## 1phlea2021001

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### Macroeconomic shock and recovery
- GDP contracted by 9.5 percent in 2020—a much steeper decline than during the Asian Financial Crisis.
- The economy began recovering with the easing of containment measures and economic policy support; expected to grow 6½ percent in 2021.
- Fund projection: 2021 real GDP growth to be 6.6. percent (January 2021 WEO).
- First half 2020: 12 percent (H/H, s.a.) real GDP contraction.
- Real GDP increased by 8.0 percent in Q3 (q/q, s.a.) and by 5.6 percent in Q4 (q/q, s.a.).
- Gross international reserves recovered by nearly US$20 billion to US$110 billion between end-April and end-year (11 months of import coverage).
- Authorities launched a credit guarantee program equal to 0.6 percent of GDP for loans to SMEs and the agricultural sector.
- Moratoria (total of five months) expired at the end of 2020.

### Key risks to financial stability
- Immediate risk: impact of COVID-19 on corporate earnings and bank asset quality.
- Banks are tightly interlinked with nonfinancial corporates (NFCs) through high credit exposures and conglomerate ownership linkages.
- The Financial Action Task Force (FATF) may place the country on the so-called grey list in 2021 without significant reforms to the effectiveness of the Anti-Money Laundering and Counter Financing of Terrorism (AML/CFT) regime.
- Physical climate risk: vulnerability to increased typhoon risks and destruction of physical capital from typhoons; physical risks are relevant to financial stability though not systemic unless extreme tail events materialize.
- Uncertainty in the growth outlook is large, mainly from the pandemic and timing of the vaccine rollout; faster recovery is possible with a quick vaccine rollout.

### Financial system structure and vulnerabilities — key statistics
- Total assets of the financial system amount to 126 percent of GDP.
- The banking system holds about 94 percent of the system’s assets.
- Bank credit is just over 50 percent of GDP.
- A third of adults have formal accounts; elsewhere reported as 34 percent of adults have formal accounts.
- Forty-six universal and commercial banks (UKBs) hold over 94 percent of bank assets.
- 60 percent of bank assets are held by the top five banks (all domestic).
- Foreign bank subsidiaries and branches hold seven percent of bank assets.
- About 500 small thrift banks (TBs) and rural and cooperative banks (RCBs).
- Eighty percent of the loans go to NFCs.
- Regulatory limit on real estate loans of 20 percent of total loans applicable to UKBs (raised to 25 percent upon COVID-19).
- A quarter of assets are securities (mostly sovereign bonds).
- Banks are liquid with nearly 40 percent of assets in securities and central bank reserves.
- Banks’ direct cross-border exposure is low at about 10 percent of bank assets and liabilities.
- Dollarization: 15 percent of deposits and 11 percent of loans are in FX.
- International remittance inflows are significant (about eight percent of GDP annually).
- Nonbank financial institutions (NBFIs) are underdeveloped.
- Domestic stock market capitalization and bond outstanding are roughly 90 percent and 30 percent of GDP, respectively.

### Bank sector performance and recent indicators
- NPL ratio rose from 2.1 percent at end-2019 to 3.4 percent in September 2020.
- CAR was stable at about 15 percent in the past ten years and rose over one percentage point since end-2019; latest actual CAR: 15.6 percent.
- Return on assets (ROA) has been about 1½ percent.
- Lending standards have tightened and credit is contracting though the credit gap remains positive as GDP contracts.
- Banks continued to receive new deposits, reducing the loan-to-deposit ratio noticeably.
- Some figures may have optimistic bias under moratoria and forbearance measures.

### Stress testing and scenario findings (solvency)
- Scenarios: baseline, upside, adverse, and severe adverse.
- System aggregate CAR (2022):
  - Latest actual: 15.6 percent
  - Baseline October: 11.7 percent
  - Upside: 13.5 percent
  - Adverse: 9.3 percent
  - Severe Adverse: 4.9 percent
- UKBs/TBs/RCBs aggregate CAR and CET1R (2022):
  - Latest actual: CAR 15.3, CET1R 12.7
  - Baseline October: CAR 11.0, CET1R 8.9
  - Upside: CAR 13.1, CET1R 10.8
  - Adverse: CAR 8.5, CET1R 6.5
  - Severe Adverse: CAR 3.7, CET1R 2.1
- Capital shortfalls (percent of GDP) to meet regulatory minima:
  - Latest actual: 0.0
  - Baseline October: Total 1.0
  - Upside: Total 0.5
  - Adverse: Total 1.9
  - Severe Adverse: Total 3.9
- Number of banks not meeting minimum requirements (2022):
  - Latest actual: 0 banks not meeting requirements
  - Baseline October: 185 banks (12 UKB, 8 TB, 6 RCB) — share of failed banks’ assets 31.8 percent
  - Upside: 178 banks — share 25.2 percent
  - Adverse: 201 banks — share 59.9 percent
  - Severe Adverse: 214 banks — share 76.4 percent
- In the unlikely severe adverse scenario, 214 banks with three-quarters of the system’s assets miss the minimum CAR requirement.
- Capital shortfalls remain moderate—below four percent of GDP even in the severe adverse scenario.

### Stress testing drivers and second-round macro effects
- A jump in NPLs is the key driver: PDs for UKBs jump to levels comparable to and higher than the AFC episode in adverse and severe adverse scenarios.
- Loan-loss provisioning (LLP), lost interest income from NPLs, and lower margins drag capital ratios down.
- Estimated second-round effects:
  - In the adverse scenario, banking sector CAR declines by nearly 8 percentage points, which could reduce real GDP level by additional 4 percentage points by 2021.
  - In the severe adverse scenario, CAR declines by nearly 12 percentage points, which could reduce real GDP level by additional 9 percentage points by 2021.
  - Second-round effects may persist for several years and may double the initial shock to GDP in adverse scenarios.
- Counterfactual policy experiment (one-time write-off of NPL worth 30 percent of LLP stock in 2021, financed by available excess capital):
  - Cost of the counterfactual policy ranges from 1½ percent to nearly 3 percent of GDP.
  - Cost-benefit table (2019 real GDP = 100):
    - Baseline: Benefit 1 = 1; Benefit 2 = 2.31; Cost = -1.56
    - Adverse: Benefit 1 = 1.62; Benefit 2 = 3.20; Cost = -2.16
    - Severe adverse: Benefit 1 = 2.23; Benefit 2 = 4.13; Cost = -2.88
  - Interpretation: single-year benefits are about the same as costs, but benefits last multiple years; total benefits from 2021 to 2022 are significantly above costs in scenarios considered.

### Bank liquidity stress testing and moratoria-related bank–NFC linkages
- Liquidity buffers: HQLA for LCR mostly reserves and sovereign securities; high reserve requirement (12 percent) significantly contributes to buffers.
- System more resilient against FX liquidity shocks than local currency shocks; FX buffers concentrated in a couple of Global-SIB branches.
- Moratoria effects:
  - Moratoria improve NFC cash balance while reducing bank cash inflows and liquid assets.
  - Without moratoria, NFC cash balance declines for debt service while increasing bank liquidity balance; but liquidity-strapped NFCs may withdraw bank deposits, weakening banks’ cash balance.
  - If banks roll over healthy maturing NFC loans, NFC liquidity recovers with or without moratoria.
  - Moratoria effectiveness depends on bank rollover behavior and NFC access to alternative financing.
- Bank–NFC liquidity linkage numerical outcomes (12-month moratorium, 70 percent moratorium take up):
  - NFC cash-to-assets ratio (percent of end-2019 total assets):
    - Rollover = 90%: 9.7, 8.8, 9.0, 10.6, 10.8
    - Rollover = 50%: 9.7, 5.3, 6.3, 9.6, 9.8
  - Bank Counter-Balancing Capacity (CBC) (percent of initial CBC):
    - Rollover = 90%: 100, 114, 106, 106, 102, 110, 109
    - Rollover = 50%: 100, 147, 110, 106, 111, 111, 110
- Policy implication: BSP could monitor banks and NFCs’ contingent financing plans to better gauge systemwide effects.

### Tail shocks and climate physical-risk analysis
- Tail events: typhoon shocks spanning 25–500 return periods; exercise uses current and future climate scenarios.
- Method: combine climate science, a catastrophe (CAT) risk model, and a macro-financial DSGE model.
- Findings:
  - Typhoon physical risk is relevant but not necessarily systemic except for extreme tail events.
  - Without other shocks, destruction of physical capital from typhoons’ wind alone would reduce bank capital ratio by only one percentage point even in a once-in-500-year event in the future.
  - Joint shock with pandemic intensifies climate change effects for extremely intense typhoons: for once-in-500-year events, the difference between current and future scenarios with the pandemic rises to 4½ percentage points.
  - Short-term valuation effect: bank capital may rise in scenarios without pandemic over the short-period due to valuation gains with securities as the central bank cut policy rate.
- Caveats: exercise covers only building/infrastructure destruction by typhoon wind (sea-level rise and floods excluded); results sensitive to model and scenario uncertainties; premature to discuss prudential policy measures based on one stress test.

### Regulatory and supervisory framework — status and gaps
- BSP has modernized bank oversight since the 2010 FSAP and shows reasonably good compliance with the Basel Core Principles (2020 BCP assessment).
- BSP plays the central role in the macroprudential policy framework given the dominance of banks.
- 2019 amendments to the BSP charter strengthened the financial stability policy framework and granted powers (e.g., Pillar 2).
- Material gaps remain:
  - BSP’s legal powers on conglomerate supervision are limited; cannot regulate, obtain prudential information, or examine parents or affiliates of banks.
  - Bank secrecy laws limit the effectiveness of supervision and have wider financial sector implications; legislative amendments recommended to give BSP, SEC, and IC direct and full access to depositor information.
- BSP issued time-bound regulatory relief measures, including forbearance related to NPL recognition and provisions, subject to prior BSP approval; uptake appears limited given tight BSP approval criteria.

### Financial safety net, resolution, and crisis management
- Resolution powers are provided to both the Philippine Deposit Insurance Corporation (PDIC) and the BSP, making the resolution process relatively complex.
- Resolution toolkit remains largely limited to liquidation; P&A tool limitations noted.
- Recommendations:
  - Designate the PDIC and give it powers to act as the resolution authority.
  - Broaden the resolution toolkit beyond liquidation, possibly including a statutory bail-in tool.
  - Expand the purchase and assumption (P&A) tool.
  - Streamline and make the Prompt Corrective Action (PCA) framework more specific to prevent critically deficient banks from operating for prolonged periods.
  - Start resolvability assessments and resolution plans for individual banks, starting with D-SIBs.
  - The central bank should provide Emergency Liquidity Assistance (ELA) only against collateral; legal framework should specify ELA conditions.
  - Consider establishing a dedicated backstop for the Deposit Insurance Fund from the government/Treasury.

