Confederation of Southern Tagalog Rural Bankers
Plenary Address – “Back to Basics”
2014 Annual Management Conference
Forbes Ballroom, Baguio Country Club
March 3, 2014

When I was invited to speak at this Conference by your colleague – and my cousin, Ricky Estrada – I was of course, honored and intrigued.

I currently serve as independent director to a number of leading public companies. I also serve as Chair, Vice-Chair, Trustee or Director in a number of not-for-profit organizations and advocacies ranging from: Good Governance (private and public), Education, Environment and Sustainable Development.

Having spent most of my professional life as an international investment banker and private equity investor I feel that, with this invitation, I have come full-circle to where “the rubber meets the road”.
Hon. Nelson (Sonny) P. Collantes – Representative, 3rd District of Tanauan, Batangas and Chairman, Committee on Banks and Financial Intermediaries, Mr. Vittorio (Vitto) Z. Almario – President, Rural Bankers Association of the Philippines (RBAP), Atty. Edward Leandro (JunJun) Z. Garcia, Jr. – Chairman, Rural Bankers Research & Development Foundation Inc. (RBRDFI), our host, Mr. Antonio (Tony) O. Pasia – President, Confederation of Southern Tagalog Rural Bankers (CSTRB, our host), Presidents, Directors and members of the many rural bankers’ federations and confederations represented here today, friends:
This Management Conference comes at a crucial time. I understand that you intend to use this occasion to “take stock”, re-visit your “raison d’etre” and craft a relevant and sustainable industry strategy.
On one hand, we have all read/learned about how the Philippines has outperformed most of our neighbors in aggregate economic growth, i.e. GDP, GNP, National Income. We have also learned that, as a “reward” for prudent Monetary and Fiscal policies, the Philippine sovereign has been “re-rated” and our country has become investment grade – and therefore entitled to benefit from forthcoming attendant funding cost benefits.

Poverty and the Inequality Imperative

Following the unprecedented post-Vietnam War global economic growth – despite a number of intervening international financial crises – the global community has begun to realize that the world is paying a steep price for this “prosperity”.

The Global Scene

Attendees at the recent Davos Conference of the World Economic Forum – that most quintessential of gatherings of the world’s movers and shakers – were told some very stark realities:

1. The 85 richest people in the world have as much wealth as the 3.5 billion poorest – the bottom half of the world’s population.

2. Almost half of the world’s wealth is owned by just one percent of the population; the wealth of the one percent richest people in the world amounts to $ 110 T, 65x the wealth of the bottom half.

3. Seven out of ten people live in countries where economic inequality has increased in the last 30 years.

4. The richest one percent increased their share of income in 24 out of 26 countries (for which there is data), between 1980 and 2012.

5. In the US – the “poster child” of the prevailing liberal economic paradigm – the wealthiest one percent captured 95 percent of post-financial crisis growth since 2009 – the bottom 90 percent became poorer. The phenomenon of “jobless growth” has burst into the scene.

The Philippines

In the Philippines, we have similarly been doused with a splash of cold water:

1. Despite exceptionally favorable macro-economic performance (GDP, National Income, Current Account, International Reserves, Inflation, etc.), we have been losing the poverty battle – or, at best, been “dead in the water”.

2. The Philippines will miss its 2015 Millenium Development goal of reducing poverty to 16.6% (it was at 25.2% in 2012). Its new goals are: 23-25% in 2014, 20-23% by 2015 and 18-20% by 2016.

3. The Social Weather Station “Self-Rated Poverty/Food Poverty” survey in the fourth quarter of 2013 showed that:

a) 55% of respondents (11.8 million households) consider themselves “poor” while 41% (8.8 million
households) consider themselves “food poor”.

b) This represented an increase from the third quarter numbers (50% and 37% respectively).

c) The 2013 average of “Poor/Food Poor” stood at 52% and 39% – not much different from 2012 (52% and 41%).

4. The Philippine agriculture/rural sector has been sorely neglected.
a) Despite accounting for 33%of our total workforce (and where 70% of Filipinos live), the sector has seen its share of total loans from the banking system decline from 9.17% (Php. 232.7 B) in March 2008 to 4.6% (Php. 197.2 B) in December 2012.
b) Pious statements of commitment to the contrary, support for this sector has been virtually nonexistent.
c) Not surprisingly, only .1% of the Q4 2013 GDP growth (6.5%) was accounted for by this sector – services and industry contributed 3.5% and 2.8% respectively.

