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NOTES FINMAN 4C

General Banking Law


Prepared by: Roma De Guzman
GBL - Enacted into law on May 23, 2000 under Republic Act 8791 also known as
General Banking Law of 2000.
Banks - entities engaged in the lending of funds obtained in the form of deposits. (Sec.
3.1, RA 8791.
Quasi Bank - refers to entities engaged in the borrowing of funds through the issuance,
endorsement or assignment with recourse or acceptance of deposit substitutes.
Types of Banks
A.

Universal Banks - A universal bank has the same powers as a commercial bank
with the following additional powers: the powers of:
1. Investment House as provided in existing laws - An Investment House is an
enterprise engaged in guaranteed underwriting of securities of another person or
enterprise, including securities of government and its instrumentalities.
2. Power to invest in non-allied and allied enterprises.
Rules for equity investments of Universal Banks in allied and non allied enterprises:
1.
The total investment in equities of allied and non allied enterprises should not
exceed 50% of the net worth of the bank.
2.
The equity investment in any one enterprise, whether allied or non allied,
should not exceed 25% of the net work of the bank.
Rules for equity investments of Universal Banks in Financial allied enterprises
1.
A universal bank can own up to 100% of the equity in a thrift bank, a rural bank
or a financial allied enterprise.
2.
A publicly listed universal bank of commercial bank may own up to 100% of the
voting stock of only 1 other universal or commercial bank.
Rules of equity investments of Universal bank in Non allied enterprises
1.
A universal bank may own up to 100% of the equity in a non financial allied
enterprise.
2.
The equity investment of a universal bank in a single non allied enterprise shall
not exceed 35 % of the total equity or the voting stock in that enterprise.
B.

Commercial banks - In addition to having the powers of a thrift bank, a


commercial bank has the power to accept drafts and issue letters of credit; discount
and negotiate promissory notes, drafts, bills of exchange, and other evidences of debt;
accept or create demand deposits; receive other types of deposits and deposit
substitutes; buy and sell foreign exchange and gold or silver bullion; acquire
marketable bonds and other debt securities; and extend credit.

Rules for equity investments of Commercial Banks in allied and non financial allied
enterprises:
1.
The total investment in equities of allied and non allied enterprises should not
exceed 35% of the net worth of the bank.
2.
The equity investment in any one enterprise, should not exceed 25% of the net
work of the bank.
3.
A commercial bank may own up to 100% of the equity of a thrift bank or a rural
bank.
4.
For equity investment in other financial allied enterprises, including another
commercial bank, they are only allowed a minority holding in that enterprise.
5.
A commercial bank may own up to 100% of equity in non financial allied
enterprise.
C.

Thrift Banks - A thrift bank has the power to accept savings and time deposits, act
as a correspondent with other financial institutions and as a collection agent for
government entities, issue mortgages, engage in real estate transactions and extend
credit. In addition, thrift banks may also maintain checking accounts, act as a
depository for government entities and local government units and engage in quasibanking and money market operations subject to the approval of the Bangko Sentral.
As per the banker Derrick Low, thrift banks are generally smaller in scale than
universal and commercial banks.
Three Types of Thrift Banks:
1. Savings and Mortgage Banks
2. Stock Savings and Loans Association
3. Private Development Banks

D.

Rural Banks - A rural bank has the power to provide adequate credit facilities to
farmers and merchants or to cooperatives of such farmers and merchants and, in
general, to the people of the rural communities of which the rural bank operates in.
Usually, Rural banks are privately owned and managed.

E.

Cooperative Banks - Similar to Rural Banks, Cooperatives promotes and


expands the rural economy in an orderly and effective manner by providing the
people in the rural communities with basic financial services. They help farmermember through the stages of production, from buying seedlings to marketing of
their produce. Cooperatives are organized primarily by cooperatives or federation of
cooperatives.

F.

Specialized Government Banks

G.

Other Classifications
Authority Given to BSP under the GBL:

A. Supervisory Powers of the Bangko Sentral ng Pilipinas


1.
2.
3.