### AML/CFT, financial integrity, and market access risks
- The FATF may include the Philippines in the list of jurisdictions with serious AML/CFT deficiencies in 2021 if insufficient progress is made by June 2021.
- 2019 APG assessment gave low/moderate grades to AML/CFT overall effectiveness.
- Actions taken:
  - AMLC issued regulations expanding the definition of suspicious transaction reports and revised reporting timelines.
  - SEC requires registered companies to disclose beneficial owners; implementing frameworks being finalized.
  - RA No. 11521 and implementing rules published on 31 January 2021 address designating tax crimes as predicate ML offenses and targeted financial sanctions against proliferation financing.
- Recommended legislative amendments:
  - Give BSP, SEC, and IC direct and full access to depositor information covered by bank secrecy laws.
  - Designate tax crimes as predicate ML offenses.
  - Establish a comprehensive legal framework for targeted financial sanctions against proliferation financing.
- Supervisory reforms: strengthen risk-based AML/CFT supervision; improve beneficial ownership information accuracy and timely access.

### Policy recommendations — prioritized and actionable (timing: ST = within one year; MT = one to three years)
- Short-term (ST)
  - Limit bank dividend distributions while downside risks remain high and be ready to take additional measures to strengthen banks’ capital if the risks materialize (FSCC members, BSP).
  - Lapse or limit the use of issued regulatory forbearance measures (BSP).
  - Ensure timely corrective actions and resolution of weak banks (BSP, PDIC).
  - Implement resolvability assessments and resolution plans, starting with D-SIBs (PDIC, BSP).
  - Make legislative amendments to (i) designate tax crimes as predicate ML offenses; and (ii) establish a comprehensive legal framework for targeted financial sanctions against proliferation financing (AMLC, DoF).
  - Strengthen risk-based AML/CFT supervision for high-risk sectors (BSP, AMLC, PAGCOR).
- Medium-term (MT)
  - Enhance collaboration within the BSP to conduct essential macroprudential risk analyses, including macro scenario stress tests (BSP).
  - Strengthen the influence of FSCC decisions by adding a comply-or-explain mechanism and providing sectoral regulators with a financial stability objective (FSCC members).
  - Expand macroprudential policy toolkit and establish operational procedures to set them in a more systemic risk-based manner (BSP).
  - Amend the bank secrecy laws to enhance supervision powers, strengthen AML/CFT effectiveness, and cooperation with foreign authorities (BSP, SEC, IC, AMLC and DoF).
  - Provide the power to the BSP to insert a regulated Financial Holding Company into a mixed conglomerate and obtain information from the wider group (BSP, DoF).
  - Designate and provide the PDIC with powers to act as resolution authority (PDIC, BSP, DoF).
  - Expand and operationalize bank resolution tools (particularly P&A) beyond liquidation (PDIC).
  - Improve information collection, monitoring of risk metrics, and stress test capacity for climate change and environmental risks (BSP).
  - Strengthen conglomerate supervision: appoint BSP as lead supervisor of financial conglomerates and conduct more frequent and comprehensive group-level risk assessments (BSP, IC, SEC, FSF).
  - Update large exposure requirements (solo and consolidated) and enhance large and related party exposure reporting requirements (BSP).

### Financial inclusion, capital markets, and credit information
- Simplify the registration and approval process for the issuance of corporate debt to deepen markets.
- The national credit registry should increase funding to enhance technology standards and resolve technical issues to make the registry functional.
- Promote digital payments to increase access to formal finance; only a quarter of adult population made or received at least one digital payment in the preceding year (2017 Global Findex).
- Domestic bond markets are underdeveloped relative to peers; NBFI sector is smaller than peers.
- Household debt from banks is the smallest among EM peers; households borrow primarily from friends and families.

*PHILIPPINES — FINANCIAL SYSTEM STABILITY ASSESSMENT, February 11, 2021.*

### 9.5 percent in 2020—a much steeper decline than during the Asian Financial Crisis. However,

### PHILIPPINES — FINANCIAL SYSTEM STABILITY ASSESSMENT

### Macroeconomic shock and recovery
- GDP contracted by 9.5 percent in 2020—a much steeper decline than during the Asian Financial Crisis.
- The economy began recovering with the easing of containment measures and economic policy support; expected to grow 6½ percent in 2021.
- Macroeconomic fundamentals at the onset of COVID-19 were stronger than in the late 1990s, but the pandemic was an extreme tail shock.

### Key risks to financial stability
- Immediate risk: impact of COVID-19 on corporate earnings and bank asset quality.
- Banks are tightly interlinked with nonfinancial corporates (NFCs) through high credit exposures and conglomerate ownership linkages.
- The Financial Action Task Force (FATF) may place the country on the so-called grey list in 2021 without significant reforms to the effectiveness of the Anti-Money Laundering and Counter Financing of Terrorism (AML/CFT) regime.
- Physical climate risk: vulnerability to increased typhoon risks and destruction of physical capital from typhoons; physical risks are relevant to financial stability though not systemic unless extreme tail events materialize.

### Stress testing and scenario findings
- Stress tests indicate banks can withstand the already severe baseline scenario.
- Banks could experience systemic solvency distress under a much more severe adverse scenario, as corporate distress would spill over to banks.
- Second-round effects from bank distress could reduce GDP further.
- Higher median and estimated losses were used in stress testing for severer scenarios.
- Regulatory forbearance that delays loss recognition could harm economic recovery by limiting credit growth; prompt loss recognition and NPL restructuring can prevent sharp deleveraging and boost GDP.

### Regulatory and supervisory framework
- The Bangko Sentral ng Pilipinas (BSP) has modernized bank oversight since the 2010 FSAP and shows reasonably good compliance with the Basel Core Principles (2020 BCP assessment).
- The BSP plays the central role in the macroprudential policy framework given the dominance of banks.
- The 2019 amendments to the BSP charter strengthened the financial stability policy framework.
- Material gaps remain: BSP’s legal powers on conglomerate supervision; bank secrecy laws limit the effectiveness of supervision and have wider financial sector implications.
- At the wake of COVID-19, the BSP issued time-bound regulatory relief measures, including strong forms of forbearance related to non-performing loan recognition and provisions, subject to prior notification to and approval of the BSP.

### Financial safety net, resolution, and crisis management
- Progress has been made reforming the financial safety net, but several 2010 FSAP issues remain relevant.
- Resolution powers are provided to both the Philippine Deposit Insurance Corporation (PDIC) and the BSP, making the resolution process relatively complex.
- The prompt corrective action (PCA) framework could be enhanced by more specific escalation procedures.
- The resolution toolkit remains largely limited to liquidation; resolvability assessments and resolution planning are not yet in place.

### Policy recommendations (prioritized and actionable)
- Limit bank dividend distributions given significant downside risks, and be ready to take additional measures to strengthen banks’ capital if downside risks materialize.
- Allow COVID-related forbearance measures to lapse as scheduled and avoid introducing new measures; prevent delayed loss recognition and excessive NPL restructuring that could limit credit growth.
- Further enhance the effectiveness of the AML/CFT framework to reduce the risk of FATF grey-listing.
- Amend unusually stringent bank secrecy laws that limit effective prudential supervision and impair financial stability, financial integrity, and development.
- Strengthen the resolution framework urgently: immediately streamline the PCA framework and begin resolvability assessments and resolution planning while legislative changes proceed.
- Over the medium term: expand the macroprudential toolkit, strengthen supervision of financial conglomerates, and enhance monitoring of climate change risks.

*PHILIPPINES — FINANCIAL SYSTEM STABILITY ASSESSMENT, February 11, 2021.*

### 15.6 percent to 11.7 percent by 2022, still above the ten percent minimum requirement even

### 1phlea2021001 - 15.6 percent to 11.7 percent by 2022, still above the ten percent minimum requirement even

### Stress-test results and scenarios
- Baseline: CAR falls from 15.6 percent to 11.7 percent by 2022, still above the ten percent minimum requirement even without sectoral policy effects.
- Adverse scenario: CAR falls to 9.3 percent.
- Severe adverse scenario: CAR falls to 4.9 percent.
- Second-round macro effects: distress could reduce the real GDP level by an additional 4 to 9 percentage points in adverse scenarios.
- Recovery: CARs start to recover in 2022 as the economy recovers.
- Caveats: Results should be interpreted cautiously given economic and model uncertainties; conservative behavioral assumptions (e.g., deleveraging) in FSAPs tend to yield larger solvency impacts during a severe crisis.

### Key policy recommendations (financial sector resilience and crisis response)
- Limit bank dividend distributions while downside risks remain high and be ready to take additional measures to strengthen banks’ capital if the risks materialize.
- If downside risks materialize:
  - Banks should recognize NPLs and restructure them promptly with additional capital as needed.
  - Prompt corrective measures and capital support can improve GDP with sustained credit provision (counterfactual policy analysis and post-AFC experience).
- Forbearance:
  - The BSP should allow the forbearance measures to lapse as scheduled and avoid introducing new measures.
  - Forbearance does not address underlying issues in weak banks, hampers banks’ ability to provide credit, and may undermine financial stability.
- Use existing flexibility in accounting and Basel capital framework and further develop macroprudential tools and buffers.
- Bank resolution framework enhancements:
  - Designate the Philippine Deposit Insurance Corporation (PDIC) and give it powers to act as the resolution authority.
  - Broaden the resolution toolkit beyond liquidation, possibly including a statutory bail-in tool.
  - Expand the purchase and assumption (P&A) tool.
  - Streamline and make the Prompt Corrective Action (PCA) framework more specific to prevent critically deficient banks from operating for prolonged periods.
  - Start resolvability assessments and resolution plans for individual banks, starting with D-SIBs.
  - Enhance and test cross-sectoral coordination mechanisms to manage potential failure of a D-SIB.
  - The central bank should provide Emergency Liquidity Assistance (ELA) only against collateral.
- Macroprudential framework and governance:
  - Enhance collaboration within the BSP to conduct macro scenario stress tests and essential financial stability exercises; decision-making should reflect monetary policy, supervisory, and macroprudential perspectives.
  - Expand macroprudential toolkit beyond the countercyclical capital buffer (CCyB); establish operational procedures and thresholds of systemic risk indicators to trigger activation of tools.
  - Elevate the influence of the Financial Stability Coordination Council (FSCC) with a comply-or-explain mechanism and by providing financial stability objectives to supervisors of nonbank financial institutions.
- Supervisory and legal reforms:
  - Amend the unusually stringent bank secrecy law that limits BSP’s legal powers for effective prudential supervision.
  - Strengthen conglomerate supervision: additional powers to obtain information from banks’ affiliates; ability to bring and supervise all related financial institutions under a regulated financial holding company.
  - Enhance regulatory powers and standards for transfer of significant ownership, controlling interest, and assessing beneficial owners’ suitability.
  - Strengthen requirements and monitoring of large exposure and related party transactions.
- AML/CFT:
  - Substantially enhance the effectiveness of the AML/CFT regime; without major reforms by June 2021, risk of inclusion in the FATF list of jurisdictions with serious AML/CFT deficiencies.
- Climate risk capacity:
  - Improve data and build capacity for climate risk analysis; incorporate physical risk scenarios (typhoon) into long-term solvency testing.