Banking and the Economy

At the risk of being somewhat pedantic, let us revisit what I feel is far too often forgotten – the nature of banks and why they exist.

If you were an average, rational investor, there is no way you would lend – let alone invest – in the equity of a typical bank, for the following reasons:

1. It’s leverage (measured in debt-to-equity or capital to assets terms) far exceeds what any conventional analyst would consider prudent.
2. A daunting maturity mismatch in its balance sheet, i.e. the weighted average maturity of its assets vs. liabilities that would give even the bravest of souls, nightmares.
3. The fact that its liquidity is based on the precarious assumption (which recent global financial crises have dramatically and repeatedly illustrated) that in the event of a crisis, one would be able to “liquefy” its principal assets, i.e. its loan portfolio.

And yet, as we know, banking is among the largest “industries” in the world. Why?

The banking business model is predicated on:

1. The law of large numbers, which says that, under “normal” market conditions, it is unlikely that the majority of depositors would choose to withdraw their funds at the same time.
2. The existence of deposit insurance to protect smaller investors and,
3. The availability of “lender of last resort” facilities during periods of systemic stress or “abnormal” market conditions.

But what justifies the state providing – what the average person/citizen would consider the “fat cats” of society – these extremely valuable privileges?

That, my friends, is the root of the issue.

Banks, and indeed the banking system, are designed to play a critical role in the economy. That role is integral to what we know as the savings-investment process.

The banking system is like the circulatory system of the economy: mobilizing cash (savings) from the surplus units (depositors and investors) and directing them to the deficit units (borrowers/issuers) that would maximize their use. The process is called financial intermediation.

The cost of a banking system’s financial intermediation may be seen as the “spread” between the yield of the system’s assets and the cost of its liabilities.

An efficient process is virtuous: providing higher yields to saver-investors and a lower cost of capital to issuer-borrowers – the entire economy benefits from a lower cost of intermediation.

One must understand that the banking system – and indeed, the financial markets – do not operate in a vacuum. They are not separable from – in fact, they are integral to – the real economy.

Hence, there is really no point to having a strong, well-capitalized and “stable” banking system where large swathes of the population are impoverished or where the benefits of growth are enjoyed by a very small minority. That would be a case of the “tail wagging the dog”, wouldn’t it?

As we noted in the earlier part of this talk, that is precisely the situation we are confronted with. Unless we take this as our “reality check” and point of departure, I do not believe we will arrive at a sensible solution.

That, ladies and gentlemen, is the way I propose you frame your discussions on your industry, its role and the formulation of a strategy that is, at once, relevant and sustainable.

The Philippine Banking Industry

The Bangko Sentral ng Pilipinas (BSP) appears pleased with the state of the Philippine banking system as at the first half of 2013, reporting that:
• Key performance indicators showed steady growth in assets, loans, deposit liabilities and capital accounts
• Soundness and stability indicators of asset quality and solvency remained strong as NPL/NPA ratios reached historic lows while capital adequacy ratio (CAR) remained above regulatory and international standards.
• Cost efficiencies and wider customer reach through maximization of technologically enabled service delivery channels led to a healthy bottom line and positive returns to shareholders.

It went on to report that (the) “landscape remained streamlined on account of continued industry consolidations, acquisitions and bank closures.”

In aggregate terms, universal and commercial banks accounted for 89.7% of total assets, 86% of net loans, 89.1% of deposits and 89.2% of capital accounts; thrift banks, 8.3%, 11.1%, 9.01 and 7.9%; rural banks, 2.07%, 2.91%, 1.89% and 3%.

By segment, the banking “industry reflected the following salient numbers:
1. ROA
a) U/KBs – 2.0%
b) Thrifts – 1.7%
c) RBs – 1.9%
d) INDUSTRY – 2.0%

2. ROE
a) U/KBs – 15.8%
b) Thrifts – 14.1%
c) RBs – 10.4%
d) INDUSTRY – 15.4%

3. Net Interest Margin
a) U/KBs – 3.2%
b) Thrifts – 5.0%
c) RBs – 10.4%
d) INDUSTRY – 3.5%

4. Cost to Income
a) U/KBs – 56.7%
b) Thrifts – 64.3%
c) RBs – 76.5%
d) INDUSTRY – 58.7%

5. Capital Adequacy Ratio (Solo)
a) U/KBs – 17.3%
b) Thrifts – 17.6%
c) RBs – 18.4%
d) INDUSTRY – 17.7%

The rural banking industry is clearly long on reach and short on “firepower”.