Issuance of rules of conduct or establishment of standards of operations of banks


Examination of banks
Oversight on all banks, in particular, compliance of all rules and standards
issued
4.
Regular Annual Audit
5.
Solvency and Liquidity Inquiry of the institution
6.
Enforcement of corrective action
B.

Policy Direction - Under this power, the BSP is allowed to prescribe ratios,
ceilings, limitations or other forms of regulation on the different types of accounts
and practices of banks and quasi banks in conformity with internationally accepted
standards and Bank International Settlements or BIS.

C.

Authority to give Authority to Financial Institution to Engage in Banking and


Quais Banking Functions - No person or entity shall engage in Banking operations
or Quasi-banking Operations without authority from the BSP. The Authority given
includes the right to revoke, suspend or annul the authority on case there is a need to
do so.

D.

Examination by the BSP - BSP has the authority to examine the bank itself and
likewise, any enterprise wholly or majority-owned or controlled by the bank.
Requisites in Organizing Banks or Quasi-Banks:

1.
2.
3.
4.

Entity must be a Stock Corporation


The funds obtained must come from twenty (20) or more persons.
That the minimum capital requirement for each category of bank is satisfied.
Must be able to present Articles of Incorporation, By Laws, accompanied by a
Certificate of Authority issued by the MB, under its seal. (Sec 14, 8791)
Continuing Management and Administration
Rules/Prohibitions/Limitations for Banks

1.

MB may prescribe its own rules on the type of stock that a bank may issue but all
stock issues must be par value stocks. (Sec. 9, RA 8791)
2.
Banks are prohibited from acquiring its own shares as security for a loan. (Sec.
10, RA 8791)
3.
Foreign - Domestic Stockholdings must be 40-60. (follow the control test but
supplement it with the grandfather rule) ( Sec. 11, RA 8791)
4.
Disclosure of Stockholdings of family groups and/or related interests. (Sec. 13,
15 RA 8791)

5.

There must be a least 5-15 Board of Directors of banks, 2 of whom shall be


independent directors. (Sec. 15, RA 8791)
6.
Fit and Proper Rule. - The MB may prescribe, pass upon and review the
qualifications and disqualifications of individuals elected or appointed bank directors
or officers and disqualify those found unfit. It even has the power, subject to due
notice to bank board of directors, to disqualify, suspend or remove bank directors or
officers who commits or omits any act which render him UNFIT for the position.
Unfitness may refer to the directors or officers integrity, experience, education,
training and competence. (Sec 16., 8791)
7.
Compensation and other benefits of Directors and Officers may be regulated by
the MB only in exceptional cases such as when ban is under
comptrollership/conservatorship, the bank is conducting business in an
unsafe/unsound manner or when bank is found to have unsatisfactory financial
condition. (Sec 18, RA8791)
8.
Public Officials are prohibited from serving as an officer of any private bank
except if service is incident to financial assistance of a GOCC or when provided for
under existing laws. (Sec 19, RA 8791)
9.
Single Borrowers Limit - the total amount of loan, credit accommodations and
guarantees that may be extended to any person, partnership, association, corporation
or entity shall not exceed 20% of the net worth of such bank.
10.
Know Your Client Rule
11.
Other Banking services Include:
-Receive in custody funds, documents and valuable objects;
-Act as financial agent and buy and sell, by order of and for the account of their
customers, shares, evidences of indebtedness and all types of securities
-Make collections and payments for the account of others and perform such other
services for their customers as are not incompatible with banking business;
-Upon prior approval of the Monetary Board, act as managing agent, adviser,
consultant or administrator of investment management/advisory/consultancy accounts
-Rent out safety deposit boxes.
12.
A bank cannot directly engage in insurance business as the insurer.
Prohibited Transactions:
I.
a.

