?
And wouldn’t banks attempt to finance the escalating liquidity shortfall, evidenced by its credit transactions, also from its deposits?
Confirming M2, Plunging Savings Deposits Growth Pulls Peso Deposit Growth to Multi-year Lows!
With August’s 5.4% growth rate, Total Deposit liabilities (TDL) growth have sunk to a multi-year (2012) low. And though TLPs continue to register higher rates than TDLs, the variance between them (TLP-TDL) reveals that bank loans have dropped at a faster than deposits since October 2018, leading to the plateauing of the loans-to-deposit ratio. (figure 3, upmost and middle pane)
Given such empirical data, insufficient funding may have hobbled the banking system's credit operations.
The staggered 175 bps increases in the BSP’s policy rates (ON RRP) from May to November 2018, perhaps may have exacerbated such tightening. But if an official lifeline rate of 4.75% can do so much damage, how robust is a system that can only operate only under emergency measures? Policy rates have averaged 7.83% from 1985 until 2019, notes the Trading Economics.
And consistent with the M2’s data, the downdraft in the total deposit liabilities has emanated principally from the plunge in savings deposits!
At 5.5% in August, peso deposits growth hit 2012 lows! Peso deposits grew 6.68% in July and 6.06% in June. In the meantime, foreign currency deposits had some recovery; it was up 4.88% in August from 3.8% in July and 4.75% in June. Peso deposits constitute 83% of the banking system’s total deposits.
And peso savings deposit growth crashed to 1.34% in August, from 4.33% in July and 2.26% in June. Peso savings accounted for a 45% share of peso deposits in August.
Other peso deposit accounts were mixed. Demand deposit growth increased by 7.98% in August from 6.6% a month ago. Time deposit growth slipped to 12.24% from 12.37%. The deflation of Long Term Negotiable Certificate of Deposits in August at (-) 6.4% was far larger than July’s -1.97%. Nonetheless, the month-on-month improvements have yet to demonstrate the reversal of the general downtrend. (figure 3, lowest pane)
Signs of deflation have also appeared in foreign currency deposits. Demand and Now deposits shrunk 5.5% in August, following a 6.6% decrease in July. The growth rate of foreign savings deposits, which account for a 48% share of foreign currency deposits, slumped to 2.47% in August from 3.25% in July.
Here is the 2018 FSR’s take on what’s eroding savings deposits: (p 15-16) [bold original, bold-italics mine]
The build up of leverage creates mismatch risks in the banking books. While financial authorities look at the CGDP ratio and the CGDP gap to get a holistic view of the standing of credit vis-Ã -vis the economy, banks get a similar—though own-view—perspective from its loan-to-deposit ratio (LDR). As expected, this has trended upwards near to levels that would theoretically represent the upper bound as a result of the reserve requirement.
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. As Figure 2.12 shows, this creates a gap between the amount of assets and the corresponding amount of deposits categorized by maturity. With the average maturity of loans calculated at 4.25 years, the maturity gap then translates into a liquidity gap as well. Banks would, therefore, not only provide for the difference between the tenor of what they lent versus the short-term deposits that they borrowed but they will also have to provide liquidity for the periodic withdrawals of those deposits.
Liquidity gaps don’t logically explain why a black hole has emerged in the banking system’s balance sheet if credit delinquencies have been minimal. The growing mismatches are simply symptoms of funding pressures encountered by borrowers, ventilated through the shortening tenor of the loan portfolio of the banking system.
Neo-Keynesian Hyman Minsky’s Financial Instability Hypothesis (FIS), may in part, explain such shifts.
Perhaps, the size of leverage has grown to a point for it to become systemically unmanageable, where recent interest rates increases may have compounded on this juncture.
From the FIS perspective, the transition from stability to instability, in particular, from hedge, to speculative and to Ponzi financing. In Ponzi financing, being unable to finance existing liabilities from normal operations to service existing liabilities, entities resort to either borrowing or sell assets. The modern variation of the Ponzi entity is the Zombie firm.
