RIZAL TECHNOLOGICAL UNIVERSITY

Cities of Mandaluyong and Pasig

SESSION NO. 6 / WEEK NO. 6

MODULE NO. 6: The Philippine Financial

System

1. The structure of the Philippine Financial System

2. Brief Description of Financial Institution: a.) Banking Institution b.) Non-Bank
Financial Institution.
3. The Evolving Philippine Financial System: a.) Signs of Growth in the domestic
market b.) Regulatory Landscape.
4. Financial Stability Assessment of the Philippine Financial System.
5. Current Risk in the Philippine Financial System.

Overview

Well-functioning financial system is crucial to a country's economic health so much so

that when the financial system breaks down, as it has in Russia and in Southeast Asia
recently, severe economic hardship results.
The financial system, through the various financial markets and financial
intermediaries, has the basic function of moving funds from those who have a surplus
to those who have a shortage of funds.
To study the effects of financial markets and financial intermediaries on the economy,
we need to acquire an understanding of their general structure and operation.

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Study Guide

Learning Outcomes

After studying the chapter, you should be able to:

1. Explain the structure of the Philippine Financial System
2. Describe the nature and basic functions of
II. Banking Institutions
a. Private Banking Institutions
b. Government Banks
Non-Bank Financial Institutions a. Private Non-Bank Financial Institutions
b. Government Non-Bank Institutions
3. Understand the evolving Philippine Financial System
•Signs of growth in the domestic market
•Regulatory landscape
4. Learn the Financial Stability Assessment of the Philippine Financial System as of
the end of Second Semester, 2018 prepared by the BSP
5. Be familiar with the current risks in the Philippine Finance System

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Topic Presentation

STRUCTURE OF THE PHILIPPINE FINANCIAL SYSTEM

I. Bangko Sentral Ng Pilipinas

II. Banking Institutions

A. Private Banking Institutions

1. Expanded Commercial Banks/Universal Banks (EKB/UB)

2. Commercial Banks (KB)

3. Thrift Banks (TB)

a. Savings and Mortgage Banks (SMB)
b. Private Development Banks (PDB)
c. Stock Savings and Loan Associations (SSLA)

4. Rural Banks (RB)

5. Cooperative Banks

B. Government banking institutions

1. Development Bank of the Philippines (DBP)

2. Land Bank of the Philippines (LBP)

3. Philippine Al-Amanah Islamic Investment Bank

III. Non-Bank Financial Institutions

A. Private non-bank financial institutions

1. Investment houses
2. Investment banks
3. Financing companies
4. Securities dealers/brokers
5. Savings and loan associations
6. Mutual funds
7. Pawnshops
8. Lending investors
9. Pension funds
10. Insurance companies
11. Credit union

B. Government Non-bank financial institutions

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1. Government Service Insurance System (GSIS)

2. Social Security System (SSS)
3. Pag-ibig

BRIEF DESCRIPTION OF THE FINANCIAL INSTITUTIONS

I. Bangko Sentral ng Pilipinas (discussed in Chapter 16)

II. Banking Institutions

A. Private Banking Institutions

1. Universal Bank (UB) or Expanded Commercial Bank (EKB) is any commercial bank,
which performs the investment house function in addition to its commercial banking
authority. It may invest in the equities of allied and non-allied enterprises. Allied
enterprises may either be financial or non-financial.

2. Commercial Bank or Domestic Bank (KB) is any commercial bank that is confined
only to commercial bank functions such as accepting drafts and issuing letters of credit,
discounting and negotiating promissory notes, drafts and bills of exchange, and other
evidences of debt, accepting or creating demand deposits, receiving other types of
deposits and deposit substitutes, buying and selling foreign exchange, and gold or
silver bullions, acquiring marketable bonds and other debt securities, and extending
credit subject to such rules that the Monetary Board may promulgate.

