Financial System and Competing Financial Service Institutions

Module 1- Topic 3. The Financial System and Competing Financial Service Institutions The Banking Sector Banks are the principal source of credit (loanable funds) for millions of individuals and families and for many units of government (school districts, cities, counties, etc.). As important as ba...

Module 1- Topic 3. The Financial System and Competing Financial Service Institutions The Banking Sector Banks are the principal source of credit (loanable funds) for millions of individuals and families and for many units of government (school districts, cities, counties, etc.). As important as banks are to the economy as a whole and to the communities they call home, there is still much confusion about what exactly a bank is. A bank can be defined in terms of: (1) the economic functions it serves, (2) the services it offers its customers, or (3) the legal basis for its existence. Certainly, banks can be identified by the functions they perform in the economy. They are involved in transferring funds from savers to borrowers (financial intermediation) and in paying for goods and services. Historically, banks have been recognized for the great range of financial services they offer—from checking and debit accounts, credit cards, and savings plans to loans for businesses, consumers, and governments (Pagoso, 2012) However, bank service menus are expanding rapidly today to include investment banking (security underwriting), insurance protection, financial planning, advice for merging companies, the sale of risk-management services to businesses and consumers, and numerous other innovative services. Banks no longer limit their service offerings to traditional services but have increasingly become general financial-service providers. Functions of Banks and Other Financial Institutions in the Global Economy Every banker faces challenges from all sides today as they reach out to their financial-service customers. Banks are only one part of a vast financial system of markets and institutions that circles the globe. The primary purpose of this ever-changing financial system is to encourage individuals and institutions to save and transfer those savings to those individuals and institutions planning to invest in new projects. This process of encouraging savings and transforming savings into investment spending causes the economy to grow, new jobs to be created, and living standards to rise. However, the financial system does more than simply transform savings into investment. It also provides a variety of supporting services essential to modern living. These include payment services that make commerce and markets possible (such as checks, credit and debit cards, and interactive Web sites), risk protection services for those who save and venture to invest (including insurance policies and derivative contracts), liquidity services (making it possible to convert the property into immediately available spending power), and credit services for those who need loans to supplement their income. Competitive Challenges for Banks For many centuries banks were way out in front of other financial-service institutions in supplying savings and investment services, payment and risk protection services, liquidity, and loans. They dominated the financial system of decades past. But, lately, banking’s financial market share frequently has fallen as other financial institutions have moved in to fight for the same turf. Some authorities in the financial-services field suggest this apparent erosion of market share may imply that traditional banking is dying. Certainly, as financial markets become more efficient and the largest customers find ways around banks to obtain the funds they need (such as by borrowing in the open market), traditional banks are less necessary in a healthy economy. Some experts argue the reason we still have thousands of banks scattered around the globe—perhaps many more than we need—is that governments often subsidize the industry through cheap deposit insurance and low-cost loans. Still, others argue that banking’s market share may be falling due to excessive government regulation, restricting the industry’s ability to compete. Perhaps banking is being “regulated to death,” which may hurt those customers who most heavily depend on banks for critical services— individuals and small businesses. Other experts counter that banking is not dying, but only changing—offering new services and changing its form—to reflect what today’s market demands. The traditional measures of the industry’s importance (like the size as captured by total assets) no longer reflect how truly diverse and competitive bankers have become in the modern world. Leading Competitors with Banks Among leading competitors with banks in wrestling for the loyalty of financial-service customers are such nonbank financial-service institutions as: Savings associations: Specialize in selling savings deposits and granting home mortgage loans and other forms of household credit to individuals and families, illustrated by such financial firms as Atlas Savings, Flatbush Savings, and Loan Association of Brooklyn, New York, and American Federal Savings Bank. In the Philippines, we have RCBC Savings Bank, BPI Savings Bank, Bank of Makati, Philippines Savings Bank, AFPSLAI Savings and Loan Assoc. Credit unions: Collect deposits from and make loans to their members as nonprofit associations of individuals sharing a common bond (such as the same employer), including such firms as American Credit Union of Milwaukee and Navy Federal Credit Union. In the Philippines, we have COA Credit Union, UE Coop. Credit Union. Money market funds: Collect short-term, liquid funds from individuals and institutions and invest these monies in quality securities of short duration, including such firms as Franklin Templeton Tax-Free Money Fund and Scudder Tax-Free Money Fund. In the Philippines, mostly the universal banks are offering the money market funds, like BDO Peso Bond Fund Mutual funds (investment companies): sell shares to the public representing an interest in a professionally managed pool of stocks, bonds, and other securities, including such financial firms as Fidelity and The Vanguard Group Hedge funds: Sell shares mainly to upscale investors that support a broad group of different kinds of assets (including nontraditional investments in commodities, real estate, loans to new and ailing companies, and other risky assets); for additional information see such firms as the Magnum Group of Hedge Funds and Turn Key Hedge Funds Security brokers and dealers: Buy and sell securities on behalf of their customers and for their own accounts, such as Charles Schwab (www.Schwab.com). Recently brokers like Schwab have become more aggressive in offering interest-bearing online checkable accounts that often post higher interest rates than many banks are willing to pay. Investment banks: Provide professional advice to corporations and governments, raise funds in the financial marketplace, seek to make business acquisitions, and trade securities, including such prominent investment banking houses as Goldman Sachs (www.goldmansachs.com) and Raymond James & Associates Equity Capital Markets Finance companies: Offer loans to commercial enterprises (such as auto and appliance dealers) and to individuals and families using funds borrowed in the open market or from other financial institutions, including such well-known financial firms as Household Finance and GMAC Financial Services Financial holding companies: (FHCs) Often include credit card companies, insurance and finance companies, and security broker/dealer firms operating under one corporate umbrella, including such leading financial conglomerates as GE Capital and UBS Warburg AG Life and property/casualty insurance companies: Protect against risks to persons or property and manage the pension plans of businesses and the retirement funds of individuals, including such industry leaders as Prudential Insurance and State Farm Insurance Companies Financial-service providers are converging in terms of the services they offer and embracing each other’s innovations. Moreover, recent changes in government rules, such as the U.S. Financial Services Modernization (Gramm-Leach-Bliley) Act of 1999, have allowed many of the financial firms listed above to offer the public one-stop shopping for financial services. To bankers, the financial-services marketplace appears to be closing in from all sides as the list of aggressive competitors grows. THE SERVICES BANKS AND MANY OF THEIR COMPETITORS OFFER TO THE PUBLIC Services Offered by Banks The following are the services offered by banks. Carrying Out Currency Exchanges History reveals that one of the first services banks offered was the currency exchange. A banker stood ready to trade one form of coin or currency (such as dollars) for another (such as francs or pesos) in return for a service fee. Such exchanges have been important to travelers over the centuries, because the traveler’s survival and comfort may depend on gaining access to local funds. Discounting Commercial Notes and Making Business Loans Early in history, bankers began discounting commercial notes—in effect, making loans to local merchants who sold the debts (accounts receivable) they held against their customers to a bank to raise cash quickly. It was a short step from discounting commercial notes to making direct loans for purchasing inventories of goods or for constructing new facilities—a service that today is provided by banks and numerous other financial-service competitors. Offering Savings Deposits Making loans proved so profitable that banks began searching for ways to raise additional loanable funds. One of the earliest sources of these funds consisted of offering savings deposits—interest-bearing funds left with depository institutions for a period of time. Safekeeping of Valuables and Certification of Value During the Middle Ages, bankers and other merchants (often called “goldsmiths”) began the practice of holding gold and other valuables owned by their customers inside secure vaults, thus reassuring customers of their safekeeping. These financial firms would assay the market value of their customers’ valuables and certify whether or not these “valuables” were worth what others had claimed. Supporting Government Activities with Credit During the Middle Ages and the early years of the Industrial Revolution, governments in Europe noted bankers’ ability to mobilize large amounts of funds. Frequently banks were chartered under the proviso that they would purchase government bonds with a portion of the deposits they received. Offering Checking Accounts (Demand Deposits) Demand deposit services—a checking account that permitted depositors to write drafts in payment for goods and services that the bank or other service provider had to honor immediately. These payment services, offered by not only banks but also credit unions, savings associations, securities brokers, and other financial service providers, proved to be one of the industry’s most important offerings because they significantly improved the efficiency of the payments process, making transactions easier, faster, and safer. Today the checking account concept has been extended to the Internet, to the use of plastic debit cards that tap your checking account electronically, and to “smart cards” that electronically store spending power. Offering Trust Services For many years banks and a few of their competitors (such as insurance and trust companies) have managed the financial affairs and property of individuals and business firms in return for a fee. This property management function, known as trust services, involves acting as trustees for wills, managing a deceased customer’s estate by paying claims against that estate, keeping valuable assets safe, and seeing to it that legal heirs receive their rightful inheritance. In commercial trust departments, trust-service providers manage pension plans for businesses and act as agents for corporations issuing stocks and bonds. Services Offered by Banks’ Competitors Granting Consumer Loans Following World War II, consumer loans expanded rapidly, though their rate of growth has slowed at times recently as bankers have run into stiff competition for consumer credit accounts from nonbank service providers, including credit unions and credit card companies. Financial Advising Customers have long asked financial institutions for advice, particularly when it comes to the use of credit and the saving or investing of funds. Many service providers today offer a wide range of financial advisory services, from helping to prepare financial plans for individuals to consulting about marketing opportunities at home and abroad for businesses. Managing Cash Over the years, financial institutions have found that some of the services they provide for themselves are also valuable for their customers. One of the most prominent is cash management services, in which a financial intermediary agrees to handle cash collections and disbursements for a business firm and to invest any temporary cash surpluses in interest-bearing assets until cash is needed to pay bills. Although banks tend to specialize mainly in business cash management services, many financial institutions today are offering similar services to individuals and families. Offering Equipment Leasing Many banks and finance companies have moved aggressively to offer their business customers the option to purchase equipment through a lease arrangement in which the lending institution buys the equipment and rents it to the customer. These equipment leasing services benefit leasing institutions as well as their customers because the lender can depreciate the leased equipment to save on taxes. Making Venture Capital Loans Increasingly, banks, security dealers, and other financial conglomerates have become active in financing the start-up costs of new companies. Because of the added risk involved this is generally done through a separate venture capital firm that raises money from investors to support young businesses in the hope of turning a profit. Selling Insurance Policies Beginning with the Great Depression of the 1930s, U.S. banks were prohibited from acting as insurance agents or underwriting insurance policies out of fear that selling insurance would increase bank risk and