Chapter 1

AN OVERVIEW OF THE PHILIPPINE FINANCIAL SYSTEM

Every individual and business organization in a civilized society are directly involved in the
financial system -a complex structure and operation.
We use money in buying goods and services. We borrow money from banks, pawnshops or
credit unions to satisfy our needs. These are some of those activities very familiar to us because
they are part of four daily activities andobservations.
However, the financial system does not only include banks, credit unions or pawnshops but also
other financial institutions like money markets, investment houses, financ- ing companies,
securities dealers, among others. Likewise part of the whole financial system are those which
have a tremendous influence in our economy such as the World Bank, the International
Monetary Fund, the Asian Devel- opment Bank, the transnational banks, the Bangko Sentral ng
Pilipinas, and other government agencies which are, in a way, associated with the laws affecting
money, credit and banking.
In a modern economy, the financial system is more sophisticated. It has a vast network of
institutions with modern facilities. Its policies and programs play a major role in the social and
economic development of any country. This proven by progressive financial centers of the world
like New York, London, Singapore, and Hong Kong.
This chapter presents the nature, importance, elements and functions of the financial system.
Also included are brief discussions on the development and growth of the Philippine financial
system, and the influence of the transnational banks, the World Bank, the International
Monetary Fund, and the Asian Development Bank in our financial setup.

Nature and Necessity of Finance

The financial system is a network of various institutions which generates, circulates, and
controls money and credit. It provides intermediation between the suppliers and users of credit.
As an integral part of the economic system, it provides loans to poor families, small producers,
big busi nessmen, and industrialists. It further, stimulates the social and economic development
of the country. It is noted that the highly developed countries like the United States, Japan, and
those in Western Europe (Great Britain, France, and Germany) have become prosperous
because of the support of financial institutions during the initial stage of their industrial
development.
These arises a need for financial institutions in a society where any individuals have surplus
incomes. People with excess incomes are inclined to place their extra funds in investments or
productive projects. Other intend to lend their money in order to earn interests. In a primitive
economy, the lenders can directly deal with the borrowers in transferring their savings.
However, in a larger market, middlemen are needed to facilitate the meeting of lenders and
borrowers. But in a developed economy, specialists are needed to satisfy the business intereats
of both suppliers and users of funds. And this is primarily the job of financial institutions. There
is no more need for the lenders to deal personally with the borrowers. Both parties transact their
business with financial institutions. This is more convenient,economical, and safer for the
lenders. From the point of economics, the transfer of funds from lenders to borrowers, through
financial institutions, creates several favorable effects in the economy. For instance, such
transfer of money can improve consumption pattern and resource allocation. People with
surplus money which they do not use for production have no positive contribution to society and
the economy. But if these idle financial resources are lent out to individuals without financial
capital but with business inclinations, then such resources become tools of production. These
will create more employment, income, and consumption. Many other members of society will be
ben- efited. In the long run, these interdependent economic activities, together with their linkage
effects, simulate further economic growth for the whole economy.

