FINFSAF QUIZ 1
Financial Statement Analysis
Horizontal Analysis
Horizontal analysis compares financial data over different periods to identify trends and growth patterns.
Vertical Analysis
Vertical analysis expresses each item in a financial statement as a percentage of a base item within the same statement.
Ratio Analysis
Ratios provide insight into various aspects of a company's performance and financial health.
Liquidity Ratios
Liquidity ratios measure a company's ability to meet its short-term obligations.
PDK Enterprise Liquidity: Comparing these ratios with industry standards and historical ratios will determine PDK's liquidity. Generally, higher ratios indicate better liquidity.
Solvency Ratios
Solvency ratios assess a company's ability to meet long-term obligations.
Banks in the Philippines are classified into several categories:
Universal Banks
Commercial Banks
Thrift Banks
Rural Banks
Cooperative Banks
Islamic Banks
Government-owned Banks
Other Banks as classified by the Bangko Sentral ng Pilipinas (BSP)
Universal and commercial banks are the dominant groups, representing approximately 70% of the resources of the banking system.
Universal Banks: Defined under the General Banking Law of 2000 (GBL), a universal bank is a commercial bank with the additional authority to exercise the powers of an investment house and invest in non-allied enterprises.
Commercial Banks: These banks do not have the authority to exercise the powers of an investment house or invest in non-allied enterprises.
Branches, subsidiaries, and affiliates of foreign banks in the Philippines are licensed either as universal or commercial banks. Some foreign banks operate offshore banking units with more limited functions. The BSP ensures that 60% of the resources or assets of the banking system are held by domestic banks that are majority-owned by Philippine nationals.
Universal Banks: Governed by the General Banking Law.
Commercial Banks: Governed by the General Banking Law.
Thrift Banks: Governed by the Thrift Banks Act.
Rural Banks: Governed by the Rural Banks Act.
Cooperative Banks: Governed by the Philippine Cooperative Code.
Islamic Banks: Governed by the Charter of Al-Amanah Islamic Investment Bank of the Philippines.
Government-owned Banks: Governed by their specific charters.
Other Banks (e.g., Digital Banks): Governed by specific circulars and regulations issued by the BSP.
The BSP has currently authorized six digital banks to operate in the Philippines:
Overseas Filipino Bank (OF Bank)
Tonik Bank
UNObank
UnionDigital Bank
GOtyme
Maya Bank
Digital banks have minimal or zero reliance on physical touchpoints but are required to have one office as a central hub in the Philippines to handle customer complaints. The BSP issued Circular No. 1105 on the establishment of digital banks, making it the BSP’s seventh bank category.
The BSP, acting through its Monetary Board, is the primary overseer of banks in the Philippines. The operations and activities of banks are subject to BSP supervision, which includes the promulgation of rules and standards, visitorial powers, and the enforcement of corrective actions. The BSP conducts regular and special examinations of banks to ensure their solvency and liquidity.
Locally incorporated banks are managed by a board of directors with 5 to 15 members, including at least two independent directors. The BSP has criteria for bank directors based on integrity, experience, education, training, and competence. Board meetings can be conducted via teleconferencing or videoconferencing, but directors must participate in at least 50% of meetings annually and physically attend at least 25%.
The BSP has published the Handbook on Corporate Governance and issued rules of procedure on administrative cases involving bank directors and officers. Each bank is required to appoint a full-time chief compliance officer to manage a compliance system.
Universal and commercial banks are subject to Basel III capital adequacy standards, including:
Risk Capital Ratio: 10% for solo and consolidated bases.
Common Equity Tier 1 (CET1) Ratio: 6%.
Tier 1 Capital Ratio: 7.5%.
Capital Conservation Buffer: 2.5% composed of CET1 capital.
Leverage Ratio: Not less than 5% on both solo and consolidated bases.
Liquidity Coverage Ratio: Adequate to withstand liquidity shocks lasting 30 days.
Thrift banks, rural banks, and cooperative banks follow the Basel 1.5 framework, a simplified version of Basel II.
Conditions for Appointment: The Monetary Board can appoint a conservator if a bank shows continuous inability or unwillingness to maintain adequate liquidity to protect depositors and creditors.
Powers of the Conservator:
Take charge of the bank's assets and liabilities.
Manage or reorganize the bank's management.
Collect monies and debts owed to the bank.
Exercise all necessary powers to restore the bank's viability.
Competency: The conservator must be knowledgeable in bank operations and management.
Duration: Conservatorship is limited to one year.
Termination: The Monetary Board will end the conservatorship when the bank can operate independently. If the bank's continued operation could lead to probable loss to depositors and creditors, Section 30 applies.
Conditions for Appointment: The Monetary Board may appoint the Philippine Deposit Insurance Corporation (PDIC) as a receiver if:
The bank has insufficient realizable assets to meet liabilities.
