The moral hazard of Landbank, DBP

Moral hazard—a situation where a party lacks the incentive to guard against a financial risk due to being protected from any potential consequences—is a bad thing in the world of finance and investments.

Among economic policymakers and regulators of financial institutions, moral hazard is something that is not only avoided but oftentimes prohibited altogether since it promotes an environment of reckless money management—a situation which, throughout history both locally and overseas, inevitably ends in grief.

Unfortunately, moral hazard is what the Bangko Sentral ng Pilipinas (BSP) risks creating after it floated last week the possibility of granting regulatory relief to the two largest banks—the Land Bank of the Philippines and the Development Bank of the Philippines (DBP)—after they remitted substantial amounts of their financial resources to the Maharlika Investment Fund.

According to BSP Governor Eli Remolona Jr., the central bank may temporarily exempt Landbank and DBP from stringent capitalization requirements imposed on Philippine banks by virtue of the combined P75 billion they plunked into the Marcos administration’s newly created pet project.

These capitalization rules are meant to ensure that financial institutions, especially those that accept deposits from the general public and lend them out to borrowers, are able to withstand the sudden shocks that hit financial markets every so often.

Our central bank chief, who worked for many years at the New York Federal Reserve, should know better. The regulator of the United States’ largest banks is known to be especially vigilant against moral hazard situations and is famous for fighting crises triggered by reckless risk-taking.

Instead of being treated like babies, Landbank and DBP should be dealt with like the financial adults that they claim to be and allowed to stand on their own feet without government providing invisible crutches to prop them up.

This is even more critical for Landbank which, if plans for it to be merged with DBP push through, stands to become the country’s largest financial institution, beating even behemoth private lenders in size.

Do we want what could become the Philippines’ largest bank to stand on a lofty perch only because the regulator exempted it from rules that are holding its competitors down?

More importantly, do we want the savings of millions of Filipinos, along with the hard-earned investments of our expatriate workers, and funds of small entrepreneurs managed by bankers who have grown soft because they are shielded from harsh market realities?

What will stop private banks from demanding from the central bank the same concessions of being exempted from prudential capital requirements when they make risky investments?

Apart from seeking regulatory relief, there’s also the principal issue of the nature of the participation of Landbank and DBP in the Maharlika fund. They did not lend it money. Instead, they invested in it. And anyone with a modicum of finance knowledge knows that investments are riskier than loans. Loans have to be repaid. Investments that go awry don’t have to and are often just written off or charged to painful experience.

To be sure, Remolona noted that both Landbank and DBP remain liquid and well-capitalized even after writing multibillion peso checks in favor of Maharlika. They remain compliant with minimum capitalization ratios even after this, he said.

That’s good because, as it stands, Philippine banks are overcapitalized by international and local standards. That means our financial institutions are sitting on too much unproductive money instead of lending it out to productive undertakings like small businesses and entrepreneurs, which would otherwise be helping grow our economy.

So if Landbank and DBP remain above the regulatory requirement, there’s no need to grant them any relief. But if their resources dip below a mandated threshold because they put their money in Maharlika, that’s a negative development that should be addressed by requiring them to raise their capital to the required level, not exempting them from it.

To be fair, Remolona didn’t say the central bank would grant these regulatory exemptions to Landbank and DBP. He only said they are looking at its possibility. Good. Consider it … and discard the idea promptly. It’s a bad idea over the long run, masquerading as a good idea over the short run.

The safety and stability of the country’s financial system depends on all stakeholders knowing that their regulator stands vigilant and eagle-eyed against malpractices and ostensibly well-meaning policies that lead to bad outcomes and government bailouts later on.