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A major major incentive for stand-alone trust corporations

(Article published in the Mar 2,2011 issue of Manila Standard Today)  

Section 2 of Bangko Sentral Circular No. 710, series of 2011, on the stand-alone trust corporation provides that a “trust corporation may be a subsidiary or an affiliate of a bank and/or a non-bank financial institution.”  However, “the investing bank or non-bank financial institution cannot engage in trust, other fiduciary business and investment management activities both directly through its separate and distinct department or similar unit in the bank or non-bank financial institution and indirectly through a subsidiary or affiliate trust corporation.

In other words, banks and non-bank financial institutions which currently have their trust departments need to chose, if they opt to stay in the trust business, to either continue with their present set-up of doing business through a unit (called trust entity) within their respective organizations, or spin-off their trust operations into a separate and distinct juridical entity called a stand-alone trust corporation.

The question that immediately pops up is what advantages and, if any disadvantages, are there in setting up either a subsidiary or affiliate to do its trust business. 

Section 8 of Circular No. 710 provides the regulator’s obvious preference in favor of the spin-off choice.  The second paragraph of said section provides that “in case a trust corporation is a subsidiary or affiliate of a bank and/or a quasi-bank, the assets under management of the trust corporation shall not form part of the relevant exposures of the parent bank and/or quasi-bank for purposes of calculating the Single Borrower’s Limit (SBL) and the ceilings for accommodations to directors, officers, stockholders and their related interests (DOSRI) of the said parent bank and/or quasi-bank.” 
 










     

And, in what seems to be stressing the obvious, the last paragraph of Section 8 states that “the purchases by the trust corporation, in behalf of its clients, of securities or investments issued by its parent bank and/or quasi-bank, shall not form part of the relevant exposures of the trust corporation for purposes of calculating the SBL and DOSRI ceilings of the said trust corporation.”

The SBL and DOSRI ceilings applied to trust transactions actually constitute the bulk of what I had referred to, when I was recently interviewed by the Financial Times (for the entire article you may go to this link: http://www.ft.com/cms/s/0/e292b83c-2b10-11e0-a65f-00144feab49a.html#axzz1CZqW6kfI or get a copy of FT’s January 31, 2011 issue)  as “ad hoc regulations” on trust operations spawned by the fact that banking and trust services were by historical happenstance undertaken in the country under one corporate roof.

SBL and DOSRI limits are prudential standards imposed on banks and quasi-banking institutions precisely because the money let to the single-borrower or to the director, officer, stockholder or related interest are sourced from the public.  Their basic rationale is that although legally, the lending by the depositor of his money with a bank causes the transfer of ownership over the money to the bank which as owner can do with it what it may (subject only to the condition of repayment when due), a bank nevertheless is constrained by the very fact that the money it is lending is, for the most part, not its own.  It is under a reasonable expectation on the part of the deposits that their ability to get back their money at maturity would not be prejudiced by recklessness or imprudence in investing and lending by the bank.

SBL is simply a more formal statement of the wisdom of not putting all one’s eggs in one basket; DOSRI is founded on the innate conflict of interest involved in lending to one’s self.  Thus, they are natural limits to banking as a business.

It happened, however, that the limits set were, as are most standards fixed by law, rigid and, after a while, did not conform to the needs of the users of funds nor the general requirements of the economy.  Bankers thus crafted products which were not deposits but which acted and behaved like deposits.  The flexibility of the trust device made this products possible. Thus, the trust product that looked like a duck, walked like a duck, and quaked like a duck, but was not a duck.  Most people did not discern the difference.

 Thus, because the trust department and the banking department are under the one roof of a bank, a banks through the use of trust products easily was able to circumvent the prudential limits on its lending imposed by the SBL and DOSRI rules.  To stop this circumvention, the Monetary Board issued a regulation, which eventually became §X409.4 on Ceiling on loans saying that “loans funded by trust accounts shall be subject to the SBL and DOSRI ceilings imposed on banks…[and] for purposes of determining compliance with said ceilings, the total amount of said loans granted by the trust department and the bank to the same person, firm, or corporation shall be combined.”

That regulation that combined the lending of the bank with the lending of the trust accounts for purposes of determining SBL and DOSRI compliance, though well-intentioned, was without any statutory basis.  In fact, it was even contrary to the fundamental thrust of the separation between trust business and banking business.  But, though of unsound legal grounding, it was nevertheless made “necessary” to prevent circumvention of the prudential tenets of safe and sound banking.

Under the stand-alone trust corporation, however, which is made very stable by the requirement of a strong capital base, i.e. initially Php 300 million and increasing depending on the volume of assets under management, that danger of circumvention of SBL and DOSRI has been minimized, if not altogether eliminated. The result is that a bank and its stand-alone subsidiary or affiliate could service their clients better.

     

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