The bank cannot pay its liabilities as they become due.
The bank cannot continue without probable losses to depositors or creditors.
The bank has willfully violated a final BSP cease-and-desist order involving fraud or dissipation of assets.
Assessment Period: Within 90 days, the receiver must determine if the bank can be rehabilitated or allowed to resume business safely.
Monetary Board Approval: Any resumption of business requires Monetary Board approval.
Liquidation: If rehabilitation is not possible, the Monetary Board will instruct the receiver to liquidate the bank.
Court Petition: The receiver files a petition in court to assist in the liquidation process.
Asset Disposal: The receiver converts the bank's assets to money, disposes of them to creditors, and recovers accounts.
Section 30 Actions: Actions taken under Section 30 are final and executory. They may not be restrained or set aside by a court except on grounds of excess jurisdiction or grave abuse of discretion.
PDIC Charter: Under the amended PDIC Charter, a closed bank ordered by the Monetary Board will be liquidated without the consent of stakeholders.
Integrity and Performance: Banks must exercise high standards of integrity and performance.
Fiduciary Duty: Breach of fiduciary duty can lead to liability for damages and unsafe or unsound banking practices, potentially causing a bank run and insolvency.
Prudential Measures:
Capital adequacy.
Reserve requirements.
Single borrower's limit (SBL).
Directors, officers, stockholders, and related interests (DOSRI) limit.
Loan-loss provisioning.
Equity investment limit.
Stress Tests: BSP reinforces prudential measures with stress tests, particularly for real estate exposures.
Consumer Protection: Standards for consumer protection include disclosure, transparency, confidentiality, fair treatment, effective recourse, and financial education. BSP-supervised institutions must have a consumer protection risk management system.
Unified Reserve: Initially set at 18% for deposit and deposit-substitute liabilities of universal and commercial banks.
Purpose: Reserves serve as a ready source of funds to respond to large withdrawals and prevent bank runs.
Purpose: Allocates bank resources across different sectors and prevents excessive loans to a single borrower or group.
Limits:
Standard SBL is 25% of the bank's net worth.
Incremental SBL of 10% for adequately secured additional liabilities.
Purpose: Levels the lending field between insiders and outsiders, preventing banks from becoming captive finance sources for insiders.
Ceilings:
Individual ceiling: Total direct credit accommodation equivalent to unencumbered deposits plus paid-capital contribution.
Aggregate ceiling: Total DOSRI credit accommodations up to 15% of the total loan portfolio or 100% of net worth.
Unsecured loans: Must not exceed 30% of total DOSRI credit accommodations.
Board Resolution: DOSRI loans require a board resolution, excluding the interested director, and must be transmitted to the BSP.
Guidelines: Banks must set up allowances for credit losses (ACL) based on the number of days of missed payments, classifying loans accordingly.
Limits:
Universal banks: Total investment in equities of allied and non-allied enterprises must not exceed 50% of net worth; individual investment must not exceed 25% of net worth.
Commercial banks: Total investment in allied enterprises must not exceed 35% of net worth; individual limit is 25%.
Approval: All equity investments require Monetary Board approval.
Criminal Prosecution: Fines ranging from 50,000 to 2 million pesos, imprisonment from two to ten years, or both.
Administrative Sanctions:
Fines up to 1 million pesos per violation or 100,000 pesos per day for continuing violations.
Suspension of rediscounting privileges, lending or foreign exchange operations, and interbank clearing privileges.
Suspension or revocation of special licenses.
Client Information: Must be kept confidential by the bank and its representatives. Disclosure requires court order, except under specific circumstances outlined by law.
Bank Deposits: Protected under the Secrecy of Bank Deposits Law, with specific exceptions.
Sources: Equity contributions from shareholders, and loans from the BSP and other lenders.
Capitalization: Minimum paid-in capital for universal and commercial banks, and risk-based capital adequacy ratios.
BSP Facilities: Rediscounting and other credit facilities, including emergency loans during financial panics.
This summary covers the key aspects of prudential regulation, conservatorship, receivership, and conduct of business for banks as outlined in the New Central Bank Act and related regulations.
Why do Banks Exist?
In an Ideal World:
Those who have excess funds need to allocate these funds efficiently.
Those who need funds seek capital to finance various needs.
This process of capital allocation is critical for economic growth.
However, the Real World Faces Challenges:
Consequences:
Adverse Selection: Occurs before the transaction when one party has more or better information than the other.
Business Example: Managers know potential returns and risks; investors do not.
Lending Example: Borrowers know their ability to repay loans; lenders do not.
Moral Hazard: Occurs after the transaction when one party takes on excessive risk because another party bears the consequences.
Business Example: Investors prefer risky projects when using borrowed funds.
Lending Example: Borrowers may misuse the loaned money.
