To get a sense of the Philippines, here are two facts: the country boasts three of the top ten largest shopping malls in the world. Yet, the markets to provide finance and investment are among the least developed. For example, its stockmarket is ranked 30th in the world by capitalization and is the smallest among the so-called Asean 5 (Indonesia, Malaysia, Philippines, Singapore and Thailand).

But its new central bank chief is ready to push for change. “Financial systems tend to be very elitist; they tend to serve those with money by definition,” muses Nestor Espenilla Jr, newly appointed governor, Bangko Sentral ng Pilipinas (BSP), the Philippine central bank. “But they should not be. We have SMEs (small, medium-size enterprises) looking for finance; we have a lot of people wanting to do remittance and save for the future.”

The last time a new Philippine central bank governor was welcomed to Room 501 at the BSP Complex in Manila, Asia was emerging from the crisis; oil price was making its rapid ascend to over US$100 a barrel; and the US subprime mortgage market was starting its death spiral.

As Espenilla takes the helm at the BSP 12 years later, the US is taking tentative steps out of its own financial mess; the oil price has collapsed and struggles to stay above US$50 a barrel; and the flood of liquidity unleashed by central banks following the crisis in the US and Europe has brought the world back from the brink.

 

It has also depressed interest rates to record low levels. “The world has been operating in an unusual/abnormal way,” agrees Espenilla. But he believes the time is right to pursue major financial sector reforms.

In a lengthy exclusive interview with The Asset, he asserts: “The Philippines is enjoying a nice demographic window; we have a young upwardly mobile population. We need to act now while there is policy space; we have to ensure that this becomes an asset rather than a liability. The period of loose monetary policy has created a window where inflation is not [yet] an issue.”

Deploying technology is a critical part of his strategy. “We welcome technology. We look at it as an enabling matter. It allows banks to do more things for its customers,” he states pointing out that the country is among the first testing grounds for mobile banking in 2000. “The Philippines is recognized as a digital pioneer. We actually play a role in setting standards globally for promoting financial inclusion especially in using digital technology.”

One of his big bets is on the National Retail Payment System (NRPS), which will start from later this year. “We created a governance framework that will allow full interoperability of financial service providers,” he explains. “You will be able to move financial values electronically from a bank account to any bank account or wallet account (in the case of regulated NBFIs such as electronic money issuers) in that ecosystem.”

Dovetailing the NRPS is the development of a national ID system. Based on a foundational ID mechanism, a number or a code will be associated with a specific biometric imprint, which can be the basis for any use case. “It should be flexible; it should not be captured by technology. For that we are looking at models done by countries such as India (Aadhaar) and in Eastern Europe.”

Espenilla hopes the NRPS will replace a lot of the cash and cheque-based transactions especially in retail. Total retail volume in the country is about 20 billion transactions a month, according to a survey conducted by the BSP in 2014. Only 1% of that was electronic while the rest was either in cash or cheque. “We want to convert at least 20% of those transactions into electronic payments by 2020. The Philippines will begin to see more electronic fund transfers and low-value, real-time push transactions – think Octopus card in Hong Kong. [But] it will not be card-based; it will be digital, mobile phone-based using any digital device.”

The embrace of digital is also to speed up financial inclusion. Based on a survey by the World Bank, only around 31% of the adult population has a bank account with a financial institution in the Philippines. While there has been progress, Espenilla says there also are a lot of exclusions. “That is a policy environment we need to address.”

In part, geography is a factor. “The Philippines is an archipelago and people are spread out to the countryside,” says the governor. “If you rely on the brick-and-mortar of financial services, that is going to be costly; it also will take time. We want to catch up; we want to move faster. This is why digital financial solutions are an important endeavor.”

 

The new payment system is also going to force another important change. Espenilla points out that while the Philippines is not behind in terms of product innovation – “in fact, we are potentially a leader” such as in micro-insurance, he proclaims that the opportunity is in delivering these products more effectively.

