The outlook of the Philippine banking sector remains strong, with robust credit growth and ongoing reforms

The banking sector in the Philippines is expanding rapidly, hitting double-digit credit growth in four of the five years from 2013 to 2017. The sector has simultaneously recorded notable improvements across major stability indicators. The country’s banking sector is highly liquid and well provisioned, and it benefits from robust macroeconomic growth, even as excess liquidity and credit concentration in certain sectors have become a concern.

All signs point to continued expansion in 2018, with non-performing loans (NPLs) declining in recent times as credit growth has gained momentum. Furthermore, global rating agencies have projected stable, sustainable expansion, although, the sector’s outsized corporate loan portfolio leaves commercial banks – particularly creditors of large conglomerates – exposed to concentration risks.

Ongoing reforms are expected to address credit concentration in the corporate sector, with the high-yield retail lending segment holding significant potential to boost banks’ lacklustre profitability. Medium- to long-term growth and financial inclusion will be supported by increased deployment of financial technology (fintech), while the establishment of a government-led national credit ratings agency should support long-term consumer credit growth.

Sector Make-Up

The banking sector comprises 43 commercial or universal banks; 57 thrift banks, including savings and mortgage banks, private development banks, stock savings and loan associations, and microfinance institutions; and 495 rural and cooperative banks. Commercial banks dominate the sector, accounting for more than 90% of total sector assets. The US International Trade Administration (ITA) reported that 21 commercial banks operate under expanded commercial banking licences, which allows them to act as investment houses for a range of services such as underwriting securities and to invest in non-allied undertakings. A further 26 commercial banks and four thrift banks are licensed to engage in derivatives activities.

According to data from the central bank, Bangko Sentral ng Pilipinas (BSP), the combined assets of the country’s banks accounted for 81.4% of total financial system assets as of the first half of 2017. Banks are the most important segment of the financial services sector and the primary source of credit for the domestic economy, with the sector’s gross value added standing at 8.6% of GDP in the first half of 2017. The BSP reported that the five banks with the largest assets as of December 2017 were BDO Unibank, at P2.53trn ($50bn), Metropolitan Bank and Trust Company, at P1.71trn ($33.8bn), Bank of the Philippine Islands, at P1.64trn ($32.4bn), Land Bank of the Philippines, at P1.62trn ($32bn), and the Philippine National Bank, at P779.8bn ($15.4bn). According to global ratings agency Moody’s, the nine listed banks it rates accounted for 75% of total banking system assets as of June 2017.

Foreign Participation

Former President Benigno Aquino III moved to liberalise the Philippine banking sector in July 2014, signing an act enabling foreign banks to open more branches and control up to 100% of new or existing voting stock of locally incorporated banks. According to the BSP, as of end-2017, 12 foreign banks had been given approval to enter the market since the legislation was passed – nine of which were in operation – and five others had shown interest in following suit. Four banks had also been given the green light to establish representative offices, with two of these having already opened. In total, 25 banks are foreign controlled, including 20 foreign branch banks and five majority-foreign-owned, locally incorporated subsidiaries. There are also three offshore banking units.

ASEAN Economic Community (AEC) integration should see foreign participation increase in the coming years, with the ITA reporting that under the AEC Blueprint, the Philippines is advancing regional financial service integration, including legislation to allow the entry of qualified ASEAN banks (QAB) under the ASEAN Banking Integration Framework (see regional analysis). Philippine authorities concluded bilateral negotiations with Malaysia’s central bank, Bank Negara Malaysia, in April 2017, establishing QAB guidelines for the first time. Later that month, the government signed a letter of intent with Thailand to formally launch the same QAB talks.

Ratings

In May 2017 global ratings agency Standard & Poor’s (S&P) reported that the sector’s good health supported its continued inclusion in Group 7 of its banking industry country risk assessment, which includes Bahrain, Bulgaria, Costa Rica, Hungary, Indonesia, Jordan, Morocco and Portugal. The agency noted the benefits of reforms undertaken by the BSP, including local banking regulations and the ongoing establishment of the government-led Credit Information Corporation (CIC), noting that improving credit fundamentals and positive economic trajectory should support local banking growth. According to S&P, the Philippines’ robust economic conditions should support borrower repayment, and credit losses are expected to remain low.