Solutions to Adverse Selection:
Information collection.
Government-mandated disclosures (e.g., annual reports, financial statements).
Screening processes.
Addressing the free rider problem (where individuals benefit from resources or services without paying for them).
Solutions to Moral Hazard:
Compensating balances.
Restrictive covenants in loan agreements.
Role of Banks:
Banks act as intermediaries between those who have excess funds and those who need funds.
They take deposits from parties with excess funds and give loans to parties in need of funds.
Banks also create money through the fractional reserve banking system.
How Banks Create Money:
Example: With a reserve requirement of 10% and an initial deposit of $100:
Bank A's balance sheet: Reserves = $10, Deposits = $100, Loans = $90.
Bank B's balance sheet: Reserves = $9, Deposits = $90, Loans = $81.
Bank C's balance sheet: Reserves = $8.1, Deposits = $81, Loans = $72.9.
This process continues, creating a money multiplier effect.
Money Multiplier:
Formula: Multiplier = 1 / Reserve Requirement Ratio
For a reserve requirement of 10%, the multiplier is 10x.
Common Ratios for Banks:
Return on Equity (ROE):
Formula: ROE = Net Income / Average Equity
Example Calculation:
Net Income = $560,000
Average Equity = ($17M + $19M) / 2 = $18M
ROE = $560,000 / $18M = 3.11%
Efficiency Ratio:
Formula: Efficiency Ratio = Non-interest Expense / Interest Revenue
Example Calculation:
Non-interest Expense = $300,000
Interest Revenue = $1,800,000
Efficiency Ratio = $300,000 / $1,800,000 = 16.67%
Non-Performing Loans (NPL) Ratio:
Formula: NPL Ratio = Non-performing Loans / Total Loans
Example Calculation:
Non-performing Loans = $10,000,000
Total Loans = $123,000,000
NPL Ratio = $10,000,000 / $123,000,000 = 8.13%
Loan to Deposit Ratio:
Formula: Loan to Deposit Ratio = Total Loans / Total Deposits
Example Calculation:
Total Loans = $123,000,000
Total Deposits = $127,000,000
Loan to Deposit Ratio = $123,000,000 / $127,000,000 = 96.85%
Capital Adequacy Ratio (CAR):
Definition: Measures a bank's available capital as a percentage of its risk-weighted assets.
Purpose: To protect depositors and ensure stability in the financial system.
Example Calculation:
Capital = $19,000,000
Risk-weighted assets:
Cash = $1M (0%)
Due from BSP = $25M (0%)
Loans (Performing) = $113M (50%)
Loans (Non-performing) = $10M (100%)
Property, Plant, Equipment = $3M (100%)
Total Risk-weighted assets = $69.5M
CAR = $19M / $69.5M = 27.34%
Basel I: Risk-based capital requirements.
Basel II: Internal risk-based approach.
Basel III: Capital conservation buffer.
Government Policy Goals: Promote a stable, efficient, competitive, dynamic, and responsive banking system.
Key Legislation:
General Banking Law
Thrift Bank Act
Rural Bank Act
Philippine Cooperative Code
Charter of Al Amanah Islamic Investment Bank
Regulatory Bodies:
Bangko Sentral ng Pilipinas (BSP): Provides oversight and conducts examinations every 12 months.
Philippine Deposit Insurance Corporation (PDIC): Ensures deposit insurance coverage up to P500,000 per deposit per bank.
Challenges in Regulation:
Compliance with Know-Your-Customer (KYC) requirements.
Data privacy concerns.
Cybersecurity threats.
Money laundering.
Consumer Protection Standards:
Disclosure and Transparency.
Protection of Client Information.
Fair Treatment.
Effective Recourse.
Financial Education.
Future Regulatory Changes:
Alignment with international standards.
Strengthening anti-money laundering capabilities.
Enhancing financial inclusion.
Encouraging innovation in financial technology.
Penalties for Violations:
Fines ranging from P50,000 to P200,000.
Imprisonment ranging from 1 to 10 years, depending on the violation.
Administrative sanctions including fines, suspension of operations, and revocation of licenses.
Insurance: A contract where an individual or entity pays an insurance company in exchange for financial protection or reimbursement of losses resulting from a covered event. The key role of insurance is to help people financially protect themselves against life’s uncertainties, such as natural disasters, car accidents, or illnesses.
Insurance Contract: Represented by a policy, in which a policyholder receives financial protection or reimbursement against losses from an insurance company. The company pools clients’ risks to make payments more affordable for the insured.
Hedging Risks: Insurance policies are used to hedge against the risk of financial losses, both big and small, resulting from damage to the insured or their property, or from liability for damage or injury caused to a third party.
Insurance: A contract (policy) where an insurer indemnifies another against losses from specific contingencies or perils.