For example, he says that there are digital solutions offered by banks. “But they tend to be designed for silos – for ecosystem-related entities. They are not meant to cross over from one bank to another. This is the reason why the NRPS is advocating strongly interoperability.”

The central bank’s goal is to create open ecosystems that will enable people and digital financial products to join in and connect to everyone in the system. By creating a governance arrangement that allows commercial decisions to happen, he believes financial institutions are then able to work with one another under fair rules of sharing. “Everybody needs to cooperate in creating a central infrastructure; basically it’s a clearing and settlement mechanism, which everybody needs to pass through.”

At a product level, he says banks are free to innovate and compete on products based on what customers want. “It’s a combination of cooperation and competition. And competition is important because that’s what gets good deals for customers. You want to have a clearing and settlement mechanism to keep the system safe and also to maintain its integrity from cybercrime and money laundering issues.”

Regtech is another area the central bank is taking a keen interest in with two pilots underway. “We are creating an API that can improve the way reports are submitted to the BSP so that we are able to mine more information and on a faster basis,” he shares. Working with R2A (Regtech for Regulators Accelerator), which is funded by the Bill & Melinda Gates Foundation, BSP is also taking the first steps into artificial intelligence. “We want to process unstructured consumer complaints to be able to draw intelligence and to focus our oversight on the market conduct of financial institutions.”

 

Market conduct is especially vital as Espenilla pursues the development of the capital market. “That’s an area ripe for reform,” he indicates. The further liberalization of the FX and derivatives markets is part of this drive. “Within the capital market, the debt market is lagging behind. It is mostly a government securities market and there are issues on liquidity and the fragmentation of it.”

The Asian Bond Monitor, compiled by the Asian Development Bank, placed the Philippines peso bond market as among the smallest in East Asia with total outstanding bonds of US$98 billion equivalent at the end of the first quarter 2017, ahead of Vietnam’s US$44 billion and behind Indonesia’s US$172 billion.

Espenilla wants to deepen the market, create a complete yield curve, improve liquidity and introduce new products such as repos. “This is timely since we want bonds, infrastructure bonds for example, that are long dated. We need a reference point to price better.”

BSP alone cannot do it, he says. “We are closely partnered with the Bureau of Treasury and the Securities and Exchange Commission. We’ve come together and will release a roadmap soon,” he says. “We also want to develop the FX market so we are able to engage foreign investors to deepen the domestic debt market.”

One area being reviewed is tax on debt instruments. Phase 4 of the proposed comprehensive tax reform package drawn up by the Department of Finance is to revisit these concerns from foreign investors, says Espenilla. “Maybe the 20% withholding tax is no longer the right vehicle; it can be lower and can be broader. Those are the kinds of thoughts that are being discussed right now and proposals put forward.”

The goal is to encourage local borrowers, including the government, to tap the local currency market as opposed to raising finance in foreign currency to support their capital requirements. “Strategically, that’s good for the BSP in terms of bank supervision,” he points out. “For the longest time, the heavy lifting of finance is being done by the banking system; banks are not really good in long-term finance because of the way they are funded. By creating a more vibrant domestic debt market together with the strong banking system, we will then create a stronger and more effective financial ecosystem that can support growth on a sustainable basis.”

 

The position of governor of the BSP is much coveted and also has an important bearing in how foreign investors view the country’s governance. Media reports suggest that apart from internal candidates, President Duterte was presented with options that included former bank presidents (one of whom was politically well-connected) and a former president of the country. In the end, Espenilla was asked to go to Malacañang Palace on May 8 and later invited to join a meeting of the Cabinet even though BSP governors normally do not attend.

Speculation as to why Espenilla eventually won the fierce contest is anyone’s guess. But his track record in going up against well-entrenched individuals and powerful families in banking must have been a part of the carefully thought through decision to appoint him.

