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PHILIPPINE INSTITUTE FOR DEVELOPMENT STUDIES Surian sa mga Pag-aaral Pangkaunlaran ng Pilipinas Policy Notes February 2003 Where Are the Benefits of Foreign Bank Liberalization? Rene B. Hapitan* he Philippines undertook its biggest effort to liberalize the financial sector when it passed the Foreign Bank Liberalization Act of 1994 (Republic Act 7721) that allowed 10 foreign banks to enter the banking system. The intention of this Law was to “create a more competitive environment and allow greater foreign participation.” Ten years after its implementation, though, have the benefits expected from their entry such as increased variety of financial services, increased intermediation activities, and adoption of new technologies already been felt? T This Policy Notes provides an analysis of the impact of the entry of these banks on the country’s banking system. The analysis is based on the results of a survey and study earlier conducted by the author regarding the __________ * The author is Assistant Professor at the College of Business and Economics, De La Salle University-Manila. No. 2003-01 perceptions of local banks on the entry of these foreign banks. Perceptions by local banks on the entry of foreign banks In order to understand the effects of the entry of foreign banks in the local banking system and the way that local banks view such entry, the author conducted a survey among 10 local banks in the Philippines. The 10 local banks consisted of six universal/commercial banks, two government-specialized banks and two savings/thrift banks. All in all, the survey respondents owned 54 percent of the total assets, 65 percent of the total deposits and 62 percent of the total capital of the entire Philippine banking industry as of December 2000. Among others, the survey results reveal the following: X There was a shift in competitive activity after the entry of foreign banks. X This competitive activity was most significant in the wholesale banking sector, specifically in loans, deposits, investment banking, and foreign exchange transactions. X Other “nonbanking” factors that were affected were fund sourcing and hiring of employees. PIDS Policy Notes are observations/analyses written by PIDS researchers on certain policy issues. The treatise is holistic in approach and aims to provide useful inputs for decisionmaking. This Notes is based on PASCN Discussion Paper No. 2001-09 entitled “Reactions to the entry of foreign banks in the Philippines: a critical study of selected local banks” by the same author under the auspices of the Philippine APEC Study Center Network (PASCN). The views expressed are those of the author and do not necessarily reflect those of PIDS or any of the study's sponsors. 2 February 2003 X The total impact in terms of potential revenues was estimated to be over P500 million as a result of these competitive factors. X Among the strategies being made to address these competitive pressures were investments in new technology, increase in advertising expenses, introduction of new products and services, and movement to other niches. X While there were noticeable improvements in the banking sector due to the entry of these foreign banks, local banks feel that to maximize their entry, they (local banks) should be allowed to open branches in the countries of origin of these foreign banks. X There were mixed reactions to a possible merger of a local with any of these foreign banks, with most of the banks opting instead to consolidate their local operation rather than merge. X Local banks were in favor of legislation that will further increase the competitive environment for these foreign banks, but not in increasing their current number. ing side. This was expected as these banks, with huge global presence, will naturally service institutional accounts, aside from their own nationals. The next sections examine these results more closely as they relate to the country’s effort to fully liberalize the financial sector. Another cause for concern is the movement of competent local managers to these foreign banks. Lured by lucrative compensation packages, many local bank managers have moved to these banks, leaving behind a depleted resource. In this regard, one human resource manager of a local bank remarked, “we should have benefited when they brought in their own staff so that we can learn from them. Instead, they learned from us.” Shift in competitive entry and pressures for local banks It is important to recognize that there exists two distinct foreign bank “sectors,” namely: (a) the “pre-RA 7721” comprising of Citibank, Hongkong Shanghai Banking Corporation (HSBC), Standard Char tered, and Bank of America, and (b) the “RA 7721 10” composed of the 10 banks (ANZ Banking Group, Bangkok Bank, Bank of China, Bank of Tokyo, Chemical Bank, Deutsche Bank, Fuji Bank (now Mizuho Corporate Bank), International Commercial Bank of China, ING Bank, and Korea Exchange Bank). The “pre-RA 7721” banks, having been in the country longer, are not part of this study. They are, however, foreign-owned banks and compete and behave like foreign banks. The reactions of local banks to the entry of the “RA 7721 10 banks” have been one where considerable competitive pressure was felt, especially in the wholesale bank- Policy Notes Quantitative and qualitative impacts of foreign bank entry Is the competitive pressure enough to cause local banks to press the “panic button?” The answers may be gleaned from the following developments. The most surprising finding of the survey was the revelation that more than P500 million in potential revenues has been lost as a result of the entry of these foreign banks. While it can be argued that this represents a small drop in the total banking asset base, lost potential revenues, especially in banking, are difficult to recover. Once these foreign banks take the local banks’ clients away, the probability of said clients to return to the latter is very slim. This reverse “brain drain” in our own territory has resulted in a curious battleground where foreign banks with local managers compete against local banks with local managers. This elicited a comment from a senior management official of a local bank that contrary to his expectations of pitting wits against these foreigners, he found himself dealing with a countryman. The depleted manpower is not only from senior or top management but also from the lower to middle management. Once a foreign bank opens, applications pour in. One senior bank manager noted that they were helpless at one point. No. 2003-01 One advantage of this development, though, is that local banks were forced to source their manpower from the universities and other institutions. And to some extent, the employment base was expanded, somewhat alleviating the unemployment situation. Strategies to meet competition from foreign banks Because of the threat posed by foreign banks, it was expected that reengineering of some or most of the local bank operations would be done. However, it seems that reengineering was not the preferred response by local banks. If they undertook it at all, it was