RP banks face new drags

MANILA, Philippines - The Philippine banking system is facing potential drags on its bottomline as the operating environment remains difficult, squeezing banks’ interest rate margins, loan growth decelerating, and the cost of lending rising.

According to a World Bank report released recently, the overhang of non-performing assets (NPAs) can be expected to further add pressure on earnings. 

“The more difficult operating environment will also test the appropriateness of individual bank capital in terms of covering unexpected losses and/or higher risk taking. While the financial system’s liquidity may provide opportunities for capital raising, some small banks may find it more difficult to increase capital, resulting in pressure for further consolidation of the banking system,” the report added.

Tensions over interest rate risk likewise have given way to concerns over credit risk as the economy enters a possible recession.

Banks continue to have a large exposure to interest rate risks. Although banks have moved some of their tradable debt securities to accounts that are not subject to fair value accounting, about P700 billion, representing 12 percent of total assets, continue to be exposed to interest rate risk.

For a 100 basis point increase in spreads on all types of government securities, it is estimated that banks can potentially lose about 50 to 70 percent of average 2006-08 profits on their government security holdings.

Given high concentration of bank investments in Philippine government paper, a further deterioration in government’s fiscal position exposes banks to potentially higher mark to market losses.

Liquidity risk, on the other hand, is mitigated by banks’ cash-rich position as seen in low loan to deposit ratios.

At the individual bank level, some banks may face greater risk due to smaller deposit base, dependence on high net-worth depositors who can easily move funds elsewhere should there be a crisis of confidence and minimal counterparty lines. “The interbank market lacks depth,” it added.

While banks’ and corporates’ financial conditions were better entering the current global crisis than the period leading up to the 1997/98 crisis (e.g., high lending growth, high corporate leverage), a deterioration in credit quality can be expected. Already, banks have reported upticks in default rates related to sectors directly affected by the crisis (e.g., exports, housing for overseas Filipinos).

The World Bank estimates that banks can afford to write off three percent of currently performing loans without charges to equity.  The non-performing loan (NPL) ratio has fallen to 4.5 percent of total loans (excluding interbank loans) end 2008 from high teens in the early ‘20s.

Sectors that have seen acceleration in lending growth in recent years and are being watched closely for potential defaults include property, power and other infrastructure project financing, and consumer lending. Credit risk is moreover heightened by the increasing concentration of lending to a few large conglomerates.

Earlier, the Asian Development Bank (ADB) said that risk spreads are modest and banks remain extremely liquid and robust.

ADB country director for Philippines Neeraj Jain said that there has been no downgrade of credit rating for the Philippine banking sector, and ranked as superior the risk supervision of the Bangko Sentral ng Pilipinas (BSP).

Jain pointed out that the yearend capital adequacy ratio (CAR) stood at 14.75 percent on a solo basis, and 15.49 percent on a consolidated basis. The BSP requires a minimum CAR of 10 percent, while the Bank for International Settlement (BIS) dictates a minimum eight percent in the international level.

Since 2003, the country’s banking sector averaged over 16 percent in CAR, while its total capital accounts to total assets stood at 10.6 percent end 2008, according to data from the International Monetary Fund (IMF) and the BSP.

 Its NPL ratio fell from 16.1 percent in 2003 to just 4.5 percent end 2008, while its non-performing asset (NPA) ratio fell from 13.2 percent in 2003 to a mere 5.1 percent last year.

Banks remained secure with average NPL coverage ratio stood at 86 percent last year from 51.5 percent five years ago. NPA coverage ratio improved from 30.9 percent in 2003 to 44.4 percent.