张伟民 Ben Tiu / Vice Chairman of International Exchange Bank, Manila, Philippines/Chairman of the Executive Committee
    
    
    Introduction
    
    I will focus my discussion on the commercial banking sector, being the dominant one in the Philippines' financial services industry.
    
    In January 1995, the General Agreement on Trade in Services (GATS), the first multilateral agreement on trade and investment in services came into effect. However, negotiations covering the financial services sector had to be extended until July 1995; although an interim agreement was settled in appreciation of the difficulties in reconciling the challenging issues in this particular sector. It was only in 1999 when the permanent agreement was reached.
    
    The GATS is governed by 3 basic principles:
    
    first, it encompasses all services except those dealing in the exercise of governmental authority; second is the national treatment principle which prohibits discrimination in favor of local providers; and third is the most-favored-nation principle (MFN), which precludes discrimination against and between other Members of the Agreement. These are the basic principles on which the whole WTO system has developed since its inception.
    
    Early Bird
    
    While the WTO and the GATS were under intense negotiations, the Philippines was already well into liberalizing its commercial banking industry. Under the various programs of the IMF-World Bank, the country embraced free trade and the development of a liberalized economic framework as the guiding principle in the conduct of its economic policies. Thus, even before the 1995 interim GAT agreement was finalized, the country had made significant advances in liberalizing its banking industry.
    
    In 1992, the Central Bank issued circular 1389 liberalizing the foreign exchange, trade, and payment systems. Under this circular, the central bank lifted foreign exchange restrictions on most current transactions. The mandatory surrender to the Central Bank of forex receipts resulting from exports and inward remittances of all kinds were removed. Limits on the allowable amount of foreign exchange purchases by residents to facilitate payments for services were substantially liberalized. The Central Bank also liberalized selected transactions in the capital accounts that make up the balance of payments. In particular, the rules restricting banks from lending in foreign currency were relaxed, thus allowing borrowers access to lower cost but high risk funds.
    
    In 1994, it passed the "Bank Liberalization Law". The law allowed the entry of ten (10) new foreign banks in addition to the four (4) that had been in existence. The newly opened foreign banks were allowed a certain limited number of branches but were, as in the case of the four already existing banks, permitted to engage in full scale commercial banking operations.
    
    At the same time, the Central Bank lifted the moratorium on the opening of new locally incorporated commercial banks and relaxed the regulations on the opening of branches by the local banks. This resulted in the almost doubling of the number of the local banks until sometime in 1999 when restrictions on branching were re-imposed.
    
    Profound Changes
    
    These measures changed the financial landscape of the Philippines quite dramatically. Total commercial banks in the country ballooned from a little over 30 to 52. From an almost oligopolistic structure, where a few dominant players had the lion share of the market, the industry turned competitive. Among the immediate changes felt were:
    
    1.Costs escalation.Human resource costs, the biggest component of bank overhead increased significantly as a result of the stiff competition for talent. Suddenly, bankers were in big demand and salaries adjusted upward quite rapidly. The increase in branch network brought about a corresponding increase in premises and other administrative cost.
    
    2.Customer focus.The Philippine banking industry prior to its liberalization was not known to be customer-driven. Now, with so many banks competing for customers, banks had to find ways to continuously
    offer more value-added services to retain their customers, as well as to attract new ones. Bank products, under intense competition, had to be priced more competitively.
    
    3.Margins were squeezed.Escalating costs and the evolving competitive environment squeezed profit margins.
    
    4.Lower credit standards.The significant increase in the numbers of banks was not accompanied by a proportional increase in the number borrowers. The fierce competitive environment resulted in the lowering of credit standards.
    
    Given the fact that economic activity in the country was somewhat on the rise after years of relative inactivity, Philippine banks tried to adapt by going very aggressive on their expansion. Given the easy access to capital and the pressure for profits, plus a more liberalized regulatory framework banks were prompted banks to grow. In some ways, one could argue that the Philippine financial crisis was partly, perhaps even largely, due to the liberalized environment in the financial services sectors, not dissimilar to the Asia financial meltdown.
    
    Most of the new foreign bank entrants concentrated on very defined market segments and chose very defined product offerings.
    
    Most of their customers tend to be multinational corporations from their home countries. In general, they tend to be in wholesale and investment banking.
    
    Because most of them rely on local funding sources, the much anticipated huge inflow of funds and the accompanying lowering cost did not materialize.
    
