Archive for the ‘Political economy’ Category


Rents, as a construct in political economy, are usually associated with monopolies and imperfect competition and markets. In the literature, rents always never represented value created in production but represented a portion of the created value captured during the distribution process. In short, rents are not created values but captured values. In this sense, rents represent pure transfer of resources from one economic actor to another; the transfers are mediated either through the market, the state, or non-market, non-state mechanisms or institutions. The economic actors may either be private agents or institutions or public entities.

But all general statements will have to be qualified. Consider Tullock’s (1988: 51) example: the person who invents and patents a cure to cancer (or AIDS) will be considered a public benefactor even if he became extremely wealthy by claiming monopoly rents on the patent.

In the main, there are three types of rent differentiated according to mode of “creation” and disposition: market rents, public choice rents, and non-market, non-state rents. Market rents (or Rent I) are rents created by natural or structural market imperfections or market power. When we say natural market imperfections, we mean market imperfections that are not caused by state action such as licenses or tariffs. If a public utility monopoly endures because huge capital requirements deter the entry of others, then we have a natural or structural market imperfection. The structural monopoly earns monopoly rents. The best example of a market rent is the classic landlord rent.

Some type I rents attract “good” rent-seeking, the latter concept defined as the expenditure of resources towards the capture of rent. An example is the cancer cure patent mentioned earlier. To the extent that the rent is successfully captured, i.e., the invented cure was successful and could be patented, the resources expended to capture the rents from the patent could not be considered to be deployed wastefully. In contrast, the use of resources to capture ownership of a choice piece of real estate is not only wasteful but also criminal.

Public choice rents (or Rent II) are the rents created by the state when it restricts entry to the market. This rent type attracts wasteful rent-seeking; the “right” to capture the rent may be sold to the highest bidder. However, it could be also be dispensed or deployed by the state to favored parties. If the state restricts market entry or competition, the actor who captures public choice rents also earns monopoly rents. The distinction between rent-seeking and rent-dispensing is an important one and will surface in the subsequent discussion on rents and development.

The third type (or Rent III) are rents created by non-economic, non-state bodies (including churches, mass media, and political parties) but are sought and could be captured by anybody–businessmen, state officials, politicians, or private citizens. While these bodies are not strictly state or market (for profit) agencies, they can create rents because they also enjoy monopoly power of sorts.

Religions monopolize the supply of spiritual goods while mass media may monopolize information. In this sense, the rents that they can earn are quite similar to market or monopoly rents. This rent type may also attract rent-seeking, albeit of a kind quite different from public choice rent-seeking. Let us illustrate this last point with the Iglesia Ni Kristo (INK) in the Philippines. The INK is obviously a newer and smaller religious organization than the Catholic Church. But it is considered to have a stronger political clout than the latter; INK members supposedly vote as a single bloc according to the dictates of their Church leaders. For this reason, INK leaders are wooed every which way by politicians and their brokers for electoral support. In return, the INK supposedly gets material and non-material rewards from their clients. Other examples are supplied by Hutchcroft (1996): the AC-DC (attack and collect-defend and collect) politician and journalist.

The fourth type of rent (Rent IV) are “criminal rents” earned from benefices granted by the powers-that-be to operate or maintain gambling, prostitution, gun-running, illegal drugs, and other illegal businesses without fear of persecution or harassment in exchange for a cut of the proceeds. Antonio Sanchez, the sentenced mayor of Calauan, Laguna (for rape and murder) appears to be a beneficiary of such a right and has apparently disposed of his rents in conspicuous consumption, patronage, pay-offs to appropriate patrons.[1] This rent type is usually associated with means of coercion and violence.

One can still identify a fifth type of rents (Rent V) if the state itself is construed as a rent-seeking agent vis-a-vis other states and other international actors, which are rent-assignors. Official development assistance and military credits are examples of this rent type and are actively sought after by many states in the developing world, including the Philippines. This type of rent is often associated with the development of clientelistic relations between the donor-state and the recipient-state.

Depending upon the active agent, it is also important to distinguish between private rent-seeking and public rent-seeking. Murphy, Shleifer and Vishny (1993: 412) define private rent seeking as taking the form of “theft, piracy, litigation, and other forms of transfer between private parties” while public rent-seeking is “either redistribution from the private sector to the state, such as taxation, or alternatively from the private sector to the government bureaucrats” taking the form of lobbying, corruption, and the like. While we may or may not fully subscribe to the notion that taxation is rent-seeking, public rent-seeking provides the bridge between rent-seeking and the much older concept of corruption.

