Download Where Are the Benefits of Foreign Bank Liberalization?

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.
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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
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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
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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