FIMA 101

BANKING AND
FINANCIAL INSTITUTIONS

Compiled by:
Assoc. Prof. Bernadette M. Panibio
Department of Financial Management
College of Accountancy and Finance
Polytechnic University of the Philippines
 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

Week 3 – Banking Institutions

Lessons:
 Nature of Banking Business
 Banking in the Philippines

 Different Roles Banks Play in the Economy

 Basic Principles of Banking

 Classifications of Banks

At the end of the lesson, the student is expected to:

 Describe the nature of banking business

 Recall the history of banking in the Philippines

 Examine Philippine banking today

 Recognize the importance of roles banks play in the economy

 Describe the different principles of banking

 Compare the different classifications of banks

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

THE NATURE OF BANKING BUSINESS

Bank is an institution which deals in money and credit. It accepts deposits from the public
and grants loans and advances to those who are in need of funds for various purposes.

Banking is an activity which involves acceptance of deposits for the purpose of lending
or investing. In addition to accepting deposits and lending funds, banking also involves
providing various other services along with its main banking activity. These are mainly
agency services, but include several general services as well.

The main operation of a bank involves financial intermediation. Transactions are created
between individuals, business firms, government institutions and foreign investors-the
suppliers and users of funds.

A bank act as a financial intermediary that serves as a middleman for different parties in
a financial transaction. It facilitates the channeling of funds between lenders and
borrowers indirectly.

Through the process of financial intermediation, certain assets or liabilities are

transformed into different assets or liabilities. As such, financial intermediaries channel
funds from people who have extra money or surplus savings (savers) to those who do
not have enough money to carry out a desired activity (borrowers). That is, savers
(lenders) give funds to an intermediary institution (such as a bank), and that institution
gives those funds to spenders (borrowers).
Essentially, banking is about confidence or trust—the belief that the bank has the money
to honor its obligations. Any crack in that confidence can trigger a run and potentially a
bank failure, even bringing down solvent institutions

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

BANKING IN THE PHILIPPINES

The Philippine banking system has evolved gradually over the span of more than a
century, starting from one bank in 1851 to a multi-faceted system which supplies credit to
the growing financial requirements of every sector in the country’s economy.

During the Spanish Period, prior to the establishment of formal banking in 1851, the Obras
Pias was organized by Fr. Juan Fernandez de Leon in 1594. The Obras Pias was a
religious foundation that accumulated large funds from the legacies of wealthy individuals
who made out wills before going out on dangerous expeditions, bequeathing their estates
to the Church or to lay confraternities. The funds of this foundation were first invested in
loans to traders to finance the galleon trade in Acapulco, Mexico.

Formal banking started in the country with the establishment of the El Banco Español
Filipino de Isabel II (later changed to El Banco de las Islas Filipinas) which is now known
as the Bank of the Philippine Islands. This is the first commercial bank organized in the
Far East.

It was during the Spanish time that the country’s first savings bank was established. The
Monte de Piedad y Caja de Ahorros de Manila was founded by Fr. Felix Huertas.

During the American Period, those banks which were already existing were allowed to
continue operations. More banks were opened to finance the increasing demand of trade
in the country.

The Philippine Bank of Commerce, which was the first private commercial bank in the
country wholly owned by Filipinos, was opened for business in 1938. The bank was
absorbed by the Philippine Commercial and Industrial Bank.

At the outbreak of World War II, the Philippines was occupied by the Japanese Imperial
Forces. During the Japanese Occupation, three domestic banks were allowed to resume
operation. They were the Philippine National Bank, Bank of the Philippine Islands, and
the Philippine Bank of Commerce.

The Japanese occupation left the banking system in a state of almost total collapse. Most
banks had worthless Japanese notes in hand. Immediate rehabilitation of the banking
system was made through the creation of the Rehabilitation Finance Corporation.

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

In 1948, upon the enactment of R.A. 265, The Central Bank Act, the banking system in
the country continued to grow and expand. The structure of the Philippine Financial
System had grown in size, became complex, and more sophisticated. Together with
these developments, there were still some aspects of the financial system that needed
improvement.

