Bangko Sentral gives banks relief on paper losses. But does this just push risk out of sight?

MANILA, Philippines – Philippine banks are getting temporary relief from the Bangko Sentral ng Pilipinas (BSP), a move meant to keep market volatility from squeezing capital ratios. But does this actually invite more risks to creep into an already stressed banking system?

Under BSP Memorandum No. M-2026-027, banks and quasi-banks may temporarily exclude certain unrealized losses, also known as paper losses, on peso government securities from the computation of their regulatory capital.

Government securities are debt papers issued by the government. Banks buy them because they are generally considered safe assets. But like other bonds, their market prices can still rise or fall.

The BSP relief applies to government securities booked under “fair value through other comprehensive income,” or FVOCI. These are securities that banks have not sold, but whose changing market value still affects the bank’s capital.

The measure is meant to cushion the impact of the Middle East conflict, which has rattled financial markets, pushed up yields, and consequently lowered the value of some bond holdings. Yield refers to the return investors demand from a bond. When yields rise, bond prices usually fall.

The relief runs from April 1 to December 31, 2026. Beginning January 2027, the usual capital rules will again apply.

In simple terms, the BSP is allowing banks to exclude some paper losses caused by market swings when computing key capital ratios. These ratios measure how much financial cushion a bank has to absorb losses. That means the relief can make banks’ capital position look stronger than it otherwise would under the usual rules.

The BSP said the goal of the new policy is to prevent “transitory market movements from unduly affecting the reported capital strength of banks and quasi-banks.”

But when regulators protect banks from the capital impact of paper losses, does that really preserve stability, or does it weaken the discipline that pushes banks to manage risks more carefully?

What are paper losses?

Paper losses happen when the market value of an asset falls, but the bank has not actually sold the asset.

For example, a bank may hold a government bond that it bought at a certain price. If interest rates rise, or if investors demand higher returns because of war, oil price spikes, inflation, or uncertainty, the market price of that bond falls.

The bank now has a paper loss because the bond is worth less in the market. But if the bank does not sell the bond and the government continues paying as promised, the bank may still recover the full value when the bond matures.

This is why paper losses can be complicated. They are not the same as realized losses from a sale, and they do not automatically mean that a bank is in trouble. But they still matter. If a bank faces a liquidity crunch and has to sell the bond, then those paper losses become very real losses. For this reason, accounting and regulatory rules can require banks to reflect those declines in capital.

When capital ratios fall, banks are supposed to become more conservative. They may slow lending, sell assets, preserve cash, or delay expansion. That is the outcome the BSP appears to be trying to avoid, especially if the losses are mainly the result of temporary market volatility rather than actual weakness in the banks’ assets.

Stability tool or source of moral hazard?

The strongest case for the BSP’s move is that it prevents a temporary market shock from becoming a bigger financial problem.

Government securities are generally high-quality assets. If their prices fall because yields suddenly rise, that does not mean the government will default or that banks made bad loans. The loss may reverse if yields fall later. It may also never become a real loss if the bank holds the security until maturity.

Forcing banks to immediately absorb the full capital impact could make them pull back from lending or sell securities at depressed prices. If several banks do this at once, the stress can feed on itself.

At the same time, capital rules exist for a reason. They incentivize banks to self-regulate and err on the side of caution. If paper losses reduce capital, they nudge banks to manage interest rate risk carefully. Banks know that if they load up on long-term bonds and yields rise, their capital ratios may take a hit.

By temporarily removing that capital hit, regulators may weaken that discipline. Banks may become less cautious if they expect relief whenever markets move against them. And consequently, when banks believe they will be protected from the consequences of some risks, they may take more of those risks. In banking, this is called the moral hazard concern.

Former BSP deputy governor Diwa Guinigundo raised the same concern. Writing for the geopolitical research analysis firm GlobalSource Partners, Guinigundo said: “The BSP’s policy choice nevertheless raises legitimate policy questions. Regulatory relief inevitably creates some degree of moral hazard. Borrowers may expect future payment relief during external shocks, while banks may become less disciplined in recognizing emerging credit risks or strengthening capital buffers if regulatory forbearance is perceived as readily available. Prolonged or repeated relief could also delay the recognition of problem assets, distort credit allocation, and weaken market discipline.”

There is also a signaling risk. Relief is meant to reassure markets, but it can also make investors ask why relief was needed in the first place. If capital ratios are adjusted during stressful periods, markets may wonder whether reported numbers still show the full picture or if there is a risk that the BSP sees that they are not aware of.

All this said, the BSP has safeguards in place even with the temporary relief extended. Banks must still recognize and report their losses in financial reports and financial statements. The BSP also said it will monitor additional government securities booked under FVOCI accounts by banks that use the relief. It may also limit their access to select BSP liquidity facilities.

The BSP has also released a statement assuring that it was monitoring risks.

“Philippine banks remain well positioned to withstand potential shocks, supported by ample liquidity, adequate capital buffers, and manageable asset quality. While some pressure may emerge in specific borrower segments, risks remain contained, with no evidence of broad-based deterioration,” the central bank said in a statement on Friday, June 26.

“The BSP expects banks to maintain prudent credit standards, adequate provisioning, strong governance, and sufficient capital and liquidity buffers. The BSP stands ready to take appropriate supervisory action, as needed, to preserve financial stability and protect the public.”

Moody’s: ‘Credit negative’

The pressure is significant because Philippine banks hold a large amount of government debt.

Moody’s Ratings said government securities accounted for about 30% of banking system assets as of March, among the highest shares in Asia. Around 40% of those holdings were classified as FVOCI, meaning they are exposed to mark-to-market treatment.

“The increase in government bond yields has pressured Philippine banks’ capital ratios because they hold a large number of long-duration government securities,” Moody’s said.

According to Moody’s, unrealized losses ranged from 1.2% to 4.3% of CET1 capital in the first quarter of 2026, while cumulative unrealized losses on CET1 capital ranged from 1.3% to 7.5%. Common Equity Tier 1, or CET1, is the strongest form of bank capital and the first line of defense against losses.

Those numbers do not point to a banking crisis. Moody’s still expects Philippine banks to remain broadly able to absorb the pressure, helped by earnings that can rebuild capital over time. But Moody’s also called the BSP relief “credit negative,” because it shields capital ratios from the impact of higher bond yields.

Fitch Ratings has also flagged a related risk. Its warning is not only about banks’ bond holdings, but also about their loan books. Fitch said rapid growth in unsecured consumer loans – or loans that do not require collateral – could raise bad-loan risks if inflation and slower income growth weaken borrowers’ ability to pay.

Fitch has already downgraded its 2026 outlook for the Philippine banking sector from “neutral” to “deteriorating,” citing the risk of higher credit impairments, slower loan growth, and weaker profitability. – Rappler.com