How do we relate rent-seeking and corruption? In a situation where the state (or a state agency) creates rents, the normal economic reaction of private actors is to use all means–legal, extra-legal, and illegal–to capture them. Lobbying government officials is a legal way while bribery is an illegal way of capturing rents. The bribe can be seen as the purchase price of a good or a service that the state officially owns but is now appropriated privately and personally by government officials. In so far as officials have discretion over the provision of these goods, they can collect bribes from private agents (Shleifer and Vishny 1993: 599).

A key flaw of much of the rent-seeking literature (of the public choice school) must be fully elucidated. Rents and rent-seeking, especially in their pejorative sense, are concepts that had been defined with reference to a fairy tale–that of perfect competition. To the extent that competition and markets are imperfect, then rents will always be available for capture.

It is true that the public choice literature had fired its strongest guns against state-created rents (or Rent II). But as we have pointed out, not all rents are created by the state nor do all rents attract wasteful rent-seeking. A whole category of rents will exist and continue to exist because certain economic assets will remain scarce relative to demand. Type II rents will disappear only if the state disappears. And lastly, one can raise the valid question whether all rent-seeking efforts are necessarily wasteful?

Among other reasons, the competition between rent-seekers is considered by public choice literature to be wasteful. The resources expended by rent-seekers are resources that could have been used for more productive purposes. In an ironic twist to neoclassical logic, it is suggested that restricting the competition for rents may reduce wasteful rent-seeking. If one follows this line of reasoning, the least wasteful situation is one where an absolute dictator, who will brook no complaint, will dispense rents as he sees fit.

It could be shown however that competitive rent-seeking can flourish in the most authoritarian political setting simply because the dictator cannot make all decisions. Below the apex of power, there will be many decision-makers at all possible levels who could compete with each other for the rents or for the power to dispense the rents according to the their competencies. The existence of these officials will similarly attract wasteful rent-seeking. It is true of course that the competition for rents is not fully open even in democracies. The costs or wastes associated with rent-seeking are thus limited, as Jomo and Gomez (1995) explain.

An opposite scenario, which is consistent with neoclassical economics, may develop with respect to public rent-seeking, or at least, in the case of bribes. If producer A can buy a government good more cheaply than producer B, then he can outcompete the former in the product market. The cheapest way to purchase a government good is to bribe a government official at a rate lower than the official level–a transaction labeled as corruption with theft by Shleifer and Vishny (1993).[2] So if producer A bribes an official to reduce his costs, his competitors must do so also. Competition between buyers of government goods will spread cost-reducing corruption, i.e., corruption with theft, across the economy. But the greater demand for cheaper government goods (meaning a greater supply of bribes) will boost bribe rates to just a shade lower than the official prices. Downward pressure on the bribes could come from the competition among bribable government officials. However, it would be easier for them to collude to keep bribe rates up than for consumers to unite for lower rates.

Finally, it is likewise useful to distinguish between rent-seeking, the expenditure of resources to capture rents created by the state; and rent-assigning, the granting by the state, or by any of its officials or agencies, of rents or of opportunities to capture rents to selected private or public actors. These processes need not be mutually exclusive in the sense that some private actors may still seek rents even as the state assigns them. Nonetheless, one can say that the more rents are assigned and are known to be assigned by the state or its leaders and officials, the less the rent-seeking will be.

Notes:

[1] A well-placed source informed me that Sanchez was the chief main­tainer of jueteng in Southern Luzon and was grossing an average of P 350 million daily. In his pay-off list are national-level officials and politicians, high-ranking military and police officials, down to the lowly barangay-tanod (village guard)..

[2] In the case of corruption without theft, the government official charges an amount (the bribe)on top of the official price of the good. He turns over to the government treasury the amount corresponding to the official price and pockets the bribe. In the case with theft, the official charges a bribe lower than the official price and does not turn in anything to government.

References

Hutchcroft, Paul (1996). “Corruption’s Obstructions: Assessing the Impact of Rents, Corruption, and Clientelism on Capitalist Development in the Philippines.” Paper read at the annual meeting of the Association for Asian Studies, Honolulu, Hawaii.

