Should Foreign Banks’ Entry into the Philippines be Further Liberalized? A Policy Review

By Atty. Juris Bernadette M. Tomboc

This paper was prepared in partial fulfillment of the requirements of the course on Trade and Investment of the San Beda Graduate School of Law. The author is thankful to Prof. Maria Cristina M. Cabrera for her insights and suggestions concerning the topic.

I. Introduction
A sound banking system is a vital component of any economy. This is recognized under Section 2 (Declaration of Policy) of Republic Act No. 8791, otherwise known as “The General Banking Law of 2000,” which provides that banks have a vital role in providing an environment that is conducive to the sustained development of the national economy and thus the State shall promote an efficient and stable banking and financial system that is globally competitive, dynamic and responsive to the needs of a developing economy. Section 2 provides thus:

“The State recognizes the vital role of banks in providing an environment conducive to the sustained development of the national economy and the fiduciary nature of banking that requires high standards of integrity and performance. In furtherance thereof, the State shall promote and maintain a stable and efficient banking and financial system that is globally competitive, dynamic and responsive to the demands of a developing economy.”

The general rule with respect to foreign ownership of banks is found in Section 11 (on Foreign Stockholdings) of Republic Act No. 8791, otherwise known as “The General Banking Law of 2000” (May 23, 2000) which provides that “foreign individuals and non-bank corporations may own or control up to forty percent (40%) of the voting stock of a domestic bank.”

The percentage of foreign-owned voting stocks in a bank is determined by the citizenship of the individual stockholders. In the case of corporate stockholders, citizenship is determined by the citizenship of its controlling stockholders, irrespective of the place of its incorporation. (Republic Act No. 8791)

In 1994, Republic Act No. 7721 otherwise known as the “Foreign Banks Liberalization Act” (May 18, 1994) provided for a liberalized entry of foreign banks into the Philippine banking system through (a) acquiring, purchasing or owning up to sixty percent of the voting stock of an existing bank, (b) investing in up to sixty percent of the voting stock of a new banking subsidiary or (c) establishing branches with full banking authority. (Section 2)

It lifted the long-standing freeze on the setting up of branches of foreign banks established under Section 11 of Republic Act No. 337, otherwise known as the “General Banking Act” (July 24, 1948). Section 11 of Republic Act No. 337 provides, viz.:

“SECTION 11. After the approval of this Act, no bank which may be established and licensed to do business in the Philippines shall receive deposits, unless incorporated under the laws of the Republic of the Philippines: Provided, however, That this prohibition shall not apply to branches and agencies of foreign banks which, at the time of the approval of this Act, are actually receiving deposits: And provided, further, That, after the passage of this Act, all deposits so received by such branches and agencies of foreign bank shall not be invested in any manner outside the territorial limits of the Republic of the Philippines.” (Emphasis supplied.)

Section 2 of Republic Act No. 7721 provided a general limitation on the entry of foreign banks by authorizing the Monetary Board to adopt measures necessary to (a) ensure that the control of seventy percent of the resources or assets of the entire banking system is held by domestic banks which are at least majority-owned by Philippine citizens, (b) prevent a dominant market position by one bank or the concentration of economic power in one or more financial institutions, or corporations, partnerships, groups or individuals with related interests, and (c) secure the listing of foreign-owned banking corporations established under (a) and (b) above in the Philippine Stock Exchange.

Foreign banks seeking to establish new banking subsidiaries or branches in the Philippines must be among the top one hundred fifty banks in the world or the top five banks in its country of origin.

With respect to foreign banks seeking to establish branches, Section 6 of Republic Act No. 7721 provides that the Monetary Board may authorize up to six new foreign banks to establish three branches each and with additional capital three more branches each in locations designated by the Monetary Board. However, the President of the Philippines upon the recommendation of the Monetary Board may approve four additional foreign banks to establish branches.

The establishment of branches was subject to a time limitation of five years from the date of effectivity of Republic Act No. 7721. However, the entry of foreign banks through the establishment of new banking subsidiaries or through investment in existing domestic banks was not subject to any time limitation (under Republic Act No. 7721).

Subsequently, Section 73 of Republic Act No. 8791 otherwise known as the “General Banking Law of 2000” expanded the entry of foreign banks by allowing a foreign bank to acquire up to one hundred percent of the voting stock of one domestic bank within seven years from its effectivity.

Further, Republic Act No. 8791 authorized the Monetary Board to allow any foreign bank that had previously availed of the privilege of acquiring sixty percent of the voting stocks of a bank pursuant to the Foreign Banks Liberalization Act and those covered by Republic Act No. 7906 otherwise known as the “Thrift Banks Act of 1995” (February 23, 1995) to increase its ownership to up to one hundred percent of the voting stock of such domestic bank.

