Financial system may face $505M in ‘collateral damage’

THE Philippine financial system may face as much as $505.3 million (P25.2 billion) in incremental “collateral damage” caused by distressed banks, as credit and contagion risks rise amid the pandemic, the ASEAN+3 Macroeconomic Research Office (AMRO) said on Tuesday.

“As a result (of the pandemic), banks are confronted with sharp drops in revenue and rising credit risks… Concurrently, banks are facing increasing bad loans, as corporate customers go under and unemployed retail borrowers struggle to service their obligations,” AMRO said in a analytical note “COVID, Credit, and Contagion risks to ASEAN+3 Financial Systems.”

In the note, AMRO did a stress test for “additional expected costs to the wider financial system from shocks to individual ASEAN+3 banks as a result of the pandemic.” Additional costs refer to the loss on top of direct credit costs already booked in the financial system before the pandemic, and costs to the wider financial system beyond the direct damage to an individual banks’ asset quality, it said.

The stress test was done by applying the actual increase in probability of default (PD) since January, prior to the global spread of the pandemic of 20 basis points (bps) to each bank.

AMRO estimated the incremental expected “collateral damage” from distressed banks on the Philippine financial system will reach $505.3 million.

The Philippines’ potential “collateral damage” are the fourth highest in the region, after China’s $19.777 billion, Singapore’s $2.926 billion and Japan’s $2.541 billion.

Hong Kong, on the otherhand, faces incremental expected losses of $292 million, followed by Indonesia’s $287 million, Korea’s $226 million, Vietnam’s $225 million, Thailand’s $133 million, and Malaysia’s $3.5 million.

Based on the impact on other financial systems excluding its own, AMRO estimated the “collateral damage” of Philippine banks in distress on the wider ASEAN financial system is valued at $3.7 million, while a $191-million impact on the financial system of ASEAN+3 is seen. The potential impact on the rest of the world’s financial system is at $184 million.

Meanwhile, AMRO projected the estimated additional credit loss of Philippine banks from source entity to direct creditors is at $252.2 million, based on the nine banks it studied.

“The total incremental expected losses to the wider financial system from a bank’s distress may be attributable to two key sources,” it said, citing the direct credit losses from defaulted obligations and the “collateral damage due to contagion through financial interconnectedness.”

AMRO explained that default risk is the likelihood that a bank cannot pay off its debts, while contagion risks are from several factors such as “borrowing-lending relationships, common business models and stakeholders, capital market transactions and market sentiment.”

For the global systemically important banks (G-SIBs), AMRO saw an incremental expected credit losses of as much as $10 billion and another $10 billion in contagion losses to the wider global financial system, while for the domestic systemically important banks (D-SIBs), the estimated incremental losses are lower at $10 million to over $1 billion in credit losses and $10 million to $1 billion for contagion losses.

“The additional expected losses from credit and contagion risks could have important ramifications for the affected FIs (financial institutions) and at the extreme, for the fiscal purse,” it said, adding that the “actual failure of any one of the G-SIBs or D-SIBs could have massive implications for the global or regional financial system.”

According to AMRO, the aim of the study is “to provide financial regulators with a gauge of the potential magnitude of any financial fallout from the ripple effects ultimately triggered by the pandemic, and allow fiscal authorities to gauge the contingent claims from the banking system if any provision or capital buffers pre-pandemic are not sufficient to cover such additional costs.” — Beatrice M. Laforga