Congress called for the review of the banking laws and in November of 1971, the
Monetary Board created the Banking Survey Commission to conduct an overall review of
the financial sector of the economy. The findings of the study were as follows:

1. The Philippine Banking System had become “unnecessarily complicated and

over-fragmented”. There were too many kinds of banks with different
objectives and specialization. They enjoy different privileges and benefits
which at the end did not give any advantage to the Philippine economy.

2. The emergence of new forms of financial intermediation had affected the price
of money and the distribution of financial resources within the economy.
3. The Philippine Banking System is still deficient to support the financial
requirement of a growing economy. Another thing is that the financial
intermediation is either doubled to be in full force or is being maximized. Based
on the foregoing findings the Commission recommended that the
establishment of new commercial banks must be stopped, and that the
classifications of banks be reduced so that the monetary and fiscal policies can
be equally applied and equal benefits be enjoyed by banks. The Commission
also recommended that the authority of the Central Bank including its
responsibilities be expanded over the financial system. Flexibility in the
exercise of the Central Bank’s power and the bank’s responsibility must be
redefined primarily as the maintenance of monetary stability in the Philippines

These recommendations resulted in the amendments to the General Banking Act, the
Central Bank Act, and other pertinent laws contained in P.D. Nos. 71, 72, 113 to 123 and
129. These amendments gave focus on the structure, operation and growth of the
financial system. With these amendments, consolidation and merges of banks were
resorted to.

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

In 1979, another mission was formed to make a further study of the Philippine financial
system with the end in view to update the system with the dynamic pace of a growing
society. The group was composed of representatives from the International Monetary
Fund and the World Bank and was called to Joint IMF/WB Mission. Both 1972 and 1980
missions have the objective of maintaining a financial system that could provide the needs
of a growing and developing economy. The 1980 survey, however, was more particular
about a more efficient financial intermediation of new and small business enterprises.
This concern of the mission is believed to improve the system and to make it more
relevant to the needs of a complicated society.

The findings of the study were as follows:

1. The legislated specialization in the Philippine banking system prevents banks

from responding to the needs of the growing economy and thus hampers them
from meeting the demands of their clientele.

2. There is more preference for short-term lending and slow growth of long-term
deposits.
Based on the findings, the mission recommended the following:

1. The legislated specialization in the Philippines should be removed. Banks

should be given the chance to offer a wide range of financial services to the
public.
2. Financial institutions were to be encouraged to extend more of long-term funds.
This is referred to as term transformation. The financial institutions may also
invest in equities of business firms.

3. An active capital market was to be developed and the lender-of-last resort

facility of the Central Bank should be fully utilized to maintain the liquidity of
banks.

These findings and recommendations were submitted to the Batasang Pambansa, which
resulted to the passing of the seven amendatory laws namely, BP Nos. 61 to 67, and the
Implementing Circulars Nos. 739-742 as issued by the Central Bank of the Philippines.
These laws intend to develop increased competition within the system and more use of
long-term funds for debt and equity financing. These amendatory laws affected the
Banking Reforms of 1980.

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

The Banking Reforms of 1980 effected a revision in the Philippine banking structure
including the administrative regulations. A new concept of banking called expanded
commercial banking or universal banking was introduced. This type of banking involves
a combination of commercial banking (full domestic and international

banking) with the powers of an investment house (underwriting, securities dealership and
equity investments). An expanded commercial bank or any unibank may acquire 100%
of the equity of an investment house, thrift banks, rural banks and other financial
undertakings. It may also invest in equities of commercial banks and non-related
undertakings with certain limitations. This new concept in banking which is known as
“one-stop banking” or “department store banking” enables the clientele to avail all banking
services they need from only one bank.

With the introduction of the universal banking concept, it was hoped that the financial
system would contribute to the economic growth and development of the country.

PHILIPPINE BANKING TODAY

The banking system in the Philippines has indeed made great strides through the years.
A clear indication of this would very well be justified by the fact that we see banks to the
right and to the left of us not only in commercial centers but also in the remote areas of
the country.