3. Thrift Banks (TB) shall include savings and mortgage banks, stock savings and loan
associations and private development banks. Their function is to accumulate the
savings of depositors and invest them together with their capital, loans secured by
bonds, mortgages in real estate and insured improvements thereon, chattel
mortgages, bonds and other forms of security or loans for personal or household
finance, whether, secured or unsecured, or in financing for home building and home
development; in readily marketable and debt securities; in commercial papers and
accounts receivables, drafts, bills of exchange, acceptances or notes arising out of
commercial transactions, and in such other investments and loans which the Monetary
Board may determine as necessary in the furtherance of national economic objectives.

a. Stock Savings and Mortgage Bank (SSMB) is any corporation organized for the purpose
of accumulating the savings of depositors and investing them, together with its
capital, in readily marketable bonds and debt securities; checks, bills of exchange,
acceptances or notes arising out of commercial transactions or in loans secured by
bonds, mortgages or real estate and insured improvements thereon and other forms
of security or in loans for personal or household finances whether secured or
unsecured, and financing for home building and home development.

b. Private Development Bank (PDB) is a bank that exercises all the powers and assumes
all the obligations of the savings and mortgage bank as provided in the General
Banking Act except as otherwise stated. The private development bank helps
construct, expand and rehabilitate agricultural and industrial sectors. The
Development Bank of the Philippines is the government counterpart of the private
development banks and helps the private development banks augment their
capitalization as provided under R.A.4093 as amended.

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c. Stock Savings and Loan Association (SLA) is any corporation engaged in the business
of accumulating the savings of its members or stockholders and using such
accumulated funds, together with its capital for loans and investment in securities of
productive enterprises, or in securities of the government and its instrumentalities,
provided that they are primarily engaged in servicing the needs of households by
providing personal finance and long term financing for home building and
development.

4. Rural Bank (RB) is any bank authorized by the Central Bank to accept deposits and
make credit available to farmers, businessmen and cottage industries in the rural
areas. Loans may be granted by the rural banks on the security of land without Torrens
title where the owner of private property can show five (5) years or more of peaceful
continuous and uninterrupted possession of the land in the concept of ownership. This
will include portions of friar land estates or other lands administered by the Bureau of
Lands that are covered by sale contracts and purchases and have paid at least five (5)
years installment thereon, without the necessity of prior approval and consent of the
Director of Lands or portions of other estates under the administration of the
Department of Agrarian Reform.

5. Cooperative Banks are banks established to assist the various cooperatives by

lending those funds at reasonable interest rates.

B. Government Institutions Banks or Specialized Government Banking

1. Development Bank of the Philippines- (DBP) provides loans for developmental

purposes, gives loans to the agricultural sector, commercial sector and the industrial
sector.

2. Land Bank of the Philippines (LBP) is a government bank, which provides financial
support in the implementation of the Agrarian Reform Program (CARP) of the
government.

3. Al-Amanah Islamic Investment Bank: Republic Act No. 6048 provides for the charter
of the Al-Amanah Islamic Investment Bank. This Act authorizes the bank to promote
and accelerate the socio-economic development of the Autonomous Region of Muslim
Mindanao by performing banking, financing and investment operations, and to
establish and participate in agriculture, commercial and industrial ventures based on
the Islamic concept of banking.

III. Non-bank Financial Institutions

A. Private non-bank Financial Institutions

1. Investment House is any enterprise, which engages in underwriting securities of

other corporations. It also generates income from sale of investments in securities.

2. Investment Banks. Investment banks, such as Goldman Sachs and Morgan Stanley,
differ from commercial banks in that they do not take in deposits and until very recently
rarely lent directly to households. They provide advice to firms issuing stocks and
bonds or considering mergers with other firms. They also engage in underwriting, in
which they guarantee a price to a firm issuing stocks or bonds and then make a profit
by selling the stocks or bonds at a higher price.

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3. Financing Company is any business enterprise where the primary purpose is to

extend credit facilities to consumers and to industrial, commercial or agricultural
entities either by discounting or factoring commercial papers or accounts, or by buying
installment contracts, leases, chattel mortgages, or other evidences of indebtedness,
or by leasing motor vehicles, heavy equipment and industrial machineries and
business and office equipment, appliance and other movable properties.

4. Securities Dealer is any person or entity engaged in the business of buying and
selling securities for his own or its client's account thereby making a profit from the
difference between the purchase prices and selling price of securities.

