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The Philippine banking system is well positioned to face the challenges ahead

By The Asian Banker Live

Nestor A. Espenilla, Jr., deputy governor, supervision and examination of Bangko Sentral ng Pilipinas, delivers the opening keynote speech at the Philippine International Banking Convention 2016. He emphasises the importance of financial stability and effective banking regulation as a solid platform to build value chain resilience in the region.

It’s my pleasure to join you for this year’s banking convention. Gatherings like this are valuable because they afford us the opportunity to take a break from the day-to-day grind of our daily pressures, so that we can assess where our financial system stands today.

This is even more important in the face of volatile markets, global policy uncertainties, and dynamic financial technology innovations. We could do a shortcut by simply pointing out that the Philippine banking industry is the only one which has been given a positive outlook by Fitch in 2016. On the other hand, Moody’s recognised the Philippines as the only banking system in the ASEAN that has a stable outlook on all the rating factors of operating environment, asset quality and capital, profitability, funding, and liquidity. These are not insignificant commentaries but all of us understand that conditions in the financial market can change rather quickly. Thus, while the positive outlook for the financial market can change, this third party assessments are quite reassuring.

We are cognisant that the real challenge actually lies with the uncertain future. Managing change and innovation and achieving stability and creating opportunity amid all of these challenges.

How can we manage change when the future is uncertain? How can we organise ourselves when change affects different actors, differently, both now and more so in the future? What does stability entail and how do we achieve it? These are questions that we keep asking ourselves.

In good times, these questions may not be prominent concerns. After all, not many of us actually want to go to see the doctor if we are feeling very well. And we’re quite happy to go about our normal business, making most of the opportunities from a good environment. Unfortunately, in bad times, these are the questions asked but invariably, in hindsight.

Given the disruptions experienced in recent years, we have drawn lessons. Answering the questions has set up a reform agenda that has fundamentally altered the financial landscape in the Philippines. Our regulatory attention has come to focus on the pursuit of financial stability. Two words, which sound rather straightforward but turnout to be very difficult even to measure, much more monitor and attain.

But why bother with financial stability? What is the context of financial stability for the BSP? The first is easily answered. The lesson from the last decade is that there is a lot happening in financial markets that are not fully transparent or well understood. Traditionally, we use the financial statements of a regulated entity to assess its health and performance. But as pointed out by former Federal Reserve chairman Ben Ben Bernanke, I quote: “A principal lesson of the crisis is that an approach to supervision that focuses narrowly on individual institutions can miss broader problems that are building up in the system.”

We bother with financial stability because it alters our prudential approach and how we think of financial resilience. Instead of focusing on strong individual parts to make a strong whole, we now also look at the whole which is not just the sum of its parts. This is something extra, and this is necessitated by the linkages that just across stake holders, products, and markets. This is the way we perceive our job.

Our definition of financial stability is fundamentally anchored on a well-functioning financial system. This includes the needed financial infrastructure to execute the transactions with finality. This recognises that there is that interconnectedness amongst the transactions, institutions and products that need to be specifically managed. And because financial markets are prone to competing interests, a governance structure must be in place to ensure good market conduct and basic fairness. All of these elements must come together so that the benefits of finance accrue to the general public, both through responsive financial products and practices as well as through good quality growth.

The focus on financial stability does not suggest though that the supervision of individual financial institutions has been set aside. To the contrary, a well-functioning financial market is not possible unless the individual institutions responsively manage risks for themselves as operating units but also especially for their clients’ interests. In this area, the BSP has diligently initiated several key reforms, which consciously strike optimal balance between the bank as a business on one hand, and as an enabler for financial consumers on the other.

We have adopted a risk-based and proportionate approach to the supervision of financial institutions to achieve this. For example, the regulatory expectations for the handling of credit and operational risks respectively have been significantly elevated through major amendments of our regulations. A comprehensive IT risk management framework was instituted three years ago, well before recent high profile incidents. And to instil sound market conduct, several key reforms were finalised to strengthen corporate governance. Among these, are the reinforced guidelines on board and senior management oversight, our compliance framework, and the rules that ensure arm’s length transactions among related parties. This is particularly significant in a financial system where there is significant dominance of conglomerate structures. These rules essentially promote proper behaviour to mitigate conflicts of interest.

