FIN 2 – Philippine Financial System “For the love of money is a root of all

kinds of evil, for which some have strayed

Unit I: The Philippine Financial System from the faith in their greediness, and
1. Definition of financial system pierced themselves through with many
2. Components of Financial system sorrows.” 1 Timothy 6:10 NKJV
3. Financial Instruments used in the Financial system
4. Development of the Philippine Financial System
5. Structure of the Philippine Financial System

Definition:
The Financial System is a network of various institutions which generates, circulates and
controls money and credit.

NATURE OF FINANCIAL SYSTEM:

 Provides intermediation between the suppliers and users of credit

 As an integral part of the economic system, provides loans to poor families, small producers, big
businessmen and industrialists.
 Stimulates the social and economic development of the country.
 Channels funds from households, firms and governments who have surplus funds (savers) to those who have
a shortage of funds (borrowers).

Saving Surplus Units Saving Deficit Units

The financial system brings together savers and borrowers in two ways.
 Direct Finance through financial markets, individual savers hold the claims issued by individual
borrowers.
 Indirect Finance through financial intermediaries that are backed by their portfolio of assets, which are
claims on the borrowers.

Methods of Fund Transfer (movement of funds):

1. DIRECT TRANSFER OF FUNDS
-firm seeking cash sells its securities directly to savers or investors who are willing to purchase them in hopes of
earning a reasonable rate of return.
Direct Transfer happens in the following markets:
Financial Markets
1. Securities Market
-Physical location where debt and equity securities are traded and sold
a. Primary Securities Markets
-The market in which new issues of securities are sold to the public
a. Secondary Securities Market
-The market in which securities are traded after they have been issued
1. Money Market
-A segment of the financial market in which financial instruments with high liquidity and
very short maturities are traded.
2. Capital Market
-The portion of the market for investment funds where equities, mortgages and bonds are
traded.
 2. Mortgage Market
-Where mortgage loans back by real property in the form of non-current assets.

3. Derivatives Market
-Facilitate the purchase and sale of derivatives securities.
-Financial contract that derive their value from underlying securities.
Examples of Derivatives: Call options, put options, convertible bonds, futures contracts, and convertible
preferred stock. A derivative can be either a risky or low-risk investment, depending upon the type of
derivative and how it is used.

4. Currency Exchange Market

-Foreign currency are traded.

2. INDIRECT TRANSFER OF FUNDS (using the INVESTMENT BANKER)

- securities at a higher price than it paid for them to the investing public.

Funtions of Investment Bankers:

- Underwriting - means assuming a risk. The investment bankers assumes the risk of selling a security issue at a
satisfactory price.
- Distributing – once the syndicate owns the securities, it must get them into the hands of ultimate investors
- Advising – a sound investment banker will be aware of prevailing market conditions and can relate those
conditions to the particular type of security that should be sold at a given time.

ELEMENTS OF THE FINANCIAL SYSTEM

a) Financial Claims
 Money and the rights to receive money under specific circumstances
 Evidenced by financial instruments which specify the terms of the claims
b) Financial Institutions
 Private (shareholder-owned) or public (government-owned) organizations that, broadly speaking, act
as a channel between savers and borrowers of funds
c) Financial Markets
 Institutional markets which expedite transactions in financial claims
d) Government Agencies
 Policy making body responsible for oversight and administration of specific functions
 Monetary Board
e) Laws and Policies
 Plans of action or tightly defined concepts intended to influence economic behavior

FUNCTIONS OF THE FINANCIAL SYSTEM

1. Financial Intermediation
- Facilitating transfer of funds from savers to users

2. Savings Function
- Providing a potentially profitable low risk outlet for the public savings

3. Investigation and credit analysis

- Ensures that funds will be used efficiently by the borrower, and protects the interests of both lender and
financial institution

4. Brokerage function
- Matching supply and demand for funds Financial institutions bring lenders and borrowers together

5. Liquidity Function
- Providing a means of raising funds by converting securities and other financial assets into cash balances

6. Policy Function
- Providing a channel for government policy to achieve society’s goal of high employment. Low inflation and
sustainable economic growth

Financial Instruments:

What is a financial instrument?

• a written legal obligation of one party to transfer something of value to another party at some future
date.

Different Type of Securities:

I. Money Market Instruments

 Short-term debt securities issued by corporations, financial institutions, and governments.
 Generally low-risk securities and are purchased by investors when they have surplus cash.

a. Treasury Bills
– T-bills are peso-denominated short term fixed-income securities issued by the Republic of the
Philippines through its Bureau of Treasury
– It is sold by BSP to finance its expenditures
– They do not pay interest, instead they are sold at a discount to face value and are redeemed at
maturity for their full face value.
• Risk: Default-free
• Maturity: 91 days to 1 year
Example, let's say you buy a 13-week T-bill priced at P98,000. Essentially, the government (and its nearly
bulletproof credit rating) writes you an IOU for P100,000 that it agrees to pay back in three months. You
will not receive regular payments as you would with a coupon bond, for example. Instead, the
appreciation - and, therefore, the value to you - comes from the difference between the discounted
value you originally paid and the amount you receive back (P100,000). In this case, the T-bill pays a
2.04% interest rate (P200/P98,000 = 2.04%) over a three-month period.