5. Savings and Loan Associations (S&Ls), which have traditionally served individual
savers and residential and commercial mortgage borrowers, accumulate the funds of
many small savers and then lend this money to home buyers and other types of
borrowers. Because the savers obtain a degree of liquidity that would be absent if they
bought the mortgages or other securities directly, perhaps the most significant
economic function of the S&Ls is to "create liquidity". Also, the S&Ls have more
expertise in analyzing credit, setting up loans, and making collections than individual
savers, so they reduce the transaction costs and increase the availability of real estate
loans.

6. Mutual funds are corporations which accept money from savers and then use these
funds to buy stocks, long-term bonds, or short term debt instruments issued by
businesses or government units. These organizations pool funds and thus reduce risks
by diversification. They also achieve economies of scale, which lower the costs of
analyzing securities, managing portfolio, and buying and selling securities. Different
funds are designed to meet the objectives of different types of savers. Hence, there
are bond funds for those who desire safety, stock funds for savers who are willing to
accept significant risks in the hope of higher returns, and still other funds that are used
as interest-bearing checking accounts (the money market funds). There are literally
hundreds of different mutual funds with dozens of different goals and purposes.

7. Pawnshops refer to persons or entities engaged in the business of lending money

with personal property, jewelry, and other durable goods as collateral for the loans
given.

8. Lending investor is any person or entity engaged in the business of effecting

securities transactions, giving loans and earns interest from them.

9. Pension funds are retirement plans funded by corporations or government agencies

for their workers and administered primarily by the trust departments of commercial
banks or by life insurance companies. Pension funds invest primarily in bonds, stocks,
mortgages, and real estate.

10. Insurance companies take savings in the form of annual premiums, then invest
these funds in stocks, bonds, real estate, and mortgages, and finally make payments
to the beneficiaries of the insured parties. In recent years, life insurance companies
have also offered a variety of tax-deferred savings plans designed to provide benefits
to the participants when they retire.

11. Credit unions are cooperative associations whose members have a common bond,
such as being employees of the same firm. Members' savings are loaned only to other
members, generally for auto purchases, home improvement loans, and even home

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mortgages. Credit unions often are the cheapest source of funds available to individual
borrowers.

B. Government Non-bank financial institutions

1. Government Service Insurance System (GSIS). Provides retirement benefits,

housing loans personal loans, emergency and calamity loans to government
employees.
2. Social Security System (SSS). Provides retirement benefits, funeral benefits,
housing loans, personal loans and calamity loans to employees who are working in
private companies and offers.
3. Pag-Ibig. Provides housing loans to both government and private employees.

THE EVOLVING PHILIPPINE FINANCIAL SYSTEM

The Philippine financial system continues to experience growth against a backdrop of

strengthening domestic economy. Political reforms, i.e., tax reforms and greater
infrastructure spending, are projected to drive the domestic growth in 2018 as these
lead to higher spending by both the government and households. The domestic
economy is also seen to gain from the momentum of global economic recovery, based
on the upward revisions of growth projections by third party analysts. However, despite
the positive outlook for the Philippines, there are internal and external developments
that pose downside risks to the domestic financial system.

To counteract the downside risks and smooth functioning of the Philippine financial
system more stringent initiatives are being pursued by the four regulatory agencies,
namely

1. Bangko Sentral ng Pilipinas (BSP)

2. Securities and Exchange Commission (SEC)

3. Insurance Commission (IC)

4. Philippine Deposit Insurance Commission (PDIC)

SIGNS OF GROWTH IN THE DOMESTIC MARKET

In recent years, growth in financial intermediation is observed in the three major

segments of the Philippine financial system.

a. The Philippine banking system has been consistently posting double digit asset growth
since January 2016. Latest data show that total resources of the banking system
amounted to PHP15.3 trillion as of end March 2018, an 11.3 percent increase from
the previous year's level of PHP13.8 trillion. This asset growth trend is mirrored by the
growth in liabilities (see Figure A).

b. Meanwhile, total assets of the insurance industry more than doubled from 2008 to
2016 (see Figure B). Although there was a two-year slowdown after 2013, the growth
rebounded in 2016, posting an 11.2 percent increase. Moreover, there has been a
steady increase in the industry's revenues relative to GDP after the GFC, with a break

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in the year proceeding typhoon Yolanda in 2013. The life insurance segment continues
to be the driver of the insurance companies' revenues.

c. The securities market has also exhibited growth. The bond market, in particular, is
comprised mostly of peso-denominated government issued securities, to which
outstanding amount as of end-March 2018 grew by 7.1 percent to reach USD117.2
billion (see Figure C). The equities market, on the other hand, registered 12 additional
companies with the PSE in the past three years, bringing the total listed companies to
268, equivalent to PHP17.31 trillion market capitalization as of end-October 2017.

