President's Message
Atty. Benedicta Du-Baladad Message from the President:

Benedicta Du-Baladad


To FINEX members and friends,

PRESIDENT’S REPORT
August 2017 Issue

Last July 19, Department of National Defense (DND) Undersecretary Cardozo Luna shared with us the security policies of the Duterte Administration amidst Marawi crisis and the Martial Law in Mindanao. Unfortunately, DND Secretary Delfin Lorenzana Jr. was not able to grace the event due to an emergency meeting that he has to attend.

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A Single Guarantee Corporation?
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BENEL D. LAGUABy BENEL D. LAGUA

MANILA BULLETIN (Business Option)
July 11, 2017

A Single Guarantee Corporation?

Business Option is a rotating column of members of the Financial Executives Institute of the Philippines appearing every Tuesday & Thursday in Manila Bulletin, business section.



Government has recently announced plans to consolidate all guarantee corporations into one unit. Ostensibly, the main reason is efficiency as government noted that most, if not all, of the governments’ guarantee operations “technically were losing money”. Fund raising through bond issuances could be easier with one big solid institution instead of having several small ones.

The revived concern for the guarantee business is most welcome, but is the policy direction addressing the root causes bugging the effectiveness of the Philippine government guarantee initiatives. Perhaps a more extensive review is warranted . We need to learn from the rich lessons of operating guarantee institutions especially in Asia. The news reports discuss the need to add new funds of P500M into the consolidated entity and while the new money is most welcome, the quoted sum looks paltry.

Let’s start by reviewing how our neighbors handle this business. In Japan, they have appropriated and transferred a huge funding of billions of Yen to their 52 credit guarantee corporations (CGC) in each prefecture (local government subdivisions headed by a governor) throughout the country. These CGCs in turn reinsure their exposure with the Japan Finance Corporation, which is wholly owned by national government. Japan has used its guarantee system to respond to various financial crises and to the country’s recession. They have saved tens of thousands of enterprises from bankruptcies, kept intact hundreds of thousands of jobs. And yes, the guarantee corporations are not making money but their key result areas are more defined by the macro-economic externalities.

Korea has two major guarantee companies, the Korea Credit Guarantee Fund and the Korea Technology Credit Guarantee Fund, employing around 4,000 staff and maintaining a network of branches throught the country, and even overseas. Taiwan not only enlarged its credit guarantee coverage and capacity for economic recovery, but has effectively used it to rebuild like in the devastating earthquake of 1999. This was made possible through policy decisions creating new guarantee facilities focused on strategic sectors such as construction, SME development, agricultural automation and industrial development.

In other words when our Asian neighbors built their guarantee systems they realized it was an investment and not a cost. And they poured funds into the system so it works as desired to catalyze industrial growth and job creation , not as income generating ventures that earn money for their government coffers. Historically, all those agencies receive regular funding support from their governments. This is the mindset that must govern any move to modify the structure of guarantees in our country. It needs full comprehension of the policy objective of setting up guarantee funds and institutions.

The financial system works well when it is able to channel funds from those labeled as surplus units (the savers) to those that have a deficit (the borrowers). Ideally, the flow of funds should be to those with the best use of funds, or to the borrowers which have an excess of investment opportunities. A large part of the funds flows are handled by intermediaries which, in this instance, are our private financial institutions like banks, finance companies and micro-finance conduits. Unfortunately, the funds flow does not happen automatically. To illustrate, people deposit money in a bank which in turn use the fund to entertain a borrower. The depositor’s claim on the loan is not a direct one. The deposit has a risk and liquidity feature different from the bank’s loan to the borrower, which by the way is now an asset of the bank. The depositor’s fund is theoretically safe and liquid; but the bank’s asset is now subject to risk and uncertaintly, especially of default. It is likewise not so liquid. Here lies the major mismatch.

The characteristics of the funds flow changes the risk and liquidity feature of financial instruments utilized. Someone has to absorb the risk of loans. Banks normally do this as part of their risk taking activity. In the normal course of business, the bank makes a lot of loans and not all loans will be good ones. Some borrowers will eventually default on its obligations. The losses out of these classses constitute the cost of the asset transformation and the risk.

If the banks are rationale wealth maximizers, certain sectors critical to the economy will be rationed out. Given these issues, the presence of guarantees are intended to reduce the cost of administration as well as the risks involved for the identified priorities. Loan losses are effectively reduced, even if the guarantee is not 100%. The banks should find it less difficult to address the concern of the sector with the incentives provided by the guaratee system. The guarantee mechanism represents a policy intervention to direct funds flow to important but unattractive sectors.

We need to have strong guarantee institutions to make this functional to the system. Oftentimes, the private financial sector institutions are concerned about the financial and administrative strength of the government guarantee institutions. Hence, the guarantee institution must have a strong capital base and must be professionally managed. Freedom from political intervention must be assured. Loan guarantees help funds flow to the priority sector while it reduces the cost and risk of banks. We have to make better use of this important resource for the financial system to efficiently allocate scarce resources from savers to borrowers.

At it core, the guarantee is an insurance product and since it is designed to address a priority concern that is by definition of higher risk class – whether SMEs, agriculture or disaster recovery – it must not be viewed as an income generator per se. Many times, premium pricing will not follow actuarial realities lest it becomes unattractive . Other economices have accepted this persective. It is about time we focus on its impact, its leveraging effects and its efficacy in achieving the target additionality outcome.

(Benel D. Lagua is Executive Vice President at the Development Bank of the Philippines. He is an active FINEX member and a long time advocate of risk-based lending for SMEs. The views expressed herein are his own and does not necessarily reflect the opinion of his office as well as FINEX.)

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