Integrated Financial Supervision: The Way Forward for the Philippines?

Following Lim and Pascual (2001), the need for strong institutions and governance structures forms the basis of the study. As noted by de Dios and Hutchcroft (2003), the most fundamental need in the Philippines is to improve the overall performance of government, insulate it from the plunder of oligarchic groups, and promote new types of private sector initiative. This includes strengthening financial regulatory agencies, given the critical role that the financial sector plays in economic growth. Thus, any effort to reform the financial supervisory structure must explicitly address this most fundamental need.

Clearly the issue of oligarchic groups is very relevant to the banking sector, since the parent companies of most banks are mixed-activities conglomerates. In particular, many of the biggest private domestic universal banks also belong to the biggest holding companies in the country, which have significant holdings in such industries as manufacturing, construction, telecommunications, transportation and retail trade.²⁴ Under the current legal framework, BSP does not have the authority to examine non-bank parent companies. Will a single financial supervisor be able to enhance the role of state, tame powerful private interests, and promote distributive justice in the Philippines, which Zhang argues are the essential political underpinnings of financial policy management and market governance? This is likely only if the financial regulatory and supervisory agency is made independent, and it is empowered to regulate the ownership of a bank to guard against effective control by a party that has an interest in securing related party loans, e.g., a party that also controls a non-financial corporation. That was the case in the Republic of Korea. Of course, clear measures to ensure accountability also have to be put in place to guard against regulatory capture, including accountability for the overall development of the financial sector and consumer protection.

The issue of family-based commercial banks used to be addressed through strict limitations on the maximum ownership share of Filipino individuals, family/business groups and corporations, and limits on loans to directors, officers, stockholders and related interests (DOSRI). Previously, under the old General Banking Act, a Filipino individual and/or family group (individuals related up to the third degree of consanguinity or affinity) could not own more than 20% of the voting stock of a domestic bank, while the ceiling for domestic corporations (not wholly or majority owned by an individual or family group) was set at 30%. Under the new General Banking Law of 2000, the ownership ceilings were raised to 40% for Filipinos and domestic nonbank corporations. However, even such ceilings seem to be nonbinding in practice, in terms of who effectively controls banks in the Philippines. Clearly, the appropriate structure for bank ownership is an issue that needs to be further examined, particularly the desirability of imposing bank holding and financial holding company structures. It should be noted that the ownership pattern of banks has not led to any significant growth of the banking sector in the past 25 years, and has adversely affected the development of the equities and corporate bond markets as well.

In addressing the issue of reforming the financial regulatory/supervisory in the Philippines, it would be instructive to examine it both from the structural point of view and the institutional point of view.

From the structural point of view, the level and nature of financial conglomeration does not warrant a dramatic shift toward a single financial supervisor. Since financial conglomerates are essentially banking in nature, effective supervision of banking groups is the key. What is needed then is to ensure that BSP can adequately undertake this function, including expanding the scope of its authority if necessary. However, a bigger issue is the weak regulatory framework over nonbanks. Putting up an independent regulator for nonbanks as a complement to the already independent central bank may be considered but it should be seen as a preliminary step to further liberalize and deregulate the nonbanking sector to promote its development. Some coordination mechanism can then be designed with BSP, including assigning lead regulator functions to BSP over universal banks. But it should not be placed under BSP; the goal is to establish a regulatory agency that is at par with BSP, and hence able to inspire consumer confidence and promote the development of the nonbanking sector as a complement and alternative to banks.

On the other hand, transforming BSP into a single financial regulator as well would be ill- advised. Given the dynamics between the state and the dominant business groups, it would unduly extend the financial safety net because the central bank’s lender of last resort function is likely to be seen as extending across all financial institutions, thereby worsening the moral hazard problem. A more important consideration is the potential negative impact of such a move on the safety, soundness and systemic stability of the financial system.

Finally, creating a single financial supervisor separate from the central bank is something that can be considered much later, after issues relating to the overall institutional environment have been dealt with. This would include amending the Constitution, which expressly assigns the supervision of banks to BSP as the central monetary authority. Such a reform would also be facilitated if the necessary expertise in regulating the different financial sectors has already been developed; that is, if upgrading of regulatory capacity and regulatory harmonization have been undertaken. The analyses in the previous sections indicate that key institutional characteristics must already be in place to undertake such a reform successfully, including sound political and legal systems and enforcement mechanisms. In particular, Barth et al. (2007) noted the dangers of strengthening official supervisory power without putting in place political and legal institutions that would induce politicians and regulators to act in society’s best interest instead of furthering their own interests. Given the overall quality of institutions in the Philippines and the time it would take to strengthen them, smaller scale reforms undertaken over time would be easier to manage, rather than a comprehensive institutional reform.

At this point, the issue with respect to financial regulatory/supervisory structure is not how many per se, but how strong, effective and competent are the financial regulators. In the Philippines, independence is important to safeguard the regulators against political intervention. At the same time, the emphasis must be on consumer protection and financial development to minimize the possibility of regulatory capture. Policymakers hesitant to support such a move towards independent regulators due to the fear of ceding power may be convinced to do so if a strong enough argument is made that the general public will ultimately benefit; that is, independence will lead to long-term benefits for financial sector soundness and stability. Strong public support for such a reform would also serve to neutralize opposition from the dominant family/business groups. Also, policymakers need to be persuaded that accountability arrangements should serve to bolster rather than rein in this independence, which is possible if the arrangements are well designed (Quintyn et al., 2007). Hence, the importance of subjecting any proposed reform to in depth studies, which should be made publicly available and subject to public debate, in order to promote understanding and hence appreciation for the reform.

As the literature concedes, every form of supervisory structure entails both benefits and risks. This accounts for the absence of a consensus on the best financial supervisory structure. But it is debatable whether coming up with such a consensus should be a goal in itself. After all, the whole point of bringing institutions into the analysis is precisely to capture country-specific factors in order to come up with the best form for a particular country. That being said, developing financial systems and deepening the reform process will ultimately rest on a clear understanding and appreciation of, and strong commitment to, strong regulatory frameworks as being in the national interest.

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