Felipe M Medalla: Banking on solid ground - the role of banks in
postpandemic recovery
Speech by Mr Felipe M Medalla, Governor of Bangko Sentral ng Pilipinas (BSP, the
central bank of the Philippines), at the Bankers' Association of the Philippines (BAP)
2nd CEO Forum, Manila, 24 October 2022.
* * *
To our friends - my friends - in the banking industry, my own colleagues from the
central bank who are here, guests, good afternoon. It is great to see familiar faces,
especially after what I thought was a very joyful reunion that we had at the central bank
after almost three years.
Thank you for inviting BSP to your second CEO Forum and for the opportunity to speak
to all of you. We at the BSP have always valued these kinds of discussions. Indeed, I
look forward to what you have to say after my speech. Do not worry if it is critical of the
central bank - I will not remember if it is you who said it; I will blame it on another bank.
Clarity of Policy Intent
I have always believed that the BSP is more effective when you understand us - not just
what we do, but why we do it - especially at a time like this where there is so much
confusion. "Is the central bank still an inflation-targeting central bank, or has it become
an exchange rate-fixing central bank?" Because-if you are fixing the exchange rate,
then your interest rate is [equivalent to] the US interest rate plus the risk premium. In
the absence of risk, like depreciation, [and] because no country ever defaults on its own
currency, then we just go to where it is [the interest rate] higher, as shown in Hong
Kong. Hong Kong cannot have an interest rate different from the United States. Indeed,
I ran a few regressions where the correlation between market rates in Hong Kong is
much closer to the United States than any other country in the sample that I have for a
very simple reason - it is a fixed exchange rate. So, this has to be explained: why does
it seem like we are "too concerned" about the exchange rate? Why were we not as
concerned before? But before I do that, I must address the topic, which is your role.
Congruence of Goals
In summary, your role is very simple: do your job well. There is no other industry where
doing your job well is as close as it can be to serving the country. Of course, that [also]
applies to central bank governors because our job is to do things for the country. In your
case, you are doing business [and] seeking profits, but if you do it well and do it under
the rules, you are actually serving the country. That is not a new thing. There are times
when self-interest and the country's interest can coincide, and I cannot think of a better
example of that than of a banker who follows the rules.
Now, a colleague of mine... found that a collapse of a stock market bubble hurts the
economy a lot less over the medium run than a collapse of a real estate bubble. The
collapse of a real estate bubble is linked to a long period of abnormally low growth rates
for three, four, even five years, while the collapse of the stock market bubble had [little
to] no effects on the economy. Of course, she did not explain why that is the case, [but]
I have a simple explanation: banks do not lend to stock market speculators. They lend a
lot to real estate. So real estate... [when it slows], it hurts the banking industry, which in
turn, results in banks being too risk-averse and, therefore, a prolonged period of slow
growth.
Indeed, this concept is not in the textbooks: the concept of balance sheet recession.
When balance sheets get destroyed [by a crisis], the economy grows slower. Because
as anyone who has taken a course in accounting knows, a lot of lending happens to be
based on balance sheets, and there is nothing like a weak balance sheet to make
people risk-averse. So, if it is the balance sheet of the banks that are weak, the impact
on the economy is prolonged. During that period of balance sheet fixing, we experience
abnormally low periods of growth.
Fortunately, we learned that from the Asian Financial Crisis. Fortunately, our
regulations, which we got [and enhanced] from previous dialogues with you,
acknowledged that that was very important. [Deputy Governor] Chuchi [Fonacier] will
testify to that. We had lots of debates about how quickly we will move towards Basel II.
Maybe we are moving too fast? And we decided, no, there is no such thing as moving
too fast. I think it's now paying dividends.
Of course, we are running out of acronyms to discuss all this: LCR, Net Stable Funding
Ratio... I forgot all the acronyms that we watch. Of course, I have been told,
"Sometimes, you are overwhelming us, bureaucrats. You are overwhelming us with
tools!" But it turns out those tools work.
My point is that banks play a huge role. Anybody in the private sector could have the
same responsibilities as a public official. By the way, I take my oath as a public official
very seriously. The last line says, "no intention of shirking from the responsibilities of
performing your duties." The last part has something to do with following God - even if
you are an Atheist, you will take that oath seriously. Because even if you do not believe
in God, you have your own conscience.
Now, I will go quickly to the slides. Banks sustained solid footing during the COVID-19
pandemic: adequate capital buffers, expanding assets, ample liquidity, growing
deposits, and lending have recovered. So, the best way to summarize this is that you
have grown without sacrificing safety. You have grown without sacrificing stability. Our
banks are growing in a healthy way without sacrificing the stability of the system and, at
the same time, protecting depositors.
Of course, that is the entire point of capitalization requirements. [Deputy Governor]
Chuchi [Fonacier] always tells me this: capitalization should match the riskiness of your
assets. Now, in other words, if you lose money, it should be your money, not your
depositors' money.