REGULATORY LANDSCAPE

A. Alignment with global standards

a. The BSP has released Circular No. 975 in October 2017 to streamline the
requirements on the issuance of bonds and commercial papers by banks and quasi-
banks and Circular Nos. and 985 in December 2017 in furtherance of liberalizing the
foreign exchange (FX) regulatory framework. It has also set the target to 01 September
2018 for banks to comply with the revised rules on liquidity risk management anchored
on the Principles for Sound Liquidity Risk Management and Supervision under the
Basel III reform agenda.

b. A key priority of the Insurance Commission (IC) is the adoption of international

reporting practices. The IC is preparing for the implementation of the Philippine
Financial Reporting Standards by the Financial Reporting Standards Council that will
be applied to insurance companies. For subsidiaries and branches of Global
Systemically Important Insurers operating in the Philippines, the IC requires keeping
reserves to pay policyholders in the event of insolvency and has set the guidelines for
the orderly acquisition, merger, consolidation, sale of insurance portfolio, and exit from
the domestic insurance business should another financial crisis global in scale triggers
a sell-off.

c. The SEC approved amendments to the Securities Regulation Code (SRC) and the
Corporation Code as well as supporting the bills on regulating Collective Investment
Schemes to enhance local regulations and conform to international best practices.
Considering the rising popularity of crypto currency, the SEC is also studying the ideal
regulatory treatment of virtual currencies (VCs) from the perspective of investor
protection. For internet-based scams, the SEC coordinates with the Ph pine National
Police and the National Bureau of Investigation which possess the resources and
expertise to assist in the investigation of cybercrimes committed by online
organizations.

d. For its part, the FDIC has entered into a cross-border partnership by way of a
Memorandum of Understanding (MOU) with eight deposit insurance agencies from
Asia, the UK and the US. The MOU fosters enhanced cooperation through exchange
of information, prompt response to technical inquiries, effective support for exchange
of experts and staff, conduct of bilateral meetings, and other collaborations to the
extent permitted by each country's laws, rules and regulations.

B. Deepening capital markets

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Various financial products have been introduced to the different segments of the
domestic market aimed at providing alternative options for raising funds or for investing
money. These include:

(1) dollar-denominated securities,

(2) exchange-traded funds,

(3) green bonds (upcoming),

(4) Personal Equity and Retirement Account,

(5) PHP government fund forward,

(6) public-private partnership shares, and

(7) real estate investment trust.

Furthermore, the SEC has initiated reforms on minimum public ownership, repurchase
agreements and shelf registration that underscore the need for improved liquidity in
the market and the importance of price discovery. The SEC is also finalizing its rules
governing the crowd funding market.

Meanwhile, the BSP, Bureau of the Treasury and SEC, with the support of the DOF,
rolled out in August 2017 the roadmap to accelerate the development of the Philippine
debt market. The three agencies, which comprise the Capital Market Working Group,
agreed to prioritize deepening of the local bond market, creating reliable financial
benchmarks and valuation of financial instruments, and establishing an integrated
financial market infrastructure (FMI).

C. Strengthening surveillance

a. The BSP has recently completed the requirements of becoming a BIS-reporting

country. This will allow access to detailed information on cross-border exposures of
other countries to the Philippines. The BSP through the FSCC has also initiated
collaborations with the Housing and Land Use Regulatory Board to develop a maiden
reportorial template targeted to real estate companies.

To further its conduct of surveillance and understanding of the underlying

developments in the insurance industry, the IC is in the process of building a database
from the quarterly reports required from insurance companies and developing
analytical tools for data mining purposes.

a. Currently, the SEC is proposing the creation of a unit for handling the rules,
regulations, policies, and guidelines concerning anti-money laundering (AML) and
counter terrorist financing (CTF) for covered entities. With the implementation of the
2015 Revised Implementing Rules and Regulations of the SRC, the SEC intends to
amend and update its guidelines on the preparation of the AML manual of covered
entities. Additionally, the SEC aims to prepare an audit plan and program regarding
the conduct of regular audits on covered entities, focusing on the compliance with
AML/CTF requirements.