### Table 1 — Selected recommended actions and timing (as presented)
- Limit bank dividend distributions while downside risks remain high and be ready to take additional measures to strengthen banks’ capital if the risks materialize to continue providing credit to the economy (FSCC members, BSP). — ST
- Enhance collaboration within the BSP to conduct essential macroprudential risk analyses, including macro scenario stress tests (BSP). — MT
- Strengthen the influence of FSCC decisions by adding a comply-or-explain mechanism and providing sectoral regulators with a financial stability objective (FSCC members). — MT
- Expand macroprudential policy toolkit and establish operational procedures to set them in a more systemic risk-based manner (BSP). — MT
- Lapse or limit the use of issued regulatory forbearance measures (BSP). — ST
- Enhance regulatory powers and standards regarding transfer of significant ownership or controlling interest and to assess the suitability of beneficial owners of banks (BSP, DoF). — ST
- Strengthen sectoral supervision, appoint the BSP as the lead supervisor of financial conglomerates, and conduct more frequent and comprehensive risk-assessment of FCs (BSP, IC, SEC, FSF). — ST
- Update the large exposure requirements (to be applicable on a solo and consolidated level) and enhance large and related party exposure reporting requirements (BSP). — ST
- Amend the bank secrecy laws to enhance supervision powers, strengthen AML/CFT effectiveness, and cooperation with foreign authorities (BSP, SEC, IC, AMLC and DoF). — MT
- Provide the power to the BSP to insert a regulated Financial Holding Company into a mixed conglomerate and obtain information from the wider group (BSP, DoF). — MT
- Make legislative amendments to (i) designate tax crimes as predicate ML offenses; and (ii) establish a comprehensive legal framework for targeted financial sanctions against proliferation financing (AMLC, DoF). — ST
- Strengthen risk-based AML/CFT supervision for high-risk sectors (BSP, AMLC, PAGCOR). — ST
- Enhance the accuracy and availability of beneficial ownership information of companies (SEC). — MT
- Ensure timely corrective actions and resolution of weak banks (BSP, PDIC). — ST
- Implement resolvability assessments and resolution plans, starting with D-SIBs (PDIC, BSP). — ST
- Make the legal framework for ELA more specific and avoid assistance without collateral (BSP). — ST
- Designate and provide the PDIC with powers to act as resolution authority (PDIC, BSP, DoF). — MT
- Expand and operationalize bank resolution tools (particularly P&A) beyond liquidation (PDIC). — MT
- Improve information collection, monitoring of risk metrics, and stress test capacity for climate change and environmental risks (BSP). — MT

(Short-term (ST) = within one year; medium-term (MT) = one to three years)

### Financial system structure and vulnerabilities
- Size and composition:
  - Total assets of the financial system amount to 126 percent of GDP.
  - The banking system holds about 94 percent of the system’s assets.
  - Bank credit is just over 50 percent of GDP.
  - A third of adults have formal accounts.
- Banking sector concentration:
  - Forty-six universal and commercial banks (UKBs) hold over 94 percent of bank assets.
  - 60 percent of bank assets are held by the top five banks (all domestic).
  - Foreign bank subsidiaries and branches hold seven percent of bank assets.
  - About 500 small thrift banks (TBs) and rural and cooperative banks (RCBs).
- Business model and exposures:
  - Eighty percent of the loans go to NFCs.
  - Regulatory limit on real estate loans of 20 percent of total loans applicable to UKBs (raised to 25 percent upon COVID-19).
  - TBs provide one-third of their loans to residential properties.
  - TBs and RCBs are more exposed to household consumption and agriculture loans.
  - A quarter of assets are securities (mostly sovereign bonds).
  - Banks are liquid with nearly 40 percent of assets in securities and central bank reserves.
- Legal and supervisory gaps:
  - Bank secrecy laws prevent banks from sharing depositor information directly with supervisors for prudential purposes, undermining supervisory effectiveness and financial integrity.
  - Seven out of the ten largest banks (holding about 60 percent of total bank assets) are related to local-family-owned mixed conglomerates, creating contagion via common exposures to large conglomerates.
- Other market features:
  - Nonbank financial institutions (NBFIs) are underdeveloped.
  - Domestic stock market capitalization and bond outstanding are roughly 90 percent and 30 percent of GDP, respectively, with government securities dominating the debt market.
  - Fintech and digital payments are nascent; only a quarter of the adult population made or received at least one digital payment in the preceding year (2017 Global Findex).
- International linkages:
  - Banks’ direct cross-border exposure is low at about 10 percent of bank assets and liabilities.
  - Dollarization: 15 percent of deposits and 11 percent of loans are in FX.
  - International remittance inflows are significant (about eight percent of GDP annually).
- Climate risk:
  - The Philippines is highly exposed to physical (typhoon) risks; climate physical risks are relevant for financial stability though not systemic unless extreme tail events (once in 250-500 years) materialize.

### Macrofinancial developments and COVID-19 impact
- Real 2020 GDP contracted by 9.5 percent.
- First half 2020: 12 percent (H/H, s.a.) real GDP contraction.
- Recovery:
  - Real GDP increased by 8.0 percent in the third quarter (q/q, s.a.).
  - Real GDP increased by 5.6 percent in the fourth quarter (q/q, s.a.).
- Fund projection: 2021 real GDP growth to be 6.6. percent (January 2021 WEO).
- Financial market and reserves:
  - Gross international reserves recovered by nearly US$20 billion to US$110 billion between end-April and end-year (11 months of import coverage).
- NFCs and policy support:
  - Authorities launched a credit guarantee program equal to 0.6 percent of GDP for loans to SMEs and the agricultural sector.
  - Moratoria (total of five months) expired at the end of 2020.
- Bank sector performance:
  - NPL ratio rose from 2.1 percent at end-2019 to 3.4 percent in September 2020.
  - CAR rose over one percentage point since end-2019 (CAR was stable at about 15 percent in the past ten years).
  - Return on assets (ROA) has been about 1½ percent.
  - Lending standards have tightened and credit is contracting though the credit gap remains positive as GDP contracts.
  - Banks continued to receive new deposits, reducing the loan-to-deposit ratio noticeably.
  - Some figures may have optimistic bias under moratoria and forbearance measures.

*Source: 1phlea2021001 (Philippines FSAP content provided).*

### 14.      The BSP also issued time-bound regulatory relief and forbearance measures

### 14.      The BSP also issued time-bound regulatory relief and forbearance measures

### BSP regulatory relief and forbearance
- BSP issued time-bound regulatory relief and forbearance measures (Appendix IV), including unusually strong forms of forbearance to delay NPL recognition and allow banks to provision over a maximum period of five years subject to the BSP’s approval.
- Uptake appears limited so far given the BSP’s tight approval criteria.
- The mission welcomes BSP’s effort to keep track of credit quality information without policy measures to maintain transparency.

### Key risks and assessment methods
- Key risks to financial stability stem from the COVID-19 crisis and bank-corporate linkages; the economic impact of COVID-19 is already much worse than the AFC.
- Uncertainty in the growth outlook is large, mainly from the pandemic and the timing of the vaccine rollout; faster recovery is possible with a quick vaccine rollout.
- Main analytical tools applied (Appendix I):
  - DSGE = Dynamic Stochastic General Equilibrium; SVAR = Structural Vector Autoregressive.
  - NFC tests assess effects of earnings shocks on loan repayment capacity.
  - Bank solvency test covers all banks; liquidity tests examine UKBs; exercises use end-2019 data.
  - Cashflow stress tests of banks and NFCs are linked to assess liquidity contagion.
  - Climate physical risk tests use climate science, a catastrophe (CAT) risk model, and a macro-financial model (Appendix I and VI).
- Exclusions/limits:
  - Except bank-NFC liquidity linkage analysis, exercises do not incorporate effects of sectoral support measures.
  - Guarantee program is limited to SMEs and the agricultural sector and small (0.6 percent of GDP).
  - Moratoria expired at the end of 2020.
  - Forbearance measures that are not compatible with Basel III should not be incorporated.

### Macroeconomic scenarios and GDP assumptions
- Four macro scenarios: baseline, upside, adverse, and severe adverse.
- All scenarios have real GDP paths more severe than the AFC but less severe than the mid-1980s political turmoil.
- The baseline is unusually weak—equivalent to nearly three standard deviation shock to GDP compared to the pre-COVID forecast.
- The severe adverse scenario adds an additional 3.8 standard deviation shock to the baseline, a total of over six standard deviation shock compared to the pre-COVID forecast.
- Policy rates are assumed to remain low in all scenarios; financial conditions tighten slightly with higher risk premiums.
- WEO forecast (Table 3) real GDP growth rates: -9.6 percent for 2020 and 6.6 percent for 2021 (slightly revised down from October WEO: -8.3 percent for 2020 and 7.4 percent for 2021) but still above the adverse scenario.

### Nonfinancial corporations (NFCs): distress assessment
- Sample mostly limited to listed firms, covering nearly half of bank loans.
- Projected debt-weighted average ICR:
  - 4.9 percent at end-2019
  - 1.3 in the baseline
  - below one in the adverse scenario
  - 0.2 in the severe adverse scenario
- Debt-at-Risk (share of debt by firms with ICR below one):
  - 5 percent at end-2019
  - about 45 percent even in the upside scenario
  - 80 percent in the severe adverse scenario
- Exchange rate shock contribution appears relatively small.
- Mitigants: support from wealthy owner families of large conglomerates and policy support for SMEs.
- Loan moratoria can help firms survive liquidity shocks but may only delay eventual bankruptcy if the crisis is persistent.

### Bank solvency stress test: headline results (2022)
- System aggregate CAR:
  - Latest actual: 15.6 percent
  - Baseline October: 11.7 percent
  - Upside: 13.5 percent
  - Adverse: 9.3 percent
  - Severe Adverse: 4.9 percent
- UKBs, TBs, RCBs CAR and CET1R (2022):
  - Latest actual: CAR 15.3, CET1R 12.7 (UKB/TB/RCB split shown in source)
  - Baseline October: CAR 11.0, CET1R 8.9
  - Upside: CAR 13.1, CET1R 10.8
  - Adverse: CAR 8.5, CET1R 6.5
  - Severe Adverse: CAR 3.7, CET1R 2.1
- Capital shortfalls (percent of GDP) to meet regulatory minima:
  - Latest actual: 0.0
  - Baseline October: Total 1.0
  - Upside: Total 0.5
  - Adverse: Total 1.9
  - Severe Adverse: Total 3.9
- Number of banks not meeting minimum requirements (2022):
  - Latest actual: 0 banks not meeting requirements (system meets minima)
  - Baseline October: 185 banks (12 UKB, 8 TB, 6 RCB) — share of failed banks’ assets 31.8 percent
  - Upside: 178 banks — share 25.2 percent
  - Adverse: 201 banks — share 59.9 percent
  - Severe Adverse: 214 banks — share 76.4 percent
- In the unlikely severe adverse scenario, 214 banks with three-quarters of the system’s assets miss the minimum CAR requirement.
- Capital shortfalls remain moderate—below four percent of GDP even in the severe adverse scenario.
- UKBs and RCBs are more likely to meet CET1 requirement (6 percent minimum) due to high quality of capital.
- All banks must comply with BSP minima: CAR 10 percent (Basel III 8 percent); CET1 6 percent (Basel III 4.5 percent); Tier 1 7.5 percent (Basel III 6 percent). Independent TBs and RCBs minima: CAR 10 percent and Tier 1 6 percent.

