FINMA 2000 / FINANCIAL MANAGEMENT

Prepared by: Ms. HAZEL JADE E. VILLAMAR

E-mail Address: [email protected]________

Central Luzon State University

Science City of Muñoz 3120
Nueva Ecija, Philippines

Instructional Module for the Course

FINMA 2000 / FINANCIAL MANAGEMENT

Module 8
CENTRAL BANKING AND THE EFFECTS OF ITS
MONETARY POLICIES IN OUR ECONOMY

Overview

This course is designed to help the student understand our present

monetary standard including the structure of the Philippine financial system.
It teaches the student how our monetary and financial system works. It is
designed to teach students on the different kinds of financial markets and
their functions, the different kinds of mutual funds, the classifications of
options and types of options commonly traded over the counter.

I. Objectives

At the end of the module, the following are expected:

A. Differentiate the New Central Band from the Old Central Bank

B. Understand the instruments being used by BSP to control the money supply

C. Discuss how does the BSP reacts during inflation and deflation

D. Compute the excess reserve

E. Identify the relationship of reserve requirement and deposit multiplier

F. Differentiate the kinds of deposits and bank accounts

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II. Learning Activities

Overview of the Bangko Sentral ng Pilipinas (BSP)

The Bangko Sentral ng Pilipinas (BSP) is the central bank of the Republic of the
Philippines. It was established on 3 July 1993 pursuant to the provisions of the 1987
Philippine Constitution and the New Central Bank Act of 1993. The BSP took over from
the Central Bank of Philippines, which was established on 3 January 1949, as the
country’s central monetary authority. The BSP enjoys fiscal and administrative autonomy
from the National Government in the pursuit of its mandated responsibilities.

Chronology of Events: Central Banking in the Philippines

1900 Act No. 52 was passed by the First Philippine Commission
placing all banks under the Bureau of Treasury. The Insular
Treasurer was authorized to supervise and examine banks
and banking activities.
February 1929 The Bureau of Banking under the Department of Finance
took over the task of banking supervision.
1939 A bill establishing a central bank was drafted by Secretary
of Finance Manuel Roxas and approved by the Philippine
Legislature. However, the bill was returned by the US
government, without action, to the Commonwealth
Government.
1946 A joint Philippine-American Finance Commission was
created to study the Philippine currency and banking
system. The Commission recommended the reform of the
monetary system, the formation of a central bank and the
regulation of money and credit.
The charter of the Central Bank of Guatemala was chosen
as the model of the proposed central bank charter.
August 1947 A Central Bank Council was formed to review the
Commission’s report and prepare the necessary legislation
for implementation.
February 1948 President Manuel Roxas submitted to Congress a bill
“Establishing the Central Bank of the Philippines”, defining
its powers in the administration of the monetary and
banking system, amending pertinent provisions of the
Administrative Code with respect to the currency and the
Bureau of Banking, and for other purposes.
The bill was signed into law as Republic Act No. 265 (The
15 June 1948 Central Bank Act) by President Elpidio Quirino.

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3 January 1949 The Central Bank of the Philippines (CBP) was inaugurated
and formally opened with Hon. Miguel Cuaderno, Sr. as the
first governor.
The broad policy objectives contained in RA No. 265
guided the CBP in the implementation of its duties and
responsibilities, particularly in relation to the promotion of
economic development in addition to the maintenance of
internal and external monetary stability.
November 1972 RA No. 265 was amended by Presidential Decree No. 72 to
make the CBP more responsive to changing economic
conditions.
PD No. 72 emphasized the maintenance of domestic and
international monetary stability as the primary objective of
the CBP. Moreover, the CBP’s authority was expanded to
include not only the supervision of the banking system but
also the regulation of the entire financial system.
January 1981 Further amendments were made with the issuance of PD
No. 1771 to improve and strengthen the financial system,
among which was the increase in the capitalization of the
CBP from P10 million to P10 billion.
Executive Order No. 16 amended the Monetary Board
1986 membership to promote greater harmony and coordination
of government monetary and fiscal policies.
3 July 1993 The Bangko Sentral ng Pilipinas (BSP) was established to
replace the CBP as the country’s central monetary
authority.

