The genesis of "deposit substitutes"
(Article Published in the Dec 5,2012 issue of Manila Standard Today)
The issuance by the Department of Finance of Revenue Regulations No. 14-2012 on November 7, 2012 caused not a slight tremor in the financial districts. Businessmen, especially the underwriters, have all along been secure in the thought that "public" meant at least 20 people.
For this reason, devices were concocted to execute borrowings which although large in total amounts were nevertheless small in terms of people borrowed from. For as long as the number of lenders were small, which was uniformly defined as less than 20, the disclosures and other safeguards, designed to protect the presumably unsophisticated investor did not kick in.
The premise is that the 19 lenders who had the capacity to pick up the receivable at such huge amounts each were, or at least ought to be, financially sophisticated enough to make their own analysis and evaluation of the investments being offered to them. Hence, there was no need to treat them like they were babes in the woods.
It came to pass that in those days the approach of money managers and advisers to the allegedly sophisticated 19 or less investors was to convince them to not deposit their moneys in the bank. Bank deposits were the relationship of choice for the financial hoi poloi, they who did not have the learning to understand the intricacies of investing. But for the sophisticated 19 or less, the relationship would be through Banker's Acceptances; Promissory Notes; Repurchase Agreements; Certificates of Assignments or Participations, both with recourse; and other documents which despite their high fallutin names were of course, merely debt instruments.
These documents were in lieu, or in place, of deposits; hence they came to be called "deposit substitutes." Thus, the term "deposit substitute" as a legal term, is in my mind a Philippine invention. It was written into the law upon the recommendation of the Joint IMF-CBP Banking Survey Commission on the Philippine Banking System, co-chaired by Dr. Armand Fabella.
The Commission submitted its recommendations to Central Bank of the Philippines Governor, Gregorio S. Licaros on January 25, 1972 in advance of the full report. The idea was to have the recommendations considered by the Monetary Board early enough and in time for submission of amendatory legislation to Congress which was then in session. Apparently not too many, except, as now revealed in his autobiography, Juan Ponce Enrile, were unaware of the martial law that was to be declared about eight months later.
It was the general observation of the Commission that "more recently, the alternative forms of deposits and placements appear to have benefitted primarily the large well-entrenched corporate entities with foreign affiliations, their creditworthiness having been more easily established. Also, the rise of new forms of financial intermediation, in terms of financial instruments and institutions, has created a gray area of regulation."
Among those gray areas of regulation was the inability of the Central Bank to effectively take control of the volume of money generated by the credit operations of the financial system due to the lack of clear authority to impose reserve requirements and interest rate ceilings on alternative forms of raising funds from the public.
Explaining Recommendation 17, the Commission observed that the so-called "deposit substitutes are alternative forms of liabilities which partake of the nature of deposits." This functional identity, notwithstanding, however, the Commission further noted that "They are not at present included among deposit liabilities subject to reserve requirements." This was the reason why "Banks and non-bank financial institutions have increasingly resorted to attracted these deposit substitutes and to issuing a variety of debt instruments to document the transactions."
It was in the context of this need to make more effective the monetary control of the Central Bank that "deposit substitutes" was defined by the Commission as "alternative forms of obtaining funds from the public, other than bank deposits, through the issuance, endorsement, and acceptance of debt instruments for the borrower's account, which may include but need not be limited to, bankers acceptances, promissory notes, participations, certificates of assignments, and similar instruments with recourse, and repurchase agreements."
The recommendation of the Commission first became part of banking law when the definition of "deposit substitute was written into the Central Bank Act as Section 100A by Section 52 of Presidential Decree No. 72 issued on November 29, 1972.
With this entry, it was inevitable that the term "deposit substitute" would also get into tax law. The term "public" was defined, under Section 22(Y) of the National Internal Revenue Code, for purposes of taxation, as "twenty (20) or more individual or corporate lenders at any one time."
Section 2 of Revenue Regulations No. 14-2012 thus did no more than return to the original and consistent core thinking on "deposit substitutes" when the term became part of the Philippine legal landscape. It was no more than a return to basics. No need nor occasion for the financial community to belly ache.