Chapter 1

AN OVERVIEW OF THE PHILIPPINE FINANCIAL SYSTEM

Every individual and business organization in a civilized society are directly involved in the financial system -a
complex structure and operation.
We use money in buying goods and services. We borrow money from banks, pawnshops or credit unions to satisfy
our needs. These are some of those activities very familiar to us because they are part of four daily activities and
observations.
However, the financial system does not only include banks, credit unions or pawnshops but also other financial
institutions like money markets, investment houses, financing companies, securities dealers, among others.
Likewise part of the whole financial system are those which have a tremendous influence in our economy such as
the World Bank, the International Monetary Fund, the Asian Devel- opment Bank, the transnational banks, the
Bangko Sentral ng Pilipinas, and other government agencies which are, in a way, associated with the laws affecting
money, credit and banking.
In a modern economy, the financial system is more sophisticated. It has a vast network of institutions with modern
facilities. Its policies and programs play a major role in the social and economic development of any country. This
proven by progressive financial centers of the world like New York, London, Singapore, and Hong Kong.
This chapter presents the nature, importance, elements and functions of the financial system. Also included are brief
discussions on the development and growth of the Philippine financial system, and the influence of the transnational
banks, the World Bank, the International Monetary Fund, and the Asian Development Bank in our financial setup.

Nature and Necessity of Finance

The financial system is a network of various institutions which generates, circulates, and controls money and credit.
It provides intermediation between the suppliers and users of credit. As an integral part of the economic system, it
provides loans to poor families, small producers, big busi nessmen, and industrialists. It further, stimulates the social
and economic development of the country. It is noted that the highly developed countries like the United States,
Japan, and those in Western Europe (Great Britain, France, and Germany) have become prosperous because of
the support of financial institutions during the initial stage of their industrial development.
These arises a need for financial institutions in a society where any individuals have surplus incomes. People with
excess incomes are inclined to place their extra funds in investments or productive projects. Other intend to lend
their money in order to earn interests. In a primitive economy, the lenders can directly deal with the borrowers in
transferring their savings. However, in a larger market, middlemen are needed to facilitate the meeting of lenders
and borrowers. But in a developed economy, specialists are needed to satisfy the business intereats of both
suppliers and users of funds. And this is primarily the job of financial institutions. There is no more need for the
lenders to deal personally with the borrowers. Both parties transact their business with financial institutions. This is
more convenient,economical, and safer for the lenders. From the point of economics, the transfer of funds from
lenders to borrowers, through financial institutions, creates several favorable effects in the economy. For instance,
such transfer of money can improve consumption pattern and resource allocation. People with surplus money which
they do not use for production have no positive contribution to society and the economy. But if these idle financial
resources are lent out to individuals without financial capital but with business inclinations, then such resources
become tools of production. These will create more employment, income, and consumption. Many other members of
society will be ben- efited. In the long run, these interdependent economic activities, together with their linkage
effects, simulate further economic growth for the whole economy.

Elements of the Financial System

1. Financial claims. These comprise the money and the rights to receive money under specific circumstances. Usu-
ally, these are evidenced by financial instruments which specify the terms of the claims. There are two broad
categories of claims: debts and equities. The latter conveys ownership rights while the former does not. The debtor
has an obligation to pay his loan plus interest. On the other hand equities are investments like shares of stock which
earn dividends,
2. Financial institutions. These are private or government organizations whose assets consist primarily of claims or
incomes primarily derived from dealing in and/or performing services in connection with claims. Institutions which
deal with the creation and issuance of claims against themselves, and use the proceeds to acquire and hold claims
against others, are commonly referred to as financial intermediaries. Such institutions act as middlemen between
suppliers and users of money. Some of these are familiar to us like commercial banks, savings and loan
associations, and finance companies. The unfamiliar ones are presented and explained in subsequent chapters of
this book.
Other financial institutions are primarily involved in services related to claims. They provide financial information and
advice, manage portfolios of financial assets on behalf of other economic units, buy and sell claims on instructions
from clients, and assist in finding sources for those economic units seeking loans. These and other services are
explained in details in subsequent chapters.
3. Financial markets. These are institutions which expe- dite transactions in financial claims. Examples are the
Manila Stock Exchange and other organizations dealing with money market operations. A financial market serves as
a means of bringing the forces of demand and supply of financial claims.
4. Government agencies. The Monetary Board is thepolicy-making body of the Bangko Sentral ng Pilipinas. Laws on
money, credit, and banking are legislated by the Congress and through executive orders issued by the President of
the Philippines. The role of the government agencies has at tremendous impact on the financial system. For
example,one very important goal of the Bangko Sentral is to attain internal and external stability of our peso.
5. Laws and policies. The national government regulates and supervises the behavior of the whole economy.
Hence, its control of the financial system is a vital condition for the whole economic behavior. Laws and policies
have been formulated to ensure the desired levels of investment, employment, production, income, and
consumption.