Subsequently, however Republic Act No. 8791 imposed a ban on the establishment of new commercial banks within three (3) years from its effectivity (Section 8). Thus, both domestic and foreign bank investments may only buy into existing banks. The moratorium was intended to consolidate banks to reduce the number of small banks. Foreign banks were still not allowed to set up new branches pursuant to the moratorium imposed under Republic Act No. 7721.

The moratorium on establishment of new foreign bank branches was extended indefinitely (WTO 2005). However, the establishment of branches of microfinance-oriented thrift banks and rural banks as well branches of microfinance-oriented banks and microfinance-oriented branches of regular banks are exempted from the moratorium pursuant to Bangko Sentral ng Pilipinas Circular Nos. 273 dated February 27, 2001 and 340 dated July 30, 2002.

Republic Act No. 8791 also included the general limitation authorizing the Monetary Board to ensure that the control of seventy percent of the resources or assets of the entire banking system is held by banks which are at least majority-owned by Philippine citizens.

Republic Act No. 7906 allowed up to sixty percent foreign ownership of the voting stocks of a thrift bank, except in cases of mergers or consolidations between existing thrift banks with foreign holdings wherein foreign ownership may be allowed to exceed sixty percent, but once reduced may no longer be allowed beyond the said sixty percent limit (Section 8). Further, Republic Act No. 7906 exempted the stockholdings of thrift banks from any ceiling on foreign ownership for a period of ten years from its effectivity.

Thus, the issue that this paper aims to address is whether the moratorium on the entry of foreign commercial banks into the Philippine banking system should be lifted. A related research problem is the determination of the factors that should be considered in determining the optimum level of control over the assets or resources of entire banking system that should be reserved to Philippine citizens, currently set by law at seventy percent.

Considering the impact of the performance of the banking system on the country’s economy, a sufficient understanding of these issues will be helpful to industry stakeholders which includes the public and bank employees as well as investors both local and foreign.

II. Statement of the Research Problem
The following are the research problem/s that this paper seeks to address:

A. What are the effects of global bank liberalization strategies?

B. Does bank liberalization cause financial and economic instability?

C. Does bank liberalization lead to enhanced competition and improved economic growth?

D. Does bank liberalization improve local access to bank credit?

E. Should the Philippine financial and banking system be further liberalized?

F. What are the precautionary steps that governments must undertake in order to avoid possible financial crises that may arise from financial and banking liberalization?

G. What steps must the government adopt in order to increase local access to bank credit?

H. What other steps must the government take in order to promote the soundness of the financial system?

III. Review of Related Literature: Effects of Global Financial and Banking Liberalization
Globalization has been defined as the “increasing liberalization and integration of economies in terms of trade and investment.” In relation to the financial sector, it has been associated with the “deregulation of banking activities within particular countries and consolidation of institutions and bank mergers that cross national borders.” (Biles 2005)

Globalization is based on the belief that liberalization results in greater competition and a more efficient allocation of resources. It has been often assumed that the domestic economy and financial sector of host countries will benefit from financial and banking liberalization as part of the global trend in political and economic integration. (Biles 2005)

Attracting foreign investments in general has also been advanced as a reason for liberalization of the banking system. Other reasons that have been offered to explain financial and banking liberalization include the assumed assymetric distribution of power in international relations and conformity to “acceptable” norms of financial policies. (Arestis, Nissanke and Stein 2005)

Further, liberalization has been justified as a means of countering repression of financial and banking systems by governments. Financial repression has been characterized by “government control of interest rates, reserve requirements and lending priorities” causing inefficiency of financial and banking systems in mobilizing a country’s resources. (Biles 2005)

A. Macroeconomic Effects of Bank Liberalization
However, in the past two decades, globally, growth in bank lending brought about by liberalization of the banking sector have frequently been associated with so-called boom-bust cycles characterized by increases in asset prices followed by a periods of instability of the financial sector. (Goodhart, Hofmann and Segoviano 2004)

One of the means by which inflation was controlled in European countries in the post-World War II period from 1945 to 1971 characterized by increasing demand was through tight bank credit controls, i.e., increasing short-term interest rates in periods of rising inflation. Further, in most countries bank credit was directed towards the manufacturing and exporting sectors. Thus, practically no bank crises arose. (Goodhart, Hofmann and Segoviano 2004)

However, starting in the 1970s banking sector liberalization in Europe increased capital inflows as well as leverage and risk-taking activity leading to procyclicality in financial systems or a boom-bust cycle. This situation was aggravated by banks’ lack of experience in risk management and the rising ratio of lending to small borrowers and individual consumers in banks’ portfolios as a result of the parallel development of capital markets for more stable large-scale industry financing. (Goodhart, Hofmann and Segoviano 2004)

