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While implementing these structural reforms requires amendments to laws and will take time, some action can be undertaken immediately. Besides, the purchase and assumption (P&A) tool should be expanded. Also, the resolution toolkit should be broadened beyond liquidation and possibly with a statutory bail-in tool. The Philippine Deposit Insurance Corporation (PDIC) should be designated and given powers to act as the resolution authority. The downside risks to the banking system also underscore the importance of further strengthening the bank resolution framework. Instead, the authorities should continue to use the flexibility of the tools available in the accounting and Basel capital framework, and, looking at the future, further develop and use macroprudential tools and buffers. Forbearance does not address the underlying issues in weak banks and hampers banks’ ability to continue providing credit and ultimately may even undermine financial stability. The BSP should allow the forbearance measures to lapse as scheduled and avoid introducing new measures. This is supported by a counterfactual policy analysis and the experience after the AFC, which suggest that such actions could improve GDP with sustained credit provision. If downside risks materialize, banks should recognize NPLs and restructure them promptly with additional capital as needed. Given the potential for large loan losses, the authorities should limit banks’ dividend distributions as a precautionary measure. Given the significant downside risks, the authorities should limit bank dividend distributions, and be ready to take additional measures to strengthen banks’ capital if the risks materialize. Moreover, conservative behavioral assumptions (e.g., deleveraging among others) in FSAPs tend to yield larger solvency impacts during a severe crisis. The results should be interpreted cautiously given the economic and model uncertainties.
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However, CARs start to recover in 2022 as the economy recovers.
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The second-round effects from such distress might reduce the real GDP level by an additional 4 to 9 percentage points in adverse scenarios. However, CAR falls to 9.3 percent in the adverse scenario, and 4.9 percent in the severe adverse scenarios. In the baseline, banks’ total capital adequacy ratio (CAR) falls from 15.6 percent to 11.7 percent by 2022, still above the ten percent minimum requirement even without sectoral policy effects. Distress to the corporate sector could be widespread even in the baseline and sharply rise in adverse scenarios, elevating credit risks to banks. While banks can withstand the exceptionally severe shocks in the baseline, they could experience a systemic solvency impact if additional downside risks materialize. With policy support and easing of containment measures, the economy started to recover in the second half of 2020 and is expected to grow 6½ percent in 2021. The authorities took various measures, including time-bound regulatory relief and forbearance measures, though the scale of loan moratoria and credit guarantees has been relatively limited. The economy had solid macro-fundamentals before COVID-19 thanks to policy efforts, but the pandemic turned out to be an extreme tail shock. GDP contracted by 9½ percent in 2020-a much sharper decline than during the Asian Financial Crisis (AFC). The immediate risk to financial stability is from the impact of COVID-19.
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Banks are tightly interlinked with nonfinancial corporates (NFCs) through conglomerate ownerships and significant exposures. The financial system is dominated by banks.