Bank credit ratings face downward pressure

Philippine banks face downward pressures on their credit ratings after the Bangko Sentral ng Pilipinas has scrapped the interest paid on their reserves. AFP

Moody’s Investors Service said banks in the Philippines face downward pressures on their credit ratings following the move of the Bangko Sentral ng Pilipinas to scrap the interest paid on their reserves.

Moody’s said that the loss of interest income resulting from the lifting of interest on reserves—the proportion of deposits held by banks that must remain untouched to ensure liquidity in the system—could lead to a decline in incomes and, in turn, in a deterioration of credit standings.

“We expect the termination of interest payments on reserves to reduce banks’ interest yields and adversely affect their net interest margins and risk-adjusted profits,” the credit-rating firm said in a recent report.

Moody’s said banks that would be affected the most were those with large deposits in proportion to their assets. It said net interest margins of banks were likely to decrease anywhere between 9 and 38 basis points.

The credit-rating firm also said that the decline in interest earnings might create the tendency for banks to increase lending even to credit-risky borrowers just to recover the loss in interest income, thereby increasing their chances of having higher exposure to bad debts.

“These additional credit exposures may boost the banks’ loan margins immediately, but they will increase the banks’ risk profiles and eventually hurt their risk-adjusted profits,” Moody’s said.

The BSP announced earlier this month that it had overhauled the reserve requirement framework for banks in a bid to rationalize and align it with international standards.

One of the key features of the reform was the removal of interest paid on the reserves of banks. Officials said most foreign central banks did not pay interest on reserves, which they said were not meant to earn but were intended to ensure liquidity within the economy would not become excessive and inflationary.

Another key feature of the reform was the reduction of the reserve requirement to 18 percent from 21 percent.

Banks were no longer allowed to keep a portion of the reserves in their own vaults as all reserves must be kept in the BSP for better monitoring.

Under the old system, 11 percent of deposits were kept in a bank’s own vault while 10 percent were kept in the BSP’s.

The move to reform the reserve requirement framework had gathered complaints from industry players, but the BSP said the move should have a neutral effect on the financial standing of banks.