Thus, banks tended to compensate for the higher risks and costs of acquiring information on smaller borrowers by requiring collateral on their loans. However, this tended to increase both property prices as well as bank sensitivity to movements in asset prices. However, increased bank risk-taking merely added to their fragility. (Goodhart, Hofmann and Segoviano 2004)

Thus, financial crisis resulted in Scandinavia in the early 1990s, Japan in the 1990s and most of East Asia in 1997 to 1998. On the other hand, Germany did not experience any financial crises since its banking system was simply re-established after World War II and has been relatively liberalized from the start. (Goodhart, Hofmann and Segoviano 2004)

Theoretically, financial sector liberalization leads to higher efficiency and faster growth. This theory seems to be supported by empirical data. The fastest growing countries have been observed to be those that experienced boom-bust cycles. There are however exceptions such as Japan which grew slower than before after its boom-bust cycle following liberalization in the mid-1980s. (Goodhart, Hofmann and Segoviano 2004)

Further, there is a question as to how long the expected boom-bust cycle would last. Studies indicate that the possibility of bank crises continues and even increases over time. The study by Arestis and Glickman [2002] reached a similar conclusion with respect to the 1997 Asian financial crisis. (Arestis, Nissanke and Stein 2005)

Thus, where economies are structurally weak and sensitive to changes in international commodity prices, shifting financial flows, and with little financial reserves, unrestrained liberalization of their financial sectors will likely result in instability. (Arestis, Nissanke and Stein 2005)

B. Bank Liberalization and Growth
Financial systems are intended to assist economic growth by reducing the transaction costs of credit. Financial systems promote saving by reducing risks and thus promote growth. Thus, studies have shown that “the level of financial development is positively associated with economic growth” and that “well-developed financial systems are associated with greater levels of productivity and capital accumulation.” (Biles 2005)

However, several other econometric studies failed to establish a causal relationship between finance and economic growth. Thus, some authors argue that finance and macroeconomic development in developing countries are mutually dependent. In the case of India in the 1970s, the high savings level did not lead to higher economic growth. Instead, economic growth in other periods (1950 to 1951 and 1998 to 1999) caused higher savings. (Arestis, Nissanke and Stein 2005)

The World Bank [1993] found a similar causation from growth to savings in Indonesia, Japan, Korea, Thailand, and Taiwan. These examples are probably more consistent with the Keynesian-type precautionary motive for saving. (Arestis, Nissanke and Stein 2005)

Moreover, in Korea the grant by the government of new banking licenses together with liberalization of regulation of the bank credit system, deregulation of interest rates, liberalization of foreign exchange policies and the opening of the capital market have all been blamed as contributing to the 1997 financial crisis. (Arestis, Nissanke and Stein 2005)

Other surveys of English-speaking African countries indicated that chaos caused by financial liberalization actually reduced the efficiency of financial intermediation as measured by the difference between deposit and lending rates. Studies in Venezuela and Jamaica found similar results. (Arestis, Nissanke and Stein 2005)

Further, in Venezuela financial liberalization policies in 1989 including the removal of quotas for priority lending, liberalization of interest rates and entry of foreign banks, and privatization of government banks were blamed for the failure of seventeen financial institutions comprising sixty percent of the assets of the entire banking system and fifty percent of total deposits in 1994 to 1995. It has been estimated that government intervention after its financial liberalization program will cost Venezuela around twenty percent of its gross domestic product. (Arestis, Nissanke and Stein 2005)

Therefore, it would seem to be more relevant to identify the components of an economy, such interlocking ownerships and linkages between the financial sector and industrial, service, agricultural and other sectors and how they interface with one another in evaluating the effect of financial development to growth. The relation between finance to development may be difficult to quantify precisely because they are not isolated variables. (Arestis, Nissanke and Stein 2005) Instead, their outcome may depend on level of economic development as well as the customs and culture of each country.

C. Bank Liberalization and Local Access to Credit
Probably one of the biggest mistakes in liberalization has been the asymmetric growth of the banking sector vis-à-vis countries’ regulatory capacities. Countries should strive to create a balanced financial sector that is responsive to the requirements of a developing economy (commercial banking, micro-financing, cooperative ownerships, etc.). Moreover, the capital market should be carefully monitored, including banks’ access to international credit to avoid financial instability that may arise from sudden, massive capital outflows. (Arestis, Nissanke and Stein 2005)

Czechoslovakia sold off ninety-five percent of its banking sector. However, these banks focused mainly on lending to rich clients and multinational investors. Although small and medium enterprises employ nearly sixty percent of the country’s workforce and contribute around forty percent of the gross domestic product, only about two percent of the SMEs were able to obtain bank loans in 2000. Banks held most of their assets in government bonds or in loans to the interbank market. The Czech Republic spent the equivalent of around twenty-one percent of its gross domestic to restore order to its financial system after liberalization. (Arestis, Nissanke and Stein 2005)

