Financial Sector Reform: Building a Banking System for a Global Economy
Governor Rafael B. Buenaventura
Bangko Sentral ng Pilipinas
It is a great honor to be invited to speak before this 33rd Annual General Meeting of the Pacific Basin Economic Council. It also gives me great pleasure to be here in beautiful Hawaii, the center of the Asia Pacific, and the heart of the PBEC family.
For this second plenary session, our topic is, "Financial Sector Reform: Building a Banking System for a Global Economy". Indeed, given the focus of this meeting, which is to find ways to adjust to the changing global landscape, it is natural that the banking system should emerge as a key sector for consideration.
For the banking system is the backbone of any economy. It is the nerve center where financial transactions flow. But like any other system, it is a two-edged sword. At the same time that it facilitates greater efficiency, it also has the potential for excesses.
What we need to look at in this session are the strategies and reforms needed to build a banking system that can respond more effectively to the fast-changing global environment.
Based on our experience during the Asian financial crisis, I have identified two major areas for reforms, which I think are very familiar now to the participants in this conference. These are the system's regulatory framework and its corporate culture. Let me start with an overview of these two areas.
A key element in the reform process is to ensure that the regulatory environment is at par with the increased risks that go with the globalized landscape. Thus, prudential regulations have to be strengthened in terms of stringency, coverage and enforcement. A more harmonized and comprehensive system of supervision across financial institutions is a necessity for greater scope and effectiveness. To ensure enforcement, the capability and independence of supervisory authorities must also be strengthened.
But improving the regulatory framework cannot be undertaken in isolation from the rest of the elements of the reform process. Weaknesses in banks' balance sheets and operating procedures must be identified and remedied to enable them to respond better to and comply adequately with the requirements of a stricture regulatory regime. Since banks are corporate entities, corporate restructuring must also take place. This means improving the underlying legal and institutional frameworks for financial and operational restructuring. The bottomline for all of these reforms is to prevent future crises by upgrading the risk management capability of banks and the supervisory authorities.
Using the imperatives for financial sector reforms, let me know outline the Philippine experience towards building a globally competitive banking system.
The Philippine banking system had gone through several episodes of policy reforms since the 1980s. These reforms included allowing a greater role for market forces such as a deregulation of interest rates, increases in bank capitalization and improvements in bank supervision. Hence, even before the crisis, there was already a high degree of market orientation in the system and the regulatory framework was continuously being improved.
Consequently, the Philippine banking system was not severely affected by the crisis. Total resources continued to rise and asset quality remained relatively sound. The NPL ration of commercial banks remained below 20 percent, well below those observed in other Asian neighbors which ranged from 20 to 75 percent. Banks' exposure to the property sector was also limited at a little over 10 percent, compared to 15-35 percent in other neighboring countries. As a result, we saw only a moderate correction in asset prices and a limited supply glut in selected segments of the property market.
Our commercial banks remained highly capitalized as indicated by their capital adequacy ratio of 17.8 percent as of November 1999. This developed from the Bangko Sentral's policy of encouraging big, globally competitive banks. To date, four major and four minor bank mergers have taken place, involving 10 commercial banks, four thrift banks and two rural banks. We expect a few more mergers this year. It is important to note that while the recent mergers increased bank concentration, initial studies conducted by the Bangko Sentral indicated that these mergers were not enough to pose a threat to overall competition levels.
In terms of corporate reforms, the Philippines has undertaken significant steps in aligning its regulatory, risk management and disclosure practices to international norms. Disclosure statements for audited financial statements of banks are generally consistent with international accounting standards. Incidentally, the Philippines is one of the first signatories to the special data dissemination standards of the international monetary fund. With respect to banking governance, the Bangko Sentral has established guidelines to govern the responsibilities of banks to ensure prudent and efficient bank administration.
Overseeing all these reforms is the Bangko Sentral ng Pilipinas, which in 1993, was granted increased fiscal and administrative autonomy under the new Central Bank Charter. Increased autonomy enable it to formulate more flexible policies that resulted in greater stability in the macro-economic environment, which in turn promoted greater market confidence in the banking system.
Looking forward, further reforms in the Philippine banking system, and in any banking system for that matter, will have to deal with the challenges of increasing sophistication and globalization in the financial environment.
Toward this end, major banking reforms have been submitted to the Philippine Congress. These proposed legislations seek to further align our prudential standards with international norms, enhance competition in the banking sector and strengthen further the supervisory and regulatory capability of the Bangko Sentral.
The amendments are also expected to enable the system to adapt to the latest innovations in banking technology, including electronic banking. With the spread of electronic commerce, banks will have to contend with the growing competition posed by alternative payment systems such as electronic shopping malls and digicash. In the process, the supervisory scope of the Bangko Sentral will have to be widened.
Reforms related to corporate restructuring are also in the pipeline. Pending in Congress are proposed amendments to the Philippine Securities Act which seek to update the operating rules for corporate debt resolution.
In the meantime that these proposed reforms are still pending in Congress, other complementary measures are also being pursued. The settlement and payment system is being upgraded to move into a real-time basis. Risk rating is being introduced to allow for early identification of problems and improve credit risk management. We have started to use the first-generation early warning system of commercial banks that will provide advance indicators on banks' solvency outlook. To complement the system on a macro basis, we are also in the process of finalizing a set of leading indicators that will enable us to detect potential system-wide currency and financial crises.
In closing, I leave you some notes on reforming the financial system, based on the Philippine experience.
Structural reforms, and for that matter banking reforms, take time to design and implement. While the initial impact is mostly painful, the benefits are less apparent since they are spread over a longer period of time. Hence, significant political courage is often needed to see the reform process through its conclusion. For one, the cooperation of the legislature is crucial in putting in place reforms that are expected to have a major impact on the banking system and the economy. In terms of enforcement, a key factor is the degree of independence of the supervisory authorities and from other vested interests. This inspires greater confidence from the private sector, which is the most crucial factor that determines the success or failure of the reform process.
Thank you and good day.