Specific Functions of Financial Institutions

The general function of financial institutions is to facilitate the transfer of funds from the savers to the users. To
transfer such savings to spenders, assistance is necessary because of the large volume of savings. Furthermore, in
a highly developed economy, certain barriers are created by individuals in the transfer of funds: risk, inconvenience
and cost of transfer, and the desire to avoid illiquidity.
Financial institutions perform certain specific functions such as:
1. Investigation and credit analysis. An individual who lends his money through a financial institution is assured of a
minimum risk. A careful investigation and credit analysis about the application of the borrower in conducted. This is
to ensure that the funds will be used efficiently by the borrower, and to protect the interests of both the lender and
the financial institution.
2 Matching the supply and demand for funds, Financial institutions perform a brokerage function. They bring the
fenders and borrowers together. They provide conveniently located offices to make things available and economical
for both parties. Some types of financial institutions purchase securities in large quantities and then sell these in
smaller lots. Financial institutions specialize in matching the supply of savings with the demand for funds.
3 Provisions for liquidity. Not a few savers are reluctant to lend their money to borrowers. They feel that they may
need cash prior to due date of payment. Or, in case they purchase bonds, they may not be able to find buyers when
they decide to liquidate their bondholdings. However, with the presence of financial institutions, the liquidity of finan-
cial assets can be increased. Through their brokerage function which provides an organized market, the investor
can find a buyer for his debt or ownership claims. Moreover, some financial institutions accept savings from
individuals who in return acquire claims against the assets of the financial institutions. In case a client of such
institution decides to liquidate his claim, the latter can pay its client with its current funds which it receives from other
savers.