### Drivers of stress-test results
- A jump in NPLs is the key driver: PDs for UKBs jump to levels comparable to and higher than the AFC episode in adverse and severe adverse scenarios, sharply increasing NPLs.
- Loan-loss provisioning (LLP), lost interest income from NPLs, and lower margins drag capital ratios down.

### Second-round effects (bank distress → real economy)
- Method: bank-by-bank solvency results used to project bank-level credit growth; model includes changes of NPL ratios and LLP ratio; aggregated credit growth fed into SVAR to estimate change in real GDP growth.
- Capital ratios were not significant in estimations.
- Estimated second-round effects:
  - In the adverse scenario, banking sector CAR declines by nearly 8 percentage points, which could reduce real GDP level by additional 4 percentage points by 2021.
  - In the severe adverse scenario, CAR declines by nearly 12 percentage points, which could reduce real GDP level by additional 9 percentage points by 2021.
  - Effects may persist for several years.
- Second-round effects may double the initial shock to GDP in adverse scenarios.

### Counterfactual policy effects (timely loss recognition / NPL restructuring)
- Counterfactual considered: one-time write-off of NPL worth 30 percent of LLP stock in 2021, financed by available excess capital (arbitrary 30 percent assumption).
- Cost of the counterfactual policy (necessary excess capital) ranges from 1½ percent to nearly 3 percent of GDP.
- Cost-benefit table (2019 real GDP = 100) — values from source:
  - Baseline:
    - Benefit 1: 1
    - Benefit 2: 2.31
    - Cost: -1.56
  - Adverse:
    - Benefit 1: 1.62
    - Benefit 2: 3.20
    - Cost: -2.16
  - Severe adverse:
    - Benefit 1: 2.23
    - Benefit 2: 4.13
    - Cost: -2.88
- Interpretation: single-year benefits are about the same as costs, but benefits last multiple years; total benefits from 2021 to 2022 are significantly above costs in scenarios considered.

### Limitations of the analysis
- Results are sensitive to assumptions on cure rates for NPLs, extent of deleveraging, and loss-given-default (LGD); atypical crisis-time patterns could bias results.
- FSAPs usually assume conservative parameters that increase negative impact.
- Exercise did not incorporate effects of policy measures because guarantees and moratoria are limited and forbearance should not be incorporated.
- Other modelling approaches for second-round effects may yield different results.

### Bank liquidity stress test and moratoria-related bank-NFC linkages
- Banks have sufficient buffers to withstand severe liquidity shocks; HQLA for LCR mostly reserves and sovereign securities.
- High reserve requirement (12 percent) significantly contributes to buffers; usability is critical for survival.
- System more resilient against FX liquidity shocks than local currency shocks; FX buffers concentrated in a couple of Global-SIB branches.
- Net stable funding ratio and cashflow analysis show similar resilience outcomes.
- Loan moratoria effects on bank-NFC liquidity:
  - Moratoria improve NFC cash balance while reducing bank cash inflows and liquid assets.
  - Without moratoria, NFC cash balance declines for debt service while increasing bank liquidity balance; but liquidity-strapped NFCs may withdraw bank deposits, weakening banks’ cash balance.
  - If banks roll over healthy maturing NFC loans, NFC liquidity recovers with or without moratoria.
  - Moratoria effectiveness depends on bank rollover behavior and NFC access to alternative financing (e.g., liquidating assets or issuing bonds).
  - Results: moratoria substantially improve NFC liquidity when banks’ rollover rate is low but less so otherwise; for banks, moratoria effects critically depend on whether NFCs withdraw deposits.
- Policy implication: BSP could monitor banks and NFCs’ contingent financing plans to better gauge systemwide effects.

### Climate change physical-risk analysis
- Method: constructed climate change macroeconomic scenarios using climate science, a CAT risk model, and macro-financial model.
- Findings:
  - Typhoon physical risk is relevant but not necessarily systemic except for extreme tail events.
  - Without other shocks, destruction of physical capital from typhoons’ wind alone would reduce bank capital ratio by only one percentage point even in a once-in-500-year event in the future.
  - Joint shock with pandemic intensifies climate change effects for extremely intense typhoons: for once-in-500-year events, the difference between current and future scenarios with the pandemic rises to 4½ percentage points.
- Short-term valuation effect: bank capital may rise in scenarios without pandemic over the short-period due to valuation gains with securities (mostly sovereign) as the central bank cut policy rate.
- BSP actions to date and recommendations:
  - BSP has started integrating green finance and Environmental, Social and Corporate Governance (ESG) principles into its investment policy, joined the NGFS, and initiated studies on rainfalls and bank performance.
  - BSP issued a circular for banks on environmental risk management, governance, and disclosure.
  - Suggested next steps: follow up with more granular regulations and guidance on risk management, stress testing, and reporting and disclosure; build supervisory capacity to monitor uptake in on-site and off-site supervision.

*Source: 1phlea2021001 - 14.      The BSP also issued time-bound regulatory relief and forbearance measures*

### 35.      Given the significant downside risks, the authorities should limit bank dividend

### 35. Given the significant downside risks, the authorities should limit bank dividend distributions and be ready to take additional measures to strengthen bank capital if downside risks materialize

### Dividend distributions and bank capital
- Given the potential for large loan losses, the authorities should limit dividend distributions as a precautionary measure.
- If downside risks materialize, the BSP should consider broader policy options, including:
  - support measures facilitating the sale and recovery of bad assets;
  - raising additional capital, starting with conglomerate owner families and private sector funding;
  - public funding only as a last resort.
- Counterfactual policy analysis indicates that timely NPL restructuring and loss recognition, financed by adequate capital, can improve GDP with sustained credit provision, and the benefits of such a policy are higher than its cost.
- Historical evidence: during the AFC, credit-to-GDP contracted from over 50 percent to 25 percent in the ten years since 1997 when NPLs were recognized and restructured only slowly, supporting the recommendation.

### Empirical indicators and stress outcomes (as presented)
- Macroeconomic Impact of Typhoons — Normal Time (2019 real GDP = 100): 100, 98, 106, 114, 100, 92, 100, 110, 85, 90, 95, 100, 105, 110, 115, 120, 125 (2019 2020 2021 2022 tt+1 tt+2 tt+3; Current scenario; Future scenario).
- Macroeconomic Impact of Typhoons and Pandemic (2019 real GDP = 100): 100, 88, 91, 99, 100, 86, 87, 95, 85, 90, 95, 100, 105, 110, 115, 120, 125 (2019 2020 2021 2022 tt+1 tt+2 tt+3; Current scenario; Future scenario).
- Impact of Typhoons on Bank Capital — Normal Time (Total capital adequacy ratio in percent): chart baseline values included (January WEO; Typhoon, once in 25 years; Typhoon, once in 500 years).
- Impact of Typhoons and Pandemic on Bank Capital (Total capital adequacy ratio in percent): selected values shown include 10.3, 9.1, 9.7, 10.2, 8.9, 9.6, 15.3, 7.7, 5.4, 6.8, 15.3, 5.2, 1.0, 3.2 (2019 2020 2021 2022 tt+1 tt+2 tt+3; Current scenario; Future scenario).

### Forbearance measures and contingency planning
- Recommendation: The BSP should allow forbearance measures to lapse as scheduled and avoid introducing new measures (Appendix IV).
- Rationale:
  - Forbearance does not address underlying issues in weak banks and hampers banks’ ability to continue to support the economy; it may ultimately undermine financial stability.
  - Forbearance can reduce bank capital’s sensitivity to risks by keeping bank capital at artificially high levels, potentially undermining micro- and macro-prudential tools’ effectiveness.
- Instead, authorities should:
  - continue to use flexibility in accounting and Basel capital frameworks;
  - further develop and use macroprudential tools and buffers.

### Macroprudential framework and oversight
- Institutional roles:
  - BSP is central bank, bank and payment system supervisor, and macroprudential authority; the BSP is the only supervisor with financial stability mandate.
  - Office of Systemic Risk Management (OSRM) created as a financial stability “unit,” headed by an Assistant Governor (AG).
  - Financial Stability Policy Committee (FSPC), a Monetary Board (MB) subcommittee, decides on macroprudential issues.
- Enhancements recommended:
  - Enhance collaboration and coordination across monetary, supervision, and OSRM to conduct essential macroprudential analysis and assure balanced decision-making.
  - Start macro-scenario stress testing; current arrangements: supervision sector implements all bank-related analysis and sets prudential tools except for CCyB, OSRM focuses on non-financial sectors and links to banks and CCyB, and no units/sectors conduct macro-scenario stress testing.
  - Consider multiple institutional arrangements for stress testing and coordination (e.g., advisory committee to FSPC; give OSRM’s AG the right to attend MB meetings).
- Financial Stability Coordination Council (FSCC):
  - FSCC is a voluntary interagency body including BSP, SEC, Insurance Commission (IC), PDIC, and Department of Finance (DoF), chaired by the BSP.
  - Recommendation: Enhance FSCC’s influence by providing powers and a clear Charter or Terms of Reference to make formal recommendations with a comply-or-explain mechanism, and provide a financial stability objective to IC, SEC, and PDIC.

### Macroprudential policy instruments and data
- Current status:
  - CCyB is the only prudential tool explicitly recognized as macroprudential.
  - BSP possesses instruments (e.g., loan-to-value (LTV), liquidity, FX positions) that are not explicitly calibrated to counter systemic structural or countercyclical risks.
  - Operational procedures and thresholds for activating tools, including CCyB, are missing.
- Data gaps:
  - Lack of granular credit risk information, including a comprehensive credit registry; LTV ratios; small and unlisted NFCs and household indebtedness survey; detailed depositor information due to bank secrecy.
  - Progress: new BSP power in the revised central bank charter to collect information from broader economic sectors and SEC’s initiatives to digitalize NFC data.

### Microprudential supervision and conglomerate oversight
- Progress:
  - BSP modernized oversight since previous FSAP and shows reasonably good compliance with the BCPs as an EM (2020 BCP assessment).
  - 2019 amendments to the BSP charter (NCBA) formalized financial stability mandate, extended scope of supervised entities, and granted legal power to ask banks to hold capital beyond minimum regulatory requirements (Pillar 2).
  - BSP has introduced several core Basel III requirements: capital definition; capital buffers; Pillar 2; leverage ratio; LCR and NSFR; supervisory framework for D-SIBs; amended core banking supervision legislation and guidelines.
- Material gaps:
  - BSP lacks powers related to conglomerate supervision: cannot regulate, obtain prudential information, or examine parents or affiliates of banks; cannot require mixed conglomerates to establish a regulated financial holding company including all group financial institutions.
  - Regulatory powers on transferring significant ownership or controlling interest and assessing beneficial owners' suitability are not clear enough.
- Recommendations:
  - Strengthen conglomerate supervision by appointing BSP as lead supervisor for FCs and conducting more frequent and comprehensive group-level risk assessments.
  - Enhance large exposure requirements and reporting on solo and consolidated bases and strengthen related party transaction reporting and monitoring.
  - Set capital ratios for FCs based on their specific risk profile as part of the Pillar 2 process.
  - IC and SEC should adopt a risk-based approach with appropriate resources to support effective conglomerate supervision.

