The Philippines: Espenilla befriends the banks who once feared him
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BANKING

The Philippines: Espenilla befriends the banks who once feared him

Before taking the top job at the Philippine central bank, Nestor Espenilla Jr was known for his toughness on financial crime – now he says he is enabling the banking system to go from strength to strength… providing it sticks to the rules.

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When Nestor Espenilla Jr stepped up to the top job at Bangko Sentral Ng Pilipinas (BSP), the central bank of the Philippines, on July 3 last year, he came with a certain reputation. Nesting, as they call him locally, had spent 36 years at the bank, many of them devoted to being extremely tough on financial crime.

Espenilla smiles when reminded of the reputation. He smiles a lot, a cheerful and quietly-spoken man whose gentle demeanour is a wholly inaccurate reflection of his time as an enforcement and surveillance banker. Even when our interview on an upper floor of a Manila hotel is interrupted by a mild earthquake, he is still smiling.

“I look at that [time] as something positive for me as governor now,” he says. “The value to the governor of understanding what’s really the strength and weakness of the banking system informs my other duties, in running monetary policy, for example.”

And despite some trepidation in the banking sector – he has previously hit RCBC with fines, caused LBC Development Bank and Banco Filipino to close outright and remains head of the anti-money laundering council for the country – Espenilla depicts himself as someone supportive of the banking sector, even accommodating, and quite happy with its health.

“Right now, I am willing to lower the reserve requirement,” he says. “We have started that long journey.” Admittedly, at 20%, Philippine banks face one of the highest reserve requirements in the world, but still, any reduction in the rate is a show of support.

“I rest comfortable that even as we lower the reserve requirement, banks will continue to behave prudently because we have put in place beforehand the right risk controls,” he says.

“We have altered the way the banks think about managing risk and we have improved their governance. Banks will behave. Even if you put liquidity in front of them, they will not go crazy and lend to anyone who can sign a piece of paper.

“Philippine banks today are very different from the banks of 10 years ago in terms of their behaviour,” he says. 



The reason we are able to continue to have a very good working relationship with the banks is that we always point out that our rules come in two flavours - Nestor Espenilla Jr


Espenilla can say this because of a professional life spent in the careful assessment of risk and the strengthening of supervision. That is why he calls his central message as governor “continuity plus plus” – continuity in price stability, continuity in broadening the tax base so as to fund infrastructure, continuity in regulatory reforms at the macro and micro-prudential level – from Basel standard implementation to corporate governance reform.

“I was very fortunate to be inheriting a very strong institution and very sound policies,” he says. “A lot of work since then has been towards maintaining and improving upon that track record.”

The ‘plus plus’ he has brought to the job, he says, is important too: “I can point to several major points of progress in the last couple of months in my watch.”

The first is momentum in the development of the domestic debt capital market.

In August, the bank unveiled a roadmap for the development of the market in partnership with the Bureau of Treasury and the Securities and Exchange Commission (SEC). This was followed by a domestic repo programme announced in November and a code of conduct for government securities dealers in February.

The SEC has also explained its processes for setting the benchmark and hence the yield curve of the market.

At the same time, Espenilla has focused on reform of the foreign exchange market.

“If we want to attract a diversity of investors into our capital markets and attract more FDI, which we badly need, we have to take a more open and liberal view on foreign exchange,” he says.

So this is Espenilla’s platform: more of the same, only better, with room for innovation, provided banks stick to the rules.

'Two flavours'

Today, Espenilla considers himself a friend to the banks, creating an environment in which they can flourish.

“The reason we are able to continue to have a very good working relationship with the banks is that we always point out that our rules come in two flavours,” he says.

“There are the rules that basically promote prudence and risk governance, and are informed by international reforms. But we have also been bold and ambitious in putting out innovative regulations that enable them to do things that they wouldn’t be able to do under traditional constructs.”

Asked for examples, he cites use of digital technology, agent banking, outsourcing, cloud computing and distributed ledgers. All are enabled under BSP regulations, often with simplified know-your-customer processes.

“If you fundamentally believe that banks have better governance underneath them, they will manage themselves well,” he says. “You also have to have faith that the BSP has the capacity to supervise their behaviour in a very efficient manner.”

Espenilla is a believer in digitization, seeing it in tandem with one of the great enthusiasms of his life, financial inclusion.

He has no doubt the banking system is ready for the competition that digital players will bring.

“Before we did the enabling regulations, we did the prudential regulations, and that has been a 10-year journey for us,” he says. “We have come to a point where we are comfortable that our banks are fundamentally solvent and liquid, with good management.”

He says the sector has been open to competition for some time anyway: foreign bank entry was liberalized in 2014, allowing 12 foreign banks to come in and compete directly.

