President Benigno Aquino III has rolled out the red carpet for international banks to enter the Philippines.
After five months of deliberation by central bankers, lawmakers and, finally, the president, the Philippines’ government passed a law in mid-July allowing foreign banks to own 100% of local lenders.
It was a quick turnaround for a country often criticised by foreign executives as being a relatively slow place to do business. And the new law emphasises the Philippines’ more relaxed approach to its banking market versus those of close neighbours.
In 2012 Indonesia’s government limited foreign financial institutions to buying no more than 40% of local banks, although some foreign banks have been able to hold on to stakes they bought before the rule change. Vietnam limits foreign strategic investors from holding more than 20% of local players; while in China the limit is 25%, and 20% for any individual foreign shareholder.
The Philippines’ government already offered a more generous 60% ownership limit for foreign financial institutions, but this new law allowing full control is a welcome contrast to its protectionist neighbours.
The country’s politicians have many reasons to urge such regulatory change. The Philippines is preparing for greater integration with its neighbours in the Association of Southeast Asian Nations (Asean), which includes Indonesia and Vietnam. It is also trying to develop the technology and know-how of its domestic banks by encouraging competition, and cooperation, with knowledgeable foreign institutions. Plus its banking sector is highly fragmented, with 673 institutions operating in the country.
Perhaps most importantly, the Philippines still gets little foreign direct investment (FDI) compared to its neighbours. It wants more, and the express desire of politicians working on the bill was to encourage it.
“If you analyse the FDI in the Asean region over the last five years, the Philippines has a very minor share,” says representative Nelson ‘Sonny’ Collantes, who introduced the bill into the House of Representatives on February 24.
Bolstering FDI might be the bill’s main intent, but market participants hope it will help solve another issue plaguing the country: a dearth of lending to small and medium enterprises (SMEs).
The Philippines’ banks have plenty of money. They just don’t want to lend it to smaller companies. That needs to change just as much as improving FDI flows if the country is to create the jobs its young population needs.
Let’s try that again
The Philippines has for many years held a more enlightened attitude towards foreign bank ownership than most of its neighbours. In fact, this will not be the first time the government has allowed foreign banks to own 100% of local lenders.
In May 2000 then-president Joseph ‘Erap’ Estrada signed the General Banking Law, modernising a previous banking act that was more than half a century old. The law scrapped the previous 60% limit for a seven-year period, although it limited just 10 foreign banks to buying full ownership stakes. But while several foreign banks took advantage of this change, there was little long-term impact on the banking system.
The Philippines is a very different country today. In 2000 the Asian financial crisis was a recent, and palpable, memory, with the Philippines’ economy having grown by only around 3.1% in the previous year, according to World Bank data. That was a lower rate than almost all of its sizeable South-east Asian neighbours. Malaysia and Singapore both grew by 6.1% in 1999, Thailand by 4.4% and Vietnam by 4.8%. Only Indonesia, one of the countries worst hit by the Asian financial crisis, registered lower growth at 0.8%.
Last year’s figures read very differently. The Philippines’ economy grew by 7.2% in 2013, higher than 3.9% in Singapore, 4.7% in Malaysia, Indonesia’s 5.78%, Thailand’s 2.9%, and even the 5.4% growth Vietnam enjoyed.
The country has become a regional economic darling. It stands alongside Malaysia as one of the only Asian economies with a positive outlook from Moody’s, which upgraded its sovereign credit rating to ‘Baa3’ in October last year. Rival agency Standard & Poor’s has been even more confident about the Philippines’ credit strength, upgrading it to ‘BBB’ in May.
Yet despite the vastly improved outlook, FDI is still not rising as quickly as bankers and politicians would like. In 2013 the Philippines witnessed net inflows of $3.86bn, according to data collated by Asean. That is only 3.2% of total FDI into the Asean region, and less than half the amount enjoyed by Vietnam, despite the Philippines’ much bigger economy.
For Collantes and his political allies, addressing this dearth of FDI was a key part of the rationale behind the new law, officially called Republic Act No. 10641. And they have a particular set of offshore investors in mind: those from Japan.
“One of the reasons [for changing the law] I believe, is because some investors — more specifically, the Japanese investors — would be more comfortable investing in a country when they are using the bank they use in their home country,” Collantes tells Asiamoney.
The logic is simple. Japanese banks are liquid, while Japanese companies are seeking to grow into Asean (see related story on page 66). Encouraging lenders from Japan to buy Philippines’ counterparts would encourage Japanese companies to expand into the country while still banking with their favourite lenders.
Law limitations
There’s no certainty that the law change will be enough to gain the attention of Japan’s big-three megabanks. The Philippines had freer ownership laws than most even before the latest rules change. Some analysts doubt the ability to get full foreign ownership will have much impact on foreign banks’ interest.
“The lifting of the foreign ownership cap is a good thing, but I’m sceptical that it will spark much consolidation,” says Ivan Tan, director of financial institutions ratings at S&P. “If you compare the Philippines to other countries in the region, the amount of foreign ownership allowed was already pretty high.
