Banks in the Philippines could experience a systemic solvency impact if additional downside risks materialize despite their ability to withstand the exceptionally severe shocks, according to the International Monetary Fund (IMF).
In a report released over the weekend, the IMF said the key risks to financial stability stem from the coronavirus disease 2019 (Covid-19) pandemic and bank-corporate linkages.
“Distress to the corporate sector could be widespread even in the baseline and sharply rise in adverse scenarios, elevating credit risks to banks,” it stressed.
In the baseline scenario, the IMF said banks’ total capital adequacy ratio (CAR) slides from 15.6 percent to 11.7 percent by 2022, still higher than the 10-percent minimum requirement even without sectoral policy effects.
However, CAR plunges to 9.3 percent in the adverse scenario, and 4.9 percent in the severe adverse scenarios.
“The second-round effects from such distress might reduce the real GDP (gross domestic product) level by an additional 4 to 9 percentage points in adverse scenarios,” the IMF also underscored.
Despite this, it said CARs start to recover in 2022 as the economy rebounds.
Given the significant downside risks, the institution added authorities should limit bank dividend distributions, and be ready to take additional measures to strengthen banks’ capital if the risks materialize.
Given the potential for large loan losses, the authorities should limit banks’ dividend distributions as a precautionary measure. If downside risks materialize, banks should recognize nonperforming loans and restructure them promptly with additional capital as needed, it recommended.
“This is supported by a counterfactual policy analysis and the experience after the AFC (Asian Financial Crisis), which suggest that such actions could improve GDP with sustained credit provision,” the IMF continued.
Furthermore, it suggested that the Bangko Sentral ng Pilipinas should allow the forbearance measures such as loan moratoria and credit guarantees to lapse as scheduled and avoid introducing new measures.
The IMF said forbearance does not address the underlying issues in weak banks and hampers banks’ ability to continue providing credit and ultimately may even undermine financial stability.
“Instead, the authorities should continue to use the flexibility of the tools available in the accounting and Basel capital framework, and, looking at the future, further develop and use macroprudential tools and buffers,” it emphasized.
The institution added that downside risks to the banking system also underscore the importance of further strengthening the bank resolution framework.
It said the Philippine Deposit Insurance Corp. should be designated and given powers to act as the resolution authority. Also, the resolution toolkit should be broadened beyond liquidation and possibly with a statutory bail-in tool.
Besides, the purchase and assumption tool should be expanded. While implementing these structural reforms requires amendments to laws and will take time, some action can be undertaken immediately, the IMF also highlighted.
“The authorities should also start working on resolvability assessments and resolution plans for individual banks, starting with D-SIBs. The cross-sectoral coordination mechanisms to manage the potential failure of a D-SIB should be enhanced and tested,” it added.
D-SIBs stands for domestic systemically important banks.