Why I don’t think PH banks are at risk of becoming insolvent

Last week, the IMF came out with a report saying that Philippine banks may experience “systemic solvency distress” if the economic impact of the COVID-19 pandemic turns out to be worse than expected.

If economic conditions continue to deteriorate, banks’ nonperforming loans (NPL) would go up sharply, resulting in significant losses. This would cause banks’ capital adequacy ratio (CAR) to drop below the 10 percent minimum requirement, increasing their risk of becoming insolvent.

This is definitely bad news for depositors like us as we face heightened risk of losing our money if the banks where we placed our deposits become insolvent.

While the IMF’s assessment is possible, especially with the reimposition of stricter lockdowns brought about by the resurgence of infections, I do not think it is probable for several reasons. First is that unlike previous crises, the peso did not depreciate this time around. Neither did interest rates go up sharply. In fact, the opposite happened, with the peso appreciating and interest rates going down. This prevented a significant increase in borrowers’ funding cost, improving their ability to meet their debt obligations.

Moreover, companies with sound businesses models are still able to raise capital by selling bonds or stocks in the financial markets. This is preventing credit worthy companies with lumpy maturities to suffer from liquidity problems.

Second is that unlike in the past, Philippine banks have been more conservative in their lending policies. Note that during the Asian financial crisis, a lot of borrowers defaulted because they availed of cheaper dollar denominated debts to speculate on properties that were not income generating. After suffering from huge losses during the Asian financial crisis, banks have generally avoided lending money for nonproductive uses.

Moreover, large corporations account for some 70 percent of banks’ loan portfolios. MSMEs and consumers, which are more vulnerable to this pandemic induced crisis, account for only 30 percent of banks’ loan books.

Because of this, the Bankers Association of the Philippines (BAP) recently said it was expecting the NPL ratio of the banking sector to peak at 6 to 7 percent, way below the 16.9 percent peak recorded during the Asian financial crisis. This is despite the sharper contraction in the country’s GDP of 9.5 percent in 2020 vs only 0.6 percent in 1998. Third, banks already have a huge buffer against potential loan losses. In anticipation of rising nonperforming loans, larger listed banks set aside four times the normal amount of annual provisions in 2020. As a result, despite the sharp increase in NPLs last year, banks’ NPL cover (or the allowance for probable loss relative to NPLs) remained above the 100 percent level for most. The high NPL cover will prevent banks from having to book significant losses, even if they fail to collect anything from distressed borrowers.

Fourth, even with their aggressive provisioning last year, all listed banks that we monitor remained profitable. Coupled with the weak demand for loans, this led to an increase in their CAR, further strengthening their ability to absorb losses. Banks’ high level of CAR is also one of the reasons why deposit rates are now at record low levels despite the crisis.

Admittedly, the deteriorating outlook of the economy may cause peak NPLs to exceed the BAP’s projection of 6 to 7 percent. However, neither do I expect banks’ CAR to fall below the 10 percent minimum requirement. As such, the public can safely keep their money in bank deposits since the risk of banks becoming insolvent is still low, especially for the big listed banks. INQ