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  • Determinants of Credit Growth and Interest Margins in the Philippines and Asia

    Tatum Blaise Pua Tan

    WP/12/123

  • 2012 International Monetary Fund WP/12/123

    IMF Working Paper

    Asia and Pacific Department

    Determinants of Credit Growth and Interest Margins in the Philippines and Asia

    Prepared by Tatum Blaise Pua Tan1

    Authorized for distribution by Rachel van Elkan

    May 2012

    This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

    Abstract

    Despite robust deposit growth, credit growth has been sluggish in the Philippines. We attribute this to legacy weaknesses in bank balance sheets, consumption-led economic growth, and relatively high net interest margins. Bank-level analysis suggests that interest margins in the Philippines rise with bank size, bank capitalization, foreign ownership, overhead costs and tax rates. Using bank-level data for a number of Asian economies, we find that higher growth, lower inflation, higher reserve requirements, greater banking sector development, smaller stock market development and lower government deficits reduce net interest margins, informing the policy debate on strengthening financial intermediation in the Philippines.

    JEL Classification Numbers: G21, O16, O53 Keywords: credit growth, net interest margins, Philippines, Asia Authors E-Mail Address: ttan@imf.org

    1 Ms. Tan is Bank Officer I at the Bangko Sentral ng Pilipinas (BSP) and was research associate in the IMF-Manila Office of the Resident Representative in 2011. The author is grateful to Dennis Botman, Vivek Arora, Rachel N.van Elkan, Jay Peiris, Ola Melander, and Yoga Affandi from the IMF and to Diwa C. Guinigundo, Ma. Cyd N. Tuao-Amador, Johnny Noe E. Ravalo, Rosabel B. Guerrero, Jose Ernesto N. Gonzales, Regina C. Juinio, Racquel A. Claveria, Hazel C. Parcon, Rosario D. Soriquez, Rebecca E. Abis, Jade Eric T. Redoblado and Cristeta B. Bagsic from the BSP for their valuable suggestions and support.

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    Contents I. Introduction ........................................................................................................................... 3II. A Brief Overview on the Philippine Banking Industry ........................................................ 6III. What Drives Private Credit? ............................................................................................... 7

    A. Data and Methodology ..................................................................................................... 7B. Empirical Results ........................................................................................................... 10

    IV. What Drives Net Interest Margins? .................................................................................. 12A. Data and Methodology ................................................................................................... 12B. Empirical Results ........................................................................................................... 16

    V. Conclusions and Policy Implications ................................................................................. 20References ............................................................................................................................... 22 Figures 1. Private Sector Credit Growth across the Region ..................................................................3 2. Private Sector Credit across the Region (as a percent of GDP) ............................................4 3. Gross International Reserves and Special Deposit Accounts ...............................................4 4. Credit and Deposit in the Philippines ...................................................................................4 5. Net Interest Margin across the Region..................................................................................5 6. Total Resources of the Philippine Financial System ............................................................6 7. Non-Performing Loans and Non-Performing Assets Ratios ................................................6 8. Investment Rate (as a percent of GDP) .................................................................................9 9. Consumption Rate (as a percent of GDP ..............................................................................9 10. Consumer Loans ................................................................................................................11 11. Herfindahl Index Across the Region..................................................................................19 12. ATM-to-Branch Ratio ........................................................................................................19 Tables 1. Regression Results on Determinants of Private Credit Growth..........................................10 2. Correlation Matrix for the Explanatory Variables of Net Interest Margins in the Philippines.............................................................................................................................12 3. Gross International Reserves and Special Deposit Accounts .............................................16 4. Regression Results on Determinants of Net Interest Margins in Selected Countries in the Region .........................................................................................................................18

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    I. INTRODUCTION

    Lingering structural and regulatory fragilities in the financial system of advanced economies emerged front and center during the recent global financial crisis, adversely affecting many emerging economies along the way. This serves as a stark reminder of the importance of a sound and well-functioning financial system in facilitating economic growth. The Philippine financial system weathered the global financial storm well, owing to significant reforms since the Asian financial crisis that have led to high capital-adequacy ratios, low non-performing loans, strong banking supervision, and generally risk-averse behavior by the banking community.

    With macro stability generally ensured, the attention of Philippine policymakers is now shifting towards achieving higher and more inclusive economic growth that includes, among others, the acceleration of financial sector development as elaborated in the Philippine Development Plan 2011-16 (2011). Several studies relate the development and efficiency of the financial system to economic growth. Levine and Zervos (1998, p.554) analyzed 47 countries over the period of 1976-1993 and concluded that financial development and economic growth are indeed positively related and that financial dynamics are a vital part of the growth process. Their results revealed that both stock market liquidity and banking sector development have a strong and positive relationship with contemporaneous and future rates of economic growth, capital accumulation, and productivity growth. Calderon and Liu (2002) tested the causality between financial development and growth over the 19601994 period for 109 countries and found that financial development improved economic growth, particularly through faster capital accumulation and growth in productivity. In addition, they found a bi-directional causality when the sample was divided between developing and industrialized countries implying that economic expansion promotes financial deepening, especially in developing countries, and vice-versa.

    So how exactly does a well-functioning financial market contribute to economic development? Levine and King (1993) used an endogenous growth model and systematically disentangled the mechanisms behind the causality. According to the authors, financial systems are able to assess prospective entrepreneurs, channel savings to projects with the highest potential productivity, allow diversification of risks associated with innovative pursuits, and disclose probable returns for undertaking such activities. Khan (2000) agrees with some of the said views and at the same time, provided additional insights, like the financial systems ability to generate liquidity for both short- and long-term projects and facilitate trade as a creditor as well as a guarantor.

    Given the importance of the financial sector for growth, private sector credit growth in the Philippines, albeit the recent uptrend, remains weak (Figure 1)

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    2002 2003 2004 2005 2007 2008 2009 2010

    Figure 1: Private Sector Credit Growth across the Region (in percent, 2002 - 2010)

    China,P.R.: Mainland China,P.R.:Hong Kong China,P.R.:Macao Indonesia Korea, Republic of

    Malaysia Philippines Thailand Vietnam Singapore

    Source: International Financial Statistics and Staff Calculations

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    consistent with a relatively lower credit-to-GDP ratio compared to most other countries in the region over the period 200210 (Figure 2). Private credit growth in the Philippines, as a percent of GDP, is not only sluggish but on a downtrend. This is surprising given the emergence of excess liquidity in the Philippines since the mid to late 2000s as evidenced by the expansion in the BSPs Special Deposit Accounts (SDAs), which was created for its liquidity-management operations as it is not allowed under its charter to issue its own securities (Figure 3). The substantial increase in SDAs ov

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