A PROJECT IN LEGAL WRITING AND RESEARCH “SHOULD PDIC EXAMINE BANK ACCOUNTS WHILE THEY ARE STILL ALIVE?” BY 2CLM VIRGILIO ANGELO GENER PAULEEN BERNADETTE RODRIGUEZ ANGELIQUE ASHLEY MARTIN MIKHAIL IVAN RAMOS JEROME MIRASOL MARK LESTER MAURICIO ROBERT SALAO PATRICK OSORIO JONA MARIE RAMOS MARK ANTHONY VILLANUEVA DAVID LAWRENZ OLIVER SAMONTE
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A PROJECT IN LEGAL WRITING AND RESEARCH
“SHOULD PDIC EXAMINE BANK ACCOUNTS WHILE THEY ARE STILL
ALIVE?”
BY 2CLM
VIRGILIO ANGELO GENER
PAULEEN BERNADETTE RODRIGUEZ
ANGELIQUE ASHLEY MARTIN
MIKHAIL IVAN RAMOS
JEROME MIRASOL
MARK LESTER MAURICIO
ROBERT SALAO
PATRICK OSORIO
JONA MARIE RAMOS
MARK ANTHONY VILLANUEVA
DAVID LAWRENZ OLIVER SAMONTE
I. The Overview of the Case
The Philippine Deposit Insurance Corporation
The Philippine Deposit Insurance Corporation (PDIC) is a government
corporation established in June 1963 under Republic Act (RA) 3591. PDIC's role as
envisioned by the Congress is to encourage savings in banks and draw idle funds into
the banking system, protect insured deposits in the event of bank closures, help
promote a sound and stable banking system, and foster public confidence in the
banking system. RA 3591 was last amended by RA 7400 in 1992 and it expanded
PDIC's authority and regulatory powers to include independent examination of banks.
The law also made PDIC the mandatory receiver/liquidator of banks ordered closed by
the Monetary Board. Furthermore, the power to grant financial assistance to banks in
danger of closing was also expanded to include assumption of liabilities in addition to
making deposits, the purchasing of assets or the making of a direct loan. The Law RA
7400 also increased the deposit insurance coverage from P40,000 to P100,000 per
depositor.
As a deposit insurer, PDIC collects semi-annual assessments from member-
banks (the current rate is 1/5 of 1% of total deposits) and it may terminate as well as
reinstate the insured status of banks under certain conditions. As co-regulator of the
banking system, PDIC conducts. In 2000, the enactment of the General Banking Act
repealed PDIC’s power to conduct independent examinations of banks offsite
examination of banks, it may issue cease and desist orders against banks following
unsafe and unsound banking practices, undertake failure resolution activities in
coordination with the Bangko Sentral ng Pilipinas (BSP); and provide financial
assistance to distressed banks.
The maximum deposit insurance coverage (MDIC) is P100,000 (roughly
US$1,905 at the present exchange rate of P52.50 : US$1) per depositor which fully
insures almost 25 million deposit accounts, representing about 92% of total deposit
accounts in the Philippine banking system (27.02 million). As of December 2002, total
insured deposits amounted to P445.5 billion out of P2.339 trillion of total deposits.
Likewise, as of year-end 2002, there were 909 insured banks consisting of 42
commercial banks, 94 thrift banks and 773 rural banks.
As a receiver/liquidator, PDIC takes control, manages and administers the affairs
of the closed bank, and determines whether the bank may be rehabilitated and resume
business with safety to its depositors, creditors and the general public; or its assets
liquidated. Prior to liquidating the assets of a closed bank, PDIC files with the relevant
court a petition for assistance in liquidation. PDIC converts the assets of the closed
bank into cash and makes a distribution of such cash and other assets to creditors of
the closed bank under the rules on concurrence and preference of credits specified by
the Civil Code of the Philippines.
PDIC is actively pursuing significant amendments to its Charter to strengthen
operational and financial capabilities in order to help it fulfill its mandates. These
include, among others, the proposed increase of the MDIC from P100,000 to P200,000
per depositor and the restoration of PDIC’s examination power. This will be done in
close coordination with BSP to effectively perform its role in protecting deposits through
effective supervision and monitoring of banks. Thus, it will complement the powers of
BSP and assist BSP in the early detection of problems of distressed banks to prevent
further deterioration and eventually, closures.