Objectives of the Bangko Sentral ng Pilipinas

1. Maintain internal and external monetary stability

2. Preserve the international value of the peso and its convertibility into other
currencies

3. Foster monetary, credit, and exchange conditions

4. Maintain economic price stability

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The Old Monetary Board

The Monetary Board is the policy-making body of the Bangko Sentral, which
consists of seven members. Members of the Old Monetary Board:
• Chairman
• Secretary of Finance
• Director General of the NEDA
• Chairman of the Board of Investments
• Secretary of Budget and Management
• 2 Private Sector Representatives

The New Central Bank

The New Central Bank Act or RA 7653 states that the state shall maintain a
Central Monetary Authority (CMA) the shall function and operate as an independent
body in charge of the areas of money, banking, and credit.

Organizational Structure of the BSP (as of December 2015)

 Monetary Stability Sector - mainly responsible for the operations/activities related

to monetary policy formulation and implementation

 Supervision and Examination Sector – mainly responsible for the regulation of

banks and other BSP-supervised financial institutions

 Resource Management Sector – mainly responsible for the management of

human, financial, and physical resources of the Bank

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 Security Plant Complex – responsible for the production of Philippine currency,

security documents, and commemorative medals and medallions

 Executive Management Services – a collective term for all departments/offices

directly reporting to the Monetary Board or to the Governor

Composition of the New Monetary Board of Bangko Sentral

The powers and functions of the BSP are exercised by its Monetary Board, which
has seven members appointed by the Philippine President. Under RA 7653, one of the
government sector members of the Monetary Board must also be a member of the
Cabinet designated by the President. The New Central Bank Act establishes certain
qualifications for the members of the Monetary Board and also prohibits members from
holding certain positions with other governmental agencies and private institutions that
may give rise to conflicts of interest. With the exception of the members of the Cabinet,
the Governor and the other members of the Monetary Board serve terms of six years
and may only be removed for cause. The Monetary Board meets at least once a week.
The Board may be called to a meeting by the Governor of the Bangko Sentral or by two
other members of the Board.

Qualifications of the Monetary Board

• must be natural born citizens of the Philippines

• at least 35 years of age, but the Governor shall be at least 45 years old

• of good moral character;

• unquestionable integrity,

• known probity and patriotism; and

• with recognized competence in social and economic disciplines

Bangko Sentral ng Pilipinas as Bank of Issue

It is the only bank authorized to manufacture and issue money, which makes it
have the monopoly of note issue. Anyone without given authority by the Bangko Sentral
shall be guilty of counterfeiting.
The Security Plant Complex (SPC) is responsible for the production of the
Philippine currency. Its establishment enables the BSP to have control of the supply,
security and quality of the Philippine currency.

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Organizational Structure of the SPC (as of March 2016)

1. Banknotes Securities and Printing Department – performs the printing of

banknotes and other security documents (e.g. passports, land titles, etc.)
2. Banknotes and Securities Producton Management Department – handles various
control and support functions in relation to the printing of banknotes and other
security documents
3. Mint and Refinery Operations Department – manages and performs the minting
of coins and commemorative medals, and the refinery of gold purchased from
local panners and miners
4. Department of General Services – manages the procurement of supplies,
equipment, and services for the SPC, client affairs and information programs,
development/implementation of SPC construction/renovation projects, and
general maintenance and upkeep of its facilities
5. Financial Services Group – prepares financial statements and records financial
receipts/disbursements, and processes bills for payment

Bangko Sentral as Lender of Last Resort

When banks need funding for lending to their clients, they borrow funds from the
Central Bank by using their notes and having them rediscounted.

Domestic Monetary Stabilization

Actions when abnormal movements occur in the monetary aggregates, credit, or

price level. Whenever the monetary aggregates or the level of credit increases or
decreases by more than 15%, or the cost of living index increases by more than 10%,
the Monetary Board shall submit reports mentioned in this section (refer to powerpoint).
The Monetary Board shall continue to submit periodic reports to the Philippine President

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and to the Congress until it considers that the monetary, credit, or price disturbances
have disappeared or have been controlled.