It is hard to think of economic development without thinking of institutions. It was said,
"The reason a market-based economy progresses is because people's creativity is
empowered." And you want to do things that are good for yourself...but it is not just you
that benefits, but [also] the entire society. But it was also said that for societies that are
most progressive, a very important part of that are the things that you are not allowed to
do. Of course, 'Thou shall not kill.' 'Thou shall not steal.' 'Thou shall not covet your
neighbor's wife.'
My point is that we must give credit to the industry, and we must give credit to all of you
who were young folks during the Asian Financial Crisis. I think this is one reason why
we are successful. Now, we have people who are running the banks [that] do not see
the Asian Financial Crisis as a theoretical thing; they were actually there when it
happened. They were not running the banks [at that time], but they were close enough
to the action to know that that should never happen again. Regulators, too, said that
should never happen again. We should have larger reserves despite [contrary] advice
from the IMF. By the way, the Bank for International Settlements (BIS) - the other
source of thinking - said Asian central banks were actually correct in building up
reserves. Of course, the question now is, what do you do with those reserves now that
times are getting challenging?
If I were to lecture now and talk about the topic, that is it. You are doing a good job. You
are doing it by following regulations. You are serving the country. And as we engage in
dialogue to finetune and improve the regulations, we become an even better economy.
A good sign is your own patience in us not fulfilling our promise to make the reserve
requirement a single digit, that you are willing to wait until June 29, 2023. Note that at
these trying times, the most effective thing to do would be to raise the reserve
requirements. And we are not doing it. We think we should use market-friendly tools to
reduce excessive liquidity. Of course, that is why we are growing our issuance of
central bank (CB) bills. That is why we are hoping you will sell down some of your bills
to your trust department. Because our research shows that sterilization of excess
liquidity by borrowing from banks is the weakest form of sterilization because you can
change your mind and lend the money [instead]. On the other hand, deposits in the
trust accounts are more sticky; these tend to get rolled over. Fortunately, the law now
allows the BSP to borrow from the public. Of course, it is more convenient that it has
done in primary auctions where only the banks can participate. That is why we are
simplifying the rules on prohibitions on foreign money and non-resident funds in our
monetary operations facilities. [We issued a circular where] if 10 percent of the fund is
non-resident, it's still [classified as a] resident.
This is the very thing - the regulators and the regulated industry have this constant
dialogue. We understand each other, and you understand why we do what we do.
I admire that you are working on corporate risk governance. Of course, we have
dreams of incorporating environmental risks into the [financial] system. [From] my point
of view, we are rounding error in global warming, but we should not forget that
environmental risks may also affect default rates. We hope the banks will incorporate
that when pricing their loans. That is my last message on our second pillar.
Challenges on the road to a Target-consistent Inflation Path
There are two more pillars. The first one, of course, is price stability. Now, let us go to
the first pillar. What you can see is that we have adjusted our [inflation] forecast.
What it is saying is that our [average inflation] forecast [for 2022] is 5.6 percent. The
simple explanation for that is that while it [the latest inflation print] is 6.9 percent, the
earlier months were much lower, so the [full-year] average is forecast to be 5.6 percent.
If not for the earlier months, this [full-year figure] would have been 6 percent or even 6.5
percent.
What we are saying now is the average inflation next year that we foresee - by the way,
this does not take into account a lot more actions that we will take. I said, and I hope my
colleagues in the Monetary Board will forgive me [for saying], "If I am the only one
voting, I will match the next Fed increase." The interest rate differential has just become
too narrow. And I really do not believe in imposing capital controls - it does more harm
than good... a country that cannot limit the number of buses on EDSA, a country where
half the vehicles are colorum, has no business imposing capital controls. All that will do
is the flows will get disguised as "trade" flows. Therefore, we now have to go and
examine every trade flow...There are short-term returns, but there is a long-run cost to
doing such.
This is the other [good] thing you will notice about us. We could have gone back to the
old days, imposing all these restrictive capital [rules]...So when you see [BSP
Treasurer] Winnie [Santiago] and [BSP Financial Supervision Deputy Governor] Chuchi
[Fonacier] together, we are angry. But we will never impose capital controls.
What this means, of course, is that we believe that the inflation rate in the first half of
next year will remain high - but it will be closer to 3 percent in the last half. But on
average, there is more than a 50/50 chance that we might miss it. That is why it is 4.1
percent, not 4 percent. We are hoping that it will at least be more than a 50/50 chance,
and I now believe we must be a little bit more aggressive, also because the economy
can withstand it. Maybe, after all, the IMF is right? The IMF [growth] forecast is 5.5
percent; ADB is 6.2 percent. Of course, I believe in the DBCC [growth target] - 6.5
percent.
That said, I have been quoted in the papers that I believe that the Fed will do another
75 bps [hike]. How exactly we will respond to the future actions of the Fed, we will be
data-dependent. But, in my view, the data already says that given their inflation, given
what is happening to the exchange rate, we must respond to the Fed point by point. If
they do 75, we do 75. If they do 50, we do 50. If they do 1 [100 bps], we do 1 [100 bps].
The point is that we have to bring back inflation to a target-consistent path...I was
looking at an article that says the level of the Fed raises are not the highest, but the rate
of increase is the highest. Maybe, to some extent, it's partially true here [in the
Philippines].