The PDIC, an independent government financial institution attached to the
Department of Finance, is governed by a five-member Board of Directors composed of
the Secretary of Finance as the ex-officio Chairman; PDIC President and CEO as Vice-
Chairman; the Governor of the central bank as an ex-officio member; and two
representatives from the private sector. The President of the Philippines appoints the
PDIC President and two private sector representatives for a term of six years.
The Functions and Powers of the Philippine Deposit Insurance Corporation
Bank Supervision and Examination
Prior to 1992, PDIC examined banks through joint missions with CBP only when
staff could be spared from the principal tasks of processing deposit claims. Following
the landmark case of a bank closed by CBP in the eighties and reopened by decision
and order of the Supreme Court, it was deemed prudent for PDIC to likewise undertake
independent examinations in the hope that similar findings by two instituted regulatory
agencies for bank closure would be difficult to challenge and be reversed in court.
Conscious of cost, efforts have been made to avoid unnecessary duplications in
examination activities of CBP through sharing of findings. With a lean staff, field
examinations by PDIC had to be limited, selected through offsite monitoring.
Findings of unsafe and unsound practices discussed with management of the
member bank are presented for deliberation of the PDIC Board. Confirmations of unsafe
and unsound findings are in turn referred to the CBP Monetary Board for follow up
actions. Corrective measures would be required by PDIC where appropriate. Financial
penalties can be imposed for non-compliance and also be basis for termination of
insured status.
Settlement of Deposit Claims
The closure of eight banks in 1968 not yet members of PDIC created a legal
dilemma for protection to uninsured depositors. This was resolved by Congress
appropriating special funds in 1969 of P15 million for payments of deposits in the closed
uninsured banks up to same limit of P10,000.00 per depositor per bank with payments
serviced by PDIC. Since then, membership became mandatory with first insured bank
closed in 1970. By mid-1998, over 339 member banks have been closed involving total
payments of P3.4 billion covering 1.16 million accounts.
Receivership and Liquidation
PDIC took on receivership and liquidation functions in 1981 with the transfer of
six rural banks from CBP and made mandatory receiver/liquidator for all banks in 1992.
Of the 339 member banks closed from 1970, PDIC currently manages 309 with the rest
either retained by CBP, rehabilitated or liquidation terminated. Of the closed banks
under PDIC, 282 are in liquidation with the balance of 27 still in receivership.
Financial Assistance to Distressed Banks
The Corporation is authorized to extend financial assistance to prevent closure
where continued operation of bank is either needed by a community or essential to
maintain financial stability. The assistance may be in the form of loans, deposit
placements, purchase of assets, or assumption of liabilities. In all cases, the assistance
must be less than cost of closure.
Assistance was first extended in 1970 to two thrift banks through loan and
deposit placement. Since then, 40 banks have benefited from such assistance of which
23 were through deposit placements, 16 in loan assistance, and one through purchase
of assets. The focus of assistance has shifted from closure prevention to rehabilitation
with emphasis on infusion of additional capital, correction of unsafe and unsound
practices, and change in ownership/management.
Termination of Insurance Status
Insured status of banks could be terminated by PDIC for failure to pay insurance
premium or for failure to correct unsafe and unsound practices. This power is intended
to enforce compliances and limit potential insurance losses likely to occur from
deteriorating financial condition without remedial measures taken.
The insurance status of 38 banks have been terminated for non-payment of
insurance premium. These were made possible through charter amendment in 1992
modifying the notification requirement for termination from receipt of notice by a bank
officer to the dispatch of notice by registered mail. Of the 38 uninsured banks, 15 have
been closed, 17 remain inoperative and inaccessible, located in a strife torn province
with the rest expected to be closed soon.
II. FINANCIAL RESOURCES
Sources of Funds
The principal sources of corporate funds are from capital infusion of government
in the form of a Permanent Insurance Fund (PIF) and incomes from insurance premium
assessments on member banks as well as from investments in government securities.