### Financial integrity (AML/CFT)
- Risk status:
  - The FATF may include the Philippines in the list of jurisdictions with serious AML/CFT deficiencies in 2021.
  - The 2019 APG assessment gave low/moderate grades to the AML/CFT regime’s overall effectiveness, including supervision, preventive measures, and entity transparency.
  - Absent sufficient progress by June 2021, the country could again be included in the FATF list and potentially face adverse effects on trade and remittances.
- Actions taken:
  - AMLC issued regulations expanding the definition of suspicious transaction reports and revised reporting timelines.
  - BSP conducted thematic reviews and is enhancing risk-based supervisory tools.
  - SEC-registered companies are now required to disclose their beneficial owners, while frameworks for access to information are being finalized.
- Further reforms recommended:
  - Legislative amendments to:
    - (i) give BSP, SEC, and IC direct and full access to individual depositor information covered by bank secrecy laws (Appendix V);
    - (ii) designate tax crimes as predicate ML offenses;
    - (iii) establish a comprehensive legal framework for targeted financial sanctions against proliferation financing.
  - AML/CFT supervisors should build supervisory capacities and ensure high-risk reporting entities understand key risks and fulfill obligations.
  - AMLC should work with supervisors to establish more efficient administrative sanctions rules.
  - Prioritize ensuring accuracy and timely access to beneficial ownership information.
  - PAGCOR should effectively apply risk mitigation and risk-based supervision measures (e.g., targeting casino junket operators) and resolve its conflict of interest from operating casinos and AML/CFT supervision.

### Financial safety net, bank resolution, and crisis management
- Resolution authority:
  - Recommendation: PDIC should be designated as and given comprehensive powers to act as resolution authority; current legislation does not explicitly single out a resolution authority.
  - PDIC appears to serve as the de-facto principal resolution authority; laws should be amended to formally designate PDIC as the resolution authority.
- Resolution toolkit gaps:
  - Bank resolution options are mainly limited to liquidation; current P&A tool does not allow leaving uninsured creditors and bad assets behind.
  - Recommendations:
    - Provide for bridge banks and possibly statutory bail-in tools;
    - Increase loss-absorbing capacity requirements;
    - Strengthen P&A tool to address potential D-SIB failures;
    - Include safeguards for bank stakeholders.
  - Early intervention and remedial action framework should be streamlined with a clearer escalation process to avoid severely deficient banks operating for too long.
  - PDIC should discontinue bailing out shareholders of weak banks by providing open bank assistance.
  - Consider establishing a dedicated backstop for the Deposit Insurance Fund from the government/Treasury to ensure prompt access to funds.
- Resolvability and planning:
  - Authorities should immediately start resolvability assessments and resolution plans for individual banks, starting with D-SIBs; incorporate assessments into supervisory and resolution frameworks.
  - Consider establishing a platform combining competencies of FSF and FSCC (e.g., a joint committee) to address D-SIB failures.
- Emergency Liquidity Assistance (ELA):
  - Legal framework should specify conditions for ELA provision: best practices suggest ELA only if a bank has exhausted market-based and shareholder liquidity support, has adequate capital, and sufficient collateral.
  - BSP should not provide uncollateralized loans but should consider taking a broader range of collateral.
  - BSP needs internal guidance on determining a bank’s capital position and general viability for ELA purposes.

### Financial inclusion
- Promoting digital payments could increase access to formal finance and deepen financial intermediation.
- Encouraging all financial institutions to participate in core domestic retail transfer systems could encourage competition and reduce the cost of digital payments.
- As households shift to bank deposits from cash, the banking system could expand its credit provision.

*Source: 1phlea2021001 - 35. Given the significant downside risks, the authorities should limit bank dividend distributions and be ready to take additional measures to strengthen bank capital if downside risks materialize.*

### 54.      Improving capital markets and credit information could also advance inclusion.

### 54.      Improving capital markets and credit information could also advance inclusion.

### Key findings on capital markets, credit information, and access
- Simplifying the registration and approval process for the issuance of corporate debt could deepen the market.
- The national credit registry should increase funding to enhance its technology standards and resolve the technical issues to make the registry functional.
- Access to formal financial accounts is low: only 34 percent of adults have formal accounts.
- Domestic bond markets are underdeveloped relative to Asian and other emerging market peers.
- Non-bank financial institution (NBFI) sector is smaller than peers.
- Household debt from banks is the smallest among EM peers; households borrow primarily from friends and families.

### Banking system structure and exposures
- Loans are concentrated in the corporate sector; real estate loans are mainly commercial and are capped at a relatively low 20 percent of total assets by the BSP.
- Directed lending under the “Agri-Agra” law accounts for about 7 percent of total loans; banks are not fully compliant. The law requires banks to invest 25 percent of the increase of funding since 2009 (about 10 percent of UKB borrowing) to the broad agricultural sector; at end-2019, UKBs provide about half of the required amounts and pay fines for shortfalls.
- Banks’ main revenue source is interest income across bank types; expenditures are mostly interest and administrative expenses, and salaries (especially for RCBs).
- Bank asset and liability composition: moderate cross-border exposure and dollarization; banks fund themselves mostly with household deposits, followed by corporate deposits, and lend primarily to non‑financial corporations (NFCs).

### Financial linkage and contagion risks
- Interconnectedness arises mainly from bank lending to conglomerates rather than interbank exposures. Large banks have significant exposures to multiple conglomerates, including their own.
- A BSP network analysis indicates that failure of major conglomerates would have larger contagion effects on banks than banks’ failure.
- Banks hold large liquidity buffers consisting of BSP reserve deposits and government securities. Foreign investment mostly flows to NFCs, then sovereign and banks.
- FX-liquidity is concentrated in a few G-SIB branches.

### Macro-financial context and COVID-19 impact
- The Philippines was more severely hit by COVID-19 than its Asian peers, with a weak growth forecast similar to the Asian Financial Crisis shock.
- Pre-crisis fundamentals were stronger: much lower sovereign debt and country risk premium and higher international reserve buffers.
- Exchange rate appreciated by end-2020; EMBI spreads and equity price deterioration in March moderated notably.
- BSP managed to cut policy rate under broadly stable inflation; T-bill rates declined.
- The credit gap remains positive despite declining credit outstanding because of GDP contraction.

### Non-financial corporate sector resilience and risks
- NFCs show strong debt service capacity supported by strong profitability.
- Interest coverage ratio (ICR) has declined slightly in recent years, largely due to higher funding costs as policy rates were tightened.
- The share of debt-at-risk remains relatively low in the region.
- Corporate cash buffers are strong, providing resources to service debt upon earnings shocks.
- Real estate prices have risen sharply since 2010, though broadly in line with income growth.

### Financial soundness and bank performance
- Bank total capital to risk-weighted assets has been stable at about 15 percent over the past decade, but at the lower side among EMs as others improved capital ratios.
- Non-performing loan (NPL) ratio has declined substantially since the Asian Crisis; smaller banks tend to have higher NPL ratios.
- Return on assets (ROA) has been stable in recent years; RCBs tend to show higher profitability; system-wide ROA is around the median among EM peers.

### Stress test results and vulnerabilities
- Non-financial corporate stress tests: market analysts forecast considerable earning shocks in 2020 for industrials, consumer discretionary, and energy sectors. Under these forecasts and the October WEO baseline, ICR deteriorates noticeably, driven mainly by earnings shocks and weaker economic growth.
- Bank solvency stress tests: while banks can withstand the baseline shock, the system’s capital adequacy ratio (CAR) declines below hurdle rate with some lags in the severe adverse scenario.
- Capital shortfalls across scenarios vary between 1 and 4.7 percent.
- Provisions and declines in net interest income are the largest contributors to CAR declines in adverse and severe adverse scenarios.

### Policy simulation and second-round effects
- A counterfactual policy simulation considers a one-time cash injection to banks that reduces the 2021 stock of loan loss provisions (LLP) by 30 percent.
- The simulated policy improves national income for several years relative to the cost of implementation in the baseline, adverse, and severe adverse scenarios, including when second-round effects are considered.

### Liquidity positions and bank-NFC linkages
- Funding structure: banks rely mostly on retail and wholesale deposits (retail deposits represent 37 percent; wholesale unsecured NFC deposits 14 percent; wholesale unsecured operational deposits 24 percent; wholesale unsecured others 7 percent; other funding 18 percent).
- HQLA composition: cash, required reserves, and excess reserves are significant; Level 1 assets and Level 2 assets compose the remainder (HQLA structure shown as 6 percent cash, 44 percent required reserves, 1 percent excess reserves, 46 percent Level 1 assets, 3 percent Level 2 assets).
- The system has sufficient liquid assets to absorb severe funding shocks, especially in FX, though FX liquidity concentration is a concern.
- Long-term funding appears mostly stable, except for a handful of branches of foreign banks. Liquidity buffers beyond 30 days appear adequate for all banks when all reserves are included.
- Bank-NFC liquidity contagion framework (cash-flow analysis) identifies three channels of liquidity contagion when NFC earning shocks reduce corporate liquid asset balances; two channels described:
  1. NFCs may liquidate their liquid assets, including bank deposits, when earnings are insufficient for operations and debt service. NFC deposit withdrawal rate is measured by (change of NFC cash balance between end-2020 and end-2019)/(end-2019 cash balance), assuming NFCs liquidate all types of liquid assets proportionally. If NFCs liquidate assets other than bank deposits and obtain alternative financing (e.g., bonds), the withdrawal rate stays low.
  2. Loan moratoria help NFCs retain liquidity but reduce cash inflows to banks (direct effect of moratoria).

