Moody's says Philippines banking system outlook stable

Rating attributed to banks' well preserved and deposit-funded balance sheets and improving domestic and global economy.

Moody's Investors Service says in a new report that the outlook for the Philippines' banking system is stable.

The stable outlook for the Philippine banking system reflects the stabilization of both the domestic economy and global conditions.

The outlooks for the Philippine banks' BFSRs -- their bank financial strength ratings -- and deposit ratings are also stable, and reflect the banks' still weak but improving asset quality and reasonable levels of liquidity, capital, and profitability as well as the expectation of some systemic support, should the need arise.

"The banks' well preserved and deposit-funded balance sheets position them favorably for growth over the next 12 to 18 months," says John Tham, a Moody's VP/Senior Credit Officer and author of the report.

Barring significant shocks, their loan loss reserves, capital, and earnings prospects also provide reasonable creditor protection.

The Philippines has emerged from the global crisis in reasonable shape. The banks' high regulatory capital ratios and negligible exposure to toxic assets bolstered confidence and stability in the local market during the turmoil.

"From a macroeconomic perspective, healthy remittances from overseas Filipino workers supported domestic demand, while moderate economic sentiment prevented the formation of asset bubbles and sharp asset price corrections felt in other economies," says Tham.

These macroeconomic factors limit the banks' downside risks, but they also reveal longer-term challenges, given their dependence on the operating environment. The outflow of human talent may eventually weaken the country's competitiveness, the health of its businesses, and its consumer wealth.

"Moreover, while moderate economic sentiment can lower the risk of unhealthy asset bubbles forming, it raises questions over the economy's vitality relative to the region," he adds.

According to the report, the pace of large-scale consolidation should slow over the next few years, given the considerable amount of time and resources that the integration of large mergers takes.

Moreover, the likelihood of mergers among the biggest banks is somewhat remote, as strong family shareholders are unlikely to cede control of their operations because of the business prowess and prestige associated with owning a bank.

However, Moody's would not rule out large or mid-sized banks buying smaller ones, to enhance their reach.

Meanwhile, competition will remain intense. The largest players will use their strong brands and balance sheets to compete aggressively.

This protects their dominant positions, but could also distort the pricing of risks in the near term, especially for banks with weaker customer bases and risk management.

Over the longer term, competitive pressure should marginalize weaker players and encourage consolidation.

Such a development will improve the banks' modest cost efficiency via better economies of scale and consolidate the system's assets under better managers. From a regulatory perspective, it would reduce the supervisory burden, although the degree of private sector influence over government decisions could limit the regulator's ability to enforce its fundamentally sound regulations.

Banks continue to grow consumer loans to diversify their portfolios. Consumer loan quality could be improved, although it is stabilizing.

The government is also encouraging the growth of microfinance lending to alleviate poverty. At this point, the banks are only gradually exploring this potentially lucrative prospect because of the risks, as well as the experience and resources needed, which reflects their careful approach to growth.