Instruments of Central Bank Actions

The Bangko Sentral endeavors to control the expansion or contraction of the

money supply, level of credit, and any rise or fall in prices, in order to maintain stability
in and out of the country. There are devices to regulate the money supply volume. Some
of them may be needed to induce expansion or contraction of money supply. Most of
them are directed toward the operation o the banking system, and is the biggest source
of the expansion of money supply.

Devices for money supply volume regulation:

1. control of the legal reserve requirement

2. control of the discount and rediscount rates

3. open market operation

4. control of collaterals required

5. imposition of portfolio ceiling

6. minimum capital ratio

7. margin requirements for L/C

8. moral suasion

Legal Bank Reserve Requirements

A reserve requirement is the proportion of banks’ deposits and deposit substitute
liabilities that banks are required to hold as reserves, which cannot be available for
lending. The BSP’s objective during inflation is to decrease the volume of money supply
by increasing the percentage of the reserve requirement on banks, and during deflation,
they increase credit expansion by decreasing the percentage of the reserve requirement
on banks.

Purposes of Imposing Legal Bank Reserve

1. monetary device for credit expansion & contraction

2. protecting the interest of depositors

3. may be used to help banks in financial distress

4. may be used in “inter-bank call loan system”

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5. may be used in settlement of bank and counter claims

All banks in the Philippines are required to maintain reserves against their deposit
liabilities in order to control the volume of money.

Laws Covering Legal Bank Reserves (RA 7653, Sec. 96 to Sec. 102)
SEC. 96. Required Reserves Against Peso Deposits. — The Monetary Board
may fix and alter the minimum reserve ratios to peso deposits, as well as to deposit
substitutes.

SEC. 97. Required Reserves Against Foreign Currency Deposits. — The

Monetary Board is similarly authorized to prescribe and modify the minimum reserve
ratios applicable to deposits denominated in foreign currencies.

SEC. 98. Reserves Against Unused Balances of Overdraft Lines. — In

order to facilitate BSP’s control over the volume of bank credit, the Monetary Board may
establish minimum reserve requirements for unused balances of overdraft lines.

SEC. 99. Increase in Reserve Requirements. — When the Monetary Board

deems it necessary to increase reserve requirements against existing liabilities, the
increase shall be made in a gradual manner and shall not exceed four percentage points
in any thirty-day period.

SEC. 100. Computation on Reserves. — The reserve position of each bank

or quasi-bank shall be calculated daily on the basis of the amount, at the close of
business for the day, of the institution's reserves and the amount of its liability accounts
against which reserves are required to be maintained.

SEC. 101. Reserve Deficiencies. — Whenever the reserve position of any

bank or quasi-bank, computed in the manner specified in the preceding section of this
Act, is below the required minimum, the bank or quasi-bank shall pay the Bangko Sentral
one-tenth of one percent (1/10 of 1%) per day on the amount of the deficiency or the
prevailing ninety-one-day treasury bill rate plus three percentage points, whichever is
higher.

SEC. 102. Interbank Settlement. — The Bangko Sentral shall establish

facilities for interbank clearing under such rules and regulations as the Monetary Board
may prescribe.

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Bank Legal Reserve Requirement and its Effect on Banks Excess Reserves and
Money Supply

Example:

Total Currency in the economy P 38 Billion

Plus: Total Demand Deposits in banks 130 Billion
P 168 Billion

Deduct: Currency in banks P 2 Billion

Currency in Government 1 Billion
Demand deposit of Government 8 Billion 11 Billion

Total Money Supply P 157 Billion

Total money supply refers to the total amount of money that is circulating in the
economy. Total demand deposits in banks are added to the total currency in the
economy because that is the amount of money that people can borrow from banks and
they can use for economic purposes. Currency in banks, currency in government,
demand deposit of government are deducted because these amounts don not circulate
in the economy.

To increase money supply, banks may either make new loans or buy fewer
securities. To decrease money supply, banks either make fewer loans or sell more
securities to the public or accept payments of loans.

Excess Reserves
It is the amount that any commercial bank can increase in money supply. It is on one
to one ratio.

