Philippines - Agricultural credit sector review

Report No. 4117-PH ILE' COy Philippines Agricultural Credit Sector Review May 12, 1983 Projects Department East Asia and Pacific Regional Office FOR OFFICIAL USE ONLY (N&H Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Peso (P) IF 1.00 = US$ 0.12 US$1.00 = P 8.3 P 1,000,000 = US$120,000 WEIGHTS AND MEASURES 1 hectare (ha) = 2.47 acres 1 kilometer (km) = 0.62 miles 1 metric ton (m ton) = 2,204.6 pounds 1 kilogram (kg) = 2.2 pounds 1 cavan rice = 50 kg 20 cavans rice = 1 m ton ABBREVIATIONS AND ACRONYMS ACA - Agricultural Credit Administration ACCFA - Agricultural Credit and Cooperative Financing Administration ALF - Agricultural Loan Fund AMC - Area Marketing Cooperative BOCD - Bureau of Cooperative Development CB - Central Bank of the Philippines CF - Compact Farm CFC - Compact Farm Clusters CRB - Cooperative Rural Bank DBP - Development Bank of the Philippines DRBSLA - Department of Rural Banks and Savings and Loan Associations FMG - Farm Management Group FSDC - Farm Systems Development Corporation GSIS - Government Service Insurance System IEDP - Integrated Estate Development Program KB - Commercial Bank LBP - Land Bank of the Philippines M-99 - Masagana 99 MAR - Ministry of Agrarian Reform MLG - Ministry of Local Government MOA - Ministry of Agriculture MNR - Ministry of Natural Resources MPWH - Ministry of Public Works and Highways NEDA - National Economic and Development Authority NFA - National Food Authority NIA - National Irrigation Administration NIDC - National Investment and Development Corporation PAB - Philippine Amanah Bank PCA - Philippine Coconut Authority PCAC - Presidential Committee on Agricultural Credit PCI - Philippine Commercial and Industrial Bank PDB - Private Development Bank PFMG - Professional Farm Management Group PHILSUCOM - Philippine Sugar Commission PNB - Philippine National Bank RB - Rural Bank RDC - Regional Development Council RPB - Republic Planters Bank SLA - Savings and Loan Association SMB - Savings and Mortgage Bank SN - Samahang Nayon (Village Cooperatives) SSS - Social Security System TBAC - Technical Board for Agricultural Credit UCPB - United Coconut Planters' Bank  FOR OFFICIAL USE ONLY PHILIPPINES AGRICULTURAL CREDIT SECTOR REVIEW PREFACE This report, based on the findings of a mission which visited the Philippines in March 1982, reviews the major issues affecting agricultural credit and makes recommendations on policy and institutional changes to address these problems. The review was undertaken in view of the serious problems of arrearages that have emerged in the Bank-assisted credit projects and Government-financed agricultural credit programs, and the weak financial condition of many banks engaged in agricultural credit activities. A major concern was to identify the causes which make agricultural financial intermediaries excessively reliant on government resources and subsidies for continued agricultural lending. The draft of this report was discussed with the Technical Board for Agricultural Credit and the Presidential Committee on Agricultural Credit during November and December 1982. The comments received have been appropriately incorporated in the final report. The report is intended to provide the basis for a continuing Bank-Government dialogue on appropriate action to strengthen the country-s agricultural credit system and policies. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   PHILIPPINES AGRICULTURAL CREDIT SECTOR REVIEW Table of Contents Page No. PREFACE SUMMARY AND RECOMMENDATIONS ....... ........... i-v 1. THE RURAL SECTOR .1.. . . . . . . . . . . . . . . . . . . . . I A. Dimensions .1... . . . . . . . . . . . . . . . . . . I B. Composition of the Rural Economy ... . . . . . . . . . . 2 C. Agricultural Performance . . . . . . . . . . . . . . . . . 3 2. THE RURAL FINANCIAL MARKET: INSTITUTIONAL AND NONINSTITUTIONAL ARRANGEMENTS. 6 A. Introduction. 6 B. Organization of the Rural Institutional Financial Market . 6 C. Noninstitutional Credit Arrangements ... . . . . . . . . 17 3. MAJOR TRENDS IN AGRICULTURAL CREDIT ... . . .... . . . . . 24 A. Introduction .... . . . . . . . . . . . . . . . . . . . 24 B. Trends . . . . . . . . . . . . . . . . . . . . . . . . . . 25 - Increased Use of Noninstitutional Credit .25 - Trends in Institutional Credit . . . . . . . . . . . . . 25 - Mediur- and Long-term Credit ... . . . . . . . . . . . 29 - Resource Mobilization ... . . . . . . . . . . . . . . 29 4. GOVERNMENT POLICIES AND PROGRAMS FOR AGRICULTURAL CREDIT .... . . . . . . . . . . . . . . . . . . . . . . . 33 A. Introduction .... . . . . . . . . . . . . . . . . . . . 33 B. Credit and Extension Programs for Commodity Production . 33 C. Agricultural Credit Quota Policy ... . . . . . . . . . . 