Borrowings from CBP supplement these resources.
The PIF authorized in 1963 for P5 million was paid-in by 1995. The amount was
increased gradually over the years to P2 billion by 1985 though not fully matched by
subscription payments. Consequently, even with assessment premium at the maximum
rate then authorized by law, resources were grossly inadequate to meet insurance
claims unleashed by a series of bank closures in the eighties. Only recourse was to
borrow from CBP with initial amount of P13 million in 1972 surging to P1.07 billion by
1985 and again to P2.75 billion by 1990. Authorized capital was subsequently raised to
P3 billion in 1992 fully paid by 1994.
Complementing capital increases to strengthen financial capacity of the
Corporation, the maximum annual rate for insurance premium assessed against total
deposits more than doubled from 1/12 to 1/5 of one percent. Premium collections
increased 186 percent in 1993 over the preceding year when the new rate was made
effective. Thereafter, collections paralleled strong deposit growth in the banking system,
accounting for 60 percent of corporate income in 1997 and a major source of reserve
provisioning against insurance losses.
Investments increased as debts were reduced with strengthening of capital and
greater collections in premium. Earnings from investment also became an important
source of income accounting for nearly 40 percent in 1997.
Deposit Insurance Fund
The deposit insurance fund (DIF) represents the consolidated resources
available to cover insurance claims from bank closures. The total DIF consists of the
government capital (PIF), provisions for insurance losses, and retained earnings. The
amount almost quadrupled over 6 years to nearly P16.0 billion by March 1998.
Provisions are set aside to cover for insurance losses arising from recoveries, from
banks closed or likely to close, inadequate to cover insured deposits paid (subrogated
claims) or to be paid.
The build up in DIF kept pace with growth in total deposits and ahead of insured
deposits following enhancement of capital and assessment income in 1992. This is
reflected in the percentage of DIF to total deposit increased slightly from 0.8 percent in
1992 to near 1.0 percent by March 1998, compared to the significant change in
percentage of DIF to insured deposit from 2.3 percent in 1992 to 5.0 percent in the
same period.
Deposit Insurance Fund and Deposit Liabilities
(In Million Pesos)
1992 1997 19981
Permanent Insurance Fund 1,973 3,000 3,000
Provision for Losses 2,025 12,092 12,747
Retained Earnings 127 228 228
Total DIF 4,125 15,320 15,975
Insured Deposits 179,618 315,137 311,612
Total Deposits 492,190 1,655,212 1,609,177
Insured/Total Deposits 36.5% 19.0% 19.4%
DIF/Insured Deposits 2.3% 4.9% 5.1%
DIF/Total Deposits 0.8% 0.9% 1.0%
Claims on Insured Deposit
From inception of PDIC, the maximum deposit amount for insurance cover increased tenfold
to P100,000.00 per depositor per bank. Following adjustments in maximum cover, percentage of
insured deposits to total deposits surged with peak of 48.3 percent in 1984 and 36.5 percent in 1992.
These tapered down following each adjustment to 19.4 percent by yearend 1997.
With size of deposit accounts in commercial banks generally larger, the percentage of
insured to total deposits is conversely lower at 17 percent compared to thrift and rural banks where
higher percentage of insured deposits of 32 percent and 63 percent were conversely related to
smaller size of deposit accounts with them.
Total Deposit Liabilities by Type of Bank, 19983
(In Million Pesos)
Total Insured %
Commercial 1,442,449 246,592 17
Thrift 130,033 41,884 32
Rural 36,695 23,136 63
Total 1,609,177 311,612
Of the 339 banks closed from the seventies, six were commercial banks, 44 thrift
banks, and 280 rural banks. Actual payments of insured deposits have reached P3.4
billion this year.
Total deposit liabilities in closed banks cumulated to P5.6 billion by 1998, about 0.35 percent
of total deposits in the banking system. Of these deposits, 44.4 percent were from commercial
banks, 41.4 percent from thrift banks, and 14.2 percent from rural banks.