Formula to get the excess reserve:

Reserve - (Demand deposit x %required reserve) = excess reserve
Example:
20% - required reserve imposed by Bangko Sentral

PNB Balance Statement

Assets Liabilities
Reserve P 2,000 Demand Deposit P 9,500
Other Assets 8,000 Net worth 500
Total P 10,000 Total P 10,000

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Using the formula above, we can compute that the PNB has a P100 of excess
reserve. Now, PNB makes new loans on its excess reserves.

PNB Balance Statement after making new loans

Assets Liabilities
Reserve P 2,000 Demand Deposit P 9,600
Other Assets 8,100 Net worth 500
Total P 10,100 Total P 10,100

Now, let us assume, PNB deposited the excess reserve to SBTC.

Assets Liabilities
Reserve P 1,900 Demand Deposit P 9,500
Other Assets 8,100 Net worth 500
Total P 10,000 Total P 10,000

SBTC Balance Statement before the deposit of PNB

Assets Liabilities
Reserve P 1,000 Demand Deposit P 5,000
Other Assets 4,300 Net worth 300
Total P 5,300 Total P 5,300

This balance statement of SBTC has no excess reserve when computed. When
the excess reserve of PNB is deposited, SBTC balance statement shows as follow.

SBTC Balance Statement after the deposit of PNB

Assets Liabilities
Reserve P 1,100 Demand Deposit P 5,100
Other Assets 4,300 Net worth 300
Total P 5,400 Total P 5,400

The deposit goes to SBTC’s reserve and the demand deposit is increased because
it is assumed that PNB granted a loan to SBTC. When computed, the SBTC Balance
Statement shows an excess reserve of P80, so it can increase the money supply by P80.

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SBTC Balance Statement when increased by money supply

Assets Liabilities
Reserve P 1,100 Demand Deposit P 5,180
Other Assets 4,380 Net worth 300
Total P 5,480 Total P 5,480

Now the SBTC has an excess reserve, it will now deposit the excess reserve to
the other bank, RCBC.

RCBC Balance Statement before the deposit of SBTC

Assets Liabilities
Reserve P 1,200 Demand Deposit P 6,000
Other Assets 5,000 Net worth 200
Total P 6,200 Total P 6,200

RCBC Balance Statement after the deposit of SBTC

Assets Liabilities
Reserve P 1,280 Demand Deposit P 6,080
Other Assets 5,000 Net worth 200
Total P 6,280 Total P 6,280

RCBC can now increase the money supply by P64. We get P64 by using the
excess reserve formula. Now, when RCBC will increase its loans, the balance statement
becomes as shown below.

RCBC Balance Statement when increased by money supply

Assets Liabilities
Reserve P 1,280 Demand Deposit P 6,144
Other Assets 5,064 Net worth 200
Total P 6,344 Total P 6,200

All in all, money supply is increased by P244 and it can still be increased further
if the P64 excess reserve of RCBC will be deposited to other banks.

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Banks Excess Reserve Increase in Money Supply

PNB P100 P100

SBTC 0 80
RCBC 0 64
Total P244

Size of multiplier formula Reserve Ratio %

1 1_______
% required reserve Deposit Multiplier

Example:

Reserve Ratio % Deposit Multiplier

40 2½
33 ½ 3
30 3½
25 4
20 5

Consolidated Balance Statement of a Commercial Bank 20%

Assets Liabilities
Reserve P 35 Billion Demand Deposit P 150 Billion
Other Assets 120 Billion Net worth 5 Billion
Total P 155 Billion Total P 155 Billion

The commercial bank has an excess reserve of 5 Billion. The actual reserve of
P35 Billion is 20% of P175 Billion. This means that the money supply or the demand
deposit can be increased by P25 Billion. When computed, the deposit multiplier is 5. For
every peso of reserve, the banking system can increase the money supply by P5 Billion.
If the deposit multiplier were 4, the bank had an excess reserve of P2 Billion.

Consolidated Balance Statement of a Commercial Bank 10%

Assets Liabilities
Reserve P 18 Billion Demand Deposit P 100 Billion
Other Assets 87 Billion Net worth 5 Billion
Total P 105 Billion Total P 105 Billion

The excess reserve is negative P2 Billion and with a deposit multiplier of 5, the
bank has to decrease its money supply by P10 Billion.