So even with about Php 250 billion from RRR released into the financial system from the 200 bps decrease in the RRR, bank liquidity remains tight, as evidenced by the deflation in cash reserves, plummeting deposits, the steep decline in the growth of credit activities and continuing downtrend in deposit liabilities. And in consideration of the 400 bps reduction from 2018, RRR cuts are far from accomplishing their mission!
Will the next 100 bps do the job? Will RRR cuts on bonds issuance by banks/QB be enough?
Has 400 BPS of RRR Cuts Lowered Intermediation Costs?
But there’s more.
The lowering of intermediation costs has been the reiterative goal declared by the BSP. Last week’s downside adjustment to the reserve requirement on bond issuance by banks and quasi-banks has merely underscored this.
Figure 4
Ever since deposit growth has become scarce, banks have raced along with the National Government (NG) for access to the public’s savings mainly through bonds.
Thanks to the National Government’s stockpiling of cash, compounded by the plunge in the CPI, as well as the panic buying in the global treasury markets, the recent boom in the treasury markets, which has pushed rates down, have provided both the banking system and the NG with a low-interest rate subsidy. Nevertheless, in spite of this, the dramatic shift of the banking system’s sourcing of funds towards bonds has exploded its share to total liabilities by almost fourfold.
Bonds payable growth spiked further by 195.43% to Php 482.7 billion in August from 191.07% to Php 472.2 billion in July. The share of bonds payable to total liabilities swelled to 3.2% in August from 3.13% a month ago. The ratio of bonds to total liabilities rocketed from .59 in August 2017 to 3.2% in August 2019, a 542% increase! (figure 4, upmost and middle windows)
Meanwhile, bills payable increased 32.7% to Php 860.36 billion in August, sharply lower than 44.75% clip in July to Php 834.34 billion. With bonds on fire, bills payable’s share to total liabilities dropped to 1.13% from 1.26% over the same period.
And yet more bank borrowing on the pipeline, some excerpts:
From the Inquirer (October 17, 2019): Rebisco group-led Asia United Bank has debuted in the local bond market with the launch on Wednesday of an offering worth at least P3 billion. AUB’s inaugural bond offering with a three-year tenor was priced to yield 4.625 percent per annum, the bank disclosed on Wednesday.
From BPI (October 8): Bank of the Philippine Islands (BPI) launches today its Long-Term Negotiable Certificates of Time Deposit (LTNCTDs) in the aggregate principal amount of up to Php 3 billion, with option to upsize, to support the Bank’s expansion plans, diversify funding sources, and offer investors an attractive investment instrument. The LTNCTDs will have a tenor of five and a half (5½) years and an interest rate of 4% p.a., paid quarterly
From PNB (September 27): Philippine National Bank (“PNB” or the “Bank”) is set to offer a second tranche of Long-Term Negotiable Certificates of Time Deposit Due 2025 (“LTNCDs”) under the authority to issue up to PhP 20.0 billion of LTNCDs granted by the Monetary Board of the Bangko Sentral ng Pilipinas (BSP) in October 2018. The Bank raised PhP 8.22 billion worth of LTNCDs last February 27, 2019.
The objective of this transition has not only been to raise money to plug the liquidity vortex, but also to increase the maturity profile of bank funding by making use of the interest rate subsidy from the present repressed interest rate environment.
The thing is, since bonds represent an expensive way to fund bank operations and its balance sheet, its funding cost have been rocketing since its transition, which had its genesis in the 4H of 2017 through the 1H of 2019. (figure 4, lowest window)
So does the data show that RRR cuts have succeeded in the lowering of the banking system’s intermediation costs?
Plummeting Savings Deposits are Signs of General Malinvestments
Figure 5
Again, despite the first 200 bps RRR reduction in 2019, tight liquidity conditions remain prevalent; all major indicators from bank lending, bank’s cash reserves, money supply growth, and peso deposits have been singing the same hymn. (figure 5, upmost window)
Nevertheless, the plunging rate of change in savings deposits, whether seen from the banking system’s balance sheet or M2, have been an ongoing dynamic or trend since 2013. (figure 5, middle window)
The difference today is that the rate of decline has reached deflationary proportions (M2).