lead to conflicts of interest in which customers asking for one service would be compelled to buy other services as well. However, this picture of extreme separation between banking and insurance changed dramatically as the new century dawned when the U.S. Congress tore down the legal barriers between the two industries, allowing banking companies to acquire control of insurance companies and, conversely, permitting insurers to acquire banks. Today, these two industries compete aggressively with each other, pursuing cross-industry mergers and acquisitions. Selling and Managing Retirement Plans Banks, trust departments, mutual funds, and insurance companies are active in managing the retirement plans that most businesses make available to their employees. This involves investing incoming funds and dispensing payments to qualified recipients who have reached retirement or become disabled. Dealing in Securities: Offering Security Brokerage and Investment Banking Services One of the most popular service targets in recent years, particularly in the United States, has been dealing in securities, executing buy and sell orders for security trading customers (referred to as security brokerage services), and marketing new securities to raise funds for corporations and other institutions (referred to as security underwriting or investment banking services). Offering Mutual Funds, Annuities, and Other Investment Products Many customers have come to demand investment products from their financial-service providers. Mutual fund investments and annuities that offer the prospect of higher yields than the returns often available on conventional bank deposits are among the most sought-after investment products. However, these product lines also tend to carry more risk than do bank deposits, which are often protected by insurance. Offering Merchant Banking Services U.S. financial-service providers are following in the footsteps of leading financial institutions all over the globe (for example, Barclays Bank of Great Britain and Deutsche Bank of Germany) in offering merchant banking services to larger corporations. These consist of the temporary purchase of corporate stock to aid the launching of a new business venture or to support the expansion of an existing company. Hence, a merchant banker becomes a temporary stockholder and bears the risk that the stock purchased may decline in value. Offering Risk Management and Hedging Services Many observers see fundamental changes going on in the banking sector with larger banks (such as J. P. Morgan Chase) moving away from a traditionally heavy emphasis on deposit-taking and loan-making toward risk intermediation—providing their customers with financial tools to combat risk exposure in return for substantial fees. The largest banks around the globe now dominate the risk-hedging field, either acting as dealers (i.e., “market makers”) in arranging for risk protection for customers from third parties or directly selling their customers the bank’s own risk-protection contracts. Roles of Banks and Their Competitors The modern bank has had to adopt many roles to remain competitive and responsive to public needs. Banking’s principal roles (and the roles performed by many of its competitors) today include: The intermediation role Transforming savings received primarily from households into credit (loans) for business firms and others in order to make investments in new buildings, equipment, and other goods. The payments role Carrying out payments for goods and services on behalf of customers (such as by issuing and clearing checks and providing a conduit for electronic payments). The guarantor role Standing behind their customers to pay off customer debts when those customers are unable to pay (such as by issuing letters of credit). The risk management role- Assisting customers in preparing financially for the risk of loss to property, persons, and financial assets. The investment banking role- Assisting corporations and governments in marketing securities and raising new funds. The savings/investment advisor role-Aiding customers in fulfilling their long-range goals for a better life by building and investing savings. The safekeeping/certification of value role- Safeguarding a customer’s valuables and certifying their true value. The agency role -Acting on behalf of customers to manage and protect their property. The policy role- Serving as a conduit for government policy in attempting to regulate the growth of the economy and pursue social goals. Module 2- Topic 1. Overview of the Philippine Financial System Pagoso (2012) stated that the Financial System of the Philippines serves as a catalyst in the country's growth and development. It is the custodian of the country's liquid reserves and based significantly on trust and confidence of the state. Also, it plays a vital role in the economic development of a country. It encourages both savings and investment, creates links between savers and investors, also, facilitates the expansion of financial markets, and aids in financial deepening and broadening. There are two major roles performed by the financial institutions, especially banks: as participants, particularly in the money creation process; and as intermediaries in the Savings-Investment process. Bank accepts deposits from the general public and provides these depositors with rational earnings as well as access to their funds. Through their lending mechanism, they are able to generate money and give finance to investors and entrepreneurs who in turn utilize this fund to provide goods and services. History of the Philippine Financial System The Philippine banking history links its origin to the 16th century with the organization of Obras pias where religious foundations which accumulated large funds from the legacies of wealthy Catholics who made out wills before going out on vicious expeditions bequeathing their estates to the Catholic church or to lay confraternities. Español-Filipino, de Isabel II, was the first bank established in 1851 that is now the bank of the Philippine Islands. Since then, the banking mechanism has progressed into a complex system to parallel the development and growth of the country's economy. Non-bank financial institutions, as they are properly known today are comparatively of recent vintage. These are the other parts of financial institutions that, together with banks, reallocate the country's financial resources. These institutions function within the regulatory frameworks whose parameters are set by Bangko Sentral ng Pilipinas (BSP) and other regulatory and supervisory authorities. Philippine Banks During the Financial Crisis in 2008 As global markets reel from the impact of the financial crisis that has claimed among its victim's corporate giants from the US to Europe, Philippine banks have, thus far, emerged largely unscathed, as pointed out by top central banker. Former Bangko Sentral ng Pilipinas Governor, Amando Tetangco Jr. said that the Philippine banking system is in a comfortably manageable state from capital and liquidity standpoint, and the past investments in banking and other financial reforms have helped shield the country from catastrophic fallouts that the