No director, officer, employee, or agent of any bank shall


Make false entries in any bank report or statement or participate in any
fraudulent transaction, thereby affecting the financial interest of, or causing damage
to, the bank or any person;
b.
Without order of a court of competent jurisdiction, disclose to any unauthorized
person any information relative to the funds or properties in the custody of the bank
belonging to private individuals, corporations, or any other entity: Provided, That
with respect to bank deposits, the provisions of existing laws shall prevail;
c.
Accept gifts, fees or commissions or any other form of remuneration in
connection with the approval of a loan or other credit accommodation from said bank;
d.
Overvalue or aid in overvaluing any security for the purpose of influencing in any
way the actions of the bank or any bank; or

e.

Outsource inherent banking functions.

II. No borrower of a bank shall


a.
Fraudulently overvalue property offered as security for a loan or other credit
accommodation from the bank;
b.
Furnish false or make misrepresentation or suppression of material facts for the
purpose of obtaining, renewing, or increasing a loan or other credit accommodation or
extending the period thereof;
c.
Attempt to defraud the said bank in the event of a court action to recover a loan
or other credit accommodation; or
d.
Offer any director, officer, employee or agent of a bank any gift, fee, commission,
or any other form of compensation in order to influence such persons into approving a
loan or other credit accommodation application.
III. No examiner, officer or employee of the Bangko Sentral or of any department,
bureau, office, branch or agency of the Government that is assigned to supervise,
examine, assist or render technical assistance to any bank shall commit any of the acts
enumerated in this Section or aid in the commission of the same.

Whatisliquidityatabank?
Liquidityatabankisameasureofitsabilitytoreadilyfindthecashitmayneedtomeet
demandsuponit.Liquiditycancomefromdirectcashholdingsincurrencyoronaccountatthe
FederalReserveorothercentralbank.Morecommonlyitcomesfromholdingsecuritiesthatcan
besoldquicklywithminimalloss.Thistypicallymeanshighlycreditworthysecurities,including
governmentbills,whichhaveshorttermmaturities.Indeediftheirmaturityisshortenoughthe
bankmaysimplywaitforthemtoreturntheprincipalatmaturity.Shortterm,verysafe
securitiesalsotendtotradeinliquidmarkets,meaningthatlargevolumescanbesoldwithout
movingpricestoomuchandwithlowtransactioncosts(usuallybasedonabid/askspread
betweenthepricedealerswillpaytobuythebidandthatatwhichtheywillselltheask.)
However,abanksliquiditysituation,particularlyinacrisis,willbeaffectedbymuch
morethanjustthisreserveofcashandhighlyliquidsecurities.Thematurityofitslessliquid
assetswillalsomatter,sincesomeofthemmaymaturebeforethecashcrunchpasses,thereby
providinganadditionalsourceoffunds.Ortheymaybesold,eventhoughthisincursa
potentiallysubstantiallossinafiresalesituationwherethebankmusttakewhateverpriceitcan
get.Ontheotherside,banksoftenhavecontingentcommitmentstopayoutcash,particularly
throughlinesofcreditofferedtoitsretailandbusinesscustomers.(Ahomeequitylineisaretail
example,whilemanybusinesseshavelinesofcreditthatallowthemtoborrowwithinsetlimits