Elements of the Financial System

1. Financial claims. These comprise the money and the rights to receive money under specific
circumstances. Usu- ally, these are evidenced by financial instruments which specify the terms
of the claims. There are two broad categories of claims: debts and equities. The latter conveys
ownership rights while the former does not. The debtor has an obligation to pay his loan plus
interest. On the other hand equities are investments like shares of stock which earn dividends,
2. Financial institutions. These are private or government organizations whose assets consist
primarily of claims or incomes primarily derived from dealing in and/or performing services in
connection with claims. Institutions which deal with the creation and issuance of claims against
themselves, and use the proceeds to acquire and hold claims against others, are commonly
referred to as financial intermediaries. Such institutions act as middlemen between suppliers
and users of money. Some of these are familiar to us like commercial banks, savings and loan
associations, and finance companies. The unfamiliar ones are presented and explained in
subsequent chapters of this book.
Other financial institutions are primarily involved in services related to claims. They provide
financial information and advice, manage portfolios of financial assets on behalf of other
economic units, buy and sell claims on instructions from clients, and assist in finding sources for
those economic units seeking loans. These and other services are explained in details in
subsequent chapters.
3. Financial markets. These are institutions which expe- dite transactions in financial claims.
Examples are the Manila Stock Exchange and other organizations dealing with money market
operations. A financial market serves as a means of bringing the forces of demand and supply
of financial claims.
4. Government agencies. The Monetary Board is thepolicy-making body of the Bangko Sentral
ng Pilipinas. Laws on money, credit, and banking are legislated by the Congress and through
executive orders issued by the President of the Philippines. The role of the government
agencies has at tremendous impact on the financial system. For example,one very important
goal of the Bangko Sentral is to attain internal and external stability of our peso.
5. Laws and policies. The national government regulates and supervises the behavior of the
whole economy. Hence, its control of the financial system is a vital condition for the whole
economic behavior. Laws and policies have been formulated to ensure the desired levels of
investment, employment, production, income, and consumption.
Specific Functions of Financial Institutions
The general function of financial institutions is to facilitate the transfer of funds from the savers
to the users. To transfer such savings to spenders, assistance is necessary because of the
large volume of savings. Furthermore, in a highly developed economy, certain barriers are
created by individuals in the transfer of funds: risk, inconvenience and cost of transfer, and the
desire to avoid illiquidity.
Financial institutions perform certain specific functions such as:
1. Investigation and credit analysis. An individual who lends his money through a financial
institution is assured of a minimum risk. A careful investigation and credit analysis about the
application of the borrower in conducted. This is to ensure that the funds will be used efficiently
by the borrower, and to protect the interests of both the lender and the financial institution.
2 Matching the supply and demand for funds, Financial institutions perform a brokerage
function. They bring the fenders and borrowers together. They provide conveniently located
offices to make things available and economical for both parties. Some types of financial
institutions purchase securities in large quantities and then sell these in smaller lots. Financial
institutions specialize in matching the supply of savings with the demand for funds.
3 Provisions for liquidity. Not a few savers are reluctant to lend their money to borrowers. They
feel that they may need cash prior to due date of payment. Or, in case they purchase bonds,
they may not be able to find buyers when they decide to liquidate their bondholdings. However,
with the presence of financial institutions, the liquidity of finan- cial assets can be increased.
Through their brokerage function which provides an organized market, the investor can find a
buyer for his debt or ownership claims. Moreover, some financial institutions accept savings
from individuals who in return acquire claims against the assets of the financial institutions. In
case a client of such institution decides to liquidate his claim, the latter can pay its client with its
current funds which it receives from other savers.