Number and Deposit Liabilities of Closed Banks
(1970 - 19984)
Number Deposits %
Commercial 6 2,514 44.4
Thrift 44 2,340 41.4
Rural 289 803 14.2
Total 339 5,657 100
On an annual basis, however, deposits in bank closures averaged 0.12 percent
of the total deposits in the banking system from 1970 to 1997. The highest rate
registered was in 1985 at 1.26% of total deposits that year following major bank
closures. In December 1997, this was at 0.007 percent.
III. ISSUES AND DIRECTIONS
Rationale for Deposit Insurance System
The deposit insurance system can be rationalized on social policy grounds to
provide protection to those least able to protect themselves. This is premised on the
implicit assumption that the less affluent save less, often with severe limitations in
access to information on conditions of banks and no knowledge of attendant risks. Their
choice of bank is primarily determined by convenience of access with hardly any
thought on risk. The asymmetry in knowledge between the more affluent and the poorer
savers justifies a protection system with limit on maximum insurance cover. The state,
in licensing banks with the privilege of taking deposits from the public, and in
supervising them to promote safe and sound banking, has responsibility to provide
safeguards against risk beyond the knowledge of the less affluent.
Confidence in banking system is another consideration for a deposit insurance
system. This has been advanced to either build up confidence or restore such in the
banks.
In systems with high degree of disclosure and ready access to banking
information for the public, deposit insurance may not be necessary. This in turn require
a high level of literacy in the population. Greater disclosure on routine basis will enable
individuals to act in the market place and instigate timely corrective actions. This will
minimize risk of failure and thus diminish need for an insurance system.
Moral Hazard
Moral hazard is a basic issue that has to be addressed in deposit insurance.
Absence of a deposit insurance system does not preclude bail-outs by governments
that can turn out more costly. In coping with the Asian currency crisis, some
governments were impelled by concerns over possible collapse of their banking system
to underwrite the cost of paying not only depositors but other creditors of distressed
banks. The solution, of course, does not lie in an insurance system alone but in the
broader strengthening of regulation and supervision over banks through enforcement of
sound practices.
Full insurance cover takes away incentives for depositors to ascertain for
themselves the condition of the bank and the risk of closure. This can be mitigated by
providing partial cover either on pro-rata basis or by limiting amount insured. Pro-rata
sharing is not in full accord with the social policy of maximum protection for the lower
income group. Introducing a cap on a pro-rata structure merely complicates calculation
and determination of amounts to pay. A ceiling on maximum amount is simple and
practical though the level to be set and periodic adjustments required remain a
challenge for all partial insurance systems.
Sources of Financing
Ideally, the insurance system should be funded solely by member banks as the
beneficiaries of the system. Budgetary appropriation passes on cost of the insurance
system to others who may not be direct beneficiaries of depositing with banks and thus,
less preferred.
Government assistance could be through loans or guaranty to enhance access to
capital markets on most advantageous term.
Philippines has a mixed system with permanent insurance fund from government
and insurance premium collected from all member banks, in contrast to US and Canada
where initial advances by the respective governments have apparently been fully
repaid. The cost of insurance is now entirely borne by banks through premium
collections levied against their insured deposits. Nevertheless, special appropriations
were made in the past to cover cost of major bank failures.
Insurance premium should be the main source of funding and can be levied
against insured deposit only or against total deposits, with the latter providing a stronger
base of income.
Treatment of public funds
Deposits of government in banks are treated differently for deposit insurance
purposes by different governments. In Canada, funds of the federal government are
categorized as crown properties with preferred priority in liquidation. Deposits of the
central government are not insured and thus assessed no premium. In the US, federal
funds deposited in banks are apparently required to be secured by liens on bank assets.
In the process, government deposits acquire superior credit status and forgo insurance
cover with no insurance premium charged either.
Philippine government deposits in banks have status of regular deposits despite
preference accorded taxes in liquidation settlement. Government deposits are thus
insured with premium collections significantly greater than amount of insurance cover.
The large differential between premium collected on government deposits in banks over
the maximum amount of insurance provides a large annual subsidy from deposits of
government to the non-government sector.
