White Knight

The closure of Export and Industry Bank (EIB) last month left about 50,000 depositors out in the cold. The saddest thing about this particular closure is that it was entirely avoidable.

As early as July 31, 2009, EIB and BDO entered into a binding agreement that would fully protect the former’s depositors and their estimated P14 billion in deposits. In that agreement, BDO will acquire selected EIB assets and assume all of the smaller bank’s deposit liabilities. The larger bank was to be EIB’s white knight in fighting insolvency.

In August 2009, the EIB-BDO transaction was presented to both the BSP and the Philippine Deposit Insurance Corporation (PDIC). The two agencies imposed several requirements before allowing the transaction to progress, including a prohibition against EIB shareholders getting paid any amount out of the proceeds of the transaction. The two banks agreed to all the conditions imposed by the BSP and the PDIC.

On November 25, 2009, the Monetary Board recognized that closing down EIB carries the risk of a systemic effect on the banking sector as a result of a drop in confidence among depositors of similarly situated banks as well as the fact that among EIB’s major depositors are investors in key industries. That assessment guided policy on the matter.

On March 2010, the PDIC board approved the transaction between EIB and BDO. The BSP likewise approved the transaction in principle, pending compliance by the two banks with the conditions imposed by the PDIC.

Just as the deal was about to be sealed, for reasons still unclear, government regulators required an updated due diligence review. This delayed the transaction for several months.

After due diligence was performed, the PDIC board again approved the transaction in April 2011. Documentation of the transaction by the two banks went apace. All the requirements were met, save for one: the resolution of a case filed by the group of businessman William Gatchalian which hampered the operations of the smaller bank.

The Gatchalian case stems from a transaction in 2003 involving this group and EIB Securities (a subsidiary of EIB). The Gatchalian group bought listed DMCI using EIB Securities as broker. On settlement date, however, the Gatchalian group failed to pay for the purchased securities. EIB Securities then proceeded to sell the purchased shares to cover its liabilities. The confirmations of the sale were signed by representatives of the Gatchalian group.

In 2004, when DMCI shares appreciated, the Gatchalian group demanded delivery of the shares they instructed to be bought but did not pay for.  The Gatchalian group won a favorable court ruling against EIB. The bank was ordered to pay Gatchalian P135 million, the value of the shares at the time of purchase.

When EIB failed to promptly pay the amount, Gatchalian filed a second suit, this time demanding P1.5 billion, representing the market value of DMCI shares at the time of the first judgment. The bank elevated the case to the CA. Unfortunately, the resolution of this case was a closing condition imposed by BDO for the transaction to be completed.

Time ran out on EIB and the BSP closed it down when liabilities exceeded assets. EIB depositors, within the period of rehabilitation, may still be brought to safe harbor and the PDIC spared the expense of paying out billions to depositors if the Gatchalian issue is settled quickly.

Black Knight

Two extremely influential groups representing American businesses have written our Department of Finance and the two chambers of Congress warning against the 1000% increase in excise taxes now being considered. That staggering increase will be a Black Knight of sorts, causing more troubles in the long run that will overwhelm whatever short-term gains might be visible.

The two business groups are: the US Chamber of Commerce (representing about 3 million American businesses) and the US-ASEAN Business Council (representing US investors in the region).

In their separate letters to the Finance Secretary and the leaders of Congress, the two American business groups urged our policymakers to look closely at the experiences of the Panama, Singapore and Malaysia. The three countries sharply increased excise taxes on tobacco products and all ended up getting less revenues.

The sharp increase in excise taxes caused an equally sharp increase in smuggling activities. In Panama, for instance, smuggled cigarettes now constitute 60% of the market. Malaysia has resorted to expensive electronic tagging devices that counterproductively raise the end-user cost of tobacco products and, ironically, abet the attractiveness of smuggling.

Unregulated, the smuggled cigarettes are often counterfeit and contain unregulated amounts of nicotine and toxic chemicals even more harmful to users. The entry of cheap smuggled products actually increased the number of smokers.

Smuggling syndicates, once they become profitable, soon become deeply entrenched, using their money to buy influence and protection. Other studies correlate smuggling syndicates to the drug cartels and even terrorist groups. They soon grow from merely law enforcement to national security concerns.

American investments account for over a third of foreign direct investments in the country. That, however, should not be the only reason for looking closely at the arguments against excessive excise taxes that the two business groups articulate.

Rice smuggling has recently spiraled beyond control for reasons I will deal with in another column. Our hog and poultry raisers are up in arms over the massive economic losses they incurred — again because of rampant smuggling that must have raked in billions for the new syndicates in power.

If smuggled rice, pork, chicken and even onions now flood our markets, will the authorities be able to cope with a surge in tobacco and alcohol smuggling?

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