YEARENDER: Banks gear up for Basel 3, Asean integration

 MANILA, Philippines - The Philippine financial system had remained resilient from all external shocks in 2013, thanks to the country’s strong economic fundamentals.

With the continuing growth in the economy, local banks are expected to be kept on their toes in the coming years.

These are generally the sentiments shared by some top bank officials and leading international rating agencies in the Philippine banking system this year and in 2014.

“We have a healthy banking sector, well-capitalized. I don’t think anybody among the major banks is facing problems with their loans, BDO Unibank president Nestor Tan said.”

“I think earnings are relatively strong, the industry performed quite well,” when asked to describe how banks fared in 2013. BDO is the country’s biggest lender, controlled by the family of retail tycoon Henry Sy Sr. of the SM Group of Companies.

For 2014, BDO sees the economy growing by a still strong 6.5 percent amid a conducive business environment. This is, however, slightly lower than the 2013 growth estimate of 6.75 percent. Main drivers of growth are expected to come from the doubling of infrastructure from the regular National Government budget of P400 billion and partly the implementation of the government’s Public-Private Partnership (PPP) program.

On the possible impact of external factors on the banking industry’s performance, Tan said as long as the economy is doing good, banks would remain stable.

“If the local economy will be affected by these external risks, then banks would be in trouble. But as long as the economy is doing well, we are okay,” he pointed out.

For his part, Bankers Association of the Philippines (BAP) and Rizal Commercial Banking Corp. (RCBC) president Lorenzo Tan hadthe banking industry would sustain its its growth path.

“Everything looks good. There’s structural demand, consumers have confidence, they’re spending, the banking industry is very strong, we have strong resources. Report of Moody’s came out and giving our banking system a positive outlook compared to other countries who got neutral or negative outlook, so I would expect good news,” he said.

Chamber of Thrift Bank and BPI Family Bank president and CEO Jose Teodoro Limcaoco shared the same optimism, saying that local banks would still perform better in the near-term.

“I think the Philippine economy will continue to be strong. I think banks will continue to show good growth for the remainder of the year. I think we still see strong consumer growth which is the focus of the thrift banks and therefore we should see good growth from our sector as well,” Limcaoco said.

Among the major challenges facing local banks, according to bank officials, would be the Basel 3 compliance and the preparation for ASEAN 2015 integration.

While most of the major players have already complied with the global Basel 3 requirements, some relatively smaller banks have yet to jack up their capital base to meet the deadline set by the monetary authorities.

The Monetary Board, the policy-making body of the Bangko Sentral ng Pilipinas (BSP), decided to adopt the capital adequacy standards in full by Jan. 1, 2014 without recourse to a staggered implementation or a gradual phase-out of ineligible capital instruments.

According to the MB, the earlier implementation of Basel 3 would put the Philippines alongside such jurisdictions as China, Australia, Hong Kong and Singapore.

Basel 3 introduces a complex package of reforms designed to improve the ability of bank capital to absorb losses, extend the coverage of financial risks and have stronger firewalls against periods of stress.

However, the Basel Committee on Banking Supervision (BCBS) outlined a staggered implementation of Basel 3 stretching through the end of 2018 to allow internationally-active banks time to raise capital organically.

But the BSP believes the 2014 compliance to the Basel rule recognizes the present strong capital position of the banking industry while providing for a reasonable transition period.

By adopting the capital adequacy standards by 2014, the BSP effectively accelerates the implementation of the Basel 3 accord for universal and commercial banks, including their subsidiary banks and quasi-banks.

A highlight of Basel 3 is the higher proportion of bank capital that is represented by common equity. Under the BSP framework, Common Equity Tier 1 (CET1) ratio will be set at a regulatory minimum of six percent while the total Tier 1 ratio will be at a 7.5 percent minimum. Both ratios are higher than the respective minimum under Basel 3.

Though it was believed that the ASEAN integration would not happen as yet in the next years, banks should begin preparing for it, said bank officials.

BSP Deputy Governor Nestor Espenilla Jr. earlier said it is likely that the ASEAN integration, at least for the financial sector, would be realized in 2020, giving local banks ample time to look for ways to enhance their competitiveness with the anticipated entry of new players from neighboring countries in the domestic market.

Tan said BDO is slowly growing its business locally in preparation for the 2015 ASEAN integration.

“(We want to focus on) local expansion. You have to have a strong local business before you can expand globally. Because for us, we don’t want to spread too thinly while our resources are not properly deployed, we still see the local market as growing. There are still underpenetrated (unbanked) areas so why go elsewhere when our local market is still strong and still offer a lot of potential for growth,” the BDO chief said.

Limcaoco, on the other hand, had said that smaller banks have been trying to beef up capital to keep up with stiffer competition in the banking industry, particularly with the upcoming integration of the ASEAN markets.

The BPI Family president said regulators are also urging small banks to consolidate to be able to survive once ASEAN 2015 kicks in.