Of those related to the global agenda, we have already completed those on capital, leverage, short term liquidity, and systemically important banks. It certainly does not end there. Afar from these, the market can expect several other initiatives to come out soon. These include the longer term liquidity framework or net stable funding ratio (NSFR), amendments of the market risk guidelines, the counter-party risk framework, an OTC derivative approach that is coordinated with our regional partners, and specific focus on the management of intraday liquidity.

Factually, many regulatory reforms have been done that bring us in alignment with global standards. But we also know that there are still several other initiatives that are on the drawing board of standard setting bodies. This just reiterates that the risk of the task of strengthening the financial system is a continuing initiative. Defining standards to address identified weaknesses, setting the bar higher when the previous approach have not work, and calibrating the standards where and when conditions vary.

Beyond the shared volume of reforms however, it is clear, that financial stability and effective banking supervision are highly complementary. The success of one feeds into the other just as we are wary that difficulties can readily spill over, if they are not managed well.

Ladies and Gentlemen, it is clear that attaining financial stability and ensuring that banks operate in a safe and sound manner are critical, prudential objectives. Having said that, it is also equally clear to us at the BSP that our success in achieving this twin prudential objectives allow us to do more – providing a critical foundation for attaining other strategic goals. That higher objective is basically to enable the financial consumer, both corporate and retail, with greater opportunities that can ultimately improve their financial well-being.

As we can see, without financial stability, progress is hindered and this is very much evident in other territories. Four specific instances come to mind. First, we have had 70 consecutive quarters of economic growth and an equally long running low inflation environment. The positive effect of this is evident in improved incomes and increased expenditures of economic actors. And borrowing from Keynes, there is a palpable sense of animal spirits driving our markets forward today. This is possible because of the health of the banking system. This growth goes beyond the extension of bank balance sheets, but also reflects an improved ability to manage increasingly complexed risks and also an effective transmission channel of monetary policy. Capital ratios both in risk-weighted terms as well as in the traditional solvency metric, by enlarge have held steady in the face of the continuing growth in risk assets. Banks hold enough high quality liquid assets to meet expected net out flows, and credit data thus far has not pointed to any imbalance between demand, supply and financing factors. This is where the BSP most appreciates the positive outlook given by international rating agencies.

They reflect a growing concern view that the Philippine banking system is well positioned not only for today but also for the challenges ahead. This in turn validates the approach that we have taken in managing the different facets of change.

Specifically, we are an enabler, in the sense that we balance overseeing the uncertainties of risks versus a desire to unlock the potential economic opportunities from risk-taking. As a banking regulator, we validate that banks operate in a safe and sound manner while defining the operating environment within which they can prudently operate. And in balance, we argue, that we have struck a rare balance that essentially nurtures change within a stable environment. This undoubtedly has been facilitated by our parallel commitment towards financial inclusion, which is my second specific case.

As an archipelago, we are naturally fragmented and the socio economical divergence across geographic locations only exacerbates that fragmentation. If financial markets are to function properly, then they must cater to the needs to all financial consumers regardless of location or economic stature.

At the most basic level, the banking industry needs to be financially inclusive to service the economic requirements of all the people and as a repository of their personal savings. This means that varied consumers have access to differentiated financial products and services. Modes of delivery will need out of the box solutions because the traditional brick-and-mortar approach would not be justifiable across all economic conditions. This is where digital financial services will play a material role going forward.

At the same time, the regulatory bar for due diligence has to be calibrated to reflect the realities of the unbanked and underbanked that inclusions specifically targets. Add to that, an array of products that are specifically fine-tuned for this target constituency. Having these fine-tuned products made available to non-traditional delivery mechanisms and operating within a risk-based and proportionate regulatory environment, subsequently defines our three pillar approach to financial inclusion.

In the past decade and a half, we have advocated inclusion. We have seen a notable shift in the banking industry. As we crafted new regulations, innovative products have been introduced and newer modes of delivery, notably through e-banking now incorporating fintech, are improving access and usage across the Philippines. 

For us, inclusion is a holistic objective to allow all households access to financial services – from saving to credit, to payments and transfers, and to investments and risk protections. Formalising this view, the national strategy for financial inclusion was launched in July 15 as a collaboration initially among 15 government agencies. This has been bolstered by the issuance of an executive order, EO 208, which institutionalises a steering committee chaired by the BSP that oversees the execution of this national strategy. 