As Spain’s leading Austrian economist Jesús Huerta de Soto explained*
Instead, regardless of the final amount of saving and investment in society (always identical ex post), all that is achieved by an attempt to force a level of investment which exceeds that of saving is the general malinvestment of the country’s saved resources and an economic crisis always destined to make it poorer
*Jesús Huerta de Soto, Artificial Booms and the Theory of "Forced Saving" Mises.org Also quoted at Bullseye! The BSP-Led FSCC’s Financial Stability Report Confirms Almost ALL the Risks I Raised on the Banking System and on Asset Bubbles September 8, 2018
The savings to bank loan ratio, which is at a historic low, reveals the extent of dissaving or capital consumption from general malinvestments taking hold in the Philippine economy. (figure 5, lowest window)
In consonance with the BSP’s adaption of the countercyclical buffer** last December, the lowering of RRR (bank reserves and bonds) has been intended to shore up the rapidly economy’s decaying capital base as ramifications of the escalation of malinvestments.
**Regulatory Bailout 2.0: BSP Launches Countercyclical Capital Buffer (CCyB) Intended to Ease Capital Reserves! December 16, 2018
By the way, here is an example of the use of the countercyclical buffer in Hong Kong.
From South China Morning Post (October 14): Hong Kong’s monetary authority said it would cut the amount of capital that banks need to set aside, in the first reduction of the ratio since 2015 to release cash into the financial system to bolster it against any impact from political risks and the city’s unprecedented civic unrest. The city’s countercyclical capital buffer (CCB) will be reduced to 2 per cent effective immediately, from the previous 2.5 per cent, according to a statement by the Hong Kong Monetary Authority (HKMA). “Economic indicators and other relevant evidence have signalled that the economic environment in Hong Kong has deteriorated significantly since June 2019,” the monetary authority’s Chief Executive Eddie Yue said. “Lowering the countercyclical capital buffer at this juncture will allow banks to be more supportive to the domestic economy and help mitigate the economic cycle.” The cut will release between HK$200 billion and HK$300 billion” (bold added)
Bluntly put, like RRRs, the countercyclical buffer frees resources of banks from regulatory rein, and function as emergency tools in times of economic or financial distress. However, these tools address the symptoms and not the disease.
Summary and Conclusion
Even when the implementation of the Interest Rate Corridor was way back in June 2016, the BSP has promoted the recent adaption of RRR adjustments, in its wake, or two years after (in 2018). The BSP pruned 200 bps in 2018, 200 bps in the May to July in 2019 with another 100 bps slated in November.
In reality, RRRs have been designed to mitigate the tightening of financial liquidity, which has been plaguing the banking industry since the end of 2017, like in the Asian Crisis.
What has the BSP’s lowering of 400 bps in RRR attained?
Cash reserves continue to contract year-on-year in August. While the boom in the treasury market improved its asset holdings, banks continue to rely on HTMs as its primary investment tool. Yet, investment gains have hardly loosened up the industry’s liquidity plight.
August NPLs spiked to multi-year highs in the face of cascading growth rates of bank lending and money supply.
Magnifying the industry’s liquidity strains have been the plunge in savings deposits, as well as signs of deflation in savings deposits M2. The banking system’s predicament on NPLs, savings deposits, bank lending, money supply, and cash are symptoms of the unexplained black hole plaguing the industry.
The rapid draining of deposits has been forcing banks to raise financing from the more expensive avenues, thereby, increasing intermediation costs. As such, the BSP expanded the reduction of reserve requirements to include the bank’s bond issuance.
The multi-year low level of savings deposits to bank loans exposes the magnified extent of malinvestment driven dissavings or capital consumption.
Like countercyclical buffers, RRRs are designed to treat symptoms and not the disease.
So far, the BSP’s RRR cuts have barely been about realigning policies on its IRC platform, but about rescuing the banking system afflicted by an escalating liquidity black hole.