In more specific terms, BSP reported that:

Bank Office Distribution
1. There were 9,543 banking offices, up 3.6% from the 9,207 at end-June 2012) with universal and commercial banks accounting for 54.8%; thrift banks, 17.4% and rural and cooperative banks, 27.8%.
2. However, banking presence remained concentrated in highly urbanized, densely populated areas with NCR on one end of the spectrum showing 100% and ARMM on another, showing 8% coverage respectively.
3. The ATM network grew 10.4% for the year as at end-June 2013 with universal/commercial banks accounting for 86%; thrift banks, 11.9% and rural/cooperative banks, 2.1%.

Profitability

From a purely financial/operational point of view, the overall banking system performed positively.
1. Net profit was up 60.6% (Php. 97.7 B vs. Php. 60.8 B).
2. Key financial indicators stood as follows: return on assets of 2% p.a., a net interest margin of 3.5% and a return on equity of 15.4%.
3. Reflecting an exceptionally long period of accommodative monetary policy (in the US and domestically), bank trading activity grew substantially resulting in an increase in the share of trading gains to total profit (20.9%) – introducing a level of earnings volatility not seen before.
4. The banking system’s cost-to-income ratio improved significantly from 64.6% to 58.7%.
5. The banking system’s ROE compares with 10 Year Philippine Treasury yields (as of February, 2014) of 4.32% p.a. – reflecting a premium on the “risk free” return on capital of a whopping 11.08%.

NPAs and NPLs
1. The NPA ratio for all banks stood at 3.13%; universal/ commercial banks, 3.13%; thrift banks, 6.29% and rural banks, 12.04% respectively.
2. NPL/NPA coverage ratios for all banks stood at 110.84% and 69.88%; universal/commercial banks, 130.11% and 77.98%; thrift banks, 72.28% and 50.28% and rural banks, 61.54% and 40.67% respectively.

Relative to the ASEAN 5
1. As at end-March 2013, the Philippines reflected a CAR of 17.8%, second to Indonesia’s 18.9% and the average of 16.8%.
2. Net Tier 1 ratio stood at 15.9%, again second to Indonesia’s 17.3% and the average of 14.2%.
While much remains to be done, it is clear that the Philippine banking industry is strong and profitable – and, one would assume, perfectly capable of discharging its fundamental development obligations.

Rural Banking and Philippine Development Imperatives

I submit that the over-arching Philippine development imperative is to substantially reduce poverty and implement an economic development program that is holistic, inclusive and sustainable.

Accordingly, it is crucial that, our rural communities in particular, are brought into the mainstream of economic activity. With technical support and focus, the rural banking industry would appear to be logical development catalysts. That is not to say that only banks based in rural communities have a role.
Former NEDA Director General Ciel Habito recently described the current USAID strategy, which appears to focus on key secondary cities (“KSC”)”, beginning with Batangas City, Cagayan de Oro and Iloilo. They seem to believe that, focused properly, these regional centers can spur growth in the surrounding rural communities.

The idea is to develop “value chain linkages” between adjoining rural-based production units (agriculture, livestock, fisheries, forests and mining) and these key secondary cities (KSCs), which provide utilities, infrastructure, processing facilities and markets (local, regional and export).

A SWOT (“Strengths, Weaknesses, Opportunities and Threats”) analysis of the Philippine industry might show the following:

1. Strengths
a) “Last mile” to the rural-based production units (real or potential).
b) Intimate knowledge of the “terrain” and the players – precisely what the larger financial institutions do not have.
c) Long-standing relationships with the community and its major players.
d) Comparatively lower absolute cost to access loan and deposit business.

2. Weaknesses
a) Lack of appropriate/cost-effective technical support covering recruitment, training, IT, credit/loan administration, treasury, etc.
b) Lack of scale, narrow talent base and limited product lines/services.