atanytime.)Ofcourse,thebiggestcontingentcommitmentinmostcasesistherequirementto
paybackdemanddepositsatanytimethatthedepositorwants.
Whydowecareaboutit?
Wecareaboutbankliquiditylevelsbecausebanksareimportanttothefinancialsystem
andtheyareinherentlyfragileiftheydonothavesufficientsafetymargins.Therecentfinancial
crisisdemonstratedinextremeformtheharmthataneconomycansufferwhencreditdriesupin
acrisis.Capitalisarguablythemostimportantsafetybuffer,sinceitprovidestheresourcesto
recoverfromsubstantiallossesofanynatureandalsogivesthosedealingwiththebank
confidenceinitssafety.
However,theproximatecauseofabanksdemiseisusuallyaliquidityproblemthat
makesitimpossibletosurviveaclassicbankrunor,nowadays,amodernequivalent,suchas
aninabilitytoaccessthedebtmarketsfornewfunding.Itisentirelypossiblefortheeconomic
valueofabanksassetstobemorethansufficienttocoverallofitsclaimsandyetforthatbank
togobustbecauseitsassetsareilliquidanditsliabilitieshaveshorttermmaturities.
Whyarebankspronetoruns?
Bankshavealwaysbeenpronetorunsbecauseoneoftheirprinciplesocialpurposesisto
performmaturitytransformation,alsoknownastimeintermediation.Inotherwords,theytake
demanddepositsandothershorttermfundsandlendthembackoutatlongermaturities.
Maturitytransformationisusefulbecausehouseholdsandbusinessesoftenhaveastrong
preferenceforasubstantialdegreeofliquidity,yetmuchoftheusefulactivityintheeconomy
requiresassuredfundingformultipleyears.
Bankssquarethiscirclebyrelyingonthefactthathouseholdsandfirmsseldomtake
advantageoftheliquiditytheyhaveobtained.Inparticular,depositsaresticky.Demand
depositscantheoreticallyallbewithdrawninasingleday,yettheiraveragebalancesshow
remarkablestabilityinnormaltimes.Therefore,bankscanlendoutthefundsforlongerperiods
withafairdegreeofassurancethatthedepositswillremainavailableorthatequivalentdeposits
canbeobtainedfromothersasneeded,perhapswithamodestboostindepositrates.
Theproblemisthatsometimesdepositorsloseconfidenceinabank,orinthebanking
system,andwithdrawtheirfundsenmasse.Thisistheclassicbankrunthathaskilledmanya
bankoverthecenturies.Theonlysurewaytocounterabankrunistorestoreconfidence,asno
bankthatengagesinanormallevelofmaturitytransformationcansurviveabankrununaided.
Asdiscussedbelow,thereismuchthatacentralbankcandotoaidwithliquiditycrises,butthere
arelimitstowhatcanbeaccomplished.
Therisksofdepositrunsaregreatenough,andhavebeendemonstratedoftenenough,
thatvirtuallyallcountrieshaveanationalsystemofdepositinsurance.Theseguaranteethatbank
depositorswillnotlosetheirfunds,uptocertainspecifiedamounts(currently$250,000inthe
US)andsometimeswithlimitsonwhatentitiesareinsured,sothatbanks,forexample,maynot
haveinsuranceontheirdepositsinotherbanks.
Depositinsuranceisaveryimportantprotectionagainstbankruns,whichtherefore
reducestheneedforbankliquidity,butdoesnoteliminateit.However,itisimportanttonote
thatmodernbanksoftenrelytoasignificantextentonshorttermborrowingsinthecapital

markets,sothatarundoesnothavetoinvolvedepositors,ornotsolelydepositors,inorderto
becomeaseriousproblem.
Theinabilitytorolloverdebtthroughnewsecuritiesissuanceshasasimilareffectto
depositwithdrawals.Therecentfinancialcrisisdemonstratedthis,sinceveryfewbanks
experienceddepositruns,yetthisdidnoteliminateliquidityproblems.Largebankinggroups
thatengageinsubstantialcapitalmarketsbusinesseshaveconsiderableaddedcomplexityintheir
liquidityneeds,inordertosupportrepobusinesses,derivativestransactions,primebrokerage,
andotheractivities.
Howcanbanksachieveadequateliquidity?
Bankscanincreasetheirliquidityinmultipleways,eachofwhichordinarilyhasacost,
including:
Shortenassetmaturities