Development of the Philippine Financial System

The first credit institutions established in the Philippines were the Obras plas which literally
mean pious works. These were started by Father Juan Fernandez de Leon in 1754. Their funds
came from pious Catholics, together with those who made their wills before undertaking
dangerous expeditions. These institutions consisted of foundations which invested their money
in trade and channeled their profits to charitable works. Most of the obras pias funds were lent
out to traders to finance the Galleon Trade. Such credit institutions had been under the control
of the friars, and eventually became commercial banks or marine insurance companies.
The last of the obras pias came to an end in 1820. Ten years later, Francisco Rodriguez
organized the Rodriguez Bank. However, this was more of a loan association than a bank. Most
of the clients of the bank were American and British merchants. When the owner died, the
bank's funda were turned over to the Queen of England.
The first Philippine bank. In 1851, the first Philippine bank was established. This was the Banco
Español-Filipino de Isabela II. Actually, the bank had been granted a charter in 1528. But it
started transacting business when several Philippine ports were opened to foreigners.
Nevertheless,foreign trade outside Manila was not very substantial. Thus,the bank handled
mostly domestic transactions.
With the opening of Suez Canal in 1869. Philippine trade expanded. European markets became
accessible to Philippine producers and this induced the country's agricul tural development. The
Banco Español-Filipino funded crops for exports and established correspondent relations in
Spain and France to help the European trade,
The growth of trade with Europe began to attract British capital to the Philippines. As a result,
the Chartered Bank of India, Australia, and China set up a Manila branch in 1873. Two years
later, the Hong Kong and Shanghai Bank also put up its branch in Manila. In 1883, both banks
opened branches in Iloilo to finance the sugar industry.
The British banks dominated the economy during the Spanish colonial rule. Likewise, British
merchants controlled the economy. Their ships, connections with China and Europe, credit
resources, and technique and machinery for large scale crop production gave them an
advantage over the other merchants from 1820s to 1900s. However, Ameri- can business
interests started to expand during this period.
In the case of Spain, it was able to put up the first savings bank in 1882 despite British
domination in the banking industry, This is Monte de Piedad. Its funds came from the obras
pias. One year later, another Spanish bank, Banco Peninsula de Ultramirano, set up a branch in
Manila.
Financial institutions during American rule. At the time the United States acquired the
Philippines in 1898 through the Treaty of Paris, its business interests were not as strong as
those of the British and Chinese. However, with "free trade" between the United States and the
Philippines as provided by the Payne-Aldrich Act of 1902, American economic control in the
Philippines substantially increased. In addition, the weakening of the British commercial
activities in Asia because of its involvement in World War I (1914-1918), gave the Americans
the opportunity to promote their business interests in the Philippines.
In 1902, the International Banking Corporation of New York set up an office in the country.
However, in 1915 the bank was acquired by the National City Bank of New York. At present this
bank is one of the top five banks in the United States and the whole world. It is now called the
First National City Bank. Through the International Banking Corporation, Americans were able
to generate more business interests in the Philippines. Other branches of American banks were
established such as the Guaranty Trust and American Bank.
Other banks were organized such as the Postal Savings Bank in 1904, and the First Agricultural
Bank of the Philippine Government in 1906. However in 1916 the assets and liabilities of the
agricultural bank transferred to the newly-organized Philippine National Bank (PNB).The
Catholic Church set up the Philippine Trust Co. in 1916 while a group of Manila-based American
businessmen established the People's Bank and Trust Co. in 1926.The Chinese were likewise
active in moneylending at very high interest rates. The Chinese banks were formed in the 1920
China Banking Corporation in 1920 and the Mercantile Bank of China in 1926.
With the coming of the Japanese Imperial Forces in 1942, the PNB closed its doors. A few
months later, the Japanese occupation forces ordered the PNB to reopen for business, and it
was supervised by Japanese military advisers during the war years. The Southern Development
Bank, a Japanese bank, put up a branch in the country to perform the role of a central bank.
War notes were then printed and circulated as money. This caused the worst inflation so far in
the country.
Postwar Financial Institutions
In 1946, the Rehabilitation Finance Corporation was established to provide credit facilities for
the rehabilitation of agriculture, commerce, and industry, and the reconstruc tion of war-
damaged properties. Some years later, it became the Development Bank of the Philippines.
Another very important milestone in the development of the Philippine financial system during
this particular period was the creation of the Central Bank of the Phil. ippines in 1948. Its
operations, however, started the following year.
By 1947, there were four branches of foreign commercial thript banks in the country and seven
local banks. Of these seven local banks, only one was owned by Filipinos. Most of the non-
commercial banks emerged after World War II and during the 1960s up to 1970s. The rural
banking system was organized in 1952. At the end of 1978, there were thirtyfive commercial
banks including the four branches of foreign banks with a nationwide network of 2,830 banking
units.

Structure of the Philippine Financial System

Bangko Sentral ng Pilipinas Banking Institutions
1. Private banking institutions
a. Commercial banking institutions
● expanded commercial banks/universal banks
● ordinary commercial banks
b. Thrift banks
● savings and mortgage banks p
● rivate development banks
● stock savings and loan associations
C. Rural banks
2. Government banking institution
a. Philippine National Bank
b. Development Bank of the Philippines
c.Land Bank of the Philippines
d. Philippine Amanah Bank
Non-Bank Financial Institutions
1. Private non-bank financial institutions
a. Investment houses
b. Investment companies
c. Financing companies
d. Securities dealers/brokers
e. Non-stock savings and loan associations non-Bank
f. Building and loan associations
g. Pawn Shops
h. Lending investors
i. Fund managers
j. Trust companies/departments
k. Insurance companies
1. Venture capital corporations
2. Government non-bank financial institution
a. Government Service Insurance System (GSIS)
b. Social Security System (SSS)