Structure and performance of the commercial banking industry in a deregulated environment : the Philippine case

Abstract

This paper provides an empirical and descriptive examination of the impact of financial deregulation on the growth, market structure and financial intermediation profile of the Philippine commercial banking industry. Specifically, the study aims to characterise the industry with respect to its stability, returns, degree of concentration and financial intermediation levels in the post-deregulation period. In addition, a framework -for the relationship between returns and the degree of concentration in the Philippine commercial banking market is developed. Several hypotheses concerning changes in commercial bank profitability, liquidity, leverage and structure were examined on a market-wide basis. The profitability measure employed was the return on equity (ROE). The loan to deposit ratio and debt to equity ratio were used as indicators of liquidity and leverage, respectively, and the indices used to measure commercial banking market structure were the Four-firm concentration ratio and the Herfindahl index. These indicators were tested under three categorized periods : the pre-deregulation period (1970 to 1979); post-deregulation : crisis period (1980 to 1986), and the post-deregulation: recovery period 1987-1991 ). Using parametric tests, the findings and implications of the empirical analysis are summarised as follows : 1. Deregulation resulted in significant differences in the overall mean profitability, liquidity and leverage indicators of the commercial banks between the categorised periods. 2. The commercial banking industry is highly concentrated. In addition, overall bank profitability and industry structure are positively correlated. 3. The commercial banking industry structure showed higher levels of concentration in the aftermath of financial deregulation. 4. Financial liberalisation has significantly improved overall commercial bank profitability . 5. The empirical model did not support finance theory which suggests that banks realise higher levels of profits in exchange for higher levels of liquidity and leverage risks in the post-deregulation period. In general, the interest rate deregulation has not delivered the desired levels of financial intermediation in the Philippine commercial banking industry. While the total nominal loans and deposit levels of the industry steadily increased, the objective of mobilising savings for longer-term credit placements was not realised. At the initial stage, the overall pattern of rising medium to long-term loan placements corresponded to a greater share of time deposits in the asset holdings of depositors. This reflected a match in the source and use of funds among banks (that is, borrow long and lend long). This favourable trend was averted by the financial and economic crisis in the late 1983 to early 1986. Overall, interest rate decontrol mobilised savings but the desired longer term deposit placements steadily declined from 1984 onwards as savings and demand deposits accounted for a rising share in the total deposit levels of the industry, implying liquidity preference among the depositors. At the same time, long-term credit placements of the commercial banks also shifted to lower-yielding short-term loans from 1984 onwards. This preference could be explained by the commercial banks' preference for more profitable and less risky shorter-termed credit due to the economic and financial uncertainty at the time the financial deregulation was set in place. The results of a mail-survey responses of bank executives validate the empirical and descriptive findings of the study. From their viewpoint, the level of competition has been very intense in the aftermath of financial deregulation. They perceive higher levels of industry concentration as a result of the mergers and consolidation following the deregulation of the banking industry. Despite keener competition, overall commercial bank profitability has been improving. Show more