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Tuesday, April 19, 2011

Where were the regulators?

On March 17, 2011, Banco Filipino was ordered closed by the Bangko Sentral ng Pilipinas or BSP and was placed under receivership. The closure was the bank's second closure in its 47 year history. The bank was clearly insolvent. It's ratio of Non-performing loans stood at 91 percent of its total loan portfolio. Over 50 percent of its total loan portfolio was made to insiders in what they call DOSRI loans. DOSRI is short for Directors, Officers, Stockholders, and Related Interests. The bank was clearly losing money on its loan portfolio. Its interest expense exceeded its interest income by PHP 1 billion a year.

But the bank was already in this condition way back as early as 2002 up to 2004 . On December 4, 2002, the bank received a 180 day “special liquidity facility” of PHP 3.5 billion by the BSP. In March 2004, 86 percent of its total loan portfolio was already classified as non-performing. DOSRI loans already made up 30 to 40 percent of its total loan portfolio.

Moreover, according to the BSP, Banco Filipino lost over PHP 2 billion a year from 2007 to 2010. In other words, the losses exceeded its last reported capital base of PHP 1.6 billion every single year since 2007, possibly even earlier. Banco Filipino again needed BSP's help again as recently as March 2009, when it received a total of PHP 4.1 billion in Overnight Clearing Lines from January 30 to March 26, 2009.

Because its cumulative losses of PHP 11.86 billion from 2007 to 2010 essentially wiped out the bank's capital several times over, the bank was essentially run as a ponzi scheme. New money replaced old money. Cash flow came from two sources: new deposits of PHP 8.4 billion since 2004 and PHP 4.5 billion in past due emergency loans from the BSP.

This ponzi scheme was run with the full knowledge and consent of the bank's regulators. BSP had a comptroller in place since 2002 as a condition of extending Banco Filipino some emergency loans. It had to know what was going on. Otherwise, the BSP regulators can be accused of gross incompetence.  Moreover, silence from BSP and PDIC meant consent. Otherwise, why keep an obviously insolvent bank open?

At any rate, this has proven to be very costly for everyone. Depositors, investors, taxpayers - all lost, and lost heavily. Moreover, their losses were magnified by the regulators failure to act sooner. Had the bank been closed earlier, the losses would have been much smaller. For instance, Banco Filipino's deposit base was PHP 15 billion at the time of closure in 2011 instead of its PHP 6.5 billion deposit base in 2004. The uninsured deposits alone at the time of closure was estimated at PHP 5.6 billion - almost equal in size to the total deposit base of PHP 6.5 billion in 2004! The Philippine Deposit Insurance Corporation could have saved a substantial portion of the PHP 9.4 billion it has to pay out to depositors of Banco Filipino out of its insurance fund.

The regulators refused to move in on Banco Filipino despite complaints from Banco Filipino's minority shareholders who had a direct and indirect 10 percent stake in the bank. In 2003, the BSP was asked by minority shareholders to place the bank under investigation for fraudulent practices, claiming that bank management and its directors had put the bank and its depositors in jeopardy. Minority shareholders provided BSP and the Monetary Board with a report that documented around PHP 2 billion in fraudulent loans to six dummy corporations closely affiliated with Banco Filipino's controlling shareholder, Bobby Aguirre. Not only did the minority shareholders complain, they sued Banco Filipino and the BSP and the Monetary Board to replace Banco Filipino's board and management and, if need be, place the bank under receivership.

Despite this, nothing happened. The minority shareholders were shut off from the bank. Basic corporate governance practices that would have provided some protection to investors and depositors was routinely ignored. The bank did not have any audited financial statements since 2002. It held no formal board meetings since 2002. The minority shareholders or any investor for that matter, had no access to information regarding the bank's financial condition. This happened despite Banco Filipino being a bank in a highly regulated sector, being a publicly listed company, and having the presence of a BSP installed comptroller as a condition of BSP's extension of emergency funds to the bank in 2002.

Clearly, the regulators are at fault. The BSP has supervisory oversight over the banking sector. PDIC monitors conditions of banks because it steps in when a bank is placed under receivership, and insures bank deposits. The S.E.C. is supposed to promote investor protection. It also ensures and enforces adherence to internationally accepted corporate governance practices. The Philippine Stock Exchange is a self regulatory organization. It disciplines listed companies that do not follow its rules.

The minority shareholders did not sit still all these years. Because the BSP and other regulators refused to move, the minority shareholders pushed their case all the way to the Supreme Court. Unfortunately, the Supreme Court, on June 19, 2009, ruled that all bank fraud cases are the exclusive jurisdiction of the BSP. The minority shareholder had no recourse to the Regional Trial Courts even if the BSP did not act on their complaints. This ruling applies to all Philippine banks. Its consequences are severe, particularly to minority foreign investors in banks who may lack the political connections of their local partners. Their investor rights will be greatly diminished. It may dissuade both foreign and local investors from further investment into the Philippine banking sector.

Why are the regulators acting this way? Why were they reluctant to act at great cost to everyone else? One possible reason is that they can personally face years of punitive litigation. And Banco Filipino provides a decent precedent, when its earlier closure in 1985 by the Central Bank (the predecessor of the BSP) was ruled by the Supreme Court as arbitrary and with grave abuse of discretion in 1991. To this day, the Central Bank, the estate of the late Central Bank governor Johzay Jobo Fernandez and three other Central Bank officers face an PHP 18.8 billion damage suit.

Another reason is that both the media and the regulators tended to characterize the Banco Filipino case as a family squabble - an inheritance dispute among members of the Aguirre clan, who have a controlling stake in the bank. But by doing this, by characterizing it as a family squabble, the regulators and the media both ignored the serious possibility of bank fraud. They exacerbated the losses of depositors, investors, and taxpayers and they contributed to the unnecessary depletion of PDIC's insurance fund.

This inaction clearly erodes confidence in the banking system. A criminally minded bank owner can steal from his own bank and get away with it, possibly for years on end. Regulators are powerless, are too intimidated, or unwilling to stop the fraud. The fraud only collapses when the bank collapses. Bank fraud cases are rarely prosecuted. If prosecution is allowed to proceed, it can be a very slow process.

How many banks have failed in recent years due to possible fraud and DOSRI violations? Orient Bank, Capitol Development Bank, Urban Bank, Homeowners Savings and Loan Association, All Asia Bank, and the Legacy Group. Moreover, prosecution is a slow process, especially in the Philippines where well funded owners can put up all sorts of legal obstacles before justice is finally served. For instance, the prosecution of Jose Go, the owner of Orient Bank which failed way back in 1998, was only allowed to proceed in November 2009. The case is still pending in court. The slow pace of justice breeds a culture of impunity.

As a consequence, the cycle of possible fraud continues. As recently as November 2010, the BSP announced that it was actively monitoring eight large commercial banks for possible DOSRI violations. In this environment, where punishment is rare, how can the public continue to place their trust and confidence in the Philippine banking system?

In this environment, where regulation is poor and ineffective, and fraudulent banking practices continue with impunity, the best way to rob a bank in the Philippines might be to own one.

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