other jurisdictions have seen. Mr. Tetangco explains that Philippine banks remain fundamentally sound and insulated from the external turbulence due largely to their domestic orientation, thus avoiding large exposures to foreign financial institutions. Components of the Philippine Financial System The Philippine financial system has two components; the banking sector and the non-bank financial institutions. Banking Sector: The banking sector consists of different types of banks such as commercial banks, specialized government banks, thrift banks (comprising of savings and mortgage banks, private development banks, and stock savings and loan association), and rural banks (including cooperative banks) Commercial Banks The Commercial Banks constitute the bulk of the banking system. These are institutions that accept deposits that are subject to withdrawal by checks. However, they also perform other functions – lending essentially on a short-term basis. They also accept drafts and letters of credit, can discount and negotiate promissory notes, drafts, bills of exchange, and other forms of indebtedness. Expanded Commercial Banks offer a wide variety of banking services among financial organizations. The banking reforms introduced expanded commercial bank or Unibanks, which in addition to the powers of commercial banks can engage in: underwriting activities equity investments in the non-allied undertaking; and up to 100% equity investments in financial intermediaries other than commercial banks. Foreign banks fall under a broad category of Universal Banks. With prior approval of the monetary board, foreign banks may operate in the Philippines through; (a) acquisition of up to 60% of an existing bank; (b) invest in up to 60% of a new banking subsidiary incorporated in the Philippines, and (c) establishment of branches with full banking authority. The last mode of entry, however, is closed with the license granted to 10 foreign banks to operate branches. Specialized Government Banks These are unique government banks that are subject to the supervision and regulation of the BSP. These are Veterans Bank of the Philippines, Development Bank of the Philippines, and Land Bank. Development Bank of the Philippines (DBP) The DBP was created by the government with the specific function of providing long-term credit to finance private development projects. It was made shortly after independence in 1946 and was named the Rehabilitation Finance Cooperation. Also, it was initially designed to provide long-term finance for the rehabilitation of agriculture, industry, and property damaged after World War II. As time proceeded, its development functions in providing long-term finance became more significant, so it was natural to change its name. Land Banks of the Philippines The LBP was set up in the early 1970s as a financial arm of the land reform program. It was the bank called upon to finance the acquisition by the government of laded estates for division and resale to small landholders, and the eventual purchase of the landholding by the tenant-lessee. Otherwise, the bank could undertake the role of commercial banks. To assist it in the land reform program, it has been granted permission to issue bonds receive deposits, and borrow with a government guarantee. Philippine Amanah Bank The Philippine Amanah Bank was created only in the mid-1970s. It was specially designed to serve the banking needs of the Muslim areas in the South. Its original conception was planned to suit the peculiar financial needs of Muslims, but as experience evolved and from the examples of banks in other Muslim countries, it became clear that traditional banking practices are essential for the survival of any bank. Thrift Banks The Thrift Bank Act of 1995 provided for the establishment, operation, and supervision of thrift banks to include savings and mortgage banks, private development banks, and stock savings and loan associations. Savings and Mortgage Banks (SMBs) SMB is organized primarily to accumulate the savings of depositors and to invest them together. With their capital, in bonds or in loans secured by bonds, real estate mortgages, and other forms of security, or in loans for personal consumption of for long0term financing in home building and home development. Small Private Banks The two major innovations undertaken in the Philippine financial system are the creation of small rural or town units that did not have the services provided by normal banking institutions. Rural Banks and Cooperatives The role of rural is to promote comprehensive development with the end in view of attaining a more equitable distribution of opportunities, income and wealth, and sustained increase in the number of goods and services. Also, rural banks were designed primarily to mobilize rural savings by accepting savings and time deposits and to provide a channel for funds from urban areas and the government sector for agriculture and individual activities in the countryside. Private Development Banks (PDBs) Private Development Banks cater specifically to the medium and long-term financing needs of the Filipino entrepreneurs. PDBs are modeled to serve like the DBP at the community or provincial level. They are also allowed to accept time and savings deposits and to provide medium and long-term credit to small and medium scale industries. Non-Banking Sector: Government Non-Bank Financial Institutions As the banking system was evolving, there was a parallel development of the other financial institutions. The insurance of workers under the government service insurance system was in operation by 1936. Compulsory social security insurance in the private of the social security system. These institutions were created essentially to protect the welfare of employees. But in consequence, they set up large funds that were generated from the insurance premium of members and the counterpart institutions. A logical result was the corresponding effort to administer the welfare programs and to protect the insurance funds that are generated. The GSIS and SSS generated forced savings, which are intended to fund the retirement benefits of its members. Funds that are collected from members which are the contribution of employers and of employees are plowed into the other parts of the financial system. Both systems provide benefits for their members. The Non-Bank Financial Institution Sector Component institutions are not banks, but currently are subject to regulation by the BSP. These are subdivided into two groups; those that engage in the lending of funds obtained from the public by the issuance of their own debt instruments (quasi-banking), and those that engage in the lending of funds from sources other than the public. However, the new Central Banks Acts (R.A No. 7653) provides the phase-out the BSP regulatory powers over non-bank financial institutions without quasi-banking function within a period of 5 years from 1993. Investment Houses Investment houses are stock corporation engages in the underwriting of securities of other corporations on a guaranteed basis. Their principal role is a capital formation that can engage in portfolio management, stock brokerage, financial consultancy, and lending