Recent moves to enhance oversight of property lending and project finance in the Philippines could make it easier to spot pockets of excess in these high-growth sectors, says Fitch Ratings.
Nevertheless, prudential standards have not been tightened under the new measures and the regulator still faces the challenge of discerning unhealthy risk-taking from productive lending that supports economic growth. Sustained rapid loan growth could create risks to the banking sector and the broader economy if left unchecked.
The new ruling by the Bangko Sentral ng Pilipinas (BSP) targets two sectors where vulnerabilities could form amid strong loan growth. Real-estate loans, which account for just over 20% of total bank lending, have risen by 21% on average over the last four years.
Meanwhile, project finance is likely to take off as the Duterte administration pushes ahead with its infrastructure investment drive.
Hampered by limitations
Greater monitoring of these lending activities has been hampered by limitations in system-wide data, and the new initiatives could help to address this, especially if more information is made available publicly.
Closer central bank scrutiny may make banks more cautious in lending to these sectors, but it does not amount to regulatory tightening to curb growth. Indeed, motor-vehicle loans have continued to grow strongly despite being subjected to similar measures since 2015. Motor-vehicle finance expanded by 24% yoy in June 2017.
High system-wide loan growth could raise the risk of a credit bubble if it continues. Bank loans have grown at roughly twice the pace of nominal GDP in the last four years - around 18% yoy on average. Bank credit to the private sector remains relatively low, at 45% of GDP at end-2016, but this ratio has risen from 32% at end-2011 and is likely to climb further in 2017.
NPL ratio has remained benign
Most banks appear to have maintained acceptable lending standards over this period and the NPL ratio has remained benign at around 2%, but in such a strong growth environment there is a risk that "blind spots" may develop, where downside risks may not be adequately priced into lending decisions.
Risks could crystallize into losses if, for example, the economy slows or interest rates rise significantly.
On the positive side, credit growth does not so far appear to be fuelling asset bubbles. Property price inflation, for example, has been moderate, averaging around 4% a year from 1Q14 to 1Q17, according to the BSP's house price index.
Rapid credit growth creates other issues for banks. Rising volumes place pressure on banks' risk management capability, systems and operations.
Banks will also face the challenge of maintaining their capital, funding and liquidity ratios as their balance sheets expand, given the minimum regulatory hurdles placed on such metrics under the Basel III regime.
The 10 largest banks reported a broadly healthy CET1 ratio of 13.4% on average at end-June 2017, which should help them cope with a potential drop in asset quality. However, double-digit loan growth could gradually diminish these buffers.
The aggregate loan/deposit ratio is also healthy, at 72% at end-July 2017, but there are already signs that excess funding and liquidity buffers may be narrowing due to rapid credit growth.
Banking system discretionary deposits with the central bank have fallen, and banks have increasingly had to turn to more expensive term deposits, long-term negotiable certificates of deposit (LTNCDs) and international debt markets to fund growth this year, as growth in lower-cost current and savings accounts (CASA) has not kept pace. This will put upward pressure on banks' funding costs if it continues.