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FINANCIAL STABILITY ASSESSMENT OF THE PHILIPPINE FINANCIAL SYSTEM

*

At its core, financial stability is preemptive in nature because it needs to mitigate the
buildup of system-wide dislocations before these vulnerabilities take concrete form.
With financial markets constantly evolving, it is however not clear what past data can
tell about future conditions. Adding another layer of complication is the fact that there
are competing measures of systemic risk while a unique set of financial stability
indicators has yet to be defined.

These issues notwithstanding, financial stability is clearly understood to reflect a "well-

functioning” financial market, addressing the financial needs of stakeholders and
avoiding distortions. This view of the overall market will then require a holistic
appreciation of the market situation in various segments of the market. Since these
segments may be experiencing different pressure points, judgment is often essential
in the overall assessment of systemic risks.

This is the reason why the FSR focuses more on thematic topics. While the market
landscape is a useful baseline, the focus is on risks and vulnerabilities that may derail
further growth as well as raise issues that may potentially have systemic implications.

The section on current risks shows how the outstanding debt level has grown rapidly,
particularly in the post-GFC period. Whether the build up of debt is already an issue is
still open for discussion. Yet, what is clear is that interest rates are rising and emerging
market currencies have been depreciating versus the United States dollar (USD).
These must mean that debt servicing is now at a higher cost than in the past, separate
from the issue of having more outstanding debt. This is our central financial stability
issue.

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The opportunity to discuss fintech and Association of Southeast Asian Nations

(ASEAN) financial integration is taken. There is no doubt that fintech provides benefits
over paper-based face-to-face transactions. This gain is especially of value to an
economy such as the Philippines which is segregated both geographically and by
demographic factors. Nevertheless, the assessment for fintech thus far has focused
on micro risks, e.g., credit and liquidity, among others. The prevailing view is that its
financial stability risks are limited, but this is also premised on the understanding that
fintech remains a small portion of market activity.

Source: Financial Stability Report (www.bsp.gov/publications/regular_fsr.asp) *

December 31, 2018

The intention is to allow fintech to develop further. One should be mindful of a key
lesson from the GFC that systemic risks may arise from seemingly smaller shocks
because accounting for the amplifying effects of interconnectedness was neglected.
Regulatory sandboxes and constant dialogues among stakeholders are critical to
ensure that one remains vigilant of the downside risks from the "disruptive" side of
fintech.

Similar to fintech, the business case is compelling for the integration of the financial
markets among member states of the ASEAN. The region continues to outpace global
growth, it saves at a higher rate than the rest of the world and it is home to a vast base
of millennials who are tech-savvy and drive retail markets. With much of ASEAN's
savings actually deployed out of the region, financial integration should provide a better
and more organized platform for retaining such savings and funding the region's
growth even more.

Yet, higher levels of cross-border interconnectedness will also provide another

possible venue for contagion risk. More generally, the previous works of Dani Rodrik
and Dirk Schoenmaker, respectively, suggest that there may be trade-offs between
sovereign policy, regional integration and financial stability. This section presents a
discussion of the issues as it is certainly relevant to the current work of various
committees on ASEAN integration.

CURRENT RISKS IN THE PHILIPPINE FINANCIAL SYSTEM

A. Repricing, refinancing and repayment risks (3Rs)

Several jurisdictions have pointed to various sources of risks that heighten financial
stability concerns. These are:

(1) The normalization of US monetary policy creates the incentive for global capital
flows to be directed towards the US, affecting asset and currency prices along the way.

(2) A slowdown in global growth and deceleration of international trade will undermine
the growth of many economies.

(3) Higher debt levels across countries will continue to leave economies vulnerable to
the changes in the growth outlook and the (continuing) rise in interest rates.

The risks flagged by other jurisdictions highlight the fact that global developments
largely affect the domestic economies. The impact, however, is much more significant
for a small and open economy such as the Philippines which is a price taker, rather
than a price setter. There are risks with rising Philippine interest rates and a local

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currency (LCY) that continues to depreciate against the US dollar. Drivers of growth
are shifting from quarter to quarter and the authorities need to be cognizant of the
factors that could derail the growth momentum. All of these market changes have to
be understood in the context of repricing, refinancing and repayment risks.