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Consolidated Balance Statement after a load is paid

Assets Liabilities
Reserve P 18 Billion Demand Deposit P 90 Billion
Other Assets 77 Billion Net worth 5 Billion
Total P 95 Billion Total P 95 Billion

The required reserve is now P18 Billion compared to negative P2 Billion.

Whenever a single commercial bank loss P500 in reserve and demand deposit
because borrowers have written checks which were deposited in other banks, the other
banks gain P500 in reserves and demand deposit.

Control the Discount and the Rediscount Rates on Loans

The Bangko Sentral extends credit to banking institutions for the following purposes:
a. Using it as a device for credit control:
b. Increase the liquidity of the banks through credit, whenever necessary.

During inflation, the Bangko Sentral increases the percentage of its rediscount
and discount rates on credits extended to banks. In contrary, they decrease the
percentage of its rediscount and discount rates on credits extended to banks during
deflation.

Interest and Rediscount Rates (RA 7653 Sec. 85)

The Bangko Sentral shall collect interest and other appropriate charges on all
loans and advances it extends, the closure receivership or the liquidation of the debtor-
institution notwithstanding. The Monetary Board shall fix the interest and rediscount
rates to be charged by the Bangko Sentral on its credit after due consideration has been
given to the credit needs of the market, the composition of the Bangko Sentral’s
portfolio, and the general requirements of the national monetary policy. Interest and
rediscount rates shall be applied to all the banks of the same category uniformly and
without discrimination.

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Changing Discount Rates and its Effect on Banks Excess Reserve and Money
Supply

Example: Consolidated balance statement of the banking system:

Asset Liabilities
Reserve 100 Billion Demand Deposit 500 Billion
Other Assets 450 Billion Loans from CB 10 Billion
Net Worth 40 Billion
________ ________
Total 550 Billion Total 550 Billion

If the reserve ratio is 20%, the commercial banking system will have a 0 (zero)
excess reserve.

Supposing the Bangko Sentral increases the discount rates from 2 ½% to 3% as

a result of abnormal situation, commercial banks who wish to borrow from the Bangko
Sentral decrease their loans from 10 to 6 billion. When the commercial banks repay this
4 billion to Bangko Sentral, the commercial banks’ loans and reserve are decreased by
4 billion. The commercial banks’ statement will now be as follows:

Asset Liabilities
Reserve 96 Billion Demand Deposit 500 Billion
Other Assets 450 Billion Loans from CB 6 Billion
Net Worth 40 Billion
________ ________
Total 546 Billion Total 546 Billion

Since the reserve ratio is still 20%, the commercial bank has a negative reserve
of 4 billion. This will therefore decrease the amount of demand deposit money in the
economy from 500 to 480 billion.

If the Bangko Sentral lowers the discount rate from 2 ½% to 2%, the commercial
banks will increase their borrowings to 13 billion. Their loans and reserve from Bangko
Sentral will increase by 3 billion. Thus, their statement will be as follows:

Asset Liabilities
Reserve 103 Billion Demand Deposit 500 Billion
Other Assets 450 Billion Loans from CB 13 Billion
Net Worth 40 Billion
________ ________
Total 553 Billion Total 553 Billion

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Open Market Operation in Government Securities

Open market operations refer to the sale or purchase of government securities

by the BSP to withdraw liquidity from or inject liquidity into the system. Government
securities refer to evidences of indebtedness of the government.

Two purposes of Government securities:

1. to raise revenue
2. to control credit

The Central Bank plays a significant role in the issue and in the placement of
government securities. It also maintains the securities, and maintains the security
stabilization fund, which is a reserve intended to be used in buying and selling of
government securities to stabilize the value and liquidity of such government securities.

Security stabilization fund is a reserve intended to be used in buying and selling

of government securities to stabilize the value and liquidity of such government
securities.

Remedies during Inflation:

a. sell to the public government securities to absorb excess cash holdings

b. sell to the banking institutions government securities

During deflation the sale of government securities to the banks decreases money
supply by the amount it would have increased if the funds have been used by the banks
in their lending operation where they undergo a multiplier effect.