Jomo, K. S. and Edmund Terence Gomez (1995). “Rents, Rent-Seeking and Rent Deployment in Malaysia.” (Typewritten.)

Murphy, Kevin, Andrei Shleifer and Robert Vishny (1993). “Why is Rent-Seeking So Costly to Growth?” American Economic Review Papers and Proceedings 83(2): 409-414.

Shleifer, Andrei and Robert Vishny (1993). “Corruption.” Quarterly Journal of Economics 108(3): 599-617.

Tullock, Gordon (1988). “Rents and Rent-Seeking.” In The Political Economy of Rent-Seeking, pp. 51-62. Edited by Charles Rowley, Robert Tollison, and Gordon Tullock. Boston: Kluwer Academic Publishers.

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Explaining the Philippine Growth Record 1946 to 2000

Note:  This is another ‘old’ paper resurrected from my external disks.  I am again sharing it for what its worth.  I intend to update the monograph to cover the presidential administrations of Gloria Macapagal-Arroyo (2001-2010) and Benigno Simeon C. Aquino III (2010-2016) very soon.


House vs. Senate

Major issues in the legislative debate included how many foreign banks would be allowed to enter, their mode of entry, how much capitalization would be required of the new entrants, and how many branches each would be entitled to open up.  The bill enacted by the Senate in April 1994 (SB 1606) was far more restrictive than that earlier passed by the House (HB 8226).  It permitted only six to eight new entrants (rather than leaving the matter up to the Monetary Board, as did the House bill), required $16 million in capitalization (rather than the roughly $5 million required by the House), and sanctioned only six branches for each of the foreign banks, whether existing or new entrant (rather than giving the foreign banks the same privileges as the domestic banks).  As to the mode of entry, SB 1606 hewed closely to the Angara-Roco-Ople version.  First, it disallowed the entry of foreign banks as a wholly-owned and controlled subsidiary incorporated under Philippine laws, which the House version permitted. Second, while HB 8226 allowed foreign banks to own up to 70% of the voting stock of an existing Philippine bank, the Senate version limits foreign ownership to 60% of a bank, whether existing or newly established.  Third, the Senate version restricts the entry of foreign banks to only one mode of entry.  The appropriate section of SB 1606 read:

Sec. 2.  Modes of Entry. – The Monetary Board may authorize foreign banks to operate in the Philippine banking system through any of the following modes: (I) by acquiring, purchasing or owning up to SIXTY PERCENT (60%) of the voting stock of an existing bank; (ii) by investing in up to SIXTY PERCENT (60%) of the voting stock of a new banking subsidiary incorporated under the laws of the Philippines; or (iii) by establishing branches with full banking authority: Provided, That a foreign bank may avail itself of only one (1) mode of entry: Provided, further, That a foreign bank or a Philippine corporation may own up to sixty percent (60%) of the voting stock of only one (1) domestic bank or new banking subsidiary.

How the banks positioned themselves in the debate

The major argument of the BAP was that, to ensure a ‘level playing field,’ foreign and domestic banks should have the same minimum capitalization requirements ($27 million for non-unibanks).  On the question of branches, however, they desired a most uneven field: retention of the three-branch limit for foreign banks, thus ensuring that the vast bulk of depositors would remain outside the reach of external competition.  As the debate heated up, the BAP waged a media campaign to weaken the extent of actual liberalization and support the more restrictive Senate bill.

The four foreign banks already in the system—in particular Citibank, by far the largest and most influential of the four—actively supported the less restrictive terms of entry.  It is believed that while these banks would be most directly affected by the entry of new foreign banks, a strong desire for more branches was apparently a stronger consideration.

As the bicameral conference committee convened to reconcile the differences between the two bills, tensions escalated between House and Senate, foreign and domestic banks, avid and reluctant reformers.  After deadlocks among key sponsors, the House and the Senate forged a May 1994 compromise allowing the entry of ten foreign banks and sticking with the Senate’s earlier six-branch restriction on the scope of their operations.  Minimum capitalization of roughly $9 million allowed three branches, and $13.5 million the rights to six.  The new law also provided a second mode of entry for foreign banks: up to 60 percent ownership of a domestically incorporated bank (as compared to the 30% to 40% permissible since the 1970s).  The BAP made no effort to hide its pleasure over the compromise; BAP president Rafael Buenaventura[1] explained that the final law “met [our] standard in terms of balancing the national interest with the country’s need for globalization without making too many unnecessary concessions.”[2]