b. Bankers’ Acceptances (BA)

– A short-term credit instrument which is created by a non-financial firm and whose payment is
guaranteed by a bank.
– An order to a bank by its customer to pay a sum of money at a future date.
– A firm’s promise to pay guaranteed by a bank
• Risk: Low degree of risk if guaranteed by strong bank.
• Maturity: Up to 180 days
BA is a short-term debt instrument issued by a firm that is guaranteed by a commercial bank. Banker's
acceptances are issued by firms as part of a commercial transaction. These instruments are similar to T-
Bills and are frequently used in money market funds. Banker's acceptances are traded at a discount
from face value on the secondary market, which can be an advantage because the banker's
acceptance does not need to be held until maturity. Banker's acceptances are regularly used financial
instruments in international trade.
Read more: http://www.investopedia.com/terms/b/bankersacceptance.asp#ixzz285OS1tr5

c. Commercial Paper
– a short term unsecured loan issued by a corporation typically financing day to day operation
– Issued by financially secured firms to large investors
• Risk: Low risk
• Maturity: Up to 270 days

An unsecured, short-term debt instrument issued by a corporation, typically for the financing of
accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper
rarely range any longer than 270 days. The debt is usually issued at a discount, reflecting prevailing
market interest rates.
A major benefit of commercial paper is that it does not need to be registered with the Securities and
Exchange Commission (SEC) as long as it matures before nine months (270 days), making it a very cost-
effective means of financing. The proceeds from this type of financing can only be used on current
 assets (inventories) and are not allowed to be used on fixed assets, such as a new plant, without SEC
involvement.

d. Certificates of Deposit
– Issued by major money center commercial banks to investors.
– A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a
specified fixed interest rate and can be issued in any denomination. CDs are generally issued by
commercial banks and are insured by the PDIC.
• Risk: Low degree of risk
• Maturity: Up to 1 year
A certificate of deposit is a promissory note issued by a bank. It is a time deposit that restricts holders
from withdrawing funds on demand. Although it is still possible to withdraw the money, this action will
often incur a penalty.

e. Mutual Funds
– Issued by companies that raise money from sale of shares and invest in and professionally
manage a diversified portfolio of securities
• Risk: Moderate

One of the main advantages of mutual funds is that they give small investors access to professionally
managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult (if
not impossible) to create with a small amount of capital. Each shareholder participates proportionally in
the gain or loss of the fund. Mutual fund units, or shares, are issued and can typically be purchased or
redeemed as needed at the fund's current net asset value (NAV) per share, which is sometimes
expressed as NAVPS.

II. Capital Market Instruments

a. Government treasury notes and bonds

– Issued by the Philippine Government
– A debt obligation issued by the government and backed by its full faith and credit.
• Risk: No risk
• Maturity: 2 to 30 years

b. Municipal Bonds
– Also known as local government bonds
– Issued by the local government to individuals and institutional investors
– Municipalities issue bonds to raise capital for their day-to-day operation.
• Risk: riskier than government bonds
• Maturity: Up to 30 years a

c. Corporate Bonds
– Type of bonds issued by corporations
– Issued by corporations to individuals and institutional investors.
• Risk: Riskier than government securities, but less risky than preferred and common stocks;
varying degree on risk within bonds depending on strength of issuer.
• Maturity: Up to 40 years

d. Mortgages
– Borrowings from commercial banks and S&L’s by individuals and businesses.
• Risk: Variable
• Maturity: Up to 30 years
- A debt instrument that is secured by the collateral of specified real estate property and that the
borrower is obliged to pay back with a predetermined set of payments. Mortgages are used by
individuals and businesses to make large purchases of real estate without paying the entire value of the
purchase up front.
 - Mortgages are also known as "liens against property" or "claims on property."
- In a residential mortgage, a home buyer pledges his or her house to the bank. The bank has a claim
on the house should the home buyer default on paying the mortgage. In the case of a foreclosure, the
bank may evict the home's tenants and sell the house, using the income from the sale to clear the
mortgage debt.

e. Leases
– Similar to a debt in that firms can lease assets rather than borrow and then buy the assets
• Risk: Low risk
• Maturity: Generally 3 to 20 years.
Types of Leases:
Capital lease
Operating lease
Sale and Leaseback
Leverage Lease

f. Preferred Stocks
– Stock whose holders have priority over common stockholders in the payment of dividends but
usually have no voting rights. Dividends are usually fixed.
– Issued by corporations to individuals and institutional investors
• Risk: riskier than corporate bonds, but less risky than common stocks
• Maturity: Unlimited

g. Common Stocks
– Common stock represents an actual ownership position in the firm, and stockholders are residual
claim holders.
– Provides voting rights, and entitling the holder to a share of the company’s success through
dividends
• Risk: Risky
• Maturity: Unlimited

h. Debentures
– A type of debt instrument that is not secured by physical asset or collateral.
– Backed only by the general creditworthiness and reputation of the issuer.
– Both corporations and governments frequently issue this type of bond in order to secure capital.
• Risk: Risky
• Maturity: Unlimited

A type of debt instrument that is not secured by physical asset or collateral. Debentures are backed
only by the general creditworthiness and reputation of the issuer. Both corporations and governments
frequently issue this type of bond in order to secure capital. Like other types of bonds, debentures are
documented in an indenture.

