Rafael Buenaventura: Laying the foundation for a progressive financial system
Speech by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the
Philippines), at The Asset Forum, ASEAN Capital Markets Forum Series, Makati City,
20 October 2004.
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Ladies and gentlemen, good morning.
Introduction
We are indebted to the Asset Magazine, headed by its dynamic editor-in-chief, Mr.. Danny Yu, for
organizing this forum on Philippine capital markets. This is an issue that should be high in our agenda
for reform. Clearly it is critical for the government to immediately deal with a looming fiscal crisis but
that should not distract us from the equally important task of accelerating the development of the
domestic capital market. Indeed, these two reforms are closely linked. Fiscal stability is an important
precondition to financial system stability. A well developed capital market enhances flexibility in fiscal
management.
BSP agenda
The BSP, as the monetary authority and supervisor of the banking system, is firmly committed to the
prioritization of domestic capital market development. First, well-functioning financial markets support
the more effective conduct of monetary policy that is key to achievement of price stability. Second, a
robust domestic capital market complements the banking system in financial intermediation and can
even relieve pressure especially during times of crises by providing alternative means of financing to
the economy. Third, the banking system has greater flexibility in managing and re-distributing its risks
via the capital market particularly through securitization and hedging.
An even more basic reason is the need to improve on the current low domestic saving rate. According
to comparative data from ADB as of 2003, the gross domestic saving rate in the Philippines was only
20.1% of GDP compared with Hong Kong (31.6%), Thailand (33.1%), Malaysia (42.9%) and
Singapore (46.7%). Even Indonesia is slightly higher at 21.5%. A low domestic saving rate is a basic
constraint to achieving higher levels of investment needed to support a faster pace of economic
growth. To promote savings, the Philippine financial market needs to offer a broader array of financial
instruments beyond bank deposits and equity.
We are particularly keen on seeing the faster development of the domestic debt market. As of 2003,
total outstanding domestic bonds accounted for just around 40 percent of GDP, compared with
85 percent for bank assets and 69 percent for equity. Most of these bonds are in the form of
government securities. In developed countries, where capital markets are deep, the bond market size
ranged from 88 percent of GDP in Euroland and 151 percent in the united states.
Our initiatives
The BSP's most fundamental contribution to the development of financial markets is fully consistent
with its primary mission - price stability. A low and stable inflation environment is a major factor that
supports a healthy financial system that is less vulnerable to crises. Under our inflation targeting
framework adopted since 2002, headline inflation is being kept within the 4-5 percent range. This
range may be temporarily breached due to intense supply side pressures such as what we are seeing
today due to abnormal oil markets, but we expect inflation to eventually revert to within the target
range.
However, we realize that achieving price stability is not enough if we are to help fast track capital
market development. More direct action is necessary. In this regard, our initiatives include advocacy of
better corporate governance and transparency, widening of investor base, and promotion of sound
market infrastructure.
We are championing better corporate governance and financial transparency so that investors will
have more confidence in placing their funds and have more reliable financial information to guide their
judgments. Although our natural starting point has been the banking system, the impact goes well
beyond that as banks themselves enforce better standards of governance in their corporate clients
that prepare them for the capital market.
In the same vein, we are demanding higher standards of conduct from external auditors so that
reliable financial statements can be properly enforced. We are complementing the governance
initiative by developing a program to promote improved financial literacy so that investors can impose
proper market discipline.
You will also note that we have been enforcing more stringently mark-to-market regulations and
looking at their further strengthening. Our aim is not just to improve financial transparency but also to
promote more active secondary market trading.
In a further move to improve financial transparency, we are also gearing towards aligning local
financial accounting standards with the International Accounting Standards (IAS). We are optimistic
that adopting the standards will help promote fairness, accuracy and transparency in the financial
statements of banks and other supervised institutions. This would help in strengthening market
discipline, encouraging sound risk management practices, and stimulating the domestic capital
market.
Other related initiatives aimed at improving transparency in the financial markets include the nurturing
of domestic credit rating agencies and the establishment of a unified credit bureau. We expect to have
the latter to be up and running by mid-2005.
A major project being implemented currently is the institutionalization of a system of independent
securities custodians. This is primarily aimed at protecting investors from fraudulent acts of multiple
securities sales and to discourage undocumented transactions. More positively, the custodian system
will support the eventual growth of securities borrowing and lending that will help promote market
liquidity.