*International Monetary Fund — Philippines team, content unit 54.*

### 3. Additional bank lending—rollover of repaid loans and new financing—also shifts liquidity from banks to

### 3. Additional bank lending—rollover of repaid loans and new financing—also shifts liquidity from banks to NFCs.

### Bank-NFC liquidity linkage — main findings
- Moratoria scenarios analyzed: 12-month moratoria and stress test period, 70 percent moratoria take up by NFCs.
- Two rollover-rate scenarios considered: high rollover rate (90 percent) and low rollover rate (50 percent).
- High rollover rate (90 percent):
  - "Moratoria improve NFCs’ cash balance above the pre-stress level, but a high rollover rate limits the deterioration of cash position even without moratoria."
  - "While moratoria’s direct effect reduces banks’ liquidity buffer noticeably, the policy effects decline once the indirect effects from deposit withdrawal are accounted for."
  - Numeric indicators shown in the NFC cash-to-assets ratio chart (In percent of end-2019 total assets, 12 month, 70 percent moratorium take up and 90 percent refinancing rate): 9.7, 8.8, 9.0, 10.6, 10.8 (labels in chart correspond to End-2019 / Without Liquidity Support / With Liquidity Support / Without Moratorium / With Moratorium).
  - Bank Counter-Balancing Capacity (CBC) chart (12 month moratorium and test horizon; rollover rate = 90%, moratorium take up = 70%; in percent of initial CBC) displays values: 100, 114, 106, 106, 102, 110, 109 (chart distinguishes Actual / Without Moratorium / With Moratorium and direct vs indirect effects of moratorium).
- Low rollover rate (50 percent):
  - "Moratoria improve NFCs’ cash balance substantially compared to the levels without the measure."
  - "With a lower rollover rate, the direct effect of moratoria on bank liquidity increase substantially. However, the policy effects become muted once the indirect effects from deposit withdrawal are accounted for."
  - Numeric indicators shown in the NFC cash-to-assets ratio chart (In percent of end-2019 total assets, 12-month, 70 percent moratorium take up and 50 percent refinancing rate): 9.7, 5.3, 6.3, 9.6, 9.8 (labels in chart correspond to End-2019 / Without Liquidity Support / With Liquidity Support / Without Moratorium / With Moratorium).
  - Bank CBC chart (12 month moratorium and test horizon; rollover rate = 50%, moratorium take up = 70%; in percent of initial CBC) displays values: 100, 147, 110, 106, 111, 111, 110 (chart distinguishes Actual / Without Moratorium / With Moratorium and direct vs indirect effects of moratorium).

- Note on rollover-rate assumptions:
  - "The rollover rates of 90 percent are comparable to the distressed level observed during the past crises. During normal time, the rollover rates usually exceed 100 percent."
  - "Fifty percent is the assumption from Basel III LCR."

### Analytical implications
- Direct vs indirect policy effects:
  - Direct effect of moratoria: immediate reduction in banks’ liquidity buffers due to delayed loan repayments.
  - Indirect effect of moratoria: deposit withdrawals by NFCs (and related liquidity shifts) can materially offset or mutate the net policy impact on bank liquidity and CBC.
- Rollover behavior matters:
  - High rollover rates (90 percent) reduce the necessity of moratoria to preserve NFC cash positions and limit deterioration in NFC liquidity even without moratoria.
  - Low rollover rates (50 percent) amplify the direct liquidity pressure on banks from moratoria, although deposit withdrawal dynamics can mute net policy effects.
- Stress testing context:
  - Scenarios use a 12-month moratorium and a stress-test period; moratorium uptake assumed at 70 percent; two refinancing/rollover rates considered (90 percent and 50 percent).

### Relevant numeric observations from charts and notes
- NFC cash-to-assets ratio (In percent of end-2019 total assets) — 12-month, 70 percent moratorium take up:
  - Rollover = 90%: 9.7, 8.8, 9.0, 10.6, 10.8
  - Rollover = 50%: 9.7, 5.3, 6.3, 9.6, 9.8
- Bank Counter-Balancing Capacity (CBC) (12 month moratorium and test horizon; rollover rate = 90%, moratorium take up = 70%; in percent of initial CBC): 100, 114, 106, 106, 102, 110, 109
- Bank CBC (12 month moratorium and test horizon; rollover rate = 50%, moratorium take up = 70%; in percent of initial CBC): 100, 147, 110, 106, 111, 111, 110

*Source: IMF staff estimates and charts from the Philippines FSAP chapter.*

### 3. Tail shocks Scenario analysis

### 3. Tail shocks Scenario analysis

### Scenario design and macro assumptions
- Three macro scenarios: baseline, adverse, and severe adverse, with varying degrees of COVID-19 impact.  
- Common features across scenarios:
  - Shocks affect mostly real economic activities.
  - Financial conditions remain relatively benign: pressures on exchange rates are limited, and the central bank can cut policy rates supported by fairly strong economic fundamentals and ample global liquidity.
- Baseline scenario:
  - Follows October 2020 WEO; accounts for tight containment in the first half of 2020 and slow recovery in the second half, with a sharp V-shaped recovery in 2021.
  - Shows a sharper GDP contraction in 2020 than the AFC but stronger medium-term growth in line with potential growth of about 6½ percent.
  - Compared to January 2020 WEO, the two-year cumulative growth in 2021 is 14.8 percentage points lower, corresponding to a three standard deviation shock using data from 1990-2019.
  - Unemployment: 11.3 percent at end-2020, returns to pre-COVID levels by 2021.
- Upside scenario:
  - Similar to baseline but assumes a faster recovery in the second half of 2020.
  - Real GDP contracts by -6.7 percent in 2020 (baseline: -8.4 percent in 2020).
  - Unemployment returns to pre-COVID levels by end-2020.
- Adverse scenario:
  - Assumes prolonged containment measures throughout 2020 and scarring in 2021 (prolonged demand shock, rise in corporate bankruptcies and credit spreads).
  - BSP cuts policy rates, reducing short term interest rates 290 basis points in 2020.
  - Stock prices decline by over 14 percent in 2020-21; corporate credit spreads rise.
  - Net interest margin declines by 15 percent at worst in the three years.
  - Unemployment: 14.8 percent by 2020 and 8.6 percent by 2021, returning to pre-COVID levels by 2022.
- Severe adverse scenario:
  - Prolonged and more stringent containment in 2020; much severer and longer scarring in 2021 equivalent to a 3.8 standard deviation shock to the two-year cumulative growth.
  - Scarring effects are temporary; medium-term growth stabilizes at same potential as baseline by 2024.
  - BSP cuts policy rates subject to zero lower bound, reducing short term interest rates 290 basis points in 2020.
  - Stock prices decline by over 14 percent in 2020-21; corporate credit spreads rise.
  - Net interest margin declines by 20 percent at worst in the three years.
  - Unemployment: 18.4 percent by 2020 and 11.9 percent by 2021, returning to pre-COVID levels by 2022.
- Adverse macro scenarios are constructed using the DSGE model developed for the climate scenario.

### Risks and buffers; behavioral adjustments
- Risks/factors assessed:
  - Credit risk (provision costs), market risk including FX risk, stress on pre-provision profits including interest margin.
- Behavioral adjustments and balance sheet assumptions:
  - Balance sheet growth assumption: Quasi-Static—balance sheet size/GDP remains constant.
  - Balance sheet composition remains constant over the stress test horizon.
  - Banks can only accumulate capital through retained earnings.
  - Dividend policy: banks pay dividends only if net income after taxes is positive; dividend payout ratio consistent with individual banks’ 2019 ratios for UKBs and historical experience during 2014-2019 for TBs and RCBs.
    - Out of 542 banks, 45 banks paid dividends: 11 UKBs, 2 TBs, and 32 RCBs.
    - Average payout ratios: 13 percent for UKBs, 0.8 percent for TBs, and 0.9 percent for RCBs.
  - Tax rate: 30% (corporate tax rate).

### Regulatory and market-based parameters; calibration
- PDs:
  - Proxies based on actual and estimated new NPL flows over performing loans.
  - PDs for banks with limited credit information taken as weighted average PD of the rest.
- LGDs:
  - 68 percent for UKBs, 35 percent for TBs, and 66 percent for RCBs (based on average historical provision coverage ratio).
- Cure rates (with respect to NPL(t-1)):
  - 10 percent for UKBs, 22 percent for TBs, and 24 percent for RCBs per year (equivalent to a quarter of historical averages).
  - Additional annual cure rate of 18 percent on New NPLs (t-1) assumed for UKBs in 2021.
- Regulatory/accounting standards:
  - Basel II standardized approach.
  - Hurdle rates: 6 percent for Common Equity Tier 1 (applies only to UKBs), 7.5 percent for Tier 1, and 10 percent for total capital (T1+T2).
  - RWAs evolve with credit growth, net of increases in provisions; RWAs adjusted by new NPLs not provisioned to reach weight of 150% required by regulation.

### Reporting format for solvency results
- Outputs:
  - Capital shortfalls per bank type.
  - Number of banks and percentage of assets failing to meet hurdle rates per bank type.
  - Evolution of capital ratios under scenario horizon per bank type and for various bank classifications.
  - Decomposition of drivers of changes in capital ratios per bank type.
  - Distribution of capital ratios per bank type over the scenario horizon.

### Banking sector: second round (bank-macro transmission)
- Institutional perimeter:
  - 46 UKBs (21 universal banks, 25 commercial banks).
  - Market share: 90.8% of total banking sector (gross) loan.
  - Data baseline: solvency stress test results for Baseline (October WEO), Adverse and Severe Adverse scenarios; starting position: End of 2019 data.
- Methodology and channels:
  - Simplified application of Catalan and Hoffmaister (2020).
  - Elasticities of individual bank loan growth to macroeconomic variables and bank-specific characteristics.
  - Elasticities of macroeconomic variables to aggregate bank loan.
- Satellite models:
  - Credit Growth Model:
    - Panel model for UKBs; dependent variable: individual bank credit growth.
    - Regressors: lags of real credit growth, contemporaneous and lags of macro variables (real GDP and change in policy rate), bank-specific factors (change in NPL ratio and loan loss reserve ratio).
    - Estimation period: 2008Q1-2019Q3.
    - CAR and difference between actual CAR and regulatory minimum were not significant and excluded.
  - SVAR macro-financial model:
    - Five equations: real credit, real GDP, inflation, real policy rate, nominal exchange rate.
    - Cholesky decomposition; real credit enters first.
    - Estimation period: 200Q4-2019Q3.
- Counterfactual policy experiment:
  - Effect of reducing LLP stock by 30 percent (only) in 2021—interpreted as using bank capital and income to write off NPLs by closing gap between NPL and LLP (1-LGD).
- Adjustments and assumptions:
  - UKBs' aggregate loan growth approximates overall banking sector loan growth.
  - Baseline real credit growth assumed equal to baseline real GDP growth.
  - Real credit growth in adverse scenarios calculated from baseline real credit growth and deviations of macro and bank-specific variables between non-baseline and baseline scenarios.
- Horizon: 3 years (2020-2022).
- Reporting outputs:
  - Second Round output: GDP growth path and GDP level path (relative to 2019 GDP).
  - Policy simulation output: benefit and cost.
    - Benefit: (1) maximum difference in level of GDP (based on cumulative GDP growth), and (2) sum of differences in level of GDP (based on cumulative GDP growth).
    - Cost: amount of funds injected into banking sector to implement policy.