In some countries like Tanzania, liberalization simply meant the transfer of ownership of state-owned banks to foreign hands. Likewise, the banking system extended loans only to a few wealthy individuals and as earlier mentioned kept huge amounts in government paper. Thus, it has been observed that instead of accessing global funds for domestic industries, many foreign banks used national savings to fund foreign investments abroad. (Arestis, Nissanke and Stein 2005)

Even in the United States, research show that the deregulation of the financial system led to the growth of a “two-tiered financial system.” Payday lenders proliferated to serve poor, urban areas that were excluded the deregulated banking system “reflecting increasing disparities in economic well-being.” The result was that poorer households ended up paying more for financial services than other households. (Biles 2005)

Likewise a “bimodal” financial system has been described to operate in Mexico. Global financial systems serve large industrial groups while domestic banks serve small businesses and households resulting in highly uneven access to financial resources and worsening inequalities in economic opportunities among Mexican states. (Biles 2005)

Financial liberalization and privatization in the early 1990s cost the Mexican government $65 billion (equivalent to seventeen percent of its gross domestic product in 1998) in 1999. (Arestis, Nissanke and Stein 2005)

Economic instability in a country leads banks to limit their investments to government bonds and short-term loans as seen in Venezuela, Nigeria and Tanzania. (Arestis, Nissanke and Stein 2005)

IV. The Philippine Experience
A. The Philippine Banking System
1. Overview
Banks form the biggest component of the Philippine financial services sector. The sector itself grew at an average of seven percent since 1999. (WTO 2005)

Banks may be classified into universal banks, performing expanded functions including those of investment houses and investing in non-allied enterprises, commercial banks, thrift banks, rural banks, cooperative banks, and Islamic banks. Commercial and universal banks accounted for ninety and seventy-three percent, respectively, of the assets of the entire banking system in 2004. (WTO 2005)

There were forty-two commercial banks of which eighteen are universal banks, eighty-seven thrift banks, seven hundred twenty rural banks, and forty-four cooperative banks in 2004. Of the total, foreign banks constitute three universal bank branches, eleven commercial bank branches and four commercial bank subsidiaries. Further, of the top twenty commercial banks in 2003, only seven remained wholly owned by Philippine citizens. (WTO 2005)

Foreign banks held less than fourteen percent of the assets of the entire banking system in 2004, representing a more than double increase from a little over six percent in 1995. (WTO 2005)

2. Non-Performing Loans (NPLs)
A significant problem that has continuously plagued the industry likely due to lack of industry information is the high level of non-performing loans (NPLs) creating a high possibility of risk of bank failure. The level of NPLs was reduced from 14.2 of total bank loans in mid 2004 to 12.5 percent at the end of 2004 due to the sale of NPLs made possible by Republic Act No. 9182 otherwise known as the Special Purpose Vehicle Act of 2002 that allowed the creation of asset management companies that are exempt from value-added, capital gains and stamp taxes. (WTO 2005)

3. Deposit Insurance
An increase in the maximum deposit insurance from P100,000.00 to P250,000.00 in 2004 increased insurance coverage from ninety-one to ninety-five percent of all depositors. The Philippine Deposit Insurance Corporation’s (PDIC) fund amounted to P41.6 billion in November 2004 considered by the PDIC to be sufficient to cover possible insurance claims from high risk banks. The International Monetary Fund considers continuing PDIC support to be a vital concern. (WTO 2005)

B. Liberalization of the Philippine Banking System
1. Objectives
The state policy objectives in liberalizing the Philippine banking system are (a) to attract foreign investments, (b) to enhance efficiency of the domestic financial system through increased competition, provision of a wider variety of financial services to Philippine enterprises, additional intermediation activities, and adoption of new technologies and processes, and (c) to make the Philippine banking system more globally competitive. (BSP Circular No. 51)

Thus, Section 1 (Declaration of Policy) of Republic Act No. 7721, otherwise known as the “Foreign Banks Liberalization Act” states, thus:

“SECTION 1. Declaration of Policy. – The State shall develop a self-reliant and independent national economy effectively controlled by Filipinos and encourage, promote, and maintain a stable, competitive, efficient, and dynamic banking and financial system that will stimulate economic growth, attract foreign investments, provide a wider variety of financial services to Philippine enterprises, households and individuals, strengthen linkages with global financial centers, enhance the country's competitiveness in the international market and serve as a channel for the flow of funds and investments into the economy to promote industrialization.