Twenty-one banks applied for entry and in early 1995 the ‘magic’ ten were selected.  These include Australia and New Zealand (ANZ) Bank, Bangkok Bank, Chemical Bank, Development Bank of Singapore, Deutsche Bank, Fuji Bank, International Commercial Bank of China, Internationale Nederlanden Groep (ING) Bank[3], Korea Exchange Bank, and Bank of Tokyo.  Three of these banks—Chemical, Deutsche, and Tokyo—were not exactly new since they had offshore banking units (OBUs) in the country prior to 1995.  By 1996, all had opened shop—and by the way they did so it was evident that their direct impact on competition would likely be confined to the very top end of the market, which was already competitive.  In general, they established offices on the upper floors of Makati skyscrapers and did not bother with the expense of lobbies or tellers.[4]  In effect, the new banks will compete in the corporate banking and trade financing, segment of the market where there’s already keen competition.  Even Citibank, the only foreign bank that may begin to have the institutional strength to tap a larger segment of the market, shied away from the market’s lower end.  It has yet to complete the six-branch quota since it only has four branches so far—Makati, Greenhills, Libis Citi-Square (the newest branch inaugurated by no less than President Estrada last April 2000), and Cebu.

To be concluded….

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[1] Mr. Buenaventura is the current governor of the Bangko Sentral ng Pilipinas (BSP).

[2] Rafael Buenaventura, “At the Forefront of Change,” Fookien Times Philippines Yearbook 1994, p. 180.

[3]When the British merchant bank, Baring Brothers, collapsed due to the uncontrolled trading of a rogue trader, it was acquired by ING.  In the process, ING Philippines also acquired Baring Securities (Philippines).

[4] Of the ten, only the Development Bank of Singapore (DBS) opened more than one branch, presumably to better oversee remittance of foreign exchange by Filipino OCWs in Singapore to relatives in the Philippines.


The legislative battle lines are drawn

In the first regular session of Congress (2nd semester of 1992), Representatives Edmigdio Tanjuatco, Jr., Margarito Teves, and Alberto Veloso authored House Bill 263 entitled “An Act Liberalizing the Entry and Scope of Operations of Foreign Banks in the Philippines, Amending for the purpose RA 337, otherwise known as the General Banking Act.” They were joined by “additional authors as manifested on the floor”: Miguel Romero, Jose Ramirez, Ramon Bagatsing, Jr., Renato Dragon, Rodolfo Albano, Dante Liban, and Angelito Sarmiento.

All of the above named representatives, save for Dragon, were not connected with the banking industry.  Dragon headed a savings bank based in Cavite before he was elected to the House.  Then in March 1993, HB 223 was substituted by HB 8226 carrying the same title.  HB 8226 had Teves as its principal author: Teves was joined this time by 65 other members of the House as co-authors.  Of this 65 co-authors, only Manuel Villar, Jr., and Ricardo Silverio  were associated with the banking industry.  But Villar only headed the Capitol Bank, another thrift bank, and is not associated with any commercial bank.  Silverio was once associated with Pilipinas Bank but only during the Marcos years.

After two months, on May 17, 1993, HB 8226 was approved on second reading by the House.  A month later, it was approved on third and final reading with an overwhelming 120-2 vote with no abstentions.  The Senators were less united than their counterparts in the House of Representatives.  Three versions were introduced in 1992: Senate Bill 839 by Gloria Macapagal-Arroyo, SB 1474 by Senators Edgardo Angara, Raul Roco and Blas Ople, and SB 1563 by Senator Leticia Ramos-Shahani.  These SBs were soon consolidated into SB 1606 in April 1994.[1]

An examination of the three SBs indicate that Shahani’s version is the most liberal one while the Angara-Roco-Ople version is the most restrictive one.  For instance, on the matter of the entry of foreign banks, the Shahani version had a section that explicitly allowed the entry of foreign banks.  The Arroyo version took the tack of repealing section 11 of the General Banking Act (GBA) that explicitly prohibited the entry of new foreign banks into the country. Meanwhile, the Angara-Roco-Ople version did not contain any provision that either explicitly allowed the entry of new banks or repealed GBA’s section 11.  Arroyo’s version was closest to HB 8226 while Shahani’s bill was apparently more liberal than the already liberal House version.

