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After severe economic recession during the 1980’s the Bangko Sentral ng Pilipinas (Central Bank of the Philippines) has taken an ultra-conservative approach in regulating banks in the Philippines. The central bank’s regulatory standards are broadly in line and sometimes even exceed international best practices. In particular, the BSP has an accelerated implementation of Basel III with full adoption by January 2014, with a common equity Tier 1 and total Tier 1 of 6% and 7.5%, respectively. This is a full year earlier than recommended by the Basel III guidelines.

The Philippine economy proved comparatively well-equipped to weather the recent global financial crisis, partly as a result of the efforts to control the fiscal deficit, bringing down debt ratios, and adopting internationally-accepted banking sector capital adequacy standards. The Philippine banking sector – which makes up 80% of total financial system resources – had limited direct exposure to distressed financial institutions overseas, while conservative regulatory policies, including the prohibition of investments in structured products, shielded the insurance sector. However, there are several consequences to this conservative regulatory approach. The Philippines is considered one of the laggards in the Asia-Pacific region in the area of bank penetration, with only 26% of the working-age population having accounts with banks or other financial institutions.

Restrictive banking regulations and high intermediation costs make it less attractive for banks to lend to small and medium scale enterprises (SMEs). Thus, banks traditionally focus on the corporate segment, especially the larger companies with long credit histories. Philippine SMEs only source 6% of their externally sourced capital from banks. This is much lower than its regional counterparts, with Thailand at 50%, Malaysia at 36% and India at 20%.

Despite being neglected by the banking industry, SMEs still account for 99.6% of registered businesses in the Philippines. According to the Department of Trade and Industry, the SME sector generated 66.9% of jobs and 32% of all economic output of the country. Moreover, 60% of all exporters are SMEs and the sector also accounts for 25% of export revenue.

The boom in the SME sector has fueled the growth of finance companies in the Philippines. SME’s prefer to get funding from finance companies rather than banks due to much faster processing of loan applications. Finance companies can usually process loans in about 2 weeks as compared to banks, which take an average of 8 months.

Banks and finance companies basically offer the same financial services, except that finance companies provide these services without asking customer deposits but other securities seen as valid and secure. Finance companies operate under the rules of the Financing Company Act of 1998 (Republic Act No. 8556) and are regulated by the Securities and Exchange Commission (SEC). However, finance companies that are a subsidiary or affiliate of a bank are still under the regulation of the central bank.

McKinsey & Company describes in detail the opportunities for financing institutions in emerging markets in one of it’s recent banking practice reports (see link below):

Micro-small and medium-sized enterprises in emerging markets: how banks can grasp a $ 350 billion opportunity.