Pursuant to this policy, the Philippine banking and financial system is hereby liberalized to create a more competitive environment and encourage greater foreign participation through increase in ownership in domestic banks by foreign banks and the entry of new foreign bank branches.

In allowing increased foreign participation in the financial system, it shall be the policy of the State that the financial system shall remain effectively controlled by Filipinos.” (Emphasis supplied.)

The Philippine started its financial liberalization program as early as the 1980s with the deregulation of interest rates. However, it was considered as lacking for purposes of promoting competition because it did not deregulated entry restrictions on foreign banks. (Ibon 2003)

Thus, former President Corazon Aquino’s administration (which started in 1986) entered into a Memorandum of Economic Policy with the International Monetary Fund to continue with the reforms of the banking system started by the government under the late President Marcos. The said reforms included an increase in the required capitalization of banks and the privatization of the Philippine National Bank. The increase in capitalization gave rise to further mergers and consolidations in the banking industry. (Ibon 2003)

Former President Ramos’ administration (which started in 1992) continued to encourage foreign investments by, among others, increasing interest rates on government Treasury bills, which led to the rise in the prime deposit rates of commercial banks to up to twenty-four percent and attracted short-term speculative investments. The 1997 financial crisis resulted in the Philippines in a capital flight of around $7 billion. (Ibon 2003)

2. Impact on the Philippine Rural Sector
The rural banking sector suffered from the stiff competition from branches of universal and commercial banks in the provinces starting in the early 1990s. Many rural banks became bankrupt or were foreclosed or merged with larger banks. Small and middle farmers suffered since they depended on rural banks for loans to finance their capital needs. (Ibon 2003)

It has been said that huge foreign banks operate around the globe to mobilize the resources of the countries that they operate in to finance lending to multinational corporations (Ibon 2003).

On the other hand, Presidential Decree No. 717 as amended (May 29, 1975) entitled “Providing an Agrarian Reform Credit and Financing System for Agrarian Reform Beneficiaries Through Banking Institutions” and otherwise known as the “Agricultural-Agrarian (or Agri-Agra) Law” requires all banks to set aside at least twenty-five percent of their loanable funds for agricultural credit in general, viz.:

“Section 3. All banking institutions, whether government or private, shall set aside at least twenty-five per cent (25%) of their loanable funds for agricultural credit in general, of which at least ten per cent (10%) of the loanable funds shall be made available for agrarian reform credit to beneficiaries mentioned in Section 1 hereof xxx”

However, banks found difficulty in lending to agrarian reform beneficiaries because the latter practically cannot meet their high interest rates and collateral requirements. Instead, banks found it easier to extend credit to large agri-business corporations. (Ibon 2003)

Further, both Republic Act No. 7721 (to encourage foreign investment in the Philippine banking system) and the BSP provided many exemptions from the requirement under Presidential Decree No. 717. Section 9 of Republic Act No. 7721 provides, viz.:

“Section 9. Development Loans Incentives. Loans extended by a foreign bank’s majority-owned subsidiary incorporated under the laws of the Philippines and/or a Philippine bank sixty percent (60%) of the voting stock of which is held by a foreign bank, to finance educational institutions, cooperatives, hospitals and other medical services, socialized or low-cost housing, and to local government units without national government guarantee, shall be included for purposes of determining compliance with the provisions of Presidential Decree No. 717, as amended.”

In addition, the BSP exempted commercial banks from the requirement of setting aside a portion of their loanable funds for agricultural credit on the condition that they will invest in eligible substitutes such as commercial papers issued by entities engaged in agricultural production, processing, storage, marketing or exportation of agricultural products (for Agri compliance) or local government unit (LGU) and PAG-IBIG housing bonds (for Agra compliance). (Ibon 2003)

Likely due to lack of access to capital financing, agriculture’s share (including forestry and fishing) in the country’s nominal gross domestic product shrunk since 1999 from 17.1 percent to 15.3 percent in 2004. Agriculture’s share of total exports also remained low from five percent in 1999 to six percent in 2005.

The downside effect of lack of capital financing to agriculture is aggravated by the fact that about seventy percent of the country’s poor depends on agriculture or on agriculture-related activities for their livelihood. Smallholders with farms averaging about two hectares each dominate agriculture. However, agricultural policy continues to aim merely at self-sufficiency. (WTO 2005)

Further, the National Food Authority (NFA) is still constrained to provide price support through relatively high tariffs, tariff quotas and non-tariff barriers for rice and corn and recently extended to sugar. This high protection contributes to the sector’s non-competitiveness. It burdens consumers, especially the poor, with high prices of these basic food commodities. It likewise detracts from the urgency of developing viable industry infrastructure and support services programs. (WTO 2005)

Furthermore, per the WTO 2005 report, the country spent P3.1 billion in 2001 (P4.3 billion in 2000) to support rice prices. The NFA’s annual cost to the economy in 1999 was estimated to be P49 billion on top of its annual budget. (WTO 2005) Thus, there is an urgent need to provide increased access to capital financing to the agricultural sector to promote its self-sufficiency and increase its competitiveness.