Debentures have no collateral. Bond buyers generally purchase debentures based on the belief that
the bond issuer is unlikely to default on the repayment. An example of a government debenture would
be any government-issued Treasury bond (T-bond) or Treasury bill (T-bill). T-bonds and T-bills are
generally considered risk free because governments, at worst, can print off more money or raise taxes
to pay these type of debts.

The Philippine Financial System

History:
Obras Pias
• A religious foundation founded by Father Juan Fernandez de Leon in 1754
• Literally means pious work
 • Funds came from pious Catholics, together with those who made their wills before undertaking
dangerous expeditions
• Funds were lent to traders to finance the Galleon Trade
• Ended 1820
1830
• Francisco Rodriguez organized the Rodriguez Banks.
• More of a loan association than a bank
1851- Establishment of Formal Banking in the Philippines

El Banco Espanol-Filipino de Isabel II (El Banco de Islas Filipinas)

• Issued the first bank note called as the pesos fuertes
• presently known as Bank of the Philippine Island
• 1st commercial bank organized in the far east
• established to finance the production of abaca, sugar, tobacco, and copra for export.
• Was the only authorized bank to issue currency notes.

Spanish Era:
1873
• Bank of India, Australia, and China setup branches in Manila
1875
• Hong Kong and Shanghai also establish branches in Manila
• In 1883 both Hong Kong and Shanghai opened branches in Iloilo to finance the sugar industry

Monte de Piedad y Caja de Ahorros de Manila

• presently known as Monte de Piedad and Savings Bank.
• Founded by Father Felix Huertas.
• Accepting deposits and extended loans on securities of personal properties.
• After Spanish rule control was given to the authority of the Archbishop of Manila.

American Period:
*During American period established banks before this period was authorize to continue operations.
*More banks were opened to finance the increasing demand of trade in the country.

1902-International Banking Corporation of New York set up an office in the country

Other established banks

1904
• Postal Savings Bank
1906
• First Agricultural Bank of the Philippine Government

Philippine National Bank

• Was organized in 1916 under Act no. 2612
• Made as the sole depository of government funds
• The only authorized bank to issue note of the country.

1916
• Catholic Church set up the Philippine Trust Company
1926
• American businessmen established the People’s Bank and Trust Co.
1920
• China Bank
1926
• Mercantile Bank of China

Philippine Bank of Commerce

• established 1938
• first private commercial bank in the country wholly owned by Filipinos
 • Absorbed by the Philippine Commercial and Industrial Bank.

The Japanese Rule:

Only three domestic banks were allowed to continue operation.
1. Philippine National Bank
2. Bank of the Philippine Islands
3. Philippine Bank of Commerce

Mickey Mouse Money

• Worthless Japanese notes use by the country.

*Japanese Rule left the country’s banking system in a state of total collapsed*

Post War Period:

1946
• Rehabilitation Finance Corporation was established to provide credit facilities for rehabilitation of
agriculture, commerce, industry, and rehabilitation of war-damaged properties
• In later years it became the Development Bank of the Philippines.

1948
• R.A. No. 265 of Central Bank Act was created
• Central Bank of the Philippines was created under Central Bank Administration

November 1971 Congress called for the review of the banking laws.
Monetary board created the IMF/CBA Banking Survey Commission
Authorized to conduct an overall review of the financial sector of the economy

• Results of the Review of IMF-CBP Banking Survey Commission

1. There were too many banks with different objective and specialization.
2. Emergence of new forms of financial intermediation had affected the price of the money.
3. Philippine Banking System is still deficient to support the financial requirement of a growing economy.

• Recommendations resulted to amendments of General Banking Act, Savings and Loan Associations
Act, Private Developments Bank Act, Charter of the Development Bank of the Philippines, Investment
House Act, and the Central Bank Act.

Offshore banking system was also set up in 1977 as one of the proposals of the IMF-CB group

In 1979, another mission was formed to make further study of the Philippine Financial System, with the view to
update the system with the dynamic pace of the growing economy.
Findings of the Study:
1. Legislated specialization in the Philippine banking system prevent banks from responding to the needs
of the growing economy
2. There is more preference for short-term lending and slow growth of long-term deposits.
Recommendations of the Body:
1. The legislated specialization in the Philippines should be removed. Banks should be given the chance to
offer wide range of financial services to the public.
2. Financial Institutions were to be encouraged to extend more long-term funds.
3. An active capital market was to be develop.
 4. The lender-of-last resort facility of the Central Bank should be fully utilized to maintain the liquidity of
banks

Financial Sector Reforms in Recent Years:

1993
• Establishment of BSP as the central monetary authority of the Philippines under R.A. 7653.
• BSP replaced the Central Bank which was established in 1949.

May 18, 1994

• R.A. 7721 Liberalism of the entry of foreign banks.