Banks and financial institutions are on edge despite the United States (US)-Iran two-week truce, as sustained increases in the cost of energy are fueling inflation and causing an economic slowdown.

The most significant spillover effect of the conflict is rising inflation, which has significantly reduced purchasing power by roughly 25 percent. This, in turn, is expected to erode the capacity of borrowers to meet their financial obligations.

Yes, Virginia, domestic banks are facing a more challenging operating environment, with risks of higher non-performing loans (NPLs) as the conflict in the Middle East slows economic activity.

Even prior to the Middle East conflict, banks were already feeling the crunch, with some of their borrowers in the construction business missing loan amortization payments due to the flood-control scandal.

The disclosure by Secretary Vivencio “Vince” Dizon at the general membership meeting (GMM) of the Management Association of the Philippines (MAP) last Wednesday, April 8—that the Department of Public Works and Highways (DPWH) is continuing unfinished and will commence new infrastructure projects—is not altogether comforting and is no guarantee.

As an aside, Sec. Vince literally brought the MAP house down as he willingly admitted that he looks “older” despite the wide age gap with the dapper lawyer Mike Toledo. “I am younger but I look older!”

Now, back to this troubling NPL issue. In my conversations with market players, there has been “no release of payment to big contractors,” which apparently included those not involved in the anomalous flood-control projects uncovered in August last year. This liquidity squeeze has trickled down to subcontractors.

“Banks are already encountering past loans from subcontractors,” admits the president of a medium-sized bank.

The latest forecasts indicate that the level of loans that have turned sour could push the absolute NPL level above 3.5 percent. Comparatively, the domestic banking system’s NPL ratio during the Covid-19 pandemic hit 4.2 percent as of end-March 2021, nearly double the 2.2-percent ratio the year before.

While NPL levels may increase moving forward, it is still comforting to note that monetary authorities have assured that the domestic banking sector’s overall soundness is not expected to be severely compromised because of mandatory loan loss provisions and capital buffers.

From what I’ve gathered in the banking alleys, the servicing of outstanding consumer loans will be impacted, as massive repatriation or disruptions to employment could significantly reduce US dollar remittances from deployed overseas Filipino workers (OFWs).

The slowdown in economic growth may lead to corporate defaults, particularly among small and medium enterprises (SMEs) and microenterprises that lack cash reserves. The debt burden on borrowers will be compounded should the Bangko Sentral ng Pilipinas (BSP) be forced to raise interest rates to quell inflationary pressures.

While banks are implementing stricter lending protocols to avoid a major surge in NPLs that could deter overall credit expansion, expectations remain that NPL ratios will climb as the year progresses, depending on how the Middle East conflict unfolds.

Thus, banks are hoping the BSP may soon provide regulatory relief similar to that extended during the pandemic. To ensure liquidity and financial stability, such relief could include relaxed loan classification rules by excluding Covid-19-affected loans from NPL/past-due ratios, staggered booking of credit losses, as well as six-month loan payment grace periods.

Latest I’ve heard, BSP Governor Eli M. Remolona Jr. is receptive to the idea. Let’s see how this regulatory relief will roll out.