### Banking sector: liquidity risk
- Institutional perimeter and coverage:
  - 40 UKBs for modified LCR tests (90 percent of banking system).
  - 46 UKBs for cashflow tests and NSFR (92 percent of banking system).
  - Data baseline: supervisory data on a solo basis; September 2019 (to be updated using March 2020 data).
- Methodologies:
  - LCR (one month), Cashflow test (one, three, and six months), NSFR (one year).
- Risks:
  - Funding liquidity, market liquidity, moratoria effects.
- Buffers:
  - LCR: stressed cash inflows and HQLA.
  - Cashflow: stressed cash inflows and counterbalancing capacity.
- Tail shocks: size of the shock
  - LCR run-off rates:
    - Household deposits: highest historical cash withdrawals at bank levels—20 percent for less stable deposits and 10 percent for stable deposits.
    - Institutional deposits: 60 percent for corporate deposits, 35 percent for operational deposits, and 20 percent for less stable, and 10 percent for stable retail deposits.
  - Haircuts: 50 percent haircut to Level 2a assets (corporate bonds).
  - Cashflow test run-off rates:
    - 1 month—50 percent on institutional deposits and 20 percent on household funding; roll-off rate of 50 percent on cash inflows.
    - Rates decline over 1-3 months and 3-6 months to reach 30, 10, and 10 percent.
  - Cashflow haircuts: 20 percent on unencumbered eligible collateral and 50 percent on equities.
  - NSFR: same as Basel III.
- Regulatory standards:
  - LCR: 100 percent (liquidity shortfall by bank).
  - Cashflow: net funding gap (shortfall) by bank.
  - NSFR: 100 percent.

### Non-financial corporate sector (NFC)
- Institutional perimeter:
  - 151 non-financial firms (147 listed and 4 non-listed).
  - Market share: 44 percent of total NFC debt; 70 percent of total market capitalization; 46 percent of total bank loans.
  - Data baseline: Capital IQ, S&P Global Market Intelligence; consolidated balance sheets as of end-2019.
- Methodology and channels:
  - Debt service capacity: ICR (one-year).
  - Cash flow: cash ratio = cash and cash equivalent / current liabilities (one-year).
  - Test horizon: 2020.
- Tail shock specifications:
  - ICR shocks:
    - Macroeconomic shocks:
      - Interest payment shock: 0 percent.
      - Exchange rate shock: 4 percent appreciation against the USD.
    - Operating income shock (percent of operating income in 2019, varying across industries):
      - Baseline: between -35 percent and -137 percent.
      - Upside: between -26 percent and -103 percent.
      - Adverse: between -39 percent and -151 percent.
      - Severe Adverse: between -47 percent and -185 percent.
      - In all scenarios, least affected industry: utilities; most affected: consumer discretionary.
  - Cash flow analysis:
    - Capex_2020 = minimum of 0.25*Capex_2019 and 0.5*depreciation_2019.
    - Debt rollover ratio = 0.9 of maturing debt.
    - Dividend payments = 0.
- Reporting outputs:
  - Distribution of ICR (median and interquartile range).
  - Debt-at-risk share by industry.
  - Firm-at-risk share by industry.
  - Cash ratio by industry.

### Bank–NFC liquidity linkage
- Institutional perimeter:
  - 151 NFCs and 40 UKBs.
  - Market share: 44 percent of total NFC debt; 70 percent of market capitalization; 46 percent of bank loans; 90 percent of banking system (UKBs).
  - Data baseline: Capital IQ, S&P Global Market Intelligence, BSP (UKB data); consolidated NFC balance sheets and solo-based UKB balance sheets as of end-2019.
- Methodology:
  - Based on 2020 IMF COVID-19 note in “system-wide FX liquidity stress test.”
  - Cash-flow based liquidity stress tests for banks and NFCs; aggregate NFC results (deposit withdrawal rate and new financing need) applied to bank-by-bank liquidity stress tests (uniform assumption across banks).
  - NFC cash flow formula (cash balance x months in 2020):
    - = Cash balance 2019 + earnings shock × net cash flows from operations × (x/12) - stressed capital expenditure × (x/12) - debt repayment with moratorium (= original debt repayment × (1- moratorium utilization) × (x/12)) + rollover of repaid debt (= debt repayment with moratorium × rollover rate) + interest income × (x/12) – interest expense × (1- moratorium utilization) × (x/12) - dividend payment × (x/12) + new financing (to bring cash balance(x, 2020) to zero for each firm).
    - In case with 5-month moratorium, debt payments (principal and interest) are set at about 40 (=5/12) percent of the original amounts in the baseline.
    - Capex_2020 = minimum of 0.25 × Capex_2019 and 0.5 × depreciation_2019.
    - Dividend payments = 0.
  - Bank cash flow / counterbalancing capacity (CBC) formula at month x in 2020:
    - = CBC at end 2019 + net cash flows from operation within x (excl. loans and interests) + debt service receipt (= bank loan principal repayment in x months × (1-moratorium utilization)) – rollover rate × debt service receipt + interest income in x months × (1- moratorium utilization) – interest expense in x months - matured bank debt repayment within x + refinancing rate for banks (90 percent) × banks’ repaid borrowing - deposit runoff rate × stock of deposits (NFC deposit runoff rate = ∆cash by x month in 2020/cash at end 2019) - new financing to NFCs (to bring NFC cash position to 0 or above for each firm) - dividend payment within x + new financing inflows into banks + valuation change of CBC (i.e., haircut).
    - Note: Moratoria and loan rollovers affect all loans (including household credit) but the analysis only considers deposit withdrawal of NFCs.
- Test horizon:
  - 5 and 12 months (moratorium period = stress testing horizon).
- Tail shock parameters:
  - Moratorium utilization rate = {0 (no moratorium), 50, 70, 90} percent.
  - NFC loans rollover rate = {50, 90} percent.
  - New financing to NFCs = {yes, no}.
  - Refinancing rate of repaid loans by banks = 90 percent.
  - Liquid asset haircuts: 0% for cash, 2% for high-quality sovereign securities, 8% for low-quality sovereign securities, 11% for corporate bond, 10% for covered bond.
- Reporting outputs:
  - NFC: change in cash balance in month x, 2020 / cash balance at end 2019.
  - Bank: change in CBC by month x, 2020 / CBC at end 2019.

### Climate change stress test of bank solvency
- Institutional perimeter:
  - 46 UKBs.
  - Market share: 92 percent of banking system by assets.
  - Data baseline: supervisory data (balance sheet and income statements) on a solo basis; starting position: December 2019.
- Methodology and channels:
  - Solvency stress test same as macro scenario stress tests (risk factors, satellite models, micro/behavioral assumptions such as LGD) following IMF solvency stress test workbox.
  - Climate scenario constructed by combining climate science, catastrophe risk, and macro-financial models.
- Risk factors:
  - Physical risks: extreme weather events (typhoons) affecting bank solvency through macro-financial impact.
  - Credit risk, market risk, net interest income, and pre-impairment income shock follow same approach as bank solvency stress test.
- Test horizon:
  - Three years upon an intense disaster.
  - Current scenario: typhoon shock materializes in 2020, using end-2019 balance sheet data and hazard rate of typhoons as of 2020.
  - Future scenario: typhoon shock materializes sometime in the mid-21st century, using end-2019 balance sheet data and hazard rate of typhoons as of the mid-21st century.
- Climate scenario formulation:
  - Climate scenario: future distribution of typhoon severity and frequencies for the Philippines using climate science models based on a global climate scenario (IPCC RCP 8.5).
    - Global temperature increase by 1.4-2.6°C above 1986-2005 levels under RCP 8.5.
    - For the Philippines: likely increase in intensity (windspeed) of severe typhoons but reduced frequency.
  - Disaster scenario: estimates physical capital losses in percent of existing stock for given likelihoods (25-500 return period).
    - For a given climate scenario, 10,000 possible losses simulated using catastrophe-risk model developed under World Bank disaster risk financing and insurance program.
    - For each return period, losses at the 90th percentile of the 10,000 simulations are used for the future scenario (current scenario roughly corresponds to the 25th percentile).
    - Sea-level rise additional effects not included.
  - Macro-financial scenario:
    - Constructed using staff-developed DSGE model calibrated for the Philippines.
    - Physical damage modeled as capital depreciation shock, causing correlated productivity shocks:
      - 1/3 of impact from short-lived capital depreciation.
      - 2/3 from persistent productivity shocks.
    - Model includes adjustment costs with investment, slowing capital accumulation and recovery.

*Italic: Source — 3. Tail shocks Scenario analysis (1phlea2021001).*

### 4. Tail shocksSize of the shock

### 4. Tail shocksSize of the shock

### Baseline scenarios
- Two baseline economic scenarios before applying typhoon shocks:
  - Normal time: January 2020 WEO forecast (before COVID-19 shock), in line with the potential growth rate of 6½ percent.
  - Pandemic: October 2020 WEO forecast that includes the impact of COVID-19.
- The two baselines are used to consider the realization of two extreme events—pandemic and severe typhoons.

### Measurement of typhoon severity
- Severity is measured by the value of destroyed physical capital in percent of existing capital (for both current and future scenarios).
- Tail events considered span 25-500 return periods (i.e., once in 25-500-years event).
- Insurance industry practice:
  - Insurers price disaster insurance aiming at the losses under a 100-year return period.
  - They examine the adequacy of their reserves for tail events (250-500 years return period).

### Implementation / Methodology (three-step approach)
- Climate scenario:
  - Taken from existing climate science research by the government of the Philippines.
  - It estimated the changes of typhoon frequency and intensity for the Philippines (windspeed) under the high-emission global scenario.
- Disaster scenario:
  - Impact of extreme typhoons measured by the value of lost physical capital over the existing capital (i.e., damage rate) is simulated using the CAT risk model developed by the World Bank.
  - The damage rate is calculated following the current typhoon hazard risk (“current scenario”) and the future risk under the above climate scenario (“future scenario”).
  - Following catastrophe insurance practice, the mission considered several tail events (once in 25–500 years).
- Macro-financial scenario:
  - The disaster impact is translated into macro-financial indicators with the staff developed DSGE model.
  - The damage rate is modeled as a capital depreciation shock, which also causes correlated productivity shocks in line with empirical findings in the literature.
  - The mission used two baseline scenarios: January 2020 WEO (without pandemic) and October 2020 WEO (with pandemic).

### Reporting and outputs
- Output presentation:
  - The level of real GDP and aggregate CAR chart for three years for current and future scenarios showing the range of potential outcomes of the baselines (without disaster shocks) and stress scenarios (with typhoon shock ranging from once in 25-500-year severity).

### Caveats, limitations, and interpretation guidance
- The exercise and results should be interpreted with caution due to significant model and scenario uncertainties in climate change stress tests.
- FSAP coverage limitations:
  - Covered only a small component of risks due to climate science and CAT risk models’ limitations.
  - Covered only the effects of building/infrastructure destructions by typhoon wind without incorporating the effects of sea-level rise and floods.
- Other omitted risks and channels that could increase impact:
  - Drought, flood, and transition risks could increase the impact in less extreme events.
  - Additional channels could amplify disaster impact, such as the impact of fiscal expansion for reconstruction on sovereign risks and their spillovers to banks.
- Given the early stage of the literature and various uncertainties, it is premature to discuss prudential policy measures based on one stress test result.