37 D. Agricultural Loan Guarantee Scheme and Crop Insurance . . 38 E. Low Interest Rates ... . . . . . . . . . . . . . . . . . 42 F. Government Subsidies ... . . . . . . . . . . . . . . . . 45 5. GOVERNMENT AGRICULTURAL POLICIES, PROGRAMS AND INSTI- TUTIONS: THEIR EFFECTS ON AGRICULTURAL INVESTMENT . . . . . 47 A. Introduction .47 B. Tenurial Reforms .47 This report was prepared by a review mission which visited the Philippines in March 1982. The mission consisted of Ramesh Deshpande, J.D. Von Pischke, Robert Hindle, John Macgregor (Bank), and Parviz Maleki and Loretta Sonn (FAO/CP). P. Brereton (Bank) assisted in preparing the report.  2- Page No. C. Support Services . . . . . . . . . . . . . . . . . . . . . 49 D. Marketing and Pricing Policies . . . . . . . . . . . . . . 52 E. Cooperatives . . . . . . . . . . . . . . . . . . . . . . . 54 F. Administrative Organization . . . . . . . . . . . . . . . . 57 6. THE STATUS OF MAJOR INSTITUTIONS IN THE RURAL FINANCIAL SECTOR . . . . . . . . 6 . . . . . . . . . . . . . . . . . . 62 A. Philippine National Bank . . . . . . . . . . . . . . . . . 62 B. Land Bank of the Philippines . . . . . . . . . . . . . . 65 C. Agricultural Credit Administration . . . . . . . . . . . . 69 D. Development Bank of the Philippines . . . . . . . . . . . . 71 E. Private Commercial Banks . . . . . . . . . . . . . . . . . 77 F. The Rural Banking System.. . . . . . 78 G. Thrift Banks . . . . . . . . . . . . . . . . . . . 84 H. Cooperative Rural Banks .. . . . . . ....... 85 I. Institutional Performance in World Bank-assisted Credit Projects . . . . . . . . . . . . . . . . . . . . . . . 86 7. SUMMARY OVERVIEW, AND A SUGGESTED ACTION PROGRAM . . . . . . . 89 A. Overview . . . . . . . . . . . . . . . . . . . . . . . . . 89 B. Problems in Agricultural Credit . . . . . . . . . 91 C. An Action Program . . . . . . . . . . . . . . . . . . . . . 98 STATISTICAL ANNEXES . . . . . . . . . . . . . . . . . . . . . . . . 113 TABLES IN TEXT Table 2.1: Structure of Financial System, 1980 . . . . . . 8 Table 2.2: Number of Financial Institutions in Operation, 1975-80 . . . . . . . . . . . . . 9 Table 2.3: Formal Institutions in Rural Financial Market . . . . . . . . . . . . . . . . 12 Table 2.4: Agricultural Loans Granted, by Bank . . . . . . 14 Table 2.5: Agricultural Loans as a Percent of Total Loans, by Bank . . . . . . . . . . . . 15 Table 3.1: Composition of Institutional and Noninstitutional Credit to Agriculture . 25 Table 3.2: Agricultural Loans Granted by Activity, 1972-75 . . . . . . . . . . . . 26 Table 3.3: Agricultural Loans Granted, 1975-80 . .27 Table 3.4: Agricultural Loans Granted by Activity, 1975-80 . . . . . . . . . . . . . . . . . . 28 Table 4.1: Coverage and Payments of Loan Guarantee Funds . 39 Table 4.2: Crop Insurance Premium Rates . . . . . . . . . 40 Table 6.1: Agricultural Production Loans Granted by PNB, 1975-81 . . . . . . . . . . . . . . . . 63 Table 6.2: LBP: Agricultural Loans Granted . . . . . . . 66 Table 6.3: DBP: Agricultural Loan Approvals . . . . .. 72 Table 6.4: DBP: Agricualtural Loan Approvals by Activity 74 Table 6.5: DBP's Margin on Agricultural Lending . . . 76 Table 6.6: Rural Banks Arrearages under Central Bank Loans, Septemer/December 1981 .81  - i- SUMMARY AND RECOMMENDATIONS 1. During the past decade or so, the Philippines- agricultural sector has made impressive gains. Overall output has grown at an average rate of 4.9% p.a. and the country has achieved self-sufficiency in rice production. The Government has introduced a number of new credit policies and programs to support its production objectives, and these have made important contributions to the sector-s production achievements. As a result of greatly expanded crop-specific credit programs, made available through a growing network of government and private banks, many more farmers found themselves able to take advantage of the greater opportunities provided by the Government's own infrastructure investments and by improved extension services. Although credit for medium and longer-term purposes did not expand much, production credit grew rapidly throughout the 1970s. Continued growth of the agricultural sector remains crucial for the future of the economy and for the 46% of the population who are farmers. The growing availability of credit, for various terms and purposes will be essential to agricultural growth. 