Risks remain for RP banks

BY NORMAN P. AQUINO, BusinessWorld Sub-Editor The Philippine banking industry’s risk profile remains high, reflecting a weak operating environment and a fragmented structure constrains its ability to attract capital to clean up balance sheets. The local regulatory environment also remains weak and unsophisticated, rating agency Standard & Poor’s Ratings Services (S&P) said in its Asian banking industry country risk assessment report. S&P put the Philippines in the bottom third among 10 groups in the world, lumping it with Indonesia, Argentina, Colombia, Egypt, El Salvador, Kazakhstan, Morocco, Pakistan, Peru and Romania. S&P’s banking industry country risk assessment or BICRA reflects the strengths and weaknesses of a country’s banking system compared with those in other countries. The rating firm noted that while the local banking sector had managed to improve its asset quality by cutting bad loans, it was more susceptible to risks than its regional counterparts. "Although profitability improved in 2005, this was due mainly to trading gains from treasury activities, predominantly from the sale of high-yielding government securities," credit analysts Ritesh Maheshwari, Ping Chew and Ryan Tsang said in a report. Mr. Maheshwari, speaking to journalists in a teleconference, noted that local banks’ asset quality has improved, but not much. "It’s not able to attract capital from the stronger players ... unlike in other systems," he pointed out. He added that in other countries, economic conditions can take care of problems with banks’ asset quality. The Philippines, however, needs "external injections" as far as capitalization is concerned. "But there is no interest outside so you need internal [support] and that’s going to be slow," Mr. Maheshwari said. In its report, S&P also criticized the country’s regulatory environment, which it said continues to be weak. It said the impending enforcement of stricter capital rules under Basel 2 in Hong Kong, Singapore, Malaysia and India, gives regulators more leeway to encourage or discourage a particular asset class. The rating firm found the regulatory environments in Singapore, Hong Kong and to an extent, Malaysia, strong, while those in India, Thailand and Taiwan adequate. "The banking regulatory environment in Indonesia, China and the Philippines generally are weak," it added. S&P said that generally, banking systems in Asia have achieved a good measure of stability, reflecting the improved financial profiles of banks across the region. Good corporate earnings, relative monetary stability, healthy economic growth and restructuring have boosted bank performance and lifted asset quality in Asia over the past few years. The rating firm said bank portfolios have lower concentration compared with those seen during the Asian financial crisis. The top 10 exposures for banks now account for a lower proportion of respective loan books. Moreover, larger parts of loan books include better quality loans such as retail assets, mostly home loans. Corporate credit profiles since the financial crisis have also been improving steadily as they benefit from improved product prices. But some sectors, such as mining, metals, steel and petrochemicals, will see a cyclical slowdown coupled with significant capacity expansion, which is expected toward the second half of 2007. The S&P report said risk-management practices and regulatory environments have likewise generally strengthened. "Nevertheless, Asian banking systems continue to face medium-to-high economic and industry risks, unexpected shocks, and the inevitable future cyclical slowdown," it added. Mr. Maheshwari said potential risks on the horizon include weakening US consumer demand, persistently high oil prices, rising interest rates, asset repricing, and the ever-present threat of bird flu. He added that an economic slowdown would be the litmus test for banks’ credit risk-management systems. Still, banking systems will face the potential crosswinds "from a position of strength" given the structural improvements made since the Asian financial crisis, the analyst said. Bangko Sentral begs to differ The local banking sector has improved significantly given various reform measures, the Bangko Sentral ng Pilipinas (BSP) yesterday said, with one regulator criticizing Standard & Poor’s as having failed to "do justice" to industry initiatives. BSP Governor Amando M. Tetangco, Jr., who is currently in Switzerland, told BusinessWorld via e-mail that regulators are moving ahead to further strengthen the local banking sector. The BSP, he said, had implemented several reforms to improve banks’ asset quality, including stronger corporate governance and tighter risk management, which he said has enhanced confidence in the system. "We are confident that the Philippine financial system will sustain its growth as our economy continues to strengthen and the benefits of reforms are realized," Mr. Tetangco said. The central bank chief said the industry’s bad loan ratio had gone down to 8.24% last April from 11.2% a year ago, adding that this should go down further with the extension of a law giving perks to special purpose vehicles that buy banks’ bad loans. "The BSP has introduced major banking sector reforms, such as strengthened audit procedures, a framework for early intervention by the BSP for banks experiencing difficulties, and legislation to establish a comprehensive credit info system," he added. Central bank Deputy Governor Nestor A. Espenilla, Jr. was less forgiving of the S&P report. In a text message, the BSP officer-in-charge said: "The S&P report does not do justice to the scale and scope of reforms that have been instituted in the Philippine banking system." He also said the Philippines "suffers from a perception handicap more than anything." "We hope S&P can deepen its engagement here," he added. Bankers, meanwhile, said the state of the local banking industry would only improve significantly if the economy also grows at a more rapid pace. "The health of the banking system is a mirror of the health of the underlying economy. Banks trade on assets that have to do with the economy," said Joey A. Bermudez, Chinatrust (Phils.) Commercial Bank Corporation president and chief executive officer. Mr. Bermudez cited S&P’s findings that much of banks’ profits come from trading gains and not from lending. "The problem is, the core business of banks, which is lending, remains weak because corporate and industrial sectors are also weak. Since there is no expansion taking place, loan demand is going to be soft," he pointed out. Another bank president who declined to be named said the industry had been focused more on cleaning up bad assets rather than expanding loan growth. "Banks are still cautious about lending after suffering heavily during the 1997 Asian financial crisis. We are still in the process of unloading nonperforming assets," the banker said. -- Karl Lester M. Yap/BusinessWorld