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The Effects of the 2008 Financial Crisis

to the Philippine Financial System

INTRODUCTION

The center of subprime mortgage crisis is the United States. It was on August 2007
when the crisis started off, it lasted for almost 1 year. The 2007-2008 crisis does not only
affect the United States itself, the effect quickly diverse into different countries. The
financial institutions on different countries teeter on the edge of bankruptcy. The financial
economic crisis ensues in which non-financial firms around the world appear to spiral
down as well. Different firms have different degrees of reliance on external finance for
their working capital need and for their long-term investment, a supply of finance shock,
if it exists, should impact different firms differently. A key idea in the field of international
finance is that a countrys choice of the exchange rate regime (i.e., fixed vs. floating
exchange rates) determines whether it can effectively deflect or passively import foreign
shocks. More specifically, a flexible exchange rate regime is supposed to provide a better
buffer against foreign shocks. The Global Economic Crisis pulled different countries to
a recession, wide-range of decrease in many aspect of growth. Following the Asian
economic crisis in 1997, the 2007 crisis until the present imposes new challenges to
the different countries specifically the developing country of Philippines.
Before the 2007 global crisis, the Philippines suffered with long-term structural
problems such that sustainable economic development seems to be just a dream.
According to the pages of Philippine economic history, the country has been dominated
by a sequence of growth spurts, brief and mediocre, followed by shard to very-sharp,
severe, and extended downturns. This economic cycle of the Philippines is known as

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The Effects of the 2008 Financial Crisis


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the boom-bust cycle. As such, economic growth record of the country has been
disappointing in comparison with its East Asian counterparts in terms of per capita GDP.
The Philippines has been affected by the crisis in a decline in three aspects:
exports, remittances from overseas Filipino workers, and foreign direct investments.
Heavily dependent on electronic and semiconductor exports, the Philippines has seen a
downward trend in its export earnings as countries in demand of these exports are now
in recession. The recession has also put to risk the jobs in the developed countries which
include those where migrant workers are employed.
This study aims to provide information about the said worldwide crisis the world
has encountered. This study also aims to provide a better understanding about the
historical background of one of the major factors why the Philippines is facing such a
difficulty on solving our economic problem.

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The Effects of the 2008 Financial Crisis


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DATA AND RELATED STUDY

The Global Economic Crisis pulled countries down from around the globe to
a recession. Wide-ranging declines in many aspects of growth characterize the overall
impact it had had on the global scale. Following the Asian economic crisis in 1997, the
present global economic crisis imposes new challenges to the Philippines as a developing
country. Following are expositions of the macroeconomic impacts of the crisis in the
Philippine setting, its implications in the prevalent poverty scenario, and policies and
programs undertaken by the government in response to the crisis.
The 2008 global economic crisis started upon the bursting of the United States
housing bubble, which was followed by bankruptcies, bailouts, foreclosures, and
takeovers of financial institutions and national governments. During a period of housing
and credit booms, banks encouraged lending to home owners by a considerably high
amount without appropriate level of transparency and financial supervision. As interest
rates rose in mid-2007, housing prices dropped extensively, and all institutions that
borrowed and invested found themselves suffering significant losses. Financial
institutions, insurance companies, and investment houses declared either declared
bankruptcies or had to be rescued financially. Economies worldwide slowed during this
period and entered to a recession. The crisis, initially financial in nature, has now taken a
full-blown economic and global scale affecting every country to the left and to the right of
the United States, and wreaking havoc in the level of both industrialized and developing
nations.

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The Effects of the 2008 Financial Crisis


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I.