The decades-long legal battle the central bank fought with the Aguirre family that eventually forced the closure of Banco Filipino in March 2011 was no doubt a feather in Espenilla’s cap. He also took on Roberto V. Ongpin, former Marcos trade and industry minister, over loans extended by a government bank to the businessman to purchase shares in a mining company for which Espenilla was singled out by Ongpin in a lawsuit in 2013. As head of bank supervision when he was the deputy governor, Espenilla also led the team investigating the Bangladesh Bank heist that resulted in a record fine of one billion pesos (US$19.5 million) slapped on RCBC, owned by the Yuchengco family, in August 2016.

The Bangladesh Bank heist last year especially tarnished the Philippines’ reputation and its ability to plug anti-money laundering (AML) loopholes. “I would characterize the recent problem as a failing of an institution to adhere to the expected standards, as opposed to generalized weak standards in the system itself,” he relates.

With the Bangladesh Bank incident, Espenilla says the corresponding response has to be targeted. The central bank “held accountable the responsible institution and showed to the world and to the public that it does not tolerate such weaknesses in the way things are run in a bank”.

Still, Espenilla recognizes the severity of the challenge of AML/CFT (combating the financing of terrorism) and cybersecurity issues. “It is a risk faced by all jurisdictions,” he says. “The Philippines has continuously elevated the standards by which we try to secure the financial system. But that does not guarantee every single institution will be compliant.” He adds that several amendments have been added to the AML law to include casinos, which were not covered previously and used in the Bangladesh bank case to launder the stolen funds.

“It is not perfect and there are still issues. The system is learning. This setback forms the basis for more reforms,” he assures. “The Philippines has shown it has the capacity to reform. We are continuing to build on this. AML is never a politically easy issue. But we do our best to strengthen the overall environment.”

 

Years of nudging the banks forward in terms of rebuilding their capital base and also to strengthen their risk management capability give Espenilla confidence that the industry is in a good position to face the future. “You would have seen in the last decade the rapid alignment of the country’s regulatory framework with the global standards across the board – capital standards, AML, governance and various kinds of risk management standards.”

These are even more critical given the unusual and abnormal conditions brought about by the ultra-loose monetary policy of the advanced economies, which is clearly coming to an end. “The world is on the mend slowly,” believes Espenilla. “But there are also a lot of risks to that recovery. Economies are operating at multi-speed. In that sense, the world is a lot harder to read now.”

While banks will complain about the higher capital standards, he is quite happy to defend them as they protect the system and maintain financial stability. “Banks should also recognize that the BSP has moved on [from strengthening] to another set of reforms – the ones that I call enabling reforms,” he points out. “We have opened a lot of opportunities for the banks even as we saw enhancements in their risk management capabilities.”

They include cross-selling, outsourcing, liberalized branching, offering of new services, and electronic payments. “There are many new things that banks can work with right now and we are able to do that because the basic comfort level has been built up in terms of the ability of banks to manage their own affairs,” he adds.

The most recent move is liberalizing the fund management business. “We have opened up the establishment of trust corporations, which can be 100% foreign owned,” he notes. “Some banks have spun off their trust departments into full-blown trust corporations. Even insurance companies have put up trust corporations to do competitive asset management business.”

A balance between strengthening and enabling go hand-in-hand, Espenilla contends. “You cannot do enabling without strengthening because that is an invitation to financial instability. On the other hand, you cannot just strengthen without creating business opportunities. Otherwise banks will not make money; unprofitable banks are not strong banks.”

BSP, he ventures, is not doing too bad on financial stability. “There, it is mostly maintenance. But it is not easy maintenance because you want to maintain the good results through to potentially turbulent times. That requires agility.”

At the same time, he believes BSP also needs innovation, imagination and the courage to execute a lot of reforms. Some of them can be disruptive because, as he notes, it is going up against a status quo that does not like change.

“I think it will be tragic for our society if we continue to preserve the status quo that does not serve a lot of people well,” he states. “That’s an inequitable society; that’s probably why we have President Duterte right now because he is responding to a basic concern that is disturbing a lot of people.”