Purchases and Sales of Government Securities (RA 7653 Sec. 91)

The Bangko Sentral may buy and sell in the open market for its own account:
a. Evidences of indebtedness issued directly by the Philippine Government/political
subdivisions
b. Evidences of indebtedness issued by government instrumentalities and fully
guaranteed by the Government.
Evidences of Indebtedness must be;
• freely negotiable;

• regularly serviced; and

• must be available to the general public through banking institutions and local
government treasuries in denominations of a thousand pesos or more.

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Issue and Negotiation of Bangko Sentral Obligations (RA 7653 Sec. 92)

The Monetary Board shall determine the interest rates, maturities and other
characteristics of said obligations of the Bangko Sentral, and may, if it deems it
advisable, denominate the obligations in gold or foreign currencies. The evidences of
indebtedness of the Bangko Sentral may be acquired by the Bangko Sentral before their
maturity, either through purchases in the open market or through redemptions at par
and by lot if the Bangko Sentral has reserved the right to make such redemptions.

Control of the Collaterals Required on Bank Loans

The Bangko Sentral has the power to impose conditions or requirements on the
securities against the loans extended by the bank. During inflation, BSP increases the
collateral requirements to decrease the loan value on collaterals, and during deflation,
BSP decrease collaterals which may be an incentive to buyers.

Required Security against Bank Loans (RA 765, Sec. 109)

SEC. 109. Coordination of Credit Policies. – Government -owned

corporations which perform banking or credit functions shall coordinate their general
credit policies with those of the Monetary Board.
Toward this end, the Monetary Board may, whenever it deems it expedient, make
suggestions or recommendations to such corporations for the more effective
coordination of their policies with those of the Bangko Sentral. The Monetary Board may
issue such regulations in order to promote the liquidity and solvency of the banking
system.

Imposition of Portfolio Ceiling

Portfolio ceiling is the upper limit that the Bangko Sentral may place on the loans
and investment of banks. It is a direct limitation on the volume of loans and investments
that banks may extend. It is instituted only during inflation.

Portfolio Ceilings (RA 7653, Sec. 107)

SEC. 107. Portfolio Ceilings. – Whenever the Monetary Board considers it

advisable to prevent or check an expansion of bank credit, the Board may place an
upper limit on the amount of loans and investments which the banks may hold, or may
place a limit on the rate of increase of such assets within specified periods of time. The
Monetary Board may apply such limits to the loans and investments of each bank or to
specific categories thereof.

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The Monetary Board shall not establish limits which are below the value of the
loans or investments of the banks on the date on which they are notified of such
restrictions. The restrictions shall be applied to all banks uniformly and without
discrimination.

Minimum Capital Ratio

The maximum ratio that the combined capital account of surplus may bear on
the banks’ corporate assets. The BSP requires 10% of the risk assets of a bank as its
minimum capital.
Risk Assets = Total assets – Non-risk assets

Margin Requirements against Letters of Credit (RA 7653, Sec. 105)

SEC. 105. Margin Requirements Against Letters of Credit. – The Monetary Board
may at any time prescribe minimum cash margins for the opening of letters of credit,
and may relate the size of the required margin to the nature of the transaction to be
financed.

Moral Suasion

The BSP defines moral suasion as the influence which the central bank exercises
to induce or convince banks to conduct operations in a manner that would contribute to
the attainment of monetary goals but not necessarily support the profit-maximizing
objectives of the banks.

Other Monetary Policies to Stabilize Banking Operations

1. fix maturity on bank loans

2. fix the maximum interest banks may pay on deposit substitutes

3. establish priorities for bank loans

4. makes periodic examination of banks’ accounting records and requires them to

submit financial statements every quarter

5. looks into the character and integrity of the bank’s incorporators, board
members, and executives

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Bangko Sentral as a Fiscal Agent

1. to be the official representative of the government to financial entities;

2. to be the depository banker of the government;

3. to be the financial adviser of the government; and

4. to manage public debts.

REFERENCE:
Laman, et.al.(2014). Financial System, Market & Management The Basics. Manila,
Philippines: GIC Enterprises & Co.,INC.

http://bsp.gov.ph
RA 7653 – The New Central Bank Act

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