Macroeconomic Impacts

Impacts of Asset Markets


The freeze

in

liquidity in

US

and European financial markets

reversed capital flows to developing countries and induced a rise in the price of
risk which entailed a drop in equity prices and exchange rate volatility. However,
following the effects of an increase in the foreign currency government bond
spread, the Philippine stock market was actually one of the least affected by the
crisis with the main index of the stock market dropping only by 24 percent, a
relatively low percentage change in comparison to those of other countries across
Asia. Similarly, from the period between July 2008 and January 2009,
the peso devaluated only by 3 percent which explains why the peso was one of
the currencies least affected by the crisis. This minimal effect on the stock market
and the Philippine peso can be attributed to the recovery of asset prices across
the Asia-Pacific region recovered in early 2009 as foreign portfolio investments
surged.
The financial turmoil that emerged in the aftermath of the Lehman Brothers
debacle magnified tensions in the global interbank and credit markets. As a result
there was a virtual freeze in liquidity in US and European financial markets which
stopped and, in many cases, reversed capital flows to emerging and developing
countries. In large part, the latter reflected sales of debt and equity securities by
nonresidents, selective withdrawals of bank deposits held with domestic banks and
a decline in inflows of foreign direct investment (World Bank, 2008).
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Monitoring the impact of these events on the real sector of the economy is
important. Rising bond spreads will raise the cost of financing external debt with
attendant effects on the fiscal position of the national government. However, higher
interest payments are not expected to materialize in the short-term. Meanwhile,
portfolio flows have been shown to have a negligible impact on consumption and
investment (Yap 2008c). Hence the gyrations in the stock market are not expected
to have a strong effect on the real sector.
Stock market and exchange rate volatility do affect macroeconomic stability
and this has implications for private investment. Investment in durable equipment
contracted by 18.5 percent in the first quarter of 2009 and a further 18.9 percent in
the second quarter. In terms of international trade, prices of traded commodities
are mostly set in the global market. Exchange rate movements, therefore, affect
profitability of exporters rather than demand for their products. Profitability of
exporters, however, has an impact on their investment and employment decisions.
Exchange rate movements affect the propensity to import, the degree of protection
of import-substituting industries, and the peso value of remittances from abroad.

Impacts on Financial Sector


The onset of the global financial crisis raised fears that many emerging

markets will face a debacle similar to the 1997 financial crisis that hit East Asia.
The initial impact on asset markets did put pressure on financial markets especially
in economies with high foreign participation in local equity markets, banking
systems that depend heavily on short-term foreign currency funding, and those
running external current account deficits (ADB, 2008). In East Asia, Korea and
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Indonesia experienced severe foreign currency liquidity shortages leading to sharp


depreciations of the won and rupiah. However, the situation improved considerably
in the first five months of 2009.
In 2008 most banks continued to report relatively high rates of return on
assets and equity, and did not experience increases in impaired assets. This
performance reflects the insignificant exposure of Philippine banks to the toxic
structured mortgage products that were extensively sold globally. Given largely
domestically-focused business and relatively strong economic activities in 2007,
profitability of Philippine banks has generally remained high in 2008.
Undoubtedly, the Philippine financial sector remains vulnerable to further
shocks that emanate from global financial centers. However, there has been no
meltdown yet similar to the events of 1997. The resilience stems from more
prudent policies and a more conservative approach by the banking system. It
would be difficult to establish which factor has been more important. Nevertheless,
policies implemented in the aftermath of the 1997 crisis did play a role in limiting
the impact of the 2008 global liquidity crunch. The BSP, however, must remain
vigilant and implement measures to maintain stability of the financial sectors.

Impacts on the Real Sector


As mentioned earlier, the slowdown of the Philippine economy in 2008 was

largely due to a sharp rise in inflation. Another important factor was the pronounced
deceleration in construction activity following a surge related to the 2007 elections
and the initial implementation of President Macapagal-Arroyos ambitious

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infrastructure program. A fall in the growth rate of personal consumption


expenditures and fixed investment in 2008. In particular, investment in public
construction contracted by 0.4 percent in 2008 after surging by 29.2 percent in
2007.
In order to isolate the impact of the crisis, the combined output of the first
two quarters and immediately preceding fourth quarter are monitored over the past
four years. The assumption is that the impact of the crisis manifested itself in the
fourth quarter of 2008 and first half of 2009. GDP growth fell to only 1.7 percent in
the combined 4th quarter of 2008 and first two quarters of 2009 after averaging 5.7
percent in the previous 3 years.
On the domestic front, it was expected that since total private investment
had been sluggish for the past decade, there would be little room for further
deterioration. Unfortunately, only public construction activity was buoyant,
expanding by 11.5 percent in the first quarter and by 29.9 percent in the second
quarter of 2009. Moreover, this is a result of stimulus measures by the national
government and is likely to be only temporary. As mentioned earlier, investment in
durable equipment contracted sharply in this same period. Fixed capital during the
combined 4th quarter of 2008 and 1st half of 2009 contracted by 12.6 percent. The
data, therefore, indicate that certain investment activities expanded despite the
crisis but these were not enough to offset the downturn in other sectors. Future
production capacity remains to be a serious problem for the Philippine economy.

