Regulation: Philippines remains a tough nut to crack
The country’s banking industry is growing fast. New laws designed to encourage foreign investment make it easier for offshore firms to wholly purchase local lenders. But there are plenty of barriers to entry aside from regulation.
by Richard Morrow
Philippine president Benigno Aquino III
The image of foreign banks may be taking a pounding across many parts of the world, but in at least one Asian country they continue to get the red carpet treatment: the Philippines.
The country’s government is eager to see more foreign banks onshore. This desire was underscored on July 15 last year when president Benigno Aquino III signed Republic Act No. 10641, ‘An act allowing the full entry of foreign banks in the Philippines’.
The rule does exactly as described, permitting non-Philippine banks to wholly acquire local lenders, establish fully owned banking subsidiaries in the country and set up branches with full banking authority. It also lets foreign banks hold up to 40% of the overall assets in the banking sector.
Previously foreign institutions had been limited to a 60% maximum ownership in the voting equity of local banks or their subsidiaries.
The rationale behind the new bank law is simple: it was designed to entice foreign banks in to help stimulate the Philippines’ rather meagre levels of foreign investment and help develop its adolescent bank industry.
Philippine banks have had success recently in selling stakes to overseas investors. On September 30 the insurance division of Taiwanese financial group Cathay Financial agreed to buy a 20% stake in Rizal Commercial Banking Corp. (RCBC), the Philippines’ ninth-largest lender by assets, at P17.9 billion ($400 million). Then on December 23 Malaysia’s sovereign wealth fund, Khazanah Nasional, bought a 2% stake in BDO Unibank from majority owner SM Investments for an undisclosed sum.
These sales followed the earlier decision by Singaporean bank leader DBS to sell its remaining 9.9% stake in Bank of the Philippine Islands (BPI) in December 2013. It sold 5.6% to GIC, Singapore’s sovereign investment company, and 4.3% to Ayala, the Philippines conglomerate that is now the biggest shareholder in BPI.
Judging by their acquisitions in Thailand and Indonesia, [the Japanese] appear most interested in control. And they like big banks. They don’t have a lot of patience to build small banks
A head of Philippines investment banking
Standard Chartered is reported to be weighing up the sale of its Philippines unit. The bank declined to comment on the story, but if true it is an indication of its lingering financial vulnerability and need to refocus its strategy.
There are many reasons foreign banks might be attracted to the Philippines. Loan growth is high, penetration low – particularly outside metro Manila – and banks are very well capitalised at Basel III standards, with low levels of non-performing loans.
But the potential withdrawal of StanChart from the Philippines points to a fundamental weakness of the country’s banking sector: fragmentation.
The country’s top 10, family-controlled banks dominate this pocket-sized industry, with roughly two thirds of its assets. A set of smaller banks sits below them, while hundreds of tiny rural and trade banks dot the rest of the country outside Manila.
This combination of factors makes the country’s banking sector, appealing as it is, a tough nut for foreign players to crack.
Vigorous and robust
There are plenty of good reasons for foreign banks to gain entry into the Philippines.
The country’s economy is vigorous and robust, growing by 6.1% in 2014 and 7.2% the previous year. JPMorgan believes it will expand 6.4% this year. Meanwhile Moody’s raised the sovereign’s foreign currency debt rating to Baa2 in December, and Standard & Poor’s assigned a triple-B rating last May.
This has helped drive foreign direct investment – admittedly from miniscule levels. Bangko Sentral ng Pilipinas (BSP), the country’s central bank, says FDI grew by 64% to reach $5.32 billion for the first 10 months of 2014. In a report it boasted that “the increase in net FDI inflows during the period was buoyed by favourable investor outlook on the Philippine economy on the back of sound macroeconomic fundamentals”.
The investment primarily went into the financial and insurance, manufacturing, real estate, wholesale and retail trade, and transportation and storage sectors. There is tremendous growth potential too. Maybank ATR Kim Eng Securities, a southeast Asia brokerage, noted in a January 29 report that only 27% of Filipinos have a bank account.
The Philippines’ banking sector has thrived during this period. The BSP says lending by universal and commercial banks in December grew by 16.8% to P4.41 trillion, on top of 20.1% growth in November.