Improvetheaverageliquidityofassets

Lengthenliabilitymaturities

Issuemoreequity

Reducecontingentcommitments

Obtainliquidityprotection

Shortenassetmaturities.
Thiscanhelpintwofundamentalways.
First,ifthematurityofsomeassetsisshortenedbyenoughthattheymatureduringtheperiodof
acashcrunch,thenthereisadirectbenefit.
Second,shortermaturityassetsgenerallyaremoreliquid.
Improvetheaverageliquidityofassets.Assetsthatwillmaturebeyondthetimehorizonofan
actualorpotentialcashcrunchcanstillbeimportantprovidersofliquidity,iftheycanbesoldin
atimelymannerwithoutanexcessiveloss.Therearemanywaysthatbankscanimproveasset
liquidity.Securitiesarenormallymoreliquidthanloansandotherassets,althoughsomelarge
loansarenowdesignedtoberelativelyeasytosellonthewholesalemarkets,sothisisamatter
ofdegreeandnotanabsolutestatement.Shortermaturityassetsareusuallymoreliquidthan
longerones.Securitiesthatareissuedinlargevolumeandbylargecompaniesgenerallyhave
greaterliquidity,asdomorecreditworthysecurities.
Lengthenliabilitymaturities.Thelongertermaliability,thelesslikelythatitwillmaturewhile
abankisstillinacashcrunch.
Issuemoreequity.Commonstockisroughlyequivalenttoabondwithaperpetualmaturity,with
theaddedadvantagethatnointerestorsimilarperiodicpaymentshavetobemade.(Dividends
arenormallypaidonlyoutofprofitsandarediscretionary.)
Reducecontingentcommitments.Cuttingbackthevolumeoflinesofcreditandothercontingent
commitmentstopayoutcashinthefuturereducesthepotentialoutflows,therebyimprovingthe
balanceofsourcesandusesofcash.

Obtainliquidityprotection.Abankcanpayanotherbankoraninsurer,orinsomecasesacentral
bank,toguaranteetheavailabilityofcashinthefuture,ifneeded.Forexample,abankcouldpay
foralineofcreditfromanotherbank.Insomecountries,bankshaveassetsprepositionedwith
theircentralbankthatcanbeusedascollateraltoborrowcashinacrisis.
Allofthesetechniqueshaveanetcostinnormaltimes.Financialmarketsusuallyhavean
upwardslopingyieldcurve,meaningthatinterestratesarehigherforlongertermsecuritiesthan
theyareforshortertermones.Thisissooftenthecasethatsuchacurveiscalledanormalyield
curveandtheexceptionalperiodsarereferredtoasshowinginverseyieldcurves.Whenthe
yieldcurvehasanupwardslope,shorteningassetmaturitiesdecreasesinvestmentincomewhile
lengtheningliabilitymaturitiesraisesinterestexpense.Similarly,moreliquidinstrumentshave
loweryields,allelseequal,reducinginvestmentincome.Equity,foritspart,ismoreexpensive
thandebt1,and1TheModiglianiMillertheoremoffinanceholdsthat,underidealized
conditions,holdingmoreequityreducesthecostofeachunitofequityanddebtbyenoughto
exactlycounterthehighercostofequityversusdebt.However,thereareavarietyofreasons
whythisdoesnotholdtothefullextentinpractice,includingthetaxadvantagesthatbanksand
otherfirmsreceiveonpaymentsofinterest,butnotofstockdividends.Therefore,thenetcostof
equitydoesexceedthatofdebtforthebank.5liquidityprotectionnormallycomesatacost,
althoughsomecentralbankfacilitiesmayhavelittleornocostuntildrawndown.
Howmuchliquidityisenough?
Sinceliquiditycomesatacost,abankfacesatradeoffbetweenthesafetyofgreaterliquidity
andtheexpenseofobtainingit.Thismakesitdifficulttoanswerthequestionofhowmuch
liquidityisenough.Worseningthedifficultyisthecomplexityofthefinancialsystemandthe
challengeofpredictingitsfuturestateandthereforetheprobabilityandseverityoffuturecash
crunches.Bankstrytoensurethattheyhavesufficientliquiditytomeetallrelevantregulatory
requirements,plusabuffertoreducethelikelihoodthatliquidityfallsbelowthesethresholdsand
triggersaregulatoryormarketresponseorcreatesconstraintsonthebanksactions.Inasimilar
way,theytrytoensurethattheyhavesufficientliquiditytoavoidadowngradefromthecredit
ratingagenciestoalevelbelowthebankstargetrating,althoughtherealwaysremainsthe
optionofacceptingalowerrating.Moresophisticatedbanksalsotrytoholdtheprobabilityofa
cripplingliquiditycrisistobelowsomefractionofapercenteachyear,basedontheirinternal
modeling