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Living Trust Accounts under closer scrutiny

(Article published in the Jan 25, 2006 issue of Manila Standard Today)

            For sometime now, a draft circular on has been circulating among the major players in the trust industry, courtesy of the Bangko Sentral ng Pilipinas, providing for “additional guidelines on Living Trust Accounts.” What is broke about living trust accounts that this proposed circular intends to fix?

         The proposed circular appears, to this old hand at least, to be simply one of many moves and counter-moves being made in the cat-and-mouse game that has been, and will be, eternally played between regulator and regulated in every industry, not just trust.  Unfortunately, the real loser in this game is neither regulator nor regulated, but instead, the bank client who has no choice (since he needs the service)  but bear with the inconvenience of coping with new rules as well as shouldering additional compliance costs.  There is very little likelihood of postponing the issue of the circular, but, it may be time for both the cat and the mouse to call for a time out immediately thereafter.

         For a long, long time, trust service by banks meant exclusively property (specifically, real property or land and building) administration, as an ancillary service to their depositors.  Then, to its credit, Far East Bank and Trust Company demonstrated to bankers that managing other types of property, such as stock and bonds, could also be a proper and profitable form of business that could stand alone.  From there it was just a short step to bank-managed trusts having no other corpus than money market instruments and bank deposit products.  This gave rise to arrangements which behaved like deposits but were not deposits.

         The then Central Bank’s (now the Bangko Sentral’s) concern is that while bank deposit and deposit products are part of a bank’s recorded (sometimes called “on-books”) liabilities, assets held in trust are not considered real liabilities of the bank; hence they are called “off-books”.  Trust accountabilities, or assets held in trust, show up in a bank’s balance sheet, if at all, only under the label “contingent liabilities”. The primary impact of this distinction is that trust assets are not subject to the same scrutiny and restrictions from the regulator as bank deposit and deposit products.


       Hence, if a certain objective can be achieved under either a trust or a deposit arrangement, it was more to the advantage of a bank that has a trust license to do whatever it could, if at all legally possible, under the trust rather than the bank deposit format.

          Thus, if Company A wants to borrow Php 1,000,000 from a bank at 10%, the latter has the option of lending the  money which the bank itself borrowed from depositor B, say at 6%. In that case, the bank has a gross profit of 4%, but, because of reserve requirements and other regulations relating to deposits, the bank nets, say only 1%.

But if B were instead talked into opening a trust account and that trust account was made to lend the money to Company A, a situation is created where everybody wins. The loan could be at  9%  so Company A pays less interest; the Bank charges a 2% trust fee, thereby earning 1% more over what would have been its income by lending depositors’ money.  And B earns 7% or 1% more than deposit rates.

This win-win-win situation, unfortunately, comes with some hidden loss, namely the loss of the protective mantle of regulations and prudential standards of bank borrowing and lending.  It is good only in good times and in bad times, as when Company A fails to pay or B wants his money before the loan matures (necessitating a buy-out by the bank or another investor), has the potential for trouble.  And trouble in some instances can be of epic proportions.  Recall, for instance, the troubles of Urban Bank and Urbancorp which started when their trust loans turned sour.

         To fight this menace, the Bangko Sentral (and even the old Central Bank) issued many regulations in the past to make sure that banks that having trust license do not do banking under the guise of trust.  The proposed circular on living trust accounts is thus, in my view, only the last (for the time being) of a long line of issuances motivated by the desire to separate the wheat, or bona-fide trust arrangements, from the chaff, or in reality deposit or bank liabilities.  I could only surmise that, based on its examination of banks, the volume of chaff has considerably increased lately, apparently due mainly to money migrating from the common trust funds (that refused to be turned into unitized investment trusts) into living trusts which remains relatively unregulated and not subject to reserves.

         The regulatory response to what it sees as a new avenue of abuse, is, understandably, to prescribe objective norms by which a pseudo living trust is distinguished from a true living trust.

A minimum entry is set; otherwise, the money can be placed only in deposits or unit investment trusts; term of the trust is also regulated; the account is terminated earlier,  the trustor is disqualified from opening a new one in the same bank for 1 year.

         Pre-printed forms --by itself, the idea of a trust agreement being pre-printed departs from the classic idea that trusts are suited to the particular needs of a client—are permitted but the heart of the agreement, namely the purpose and dispositive clauses, must be filled up individually and signed by the client.  Bank proper personnel, i.e. those not in the trust department, are not allowed to market living trusts and may no longer sign for the bank, as trustee.  They may only make referrals.

         The trust industry is given a period to adjust currently existing arrangements and comply.  Beyond that period, non-compliant trusts would have to be booked by the bank under its “Other Fiduciary Accounts” thereby denying to the arrangements the hereto enjoyed exemption from reserve requirements.  Of course, sanctions for violations are also provided.

         Trust officers have suggested some changes to the original draft of the circular and view the thrust of the proposal with concern.  They fear that tightening up on living trusts will kill the business.  I do not think so.  There will always be a need by some clients for a bona fide living trust.  And the trust device ought to be and will be available in some form or another, for as long as there are people who could not or would not take care of themselves.

          The “additional guidelines” in the proposed circular, in my view, are, however, of the same genre as curfews and firearms ban in the battle against criminality.  Their most felt result is the inconvenience caused to the greater number of law-abiding trust users and trust providers due to the incorrigible behavior of the evading few. But, like curfews and firearms bans, the additional guidelines do not go to the core of the problem.

         A more fundamental and broad-based approach is needed to sharply delineate banking functions from trust functions, to clearly differentiate an entity which does business with the client (like receiving its deposits) from another which does business for a client (like being its trustee). Unless that drastic difference is recognized, cat-and-mouse will continue to be the name of the game.