On the question, for instance, of the mode of entry of new foreign banks, the House and Arroyo versions both provided for three possible modalities: establishment of branches for the four existing foreign banks; establishment of wholly- or majority-owned and controlled banking subsidiaries; and to invest in new shares of stocks or acquire into existing foreign-owned stocks up to 70% of the voting stock of an existing bank.  Under the first modality, Bank of America, Citibank, Hongkong and Shanghai Bank,  and Standard Chartered Bank can open new branches.  Under the second mode, a new foreign bank, for example Dresdner Bank of Germany may decide to establish Dresdner Bank (Philippines) and could own up to 100% of its voting stock.  In the third option, a foreign bank that already has a stake in an existing Philippine bank may opt to increase its share in the same bank.  For example, Chemical Bank of New York, which already had a stake in Far East Bank, may increase its investment in the same bank.  Or it could also happen that Citibank may want to buy into Far East Bank by buying Chemical Bank’s share.  The Shahani version goes beyond the three options mentioned in HB 8226 and proceeds to specify what kinds of business the foreign banks can undertake in the country.  They include:

  • “Lending of funds obtained from the public through receipt of deposits provided that all peso deposits shall not be vested in any manner outside the Philippines”;
  • General banking business; and
  • “Maintain by themselves or by assignee any suit for the recovery of any debt, claim, or demand whatsoever” (Comparative Analysis 1993).

On the other hand, the Angara-Roco-Ople version does not contain any provision on the mode of entry of new foreign banks (as it was equally silent on the entry of new banks), capital requirements, expansion of foreign banks’ scope of operations within the Philippines, and the general guidelines for the approval of entry of the new foreign banks.  It was as if the three senators were not in favor of the entry of new foreign banks at all.  The only concession that the three senators allowed in this direction was to increase the foreign equity ownership in existing Philippine banks from 30% allowed by the GBA to 50% of voting stock.  The other Senate versions and HB 8226 were more liberal allowing from a maximum of 70-100% in foreign ownership of banks organized according to Philippine law.  In effect, the three simply wanted to keep the existing number of commercial banks in place.  In so far as this version is concerned, they were not even in favor of allowing Bank of America et al to increase the number of their branches in the country.

In delineating the guidelines for the approval of entry of new foreign banks, the Shahani version was more liberal compared to HB 8226.  It adopted all of the HB 8226’s stipulations except the ‘reciprocity’ requirement.  The House version required that only applications from banks domiciled in countries that also allow the operation of Philippine banks in their jurisdictions will be qualified.  The Shahani version dropped this restriction altogether (Comparative Analysis 1993).

The political alignments in both legislative chambers must be reviewed in order to put in proper context the dynamics underlying the process of passing the Bank Liberalization Law of 1994 (R.A. 7721, entitled “An Act Liberalizing the Entry and Scope of Operations of Foreign Banks in the Philippines and for other Purposes).  President Ramos run and won under the banner of Lakas-NUCD, a breakaway party from the Laban ng Demokratikong Pilipino (LDP).  In the House of Representatives, Ramos’ able lieutenant, House speaker Jose de Venecia not only to managed to raid the LDP ranks and entice many into the Lakas fold but also forged a ‘Rainbow Coalition’ composed of incumbents from Lakas, LDP, the Liberal Party, the Nationalist Peoples’ Coalition (NPC), and the Nacionalista Party that invariably supported administration bills. And the Bank Liberalization Law was definitely an administration bill.

In the Senate, however, Lakas had only two senators, Shahani and Santanina Rasul.  Furthermore, the Lakas senators were relative lightweights especially in economic issues compared to the LDP stalwarts who dominated the Senate in terms of influence and prestige—Angara, Roco, Ople, Arroyo, Alberto Romulo, and Neptali Gonzales. Only in late 1994 did the Lakas and the LDP enter into a coalition with each other, a union rhapsodized by columnist Amando Doronilla as the dawning of a new, issue-based politics in the country while derided by other media pundits as the marriage of convenience of not-so-innocent harlots.

The 1992 Senate versions however indicate some fissures within LDP with Gloria Macapagal-Arroyo hewing closely to Ramos’ overall program of economic liberalization.  Angara, Roco and Ople appear to be still wedded to the protectionist, rent-seeking past, for good reason.  Before becoming legislators, Angara and Roco were stalwarts of the top-drawer ACCRA law firm, which counted among its many clients the top corporations, financial or otherwise, of the country.  Between the two, Roco was clearly associated with a family group, the Sorianos who had strong interests in San Miguel Corporation and controlled a middling commercial bank, the Asian Bank.  Angara, meanwhile developed strong links with the coconut monopoly established during the Marcos years and headed by Eduardo “Danding” Cojuangco, who in turn had substantial holdings in the United Coconut Planters Bank and San Miguel Corporation.