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The Effects of the 2008 Financial Crisis


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Impacts of Fiscal Deficit and External Accounts


To counter adverse effects of the crisis, the Philippine government felt the

need to increase its expenditures. Apart from government expenditure, of primary


concern was the weak revenues generated by the government with fiscal deficit
reaching P111.8 billion in the first quarter of 2009 as compared to P25.8 billion in
the same period of the previous year. Despite suffering the least in terms of the
stock exchange and financial markets among East Asian countries, the Philippines
lagged in tax effort in comparison to other nations. Meanwhile, private sector flows
in the external account declined and led to a net outflow of $708 million in 2009, a
sharp turning away from a net inflow of $507 million in 2008. This eventually led to
a fall in stock prices and depreciation or devaluation of the peso.

Domestic Banking
The Philippine banking system has remained resilient despite the

heightened level of global financial distress. This is primarily due to several factors:
first, the limited exposure of domestic banks to the US subprime fallout and other
related securitized assets, which accounted for only 0.4% of the banking systems
total assets as of 30 June 2008; second, its relatively strong bank balance sheets
with a return to profitability; third, improvements in risk and liquidity management;
fourth, strengthening of supervisory and regulatory systems; and fifth, moves by
banks into more profitable domestic business lines such as consumer lending.
In fact, in the first half of 2009, local banks managed to register respectable
growth in their key balance sheet accounts. During the period, banks were able to

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provide higher provisions for credit losses, plough back undivided profits to
reinforce their capital base and achieve greater efficiency in their operations on
account of greater maximization of e-banking technologies. Philippine banks
recorded solid performances in terms of asset quality, capital position and
profitability. Overall, the system was able to maintain net profit despite the decline
in treasury-related operations due to substantial revaluations of unrealized gains
from banks FX transactions.

II.

BSPs Response to the Crisis


In response to the global financial turmoil, the BSP carefully considered
opportunities for monetary policy easing amid the potential tightening of financial
conditions while remaining faithful to its core mandate of maintaining price stability.
The BSP pursued policies that would infuse appropriate levels of liquidity to
maintain the efficient functioning of the financial markets and help avert the
shrinkage of domestic markets while keeping its eye on price developments.
Because the Philippine economy did not experience as deep a crisis as the
advanced economies, monetary easing by the BSP was of a relatively smaller
magnitude and thus involved conventional measures.
In many ways, the BSPs interest rate easing and liquidity provision
measures were confidence-building moves, signaling the BSPs commitment to
ensuring ample money supply in order to fuel the economys growth engine and

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The Effects of the 2008 Financial Crisis


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maintaining low interest rates to reduce the cost of borrowing to firms and
households and therefore support investment and consumption growth.

Policy rate reduction


With easing price pressures due to muted demand pressures, the BSP

moved to cut policy rates by 200 bp from December 2008, bringing the overnight
borrowing or reverse repurchase rate to 4.0% and the overnight lending or
repurchase rate to 6.0%. The rate reductions were intended to help stimulate
economic growth and/or dampen the slowdown in economic activity by reducing
the cost of borrowing, thereby reducing the financial burden of firms and
households. Reduced policy rates also helped to mitigate the negative feedback
loop between weakening economic conditions and a more cautious financial
sector. The action also helped to boost business and consumer confidence.

Liquidity-enhancing measures
With the growing concern that local banks could encounter problems in

sourcing dollars, the BSP implemented several measures to help infuse dollar
liquidity into the domestic financial system. The BSP opened a US dollar repo
facility to augment dollar liquidity in the FX market and ensure the ready availability
of credit for imports and other legitimate funding requirements. For this facility, the
Monetary Board (MB) approved the use of foreign denominated sovereign debt
securities (ROP) as collateral for loan availments. The guidelines were amended
the following month to limit the facility only to banks with legitimate foreign
currency-denominated funding needs, provided that the borrowing would be for the

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account of the applicant bank and would not be used to fund the liquidity
requirements of foreign branches, affiliates or subsidiaries.
Lastly, the BSP launched the Credit Surety Fund Programme (CSFP) in the
second half of 2008 to help ensure that small businesses had access to financing.
The CSFP is a credit enhancement scheme that allows micro, small and medium
enterprises (MSMEs) that are members of cooperatives to borrow from banks even
without collateral. Loans granted by banks under the Programme are eligible for
rediscounting with the BSP through the Department of Loans and Credit (DLC).