Moody’s echoed these sentiments in September 2017, when it reaffirmed its stable outlook for the banking system, which it has done since November 2015. Moody’s reported that the sector had demonstrated good asset performance, strong loss buffers and ample liquidity capacity, which should enable sustained, rapid loan growth. The agency’s stable outlook is supported by strong macroeconomic fundamentals, with its baseline scenario assuming GDP growth will hit 6.8% in 2018, up slightly from 6.7% in 2017, supported by strong domestic consumption and faster deployment of investment.

Banks have continued to exhibit strong funding profiles that are dominated by deposits and demonstrate little reliance on short-term wholesale funding, according to Moody’s. Asset performance is also expected to continue to be stable and the credit metrics of corporate customers are likely to remain sound through to the end of 2018.

New Growth

The sector has undergone a period of rapid expansion in recent years, bolstered by double-digit lending growth and a prudent central bank policy. This has improved liquidity and stability, and set the stage for long-term expansion. The sector’s gross assets have also been on a consistent upward trajectory, increasing by 23.9% in 2013 to end the year at P10.2trn ($201.5bn), according to BSP data, before rising by 11.9% to P11.4trn ($225.2bn) at the end of 2014 and 8% to P12.3trn ($243bn) in 2015. This growth accelerated in 2016 to 12.4%, hitting P13.8trn ($272.6bn), and remained high at 11.4% in 2017, ending the year at P15.4trn ($304.2bn).

Lending has shown equally strong growth, with the BSP reporting that the total loan portfolio jumped 15.8% in 2013 to P4.9trn ($96.8bn), 19% in 2014 to P5.83trn ($115.2bn) and 12% to P6.53trn ($129bn) in 2015. Gross lending rose by 16.5% in 2016 to end the year at P7.61trn ($150.3bn) and by 16.4% to P8.86trn ($175bn) in 2017. Corporate customers generally account for the vast majority of banks’ loan portfolios, at around 80%. The gross loans-to-deposit ratio has also risen since the 2013 rate of 64.36%, hitting 68.42% in 2014, 70.71% in 2015, 72.45% in 2016 and 75.6% in 2017.

The BSP reports that at the end of the first half of 2017 outstanding loans in the banking system were dominated by real estate, at 17.3%, wholesale and retail trade, at 11.7%, manufacturing, at 11.1%, and household and consumer loans, at 10.5%. The Philippines is a net cross-border lender, recording a net financial asset position of $6.9bn in the first half of 2017, against $5.9bn in the same period of 2016.

Profits

However, profitability has not kept pace with broader sector growth. Accoording to S&P, return on assets was 1.2% in 2016, while return on equity was 9.5%, which is uncharacteristic of nations like the Philippines with favourable demographics, strong structural growth and low credit penetration. This was attributed to heavy credit concentration in low-yielding corporate loans, with higher-yielding retail loans, such as mortgages and auto loans, seen as having the potential to boost interest margins. S&P also attributes low levels of consumer lending to the country’s poor cost efficiency, reporting that the banking system’s cost-to-income ratio was 63% in 2016, significantly higher than the ASEAN norm of 40-50%. This is partly due to the high cost of maintaining physical branches in the Philippines, a result of low branch penetration rates in the provinces.

Although banks have invested heavily in building branch networks, expansion of branches outside of Manila is likely to increase costs faster than assets. This has, however, created significant opportunities in the country’s burgeoning fintech industry, which is expected to significantly improve financial inclusion and credit access in the coming years.

Stability Indicators

In a 2017 status report on the Philippine financial system, the BSP reported that banks continued to build up buffers against a backdrop of double-digit loan growth, reporting that banks’ asset quality, provisioning, capital buffers and liquidity levels are strong, with NPLs declining as a result, further supporting sector stability.