To be continued…..

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[1]  A document entitled “Comparative Analysis Between RA 337, HB 8226, SB 839, SB 1474, SB 1563” and dated 10 January 1993 is the basic source of information for the subsequent discussion.  Unfortunately, the document does not indicate any author, and the author forgot the exact provenance of the same.  For purposes of citation in text, it will be subsequently referred to as Comparative Analysis 1993.


Bank liberalization under Ramos, serious this time around

The Ramos administration, in addition to creating a new monetary authority, also pushed for a substantial program of banking liberalization.  Concretely, this meant allowing the entry of new banks (domestic and foreign) and easing branching privileges for these same banks.  Pressures for opening up the industry can be traced to the 1988 World Bank report, which argued that “the strong domestic banks should not feel forever insulated from competition.”[1]  But initial response was essentially limited to the Central Bank’s March 1989 declaration that purported to remove restrictions on new commercial bank licenses[2] and reorient other key aspects of supervisory policy.

This display of reformist zeal, however, was probably meant to have more impact on the release of the first tranche of the World Bank’s financial sector adjustment loan than on the financial sector itself.  No new banking licenses were granted until Central Bank governor Jose Cuisia’s term began in 1990—and then only up to two savings banks (Family Savings Bank and Philippine Savings Bank), which were allowed to upgrade themselves to commercial banks.  In fact, no genuinely new players were allowed into the system until 1994.  Under Cuisia, the only real progress toward liberalization was the loosening of previously tight restrictions on the opening of new branches.[3]  The broader reform initiative of the late years of President Corazon Aquino’s regime was the ‘New Economic Program’ launched by finance secretary Jesus Estanislao in 1990.  While it included a by-now pro-forma denunciation of the cartel-type practices of banks, no serious challenge to the banking sector was attempted.  In fact, even the central element of the Estanislao program—tariff reform—was thwarted by import-substitution-industrialization (ISI) interests (Hutchcroft 1998).

By 1992, a combination of international and domestic factors promoted much greater momentum toward a wide-reaching program of economic liberalization.  The administration of President Fidel V. Ramos displayed new understanding of the country’s place in the world economy, and a clear sense of its weakness in competing effectively in the international and regional arenas.  This new momentum was manifested by a significant degree of liberalization of foreign exchange, foreign investment, and trade; as well as a major challenge to the cartels and monopolies in telecommunications and inter-island shipping.  In time, Ramos’ advisers and other advocates of liberalization trained their sights on the banking sector.

Even before Ramos assumed the presidency in mid-1992, the Central Bank was seriously mulling over plans to liberalize the banking sector by allowing the entry of new players.  A senior CB official, Mercedes Suleik (1992, p. 15) wrote in the CB Review: “the Central Bank is reviewing the restrictive policy on the entry of foreign banks in the Philippines with a view to recommending to Congress liberalization of these statuary restrictions in line with the overall policy of encouraging foreign investments.”  By law, foreign banks are not authorized to operate in the Philippines with the exception of foreign bank branches already operating when the General Banking Act took effect in 1949.  The same law also provided that at least 70% of the voting equity of banks organized under Philippine law must be owned by Filipino citizens.  Furthermore, the four foreign banks were prohibited from opening new branches within the Philippines, barred from accepting deposits from government, and could rarely avail of the CB rediscount facility.

In an address before the European Chamber of Commerce of the Philippines (ECCP) in March 1992, CB Governor Cuisia informed the European businessmen that “the Central Bank supports moves to liberalize the entry of foreign banks which, with their large capital base and established track record, can contribute to a stronger and more efficient banking system” (CB Review April 1992, p. 2).

