(DP 2002-06) Bank Performance and Rate of Economic Recovery: The Philippine Case

Abstract

The paper sees imprudent lending by a weak banking system as an important and common cause of the East Asian crisis. The crisis-hit economies' banking systems had not put in place prudential rules and practices and their organization was subjugated to power politics and big business control. Many of their member banks engaged in imprudent connected lending which later turned up as non-performing loans, NPL. These have real and financial costs. Bad investments produce smaller or even zero value added  thus slowing down growth. Banks' fund supply falls when loans do not get repaid. NPL also reduce banks' interest income and raise their collection and other transactions costs. The health of the Philippine banking system is analyzed in terms of aggregate and cross-section performance indicators such as sources and uses of funds, NPL/loan ratio, NPL/equity ratio and capital/asset ratio. Performance, as gauged from these ratios, varied widely accross banks. NPL ratio ranged from 8% to 69%. Six banks had serious NPL ratio exceeding 20% and NPL/equity ratio much exceeding unity. Bank performance is not explained by size or state-private ownership. Two of the problematic banks were large state banks and four were private of varied sizes. The problematic banks composed a relatively small segment of the system so that thier insolvency did not cause a systemic bank run. A core group of fairly strong private banks had existed and withstood the turmoil of the past three decades including the 1983-1985 economic crisis, the 1989-1991 recession and the Asian crisis. They had acquired a reputation of good banking. It appears that their presence had preserved the people's confidence in banking so that a systemic bank-run was avoided. Depositors did not react in a herding manner, they were discriminating in their response to the crisis and to the news of specific bank failure. NPL has contributed to the slow recovery of the economy as the banks are unable to increase credit and lower interest cost.