Regulatory forbearance
Complementing the aforementioned measures, the BSP also responded to

the global financial crisis with regulatory forbearance. To safeguard confidence in


the banking system, on 30 October 2008 the Monetary Board approved the
guidelines allowing financial institutions to reclassify financial assets from
categories measured at fair value to those measured at amortized cost. Financial
institutions were allowed to reclassify their investments in debt and equity
securities from their held for trading or available for sale categories to the held
to maturity or the unquoted debt securities classified as loans categories.
Likewise, the maximum deposit insurance coverage was increased to PHP
500,000 from PHP 250,000.

Cooperation and communication


Lastly, in response to the BSPs call for a coordinated domestic response

to the global financial turmoil, the Bankers Association of the Philippines (BAP)
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adopted several measures by way of a gentlemens agreement at end-October


2008. For example, banks agreed to voluntarily halve their purchases or
overbought position in the FX market to US$ 25 million (or 10% of unimpaired
capital) from the prevailing US$ 50 million (or 20% of unimpaired capital), which
helped to ease pressure on the demand for dollars. Moreover, the BSP further
strengthened engagements with regional peers to share information, discuss
emerging developments and pool resources, if necessary even FX reserves.
In responding to the crisis, the BSP also found it important to improve
transparency and communicate its near-term policy objectives. Communicating to
the market and the public that the BSP is committed to ensuring that there is ample
liquidity to keep the financial markets functioning and to helping fund the growth
requirements of the economy has helped to stabilize financial markets and anchor
inflation expectations going forward. Markets have, for instance, reacted positively
to monetary policy actions that reassure them of the BSPs commitment to keeping
inflation in check. Clear communication will also avoid confusion about the BSPs
monetary policy stance going forward.

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CONCLUSION

From the study and data gathered above, we come up with the various conclusions
and understanding about the implications of banking system and monetary policies to real
life occurrence in today's world economy, such as the 2008 Global Economic Crisis.
Philippines being a part of global economy, was not spared from the effect of the
crisis. If rich countries were severely affected that most of them resulted to recession,
what more we could expect to the developing countries like the Philippines but to be
affected as well. Surprisingly, the effect to our economy was minimal compare to what is
expected to happen, unlike in the case of other neighboring Asian countries who
experience great decline in the factors of economy. The Philippines also experienced
downfalls but the impact is not too much to despair. Base on the gathered data those
declines were primarily brought by sharp rise of inflation and other events in the Philippine
economy, but not the result of the crisis. The impact is contrary to what is expected that
the emerging and developing countries will face the debacle just like what had happened
in the East Asian crisis during 1997.
The Philippine financial sector is resilient and stable during that time. The stability
was brought by the reforms that were put in place since the 1997 crisis. Maintenance of
high levels of loan to deposit ratios together with the decline of the ratio of nonperforming
loans to total loans kept profitability of local banking generally high despite the crisis. To
the countrys fortune, no meltdowns occurred as during the previous 1997 Asian crisis.

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Therefore, the Philippines were able to weather the crisis because of the policies
that are collectively put together to addressed to the economys need and unpredictable
events. We also conclude that these policies need to be work on carefully for the benefit
of the economy in the long run. Finally, it is the monetary policies and strategies that took
effort to have a great impact in what could have been the crisis done to our economy.

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REFERENCES

Economic Crisis and Response in the Philippines. Wikipedia.

Financial crisis of 200708. Wikipedia.

Guinigundo, Diwa C. The impact of the global financial crisis on the Philippine financial
system an assessment

Yap, Josef T. Reyes, Cecilia M. Cuenca, Janet S. Impact of the Global Financial and
Economic Crisis on the Philippines. October 2009.

Yap, Josef T. The 2008 Global Financial and Economic Crisis: Impact on the
Philippines and Policy Responses at the National and Regional Levels. November
2009.

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