Author’s note:

I have rummaged through my external hard disks and came across this old paper on the Banking Liberalization Law of 1994.  I thought I could share it with my readers for whatever its worth.





In a survey of financial systems and economic policy in several developing economies, the Philippine financial system was said to be “a case where a small group of powerful players in the private sector has maximized its share of rents at the expense of the rest of the country” (Lee and Haggard 1995: 20). It was contrasted with the financial system in South Korea, which was controlled by the state that in turn assigned credits and other rents to export champions—the big industrial conglomerates known as the chaebols.

Preferential finance to export-oriented firms, administered by a strong state and a competent bureaucracy, contributed immensely to the country’s economic miracle.  South Korea graduated to developed economy status (as the newest member of the Organization for Economic Cooperation and Development) before the onset of the Asian financial crisis in 1997 (Mendoza 1995 & 1996).  In both countries, there appears to be very strong links between the state and the private business sector, forming what could be called a ‘quasi-internal organization’ (QIO) in South Korea (Nam and Lee 1995) or a “quasi-public network” in the Philippines (Montes and Ravalo 1995).

The basic difference is the senior element in the partnership.  In the South Korean sword-won alliance, the state was clearly dominant; in the Philippines, the private business sector dominates a weak state and extracts substantial rents from it.  According to Montes and Ravalo (1995), private business and the state leaders and bureaucrats in the Philippines have formed a “quasi-public network” whose objective is the protection of the economic position of its members. Filipino politicians and bureaucrats have adopted this behavior in the light of their relative weakness vis-à-vis private interests.

Selective credit allocation has been used by the Philippine financial authorities to support the country’s traditional (cash-crop, timber, and mineral) exports and import-substituting industries.  Though there had been many attempts to change, the economy maintained an inward-looking foreign trade regime, with bank credit going to heavily protected industries. This situation is not surprising given the control of these industries by powerful family groups and, in effect, their control of credit allocation, both through their influence over government banks and through their ownership of banking institutions.  For a few examples:

  • the Lopez family was a major landowner and controlled the Manila Electric Company (MERALCO), the ABS-CBN radio-television network, the Manila Chronicle and the Philippine Commercial and Industrial Bank;
  • the Puyat family was into light manufacturing, agri-business, real estate, and controlled the Manila Banking Corporation;
  • the Aboitiz family was a major landowner in the Visayas, a major player in the grains trade and grains processing sector, and it teamed up with the Kalaw family to form the Insular Bank of Asia and America together with Bank of America and Daichi-Kangyo Bank of Japan;
  • the Laurel family was also a major landowner, owner of schools (e.g., the Lyceum of the Philippines), and controlled the Philippine Banking Corporation; and
  • the Madrigal family had a major stake in the Consolidated Banking Corporation and in inter-island shipping (Madrigal Lines) apart from being a major landowner.

Some of these families thought it necessary to have some of their family members elected to the highest reaches of Philippine officialdom. For example, Fernando Lopez, Jr. was elected Vice President of the Republic in 1965 and was re-elected in 1969 as part of the Ferdinand Marcos-Fernando Lopez tandem; Gil Puyat became Senate President; Jose B. Laurel, Jr. became Speaker of the House of Representatives; and Maria Kalaw-Katigbak served as senator–all before martial law was declared in 1972.

In such a situation, the type of financial system—whether liberal or repressed (the latter meaning, with heavy state intervention)—matters little to credit allocation. The financial system will allocate credit to the same enterprises, even where and when the financial system was liberalized.

In the literature of money, finance, and economic development, a liberal financial system is one where savings are mobilized and credit is allocated based on market-determined interest rates.  As with product and labor markets, the money market in such a financial system will reflect the scarcity values of money. In a repressed financial system, the government maintains lower-than-market interest rates and thus plays a definite role in credit allocation.

The question of the appropriate financial policy is clearly linked to the larger question about the suitable role of the state in economic development.  The literature makes clear distinction between ‘commercial finance’ and ‘development finance.’  The first type of finance is supposedly the finance supplied and demanded in a liberal economic system.  Authorities in developing economies have justified financial repression and state intervention in financial markets for the purpose of providing ‘development finance’—in other words, cheap credit to supposedly spur economic development and alleviate poverty.  The government was supposed to establish public financial institutions to provide ‘development finance’ to fund big development projects with long gestation periods[2] while private bankers will provide shorter-term and more expensive ‘commercial finance’ to private business.