Liberalization efforts were assisted by earlier disruption in the cordial relations that had long existed within the banking industry.  In particular, the introduction of automated teller machines (ATMs)[4] in the late 1980s encouraged growing tensions between the stronger domestic banks and the foreign banks.[5]  While the domestic banks were rapidly expanding their share of the lower end of the deposit market (where funds could be obtained at generally negative real interest rates[6]), the foreign banks were restricted to three branches and forced to raise funds at the upper end of the deposit market (at much higher, positive real rates of interest).  In response to these limitations, Citibank publicized in 1991 a careful analysis of the large intermediation spreads earned by Philippine-based banks.  While high reserve requirements and other regulatory factors partially accounted for the big spread, Citibank economists asserted that “oligopolistic market power” was also very much to blame.  They further declared that banks with greatest access to regular deposits (the largest domestic banks) were enjoying “excessive profit margins,” and should begin paying savers positive real rates of return (with “risk premium for keeping their savings in the Philippines”).  Their analysis concluded by urging that the overall system be “gradually deregulated” and opened to new entrants.  In a letter of response, the president of the Bankers Association of the Philippines (BAP)[7] made clear that Citibank’s public break with the ranks was not appreciated[8] ( Hutchcroft 1998, pp. 213-4).

As momentum for liberalization gathered steam over the next two years, the BAP eventually adopted the approach of supporting reform in general terms but curbing it as much as possible in its specifics.  This became most apparent in 1993, when the Ramos administration proposed its major initiative for the banking sector: allowing more foreign banks to establish wholly-owned operations in the country.  The number of banks enjoying such privileges was restricted to four—Citibank, Bank of America, Chartered Bank, and Hong-Kong & Shanghai Bank—in the late 1940s.

As debate over the entry of more foreign banks shaped up in late 1993 and early 1994, the key question was not whether the reform would take place but how.  On one side of the debate were those favoring more liberal terms of entry: Ramos and his key advisers (particularly national security adviser Jose Almonte), the House of Representatives (in general very supportive of Ramos’ economic liberalization program), the four foreign banks, multilateral institutions, and the US government.  The side seeking to restrict the terms of entry was led by the BAP, which relied in turn on vital assistance from key allies in the Senate.

To be continued….

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[1] World Bank, Philippine Financial System (1988), vi.

[2] On May 16, 1989, the Central Bank issued CB Circular 1200 which lifted the moratorium on the establishment of new banks.

[3] Central Bank Circular 1281, dated April 15, 1991, provided many more branch licenses through an auction process.  Rural banks were also given the privilege of nationwide branching under Circular 1280 dated the same day.  An even more permissive policy was instituted in 1993, when branch licenses became available to any bank satisfying certain minimum capital requirements.

[4] The operation of ATMs was allowed, subject to certain regulations specified in CB Circular 1286, dated May 23, 1991.

[5] Up until the passage of the Bank Liberalization Law of 1994, only four foreign banks were given CB licenses to undertake full commercial banking operations in the Philippines.  They were Bank of America, Citibank, Hong Kong & Shanghai Bank, and the Standard Chartered Bank.  In 1977, other foreign banks were allowed to establish presence and operate in the Philippines but only as offshore banking units (OBUs).  As OBUs, these banks can only conduct offshore banking business—acceptance of deposits from non-Philippine residents and lending to non-residents and to Philippine banks and the Central Bank of the Philippines, as well as other government agencies as authorized by the CB. Later on, these OBUs were allowed to negotiate incoming export letters of credit (LCs) and to provide full foreign exchange services for all foreign currency non-trade remittances (Suleik 1992).

[6] When the interest rates that banks pay to their depositors are lower than the prevailing inflation rates, real interest rates are negative or are below zero.  When real interest rates are negative, the bank depositor would be better off spending or using his cash elsewhere rather than depositing the same in the bank.

[7] All the commercial banks, domestic and foreign, including Citibank were members of the Bankers Association of the Philippines (BAP).

[8] Citibank study, “Bank Intermediation Spreads,” unpublished manuscript, n.d. [1991?]; Letter from Xavier P. Loinaz, president of the BAP (and the Bank of the Philippine Islands), to William Ferguson, Citibank vice president, Febuary 1, 1991.


Financial liberalization in the Philippines

In 1985, financial liberalization was introduced in the Philippines by international financial institutions such as the World Bank, and government control over interest rates was completely eliminated. However, yield rates on bank deposits remained fixed at low rates and, consequently, the amount of domestic savings did not increase much.  Long-term finance likewise remained scarce.  According to many observers, the reason is that financial liberalization in the Philippines did not affect in a significant way the oligopolistic structure of the financial system and therefore had little effect on the market behavior of the major financiers.[1]  Furthermore, because of its administrative weakness and lack of insulation (from vested interests), the government was unable or unwilling to break the banks’ control of the financial system or to institute prudential regulation of and supervision over the banks.

