Time to bring down bank reserve ratios?

Major Philippine banks are still hoping that a cut in reserve requirement ratios, currently at 18 percent, will be decided keeping with the current condition of local and global financial markets.

In March and June last year, the Bangko Sentral ng Pilipinas (BSP) allowed banks to bring down reserve ratios twice, from 20 percent to the current 18 percent by 100 basis points each, to free up about P200 billion for increased lending and bank investments.

It was supposed to start a gradual easing in recognition of a slowdown in the entry of foreign investment funds to the country and the recovery of the US market and other major world economies.

However, an escalation of inflation resulting from manipulated rice and food shortages in the local economy, with commodity prices rising by an average of 4.3 percent in the first half of 2018, led the BSP to temporarily hold back further reserve ratio reductions.

Instead, the BSP continued with increasing its interest rates throughout the year in an attempt to temper inflation, which had reached a high of 6.7 percent in September, way above the BSP’s two percent to four percent range target for the year.

After a series of measures instituted by government to counteract high inflation, including a relaxed importation of rice and other affected food items, the BSP is now back to studying what to do with the still high reserve ratio on bank deposits.

Too cautious

A number of banks agree that the current 18 percent reserve ratio is way too high for the Philippines, although it must be noted that the BSP has always been the soul of prudence, gearing more on the cautious rather than risk-taking.

Most of our neighbors in the ASEAN region, and even in Asia, have single-digit reserve ratios ranging from one percent for Thailand to eight percent for Cambodia. Many central banks in mature economies don’t even have reserve ratios for bank deposits.

The Philippine central bank realizes that current deposit reserves need to be pared down to lower friction costs in the banking sector, create a more efficient financial intermediation, and help curb shadow banking with the rise of strong alternatives offered by fintech and digital innovation.

Liquidity crunch

A recent liquidity crunch in the banking sector has sent signals to the BSP that reserve ratio cuts need to be implemented to keep benchmark interest rates within a decent range that would not burden the market.

Newly minted BSP Governor Ben Diokno had recently indicated that a quarterly easing of the bank reserve ratio would be in order, and that the goal would be to bring this to single digit by 2023 when his term ends.

Historically, though, this could prove to be challenge for the self-professed data-dependent central bank. In the last two decades, reserve ratios had never dropped to below 11 percent, and conservatism had even resulted in the ratios rising to 21 percent on several occasions.

Of course, with the government’s Build Build Build going full steam ahead, there may be added pressure for the central bank to take a more liberal stance this year, and to look further to the next few years with more government infrastructure projects in the pipeline.

Back on track

Meanwhile, the economy can expect further cuts in the overnight borrowing rates after inflation data indicated normalization, going back to the two percent to four percent target for the year. The last Monetary Board meeting cut rates by 25 basis points to 4.5 percent.

While some economists have discounted further rate cuts after gross domestic productivity (GDP) registered a four-year low of 5.6 percent only during the first quarter of the year, this should be regarded more as a function of the delays in the 2019 budget appropriation.

The recent election spending and the ongoing infrastructure projects will certainly offset the low GDP growth rate in the next three quarters. Externally, global risks are once again being flagged, and other countries are likewise keeping caution by lowering interest rates.

Still, even with lower borrowing rates possible within the year, it would be best to lower reserve requirement ratios at the same time. As one banker opined, what’s the use of cheap money when there’s no money circulating.

Batting for an ‘A’

Standard and Poor’s (S&P) recently gave the Philippines its highest credit rating in history, a BBB+, which is just a notch away from A levels. This is a vindication of the efforts of our bureaucrats, including those from past administrations, to steer the country’s economic plight to higher investment grade ratings.

S&P cited the Philippines’ “solid government fiscal accounts, low public indebtedness, and the economy’s sound external settings.” The international credit rating agency has said it may give the Philippines an A- rating in two years’ time should there be significant improvements in the government’s fiscal reform initiatives.

With several packages in the current comprehensive tax reform program being managed by the Department of Finance, there is indeed good scope to get into the “A” club.

What we need now is to continue pursuing the second tax reform package that would slash corporate income taxes to parity with other countries in the region, thereby increasing our competitiveness. Of course, all discussions about reforming tax incentives should be calculated so that it attracts more investors, rather than driving them away.

The DOF may be able to reduce corporate taxes, but if there are no investors because tax incentives have been pruned, there’s more to lose than to gain.

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