Common Types: Life, health, homeowners, commercial building, and auto insurance.
Core Components: Deductible, policy limit, and premium.
Types of Insurance: Auto, health, homeowners, and life insurance are the most common.
Three Critical Components:
Premium: The price of the policy, typically expressed as a monthly cost, determined by the insurer based on the risk profile.
Policy Limit: The maximum amount the insurer will pay under the policy for a covered loss.
Deductible: The amount the policyholder must pay out of pocket before the insurer pays a claim. Higher deductibles generally result in lower premiums.
Premium
The cost of the insurance policy, typically paid monthly.
Determined by the insurer based on the insured's risk profile.
Policy Limit
The maximum amount the insurer will pay for a covered loss.
Limits can be set per period, per loss, or over the life of the policy.
For life insurance, the maximum amount is the face value, paid to beneficiaries upon the insured's death.
Deductible
The out-of-pocket amount the policyholder must pay before the insurer covers a claim.
Higher deductibles usually result in lower premiums.
Health Insurance: Important for individuals with chronic health issues or regular medical needs. Lower deductibles mean higher premiums but offer better access to medical care.
Home Insurance: Protects home and possessions against damage or theft. Required by mortgage companies.
Auto Insurance: Provides financial protection against accidents, theft, vandalism, or natural disasters. Policyholders pay premiums to cover accident-related costs.
Life Insurance: A contract guaranteeing a sum of money to beneficiaries upon the insured's death, in exchange for premiums paid during the policyholder's lifetime.
Endowment Plans: Offer educational benefits payable.
Whole Life Insurance: Provides cash benefits starting at the end of the 6th policy year and every 2 years thereafter until age 100.
Women-specific Insurance: Covers female-specific critical illnesses and surgeries.
Hospital Income Plans: Offer coverage for 10 years and return a percentage of the premium if the insured outlives the coverage period.
Investment-linked Insurance Plans: Provide protection until age 88, with single pay options (front-end or back-end load).
Travel Insurance: Covers costs and losses associated with domestic or international travel.
Insurance: A policy where an insurer indemnifies another against specific losses.
Common Policies: Life, health, homeowners, and auto insurance.
Core Components: Deductible, policy limit, and premium.
Early Acquisition: Obtaining insurance at a younger age generally results in lower premiums.
Cash Benefits: Policies with cash benefits allow enjoyment of the face amount upon maturity.
Timely Payments: Regular payment of premiums (annually, semi-annually, quarterly, or monthly) is crucial to avoid defaults or lapses, ensuring the policy remains active and benefits are retained.
Pure Risk: Involves situations where there is a possibility of loss or no loss, with no potential for financial gain.
Speculative Risk: Involves situations where there is a possibility of either a financial gain or loss.
Insurable Risk: Risks that can be covered by an insurance policy.
Risk Management: Insurance companies manage risks through elimination, transfer, or sharing with insured parties.
Definition: Occurs when one party in a transaction has more or better information than the other party.
Consequences:
Adverse Selection: When one party takes advantage of the information asymmetry before the transaction. Example: A person with a pre-existing condition buys life insurance without disclosing the condition.
Moral Hazard: When one party engages in riskier behavior because they do not bear the full consequences of that risk after the transaction. Example: A person drives recklessly after obtaining auto insurance.
Adverse Selection:
Medical examinations
Collection of additional information
Moral Hazard:
Implementation of deductible clauses
Increased premiums for risky behaviors
Agent: Sells insurance policies to individuals or entities.
Underwriter: Evaluates risks and determines the terms and premium for insurance policies.
Actuary: Uses statistics to calculate risks and premiums.
Claims Adjuster: Evaluates claims and determines the amount of compensation.
Expense Ratio: Underwriting Expenses / Net Earned Premium
Loss Ratio: Claims Expense / Net Earned Premium
Combined Operating Ratio: (Underwriting Expenses + Claims Expense) / Net Earned Premium
Insurance Margin: Insurance Profit / Net Earned Premium
RBC2 Ratio: Total Average Capital / RBC Requirement (Risk-Based Capital Requirement)
Net Earned Premium (NEP): Gross written premium minus reinsurance expense.
Insurance Commission (IC): Under the Department of Finance (DOF).
Regulated Entities:
Insurance and Reinsurance Companies
Mutual Benefit Associations
Health Maintenance Organizations (HMOs)
Rating Organizations
Pre-need Companies
Local Corporations or Foreign Branches
Capital Requirements:
2019: ₱900,000,000
2022: ₱1,300,000,000
New Business: Paid-up capital of at least ₱1,000,000,000
Microinsurance: At least ₱500,000,000
Risk-Based Capital (RBC):
RBC2 Ratio: Total Average Capital / RBC Requirement, with RBC2 Ratio ≥ 100%
Tier 2 Capital ≤ 50% of Tier 1 Capital
Financial Statement Analysis
Horizontal Analysis
Horizontal analysis compares financial data over different periods to identify trends and growth patterns.