“But having a good, solid banking system is not really great if a lot of the population is unserved,” he says. “In affordability, the margins are very good for the banks but bad for the customer, and the service could be better. So, we think competition disciplines that process; it forces banks to be more innovative and makes services more affordable, which is fulfilling a broader public responsibility.”

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Fintechs are gaining traction in the Philippines: Mynt is an obvious example; it has Ant Financial as a 45% shareholder and Globe Telecom as another backer. While Mynt has rolled out its own cashless payment options, generally Espenilla believes fintechs prefer to work with the banks.

“Our observation is that fintechs increasingly are gravitating towards real partnerships rather than standalone,” he says. “The reason is the public still do not trust new players. They trust the traditional regulated banks.”

Keen to “walk the talk,” as he puts it, BSP has set up two fintech pilots of its own: an interface that makes it easier for banks to submit report data and the use of artificial intelligence in consumer protection.

Growth

The Philippine economy is humming. Whatever human rights misgivings the world may have about president Rodrigo Duterte and whatever environmental concerns about his ‘Build, Build, Build’ agenda, the numbers are good.

Fitch, which belatedly raised the sovereign credit rating to triple-B in December three years after the other two rating agencies did, forecasts real GDP growth of 6.8% in 2018/19. Foreign exchange reserves have doubled in the last 10 years and stand at over $80 billion. Espenilla expects the country to be rated triple-B+ within a couple of years. Concerns these days are about overheating.

For the place to keep growing, it needs better infrastructure, which is hardly a new thing to say (it is exactly the same conversation Euromoney had on a visit to Manila in 1995).

“I think it’s a non-issue,” says Espenilla drily, “that we need a lot more infrastructure.”

But it is the main driver behind local currency debt market reform.

“We are very focused on developing this market precisely because we are spending to build, build, build and that will require patient money behind it,” he says. 



We have always prepared for the day that the cycle will turn. And the cycle is turning - Nestor Espenilla Jr


Generally, patient capital has been impossible to find in the Philippines. Commercial bank money is short-term and the country does not have the institutions for longer-term investment. Borrowing overseas is an option, but, 20 years after the Asian financial crisis, the Philippines is still wary about it and the currency exposures it brings. External debt exposure is down to 23% of GDP – it has been in the 40s – and the central bank is proud of the number and wants to defend it.

But perhaps the mix of capital is changing domestically. The growing economy is creating wealth and people are looking for long-term investment homes for their money.

“Developing a domestic debt market gives an opportunity for individuals and institutions to safely invest, as opposed to putting it in get-rich-quick schemes,” says Espenilla.

Certainly the demand side is huge because of the infrastructure need.

“We should be concerned if our corporates, especially if they are doing PPPs (public-private partnerships), are going to borrow long term in foreign currency for some of these projects,” he says, as a tremor rocks the building with appropriate mild menace. “If they can raise funding in pesos for these investment activities, that works better.”

That said, he still welcomes foreign investors.

“They add to the depth and price discovery of the market,” he says.

And this is why he wants to develop the forex market in tandem with an efficient money market.

“We look at it as a set of reforms that look at each other,” he says.

Support

The market is pretty supportive of what it has seen. Nomura analyst Euben Paracuelles met Espenilla recently.

“What stood out for me was the governor’s strong focus on long-term reforms to develop the financial sector and reduce disintermediation in the banking system,” says Paracuelles.

It is a good time to be confident in your economic resilience. With the US and much of the rest of world in a rising rate cycle, the impact on emerging markets is being watched closely. The Philippines, like many Asian countries that received enormous inflows during the low interest rate years, has been preparing for this for some time.

“Our attitude back then was: ‘We’re not going to let this wall of liquidity inflate the economy and create asset bubbles, because that will just create problems down the road,’” says Espenilla.

That liquidity was essentially quarantined in international reserves, which came at a great opportunity cost.

“But we have always prepared for the day that the cycle will turn,” he says. “And the cycle is turning.”

The exchange rate has been allowed to fall and some reserves to depart.

“We allowed that mechanism to correct itself,” he says. “I’m not worried about a sudden tantrum, with money running out of the exit in the Philippines.”

Asked if he is enjoying the job, there is a sufficiently long pause to trigger laughter among his staff before he says that he is.

“What I enjoy about it is the ability to initiate strategic projects which, in my judgement, we can use to sustain the very positive trends,” he says. He says things like payment reform are “things that add my own flavour to the continuity.”

Financial inclusion will clearly remain instrumental to his policies – “it’s always a pleasure to see people becoming connected to the financial system” – and the country is implementing a biometric national ID card system modelled on India’s Aadhaar.

“We feel,” he says, “like we are prepared.”





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