The sector’s capital is at a comfortable level and is considered high quality, with the total lending of capital stock to banks rising by P78bn ($1.5bn) between the second half of 2016 and the first half of 2017, and net income rising to P81.3bn ($1.6bn) as a result. Although commercial banks’ capital adequacy ratio (CAR) dropped from 18.4% of risk-weighted assets in 2012 to 17.7% in 2013, 16.2% in 2014, 15.8% in 2015 and 15.1% in 2016, this remains substantially higher than Basel III’s minimum CAR of 8%. Furthermore, the BSP reported that the sector’s CAR had rebounded to 16% as of the first half of 2017.

This means that the banking system has sufficient Tier-1, high-quality liquid assets, with the sector’s liquidity coverage ratio also comfortably above the 100% minimum level. Moody’s expects banks’ capitalisation to remain strong in 2018, although it could weaken slightly under pressure from rapid credit growth and the implementation of the new financial reporting reforms, Philippine Financial Reporting Standards 9 (PFRS 9).

Provisioning and capital buffers remain strong, even as NPLs continue to decline, with the BSP data showing the sector’s gross NPL ratio fell from 2.77% in 2013 to 2.31% in 2014, 2.09% in 2015, 1.89% in 2016 and 1.73% in 2017. The commercial banking segment’s NPL ratio experienced an even sharper drop, easing from 2.8% in 2012 to 2.1% in 2013, 1.8% in 2014, 1.6% in 2015, 1.4% in 2016 and 1.2% in 2017.

As banks put a greater focus on retail loans, NPLs could rise, as these types of loans tend to have higher delinquency rates than corporate ones, according to Moody’s. However, the BSP’s proactive, prudent and cautionary approach to policy-making is expected to maintain stability in 2018.

BSP Supervision

Indeed, the BSP is largely credited with the credit for the sector’s improved stability, after it rolled out a host of regulatory reforms to improve transparency and mitigate credit risks, including the PFRS 9 standards and new limits on real estate lending. For example, in January 2018 Nestor A Espenilla Jr, governor of the BSP, told local media that the bank is closely monitoring credit and leverage levels, particularly in sectors with the potential to hold pockets of excessive lending, such as the real estate sector. While the country’s creditto-GDP ratio is among the lowest in Asia, at 63%, the bank is deploying targeted reforms to prevent any one sector from overheating. In the same month, Circular 976, which limits real estate lending to 20% of a bank’s total exposure, came into effect.

Under Circular 963, which was first issued in June 2017, the PFRS 9 standards will be enforced via the introduction of penalties for players that do not comply. Each issue of non-compliance will result in fines ranging from P150 ($2.96) for rural and cooperative lenders, to P3000 ($59.27) for universal banks. The PFRS 9, meanwhile, incorporates an expected credit loss model, and its key aspects include a three-stage general impairment model for assets that are performing, under-performing or non-performing; a stage assessment based on relative, rather than absolute, credit risk; and an impairment model based on expected, as opposed to incurred, losses. According to consultancy PwC, the new model will require extensive improvements in disclosures and the collection of credit information.

Rate Hike Potential

Espenilla has stressed that the BSP is unlikely to adjust interest rates in response to strong loan growth, as it would negatively affect the broader economy. In March 2018 the bank’s Monetary Board kept its overnight reverse repurchase (repo) rate at 3%, attributing its decision to expectations that inflation will not breach its target range of 2-4% in 2018 and 2019 (see Economy chapter). The board has not adjusted this rate since September 2016, when it cut it from 4%. The 3% reverse repo rate, which is central to the BSP’s policy rate corridor, enables the central bank to charge up to 3.5% on commercial bank borrowing from its overnight lending facility. According to local media, the recently launched term deposit auction facility now acts as the BSP’s primary short-term mechanism to absorb excess liquidity in the system to prevent sharp consumer price inflation.

Although BSP officials have told local media that they remain confident inflation will remain within the targeted band, economists increasingly project an interest rate hike in the second quarter of 2018, with the bank expected to begin raising its benchmark rate as pressures from higher taxes, strong macroeconomic growth and rising global oil prices force an intervention (see Economy chapter).