The reforms in the financial system, undertaken in response to the financial institution failures generated by the Dewey Dee financial scandal in 1981[2], actually took the tack of creating large multi-purpose universal banks or the so-called expanded commercial banks (ECBs).  The idea then was to exert greater control of the quasi-banking (read as: money market) activities of non-banks (investment houses, merchant banks, finance companies) by incorporating these same activities under a universal bank’s umbrella.  Of course, the core of a universal was a commercial bank.  To be able to form these universal banks, consolidations, mergers, and the further infusion of foreign equity, were encouraged.  For example, the Ayala-controlled Bank of the Philippines became a universal bank after it formally acquired (from the Ayala Corporation) the Ayala Investment and Development Corporation (AIDC)—the merchant bank with which it long worked very closely.

In effect, the banking reforms adopted in the waning years of the Marcos dictatorship did little to de-monopolize the financial system.  As a consequence, private banks continued to dominate the supply of credit and dictate cost of money.  As government banks either retreated or were privatized, the ‘developmental finance’ paradigm practically disappeared as declared by Central Bank governor Jose B. Fernandez, Jr. in the Business World November 16, 1987 issue.  The fact that Fernandez came from the commercial banking industry explains to a great extent his accommodating attitude to commercial bankers in general, though he applied the screws on several bankers who earned ire of the incumbent president he was serving or his own displeasure, notably Vicente Puyat of Manila Bank[3] and Tomas Aguirre of Banco Filipino. The administration of President Aquino did not change the overall bank-friendly policy since she retained Fernandez as CB governor up to 1990. It will take the administration of President Fidel Ramos to effect serious changes in financial policy.  But President Ramos had to create a new central monetary authority first to replace the ailing Central Bank.  This was accomplished through R.A. 7653, otherwise known as the New Central Bank Act, signed into law by Ramos on June 14, 1993, which established and organized the Bangko Sentral ng Pilipinas (BSP).

To be continued….

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[1] De Dios (1996) however reports that there is healthy dispute as to whether the Philippine banking industry is indeed heavily concentrated.  But he argues that the consequences, not the level of concentration in the banking industry, were of greater import.  For one, average profit margins are higher than average.  Many observers attribute the higher profit margins to banking system concentration that has allowed the exercise of oligopolistic power, or even of collusion (Lamberte 1991 and Tan 1989).

[2] The author was a member of the Investment House Association of the Philippines (IHAP) team that wrote the IHAP paper entitled “Reforming the Philippine Financial System” in response to the aftermath generated by the scandal. Dee was a Chinese businessman who frequented the gaming tables too often and fled the country in January 1981, leaving over $80 million in short-term debt adrift in the money market.  This led to the bankruptcy of three investment houses, which, in turn, forced the Central Bank to orchestrate equity and deposit infusion from government corporations into several private commercial banks.  Apart from Bancom Development Corporation, the Investment and Underwriting Corporation of the Philippines (IUCP)—associated with Marcos crony Herminio Disini, and the Philippine Finance Corporation—associated with another Marcos crony, Ricardo Silverio, were affected.  Among the banks that received government support were International Corporate Bank and the Commercial Bank of Manila (both controlled by Disini), Pilipinas Bank (controlled by Silverio), and Union Bank of the Philippines (associated with Bancom).  A fuller story is supplied by Hutchcroft (1998).

[3] Vicente “Teng” Puyat first flirted with Marcos by inviting the entry of Gregorio “Greggy” Araneta III into the Manila Bank board of directors in 1984.  At the same time, however, Teng was also among the members of the Ayala Avenue business community actively engaged in mounting protests against the dictatorship.  Once President Aquino came to power, Teng had a falling out with the new administration because of the retention of Fernandez as CB governor. When he was excluded from the Cory senatorial line-up he crossed over and joined his former Marcosist allies in the Grand Alliance for Democracy for the 1987 elections.  He lost however and soon after was booted out by Fernandez from the Manila Bank board (Hutchcroft 1998, pp. 190-91).   Thereafter, he was strongly rumored to be supporting the coup attempts of Col. Gringo Honasan against President Aquino.


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.

 

Introduction[1]

 

 

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….

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[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.