Economic Update
The Philippines banking sector is staying strong despite the uncertain global economic outlook. While profits are likely to fall as a result of the volatile global economic environment, the fundamentals underpinning the sector remain sound and will ensure continued growth. Consolidation is also expected to carry on throughout 2009, with a number of key mergers, along with the implementation of further reforms and a cooling of inflation.

The central bank, Bangko Sentral ng Pilipinas (BSP), has been actively encouraging mergers and acquisitions in a very fragmented market to further strengthen the competitiveness of the local banking sector. 2007 saw the merger between Union Bank of the Philippines and International Exchange Bank, as well as China Bank and Manila Banking Corporation, and that of Banco de Oro and Equitable PCI in 2006. The merger between Philippine National Bank (PNB) and Allied Bank, originally targeted for end-2008, is now expected to be completed by mid-2009. Yet, some industry insiders say the process may now shift to small and medium-sized banks, as they are trying to stave off increased competition from the largest banks in the country.

In terms of total assets owned, the five biggest banks in the Philippines (the privately-owned Banco de Oro-Equitable Bank, Metropolitan Bank and Bank of the Philippine Islands; and the government-owned Land bank and Development Bank of the Philippines) control around 46% of the sector, according to BSP statistics as of June 2008.

“I think the era of large mergers is probably over. The top five banks will jockey for position but are likely to remain the same. For this reason I expect the majority of M&As among banks to be driven by pressures on cost efficiencies and mainly among the small to medium sized banks,” Raul de Mesa, CEO of the Bank of Commerce, a subsidiary of San Miguel, told OBG.

The BSP is also pushing for further reform, beginning with the recently announced liberalisation of foreign exchange (forex) transactions. This is the third such set of forex reforms to pass through the BSP since 1993 and is meant to condense the first two reforms into one consolidated framework. The policy is particularly notable considering most central banks seek to restrict forex transactions during times of market volatility.

Last week, Central Bank Governor Amando Tetangco Jr. told the local press that “The third phase of reforms includes the liberalisation and streamlining of rules on foreign borrowings of private banks for relending purposes and registration of inward foreign portfolio investments. It will also improve the monitoring of foreign exchange flows and clarify existing practices.”

Meanwhile, the BSP is expected to continue lowering interbank lending rates, especially as low fuel prices continue to reduce inflationary pressure. According to a report issued by First Metro Investment Corporation and the University of Asia and the Pacific, headline inflation is expected to further decline throughout 2009 and fall below 5% as early as May, after having averaged an estimated 9.4% in 2008.

Central Bank Governor Amando M Tetangco Jr. told OBG it was essential to maintain a strong Peso as “any amount of unnecessary depreciation would exacerbate inflation”.

Furthermore, new rules on transparency and governance are helping to improve the operational soundness of Philippine’s banks. In particular, the country’s implementation of Basel II in July 2007 further strengthened the capital adequacy ratio (CAR) of banks. Average CARs for the sector as a whole are running close to 15%, well above the national and international standards of 10% and 8% respectively. Asset quality ratios also show a noteworthy improvement as non-performing loan (NPLs) fell below 5% of total assets last year.

These figures certainly reflect an improvement in the overall risk management framework. Thanks to conservative banking practices and sensible fiscal guidance, the BSP has limited its exposure to the ongoing global financial crisis. However, other sectors of the economy, particularly those that rely heavily on external sources such as industrial exports, will likely catch the brunt of a US-led recession, which could have serious implications for the financial sector.

Nestor Tan, President of the Banco de Oro (BDO), told OBG, “The subprime crisis and the US slowdown will have little direct impact on the Philippine banking sector. An indirect impact, however, is being felt. The US slowdown in particular has created a ‘wait and see attitude among players’.”

Another leading bank is showing confidence in the financial sector. According to Aurelio Montinola, CEO of the Bank of the Philippine Islands, “The good news is that there is an abundant amount of liquidity circling around the country and the region. This capital is waiting to be spent and to some degree ensures that this slow period will be short and shallow…We are prepared for consumer spending to slow in 2009 as higher interest rates and a slower economy take their toll. Still, I expect most sectors of the banking industry to grow, albeit at a slower pace.”

While the Philippines is far from immune from the financial crisis fallout, with both bank profits and exports particularly sensitive to any fluctuations, the set of reforms the BSP has implemented will help buffer the country’s financial sector from any undue aggravation.