Development of the Philippine Financial System

The first credit institutions established in the Philippines were the Obras plas which literally mean pious works.
These were started by Father Juan Fernandez de Leon in 1754. Their funds came from pious Catholics, together
with those who made their wills before undertaking dangerous expeditions. These institutions consisted of
foundations which invested their money in trade and channeled their profits to charitable works. Most of the obras
pias funds were lent out to traders to finance the Galleon Trade. Such credit institutions had been under the control
of the friars, and eventually became commercial banks or marine insurance companies.
The last of the obras pias came to an end in 1820. Ten years later, Francisco Rodriguez organized the Rodriguez
Bank. However, this was more of a loan association than a bank. Most of the clients of the bank were American and
British merchants. When the owner died, the bank's funda were turned over to the Queen of England.
The first Philippine bank. In 1851, the first Philippine bank was established. This was the Banco Español-Filipino de
Isabela II. Actually, the bank had been granted a charter in 1528. But it started transacting business when several
Philippine ports were opened to foreigners. Nevertheless,foreign trade outside Manila was not very substantial.
Thus,the bank handled mostly domestic transactions.
With the opening of Suez Canal in 1869. Philippine trade expanded. European markets became accessible to
Philippine producers and this induced the country's agricul tural development. The Banco Español-Filipino funded
crops for exports and established correspondent relations in Spain and France to help the European trade,
The growth of trade with Europe began to attract British capital to the Philippines. As a result, the Chartered Bank of
India, Australia, and China set up a Manila branch in 1873. Two years later, the Hong Kong and Shanghai Bank
also put up its branch in Manila. In 1883, both banks opened branches in Iloilo to finance the sugar industry.
The British banks dominated the economy during the Spanish colonial rule. Likewise, British merchants controlled
the economy. Their ships, connections with China and Europe, credit resources, and technique and machinery for
large scale crop production gave them an advantage over the other merchants from 1820s to 1900s. However,
Ameri- can business interests started to expand during this period.
In the case of Spain, it was able to put up the first savings bank in 1882 despite British domination in the banking
industry, This is Monte de Piedad. Its funds came from the obras pias. One year later, another Spanish bank, Banco
Peninsula de Ultramirano, set up a branch in Manila.
Financial institutions during American rule. At the time the United States acquired the Philippines in 1898 through
the Treaty of Paris, its business interests were not as strong as those of the British and Chinese. However, with
"free trade" between the United States and the Philippines as provided by the Payne-Aldrich Act of 1902, American
economic control in the Philippines substantially increased. In addition, the weakening of the British commercial
activities in Asia because of its involvement in World War I (1914-1918), gave the Americans the opportunity to
promote their business interests in the Philippines.
In 1902, the International Banking Corporation of New York set up an office in the country. However, in 1915 the
bank was acquired by the National City Bank of New York. At present this bank is one of the top five banks in the
United States and the whole world. It is now called the First National City Bank. Through the International Banking
Corporation, Americans were able to generate more business interests in the Philippines. Other branches of
American banks were established such as the Guaranty Trust and American Bank.
Other banks were organized such as the Postal Savings Bank in 1904, and the First Agricultural Bank of the
Philippine Government in 1906. However in 1916 the assets and liabilities of the agricultural bank transferred to the
newly-organized Philippine National Bank (PNB).The Catholic Church set up the Philippine Trust Co. in 1916 while a
group of Manila-based American businessmen established the People's Bank and Trust Co. in 1926.The Chinese
were likewise active in moneylending at very high interest rates. The Chinese banks were formed in the 1920 China
Banking Corporation in 1920 and the Mercantile Bank of China in 1926.
With the coming of the Japanese Imperial Forces in 1942, the PNB closed its doors. A few months later, the
Japanese occupation forces ordered the PNB to reopen for business, and it was supervised by Japanese military
advisers during the war years. The Southern Development Bank, a Japanese bank, put up a branch in the country
to perform the role of a central bank. War notes were then printed and circulated as money. This caused the worst
inflation so far in the country.
Postwar Financial Institutions
In 1946, the Rehabilitation Finance Corporation was established to provide credit facilities for the rehabilitation of
agriculture, commerce, and industry, and the reconstruc tion of war-damaged properties. Some years later, it
became the Development Bank of the Philippines.
Another very important milestone in the development of the Philippine financial system during this particular period
was the creation of the Central Bank of the Phil. ippines in 1948. Its operations, however, started the following year.
By 1947, there were four branches of foreign commercial thript banks in the country and seven local banks. Of these
seven local banks, only one was owned by Filipinos. Most of the non-commercial banks emerged after World War II
and during the 1960s up to 1970s. The rural banking system was organized in 1952. At the end of 1978, there were
thirtyfive commercial banks including the four branches of foreign banks with a nationwide network of 2,830 banking
units.
Structure of the Philippine Financial System
Bangko Sentral ng Pilipinas Banking Institutions
1. Private banking institutions
a. Commercial banking institutions
● expanded commercial banks/universal banks
● ordinary commercial banks
b. Thrift banks
● savings and mortgage banks p
● rivate development banks
● stock savings and loan associations
C. Rural banks
2. Government banking institution
a. Philippine National Bank
b. Development Bank of the Philippines
c.Land Bank of the Philippines
d. Philippine Amanah Bank
Non-Bank Financial Institutions
1. Private non-bank financial institutions
a. Investment houses
b. Investment companies
c. Financing companies
d. Securities dealers/brokers
e. Non-stock savings and loan associations non-Bank
f. Building and loan associations
g. Pawn Shops
h. Lending investors
i. Fund managers
j. Trust companies/departments
k. Insurance companies
1. Venture capital corporations
2. Government non-bank financial institution
a. Government Service Insurance System (GSIS)
b. Social Security System (SSS)