2. Despite the strong performance of agriculture during the 1970s, and the support provided by rural credit institutions over many of those years, the present condition of the rural credit markets is far from healthy. A large number of the loans made by both government and private banks have fallen into arrears, disqualifying many borrowers from further loans and disqualifying the banks from use of discount privileges at the Central Bank (CB). These twin constraints have caused the proportion of institutional credit, which rose to 68% in the mid-seventies when the government-sponsored supervised credit programs were in full swing (1975), to fall back to only 32% in late 1970s. Currently about two-thirds of all agricultural credit is being provided by informal or non-institutional sources -- relatives, friends, traders, landlords, and professional moneylenders. Noninstitutional credit usually costs more than institutional credit, and is generally not available for medium- and longer-term loans. In 1980, 98% of bank credit was for short-term use, i.e., for loans that had to be repaid within 12 months. 3. The unhealthy state into which rural credit institutions have fallen has not only reduced credit availability but has threatened the viability of many of the institutions, both public and private. The Government's major term lending institution, the Development Bank of the Philippines (DBP), has arrears of + 1.1 billion or 65% of the amount due for repayment (para. 6.39). The Philippine National Bank (PNB), a government commercial bank, has arrears of nearly P 200 million (para. 6.06). The privately owned rural banks have arrears of over P 1 billion owed to the CB, disqualifying about one half of 1,041 banks from further access to rediscounting facilities. Much of the serious arrearage problem has arisen in the Government-sponsored supervised credit programs designed to achieve production targets for specific crops. Supervised credit does not require collateral, and the drying up of it has caused a shift towards nonsupervised credit, which almost always  - fi - requires collateral. However, even the performance of non-supervised credit programs, which provide collateralized loans to farmers and commercial entrepreneurs in relatively high income groups, has not been satisfactory because of low subloan collections. A large proportion of small farmers have no collateral to offer, partly because the land reform program has moved slowly and has not yet given many farmers clear land titles. These developments also underlie the return to much greater reliance on noninstitutional credit. 4. Apart from arrearages the rural credit system has many other weaknesses that need attention. Some of the more important weaknesses are noted below: (a) Rural financial institutions have typically specialized their functions, and this has inhibited efficient financial intermediation, led to high transaction costs and a limited spread of risk, and restricted the range of banking services available to farmers. Examples of functional specialization relate to the type of clientele served (small vs. larger farmers), length of loan (short vs. long-term), type of commodity financed (coconut, sugar, etc.) and activity financed (production, marketing or processing). Rural banks, PNB, the Land Bank of the Philippines (LBP), and the Agricultural Credit Administration (ACA) support smallholder rice and corn production while private commercial banks, DBP and PDBs finance only a selective clientele, usually medium- and large-scale borrowers. (b) Although there has been a considerable expansion of rural banking facilities during the past decade, the country's banking system is still highly urban-oriented, leaving many rural areas seriously "under-banked." (c) The banking system has not been fully successful in tapping the rural savings potential. Although the limited network of rural credit institutions partly explains the low mobilization rate, a more important reason has been the government's low interest rate policy which was not adequate to attract larger savings. With inadequate deposits to finance their lending, and low interest rates on agricultural loans, rural credit institutions have had to rely heavily on low-cost funds provided by Government.  - iii - (d) The transaction costs of banks handling supervised credit have been high, despite access to low-cost funds through CB rediscounting. The transaction costs include not only administrative costs (4.5-6.0%) but compulsory insurance premiums (3%) and the cost of carrying past due loans (4% for rural banks, 12% for PNB). With lending rates regulated at 12% (15% for corn), many banks found supervised credit lending unprofitable. From the farmers viewpoint, a 12-15% interest cost was not in fact their full borrowing cost: to this had to be added a 2% service charge, a 3% charge for compulsory deposits in the Barrio Saving Fund (since discontinued), plus a transaction charge of 3%. For many farmers, these and other costs have pushed the cost of institutional credit close to that of informal credit, which is often easier to arrange. 