    Beneficially, however, stiff competition among local banks and the entry of foreign banks gave birth to more advanced technologies and more sophisticated financial products. Foreign banks and the new local players put pressure on the older players to improve efficiency, adopt global standards, and improve their managerial and technical skills.
    
    1997 Crisis
    
    With the 1997 Asian crisis, the situation changed dramatically. While the Philippine banking industry was the least affected among the Southeast Asian countries, it nevertheless experienced a lot of difficulties.The peso collapsed and under pressure from the IMF, interest rates rose, exacerbating the non-performing loan problem of the industry. Expectedly, banks became more circumspect in their lending activities.
    
    The foreign exchange crisis and its subsequent leap to the real economy highlighted the weaknesses of the commercial banking industry. The clear difference in the way they operate, particularly in the area of risk management and global standards of best practices became apparent.
    
    The changes resulting from liberalization and the 1997 crisis also brought to the fore the need for regulators to improve standards of supervision and upgrade the skill level of its personnel. There are some quarters who argue that the challenges that arose from the 1997 crisis was also due, to some extent, to the inability of bank regulators in the Southeast Asian region.
    
    Reform Program
    
    The perceived weaknesses of the local banking industry, the difficulties in accessing the international capital markets, the birth of new products and services and the challenge on the part of the regulators to adapt to these developments are putting a lot of pressure for more regulations. These are focused on the following areas:
    
    Adoption of global standards of best practices
    
    Development and deepening of the capital markets
    
    Improving regulatory capabilities Proper measurement of risks and capital management.
    
    Among the major initiatives that have been done and/or are in the process of development are the following:
    
    Adoption of the BIS framework.
    
    The Bangko Sentral ng Pilipinas (BSP) has put in effect the new capital adequacy regulations based on this framework. A circular on the treatment of market risks and its proper accounting and valuation is forthcoming soon.
    
    Improvements in market convention as regards foreign exchange and fixed income securities both on proprietary trading and public distribution.
    
    Opening of a Fixed Income Exchange which will provide a platform not only for government issued debt to widen its distribution capabilities but also for private issuers of debt to have better access to investors. The exchange is also expected to evolve a better price discovery mechanism and a more transparent and efficient fixed income market.
    
    Improvements of the settlements, valuation, and custody systems which should improve public awareness and confidence in the market.
    
    Upgrading of skills of both market participants and regulators.
    
    Assessing the current situation.
    
    In its entire history, the Philippine banking industry perhaps experienced the most profound changes in the last ten years. While these changes were brought about by a confluence of factors, foremost of which is the seemingly irreversible trend toward globalization, the liberalization of the industry and the entry of foreign banks certainly were big impetuses for these changes.
    
    The questions that are inevitably asked are:
    
    Has liberalization done good for the Philippine banking industry?
    
    As of the quarter ending June 30, the foreign bank branches and subsidiaries control about 17.5% of the total resources of the commercial banking industry. This is still far from the statutory limit of 30%. Furthermore, while the Philippines adopts free trade and liberalization as a general policy framework, it still maintained several measures to balance the competitive environment. Among these measures are: the aforementioned 30% limit on total resources for foreign banks and limited branching capabilities. If the trend over the last few years is any indication, it appears that there are certain segments of the market that will remain mostly with local players.
    
    The Philippine banking industry has some peculiarities that put it at some disadvantage over foreign banks. The industry is fragmented with even the biggest player still relatively small by global standards. Unlike banks in other countries, which are much bigger and are able to compete head-on with its foreign rivals, local Philippine banks do not have the size.
    
    Future Prospects
    
    The situation is still fluid. Unlike its southeast Asian neighbors whose very pronounced problems from the 1997 crisis were brought to a head earlier and are on their way to recovery, Philippine banks are still doing a lot of balance sheet repair. Necessary legislation that would aid in solving the non-performing assets problem has yet to be passed. And while the industry as a whole is able to adjust, there is still that possibility that a few could face difficulties.
    
    Many believe that the Philippine market is too small for 44 commercial banks (reduced from its peak of 52 after a number of mergers). More consolidations are expected to happen in the next few years. And when the dust settles, it is likely that foreign banks, including its local subsidiaries which are formally classified as local entities, will end up with a bigger share of the market from where we are right now.
    
    The expected consolidation, the on-going reform programs, and the possible bigger roles for foreign players could help hasten the development of the industry to bring it closer to global standards.