Vertical Analysis
Vertical analysis expresses each item in a financial statement as a percentage of a base item within the same statement.
Ratio Analysis
Ratios provide insight into various aspects of a company's performance and financial health.
Liquidity Ratios
Liquidity ratios measure a company's ability to meet its short-term obligations.
PDK Enterprise Liquidity: Comparing these ratios with industry standards and historical ratios will determine PDK's liquidity. Generally, higher ratios indicate better liquidity.
Solvency Ratios
Solvency ratios assess a company's ability to meet long-term obligations.
Banks in the Philippines are classified into several categories:
Universal Banks
Commercial Banks
Thrift Banks
Rural Banks
Cooperative Banks
Islamic Banks
Government-owned Banks
Other Banks as classified by the Bangko Sentral ng Pilipinas (BSP)
Universal and commercial banks are the dominant groups, representing approximately 70% of the resources of the banking system.
Universal Banks: Defined under the General Banking Law of 2000 (GBL), a universal bank is a commercial bank with the additional authority to exercise the powers of an investment house and invest in non-allied enterprises.
Commercial Banks: These banks do not have the authority to exercise the powers of an investment house or invest in non-allied enterprises.
Branches, subsidiaries, and affiliates of foreign banks in the Philippines are licensed either as universal or commercial banks. Some foreign banks operate offshore banking units with more limited functions. The BSP ensures that 60% of the resources or assets of the banking system are held by domestic banks that are majority-owned by Philippine nationals.
Universal Banks: Governed by the General Banking Law.
Commercial Banks: Governed by the General Banking Law.
Thrift Banks: Governed by the Thrift Banks Act.
Rural Banks: Governed by the Rural Banks Act.
Cooperative Banks: Governed by the Philippine Cooperative Code.
Islamic Banks: Governed by the Charter of Al-Amanah Islamic Investment Bank of the Philippines.
Government-owned Banks: Governed by their specific charters.
Other Banks (e.g., Digital Banks): Governed by specific circulars and regulations issued by the BSP.
The BSP has currently authorized six digital banks to operate in the Philippines:
Overseas Filipino Bank (OF Bank)
Tonik Bank
UNObank
UnionDigital Bank
GOtyme
Maya Bank
Digital banks have minimal or zero reliance on physical touchpoints but are required to have one office as a central hub in the Philippines to handle customer complaints. The BSP issued Circular No. 1105 on the establishment of digital banks, making it the BSP’s seventh bank category.
The BSP, acting through its Monetary Board, is the primary overseer of banks in the Philippines. The operations and activities of banks are subject to BSP supervision, which includes the promulgation of rules and standards, visitorial powers, and the enforcement of corrective actions. The BSP conducts regular and special examinations of banks to ensure their solvency and liquidity.
Locally incorporated banks are managed by a board of directors with 5 to 15 members, including at least two independent directors. The BSP has criteria for bank directors based on integrity, experience, education, training, and competence. Board meetings can be conducted via teleconferencing or videoconferencing, but directors must participate in at least 50% of meetings annually and physically attend at least 25%.
The BSP has published the Handbook on Corporate Governance and issued rules of procedure on administrative cases involving bank directors and officers. Each bank is required to appoint a full-time chief compliance officer to manage a compliance system.
Universal and commercial banks are subject to Basel III capital adequacy standards, including:
Risk Capital Ratio: 10% for solo and consolidated bases.
Common Equity Tier 1 (CET1) Ratio: 6%.
Tier 1 Capital Ratio: 7.5%.
Capital Conservation Buffer: 2.5% composed of CET1 capital.
Leverage Ratio: Not less than 5% on both solo and consolidated bases.
Liquidity Coverage Ratio: Adequate to withstand liquidity shocks lasting 30 days.
Thrift banks, rural banks, and cooperative banks follow the Basel 1.5 framework, a simplified version of Basel II.
Conditions for Appointment: The Monetary Board can appoint a conservator if a bank shows continuous inability or unwillingness to maintain adequate liquidity to protect depositors and creditors.
Powers of the Conservator:
Take charge of the bank's assets and liabilities.
Manage or reorganize the bank's management.
Collect monies and debts owed to the bank.
Exercise all necessary powers to restore the bank's viability.
Competency: The conservator must be knowledgeable in bank operations and management.
Duration: Conservatorship is limited to one year.
Termination: The Monetary Board will end the conservatorship when the bank can operate independently. If the bank's continued operation could lead to probable loss to depositors and creditors, Section 30 applies.
Conditions for Appointment: The Monetary Board may appoint the Philippine Deposit Insurance Corporation (PDIC) as a receiver if:
The bank has insufficient realizable assets to meet liabilities.
