This record is a partial extract of the original cable. The full text of the original cable is not available.

230802Z Dec 05

UNCLAS SECTION 01 OF 04 MANILA 005951 
 
SIPDIS 
 
Sensitive 
 
STATE FOR EAP/EP, EB/IFD, E 
STATE ALSO PASS FED RESERVE SAN FRANCISCO 
STATE ALSO PASS EXIM and OPIC 
STATE ALSO PASS USAID FOR AA/ANE and AA/G 
TREASURY FOR OASIA 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV EINV RP
SUBJECT:  Banking System More Stable But Still Vulnerable 
 
Ref:  a) Manila 5519   b) Manila 4639 
 
Sensitive but Unclassified - Not for Internet - Protect 
Accordingly. 
 
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Summary 
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¶1.  (SBU)  The Philippine Government is working to 
overcome the reputation of the banking sector as weak and 
inefficient with insufficient oversight.  Although it 
remains fragmented, the central bank has successfully 
encouraged consolidation and has introduced many reforms 
to strengthen banks and compel them to clean up their non- 
performing loans (ref a) while introducing more rigid 
accounting standards and improving its own management 
capability.  The Central Bank is updating and expanding 
banking regulations in line with international best 
practices, strengthening banking sector oversight and 
governance, and pushing for revisions to its charter that 
will expand legal protection and authority.  End Summary. 
 
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Banking System Overview 
----------------------- 
 
¶2.  (U)  Currently, there are 40 commercial banks in the 
Philippines along with 83 thrift banks and 750 rural and 
cooperative banks.  The commercial banks control 91% of 
total banking sector assets, amounting to 3.9 trillion 
pesos ($72 billion).  This is approximately 80% of 
Philippine GDP in 2004, one of the lowest percentages in 
the region.  Bear Sterns noted in comparison that these 
assets were $11 billion less than the total assets of 
Singapore's second-ranked bank, United Overseas Bank, at 
end-2004.  Only Indonesia and India have smaller 
proportion of bank assets per GDP, though the Philippine 
ratio compares favorably with many emerging market 
banking systems outside of Asia. 
 
¶3.  (U)  Fourteen of the 40 commercial banks are branches 
of foreign banks that collectively own 14% of the total 
assets in the banking system.  The four biggest foreign 
banks -- Citibank N.A., Standard Chartered, Hong Kong 
Shanghai Bank Corporation (HSBC), and Bank of America -- 
hold 65% of foreign bank assets.  The GRP passed 
legislation in 1994 (the Foreign Bank Liberalization Act) 
opening up the banking sector to 10 more foreign-branch 
banks, or to own up to 60 percent of a new or existing 
local subsidiary.  All ten slots have been filled.  The 
Philippines is, therefore, currently closed to banking 
institutions seeking to operate as foreign branch banks 
in the country.  Foreign branch banks that were allowed 
entry under the 1994 legislation are limited to putting 
up six branch offices each.  The four foreign banks that 
had been operating in the Philippines prior to 1948 were 
each allowed to open a maximum of six additional branch 
offices.  Current regulations mandate that majority 
Filipino-owned domestic banks should at all times control 
70 percent or more of total banking system assets.  Rural 
banking remains closed to foreigners. 
 
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Reigning in Excess Cash 
----------------------- 
 
¶4.  (U)  As one of its monetary policy measures, the 
Central Bank (Bangko Sentral ng Pilipinas, or BSP) 
adjusts the banking sector's required reserve ratio of 
deposits to loans to control the supply of pesos.  It 
increased the reserve ratio by 2 percentage points in 
July 2005 to 21% because of the high volume of pesos in 
the market.  Each bank must now hold 10% of its pesos in 
"regular" reserves with the BSP at zero or minimal 
interest rates.  Banks must hold another 11% in 
"liquidity" reserves, which can be invested in market- 
yield government securities.  In addition, the BSP has 
raised overnight policy rates by 0.75 percentage points 
thus far in 2005. 
 
¶5.  (U)  Even with the increase in reserves requirements 
and policy rates, domestic liquidity has risen 14% for 
the year through October.  BSP Governor Tetangco 
attributed the sustained expansion in the money supply to 
the large amount of hard currency remitted from overseas 
workers (ref b) and portfolio investments in the 
resurgent stock market.  The BSP reported November 30 
that the speculative financing flows of $2.1 billion so 
far in 2005 are already four times greater than all of 
last year.  The bulk of this hot money went into the 
stock market, which closed near the 2100 level on 
December 1.  Bankers noted that the BSP has resisted 
taking some of the pesos out of circulation by either 
raising the reserve requirement or selling securities on 
the open market because the BSP is already flush with 
cash.  As one indication, the BSP's foreign assets have 
increased year-on-year by 9.7% while its foreign 
liabilities declined by 50%. 
 
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Neither a Borrower Nor a Lender Be 
---------------------------------- 
 
¶6.  (SBU)  One feature of the banking system since the 
Asian financial crisis is its reluctance to make new 
loans.  Bankers commented to Econoff that the corporate 
sector has few major expansion plans that require outside 
funding and so are not interested in loans.  "There is 
little corporate appetite to expand because of political 
uncertainties, weak infrastructure, and regulatory 
uncertainty," said one banker.  Because of the huge 
amount of cash chasing few customers, it is a borrower's 
market.  The competition creates a low spread between 
consumer deposit and loan interest rates, compelling 
banks to chase after their elite customers to maximize 
lending and reduce risk.  Even so, the Philippines has 
the lowest ratio of consumer loans to deposits among all 
the countries in Southeast Asia - only 53% and falling. 
Loans account for less than 40% of total assets and this 
ratio is also on the decline.  Deposits are growing more 
rapidly than loans, to the detriment of economic recovery 
and job creation, though it helps the government to issue 
new bonds for financing the budget deficit. 
 