This task certainly does not end with the written documents since the needs of the financial consumers will precisely evolve overtime. Financial inclusion for us will thus be a growing concern as is the banking market itself. 

And these represent my last two instances where the stability of the financial system and the safety and soundness of the banking industry provide greater opportunities that improve consumer well-being. 

And my third instance is the unfolding integration of the ASEAN Financial Community. Already, the integration of banking systems under the ASEAN Banking Integration framework or ABIF is under way. And I’m sure that everyone here have seen the numbers. In consistently growing region that saves more than the rest of the world underpin by a young, mobile, and tech-savvy population. 

And when you put the banks in the middle of that paradigm, there are exponential opportunities that naturally present themselves. Competition will identify efficient production locations and enhanced distribution channels should benefit consumers with lower prices. Integrated financial markets make funds more fungible in line with saving, borrowing and investing opportunities that will be available to all in ASEAN. 

In the context of the ASEAN banking integration, it makes its own case for providing consumers with the added opportunities that would improve their well-being. But we also cannot lose sight of the fact that our banking industry must be strong and our financial system stable to position ourselves as a solid link in the ABIF value chain. We can contribute to the greater good of ASEAN banking because the Philippines, itself, is an economic good. We do not allow those animals spirits to get ahead of us. Never losing sight of maintaining sound macro financial fundamentals, the same essentials that have escalated the sovereign to investment grade status and supported ably by a solid banking system anchor with a positive outlook. 

Having talked about great momentum, financial inclusion and regional integration, let me tie together all of these with my fourth case, which is the emergence of financial technology or fintech. Economists talked of production functions a lot and for the Philippines, skilled labour is certainly the dominantly resource. But we should not overlooked that such highly skilled labour resource today is much more technology-oriented than those of us from an earlier generation. 

This suggests that our economic growth is not entirely of the old-production function but we have a fair application of technologies even though this is not yet readily evident in the macro statistics. The same technology is what allows us to deploy non-traditional delivery mechanisms under financial inclusion and to the financial technology as well that allows the unbundling function and distribution as well as saving and investment on cross border basis. 

With so much at stake, it is critical that we take an open and progressive approach to financial technology innovation while ensuring that there is sufficient regulation over the handling and operation of such financial technology. For the BSP, we first comprehensively set our supervisory expectations when we issued our IT Risk Management framework back in 2013. This provides the overarching principles-based guideline against which we evaluate prudent use of financial technology by BSP-supervised financial institutions. Reflecting this, for example, the migration from magnetic stripes to more secured chip-based cards is now in full swing and will be fully deployed by the beginning of next year. 

Amid these changes, consumer protection must continue to be an important imperative of the BSP. Our approach to financial technology is to engage the new providers of financial services, understand the business model, and what risks are being introduced. And on that basis calibrate our regulations. It is both a two-way street, regulations can change in response to financial technology developments. 

Ladies and gentlemen, I have taken quite a bit of time to cover much ground but in reality there are many other issues that are percolating within the banking industry. It would be an injustice to raise them all within this short time frame and even doing so, we’ll probably extend us too much. 

What is clear thus far is that the banking system has been able to effectively manage the complexness that present themselves. Taking advantage of opportunities without undue risk concentration. This sound banking system has been a positive contributor to the pursuit of financial stability and has facilitated economic growth as well. 

We have always said that the tasks are too enormous and must therefore be a shared responsibility. We are therefore thankful for the partnership of our fellow regulators as we push forward our committed agenda towards financial stability. We are also highly appreciative of the collaboration with the banking community who take to heart the changing banking architecture and accept the reality of heightened regulatory premium. In this regard, we are glad to be a partner of the banking industry, even now they are embarking of their strategic review of what are the opportunities emerging in this rapidly changing environment. We are distinctly focused on the financial consumer as the bank should be being consumer-centric because we want more inclusive banking industry – one were consumer protection and financial literacy are institutionalised and we do thank our third-party assessors and commentators for the continuous opportunity to engage them because they remind us that there is always room for improvement. Thank you very much and good morning to all of you.


Categories: Philippines, Regulation, Risk and Regulation, Technology & Operations
Keywords: Technology, Fintech, Financial Inclusion
Institution: Bangko Sentral Ng Pilipinas, BSP
Country: The Philippines
Region: Asia Pacific
Guest: Jr. Nestor A. Espenilla
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