That has observers excited. Moody’s analyst Alka Anbarasu notes the Philippines’ banking sector is the only system among 70 covered by the ratings agency in the region that has a positive outlook. “It’s an outlier among banking systems, which largely reflects its growth and our expectations for more improvements in the country’s [macroeconomic] fundamentals,” she says.
The only downside has been in profitability, courtesy of a turf war that has crimped profits among leading banks. BDO Unibank for example reported a 8.2% nine-month fall in net income to P16.7 billion in October 2014. However, that could change this year. Maybank predicts the banking sector’s operating profit would grow 11.4% this year and net profit rise 14% as lenders benefit from increasing loan demand, stable interest rates and lower credit costs.
Many of them are controlled by sprawling, family-controlled conglomerates.
For example, BDO Unibank, the country’s largest bank with P1.7 trillion in assets as of September 30, 2014, is part of SM Investments, a group run by Henry Sy, the country’s richest man. Metropolitan Bank & Trust, the second-largest with P1.23 trillion in assets, was created and is mostly owned by the Ty family, while BPI (P1.07 trillion in assets) is majority owned by Ayala.
Capital-rich but stuck Banks in Japan, Singapore and Malaysia look like the most logical acquirers of Philippine lenders. Bankers and analysts mention Bank of Tokyo Mitsubishi, Sumitomo Mitsui Financial Group and Mizuho Financial Group of Japan, as well as DBS and UOB of Singapore, and Malaysia’s CIMB and Maybank as among the most obvious candidates.
The Japanese banks make particular sense, being capital-rich but stuck in a moribund economy. “I talked to some Japanese banks after the law change that were interested in taking minority stakes or buying local banks wholesale,” says Rafael Garchitorena, equity strategist for the Philippines at Deutsche Regis and brother of the CIC’s Jaime.
However, a Manila-based head of Philippines investment banking at an international institution cautions that interest may be size-specific. “Judging by their [Japanese] recent acquisitions in Thailand and Indonesia they appear most interested in control. And they like big banks. They don’t have a lot of patience to build small banks,” he says.
The likes of DBS and CIMB may want local acquisitions to help round out flourishing southeast Asia businesses. The former’s sale of its minority stake in BPI may free it up to pursue a more meaningful market entrance, either alone or with another partner. Meanwhile the latter came close to acquiring a stake in conglomerate San Miguel’s Bank of Commerce in 2013, until disagreements over valuation proved insurmountable. ANZ, the most Asia-focused of Australia’s big four banks, is considered a potential acquirer too.
Scepticism abounds over how much international lenders would commit to building the banking sector in the commercial and retail areas that need it the most after several entered the country in the 1990s, only to retreat again after the onset of the Asia financial crisis in 1997.
“We think international players looking to enter would prefer to have a local partner play a role, to give them more advice and keep existing relationships intact,” says Moody’s Anbarasu.
Proving a drain
Alliances are a costly business under new Basel III rules, which require banks to directly offset them with tier 1 bank capital. However, leading banks in Japan and Taiwan might prove willing to stomach the steep offsets involved.
“Banks in Taiwan and Japan have very little domestic growth potential. In contrast Philippine banks look appealing and potentially worth the Basel III capital treatment of minority-stake investments,” says Tan of S&P.
Basel III requirements are already proving a drain on the country’s small institutions and encouraging consolidation. The larger banks stand to be affected by new regulations, with the BSP looking to introduce the concept of domestic systemically important banks (D-Sibs).
Its plans are complementary to those being spearheaded by the Financial Stability Board, which released a paper in November suggesting that global systemically important banks (G-Sibs) possess instruments worth 16% to 20% of their risk-weighted assets for loss absorption purposes.
The BSP’s monetary board has taken a different tack, introducing guidelines to determine D-Sibs in October that would require banks designated as such to raise their minimum common equity tier-1 ratio by 1.5 to 3.5 percentage points. This will be on top of the existing CET1 minimum of 6% and the capital conservation buffer of 2.5%. Such costs are set to hurt the performance of even profit-focused banks.
Falling returns might persuade bank owners to consider tie-ups with capital-rich foreign banks. Such agreements would prove particularly amenable if the foreign parties are willing to sign agreements to vote together with the family owners.