“Under Basel III capital rules, minority investments are inefficient because they are deducted from Tier 1 capital in full. But that is not the case for majority ownership, whether it is 60% or 100%. This change will not fundamentally improve the attractiveness of the system for foreign owners.”
Not everybody agrees. A Manila-based lawyer notes that not having to explain itself to a partner, or to list part of its business on the stock exchange, should be enough to tip the scales, at least for some foreign banks.
And Collantes has his own response to any doubters: he has been directly approached by foreign bankers who want to expand but have so far been hindered from doing so.
“A lot of foreign banks want to enter the Philippines at this point in time because of the economic boom,” he tells Asiamoney.
Some market participants think the benefits may be beyond even his expectations. The hope, they say, is that extra competition could push more of the country’s lenders to the SME sector, a segment of the economy that still remains under-banked.
Red-tape restrictions
There’s another potential consequence: local lenders could be forced to reappraise their lending strategies.
While the Philippines has improved on almost any financial metric since the Asian financial crisis, one of the few things not to have changed much is the low penetration of lending. It’s a key limiting factor for a country keen to accelerate its economic growth and lift more of its population out of poverty.
“The access to finance has not improved despite excess liquidity,” says Jesse Ang, resident representative at the International Finance Corp. (IFC) in the Philippines. “Something needs to be done to improve lending. That’s what competition should do. Perhaps we will get foreign banks in this market that can bring such an appetite to lend into the country. We’re so far from where we should be in terms of credit to GDP.”
SMEs in the Philippines make up only around 35% of the economy, according to a report released by the Philippine Institute for Development Studies in April 2013. But given the liquidity in the domestic banking system, there is clear scope for that to increase.
The Philippines’ domestic credit to the private sector, expressed as a percentage of GDP, stood at 33.4% at the end of 2012, the most recent year available in the World Bank’s database. That is around the same level it was a decade earlier, and far lower than the 56.5% credit-to-GDP figure recorded in 1997.
These low debt levels may, on first glance, be seen as positive. Japan, in contrast, is constantly criticised for its high debt. But without widespread access to lending, in particular by SMEs, economic growth will not create new national champions but simply bolster old ones.
Credit to GDP was 116.2% in Singapore at the end of 2012, 148.3% in Thailand, and 94.8% in Vietnam, according to the World Bank. By contrast, Indonesia and the Philippines trailed far behind, both having credit-to-GDP figures in the mid-thirties. This is understandable in Indonesia, which has a fairly tight banking system, analysts say. But in the Philippines there is more than enough liquidity. For some reason, their big deposits are just not turning into enough loans.
One of the reasons analysts offer for the Philippines’ low loan penetration is geography. The country comprises more than 7,000 islands and there is consequently a physical hurdle to the inter-connectedness of bank lending.
Collantes meanwhile argues that the low levels of lending, particularly to SMEs, are in large part down to approval requirements that are simply too strict. As an example he points to farmers who are unable to get bank loans despite a law requiring domestic lenders to give 25% of their loans to the agricultural sector.
Part of the problem, market participants say, is that banks have not historically had the incentives to search for good SME clients. They have enjoyed years of profit from government bonds, thanks to an upward ratings trend that has pushed bond prices higher. But now that government bond prices have started to stabilise, they need to look elsewhere for their profits.
Competition crush
There are two main ways the new foreign bank law could drive lending to SMEs: foreign banks come in and lend to SMEs directly, or local banks feel pressured by the extra competition to find and exploit every untapped source of revenue.
Most analysts think the latter is more likely, at least in the short term. This could partly be driven by consolidation, which would allow individual banks to expand their knowledge of smaller clients.
Being an archipelago has led to a highly fragmented banking sector. At the end of 2013 the country had 673 banks, according to data from Bangko Sentral ng Pilipinas. That includes 36 universal and commercial banks and 71 thrift banks. The sector looks ripe for consolidation.
“The [rule] change is likely to drive further consolidation in the sector, led by both foreign and domestic banks, and domestic banks will have to find ways to improve their productivity and cost efficiency to compete,” say bank analysts at Fitch.
Collantes agrees that further local bank consolidation could be a consequence of the new law. However he thinks it is unlikely local SMEs will benefit much.
But others are more optimistic about this possible unintended consequence of the foreign bank law. The most obvious source of growth for local banks, especially when foreign banks try to poach some of their trade finance business, is going to be turning towards high-yielding smaller companies. Competition may be the one thing to make SME lending really take off.
“It is almost always a good thing to add more competition to a market,” says the IFC’s Ang. “This is going to spur better institutions, and larger institutions, but it should also expand access to finance among smaller borrowers.”
The desire to attract foreign banks into the Philippines is sensible, as is the hope that it will also spur corporate FDI afterwards. But the greater ramification could be if it forces the country’s banking sector into a round of much-needed consolidation, and fosters a more competitive environment amongst the larger institutions that remain.
That could yet lead the companies with the most growth potential to get access to the funds they so sorely need.
Aquino and the Philippines’ government are eager to welcome foreign banks into one of Asia’s fastest growing economies. It makes sense for some to accept the invitation.