The business of banking has changed irreversibly and banks must step up to meet clients’
higher expectations for greater safety, for better returns, and for more choices.
Developments in technology have more contributions in these irreversible changes in the
banking system. Technology has brought us to e-banking, the provision of banking
services over the Internet or other electronic networks. Banks wishing to turn to e-banking
must seek approval from the Monetary Board of the BSP. They must follow the
procedures and requirements stipulated in BSP Circular No. 269, the new guidelines
concerning electronic banking services.
There have been significant legislations passed into law that govern the present
Philippine banking system. On May 23, 2000, the passage into law of R.A. 8791,
otherwise known as the General Banking Law of 2000, institutionalized a certain mass of
banking reforms in the Philippines. It provides the regulation of the organization and
operations of banks, quasi-banks and trust entities. Among the more important features
of the new law are the following:

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

 Greater foreign participation in the system, thus inducing competition. Foreign

banks are allowed to acquire up to 100 percent of the voting stock of an existing
bank within seven years after the effectivity of the Act
 Three-year moratorium on the establishment of commercial banks to hasten the
ongoing consolidation process in the banking system
 Stricter rules governing bank exposure to directors, officers, stockholders and
related interests (DOSRI). The definition of DOSRI is expanded to include
investments of the bank in enterprises owned or controlled by said DOSRI.
 Application of fit-proper rule test for a director or officer to hold said position in a
bank. In this regard, the Monetary Board is empowered to disqualify, remove or
suspend a director or officer for acts or omissions that render him unfit for the
position
 Grant of authority to the BSP to regulate electronic banking to ensure adequate
protection of banks’ depositors and other clients.

Republic Act 9160, otherwise known as the Anti-Money Laundering Act of 2001 was
passed into law on September 29, 2001. There are five salient features of AMLA:

 Money laundering is now a crime in the Philippines

It identifies the forms of business institutions or “covered institutions” which are
required to submit reports about suspicious or “covered transactions” to authorized
persons

The creation of an Anti-Money Laundering Council that will administer the implementation
of RA 9160

 The amendment of the Bank Secrecy Law which has been blamed for making our
country a potential haven for money laundering. The objective of RA 9160 is to
ensure that the country is not used for money laundering. However, it continues
to protect and preserve the integrity and confidentiality of bank accounts.
 The institution of procedures and arrangements that facilitate cooperation between
the Philippines and foreign governments in the investigation and prosecution of
money launderers

In the commercial banking industry, which will continue to be the core of the banking
industry the country is steadily moving to a scenario in which there are fewer but more
financially powerful main banks that are better able to compete in a borderless world.
That is the most compelling force behind the current wave of banks mergers and

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

acquisitions. Merger is the absorption of one or more corporations by another existing

corporation which retains its identity and takes over the rights, privileges, franchises and
properties and assumes all liabilities and obligations of the absorbed corporation(s) in the
same manner as if it had itself incurred such liabilities or obligations. The absorbing
corporation continues its existence while the life or lives of the other corporation(s) is/are
terminated. Consolidation is the union of two or more corporations into a single new
corporation, called the consolidated corporation. All the constituent corporations thereby
cease to exist as separate entities. The consolidated corporation shall thereupon and
thereafter possess all the liabilities and obligations of each of the constituent corporations
in the same manner as if it had itself incurred such liabilities or obligations.

On April 19, 2000, the Monetary Board approved the issuance of Circular No. 237,
consolidating and clarifying all existing rules and regulations on mergers and acquisitions
of banks and other financial institutions as well as improving the incentive package. This
was done to foster banks, bring about more and better financial services at lower cost,
and promote stability and efficiency in the Philippine banking sector.

FUNDAMENTAL FORCES OF CHANGE

The basic theme is that increased competition has encouraged banks to assume
increased portfolio risks in order to earn acceptable returns. As bank regulators have
tried to reduce overall risk by raising capital requirement, banks have moved assets off
their balance sheets and tried to replace interest income with fee income. In these efforts,
banks attempt to be more like insurance brokers, realtors and investment bankers
competing with a broader range of firms in more product markets. As capital becomes
increasingly costly or impossible to obtain, individual firms are forced to merge to continue
operations.