5. A 1980 joint IMF/World Bank review of the Philippine financial sector led the Government to introduce a set of reforms that had two main objectives, (a) increased competition among financial institutions to achieve greater efficiency and (b) the greater availability of longer-term credit. One major change designed to help achieve these aims was the deregulation of interest rates on both deposits and loans, excluding agricultural loans refinanced by CB. The benefits of liberalization are unlikely to be felt in agriculture until remedial measures are taken to overcome the difficulties that are now preventing rural credit institutions from giving farmers the help they need. Recommendations 6. Chapter 7 of the report suggests an Action Program to nurse the rural credit markets back to health. There are three broad sets of problems that need to be addressed: (a) limitations on the supply of formal credit to farmers; (b) institutional weaknesses; and (c) deficiencies in government policies affecting agricultural credit. The principal means proposed for addressing these problems are: (a) Fostering greater competition between formal and informal lenders; (b) Completing the deregulation of interest rates in order to promote greater deposit mobilization in rural areas and the use of deposit resources for agricultural lending; (c) Rationalizing and, in phases, eliminating credit subsidies;  - iv - (d) Increasing the efficiency of the rural financial markets through functional de-specialization and the financial rehabilitation of DBP and the private and cooperative rural banks; increased participation of commercial banks and savings and mortgage banks in agricultural lending, especially for medium- and long-term credit; and an improved field-level credit-delivery mechanism, including the strengthening of village cooperatives; and (e) Establishing an agency or mechanism to support retail lending agencies and to coordinate their agricultural credit activities. Implementation of these objectives will require a number of initiatives by the Government, including agreement on flexible interest rate policies for the sector, changes in the corporate policies of some banks, a realistic resolu- tion of the problem concerning the large volume of uncollectable debts, and the creation of a new central mechanism to support retail lending institu- tions. Equally important will be agricultural pricing policies which will, as early as feasible, turn the terms of trade in favor of agriculture, with emphasis on benefiting the productive activities of small farmers. Some of these steps must be taken promptly, but the creation of a sound system of rural credit will require various actions extending over several years.  1. THE RURAL SECTOR A. Dimensions 1.01 Agriculture, including forestry and fisheries, plays a dominant role in the Philippine economy. The country's population is predominantly rural, with about 70% (34 million people) living in rural areas, two thirds of whom depend on farming for their livelihood. Over all, more than half of the labor force are engaged in agricultural activities. Agriculture produces about 26% of gross domestic product (GDP) and 60% of aggregate export receipts. 1.02 Of the total land area of 30 million ha, about 28% is cultivated./I Nearly three fourths of this is devoted to grains, essentially rice and corn. Other important crops are coconut, sugarcane, fiber crops, pineapple, banana and tobacco. Almost all of the irrigated area, estimated at 1.2 million ha, is planted to rice; rainfed agriculture, which sustains 60% of the total farm population, is dominated by mixed farming systems where rice, corn and coconut are grown together with livestock raising. 1.03 The rural scene is characterized by small units farmed by tenant families. The Agricultural Census of 1971 estimated the total number of farm holdings at 2.35 million, 85% of which were less than 5 ha. The average farm size was 3.6 ha for all commodities, 2.7 ha for palay and 13.6 ha for sugar. Due to population growth and inheritance customs, the average farm may now be even smaller, probably about 2.7 ha, and fragmented. 1.04 Farm productivity is generally low and, combined with land scarcity and the fact that most of the non-marginal lands are already under cultivation, results in low incomes. In 1971, the average family income in rural areas was about P 4,400 (US$580), representing 75% of the national average. According to the World Bank's 1980 Poverty Report,/2 about three quarters of the poorest 40% of all Filipino families in the 1970s lived in rural areas, with per capita incomes equivalent to the 1975 poverty line of P 827 (US$110) /3 or less. While farm size was the most /1 Effective harvested area is larger due to multiple cropping. /2 World Bank, "Aspects of Poverty in the Philippines: A Review and Assessment," Report No. 2984-PH, December 1, 1980. /3 P 1,103 (US$147) for urban areas.  - 2 - important variable explaining disparities in income level, poverty incidence varies considerably among the 13 regions in the country. Together with relatively poor access to services and social infrastructure, low farm incomes have encouraged migration from the rural to the urban areas, particularly in the Manila region where population grew by more than a million in the period 1975-1980. B. Composition of the Rural Economy 1.05 Crop production is the predominant subsector, contributing 61% of gross value added in agriculture./l Livestock and poultry accounted for 12%, fisheries 18% and forestry 8% (Annex 1, Table 1)./2 1.06 Food crops are more important than commercial crops in both area and value of production, occupying some 69% of the planted area and yielding 64% of the value of production. Rice is grown on 3.5 million ha, providing the staple of both urban and rural populations in the lowlands and plains. Corn, the other major food crop, is grown on a subsistence basis on about 3.3 million ha, mainly in the uplands where it is complemented by upland rice and root crops. Corn also provides livestock feed. Yields are typically low (0.8-0.9 tons per ha). 1.07 The commercial crops area is largely planted to coconut /3 (about 3 million ha), followed by sugar, abaca and coffee. Sugarcane and coconut products account for about 83% of the total value of commercial crops. Exports of copra have fluctuated widely but those of both dessicated coconut and coconut oil have registered steady increases. Despite a much smaller magnitude, the two most successful commercial crops in recent years have been pineapple and bananas, both developed efficiently as plantation crops. Cotton production has also increased. 1.08 In livestock, commercial pig and poultry farming has expanded rapidly, while beef production has been lagging behind fast-growing demand. Forty percent of the beef consumed is imported, mainly in the form of corned beef. About three quarters of the nearly 2 million farms with cattle - mainly carabao for power - are in rainfed areas, concentrated in the drier and upland zones. /1 1975 figures. /2 Gross value added at 1972 constant prices in Annex 1, Table 2. /3 One third of the population is in one way or another involved in the coconut industry.  1.09 The country's vast inland fishery resources are estimated to include 900,000 ha of freshwater areas, mainly suited for fishpond purposes; about 20% of this potential has been developed. Marine fishing grounds covering about 170 million ha of coastlines have a potential maximum sustain- able yield of 1.95 million tons, of which about 1.25 million tons are exploited. However, some traditional fishing grounds are already overfished, and this has become a major economic and social problem, particularly for the 200,000 or so "municipal fishermen" who constitute part of the rural poor. 1.10 Forest resources occupy some 65% of the total land area, or 13.7 million ha, most of which is public forest lands. Although commercial forests are estimated to contain 1.9 billion cubic meters of sound wood resources, exploitation has greatly reduced timber stands. Stricter supervision of fellings, planting of fast growing species, and squatter control are among new approaches that should enable sustainable exploitation of the forests. C. Agricultural Performance 1.11 Self-sufficiency in food production, especially in rice, has consistently received highest government priority. This objective was achieved in 1977 through a two-pronged strategy which envisaged: expansion and rehabilitation of irrigation systems to remove the constraint of inadequate water supplies; and increased use of high-yielding varieties (HYVs), fertilizers and pesticides through the Masagana-99 (M-99) credit- cum-extension program. During the last decade the Philippines also made significant progress toward other objectives which included expansion of agriculture-s share in exports, land reform and land distribution, and conservation of natural resources. Since the early 1970s, the Government has accorded increasing importance to raising income levels of small farmers and fishermen, and reducing income disparities between the rich and the poor, between rural and urban areas and among the rural regions. 1.12 Although in proportion to other sectors of the economy, the contri- bution of agriculture has been declining slowly, from 28.9% of GDP in 1970 to 25.5% /1 in 1980, the agricultural sector grew at an annual rate of about 4.9% during 1970-80 which was comparable to the performance of other East Asian countries (Annex 1, Table 3). Increased grain production was associ- ated with the Philippines' shift from being a major importer of rice up to /1 Preliminary estimate of NEDA.  - 4 - 1977 to having small exportable surpluses (currently estimated at about 200,000 tons a year). Corn production, however, continues to be below the total estimated corn consumption for food, feeds and other uses. Output of vegetables, peas and beans, fruits and nuts, roots and tubers has markedly and steadily increased. Vegetable and fruit production, however, is constrained by problems related to post-harvest facilities, marketing and distribution. 1.13 From a small base, coffee and rubber production have increased by more than 10a annually, and export potentials are good. Among other export crops, results have varied: output of cocoa is estimated to have fallen, while that of abaca and tobacco has essentially remained at the same level. Production of sugar has risen at less than 2.5% p.a. Exports of bananas and pineapple have notably increased, but coconut, still the country's major foreign exchange earner, has suffered from low world market prices and fluctuating yields due to weather conditions, diseases and the age of the trees. 1.14 While production of fish, pigs and poultry has expanded significantly, value added in the traditional livestock (cattle) subsector stagnated during the 1970s. However, Government has intensified its activities to promote livestock production, in particular through Bakahang Barangay and other credit programs. 1.15 Continued agricultural growth will remain crucial for the Philippines to grapple with its major economic problems. First, although the total population is growing by 2.5% annually, the labor force is projected to increase by 3.7% annually due to very high fertility rates pre- vailing in the 1960s, before the introduction of family planning programs, and an expected increase in the proportion of working women. Between L980 and 1987, the economy will have to find jobs for 5 million people, or 700,000 persons annually, if an increase in unemployment is to be prevented. While the manufacturing sector will promote more rapid growth of employment, the labor force is expected to grow so rapidly that most of the increment will have to be absorbed by the agricultural sector./l Second, despite significant increases in output, the Philippines' agricultural productivity continues to be low by international standards. Reaching higher levels; of productivity. both in irrigated and rainfed areas, is important for general economic growth and for increased rural incomes. Third, during the last decade average rural incomes increased in real terms as the rate of growth /1 World Bank, "The Philippines - Selected Issues for the 1983-87 Plan. Period," Report No. 3861-PH, June 1, 1982.  - 5 - of agricultural production exceeded that of the population by a substantial margin. But while employment increased by more than 20%, the gains in both income and employment were not evenly produced. Fourth, agricultural strategies will also have to respond to ongoing efforts to reduce dependence on imported energy, promote larger domestic resource mobilization and, in the context of deteriorating terms of trade, reduce dependence on foreign borrowings and promote exports. 1.16 The Government's proposed development plan (1983-87) therefore envisages more efficient exploitation of agricultural potential, sustained self-sufficiency in rice, fish, poultry, pork and fruits and vegetables and expanded production of export crops, import substitutes and agro-industry crops. The development of infrastructure, particularly small-scale irriga- tion systems, mini hydro projects, and farm-to-market roads, will receive high priority. Agrarian reform is proposed to be intensified. Crop insur- ance will be expanded. Incremental resources are intended to be generated from greater reliance on domestic savings through financial innovations and more efficient intermediation, development of long-term capital markets, expanded commercial banking, greater reliance on resource mobilization through issue of government securities, and floating interest rates. The new plan emphasizes significant improvement in access by a larger section of the population to facilities and resources such as infrastructure, credit, raw materials, technology and markets. Formal credit-facilitated agricul- tural development and efficient financial intermediation, particularly resource mobilization and credit, should support Government's development objectives in agriculture. It is against this background that this report reviews Philippine agricultural credit.  - 6 - 2. THE RURAL FINANCIAL MARKET: INSTITUTIONAL AND NONINSTITUTIONAL ARRANGEMENTS A. Introduction 2.01 The Philippine rural financial market consists of a formal institutional sector and an informal noninstitutional sector. Institu-- tional credit for agriculture is offered by a variety of government- and privately-owned entities whose lending operations often have rather well defined emphasis in terms of loan amount (large vs. small loans), duration (long vs. short-term), recipients (commercial operations, agrarian reform beneficiaries, etc.), commodities (sugar, coconut, etc.) and activity (production, marketing or processing). Noninstitutional credit is offered by private moneylenders, traders, relatives, friends and landlords. It tends to be short-term, often requiring no collateral but at interest rates which are substantially above those used for institutional credit. B. Organization of the Rural Institutional Financial Market 2.02 A clear demarcation between the Philippines' rural and nonrural financial markets is not feasible /1 since the Manila offices of rural credit institutions participate in the rural financial market through resource mobilization and the extension of credit for agricultural activities. In fact, the Metro Manila area has a sizable share in institutional credit for agriculture. The national financial structure is therefore described below in order to provide a context for the operations of the rural sector. Structure of the National Financial System 2.03 The financial sector in the Philippines is relatively well- developed. The sector grew rapidly during the 1960s, and total resources /1 In the Philippines, rural areas are defined as those with a population density of less than 1,000 persons per sq km and where at least 50% of the population is engaged in agricultural activities. By this definition, 99.4% of the total land area of the country is classified as rural, and 84% of the 1970 population are rural dwellers. In this report, however, "rural" refers to areas outside Metro Manila, which represent 99.8% of the country's total land area, where 89% of the 1970 population reside. Systematic data on financial institutions' activities in "rural" areas and "nonrural" areas are not available.  - 7 - of the financial system as a percentage of GNP increased from 48% in 1960 to 115% in 1980. During 1975-80, growth in total assets averaged 8% p.a. in real terms while real GNP grew at 6% (Table 2.1). This growth was accom- panied with and made possible by a significant expansion in the network of offices, which increased from 3,396 in 1975 to 4,918 in 1980 (Table 2.2). Exclusive of the Central Bank portfolio, ownership of the sector is about equally divided between private and government entities. 2.04 Within the financial sector, the banking system is predominant and controls about 60% of total assets, mainly through the commercial banks. Non-banking financial institutions account for a relatively small share of total assets, but perform specialized functions not handled by the commer- cial banks, and thus broaden the sector's geographical coverage and range of services. Insurance companies and investment houses, for example, are important by undertaking resource mobilization and capital formation. 2.05 The Banking Sector. The banking system comprises commercial banks, rural banks, thrift banks ard specialized government-owned banks. The Central Bank (CB) is responsible for monetary stability and credit regulation. It also ensures availability of credit for agricultural produc- tion and related activities, as far as is consistent with conventional central banking functions. 2.06 Commercial Banks. At the end of World War II, there were 4 domestic banks and 4 foreign banks. However, at the end of 1980, the commercial banking sector included a total of 32 banks, comprising 26 private domestic banks, 2 government or semi-government banks and 4 branches of foreign commercial banks. A large number of banks were established between 1955-65, in response to government efforts to rehabilitate the banking industry and to meet the growing demand for financial services. The government-owned Philippine National Bank (PNB), established in 1916, is the largest commercial bank in the country with 175 offices and 25% of the total assets of the banking system. The five largest private domestic banks have 23% of total assets and 616 offices./1 Foreign banks own about 12% of total assets and operate mainly in Metro Manila. 2.07 Commercial banks operate through 1,503 offices, more than half of which are in Metro Manila (651), Central Luzon (121) and Southern Tagalog (106). Other regions, particularly Ilocos, Cagayan, Visayas and Mindanao /1 Bank of the Philippine Islands, Allied Bank, Metropolitan Bank, United Planters Bank and Far East Bank & Trust Co.  - 8 - Table 2.1: PHILIPPINES: STRUCTURE OF FINANCIAL SYSTEM, 1980 (Billion pesos and percentages) Asset size Real rates of growth p.a. Compo- 1960- 1965- 1970- 1975- Amount sition 65 70 75 80 (Pesos) -