more out of good business sense rather than as a reaction to the entry of foreign banks. Several banks even mentioned that reengineering was more of a response to competitive pressure from the local, not foreign, banks. In this regard, the strategies employed to meet competition were seen to be more of a response to a “marketing” rather than a “banking” problem. Investing in new technology, going to new marketing niches, increasing advertising spending, and creating new products and services were all part of the marketing mix whereas reviewing interest rates and pricing were not even rated highly in the survey. This changed, however, with the New Central Banking Act of 2000. With this, more liberal branching guidelines have allowed foreign banks to take advantage. Among the most significant was the acquisition of HSBC Bank of a savings bank network, allowing it to leapfrog the tedious process of acquiring a savings bank license. The acquisition is significant as it signals a clear intention to bring competition to the retail banking sector. Should other foreign banks follow HSBC’s lead, there will be a “crowding-out” effect that will reach all the way to the retail banking sector. This will bring the fight to where the local banks have a distinct competitive advantage. In such a scenario, the result will be a vibrant sector where the ultimate beneficiary is the small depositor, borrower, and/ or investor. Such scenario, however, may backfire if the 3 domestic retail market does not expand as fast as the new players come in. Threat of liberal branching policies and bank mergers Most of the banks surveyed were not really alarmed over the entry of foreign banks because under RA 7721, they were allowed a maximum of only three branches subject to Bangko Sentral approval. With the New General Banking Act, however, an environment for liberal branching policies is now possible for foreign banks. And should they take advantage of this, a host of different business combinations can occur. Foreign banks can apply for more branches in numerous locations. Or, as in the case of HSBC, they may acquire a local bank network. Liberal branching policies are therefore the most important threat to local banking stability by far. In order to maintain interest rate spreads enjoyed by foreign banks, they may now resort to their new technology and new products and services to reach out to the smaller depositors. This will now accelerate the pace of innovation in the sector and should force local banks to react or even become pro-active. One possible solution could be bank mergers but as the survey showed, local banks remain ambivalent to the idea. They would rather combine with other local banks or in the case of Metrobank acquiring Global Bank from tneir Japanese partners and Bank of the Philippines absorbing DBS Bank, they become the surviving entity. The present environment and Bangko Sentral regulations allow for more consolidations of this nature. Maximizing the entry of foreign banks and reciprocity arrangements A senior officer of a local bank lamented the fact that while the government has allowed a level playing field for foreign banks to come in, it has not done enough to use the same for local banks to allow them to open branches in foreign banks’ countries of origin. This would be the next step to maximize the benefits brought about by the Policy Notes 4 February 2003 entry of foreign banks, something that was not explicitly stated in RA 7721. There are enormous benefits in a reciprocity arrangement. If the foreign banks are hesitant to bring in the technology to the country, then a local bank presence in their country of origin will allow the local banks to see and experience for themselves said technology and then bring it back to the country. The derivatives market and other markets for exotic securities, long-developed in the United States and Europe, remain an enigma in this country because aside from those working in foreign banks and multinational corporations, there are only a few local experts in the field. This expertise can only be learned first-hand and reciprocity arrangement is probably the best solution to develop such an expertise. Establishing local branches abroad could undoubtedly be the best alternative to sending small delegations of individuals to training programs abroad. Another important finding in the survey is that local banks are in favor of increasing the competitive environment of foreign bank entry but not of increasing their number. We can only interpret this finding in the context of the New Banking Act which allows for a more liberal network of existing banks but closes the door for new ones to come in. Policy recommendations As shown in the preceding sections, the impact of the benefits of liberalizing the financial sector through RA 7721 have been slow in being felt. This was aggravated by the Asian financial crisis and the September 11 attacks. There are, however, some ways to maximize the entry of foreign banks in the context of existing laws. These include the following: X Allow for reciprocity agreements in establishing local bank branches in the countries of origin of the foreign banks. The technology transfer will become faster and more efficient. X Strengthen branching laws to allow foreign banks to acquire all types of banks, including other commercial Policy Notes banks, savings and thrift banks, and even rural banks. As these foreign banks take over these local banks, the technology transfer to these acquisitions will make the acquired banks stronger. X Allow foreign banks to assume “universal bank” status by increasing capital requirements. Increasing capital requirements will not only increase the amount of foreign investments but also accelerate acquisitions of allied business such as insurance companies and investment houses as these foreign banks become universal banks. X Provide incentives for local banks to set up branches abroad. This will be an alternative approach to gaining imported financial technology should reciprocity arrangements fail or stall. X Encourage local and foreign banks to exchange technologies to improve their products and services in order to reach as many small depositors and investors as possible. Allowing foreign banks to participate in lending to small and medium enterprises and at the same time, incorporating the experience of local banks in administering these loans will allow faster dispersal of funds to the countryside. Finally, it should be made clear that this Notes does not try to suggest adversarial roles between local and foreign banks. In fact, the faster the two sectors get together in a spirit of healthy competition, the faster the pace of liberalization and reaching out to as many individuals as possible will be. For further information, please contact The Research Information Staff Philippine Institute for Development Studies NEDA sa Makati Building, 106 Amorsolo Street Legaspi Village, 1229 Makati City Telephone Nos: 892-4059 and 893-5705 Fax Nos: 893-9589 and 816-1091 E-mail: [email protected]; [email protected] The Policy Notes series is available online at http://www.pids.gov.ph