3. Opportunities
a) Strategic partnerships (on an industry, regional and institutional basis).
i. Educational institutions: for training, recruitment (OTJ and permanent), and market research in exchange for case research and placement of graduates.
ii. Selected Universal/Private Banks and LBP: for training, systems (credit, loan administration, treasury), funding, “syndications”, origination of larger deals, etc.
iii. DBP: offer to serve as an alternative to a far more expensive branch network development strategy; explore “window 3” possibilities.
iv. Specialized Agencies e.g. Phil-Exim (export credit programs), NDC, Dep-Ed (school-house reconstruction), DSWD (CCT Program), etc.
v. Leading Micro-Finance Institutions (e.g. Card, etc)
vi. Foundations and Enterprises with significant CSR programs.
viii. Indigenous communities with significant ancestral domain land and “developable” resource base, e.g. commercial forest and processing facilities at the Lumad ancestral domain in the CARAGA region.
ix. Enterprises with a large number of suppliers or sub-contractors.

b) On an industry or region basis, approach multi-lateral and bi-lateral agencies: to secure funding and technical support for training, modernization and special programs (e.g. ADB’s inclusive growth program).
c) Substantial infrastructure-related projects (e.g. construction, tourism, municipal utilities, etc).
d) Reconstruction of typhoon/earthquake-ravaged communities (housing, schools, etc.)
e) Higher-value agro-industry (e.g. new coconut product processing, latex rubber, cacao, Arabica coffee, livestock, commercial fishing, cultivation and processing, etc.).
f) Tourism-related services in designated tourism “hubs”.

4. Threats
a) Inertia or the will to reinvent itself.
b) NPA/NPL levels.
c) Lack of capital/funding.
d) Shortage of talent committed to build a future in your banks’ respective communities.
e) Reluctance to invest in relevant new technology and “professional management” systems and processes.
f) Reluctance to adapt to modern governance practices.
g) Unpreparedness for ASEAN integration.

As a matter of strategy, I recommend that the rural banking industry get together and:
1. Consider a subtle, but fundamental, change in how it sees itself and, as a consequence, begin to modify its business model.

a) More than offering just its modest balance sheet resources, the rural banker should strive to be a trusted “financial adviser” and, in time, hopefully gate-keeper to the community. In this role, it would:
i. Assist in determining the community’s financing needs, ii. Propose financing solutions (which may or may not involve a balance sheet exposure on its part) and,
iii. Introduce the appropriate finciers and investors to the community.

b) The process will take time and require a significant training/re-training for both young and the existing senior managements of the rural banks.
c) However, if successful, it would create a significant and relevant non-interest income stream for the rural banks.

2. Engage qualified/capable outside advisers to:
a) Assist you formulate a strategy and implementation plan for the key segments of the rural banking industry, i.e. the authentically rural and the somewhat more urban).
b) Recommend short and medium term target institutional partnerships from among those indicated.
c) Assist in negotiating the subject partnerships.
d) Select and/or design training programs for the industry based on it most pressing imperatives and its overall vision.

3. Secure BSP endorsement and advice on which multilateral, bi-lateral and other agencies to approach for technical and financial support to implement your strategy.

Ladies and gentlemen, you have a formidable challenge and opportunity before you.

Quite apart from energy, commitment and focus, engaging this challenge will require you to re-invent yourselves. You must dare to innovate, collaborate and listen to a wide range of partners – with diverse points of view.

I wish you every success on this exciting journey – our country needs you to win!

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*Francis G. Estrada currently serves as independent director in a number of public and private For Profit and Not-for-Profit organizations. He was the first alumnus to be elected President and Chief Executive Officer of the Asian Institute of Management (“AIM”). He has served as Chairman of the board of trustees at De La Salle University, its leading member institution and a leading private Philippine university. He serves as independent director and adviser to a number of for-profit and not-for-profit institutions in Asia. Upon his return to the Philippines in 1997, after 22 years overseas, Mr. Estrada co-founded and served as Chairman, General Partner of Equity Managers Asia, Inc. (Philippines), a financial and investment advisory boutique.

To download a copy of the speech, please click on this link: Speech of Mr. Francis Estrada during the 2014 Annual Management Conference of the Confederation of Southern Tagalog Rural Banks (CSTRB)