operations. Financing Companies These are corporations or general partnerships extending credit facilities to consumers and to industrial, commercial, or agricultural enterprises and leasing movable properties. Investment Companies These are issuers of securities primarily engaged in the business of investing or trading in securities. These are two types of investment companies: Open-End Company aka Mutual Fund, which offers for sale or has outstanding redeemable securities of which it is the issuer; and Close Company, which is an Investment Company whose shares issued are not redeemable Securities Dealers and Brokers A securities dealer buys and sells shares of stock of another or acquires securities for profit. On the contrary, a securities broker facilitates transactions between a buyer and seller of securities for a commission. Venture Capital Corporations These are organized jointly by private banks, the National Development Corporation, and the Technology Livelihood Research Center and/or other government agencies to develop, promote and assist small and medium scales enterprises through debt to equity financing. Pawnshops There are businesses that engage in lending money on personal property delivered as security or pledge. These may be organized as a sole proprietorship by Filipinos, or a partnership with 70% of the capital subscribed by Filipinos or as a corporation with 70% of the equity owned by Filipinos Lending Investors Lending investors are those who make a practice of lending money for themselves or others. They extend all types of loans, generally short-term, often without collateral, using their own capital. Government Non-Bank Institutions There are financing companies created under special charters. These consist of the National Development Corporation, Philippine Veterans Investment Development Philippine Export, and Foreign Loan Guarantee Corporation, National Home Mortgage Finance Corporation, and Small Business Guarantee and Finance Corporation. Mutual Building and Loan Associations These are corporations whose capital stock must be subscribed by the stockholders in regular equal installments with the purpose of accumulating the stockholders' savings and repaying them with their accumulated savings and profits upon surrender of their shares in order to encourage industry, saving and home building amongst its stockholders. Stock Savings and Loan Associations (SSLAs) These are associations operating under the Saving and Loan Association Act and are licensed and supervised by the BSP. Their membership is confined to a well-defined group of persons. SSLA is not allowed to do business with the general public but accept deposits from and grant loans to their member depositors only. Module 2 - Topic 2. History of the Bank (BSP) and its Vision and Mission The Bangko Sentral ng Pilipinas (BSP) is the central bank of the Republic of the Philippines. It was established on 3 July 1993 pursuant to the provisions of the 1987 Philippine Constitution and the New Central Bank Act of 1993. The BSP took over from the Central Bank of the Philippines, which was established on 3 January 1949, as the country’s central monetary authority. The BSP enjoys fiscal and administrative autonomy from the National Government in the pursuit of its mandated responsibilities. Chronology of Events Central Banking in the Philippines Act No. 52 was passed by the First Philippine Commission placing all banks under the Bureau of Treasury. The Insular Treasurer was 1900 authorized to supervise and examine banks and banking activities. The Bureau of Banking under the Department of Finance took over February 1929 the task of banking supervision. A bill establishing a central bank was drafted by Secretary of Finance Manuel Roxas and approved by the Philippine Legislature. However, 1939 the bill was returned by the US government, without action, to the Commonwealth Government. A joint Philippine-American Finance Commission was created to study the Philippine currency and banking system. The Commission recommended the reform of the monetary system, the formation of 1946 a central bank and the regulation of money and credit. The charter of the Central Bank of Guatemala was chosen as the model of the proposed central bank charter.  A Central Bank Council was formed to review the Commission’s August 1947 report and prepare the necessary legislation for implementation. President Manuel Roxas submitted to Congress a bill “Establishing the Central Bank of the Philippines, defining its powers in the February 1948 administration of the monetary and banking system, amending pertinent provisions of the Administrative Code with respect to the currency and the Bureau of Banking, and for other purposes. The bill was signed into law as Republic Act No. 265 (The Central 15 June 1948 Bank Act) by President Elpidio Quirino. The Central Bank of the Philippines (CBP) was inaugurated and formally opened with Hon. Miguel Cuaderno, Sr. as the first governor. 3 January 1949 The broad policy objectives contained in RA No. 265 guided the CBP in the implementation of its duties and responsibilities, particularly in relation to the promotion of economic development in addition to the maintenance of internal and external monetary stability. RA No. 265 was amended by Presidential Decree No. 72 to make the CBP more responsive to changing economic conditions. PD No. 72 emphasized the maintenance of domestic and November 1972 international monetary stability as the primary objective of the CBP. Moreover, the CBP’s authority was expanded to include not only the supervision of the banking system but also the regulation of the entire financial system. Further amendments were made with the issuance of PD No. 1771 to improve and strengthen the financial system, among which was January 1981 the increase in the capitalization of the CBP from P10 million to P10 billion. Executive Order No. 16 amended the Monetary Board membership 1986 to promote greater harmony and coordination of government monetary and fiscal policies.  Republic Act No. 7653 was passed establishing the Bangko Sentral 3 July 1993 ng Pilipinas (BSP), replacing CBP as the country's central monetary authority. Republic Act No. 11211 was passed amending RA No. 7653. The 14 February 2019 charter amendments bolster the capability of the BSP to safeguard price stability and financial system stability. Vision and Mission The BSP Vision The BSP aims to be recognized globally as the monetary authority and primary financial system supervisor that supports a strong economy and promotes a high quality of life for all Filipinos. The BSP Mission To promote and maintain price stability, a strong financial system, and a safe and efficient payments and settlements system conducive to sustainable and inclusive growth of the economy. BSP Values 1. Excellence Consistently doing our best to master our craft, continually improving our competencies, and learning new things in pursuit of the organizational goals, comparable to the best practices of other central banks. 2. Patriotism Selfless commitment to the service of the Filipino people and the country 3. Integrity Performing mandate with sincerity, honesty, and uprightness, worthy of respect and emulation from others. 