Salazar (2005) noted that “rural banks are the only existing and sustainable national delivery system to the countryside and to SMEs for financial and non-financial services and products.”

While rural banks are numerous as compared to commercial banks, they hold only two percent (P78.8 billion) of the assets of the entire banking system of P3,529.1 billion. Further, while the small size of rural banks (seventy-five percent have asset sizes of less than P100 million) lends flexibility to them in accessing the countryside, it also imposes a financial limitation on their operations. Thus, likewise there is a need for the government to assist the growth and development of the rural banking sector. (Salazar 2005)

3. Financing of Small and Medium Enterprises (SMEs)
Further, Republic Act No. 8289 (1998) amending Republic Act No. 6977 (1991) otherwise known as the Magna Carta Law for Small Enterprises mandated all financing institutions to set aside at least six percent of their total loan portfolio for small enterprises and at least two percent for medium enterprises. (WTO 2005)

Based on submitted reports, the banking system over-complied with the legal requirements. However, ratios of performance by rural banks and thrift banks consistently exceeded those by commercial banks probably due to the latter’s difficulty in extending loans to small enterprises. (Salazar 2005)

Further, it would seem that commercial banks has consistently used indirect modes of compliance. The ratio of direct compliance to gross loan portfolio remained stable from 1998 to 2003. In addition, the upward adjustment of the criteria for determining small and medium enterprises allowed commercial banks to classify more of their loans under medium enterprises. (Salazar 2005)

Moreover, the higher rates of compliance are considered to be inconsistent with the persistent clamor for more loans by small and medium enterprises. This implies either that the legal requirements are not sufficient or that banks are over-reporting loans to the SME sector. (Salazar 2005) Thus, according to Salazar (2005) a breakdown of the BSP’s reports according to micro, small and medium categories and the number of enterprises availing of the loans would be useful.

4. Bank Liberalization and Laying-off of Bank Workers
Another serious issue in relation to bank mergers is the loss of jobs by displaced employees. For example, Deutsche Bank’s merger with Bankers Trust abroad reportedly resulted in the loss of five thousand five hundred jobs. (Ibon 2003)

In the Philippines, the merger between the Bank of the Philippine Islands and Far East Bank and Trust Company is reported to have resulted in the laying-off of three hundred employees, while the merger between Prudential and Pilipinas Bank reportedly led to the loss of one hundred forty-three jobs. (Ibon 2003)

C. The BSP’s Monetary Policy
Republic Act No. 7653, otherwise known as the New Central Bank Act, states that the primary objective of the Bangko Sentral is “to maintain price stability conducive to a balanced and sustainable growth of the economy.” In this connection the BSP was mandated to “promote and maintain monetary stability and the convertibility of the peso.”

In 2002, the BSP’s Monetary Board discontinued after ten years the use of monetary targeting in favor of inflation targeting due to the weakening link between the base money supply and inflation as a result of global financial liberalization. Thus, as explained by Guinigundo (2005):

“As the International Monetary Fund (1999) reported, for example, the demand for base money became increasingly difficult to predict against a background of unstable broad money demand and unforeseen shifts in the money multiplier. Short-run volatility in money demand, traced to rapid developments in financial intermediation as well as to recurrent macroeconomic cycles and financial crises, tended to limit the usefulness of monetary targets.”

According to Guinigundo (2005) since the Philippines is a “small, open economy,” “sharp fluctuations in the exchange rate and excessive speculation in the foreign exchange market can have [a] significantly adverse impact on the price objective of monetary authorities.” Thus:

“Fluctuations in the exchange rate were often linked to balance of payments crises resulting from a sudden massive outflow of foreign capital or an excessive rise in imports relative to export earnings, all of which lead to a weaker peso which, in turn, feeds into the overall level of consumer prices. This is particularly critical in the Philippines given its openness and small size relative to the global economy. xxx” (Guinigundo 2005)

Further, Philippine policymakers are aware that “the operating environment for monetary policy, particularly under an inflation targeting regime, is in fact different in emerging market economies compared to those in advanced countries.” (Guinigundo 2005)

The BSP manages inflation by adjusting its monetary policy settings, for example, by increasing or maintaining higher policy interest rates and liquidity reserve requirements of banks and through other non-monetary measures. However, the BSP found that the government’s use of non-monetary measures were not as effective as adjusting its monetary policy settings. Guinigundo (2005) explained the Philippines’ inflation targeting experience in 2004 thus:

“Given the supply-driven inflation in 2004, the BSP opted to maintain its stance unchanged (where the policy interest rates were maintained by the liquidity reserve requirements were raised by 2 percentage points in February as a preemptive measure against the potential inflationary impact of foreign exchange rate volatility). However, the BSP also actively supported the use of non-monetary government intervention measures to address more directly the supply-side risks, particularly in the case of food prices. These non-monetary measures were only partly successful. They produced encouraging results for food prices, but were less effective in the case of petroleum prices. Part of the reason was that, unlike other Asian countries such as Thailand, Malaysia, and Indonesia, the Philippines currently does not have in place a system of government subsidies for petroleum products because of the deregulated domestic oil industry that employs market-based pricing for fuel. Most important, the Philippines has limited fiscal resources. This would largely explain the higher inflation rate in the Philippines relative to most of its Asian neighbors in 2004.” (Guinigundo 2005)

However, one significant policy concern in relation to the new inflation targeting framework and the crucial role that banks play is the high level of bank NPLs causing banks to reduce lending. A weak bank sector weakens the ability of the BSP to adjust monetary policy settings. Thus:

“Non-performing loans could potentially erode banks’ capital adequacy and undermine the health of the sector through higher loan loss provisioning. A weak banking sector impairs the transmission of monetary policy changes to the economy, since bank credit is an important channel of monetary policy in the Philippine setting.” (Guinigundo 2005)

D. Moratorium on the Entry of Foreign Banks into the Philippines
The BSP has been instrumental in slowing down the entry of foreign banks into the Philippine banking system since 1999 to the present and in increasing capitalization requirements in order to promote consolidation for stability of the banking sector. As a result, many mergers were implemented including the acquisition of thrift banks by foreign bank branches of Citibank and Hongkong Shanghai Banking Corporation. Further, the top five commercial banks accounted for almost half of the assets of universal and commercial banks in 2004 (WTO 2005)

As mentioned in the Introduction, the moratorium imposed under Republic Act Nos. 8971 and 7921 has been extended indefinitely (WTO 2005) with the exception the establishment of branches of microfinance-oriented thrift banks and rural banks as well branches of microfinance-oriented banks and microfinance-oriented branches of regular banks pursuant to Bangko Sentral ng Pilipinas Circular Nos. 273 dated February 27, 2001 and 340 dated July 30, 2002.

E. Should the Moratorium be Lifted?
The Report of the Secretariat of the World Trade Organization on the Philippine banking sector noted that although Republic Act Nos. 8791 and 7721 mandates that the banking system should remain “effectively controlled by Filipinos” with control of seventy percent of the resources or assets of the entire banking system to be held by banks which are at least majority-owned by Philippine citizens, foreign-controlled banks currently hold less than fourteen percent of the entire banking sector’s assets, which is less than one-half of the allowed limit. (WTO 2005)

On the other hand, Philippine banking laws are more liberal than the country’s commitments in the General Agreement on Trade in Services from 1999 up to 2004. Likely due to the reported failures of financial and banking liberalization programs in other countries, the WTO found it difficult give a final assessment of the impact of the moratorium on international trade. Thus it simply noted that the former might have suppressed competition in the banking sector. (WTO 2005)

Indeed, increased competition in the Philippine banking sector may have helped reduce interest rate spreads from averages of 5.9 percentage points on savings rate and 4.2 percentage points on short-term time deposit rates in 1998 to 1999 to 4.6 and 3.5 percentage points, respectively, in 2000 to 2003. (WTO 2005)

On the other hand, as discussed earlier certain sectors have raised the concern that the concentration of assets of the banking sector in universal and commercial banks resulted in the deprivation of farmers and small businesses of access to bank loans while bank mergers led to the loss of a substantial number of jobs by bank employees. (Salazar 2005 and Ibon 2003)

V. Conclusion
Indeed, other countries’ experiences point out that uncontrolled liberalization of financial and banking systems do not necessarily lead to economic growth. On the contrary, unrestrained financial and bank liberalization may greatly increase the possibility of macroeconomic crises (via the money multiplier effect that banks create) and thus produce a counter-productive effect on the domestic economy.

Thus, the beneficial effect of different degrees of banking sector liberalization on a country’s seems to be influenced by many factors aside from the theoretical relationship between savings and investment. Such factors include the size of and level of economic development, customs and culture in each particular country. Further, it does not seem possible to evaluate a financial system’s stability separately from its country’s economic stability as a whole.

Thus, strengthening the financial system requires paying attention to all the sectors that it interacts with both private and public, the country’s infrastructure, legal system, tax regime, and political and socioeconomic environment.