We have systematically tightened prudential and risk management standards. This will definitely
strengthen the banking system. In the process, risk-based capital requirements based on the Basle
framework have stimulated the issuance of tier 2 subordinated debt as part of the recapitalization
process. Down the road, as the stock market recovers, banks should be issuing more equity to bolster
tier 1 capital.
We intend to bring the banking system in compliance with Basle 2 by 2007. In preparation, we are now
requiring universal and commercial banks to formally set up a minimum internal credit risk rating
system for the underwriting and ongoing administration of corporate credit exposures. This is
embodied in Circular No. 439 which also requires that in rating corporate clients, banks use only
financial statements audited by sec-accredited external auditors.
Moreover, in quick succession, we have issued tougher standards on the management of large
exposures, on single borrower limits, and on DOSRI lending. These will likely spur corporate
borrowers to diversify their funding sources beyond the usual friendly banks and in the direction of the
capital market.
But not all regulatory initiatives have been towards tightening. We have also introduced changes to
remove obstacles to capital market development and create opportunities for banks with respect to
capital market related business. These include selective lowering of reserve requirements for repo
transactions that meet certain standards as well as for other financial products. Over the medium-term,
we hope to effect a phased generalized lowering of reserve requirements to be more competitive with
low reserve requirement regimes found in most other countries.
We have likewise allowed the introduction of new and innovative financial instruments in the domestic
market, including complex structured products under appropriate regulatory arrangements.
Recently, we have launched an initiative to reform the common trust fund (CTF) and replace it with a
better product called the unit investment trust fund (UITF). It will be better in the sense that its assets
will be marked-to-market daily so that investors will not be misled as to the real performance of their
investments. These should avoid any residual risks to the bank as asset manager. As an investment
product, UITFs will be more competitive as it will no longer be subject to reserve requirements as
these are no longer effectively considered as deposit substitutes. We expect UITFs to eventually
evolve into major institutional investors in the capital market competing against mutual funds and other
collective investment schemes.
We are also intensifying our coordination efforts with other financial regulators so that we can achieve
a more level regulatory playing field. In July 2004, a Memorandum of Agreement was signed by the
BSP, the Securities and Exchange Commission (SEC), the Insurance Commission (IC) and the
Philippine Deposit Insurance Corporation (PDIC) to formally establish a Financial Sector Forum (FSF).
This further enhances coordination arrangements among the concerned agencies, particularly with
regard to more effective supervision of financial conglomerates, to information exchange, and to
consumer protection.
Aside from developing a more conducive regulatory environment, we are helping develop appropriate
market infrastructure. In this regard, we are strongly supporting the private sector initiative, led by the
BAP, to establish the fixed income exchange and its related infrastructure to ensure efficient and safe
clearing and settlement of securities transactions.
Finally, our reform initiatives are benefiting from the support of Congress which has decisively acted
on certain vital pieces of legislation including the elimination of DST on secondary trading, the SPV
Law and the Asset Securitization Law. All of these measures will help spur the domestic capital
market. The BSP has worked hard with other interested partners to get these laws enacted and we will
continue to do so for other pending legislation that support capital market development.
Although much progress has already been made, the work is still far from over. The BSP will continue
to push for more reforms in the financial system, specifically: (1) a special legislation to support a
strong credit reporting system; (2) the enactment of a more balanced bankruptcy resolution
framework; and (3) the enactment of the proposed changes to the BSP Charter to strengthen our
ability to clean up the banking system and properly enforce prudential standards.
We particularly attach great importance to the amendment of the BSP Charter. Unless we are able to
properly police the banking system with sufficient powers, we will be constantly plagued by a
vulnerable banking system. A vulnerable banking system will not be responsive to our financing
needs. And because banks play important roles in support of the capital market whether as investors,
underwriters, managers, market makers, issuers and guarantors, a weak banking system will also
hamper their development of the domestic capital market.
Conclusion
The financial sector reform agenda is a truly major task. We need to move boldly across a broad front.
Neither the BSP nor the government as a whole can do the job alone. We need to work together, the
public and the private sector, to build a truly progressive financial system.
Thank you very much. I hope my remarks will stimulate a lively discussion that should move us to
action.