4. Solidarity Performing with team spirit; acting and thinking like one in the pursuit of common goals and objectives 5. Accountability Taking full responsibility for one's or group's actions Module 2 - Topic 3. Overview of Functions and Operations Objectives of the BSP The BSP’s primary objective is to maintain price stability conducive to a balanced and sustainable economic growth. The BSP also aims to promote and preserve monetary stability and the convertibility of the national currency. Responsibilities and Functions of the BSP It shall be the responsibility of the BSP: To provide policy directions in the areas of money, banking, and credit; To supervise the operations of the banks and to exercise such regulatory and examination powers as provided under Republic Act No. 11211 (The New Central Bank Act, as amended) and other pertinent laws over the quasi-banking operations of non-bank financial institutions; and To exercise regulatory and examination powers over money service businesses, credit-granting businesses, and payment system operators To promote and maintain monetary stability and the convertibility of the peso; To promote financial stability and closely work with the National Government, including, but not limited to, the Department of Finance, the Securities and Exchange Commission, the Insurance Commission, and the Philippine Deposit Insurance Corporation; To oversee the payment and settlement systems in the Philippines, including critical financial market infrastructures, in order to promote sound and prudent practices consistent with the maintenance of financial stability; and To promote broad and convenient access to high-quality financial services and consider the interest of the general public. Under the New Central Bank Act, the BSP performs the following functions, all of which relate to its status as the Republic’s central monetary authority. Liquidity Management. The BSP formulates and implements monetary policy aimed at influencing money supply consistent with its primary objective to maintain price stability. Currency issue. The BSP has the exclusive power to issue the national currency. All notes and coins issued by the BSP are fully guaranteed by the Government and are considered legal tender for all private and public debts. Lender of last resort. The BSP extends discounts, loans and advances to banking institutions for liquidity purposes. Financial Supervision. The BSP supervises banks and exercises regulatory powers over non-bank institutions performing quasi-banking functions. Management of foreign currency reserves. The BSP seeks to maintain sufficient international reserves to meet any foreseeable net demands for foreign currencies in order to preserve the international stability and convertibility of the Philippine peso. Determination of exchange rate policy. The BSP determines the exchange rate policy of the Philippines. Currently, the BSP adheres to a market-oriented foreign exchange rate policy such that the role of BSP is principally to ensure orderly conditions in the market. Other activities. The BSP functions as the banker, financial advisor, and official depository of the Government, its political subdivisions and instrumentalities, and government-owned and -controlled corporations. Module 3 - Topic 1. Bank Sources of Funds-2 BANK SOURCES OF FUNDS Madura (2014) explained that to understand how any financial institution (or subsidiary of that institution) obtains funds and uses funds, its balance sheet can be reviewed. The institution’s reported liabilities and equity indicate its sources of funds, and its reported assets indicate its uses of funds. The major sources of commercial bank funds are summarized as follows; 1. Deposit Accounts Transaction deposits Demand deposit account, or checking account, is offered to customers who desire to write checks against their account. A conventional demand deposit account requires a small minimum balance and pays no interest. From the bank’s perspective, demand deposit accounts are classified as transaction accounts that provide a source of funds that can be used until withdrawn by customers (as checks are written). Negotiable order of withdrawal (NOW) account pays interest as well as providing checking services. Because NOW accounts at most financial institutions require a larger minimum balance than some consumers are willing to maintain in a transaction account, traditional demand deposit accounts are still popular. Electronic Transactions Computer banking enables bank customers to view their bank accounts online, pay bills, make credit card payments, order more checks, and transfer funds between accounts. Bank customers use automated teller machines (ATMs) to make withdrawals from their transaction accounts, add deposits, check account balances, and transfer funds. Debit cards allow bank customers to use a card when making purchases and have their bank account debited to reflect the amount spent. Savings deposits The traditional savings account is the passbook savings account, which does not permit check writing. Passbook savings accounts continue to attract savers with a small number of funds, as such accounts often have no required minimum balance. Time deposits Time deposits are deposits that cannot be withdrawn until specified maturity date. The two most common types of time deposits are certificates of deposit (CDs) and negotiable certificates of deposit. Certificates of Deposit A common type of time deposit is a retail certificate of deposit (or retail CD), which requires a specified minimum amount of funds to be deposited for a specified period of time. The rates offered by CDs are easily accessible on numerous websites. For example, Bank-Rate (www.bankrate.com) and Bank CD-Rate Scanner (www.bankcd.com) identify banks that are currently paying the highest rates on CDs. Negotiable Certificates of Deposit Another type of time deposit is the negotiable CD (NCD), which is offered by some large banks to corporations. Negotiable CDs are similar to retail CDs in that they have a specified maturity date and require a minimum deposit. Their maturities are typically short term, and their minimum deposit requirement is $100,000. A secondary market for NCDs does exist. Money market deposit accounts Money market deposit accounts (MMDAs) differ from conventional time deposits in that they do not specify a maturity. From the depositor’s point of view, MMDAs are more liquid than retail CDs but offer a lower interest rate. They differ from NOW accounts in that they provide limited check-writing ability (a limited number of transactions is allowed per month), require a larger minimum balance, and offer a higher yield. The remaining sources of funds to be described are of a non-depository nature. Such sources are necessary when a bank temporarily needs more funds than are being deposited. Some banks use non-depository funds as a permanent source of funds. 