B. Developments in the credit market

Local intermediation continues to be peso-funded but with some support from foreign
currency (FCY) sources. The total loan portfolio of the banking system increased
significantly over the years (Figure 3.1) and is principally funded by peso deposits.
Looking at the spot and forward rates in the currency and interest rate markets, the
incentive would have been to borrow in Philippine peso and to invest these in US dollar
instruments. Yet, this is not the case and instead, banks have increased their FCY
debts to augment the growth in domestic currency loans (Figure 3.2).

This can be validated in Figure 3.3 which shows that borrowings of Philippine banks
from BIS-reporting jurisdictions have increased to USD11.7 billion as of end-December
2017. This can only mean that Philippine banks want to maximize the benefits of taking
on added credit risks in Philippine peso terms and they see as manageable the cross-
currency risks from sourcing the incremental funds from FCY loans.

C. Continuous demand for credit by corporate enterprises and households is evident

in the domestic economy

This funding strategy is a clear positive vote for local economic activity. Specifically,
non-financial corporation's (NFCs) and households account for a significant portion of
the incremental loans provided by the banking system. As a matter of fact, firms listed
in the PSE15 exhibited a rising debt to-equity ratio, from about 45 percent in 2008 to
more than 86 percent as of end-March 2018 (Figure 3.4).

Apart from bank loans, NFCs have also resorted to the bond market for their financing
needs. Figure 3.5 shows increasing levels of corporate debt issuances, both in LCY
and in US dollars. The level of corporate debt issued in US dollars, in particular, had
increased since 2010, reaching USD11.2 billion as of end-March 2018 after tapering
in recent periods.

Data limitation prevents an accurate assessment of household debt. As a proxy, Figure

3.6 shows rising consumer loans since 2012, of which majority were residential real
estate loans and motor vehicle loans. Nevertheless, beyond the increase in consumer
loans, the greater concern lies with what appears to be higher household leverage.
Aside from consumer loans, the 2014 BSP Consumer Finance Survey (CFS) indicates
that less than 14 percent of the households were borrowing from banks to finance the
purchase of a residential real estate, motor vehicle or household appliance (Figure
3.7). This only makes urgent the need to get a better handle of household debt outside
the formal sector. Box Article 4 presents an alternative way of estimating household
indebtedness using the Family Income and Expenditure Survey (FIES).16

The continuous demand for credit is welcomed as it represents further "financial

deepening" of the economy. However, one has to also appreciate the higher debt
levels against the potential risks from rising interest rates and the peso depreciation.
This is a debt service burden issue and is at the core of what is referred to as the 3Rs
or repricing, refinancing and repayment risks.

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Guided Exercises / Learning Activities

REVIEW QUESTIONS

1. Compare the function of a commercial bank with the function of universal bank

2. Enumerate 3 government banks.

3. Which of the following is not a thrift bank?

a. Private development bank

b. Stock savings and loan associations
c. Stock savings and mortgage banks
d. Cooperative banks

4. A bank which caters to farmers businessmen and cottage industries in the rural
areas

a. Rural bank
b. Cooperative bank
c. Saving and loans association
d. Universal bank

5. Which of the following is not a government bank?

a Land Bank of the Philippines

b. Al-Amanah Islamic Investment Bank
c. Philippine National Bank d. Development Bank of the Philippines

6. Which of the following is not a government agency that regulates financial

institutions?

a. Insurance Commission
b. Bangko Senral ng Pilipinas
c. Securities and Exchange Commission
d. Bureau of Internal Revenue

7. Explain briefly how the following regulatory agencies intend to align their policies,
roles and practices with global standards

a. BSP
b. SEC
c. Insurance Commission

8. Discuss briefly the following current risks in the Philippine Financial system

a. Repricing, refinancing and repayment risks

b. Developments in the credit market
c. Increasing demand for credit by corporate business and households

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Assessment

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Assignment

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References

BOOK: FINANCIAL MARKETS AND INSTITUTION

Author/s:
Ma. Elenita Balatbat Cabrera, BBA, MBA, CPA, CMA
Gilbert Anthony B. Cabrera, BBA, MBA, CPA

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