All these feed into the financial system. The Basel II framework that the Bank for International Settlements recommended for implementation from end-2006 bases capital adequacy requirements on variable risk assessments of several factors including credit, market, operational, liquidity, reputational, and regulatory risks (Espenilla 2005)

In the Philippines, it would seem that the earlier liberalization of entry of foreign commercial banks was founded on the government’s desire to promote industrialization. However, it also appears that the law neglected to provide for the development of the country’s agricultural sector. This development doubly affected the country’s poor due to lower agricultural incomes and higher prices of rice. Thus, there is an urgent need to balance financial growth by seeking out new ways to provide capital financing for the agricultural sector.

VI. Recommendations
Banking and financial sector liberalization in the Philippines should be gradually paced to match its growing level of economic development. More foreign banks may be allowed entry into the domestic banking system to increase competition and efficiency of the banking sector as the local economy matures and becomes more resistant to economic shocks that may be caused by massive capital flows.

Further, while the government’s reliance on the Philippine banking system to transmit its monetary policy to the economy has been effective considering that national inflation levels have been fairly controlled, the same is in the nature an additional indirect tax on the domestic banking sector due to restrictions on the use of bank capital. (Guinigundo 2005) The World Bank’s Report and Guidelines (1992) provide that “excessive and repetitive tax measures have a confiscatory effect and could amount to indirect expropriation” (Sornarajah 2004). Suffice to say, the same constitutes a disincentive to both foreign and domestic investors in the Philippine banking sector.

As mentioned earlier, Philippine law sought to compensate for the disincentive by exempting new foreign and majority foreign-owned banks from the requirement of reserving a portion of their loanable funds for agricultural credit. A substantially similar rule was extended to all banks by the BSP. However, the consequent decrease in available funding for agriculture has adversely affected the rural sector as well as the entire country and economy.

Thus, the proposed solution is not to re-impose the requirement on all banks to set aside a portion of their loanable funds for agricultural credit but to provide compensating incentives for those who do. Thus, the national government may look into the possibility of extending income and other tax exemptions or preferential income tax rates to rural banks considering that only the latter has authority to mobilize savings as compared to cooperatives, pawnshops and other lending institutions including NGOs. Likewise, the national government may look into the possibility of providing fiscal incentives to commercial and universal banks that extend credit to rural banks such as corresponding preferential tax treatment.

References:
Republic Act No. 8791, otherwise known as “The General Banking Law of 2000” (May 23, 2000)

Republic Act No. 7906, otherwise known as “The Thrift Banks Act of 1995” (February 23, 1995)

Republic Act No. 7721, otherwise known as “Foreign Banks Liberalization Act” (May 18, 1994)

Republic Act No. 337, otherwise known as the “General Banking Act” (July 24, 1948)

Presidential Decree No. 717 as amended otherwise known as “Agricultural-Agrarian (or Agri-Agra) Law” (May 29, 1975)

BSP Circular No. 340 (July 30, 2002)

BSP Circular No. 273 (February 27, 2001)

BSP Circular No. 51 Implementing Republic Act No. 7721 (October 14, 1994)

Arestis, P., Nissanke, M. and Stein, H. (2005). Finance and Development: Institutional and Policy Alternatives to Financial Liberalization Theory. Eastern Economic Journal. Bloomsburg: Spring 2005. Vol. 31, Issue 2, p. 245-263 (19 pp.).

Biles, J.J. (2005). Globalization of Banking and Local Access to Financial Resources: A Case Study from Southeastern Mexico. The Industrial Geographer. Terre Haute: Spring 2005. Vol. 2, Issue 2, p. 159-173 (15 pp.).

Espenilla, Jr. N.A. (2005). Bank Risk Management & Risk-Based Capital Standards. The Bangko Sentral & The Philippine Economy. Manila: BSP.

Goodhart, C. (2004). Bank Regulation and Macroeconomic Fluctuations. Oxford Review of Economic Policy: European Financial Integration. Oxford: Winter 2004. Vol. 20, Issue 4, p. 591-615.

Guinigundo, D.C. (2005). Inflation Targeting: The Philippine Experience. The Bangko Sentral & The Philippine Economy. Manila: BSP.

Report by the WTO Secretariat (2005). Trade Policy Review: Philippine Sector. World Trade Organization website. http://www.wto.org/

Salazar, M.S., Jr. (2005). BSP in Small & Medium Enterprise Development. The Bangko Sentral & The Philippine Economy. Manila: BSP.

Sornarajah, M. (2004). The International Law on Foreign Investment. UK: Cambridge.

Thacker, S. and Gosavi, M. (1994). India. International Financial Law Review: Banking Yearbook 1994. London: July 1994. p. 71 (3 pp.).

Workers Desk, IBON Databank and Research Center (2003). The Philippine Banking Sector. Manila: Ibon.