2. Borrowed Funds Federal funds purchased (borrowed) The federal funds market allows depository institutions to accommodate the short-term liquidity needs of other financial institutions. The interest rate charged in the federal funds market is called the federal funds rate. Like other market interest rates, it moves in reaction to changes in demand or supply or both. If many banks have excess funds and few banks are short of funds, the federal funds rate will be low. The federal funds rate is quoted on an annualized basis (using a 360-day year) even though the loans are usually for terms of less than one week. This rate is typically close to the yield on a Treasury security with a similar term remaining until maturity. Borrowing from the Federal Reserve banks Another temporary source of funds for banks is the Federal Reserve System, which serves as the U.S. central bank. Along with other bank regulators, the Federal Reserve district banks regulate certain activities of banks. They also provide short-term loans to banks (as well as to some other depository institutions). This form of borrowing by banks is often referred to as borrowing at the discount window. The interest rate charged on these loans is known as the primary credit lending rate. As of January 2003, the primary credit lending rate was to be set at a level that always exceeded the federal funds rate. This was intended to ensure that banks rely on the federal funds market for normal short-term financing and borrow from the Fed only as a last resort. Loans from the Federal Reserve are short term, commonly from one day to a few weeks. To ensure there is a justifiable need for the funds, banks that wish to borrow at the Federal Reserve must first obtain the Fed’s approval. The Federal Reserve is intended to be a source of funds for banks that experience unanticipated shortages of reserves. Frequent borrowing to offset reserve shortages implies that the bank has a permanent rather than a temporary need for funds and should, therefore, satisfy this need with a more permanent source of funds 3. Long-Term Sources of Funds Bonds issued by the bank Like other corporations, banks own some fixed assets such as land, buildings, and equipment. These assets often have an expected life of 20 years or more and are usually financed with such long-term sources as the issuance of bonds. Common purchasers of these bonds are households and various financial institutions, including life insurance companies and pension funds. Bank capital Bank capital generally represents funds acquired by the issuance of stock or the retention of earnings. In either case, the bank has no obligation to pay out funds in the future. Bank capital as defined here represents the equity or net worth of the bank. Capital can be classified as primary or secondary. Primary capital results from issuing common or preferred stock or retaining earnings, whereas secondary capital results from issuing subordinated notes and bonds. A bank’s capital must be sufficient to absorb operating losses in the event that expenses or losses exceed revenues, regardless of the reason for the losses. Although the issuance of a new stock increases a bank’s capital, it dilutes the bank’s ownership because of the proportion of the bank owned by existing shareholders decreases. Bank regulators are concerned that banks might maintain a lower level of capital than they should and have therefore imposed capital requirements on them. The required level of capital for each bank depends on its risk. Assets with low risk are assigned relatively low weights while assets with high risk are assigned high weights. 4. Repurchase agreements A repurchase agreement (repo) represents the sale of securities by one party to another with an agreement to repurchase the securities at a specified date and price. Banks often use a repo as a source of funds when they expect to need funds for just a few days. Repurchase agreement transactions occur through a telecommunications network connecting large banks, other corporations, government securities dealers, and federal funds brokers. The yield on repurchase agreements is slightly less than the federal funds rate at any given time because the funds loaned out are backed by collateral and are therefore less risky. 5. Eurodollar borrowings If a U.S. bank is in need of short-term funds, it may borrow dollars from those banks outside the United States (typically in Europe) that accept dollar-denominated deposits, or Eurodollars. Some foreign banks (or foreign branches of U.S. banks) accept large short-term deposits and make short-term loans in dollars. Because U.S. dollars are widely used as an international medium of exchange, the Eurodollar market is very active Module 3 - Topic 2. Uses of Funds by Banks-2 The more common uses of funds by banks include the following: Cash Bank Loans Investment in Securities Repurchase Agreements 1. Cash Banks also hold cash to maintain some liquidity and to accommodate any withdrawal requests by depositors. Because banks do not earn income from cash, they hold only as much cash as is necessary to maintain a sufficient degree of liquidity. 2. Bank Loans The main use of bank funds is for loans. The loan amount and maturity can be tailored to the borrower’s needs. Types of Business Loans Working Capital A common type of business loan is sometimes called a self-liquidating loan. It is designed to support ongoing business operations. A working capital loan can support the business until sufficient cash inflows are generated. These loans are typically short term, but they may be needed by businesses on a frequent basis. Term Loans Banks also offer term loans, which are used primarily to finance the purchase of fixed assets such as machinery. With a term loan, a specified amount of funds is loaned out for a specified period of time and a specified purpose. 3. Bullet Loan Term loans can be amortized so that the borrower makes fixed periodic payments over the life of the loan. Alternatively, the bank can periodically request interest payments, with the loan principal to be paid off in one lump sum (called a balloon payment) at a specified date in the future. This is known as a bullet loan. Loan Participations Some large corporations wish to borrow a larger amount of funds than any individual bank is willing to provide. To accommodate a corporation, several banks may be willing to pool their available funds in what is referred to as loan participation. The lead bank is expected to ensure that the borrower repays the loan. Normally, however, the lead bank is not required to guarantee the interest payments. Thus all participating banks are exposed to credit (default) risk. Loan Supporting Leverage Buyouts Some commercial banks finance leveraged buyouts (LBOs), in which a management group or a business relies mostly on debt to purchase the equity of another business. Some banks originate the loans designed for LBOs and then sell them to other financial institutions, such as insurance companies, pension funds, and foreign banks. Collateral Requirements for Business Loans Commercial banks are increasingly accepting intangible assets (such as patents, brand names, and licenses to franchises and distributorships) as collateral for commercial loans. Lender Liability on Business Loans In recent years, businesses that previously obtained loans from banks have filed lawsuits claiming that the banks terminated further financing without sufficient notice. Volume of Business