Philippines - Financial Sector Adjustment Program

Document of The World Bank FOR OQmFCLAL USE ONLY Reprt No. P-5002-PH REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$300 MILLION TO THE REPUBLIC OF THE PHILIPPINES FOR A FINANCIAL SECTOR ADJVSTMENT PROGRAM APRIL 6, 1989 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 November 1988 - US$1.0 - P21.4 June 1988 - US$1.0 = P20.9 P 1.0 = US$0.048 Average 1987 - US$1.0 - P 20.6 P 1.0 = US$0.049 Average 1986 - US$1.0 = P 20.4 P 1.0 - US$0.049 Fiscal Year January 1 to December 31 ACRONYMS AIC - Average Intermediation Cost ALF - Agricultural Loan Fund APT - Asset Privatization Trust ASC - Accounting Standards Council BAP - Bankers Association of the Philippines CBP - Central Bank of the Philippines CALF - Comprehensive Agricultural Loan Fund CPI - Consumer Price Index DBP - Development Bank of the Philippines DOA - Department of Agriculture DOF - Department of Finance EFF - Extended Fund Facility ERL - Economic Recovery Loan PSS - Financial Sector Study GAAP - Generally Accepted Accounting Principles GCs - Government CorporAtions GDP - Gross Domestic Proluct GEM - Gross Earnings Margin GFIs - Government Financial Institutions GNP - Gross National Product GRT - Gross Receipts Tax IGLF - Industrial Guarantee and Loan Fund IMF - International Monetary Fund MB - Monetary Board NEDA - National Economic and Development Authority PDIC - Philippine Deposit Insurance Corporation PFI - Participating Financial Institutions PNB - Philippine National Bank QIRs - Quantitative Import Restrictions SEC - Securities and Exchange Commission VAT - Value Added Tax  FOR OFFICIAL USE ONLY THE PUILIPZUES IUXANCIAL SECTOR -DJUSTMENT LOAN Table of Contents Pl R No. LOAN SUR4ARY ... 1 . ......... *......... I. TH Coom . .................. 1 Introduction .............. 1 Stabilization and Macro-Economic I ............. Savings and Inv esttent ........... ................... 2 Future Growth ....................................... 3 Structural Reforms ............. .................... 6 IMF Relations .................... a II. THE FINANCIAL SECTOR ........................ S A. Overview ..................................... I ...... 8 B. The Coae_rcial Banking Sector . . . 10 C. Problems Facing the Banking Sector . . 11 Overview ................................. * ...... 11 Supervision and Regulation of Commercial Banks ... 12 Protection of Insured Depositors . . 14 Internediation Costs ...... ..... IS Mobilization and Delivery of Term Funds .......... 17 D. Financial Sector-Macro Linkages . . 19 III. THg FINANCAL SECTOR ADJUSTMENT PROGRM ................ 20 A. Perspective and Objectives .......................... 20 The Perspective .................................. 20 Objectives of the Adjustment Program . . 21 B. The Program . . ....................................... 21 Bank Supervision and Regulation . . 21 Arrangements for Depositor Protection . . 23 Intermediation Costs ...24 Mobilization and Delivery of Term Fund . .27 IV. PROGRAM IPLEENTATION ................................. 28 Actions Completed or in Progress .................... 29 Future Actions ...................................... 30 V. THE PROPOSED LOAN . . . . ............... 31 Description of the Loan .... 31 Procurement and Disbursement . . . . 33 Audit ............................................. 4 33 Statement of Policy on Financial Sector Adjustment.. 33 Cofinancing . . ....................................... 34 Technical Assistance . .................; 34 Benefits and Risks .... 34 This document has a restricted distribution and may be used by tecipients only in the performance of their official duties. Its contents may not otherwise be disclsed without World Bank authorzation.  VI. BANK GROUP OPERASIONS IN THE PHILIPPINES ................ 35 VII. BAIKIPUMD COOPEUATION .................. . * ***... 37 VIII. REXCOMXilATION ... ..... ................. ... 37 ANNEXES Annex Is Economic Indicators Annex 2: Statement of Policy on Financial Sector Adjustment Annex 3: Action to Support Financial Sector Adjustment - Implementation Schedule Annex 4: Supplementary Project Data Sheet Annex 5: -Status of Bank Group Operations in the Philippines  TIB PHILIPPINES FINANCIAL SECTOR ADJUSTMENT LOAN Loan Summary Borrowers Republic of the Philippines Amount: US$300 million equivalent. Terms: The Bank loan will be for 20 years, including 5 years of grace, at the standard variable interest rate. Program Description: The broad objective of the proposed financial sector reforms is to strengthen the financial system, particularly the commercial banking segment. More specifically, the reform program aims to: (a) strengthen the supervision and regulatory framework for commercial banks, (b) improve the institutional arrangement for depositor protection, (c) reduce intermediation costs in the banking system, and (d) improve the institutional framework for the mobilization and delivery of long-term credit. Bank supervision and regulation would be improved through Ci) strengthening legal and supervisory framework so as to empower the Central Bank of the Philippines (CBP) to take corrective actions in a timely fashion with respect to problem banks and, if necessary, to effect bank closures; and (ii) improving supervisory and regulatory procedures. Arrangements for depositor protection would be strengthened by enlarging the role of the Philippine Deposit Insurance Corporation (PDIC) to empower it to act as receiver- liquidator of failing banks and strengthening it finaneially and institutionally. Intermediation costs would be recw.ced through promotion of more effective competition, reduct on and elimination of certain taxes on financial intermediation and improvement of laws governing debt recovery and insolvencies. Fund mobilization and medium- and long-term credit delivery would be enhanced by revamping the Development Bank of the Philippines (DBP) to enable it to act essentially as a wholesaler of long-t'rm funds, and by the elimination of the role of the Centra: Bank of the Philippines in the management of government sponsored credit programs. The Export-Import Bank of Japan is likely to cofinance the proposed loan in an amount equivalent or close to the Bank loan.  -ii - To help the Government implement the adjustment program, a technical assistance program funded through a grant by the Government of Japan will be undertaken. This-will involve upgrading the staff and srytems capabilities of CDP, PDIC and DBP. Benefits: The loan will support broad development efforts of the Government. This support will come in the form of li) encouraging policy and institutional reforms, (ii) providing direct balance of payment and budgetary support, and (iii) improving the banking environment which should lead to better savings performance in ths,future. It is expected that bank supervision and regulation functions will improve in effectiveness and less time will be wasted in unnecessary litigation which has been a,problem in the past. The reforms are expected to enhance confidence in the banking system, improve efficiency and lower the cost of services provided to real sectors, and give an impetus to overall economic development and growth. In short, the reform program is expected to result in a healthier, more competitive and efficient banking system, with consequent benefits to the investors and savers alike. Risks: The principal risk is that the legislative action could either be unduly delayed or prove to be deficient when completed. The risk is mitigated by the fact that the key amendments have already been drafted and presented to the Congress so that the legislative process has already begun. Satisfactory progress, including actual passage of key legislation, will be a condition for the release of the second tranche. The Government's commitment to carry out the needed reforms is very high, and a significant number of prior actions have already been taken. Estimated Disbursements, The proposed loan would be disbursed in two equal installments. Given the actions already taken and to be taken prior to Board presentation, the first tranche of US$150 million equivalent would be available for disbursement as the loan becomes effective. The second tranche, also of US$150 million, would be released after completion of the agreed actions. Disbursements are estimated as follows: FY90 FY91 -- US$ million -- Annual 150 150 Cumulative 150 300 Appraisal Report: This is a combined President's and Staff Appraisal Report.  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXE(CTIVE DIRECTORS ON A PROPOSED 'LOAN TO THE REPUBLIC OF THE PHILIPPINES FOR A FINANCIAL SECTOR ADJUSTMENT PROGRAM I submit the following report and recommendation on a proposed loan to the Republic of the Philippines for the equivalent of US$300 million-to support a Financial Sector Adjustment Program. The loan would have a term of 20 years, including five years of grace, at the standard variable interest, rate. I. THE ECONOMY Introduction 1.1 Recent Bank economic reports 1/ have given a detailed account of-the performance of the Philippine economy. In brief these reports indicate that while economic growth in the Philippines was rapil during the 19708, distortions in the pattern of incentives resulted in inefficient investments, slow growth in employmentand low levels of domestic savings. Heavily dependent on imports and foreign capital, the economy did not adjust well to the severe external Mhocks of the post-1979 period - high oil prices and interest rates, and aecliu-ing export prices. The economy experienced declining growth rates, a deteriorating balance of payments, and the accumulation of a large external debt. A political crisis in 1983, combined with a world-wide debt crisis, led to a cessation of foreign credits, and forced the Government to embark on a major stabilization effort. Stabilization and Macro-Economic Issues 1.2 The Government's stabilization measures were supported by International Monetary Fund (IMF) Standby Arrangements of Decembei 1984 and October 1986. Overall, the objectives of the stabilization programs have been met or surpassed. Inflation has been brought under control with the consumer price index Legistering an increase of 8.82 in 1988 and 3.82 in 1987, compared to 502 in 1984 and 23Z2 in 1985. The current account swung from a deficit of 4.8Z of GNP in 1984 to a surplus equal to 3.02 of GNP in 1986, and showed only slight deficits in 1987 (1.32) and 1988 (1.0Z). GDP growth was positive in 1986 after two years of decline, showed an impressive acceleration to 4.72 in 1987, and is estimated to have grown by 6.62 in 1988. The economy is now substantially more open and distortions have been reduced. 11 Philippines: An Agenda for Adjustment and Growth (Report No. 5268-PH, November 30, 1984), Philippines: A Framework for Economic Recovery (Report No. 6530-Pd, November 5, 1986), Philippines: Toward Sustaining the Economic Recovery (Report No. 7438-PH, January 30, 1989).  -2- 1.3 The remarkable progress made thus far by the Philippine economy should not mask the challenges that lie ahead. The Government's fiscal situation remain's a cause for worry, with the public sector'deficit in 1988 estimated at 3.42 of GDP. Overall, the investment'rate is low (about 182 of GNP) and wll