*Source: 4. Tail shocksSize of the shock (chapter/section content provided).*

### 3.   The C

### 3.   The C

### COVID-19 impact, macroeconomic stance, and fiscal space
- The COVID-19 pandemic "continues to pose shocks to the global economy and the Philippines is not insulated from the adverse effects."
- The Philippine Banking System (PBS) "continues to post comfortable margin over the prescribed minimum capital ratio of 10 percent (10%) amid the pandemic."
- Banks "have also increased their provisions for credit losses since the onset of the crisis."
- Authorities’ stance on stress tests and capital: "Based on the authorities’ internal stress testing exercises, capital levels will only be affected in extremely severe scenarios." Authorities "are highly confident that risks to the banking sector will be well-contained under the baseline scenario and stand ready to provide more targeted support if the worst-case scenario materializes."
- Vaccine procurement and indemnity: a bill "will hasten the procurement of vaccines and create an indemnity fund to cover compensation for individuals who may experience adverse side effects."
- Policy support: "Adequate monetary accommodation was provided to complement crucial fiscal policy measures in supporting private demand and market confidence."
- Fiscal measures and space:
  - 2021 national budget prioritizes health-related programs and infrastructure projects.
  - Bayanihan 2 extended under Republic Act (RA) No. 11519 until 30 June 2021.
  - 2020 national budget extended under RA No. 11520 until 31 December 2021.
  - BSP extended provisional advances to the government in support of its measures to deal with the health crisis.
- Public debt metrics and composition: "The country’s outstanding debt-to-GDP ratio remains manageable and relatively low at 54.5 percent as of the last quarter of 2020." "The bulk of the debt is denominated in local currency at about 70 percent."
- Authorities’ view: "Overall, the country’s fiscal position remains sound and favorable, providing enough fiscal policy leeway for the government to respond to crisis."

### Dividend distribution, capital buffers, and supervisory forbearance
- BSP authority on dividends: "the BSP may limit or prohibit dividend declaration as provided in the law and the regulations governing dividends, as necessary."
- Dividend prohibitions handled case-by-case considering: "the bank’s varied internal capital targets, stress testing results, risk profile, among other factors."
- Restrictions apply to banks applying for relief measures and "applies automatically to banks that utilize their capital conservation buffers and may be imposed on banks that have reached their internal capital targets."

### Stress testing, regulatory reliefs, and interpretation caveats
- Authorities agree stress test results "should be interpreted with caution due to possible bias in the results which are sensitive to the assumptions."
- Conservatism in FSAP assumptions "increase the negative impact while credit risk during a deep economic crisis may evolve differently from what historical patterns imply."
- IMF solvency stress test limitations noted: it "did not consider the effects of regulatory response and statutory loan moratoria."
- BSP stance on relief measures: "strongly considers the time-bound relief measures implemented as crucial in supporting banks to weather the crisis and in promoting the overall stability of the financial system."
- BSP is "assessing the appropriate timing to reduce or scale back the COVID-19 relief measures to ensure smooth transition post-pandemic."
- Banking industry statistics published on the BSP website "reflect the actual level of soured loans and do not consider said relief measures."

### Legislative and structural measures to address NPAs and support recovery
- Republic Act No. 11523 (FIST Act): will "facilitate the mobilization of savings and investments in the financial system to support the country’s economic recovery and sustained growth" and "ease banking system stress through the removal of soured loans and other non-performing assets (NPAs) by banks."
  - FIST Act was signed into law by President Rodrigo Duterte on 16 February 2021.
- GUIDE bill: "proposed Government Financial Institutions Unified Initiatives to Distressed Enterprises for Economic Recovery (GUIDE) bill aims to reinforce the capacity of government financial institutions to give financial assistance necessary for the continued operations of micro, small, and medium enterprises (MSMEs) and other strategically important industries."
  - GUIDE bill was approved on the third and final reading at the House of Representatives on 9 February 2021.
- CREATE bill: "Corporate Recovery and Tax Incentives for Enterprises (CREATE) bill aims to reduce corporate income tax and rationalize fiscal incentives."
  - CREATE bill was ratified at both Houses of Congress on 4 February 2021 and for signature by the President.

### Climate change, disaster risk management, and data needs for stress testing
- Authorities agree on "improving data collection to enhance analysis of climate risks, particularly physical risks and its impact on individual financial institutions and the overall financial system."
- Capacity building and awareness campaigns underway covering "climate change and sustainable finance" and "environmental and social risk management."
- Institutional frameworks relevant for climate stress testing:
  - Climate Change Act of 2009 created the Climate Change Commission.
  - National Climate Change Action Plan 2011-2028 prioritizes: "food security, water sufficiency, ecological and environmental stability, human security, climate-smart industries and services, sustainable energy and knowledge and capacity development."
  - Philippine Disaster Risk Reduction and Management Act formed DRRM councils and "established the local DRRM fund, setting aside 5% of estimated revenues for prevention, mitigation, and responses."
  - National government issued catastrophe bonds providing protection against "earthquake and tropical cyclone risks through the issuance of insurance-linked securities."
- Authorities committed to "fiscal discipline and consolidation over the medium-term, consistent with its monetary and financial sector stability objectives."

### Macroprudential policy framework and institutional oversight
- Milestone developments:
  - Establishment of the Financial Stability Coordination Council (FSCC) in 2011.
  - Conferment of the BSP’s financial stability mandate in 2019.
  - Creation of an en-banc Board-level Financial Stability Policy Committee at the BSP in 2020.
  - Release of the Macroprudential Policy Strategy Framework in 2020.
- An Executive Order to further strengthen and institutionalize the FSCC has been submitted for signature by the President.
- BSP initiatives: sharpening macroprudential toolkit, enhancing data-gathering authority for policy and statistical purposes as provided in the amended BSP Charter.
- Internal governance: board-level committees and the Advisory Committee to the Monetary Board consider "financial stability and financial supervision implications" in decision-making; preparatory board meetings include Monetary Board members and heads of relevant units.

### Banking supervision, conglomerate supervision, and legislative priorities
- Authorities welcome FSAP recommendations on Basel Core Principles (BCPs) and conglomerate supervision.
- Support for lifting bank deposit secrecy laws: "financial sector regulators affirm the views of the FSAP mission team on the critical benefits of lifting the bank deposit secrecy laws."
- Conglomerate supervision approach:
  - FSF contemplated a lead coordinating regulator but adopted "common standards across the financial sector" due to mixed financial and non-financial interests of conglomerates.
  - FSF drafted a Memorandum of Agreement on establishing a supervisory college for group-wide risk assessment and cross-cutting issues.
- BSP powers on ownership transfers: amended BSP Charter "has authorized the BSP to disapprove transfer of shares to parties who are deemed unfit and improper to hold or own shares of banks."
- BSP regulatory updates: "recently amended its regulations to require ultimate beneficial owners to provide documents for the BSP to better assess the ownership and control structure for the establishment of new banks or in cases of transfer of bank shares."
- SEC action: "Beneficial Ownership Transparency Guidelines" issued in January 2021, including "prohibition of bearer shares and requires mandatory disclosure of the identity of beneficial owners."
- Legislative agenda: BSP and financial sector authorities "working closely with both Houses of Congress for the approval to amend the Bank Deposit Secrecy Laws, expand the BSP’s authority on conglomerate supervision and pass other critical legislative reforms."

### AML/CFT, information sharing, and bank secrecy
- One-nation AML/CFT approach: Executive Order No. 68 adopted the National AML/CFT Strategy (NACS) in November 2018.
- NACS requires relevant agencies to implement action plans from the National Risk Assessment (NRA) on ML/TF; one key action plan is the enhancement of financial intelligence sharing.
- AMLC powers: "the Anti-Money Laundering Council (AMLC) can share bank account information, among others, to support supervisory actions, including for prudential supervision, when requested by the relevant agencies."
- Legal clarity on bank secrecy: "Section 24 of the Anti-Money Laundering Act, as amended, has expressly repealed the existing bank deposit secrecy laws (i.e., Republic Act Nos. 1405 and 6426) by providing the AMLC with unimpeded access to bank account information."
- APG assessment: Asia Pacific Group on Money Laundering rated the Philippines "Largely Compliant" and "Compliant" on Recommendations 9 and 29, recognizing that bank secrecy law "does not inhibit the implementation of the FATF Recommendations."
- BSP examination powers: "there are defined circumstances that allow the BSP to examine bank accounts in compliance with the AML Act and in cases of unsafe and unsound banking."
- RA No. 11521 (An Act Further Strengthening the Anti-Money Laundering Law) addressed recommendations to:
  - "(i) designate tax crimes as predicate money laundering offenses; and (ii) establish a comprehensive legal framework for targeted financial sanctions against proliferation financing."
  - Implementing rules and regulations on targeted financial sanctions were published on 31 January 2021.

### Financial safety net, resolution framework, and crisis management
- Progress since 2010 FSAP: amendments to PDIC and BSP Charters, strengthened collaboration via FSCC, introduction of D-SIB recovery plans, enhanced legal protections for BSP and PDIC personnel, streamlined BSP early-intervention and prompt corrective action framework, establishment of banks for resolution (BRes) framework.
- BSP revisions: revised guidelines in October 2020 to tighten implementation of Section 30(c) of Republic Act No. 7653, as amended, allowing the BSP to resolve banks more promptly.
- Resolution planning: authorities acknowledge need to "conduct resolvability assessments and to formulate resolution plans for individual banks."
- Division of resolution powers: legal framework "vests the resolution authority to both the BSP and the PDIC"; the resolution power "ultimately resides with the BSP with respect to operating financial institutions under its jurisdiction" while PDIC acts when BSP cannot due to conflict of interest or beyond mandate; after a bank is closed, "PDIC shall be designated as receiver" and shall proceed with takeover and liquidation.
- BSP-PDIC coordination: joint examinations, regular meetings to discuss banks under PCA or BRes, and information sharing; BSP processes in resolving banks are covered by Quality Management System subject to internal and third-party assessments.
- Bridge bank and bail-in tools:
  - A bridge bank authority was proposed previously but legislation was unsuccessful.
  - A formal bail-in framework is yet to be established; BSP requires "loss absorption features in Additional Tier 1 and Tier 2 capital instruments issued by banks which can be tapped as a bail-in tool for the meantime."
- Timely corrective action: BSP is revising and streamlining early intervention and remedial frameworks (Prompt Corrective Action Framework, Letter of Commitment) and "has tightened the basis of prohibiting a bank from doing business under Section 30 of the amended BSP Charter."
- Portfolio of problem banks: "continuous effort in enhancing supervisory policies and implementation has resulted in a significant decline in the portfolio of problem banks since the 2010 FSAP."
- Entities under PCA: "entities currently under the PCA framework do not pose systemic risk to the Philippine financial system."
- Emergency Liquidity Assistance (ELA):
  - Legal framework deemed sufficient: "explicitly provides the specific conditions for availing ELA and the broad range of acceptable ELA collaterals."
  - Section 84 specifies acceptable prime collaterals, but BSP has flexibility to accept other collaterals authorized by the Monetary Board.
  - BSP has "not provided uncollateralized loans under Section 83 of the amended BSP Charter, as it is not operational up to this time." All availments under ELA are secured by first class collaterals as required under Section 84.
  - BSP will consider mission team insights in ongoing study covering Section 83.

*Source: 1phlea2021001 - 3.   The C (IMF chapter/section)*

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_Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1phlea2021001.pdf_