Increased Competition
Today, the world of banking is quite different. Banks are basically free to set the price for
their services and the type of services they offer as are other companies are also free to
offer banking-type services at competitive prices. Bankers now compete directly in price,
product offerings and service.

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

Competition for Deposits

The range of deposit products is much broader than what was previously available.
Advances in technology means that businesses and consumers have substantially
greater choices than before. The vast amount of information available on the Internet
means that customers can quickly and easily obtain rate quotes from financial institutions.
Deposit services are often priced to encourage customers to conduct the bulk of their
banking business with one firm.
Competition for Loans

As bank funding costs increased, competition for loans put downward pressure on loan
yields and interest spreads over the cost of bank funds. High quality corporate borrowers
have always had the option to issue commercial papers or long-term bonds rather than
borrow from banks.

Banks pursue different strategies. Small- to medium-sized banks continue to concentrate

on loans but seek to strengthen customer relationships by offering personal service. They
have also rediscovered the consumer loan.
Competition for Payment Services

Once the exclusive domain of banks and other depository institutions the nation’s
payment system has become highly competitive. The real challenge in the delivery of
payment processing services is emerging electronic payment systems. Why is Microsoft
considered a threat to banks? Many analysts argue that the future delivery of banking
services will not take place in the brick and mortar branches of a bank building but rather
through smart cards, ATM networks (which the banks control) and the Internet (which
banks do not control). No individual owns the Internet and any business can offer services
over the Internet. The payment system is highly dynamic and constantly changing.
Competition for Other Bank Services

Banks and their affiliates offer many products and services in addition to deposits and
loans. A partial list includes trust services, brokerage, securities underwriting, real estate
appraisal, personal financial counseling.

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

FINANCIAL INNOVATION

Financial innovation is the catalyst behind the evolving financial services industry and the
restructuring of financial markets. It represents the systematic process of change in
instruments, institutions and operating policies that determine the structure of our financial
system.

Innovations take the form of new securities and financial markets, new products and
services, new organizational forms, and new delivery systems. Financial institutions
change the characteristics of financial instruments traded by the public and create new
financial markets which provide liquidity. Bank managers change the composition of their
banks’ balance sheets by altering the mix of products and services offered and by
competing in extended geographic markets. Financial institutions form holding
companies, acquire subsidiaries and merge with other entities. Institutions may modify
the means by which they offer products and services. Recent trends incorporate
technological advances with the development of cash management accounts, including
the use of automated teller machines, home banking via computer and the Internet and
shared national and international electronic funds transfer system.

Innovations have many causes. Times may need to stop the loss of deposits, enter new
geographic or product markets, deliver services with cheaper and better technology,
increase their capital base, alter their tax position, reduce their risk profile, or cut operation
costs. In virtually every case, the intent is to improve their competitive position. The
external environment, evidenced by volatile economic conditions, new regulations and
technological developments, creates the opportunity for innovation

Innovation in delivery systems normally takes the form of new technological development
to facilitate funds transfers. Banks popularized ATMs and POS terminals in retail outlets.
More recent innovations include the development of debit cards, home banking networks
and Internet banking.

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

Different Roles Banks Play in the Economy

Intermediation Role

Transforming savings received primarily from households into credit (loans) for business
firms and others in order to make investments in new building, equipment and other goods
Payments Role

Carrying out payments for goods and services on behalf of customers (such as issuing
and clearing checks, wiring funds, providing a conduit for electronic payments, and
dispensing currency and coin
Guarantor Role

Standing behind their customers to pay off customer debts when those customers are
unable to pay (such as issuing letters of credit)
Risk Management Role

Assisting customers in preparing financially for the risk of loss to property and persons
Savings/Investment Advisor Role

Aiding customers in fulfilling their long-range goals for a better life by building, managing
and protecting savings
Agency Role

Acting on behalf of customers to manage and protect their property or issue and redeem
their securities (usually provided through a trust department)
Safekeeping/Certification of Value Role

Safeguarding a customer’s valuables and appraising and certifying their true market value
Policy Role

Serving as conduit for government policy in attempting to regulate the growth of the
economy and pursue social goals

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

Basic Principles of Banking

Principle of Liquidity

Deposits are the life blood of the bank. Depositors are repayable on demand or after
expiry of a certain period. Everyday depositors either deposit or withdraw cash. To meet
the demand for cash, all banks have to keep certain amount of cash in their custody.
Principle of Profitability

The driving force of commercial enterprise is to generate profit. So, it is true in case of
banks
Principle of Solvency

Banks should be financially sound and maintain a required capital for running the
business.