Neoclassical economic theory frowns on state intervention and financial repression, arguing that it will lead to an inefficient allocation of resources, financial or otherwise.  The case of South Korea, however, is a puzzle to the neoclassical economist who is taught that financial repression leads to poor economic growth.  The theory of ‘quasi-internal organization’ (QIO) alluded to earlier was an attempt to solve this theoretical and practical conundrum.  Purportedly, decisions to allocate credit will be in the hands of government bureaucrats and bankers who lack both the information and the incentive (since government banks are more development-oriented than profit-oriented) to allocate credit efficiently.  Government officials are also more likely to be influenced by non-economic (read as: political) considerations, including distributive pressures from rent-seeking groups.  Furthermore, since cheap credit lowers the relative cost of capital, it leads to the adoption of overly capital-intensive production technologies.  In sum, therefore, preferential credit will reinforce other biases in the system of incentives—such as the emphasis on import substitution in manufacturing over export-oriented manufacturing and agriculture (Lee and Haggard 1995).  In this case, preferential credit is actually anti-poor since capital-intensive industries do not employ a lot and will not employ unskilled poor rural laborers.

What interests would prosper and benefit from a more liberal and internationalized financial system?  What interests are going to be harmed by financial liberalization?  Haggard and Maxfield (1996) offer interesting arguments to explain even the puzzling situation where sectoral interests favored by a prevailing repressive financial regime would concede to a change of policy.

All over the developing world, governments have traditionally controlled capital movements, the foreign exchange transactions of domestic banks, and the entry of foreign financial institutions.  In fact, several studies have shown that developed economies have completed the internationalization of their money markets (Goodman and Pauly 1993; Pauly 1988; and Rosenbluth 1989).

Governments may also be wary of financial openness because “increased financial integration holds governments hostage to foreign exchange and capital markets, forcing greater fiscal and monetary discipline than they might otherwise choose” (Haggard and Maxfield 1996: 210; see also Andrews 1994; Frieden 1991; Kurzer 1991 and 1993; and Winters 1994).  To the extent that financial openness undermines domestic financial controls, it eliminates a tool of both industrial policy and patronage and reduces the opportunity for governments to raise funds through the sale of public instruments at lower-than-world borrowing rates (Haggard and Maxfield 1996; Alesina and Tabellini 1989).

Many analysts opined that increasing economic integration of many developing countries with the global economy has increased pressures to liberalize domestic financial markets.  Frieden and Rogowski  (1996) both argued that increasing economic integration and, consequently, economic interdependence increases the political clout of domestic actors with foreign ties, expands the matrices of interests likely to benefit from, and demand, greater economic openness, and thus tilts the balance of political forces toward a liberal and more internationalist bent.  Furthermore, interdependence also expands the political weight of foreign capital in domestic politics.  Foreign banks and financial firms from the developed economies have become active lobbyists for financial liberalization in developing economies and have enlisted their respective governments to apply pressure for economic/financial liberalization.  Lastly, the increasing magnitude and complexity of goods and capital flows make financial controls extremely difficult to enforce anyway.

Others, however, maintain that balance of payments crises have been a more important source of pressure for financial liberalization in the developing world (Haggard and Maxfield 1996).  This makes sense: economies facing balance-of-payments (BOP) difficulties can better court foreign exchange from external sources if the domestic financial regime was liberal rather than repressed or heavily controlled.  Foreign fund-placers are assured that they will be able to immediately liquidate their placements in a domestic jurisdiction with such a financial policy.  For this reason alone, a foreign-exchange strapped economy with a liberal economic regime will enjoy greater capital flows than a similarly-situated but more repressive one. Using both arguments, this paper will be able to identify the interests involved in the banking liberalization debate in the Philippines and attempt to explain their stances and behavior.


To be continued….


[1] A great deal of the discussion in this section is informed by the author’s extensive exposure to the Philippine financial system in various capacities: as instructor in the economics of money and banking and economic development at UP College of Arts and Sciences, Manila from 1978 to 1992; as financial reporter for the Business Day from 1977 to 1979 and again in 1985-86; as senior researcher of the Bancom Development Corporation from 1980 to 1981; and as researcher of the Bancom Group Inc. and the Bancom Health Care Corporation from 1976 to 1977.  The Bancom Development Corporation (BDC), under its president, Sixto Kalaw-Roxas, started quasi-banking in the country.

[2] Domestic private bankers in developing countries will, according to the literature, avoid providing finance for these projects since they are capital-intensive and have long gestation periods.  Examples of these projects may include a petro-chemical plant, hydroelectric dams, steel and aluminum smelting plants, and public infrastructure such as harbors, ports, and telecommunication systems.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s