¶7.  (SBU)  BSP Deputy Governor Espenilla admitted that 
Philippine industry growth is primarily in the service 
sector, not in manufacturing where the country needs it. 
Instead of corporate lending, it is consumer lending that 
is growing rapidly, fueled by the massive growth in 
overseas remittances.  There has been double-digit growth 
in credit card issuance and use, he said, as well as auto 
loans.  The BSP is developing credit information system 
legislation that will force credit providers to submit 
customer accounts and transaction history into a central 
data bureau that will help ensure individuals do not take 
on excessive amounts of lending. 
 
¶8.  (SBU)  As a result of the low loan rate, the 
Philippine banking system's role as an investor in fixed 
income securities is almost as important as its role as 
provider of loans.  Thus, around one-quarter of RP bank 
assets consist of securities - largely bonds - issued 
primarily by the GRP, though RP banks and corporations 
have begun to issue their own smaller dollar-denominated 
bonds as well.  Citibank Vice-President for Debt and 
Capital Markets Cheli Tabuena said the private banking 
sector issues only 5% of the bonds in the Philippines by 
value, but this number is growing quickly. 
 
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Consolidation, Not Expansion 
---------------------------- 
 
¶9.  (SBU)  Another structural aspect of the Philippine 
banking system is its fragmentation, with 40 banks in a 
roughly $100 billion economy, compounding a severe 
concentration of assets in a small number of banks. 
Twenty-four of the banks accounted for less than 1% of 
banking system assets.  The top five individual banks 
(Metrobank, Bank of the Philippine Islands, EPCI, 
Landbank, and Citibank) account for 48% of the assets and 
the top ten banks account for 71%.  According to Bear 
Sterns, this ownership concentration is growing after 
recent consolidations of banks within the Sy family 
(Equitable and PCI which will likely merge with Banco de 
Oro) and by Lucio Tan, who owns Allied Bank and bought 
out the government shares in Philippine National Bank. 
 
¶10.  (SBU)  The BSP is encouraging the banking industry 
to merge or stand on its own feet.  Espenilla said he 
hoped the number of banks would eventually dwindle to 
less than a dozen.  The General Banking Law of 2000 
created a seven-year window during which foreign banks 
may own up to 100 percent of one locally incorporated 
commercial or thrift bank.  However, these investments 
can be made only in existing and not new banks; since 
1999, the BSP has imposed a complete moratorium on new 
bank licenses, except for those engaged in micro-finance. 
Already several banks have merged (down from 42 
commercial banks in 2004 to 40 at present) and others are 
in various stages of takeover by larger banks.  Citibank, 
for example, is taking over the 53 branch offices of 
Insular Bank and JP Morgan may be taking over a small 
bank chain soon as well.  The BSP announced in November a 
partial liberalization of its branch moratorium for 
domestic banks outside of seven core cities, including 
Manila, where branching will remain frozen.  The BSP also 
announced relaxation of rules to give bank automatic 
extension of special licenses for certain banking 
activities unless revoked for cause. 
 
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Other Banking Sector Reforms 
---------------------------- 
 
¶11.  (SBU)  Espenilla told econoff that the GRP has 
drafted a law creating independent retirement accounts 
with tax incentives.  It has also promoted revisions to 
the investment competency act to develop mutual fund 
standards, and a fixed income exchange to encourage more 
transparent trading and clearing systems for fixed income 
recipients.  The GRP has finalized its rules for third 
party custodianship, which will require a separate bank 
to sell securities from an account-holder's regular bank. 
This boosts consumer protection, prudential standards, 
and capital market development, he said. 
 
¶12.  (SBU)  Otherwise, the BSP is updating and expanding 
banking regulations in line with international best 
practices, using the standards and codes of the Basel II 
conference.  Espenilla said he hopes to strengthen risk- 
based management and impose risk-based capital, improve 
corporate governance, and strengthen the appraisal 
process through USAID to evaluate the banking system 
assets.  (Note:  The BSP is advocating for the passage of 
a credit bureau bill, now pending before the Senate and 
Congress, that will mandate all banks and other major 
credit providers to submit customer credit accounts and 
transaction history into a central credit bureau that 
will guide credit providers in screening prospective 
borrowers.  USAID assisted the BSP in developing the bill 
and studying credit bureau operations.  End Note.)  He 
said the BSP needs an amendment to its charter, 
especially parts related to legal protection and 
authority.  For example, there have been many suits 
against individuals in the BSP, including a number 
against the former Deputy Governor, because the laws are 
unclear or weak regarding the ability to close down or 
restrict lending from banks in jeopardy.  Recently, 
Espenilla commented, the BSP has been winning its cases 
since the Monetary Board granted them more leeway to hire 
better lawyers. 
 
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Comment 
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¶13.  (SBU)  Based on the positive developments listed 
above, the banking sector's reputation and impact on the 
investment climate deserve reconsideration.  The BSP has 
had a series of strong leaders with acumen and foresight. 
Their efforts have resulted in a banking sector that is 
more stable, efficient, and transparent than at any time 
in the past and could, provided reforms continue, 
eventually rise to rival the effectiveness of financial 
systems in the region. 
 
Jones