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

Principle of Safety

While investing the fund, banks are to be cautions because bank’s money is depositor’s
money. Unless the money lent out is safe, the banks can’t pay depositors money back.
Therefore, the banks are considering very seriously the aspects of safety of the lent-out
money.
Principle of Collection of Savings

This is a very important principle for today’s banking business. Banks always seek huge
amount of idle money from the clients. Now a day’s banks fix up the target for their
employees to generate more savings from the people.
Principle of Loan and Investment Policy

The main earning sources of banks are lending and investing money to the viable
projects. Banks always try to earn profit through sound investment.
Principle of Economy

Banks never go for any unnecessary expenditure. They always try to maintain their
functions with economy that increase their yearly profit.
Principle of Providing Services

Commercial bank thinks that customer service should be done efficiently and promptly. A
better service brings great reputation for the bank
Principle of Secrecy

Bank maintains and keeps the clients’ accounts secretly. Nobody except the authorized
person is allowed to see the accounts of the clients.
Principle of Modernization

It is the age of science and technology. So to cope up with the advanced world the bank
has to adopt modern technical services like online banking, credit card etc.
Principle of Specialization

It is an age of specialization. Banks segments their whole functions into various parts and
place their human resources according to their efficiency.
Principle of Location

Banks choose a suitable site where the availability of customers is large.

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

Principle of Relation

Banks always try to maintain a good relation with their clients and potential customers.
Principle of Publicity

It is an age of publicity. If you would like to earn more money, you have to give more
advertisement through various media. In that case, banks follow this kind of principle to
increase their customers.

Classifications of Banks

Banks are classified into the following subject to the power of the Monetary Board to
create other classes or kinds of banks:

 Universal banks (UBs)

 Commercial banks (KBs)
 Thrift banks (TBs), as defined in Republic Act (R.A.) No. 7906, which shall be
composed of: savings and mortgage banks, stock savings and loan associations,
and private development banks
 Rural banks (RBs)as defined in R.A. No. 7353
 Cooperative banks (Coop Banks)
 Islamic banks (IBs)
 Digital banks

Universal and commercial banks represent the largest single group, resource-wise, of
financial institutions in the country. They offer the widest variety of banking services
among financial institutions. In addition to the function of an ordinary commercial bank,
universal banks are also authorized to engage in underwriting and other functions of
investment houses, and to invest in equities of non-allied undertakings.
The thrift banking system is composed of savings and mortgage banks, private
development banks, stock savings and loan associations and microfinance thrift banks.
Thrift banks are engaged in accumulating savings of depositors and investing them. They
also provide short-term working capital and medium- and long-term financing to
businesses engaged in agriculture, services, industry and housing, and diversified
financial and allied services, and to their chosen markets and constituencies, especially
small- and medium- enterprises and individuals.

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 FIMA 101 BANKING AND FINANCIAL INSTITUTIONS
By: Assoc. Prof. Bernadette M. Panibio

Rural and cooperative banks are the more popular type of banks in the rural communities.
Their role is to promote and expand the rural economy in an orderly and effective manner
by providing the people in the rural communities with basic financial services. Rural and
cooperative banks help farmers through the stages of production, from buying seedlings
to marketing of their produce. Rural banks and cooperative banks are differentiated from
each other by ownership. While rural banks are privately owned and managed,
cooperative banks are organized/owned by cooperatives or federation of cooperatives.
Islamic Banks promote and accelerate socio-economic development by performing
banking, financing and investment operations and establish and participate in agricultural,
commercial and industrial ventures based on the Islamic concept of banking
Digital banks are the newest type of banks that offer broad range of financial services,
such as deposits, loans, payment services and money transfer, to the poor and low-
income households for their micro-enterprises and small businesses.

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