Access to information
A deposit insurer must have access to all bank records in order to assess risks
properly and determine the adequacy of the Insurance Fund. Since payments will be
based on deposit accounts, these records must be routinely available for insurer to
examine to foster correct and timely entries. Good records will enable prompt servicing
of deposit claims and facilitate resolution of failed banks.
The effectiveness of the corporation as an insurer is severely compromised by
the law on secrecy of deposits that bars examiners from auditing deposit accounts.
Deposit records are available to PDIC only upon closure of bank. Invariably, the records
of closed banks are in poor state, requiring tedious verification of accounts and
protracted processing of claims delaying payments to detriment of depositors. In some
cases, deposit claims were made by court order despite absence of entries in the books
of the bank.
Any restrictions on access of supervisors to bank records will impair their ability
to enforce sound and safe banking practices. Prompt corrective actions will be
hampered with implications on greater cost in resolution of failed banks.
The best protection for depositors is knowledge of the true condition of the banks
through timely and accurate reports and disclosures. A principal thrust of supervision
should therefore be greater transparency with more information disclosed to the public.
In this regard, audit firms of banks should bear responsibilities including accountability
for deficiencies in their audited reports. They can be mobilized to strengthen supervision
by requiring submission of their material findings on banks to regulators.
Power to terminate insurance
The insurer should have the power to terminate insurance of banks to enforce
compliance and minimize insurance losses. This will unfortunately deprive depositors of
recourse to the insurer and rely solely on recovery of their deposits from assets of failed
bank.
Insurance cover of a member bank in PDIC can be terminated for non-payment
of premium or for violation of cease and desist order. Deposits as of termination date
remain insured for ninety days. If the bank is not closed by the Monetary Board* within
this ninety day period, only recourse of depositor will be to the bank not PDIC, the
insurer. On the other hand, without the power to terminate insurance, the bank can
continue to attract deposits with high interest, ultimately to be borne by the insurer.
Prompt servicing of insurance claims
The effectiveness of deposit insurance in sustaining confidence in the banking
system is enhanced by prompt payments of insured deposit claims. This depends on
good state of deposit records to facilitate processing. Insurer should have ready
resources and flexibility in payoff operations to expedite payments at convenience of
depositors.
Least cost resolution and systemic risk
The guiding principle for assistance is least cost resolution where cost of
assistance is less than cost of closure. The determination of such cost can be complex
where information is poor, aggravated by forbearances in supervision. On the other
hand, least cost resolution may not adequately address systemic concerns where
closure may be destabilizing to the system. In the Philippines, assistance beyond least
cost from PDIC were provided by CBP to cover the amount required for bank
rehabilitation.
Adequacy of the insurance fund
Determination of the appropriate amount of reserve provisioning for insurance
losses is complex in the absence of necessary database suitable for actuarial analysis.
Failure experiences vary in different countries with insurers evolving ways to determine
amount deemed appropriate for their own circumstances. The US, for instance, has a
bank insurance fund and a savings insurance fund prescribed by law to be a percentage
of deposits in different bank group. PDIC evolved from setting aside 95% of corporate
income to build up the deposit insurance fund and developed a framework for
approximating possible insurance losses by relating failure probabilities to capital
adequacy measures with adjustments for possible recoveries from closed banks.
Receivership and liquidation
Receivership and liquidation functions are not well developed in emerging
economies. Undeveloped legal framework, poor records of closed banks, nascent stage
of judicial experience and absence of market specialists in this field have hobbled
progress in receivership/liquidation work.
The Philippine experience in the management of bank receivership/liquidation by
public entities like the CBP and now the PDIC argues for development of capacity in the
private sector to carry out such functions. This will avoid subjecting the process of
receivership and liquidation to the rigors of public auditing standards enforced by
government Commission on Audit on accountability of public funds. Rigidities in
government audit rules severely restrict capacity to compromise on collections of loans,
negotiated sales for early disposal of assets routinely entered into in private transaction
to terminate liquidation soonest. The government rules preclude early termination of
liquidation with toll on deterioration in asset quality and exclusion from economic use.
II. The Ratio Decidendi of the Supreme Court Jurisprudence