Report No. PID6477 Project Name Philippines-Banking System Reform Loan (@) Region East Asia and Pacific Region Sector Finance Project ID PHPE56524 Borrower Republic of Philippines Implementing Agency Bangko Sentral Ng Pilipinas A. Mabini Street Corner Vito Cruz, Malate Manila, Philippines Tel: (63-2) 524-7011 Department of Finance Fax: (63-2) 521-9495 5-Storey Building BSP Complex A. Mabini Street Manila, Philippines Tel: (63-2) 525-0380 Fax: (63-2) 522-3987 Date PID prepared May 29, 1998 Project Appraisal Date August 1998 Projected Board Date December 1998 Background The proposed loan responds to a request from the Philippine authorities for assistance from the World Bank in early 1998. The specific request was for technical assistance and balance of payments support to strengthen the financial sector and to provide a buffer against the uncertainties associated with the current external financing environment. Since this request, the Bank has provided technical assistance in a number of areas within the financial sector including banking, corporate sector, contractual savings and housing finance. In addition, the Bank will provide technical assistance through a Policy and Human Resources Development grant recently approved by Japan to strengthen supervision capabilities within the Bangko Sentral ng Pilipinas (BSP) and Philippines Deposit Insurance Corporation (PDIC), and to strengthen the Securities and Exchange Commission's (SEC) capacity to address issues relating to corporate distress. The focus of the proposed loan relates to banking reform since this is the area most immediately impacted by the East Asian financial crisis. The Philippine banking system has withstood the impact of the regional crisis much better than most other market economies in the region. Nevertheless, in view of the magnitude of financial market shocks already experienced and the uncertain evolution of regional developments, initiating a credible package of reforms provides the best means for safeguarding the soundness of the banking system on a sustainable basis. Objectives The purpose of the proposed loan is to strengthen the banking system and enable it to better withstand current difficulties and future shocks through a comprehensive medium-term reform program. The major elements of this program are to: - Improve on an ongoing basis the incentives for supervisors, bank owners, and the market to strengthen the framework for prudent banking. - Enhance the framework and the authorities' preparedness for early intervention and resolution of troubled banks. - Strengthen the financial performance of the Philippine National Bank (PNB). - Reduce the incentives for regulatory and tax arbitrage across financial institutions and between intermediation in different currencies. Description Reforms to strengthen the banking system to be supported by the proposed loan include policies to: improve the prudential framework and supervisory effectiveness; enhance transparency and market discipline; refine the intervention and resolution framework for troubled banks; strengthen PNB; and reduce regulatory arbitrage and intermediation costs. Thus the banking reform agenda supports a program of raising capital requirements, adjusting accounting standards including provisioning requirements towards international best practice, requiring greater public disclosure by banks, reducing intermediation costs in order to reduce borrower interest costs, tightening entry standards, facilitating exit of insolvent institutions, and improving the ability and incentive for bank supervisors to conduct their tasks. Legislative changes are essential to the success of the program and include proposals to enhance the supervisory and enforcement powers of the BSP and PDIC and augment the legal authority of the BSP and PDIC to resolve troubled banks. Financing A fast disbursing, tranched loan of $300 million is proposed. The closing date of the loan is expected to be June 30, 2000. Benefits and Risks Maintaining a sustained effort to strengthen the banking system will remain essential over the medium term as the banks face continued stress from financial market turbulence. Associating the Bank with policy advice and lending for banking reform can strengthen the quality of the reform program and improve confidence in the banking system. Even assuming a rapid return to normalcy within the region, the banking system would benefit from the enhanced prudential framework envisaged under the reform program, in order to exercise the appropriate degree of restraint in intermediating potentially large private capital flows. The Philippine economy remains vulnerable to a deterioration in the regional environment, which would adversely impact financial markets. Even -2 - without such deterioration, the banking system faces a period of increased stress from a slowdown in growth, high interest rates, peso depreciation and weaker real estate prices that have strained corporate balance sheets. A number of banks could fall short of capital adequacy requirements with the increased burden of nonperforming loans. The Bank can mitigate risks within the banking system by improving the quality of the banking reform program and enhancing investor confidence, thereby improving its prospects of succeeding. Environmental Aspects In accordance with Bank guidelines, the proposed operation has been placed in Category "U" and will not require an environmental assessment. Poverty Category Not applicable Contact Point: The InfoShop The World Bank 1818 H Street, N.W. Washington, D.C. 20433 Telephone No. (202)458 5454 Fax No. (202) 522 1500 Note: This is information on an evolving project. Certain activities and/or components may not be included in the final project. Processed by the InfoShop week ending November 13, 1998. - 3 -