The bank cannot pay its liabilities as they become due.
The bank cannot continue without probable losses to depositors or creditors.
The bank has willfully violated a final BSP cease-and-desist order involving fraud or dissipation of assets.
Assessment Period: Within 90 days, the receiver must determine if the bank can be rehabilitated or allowed to resume business safely.
Monetary Board Approval: Any resumption of business requires Monetary Board approval.
Liquidation: If rehabilitation is not possible, the Monetary Board will instruct the receiver to liquidate the bank.
Court Petition: The receiver files a petition in court to assist in the liquidation process.
Asset Disposal: The receiver converts the bank's assets to money, disposes of them to creditors, and recovers accounts.
Section 30 Actions: Actions taken under Section 30 are final and executory. They may not be restrained or set aside by a court except on grounds of excess jurisdiction or grave abuse of discretion.
PDIC Charter: Under the amended PDIC Charter, a closed bank ordered by the Monetary Board will be liquidated without the consent of stakeholders.
Integrity and Performance: Banks must exercise high standards of integrity and performance.
Fiduciary Duty: Breach of fiduciary duty can lead to liability for damages and unsafe or unsound banking practices, potentially causing a bank run and insolvency.
Prudential Measures:
Capital adequacy.
Reserve requirements.
Single borrower's limit (SBL).
Directors, officers, stockholders, and related interests (DOSRI) limit.
Loan-loss provisioning.
Equity investment limit.
Stress Tests: BSP reinforces prudential measures with stress tests, particularly for real estate exposures.
Consumer Protection: Standards for consumer protection include disclosure, transparency, confidentiality, fair treatment, effective recourse, and financial education. BSP-supervised institutions must have a consumer protection risk management system.
Unified Reserve: Initially set at 18% for deposit and deposit-substitute liabilities of universal and commercial banks.
Purpose: Reserves serve as a ready source of funds to respond to large withdrawals and prevent bank runs.
Purpose: Allocates bank resources across different sectors and prevents excessive loans to a single borrower or group.
Limits:
Standard SBL is 25% of the bank's net worth.
Incremental SBL of 10% for adequately secured additional liabilities.
Purpose: Levels the lending field between insiders and outsiders, preventing banks from becoming captive finance sources for insiders.
Ceilings:
Individual ceiling: Total direct credit accommodation equivalent to unencumbered deposits plus paid-capital contribution.
Aggregate ceiling: Total DOSRI credit accommodations up to 15% of the total loan portfolio or 100% of net worth.
Unsecured loans: Must not exceed 30% of total DOSRI credit accommodations.
Board Resolution: DOSRI loans require a board resolution, excluding the interested director, and must be transmitted to the BSP.
Guidelines: Banks must set up allowances for credit losses (ACL) based on the number of days of missed payments, classifying loans accordingly.
Limits:
Universal banks: Total investment in equities of allied and non-allied enterprises must not exceed 50% of net worth; individual investment must not exceed 25% of net worth.
Commercial banks: Total investment in allied enterprises must not exceed 35% of net worth; individual limit is 25%.
Approval: All equity investments require Monetary Board approval.
Criminal Prosecution: Fines ranging from 50,000 to 2 million pesos, imprisonment from two to ten years, or both.
Administrative Sanctions:
Fines up to 1 million pesos per violation or 100,000 pesos per day for continuing violations.
Suspension of rediscounting privileges, lending or foreign exchange operations, and interbank clearing privileges.
Suspension or revocation of special licenses.
Client Information: Must be kept confidential by the bank and its representatives. Disclosure requires court order, except under specific circumstances outlined by law.
Bank Deposits: Protected under the Secrecy of Bank Deposits Law, with specific exceptions.
Sources: Equity contributions from shareholders, and loans from the BSP and other lenders.
Capitalization: Minimum paid-in capital for universal and commercial banks, and risk-based capital adequacy ratios.
BSP Facilities: Rediscounting and other credit facilities, including emergency loans during financial panics.
This summary covers the key aspects of prudential regulation, conservatorship, receivership, and conduct of business for banks as outlined in the New Central Bank Act and related regulations.
Why do Banks Exist?
In an Ideal World:
Those who have excess funds need to allocate these funds efficiently.
Those who need funds seek capital to finance various needs.
This process of capital allocation is critical for economic growth.
However, the Real World Faces Challenges:
Consequences:
Adverse Selection: Occurs before the transaction when one party has more or better information than the other.
Business Example: Managers know potential returns and risks; investors do not.
Lending Example: Borrowers know their ability to repay loans; lenders do not.
Moral Hazard: Occurs after the transaction when one party takes on excessive risk because another party bears the consequences.
Business Example: Investors prefer risky projects when using borrowed funds.
Lending Example: Borrowers may misuse the loaned money.