Lending growth is, nonetheless, expected to maintain momentum in 2018. According to an August 2017 S&P report titled “Philippine Banks to Continue to Ride Robust Economic Growth”, the local credit cycle is still on an upswing, as it remains supported by healthy corporate profits and abundant liquidity. This is in sharp contrast to the situation in Indonesia and Thailand, both of which are in the midst of a downcycle. However, the S&P report does note that with corporate lending heavily skewed towards large domestic conglomerates, Philippine banks remain exposed to concentration risk.

While conglomerates have larger balance sheets and a track record of resilience to market crises, the complex nature of such companies, which often hold multiple operating subsidiaries and cross holdings, creates risks arising from their interconnectedness.

Consumer Lending

Capitalising on growth opportunities in the relatively untapped consumer lending segment will be an important priority for the banking system. Consumer loans accounted for 17.6% of the total loan portfolio as of December 2017 – the lowest rate of consumer lending in ASEAN – and S&P reports that the ratio of consumer loans to GDP stood at 8.8% at the end of 2016. In its aforementioned report, S&P identified consumer lending as one of the sector’s biggest weak points, writing that the country’s low per capita incomes constrain repayment abilities. Indeed, consumer lending’s NPL ratios remain elevated compared to the broader industry average, although the situation has improved significantly in recent years: the BSP reports that the consumer NPL ratio fell from 6.71% in 2012 to 5.34% in 2013, 4.81% in 2014, 4.49% in 2015, 3.92% in 2016 and 3.86% in 2017. Credit card receivables’ NPL ratio plummeted from 11.13% in 2012 to 5.53% in 2017, while for mortgages it dropped from 4.12% to 2.83% and for motor vehicles loans it moderated from 4.64% to 3.78%.

The consumer loan segment has recorded strong growth in recent years. Its loan portfolio more than doubled between 2012 and 2017, increasing from P629bn ($12.4bn) to P1.49trn ($29.4bn). Vehicle lending, meanwhile, nearly tripled, rising from P160bn ($3.2bn) to P475bn ($9.4bn) over the same period. Credit card lending jumped from P149bn ($2.9bn) in 2012 to hit P239bn ($4.7bn) in 2017, and mortgage market growth has been even more pronounced, with the total residential real estate loan portfolio increasing from P265bn ($5.2bn) in 2012 to P600bn ($11.2bn) in 2017, equivalent to 40.2% of total consumer lending in 2017.

Boosting consumer lending will be particularly important because the consumer segment offers higher interest margins than low-risk corporate lending, and therefore has the potential to significantly improve bank profitability. However, S&P reports that high branch costs associated with reaching remote customers will likely remain a hindrance, and banks continue to be overly cautious about expanding their consumer lending portfolios due to a lack of comprehensive consumer data and higher NPL ratios in the consumer segment.

CIC

This could change in the near term, given the government’s announcement it will establish the CIC and sanction four other credit bureaux to improve access to credit information. Republic Act No. 9510, the Credit Information System Act, was promulgated in October 2008 and mandates the establishment of a centralised credit information system, the CIC. The law also stipulates that lenders submit all credit data of their borrowers to the CIC database.

Local media reported that 104 financial entities signed on for the CIC’s eight-month pilot project, which was launched in May 2017, with the system offering services to two types of users: special accessing entities, or credit bureaux; and submitting financial institutions, including banks, cooperatives and lending firms. Special accessing entities participating in the CIC project include CIBI Information, South Africa’s Compuscan, Italy’s CRIF and US-based TransUnion. However, Jaime Garchitorena, president and CEO of the CIC, told local media that the bureau’s scheduled January 2018 launch would be pushed back as a result of cybersecurity risks, and as of mid-2018 no official launch had been announced.

Outlook

Delays to the formal launch of the CIC could weigh on lending diversification and higher profits in 2018, although the banking sector as a whole remains well positioned for another year of robust growth. S&P has projected lending growth of between 15% and 17% in 2018, supported by new infrastructure projects launched under the Build, Build, Build programme, with government financial institutions expected to play a more prominent role in infrastructure financing and fintech adoption expected to improve financial inclusion. Prudent supervision and policy-making have enabled the sector to improve liquidity and provisioning against a backdrop of rapid macroeconomic growth, with the low credit penetration and rising credit demand set to keep the sector on a strong upwards trajectory.