Fitch: Tighter rules on bank real estate loans to help avoid asset bubbles

Fitch Ratings on Thursday welcomed the tighter rules on real estate loans issued by the Bangko Sentral ng Pilipinas recently, as the debt watcher flagged risks from uncontrolled rapid loan growth not only to banks but also the wider economy.

In a statement, Fitch said that “recent moves to enhance oversight of property lending and project finance in the Philippines could make it easier to spot pockets of excess in these high-growth sectors.”

Fitch was referring to the recent move of the Monetary Board, the BSP’s highest policymaking body, to enhance prudential reporting requirements aimed at strengthening oversight of banks’ real estate as well as project finance exposures.

“The new ruling by the BSP targets two sectors where vulnerabilities could form amid strong loan growth. Real-estate loans, which account for just over 20 percent of total bank lending, have risen by 21 percent on average over the last four years. Meanwhile, project finance is likely to take off as the Duterte administration pushes ahead with its infrastructure investment drive,” Fitch noted.

However, Fitch said that “prudential standards have not been tightened under the new measures and the regulator still faces the challenge of discerning unhealthy risk-taking from productive lending that supports economic growth.”

According to Fitch, “closer central bank scrutiny may make banks more cautious in lending to these sectors, but it does not amount to regulatory tightening to curb growth.”

For instance, Fitch pointed out that car loans, despite being under stricter oversight since 2015, continued to post robust growth, jumping 24 percent year-on-year last June.

To date, rapid credit growth to the real estate sector “does not so far appear to be fueling asset bubbles,” Fitch said.

“Property price inflation, for example, has been moderate, averaging around 4 percent a year from the first quarter of 2014 to the first quarter of 2017, according to the BSP’s house price index,” it noted.

Moving forward, however, “sustained rapid loan growth could create risks to the banking sector and the broader economy if left unchecked,” according to Fitch.

“High system-wide loan growth could raise the risk of a credit bubble if it continues. Bank loans have grown at roughly twice the pace of nominal GDP [gross domestic product] in the last four years—around 18-percent year-on-year on average. Bank credit to the private sector remains relatively low, at 45 percent of GDP at end-2016, but this ratio has risen from 32 percent at end-2011 and is likely to climb further in 2017. Most banks appear to have maintained acceptable lending standards over this period and the NPL [nonperforming loan] ratio has remained benign at around 2 percent, but in such a strong growth environment there is a risk that ‘blind spots’ may develop, where downside risks may not be adequately priced into lending decisions,” it said.

“Risks could crystallise into losses if, for example, the economy slows or interest rates rise significantly,” it added.

As for individual banks, Fitch said “rising volumes place pressure on banks’ risk management capability, systems and operations.”

“Banks will also face the challenge of maintaining their capital, funding and liquidity ratios as their balance sheets expand, given the minimum regulatory hurdles placed on such metrics under the Basel III regime. The 10 largest banks reported a broadly healthy CET1 [Common Equity Tier 1] of 13.4 percent on average at end-June 2017, which should help them cope with a potential drop in asset quality. However, double-digit loan growth could gradually diminish these buffers,” Fitch said.

“The aggregate loan/deposit ratio is also healthy, at 72 percent at end-July 2017, but there are already signs that excess funding and liquidity buffers may be narrowing due to rapid credit growth. Banking system discretionary deposits with the central bank have fallen, and banks have increasingly had to turn to more expensive term deposits, long-term negotiable certificates of deposit (LTNCDs) and international debt markets to fund growth this year, as growth in lower-cost current and savings accounts (CASA) has not kept pace. This will put upward pressure on banks’ funding costs if it continues,” Fitch added. /je