Solutions to Adverse Selection:
Information collection.
Government-mandated disclosures (e.g., annual reports, financial statements).
Screening processes.
Addressing the free rider problem (where individuals benefit from resources or services without paying for them).
Solutions to Moral Hazard:
Compensating balances.
Restrictive covenants in loan agreements.
Role of Banks:
Banks act as intermediaries between those who have excess funds and those who need funds.
They take deposits from parties with excess funds and give loans to parties in need of funds.
Banks also create money through the fractional reserve banking system.
How Banks Create Money:
Example: With a reserve requirement of 10% and an initial deposit of $100:
Bank A's balance sheet: Reserves = $10, Deposits = $100, Loans = $90.
Bank B's balance sheet: Reserves = $9, Deposits = $90, Loans = $81.
Bank C's balance sheet: Reserves = $8.1, Deposits = $81, Loans = $72.9.
This process continues, creating a money multiplier effect.
Money Multiplier:
Formula: Multiplier = 1 / Reserve Requirement Ratio
For a reserve requirement of 10%, the multiplier is 10x.
Common Ratios for Banks:
Return on Equity (ROE):
Formula: ROE = Net Income / Average Equity
Example Calculation:
Net Income = $560,000
Average Equity = ($17M + $19M) / 2 = $18M
ROE = $560,000 / $18M = 3.11%
Efficiency Ratio:
Formula: Efficiency Ratio = Non-interest Expense / Interest Revenue
Example Calculation:
Non-interest Expense = $300,000
Interest Revenue = $1,800,000
Efficiency Ratio = $300,000 / $1,800,000 = 16.67%
Non-Performing Loans (NPL) Ratio:
Formula: NPL Ratio = Non-performing Loans / Total Loans
Example Calculation:
Non-performing Loans = $10,000,000
Total Loans = $123,000,000
NPL Ratio = $10,000,000 / $123,000,000 = 8.13%
Loan to Deposit Ratio:
Formula: Loan to Deposit Ratio = Total Loans / Total Deposits
Example Calculation:
Total Loans = $123,000,000
Total Deposits = $127,000,000
Loan to Deposit Ratio = $123,000,000 / $127,000,000 = 96.85%
Capital Adequacy Ratio (CAR):
Definition: Measures a bank's available capital as a percentage of its risk-weighted assets.
Purpose: To protect depositors and ensure stability in the financial system.
Example Calculation:
Capital = $19,000,000
Risk-weighted assets:
Cash = $1M (0%)
Due from BSP = $25M (0%)
Loans (Performing) = $113M (50%)
Loans (Non-performing) = $10M (100%)
Property, Plant, Equipment = $3M (100%)
Total Risk-weighted assets = $69.5M
CAR = $19M / $69.5M = 27.34%
Basel I: Risk-based capital requirements.
Basel II: Internal risk-based approach.
Basel III: Capital conservation buffer.
Government Policy Goals: Promote a stable, efficient, competitive, dynamic, and responsive banking system.
Key Legislation:
General Banking Law
Thrift Bank Act
Rural Bank Act
Philippine Cooperative Code
Charter of Al Amanah Islamic Investment Bank
Regulatory Bodies:
Bangko Sentral ng Pilipinas (BSP): Provides oversight and conducts examinations every 12 months.
Philippine Deposit Insurance Corporation (PDIC): Ensures deposit insurance coverage up to P500,000 per deposit per bank.
Challenges in Regulation:
Compliance with Know-Your-Customer (KYC) requirements.
Data privacy concerns.
Cybersecurity threats.
Money laundering.
Consumer Protection Standards:
Disclosure and Transparency.
Protection of Client Information.
Fair Treatment.
Effective Recourse.
Financial Education.
Future Regulatory Changes:
Alignment with international standards.
Strengthening anti-money laundering capabilities.
Enhancing financial inclusion.
Encouraging innovation in financial technology.
Penalties for Violations:
Fines ranging from P50,000 to P200,000.
Imprisonment ranging from 1 to 10 years, depending on the violation.
Administrative sanctions including fines, suspension of operations, and revocation of licenses.
Insurance: A contract where an individual or entity pays an insurance company in exchange for financial protection or reimbursement of losses resulting from a covered event. The key role of insurance is to help people financially protect themselves against life’s uncertainties, such as natural disasters, car accidents, or illnesses.
Insurance Contract: Represented by a policy, in which a policyholder receives financial protection or reimbursement against losses from an insurance company. The company pools clients’ risks to make payments more affordable for the insured.
Hedging Risks: Insurance policies are used to hedge against the risk of financial losses, both big and small, resulting from damage to the insured or their property, or from liability for damage or injury caused to a third party.
Insurance: A contract (policy) where an insurer indemnifies another against losses from specific contingencies or perils.
Common Types: Life, health, homeowners, commercial building, and auto insurance.