Loans The volume of business loans provided by commercial banks changes over time in response to economic conditions. When the economy is strong, businesses are more willing to finance expansion. When economic conditions are weak, businesses defer expansion plans and therefore do not need as much financing. Types of Consumer Loans Commercial banks provide individuals with installment loans to finance purchases of cars and household products. These loans require borrowers to make periodic payments over time. Banks also provide credit cards to consumers who qualify, enabling them to purchase various goods without having to reapply for credit on each purchase. Credit cardholders are assigned a maximum limit based on their income and employment record, and a fixed annual fee may be charged. Assessing the applicant’s creditworthiness is much easier for consumer loans than for corporate loans. An individual’s cash flow is typically simpler and more predictable than a firm’s cash flow. In addition, the average loan amount to an individual is relatively small, warranting a less detailed credit analysis. Real Estate Loans Banks also provide real estate loans. For residential real estate loans, the maturity on a mortgage is typically 15 to 30 years, although shorter-term mortgages with a balloon payment are also common. The loan is backed by the residence purchased. During the economic expansion in the 2004–2006 period, many banks offered loans to home buyers of questionable credit standards. These subprime mortgages were given to home buyers who had relatively lower income, high existing debt, or only a small down payment for purchasing a home. Many commercial banks expected to bene- fit from subprime mortgage loans because they could charge up-front fees (such as appraisal fees) and higher interest rates on the mortgages to compensate for the risk of default. Commercial banks also provide commercial real estate loans, such as loans to build shopping malls. In general, during the early 2000s banks required more stringent standards for borrowers to qualify for commercial real estate loans. 3. Investment in Securities Banks purchase various types of securities. One advantage of investing funds in securities rather than loans is that the securities tend to be more liquid. Treasury and Agency Securities Banks purchase Treasury securities as well as securities issued by agencies of the federal government. Government agency securities can be sold in the secondary market, but the market is not as active as it is for Treasury securities. Corporate and Municipal Bonds Banks also purchase corporate and municipal bonds. Although corporate bonds are subject to credit risk, they offer a higher return than Treasury or government agency securities. Municipal bonds exhibit some degree of risk but can also provide an attractive return to banks, especially when their after-tax return is considered. Mortgage-Backed Securities Banks also commonly purchase mortgage-backed securities (MBS), which represent packages of mortgages. Banks tend to purchase mortgages within a particular “tranche” that is categorized as having a relatively low risk. 4. Repurchase Agreements Recall that, from the borrower’s perspective, a repurchase agreement transaction involves repurchasing the securities it had previously sold. From a lender’s perspective, the repo represents a sale of securities that it had previously purchased. Banks can act as the lender (on a repo) by purchasing a corporation’s holdings of Treasury securities and then selling them back at a later date. This provides short-term funds to the corporation, and the bank’s loan is backed by these securities. Module 3 - Topic 3. Off-Balance Sheet Activities-2 Off-balance sheet (OBS) items is a term for assets or liabilities that do not appear on a company's balance sheet. Although not recorded on the balance sheet, they are still assets and liabilities of the company. Off-balance sheet items are typically those not owned by or are a direct obligation of the company. For example, when loans are securitized and sold off as investments, the secured debt is often kept off the bank's books [online]. Madura (2014) stated that banks commonly engage in off-balance-sheet activities, which generate fee income without requiring an investment of funds. However, these activities do create a contingent obligation for banks. The following are some of the more popular off-balance sheet activities; Loan commitments Standby letters of credit Forward contracts on currencies Interest rate SWAP contracts Credit default SWAP contracts 1. Loan Commitments A loan commitment is an obligation by a bank to provide a specified loan amount to a particular firm upon the firm’s request. The interest rate and purpose of the loan may also be specified. The bank charges a fee for offering the commitment. One type of loan commitment is a note issuance facility (NIF), in which the bank agrees to purchase the commercial paper of a firm if the firm cannot place its paper in the market at an acceptable interest rate. Although banks earn fees for their commitments, they could experience illiquidity if numerous firms request their loans at the same time. 2. Standby Letters of Credit A standby letter of credit (SLC) backs a customer’s obligation to a third party. If the customer does not meet its obligation, the bank will. The third-party may require that the customer obtain an SLC to complete a business transaction. For example, consider a municipality that wants to issue bonds. To ensure that the bonds are easily placed, a bank could provide an SLC that guarantees payment of interest and principal. 3. Forward Contracts on Currencies A forward contract on currency is an agreement between a customer and a bank to exchange one currency for another on a particular future date at a specified exchange rate. Banks engage in forward contracts with customers that desire to hedge their exchange rate risk. 4. Interest Rate Swap Contracts Banks also serve as intermediaries for interest rate swaps, whereby two parties agree to periodically exchange interest payments on a specified notional amount of principal. Once again, the bank receives a transaction fee for its services. If it guarantees payments to both parties, it is exposed to the possibility that one of the parties will default on its obligation. In that event, the bank must assume the role of that party and fulfill the obligation to the other party. Some banks facilitate currency swaps (for a fee) by finding parties with opposite future currency needs and executing a swap agreement. Currency swaps are similar to forward contracts, but they are usually for more distant future dates. 5. Credit Default Swap Contracts Credit default swaps are privately negotiated contracts that protect investors against the risk of default on particular debt securities. Some commercial banks and other financial institutions buy them in order to protect their own investments in debt securities against default risk. Other banks and financial institutions sell them. The banks that sell credit default swaps receive periodic coupon payments for the term of the swap agreement. A typical term of a credit default swap is five years.