“I think the BSP clearly wants banks to strengthen by increasing capital. Deputy Governor (Nestor Espenilla) mentioned about rural banks graduating to thrift banks. I think I see more of that happening. What’s the underlining reason for a merger, I guess, is to get bigger in size but you know it’s the question of how relevant is the size of a target versus an acquirer,” he said.

He said mergers and consolidation in the banking industry are expected to continue in preparation for the Basel 3 requirement and at the same time for the ASEAN market integration.

Under banking rules, thrift banks which are subsidiaries of universal and commercial banks would have to comply with the Basel 3 requirement by January 2014. Among the thrift banks with parent commercial/universal bank parents are BPI Family, RCBC Savings, HSBC Savings, Citibank Savings, Security Bank Savings, UCPB Savings Bank and China Bank Savings.

Independent thrift/savings bank on the other hand, must comply with the requirement under the reduced form of Basel 1.5.

Positive Ratings

International rating agencies Moody’s Investors Service and Fitch Ratings are one in their assessment that highly-capitalized Philippine banks would perform well in the coming years.

In the latest Global Credit Research authored by Moody’s managing director Stephen Long, it said “Philippine banks are an outlier, with their credit profiles remaining on an improving trend, benefiting from a strong economic outlook, even after recent disasters and the absence of concerns about excessive credit growth.”

Moody’s said its outlook for local banks are still “positive”. “The Philippines continues to be a positive outlier, with strong economic momentum but only moderate credit expansion compared to nominal GDP growth.”

On liquidity, Moody’s said banks in the Philippine have seen loans outpace deposits, but domestic liquidity remains ample.

On asset quality, it said “while banks in the Philippines now report impaired assets at record lows, we expect no meaningful deterioration despite impact of recent disasters.”

Fitch, for its part, said the local banks’ healthy capitalization, ample liquidity, and relatively high loan-loss reserves would enable them perform well and avoid credit risks.

“The stable outlook on the ratings of most large Philippine banks and the broader sector reflects their high core capitalization, sound funding and liquidity, and rising loan-loss reserves,” Fitch said in its latest report titled “Emerging Asia Banks Face A More Challenging 2014.”

According to Fitch, “these strengths should offset the risks of higher credit growth in a buoyant local economy. Current ratings also reflect longstanding issues in the banking sector – including loan concentration, modest reserves against foreclosed properties, developing corporate governance, and the presence of families as controlling shareholders.”

“This backdrop should support banks lending activities, while NPLs (non-performing loans) and foreclosed properties may stay manageable,” Fitch said.

Fitch noted that the BSP has been closely watching such developments and may deploy macroprudential measures to counter any systemic risks.

Aside from raising capital for Basel 3, banks will have to realign their investment portfolio with the expected gradual phase out of the BSP’s special deposit accounts (SDAs).

Under BSP Memorandum 2013-021, trust departments will have to remove 30 percent of singular investment management accounts (IMA) parked on the SDA by July 31. A complete phase-out was carried out in November.

BPI wealth management head Mario Miranda earlier said the phase-out of the SDAs would present a major “challenge” for banks, particularly to their respective trust departments.

“This year is challenging for all the trust departments of all banks. The SDA is being phased out so a lot of the banks have huge volumes of SDA and some of those SDA will go back to time deposit, some of those will go to investments. So it is going to be a challenge for all trust departments of all banks to be growing this year, Miranda said.

As for smaller banks, one major challenge is to keep up with lower non-performing loan (NPL) level. NPLs are loans that remain unpaid 30 days after due date. The NPL ratio is a gauge of how much of the total loans granted during a particular period were unpaid and had to be shouldered by banks.

Newly-elected Rural Bankers Association of the Philippines (RBAP) president  Vittorio Almario earlier expressed optimistism that their members would be able to face the challenge of bringing down their NPLs.

“It is really to the interest of the bank that more and more loans are being paid. There are measures that are being done. There are procedures that are within the scope of our guide with the BSP. But NPL is also a business decision of the bank whether for them or not. They also have to make sure when they loaned out they get paid so it is a concern. You have to watch out for trends. That’s why the BSP encourages us not to concentrate on certain sectors. The name of the game is really prudence,” he said.

Merger and consolidation

While two major talks on merger and consolidation which took place in the early part of 2013 did not push through, two fairly large acquisition moves were carried out during the year.

It would be recalled that discussions for a possible merger between Bank of the Philippine Islands (BPI) and Philippine National Bank (PNB), as well as the entry of Malaysia’s CIMB in San Miguel Corp.’s Bank of Commerce (BOC) bogged down.

However, Sy-led China Banking Corp. has acquired Planters Bank, owned by the family of former ambassador Jesus Tambunting. BDO Unibank Inc., the main banking arm of the Sy family, has also recently bought Citibank Savings Bank.

Overall assessment

It was believed that Asia’s banks, including the Philippines, would continue to compare well with those of other regions.

“Most systems in Asia are well capitalized and enjoy a strong profitability buffer, while the assets remain largely funded by domestic deposits, a situation which adds resilience to their liquidity profile,” Moody’s said.

Moody’s also expects these strengths to persist in 2014, allowing most systems to remain resilient in our base case scenario, which is characterized by the gradual recovery in global growth.