BSP closely watching ‘too big to fail’ banks

Published January 11, 2021, 7:00 AM

by Lee C. Chipongian

The central bank’s scrutiny of domestic systemically important banks (D-SIBs) – these are large financial institutions deemed too big to fail – are heightened by enhanced D-SIBs metrics in response to rising pandemic-induced systemic threats to the financial system.

 Bangko Sentral ng Pilipinas (BSP) Governor Benjamin E. Diokno said it is crucial to determine the true condition of D-SIBs and its impact on the Philippine banking system (PBS), the banking industry as a whole, and on the economy currently in recession.

Bangko Sentral ng Pilipinas (BSP) Governor Benjamin E. Diokno (MB file)

Diokno said measures on how they monitor, assess and review the capital health of D-SIBs have been improved to “ensure that the BSP will be able to determine the true status or health of the financial system and individual banks.”

“This will serve as basis for ascertaining whether additional or fine-tuning of existing policy measures are needed,” he said in an email.

Unlike some Asian central banks, the BSP has yet to publicly identify D-SIBs. The BSP initially listed 14 Philippines banks deemed “too big to fail” but were not named. As of end-2020, there are 46 big banks or banks with universal and commercial banking license, and these control more than 93 percent of PBS assets.

 “D-SIBs are on a solid footing at the onset of the pandemic,” Diokno reiterated. “The BSP however, recognizes that the full impact of the crisis has yet to clearly unfold. It is in this regard that the BSP closely monitors and actively engages these banks to continuously assess their financial position and performance,” he said.

D-SIBs amid the pandemic

After 10 months of navigating through the uncertainties brought on by COVID-19 crisis, which is still far from being over, the BSP’s highest-ranking official remains confident that the still-undisclosed D-SIBs are liquid and could possibly handle a few more hits this year.

“From the perspective of the bank’s capital adequacy and ability to handle potential losses, D-SIBs are adequately capitalized considering their risk profiles and business models,” according to Diokno.

 As of end-March 2020 when the government has just declared several key locations in lockdown, the capital adequacy ratio of D-SIBs on solo and consolidated bases was at an average 14.8 percent and 15.5 percent, respectively.

Data also show D-SIB’s consolidated Basel III Leverage Ratio continue to be significantly above the BSP’s five percent benchmark, and three percent international thresholds.

D-SIBs liquidity coverage ratio and net stable funding ratio was also higher than what the BSP considers as the minimum. “This indicates D-SIBs’ ability to manage short- to medium-term shocks on their liquidity position,” said Diokno.

D-SIBs’ average gross non-performing loans ratio climbed to 2.9 percent in September 2020, higher than the 1.8 percent ratio in March, noted Diokno. “This uptick, however, is relatively low vis-a- vis the PBS and industry’s 3.5 percent and three percent, respectively,” he pointed out.

“Moreover, D-SIBs have been booking higher loan-loss provisions since the start of the year. In particular, D-SIBs average NPL coverage ratio stood 153.7 percent, higher than the PBS and industry’s 91.5 percent and 102.9 percent, respectively,” said Diokno.

The BSP’s latest Banking Sector Outlook Survey, released on Friday, said most banks think the PBS will continue to be relatively stable with double digit growth in assets, loans, investments, deposits and net income. The uncertainties in the operating environment pose the biggest hurdle in the banking system’s amount of loans, loan quality, and profitability, said the BSP. The survey also showed that banks intend to keep a reasonable risk-based capital and liquidity, to enhance their risk management systems to safeguard financial system stability, and to strengthen organizational conduct and risk culture in order to thrive amid the volatility and complexity of the operating environment. “This implies that banks will calibrate its strategies to maintain a loss-absorbing capital buffer while at the same time

ensure confidence of the public in providing enough liquidity and funding in 2021 to 2022,” said the BSP.

Updating D-SIBs metrics

The International Monetary Fund (IMF) said it has been a concern that majority of D-SIBs are controlled or part of conglomerate structures or wider groups of non-regulated parent companies and affiliates with non-banking activities, therefore the BSP has no power over them.

The BSP has issued a D-SIBs revised framework that basically expanded how they will consider banks as D-SIBs, classified as such according to size, interconnectedness, complexity and market importance. The 2019 D-SIBs circular added substitutability and financial institution infrastructure to the mix, and adopted nine indicators that will make a bank a D-SIB.

As defined by the BSP, D-SIBs are banks whose distress or disorderly failure would cause significant disruptions to the wider financial system and economy. Basically the revision was in the differential weights of categories/indicators and the composition of indicators including adoption of threshold level, and calibration of the level of additional capital requirement.

The categories such as the size and interconnectedness of a bank are given scores and the results serve as measure in determining a bank’s systemic importance in the Philippines.

D-SIB indicators also have allocated weightings such as total exposures as defined for use in the Basel III Leverage Ratio, intra-financial system assets, and intra-financial system liabilities. These metrics also include securities outstanding, assets under custody, payments activity, and underwritten transactions in debt and equity markets.

 D-SIBs allocation will be based on the distribution of their systemic scores and the BSP will run the same assessment every year. Reallocation of D-SIBs into systemic importance can change depending as per updated supervisory judgment which “may be applied to add and/or remove banks to from the list of D-SlBs.” For example, a bank’s major expansion/contraction of operation, or merger and acquisition, or major change in the ownership/structure will affect its D-SIB standing.

In a November 2020 country report (Philippines: Financial Sector Assessment Program-Detailed Assessment of Observance — Basel Core Principles for Effective Banking Supervision) by the IMF’s monetary and capital markets department, they still find some weakness in the way BSP monitors D-SIBs.

 The IMF said the BSP needs to strengthen its ability to scrutinize the impact of “mixed conglomerate structures” on D-SIBs. It noted that the BSP is dependent or rely “to a large extent” on public information when assessing wider-based conglomerates’ risk profile because it has no power to supervise a bank’s parent company or its wider group to “review their activities to determine their impact on the safety and soundness of the bank and the bank groups within the conglomerates.”

 Limitations on BSP’s enforcement powers also impair its ability to fully protect the bank from the actions of parent companies and affiliates, said the IMF.

While the BSP’s amended charter has given it additional power or authority to obtain data and information for “statistical and policy development purposes” it still has quite a “limited scope” since the updated central bank law “does not provide the BSP with sufficient powers to assess any potential negative impact the activities of those companies may have on the safety and soundness of the banking group.”

The IMF also noted that BSP’s ability to review what it called the resolvability of banks, especially D-SIBs, and in executing an “orderly resolution of a problem bank” such as in avoiding bank failure — in all these things, it said the BSP still has to develop an effective way of dealing with a collapsed bank.

The BSP has its prompt corrective action (PCA) framework where problematic banks are placed, sometimes referred to as BSP’s ICU for failing banks. “BSP should incorporate an assessment of resolvability into its supervisory framework, especially for D-SIBs, in conjunction with the PDIC (Philippine Deposit Insurance Corp.),” said the IMF. It added that the BSP “should continue its ongoing efforts to ensure that the PCA framework effectively operates to require firms to be placed into resolution at an early stage and before equity has been exhausted, and that the supporting legal and regulatory framework ensures the transition of problem banks to the PDIC is on a timely basis to avoid losses to the deposit insurance fund and mitigate moral hazard risks.”