Banking on mergers to survive

Some six years ago, after assuming the post of central bank governor, Rafael Buenaventura spoke of a vision of having only five large local banks aggressively competing against their foreign counterparts. As things stand today, this dream will not happen during his term with barely a few months left before he steps down from office.

Presently, the industry is still far from achieving that goal, although there have been recent signs that a new wave of mergers and consolidation is in the offing. Here’s hoping that this would lead to stronger financial institutions that will ultimately benefit the public.

For starters, last month, Citibank announced its purchase of thrift Insular Bank, which is an indication that foreign banks are fortifying their presence in the Philippine banking sector, and preferring the faster mode of asset build-up through acquisition.

Just recently too, there was the government’s announcement that it had agreed with businessman Lucio Tan to jointly sell two thirds of their combined 90 percent stake in Philippine National Bank (PNB). Given PNB’s size (bad assets and otherwise), it would be interesting to find out if any of the existing banks would take the bait for the prospect of being the fifth biggest in the country.

Much Ado About Basel 2

What seems to be actually forcing local banks to improve both their asset and capital structure is the central bank’s decision to adopt the Basel 2 Accord, an agreement that will in effect force weak banks to offer themselves up for sale to bigger and fundamentally sound financial institutions.

Basel 2, to be enforced locally by 2007, is a revision of the original Basel Capital Accord signed by the world’s central banks in 1988. While Basel 1 agreed actions covered only risks associated to credit and prevailing market conditions, Basel 2 now also covers risks involving bank operations.

Under Basel 2, banks are required higher levels of capital or larger provisions for borrowers that have higher levels of credit risks. Ergo, banks whose borrowers are more delinquent in their debt repayments (as seen through their NPL levels) would be required to set aside higher provisions.

In the case of PNB, for instance, it must beef up its capital to support a non-performing loan level of something like 50 percent of its total loan portfolio. Because the government, as one of the bank’s major shareholders is not in a position to provide the additional capital, it must seriously consider getting out of the business.

Larger Capital, Better Governance

The new framework as defined by Basel 2 also establishes an explicit capital charge for a bank’s exposures to the risk of losses caused by failures in systems, processes, or bank staff actions and those that are caused by external events, such as natural disasters.

Basel 2 likewise sets standards for the supervisory review process and for disclosure practices to make banks more transparent to shareholders and depositors.

This is in line with current calls for stronger corporate governance and more effective management teams to keep a bank’s health.

In effect, it is one way of saying that when things go wrong, it’s not always the world – meaning the borrower and the market – that is the problem. Sometimes, a bank’s downfall is often the result of excesses committed by either its major shareholders or its management team or both.

Even before the deadline of 2007, the central bank has been advancing the inclusion of several Basel 2 provisions in the current local banking framework. Some of these is the lower risk weighting for highly rated corporate entities, the higher risk weighting for past due claims, and the standardized approach for securitization exposures.

The draft implementation guidelines on the other Basel 2 provisions are supposedly being circulated to the industry for comments, after which the final implementation guidelines will be issued towards the end of the year.

Monetary authorities and bank supervisors are now diligently examining bank books to ensure that there will be adequate capital to support prevailing risks as specified in the Basel 2 accord.

Too Many Banks

Basel or no Basel though, the Philippines continues to be over-banked and over-branched. There are about 19,000 bank offices of which 7,593 are bank branches.

Every city or municipality is being served by an average of five branches, with a higher concentration definitely in urban Manila.

This would have been all right except that loans, the banks’ main source of revenues, are not growing as robust as what they would want to, to support their operating costs. The high overhead and operating costs, plus the huge levels of distresses assets, are also factors that influence the move for further consolidation in the sector.

Worth mentioning here are banks like PNB and UCPB, both of which, aside from being burdened with billions of non-performing assets, are also under government control and essentially with very limited funds to provide support in case of a downturn.

Just imagine how their capital bases and their loan provisions would be wiped away once they dispose of their distressed assets through heavily discounted transactions like the SPAV.

While raising quasi-debt capital is always an option, the question for these banks really is at what cost are they willing to borrow just to beef up their capital base? Or can their borrowings be supported by the current state of the industry characterized by sluggish loan growth and huge distressed asset burden? So, quo vadis, PNB and UCPB?

Cleansing The Justice System

In the words of the current DOJ Secretary Raul M. Gonzalez, there is no real social justice if there is no proper administration of the criminal justice system. And there will be no properly functioning justice system if there is a lack of qualified manpower, and if those who are currently in the ranks are mired in corruption.

The thousands of pending cases clogging the different courts, and the non-resolution and non-apprehension of guilty parties even in highly publicized cases reinforce public perception that the criminal justice system in the country is not effectively being administered. If the rich cannot obtain speedy justice, then more so the poor Juan de la Cruzes who cannot afford the exorbitant fees of lawyers.

To preserve our democratic way of life, it is imperative that the justice system, one of the pillars of a just and orderly society, must be strengthened.

To achieve this, it must be devoid of politics and corruption. Can this be done?

Join us in "BREAKING BARRIERS" on Wednesday, 20th April 2005, IBC-TV13 (11 p.m.), and gain insights into the views of Secretary Raul Maravilla Gonzalez of the Department of Justice on issues confronting DOJ as it pursues its mandate. Watch it.

Should you wish to share any insights, write me at Link Edge, 4th Floor, 156 Valero Street, Salcedo Village, 1227 Makati City. Or e-mail me at [email protected]. If you wish to view the previous columns, you may visit my website at http://bizlinks.linkedge.biz.