Core Components: Deductible, policy limit, and premium.
Types of Insurance: Auto, health, homeowners, and life insurance are the most common.
Three Critical Components:
Premium: The price of the policy, typically expressed as a monthly cost, determined by the insurer based on the risk profile.
Policy Limit: The maximum amount the insurer will pay under the policy for a covered loss.
Deductible: The amount the policyholder must pay out of pocket before the insurer pays a claim. Higher deductibles generally result in lower premiums.
Premium
The cost of the insurance policy, typically paid monthly.
Determined by the insurer based on the insured's risk profile.
Policy Limit
The maximum amount the insurer will pay for a covered loss.
Limits can be set per period, per loss, or over the life of the policy.
For life insurance, the maximum amount is the face value, paid to beneficiaries upon the insured's death.
Deductible
The out-of-pocket amount the policyholder must pay before the insurer covers a claim.
Higher deductibles usually result in lower premiums.
Health Insurance: Important for individuals with chronic health issues or regular medical needs. Lower deductibles mean higher premiums but offer better access to medical care.
Home Insurance: Protects home and possessions against damage or theft. Required by mortgage companies.
Auto Insurance: Provides financial protection against accidents, theft, vandalism, or natural disasters. Policyholders pay premiums to cover accident-related costs.
Life Insurance: A contract guaranteeing a sum of money to beneficiaries upon the insured's death, in exchange for premiums paid during the policyholder's lifetime.
Endowment Plans: Offer educational benefits payable.
Whole Life Insurance: Provides cash benefits starting at the end of the 6th policy year and every 2 years thereafter until age 100.
Women-specific Insurance: Covers female-specific critical illnesses and surgeries.
Hospital Income Plans: Offer coverage for 10 years and return a percentage of the premium if the insured outlives the coverage period.
Investment-linked Insurance Plans: Provide protection until age 88, with single pay options (front-end or back-end load).
Travel Insurance: Covers costs and losses associated with domestic or international travel.
Insurance: A policy where an insurer indemnifies another against specific losses.
Common Policies: Life, health, homeowners, and auto insurance.
Core Components: Deductible, policy limit, and premium.
Early Acquisition: Obtaining insurance at a younger age generally results in lower premiums.
Cash Benefits: Policies with cash benefits allow enjoyment of the face amount upon maturity.
Timely Payments: Regular payment of premiums (annually, semi-annually, quarterly, or monthly) is crucial to avoid defaults or lapses, ensuring the policy remains active and benefits are retained.
Pure Risk: Involves situations where there is a possibility of loss or no loss, with no potential for financial gain.
Speculative Risk: Involves situations where there is a possibility of either a financial gain or loss.
Insurable Risk: Risks that can be covered by an insurance policy.
Risk Management: Insurance companies manage risks through elimination, transfer, or sharing with insured parties.
Definition: Occurs when one party in a transaction has more or better information than the other party.
Consequences:
Adverse Selection: When one party takes advantage of the information asymmetry before the transaction. Example: A person with a pre-existing condition buys life insurance without disclosing the condition.
Moral Hazard: When one party engages in riskier behavior because they do not bear the full consequences of that risk after the transaction. Example: A person drives recklessly after obtaining auto insurance.
Adverse Selection:
Medical examinations
Collection of additional information
Moral Hazard:
Implementation of deductible clauses
Increased premiums for risky behaviors
Agent: Sells insurance policies to individuals or entities.
Underwriter: Evaluates risks and determines the terms and premium for insurance policies.
Actuary: Uses statistics to calculate risks and premiums.
Claims Adjuster: Evaluates claims and determines the amount of compensation.
Expense Ratio: Underwriting Expenses / Net Earned Premium
Loss Ratio: Claims Expense / Net Earned Premium
Combined Operating Ratio: (Underwriting Expenses + Claims Expense) / Net Earned Premium
Insurance Margin: Insurance Profit / Net Earned Premium
RBC2 Ratio: Total Average Capital / RBC Requirement (Risk-Based Capital Requirement)
Net Earned Premium (NEP): Gross written premium minus reinsurance expense.
Insurance Commission (IC): Under the Department of Finance (DOF).
Regulated Entities:
Insurance and Reinsurance Companies
Mutual Benefit Associations
Health Maintenance Organizations (HMOs)
Rating Organizations
Pre-need Companies
Local Corporations or Foreign Branches
Capital Requirements:
2019: ₱900,000,000
2022: ₱1,300,000,000
New Business: Paid-up capital of at least ₱1,000,000,000
Microinsurance: At least ₱500,000,000
Risk-Based Capital (RBC):
RBC2 Ratio: Total Average Capital / RBC Requirement, with RBC2 Ratio ≥ 100%
Tier 2 Capital ≤ 50% of Tier 1 Capital