Now, let me go back. Why was there a need to act? Because of the pandemic. The
pandemic hurt us so much that if we had not acted, the economy would have
contracted by 15 percent rather than 10 percent. So we brought the policy rate to a
record-low of 2 percent. We extended 600 billion in interest-free loans to the
government, which they have already paid. In addition, the bond markets were going
crazy. The theory says the pandemic will reduce demand for capex and increase the
motive to save; therefore, interest rates will fall. But the markets were doing exactly the
opposite. Because as [former Bank of England governor] Lord King said, "The
Philippine preference will dominate the equilibration of savings and investment." Since
"savings and investment" is very Keynesian, it must always be equal in the end. The
only way it will be equal is if people become poorer. If the plan to save becomes too
much, the only way to reduce it is if people must have less to save. This is the classic
Keynesian recession. The BSP did not like that, so we were aggressive. We thought, at
that time, [as the economy was emerging] out of the pandemic, rising yields would
destroy confidence, destroy the economy to the point that we would not recover.
And the plan was to exit from that [accommodative measures] gradually. If you noticed,
our first two [rate] increases were 25 bps. But of course, a lot of things have changed -
the Ukraine war and the fact that while everybody was forecasting US inflation will be
low and transitory, what happened? Exactly the opposite: [US inflation was] high and
persistent. All these things together made us exit a lot faster than we planned.
What was the result? The result, of course, if you compare the two, we raised our policy
rate by 25 bps, 25 bps, 75 bps, 50 bps, and 50 bps. In the case of the US, they did 25
bps, 50 bps, 75 bps, 75 bps, and 75 bps. We did not match the Fed. But then, in the
process, the interest rate differential would become too narrow. If they do another 75
and we will do [only] 50, the differential would be much too narrow for comfort.
Calibrating the Policy Levers in our Tool Kit
If you look at it, it is really true that what you have is a strong dollar and not a weak
peso. Of course, if you are the person who is being hurt by the exchange rate, you will
not care about the difference - imported goods are still expensive because [they are]
dollar-denominated. If you notice, if you take out the JPY and KRW and add the Euro,
take out the HKD, SGD, and IDR, the other currencies are almost all the same on the
chart. Indeed, the reason the HKD is different is because it's pegged to the US dollar.
And Indonesia. Why [did they depreciate by only 8.5 percent]? They actually benefitted
[from high energy prices]. Coal went from $50/ton to $200/ton. If you take out those
things, you will notice we are all being affected the same way. Of course, in our case,
one of our strengths is that we have more than ample reserves and we have very
durable remittances. Large as it is, our remittances are still growing by 4 percent, even
during the worst of times. Of course, we also have BPO and FDIs.
In general, what we are doing is actually quite simple: three tools. One is adjust interest
rates. The second one is let the peso-dollar rate serve as a shock absorber. Since this
shock tremendously increases the price of our imports, the price of dollars will rise.
Therefore, we must let the currency adjust. These are fundamental. But if too much of
that adjusting takes place, then the exchange rate becomes a political issue. And that
can complicate central banking. Therefore, it is nice to sell reserves as well. The IMF
says use [tool] 1 and [tool] 2 and wait very long before you use [tool] 3 [to sell forex
reserves].
Then, of course, we hope that the government will use non-monetary measures that are
market-friendly: import the things you do not produce very well - sugar, for one, and
meat because we were hit by Swine flu. We are confident that that is going to happen.
We are hoping that a combination of these four medicines will help us achieve a
targetconsistent path of inflation, hopefully with the least amount of output loss.
Another option is we increase the size of our borrowings from you, which will actually
reduce liquidity. When you look at the BSP, we have the policy rate and what we call
the weighted average of our CB bills. If you look at the average of our TDF and the CB
bills, the gap between these and the policy rate has widened. That is a more subtle part
of monetary policy. It allows us a little bit more flexibility.
I will probably cut the discussion on financial inclusion and digital payments because I
cannot do justice to these topics without doing 15 more minutes. So I will skip these
slides.
Concluding Thoughts
Let me end by saying that times are indeed very challenging. This is, to say the least,
probably the most difficult time I have observed since I joined the Monetary Board. It is
not a difficult time for me; the difficult time is when my wife says, "Do not eat this. Do
not eat that." That is the problem when you are married to a nutritionist. But I am
confident that, with your help, we can navigate through these challenges.
As we make our way out of the pandemic, the BSP will continue to rely on the collective
efforts of banks in achieving our primary objectives. Rest assured that we at the BSP
will continue to foster an enabling environment for the financial institutions under our
supervision.
This year and beyond, I trust the BAP will continue to be a reliable and excellent partner
in nation-building and the more difficult task of rebuilding.
Beyond the numbers and business targets, I hope we can count on your support to
bring more Filipinos into the fold of the formal financial institution and help them move
up in life. By casting a wider net, more Filipinos will be able to leverage the benefits of
financial products and services. In turn, more Filipinos will be able to contribute to
economic growth.
Maraming salamat na inimbita niyo kami dito.