Philippine banks are small, compared to their peers in other countries like Singapore and Japan, and the domestic banking industry has often been considered as a laggard, because of its failure to keep pace with developments in banking, including the introduction of sophisticated financial products.

Basically, banking in the Philippines is deposit taking and lending, or investing in treasury bills and bonds.

The failure to participate in the marketing of sophisticated financial products meant the loss of income opportunities for banks because the new products offered higher returns than government securities or traditional loans.

That’s bad. Or is it?

The subprime crisis that erupted in the United States in 2007 and became a full-blown financial crisis in 2008 has been blamed on the lax regulation of the financial system and the greed on the part of banks and other financial institutions. The thirst for bigger and bigger profits drove these institutions to finance home purchases even for people who would not have been eligible because of inadequate income. That’s why the financing is called subprime.

The system was awash with cash, and financial institutions introduced newer and newer products to absorb that cash. In simple terms, the purchase of a home was no longer covered by a single mortgage, but by several layers of mortgages as well as insurance products for such mortgages. It was essentially a pyramid – when the original homebuyer who in the first place had no capacity to pay – defaulted on the loan. The pyramid collapsed.

U.S. banks that have existed for over a century collapsed – the most popular is the giant investment banking group Lehman Brothers, which declared bankruptcy. The loss of confidence triggered a chain reaction, first in the U.S., then the world. Thus, the global turmoil that continues today.

Several local banks disclosed their exposure to the sophisticated financial products. Fortunately, reforms that were instituted after the 1997 Asian financial crisis instilled prudence and promoted adequate capitalization among local banks. In general, the U.S. crisis affected only a small fraction of the local banking system’s resources.

Global investment banks and credit rating agencies described the Philippines as an “island of calm” amid the global financial turbulence, and observed that the lack of sophistication restricted the local banks’ investments in the sophisticated or structured financial products that led to the crisis in the U.S.

The banks that invested in Lehman Brothers have made adequate provisions to cover their losses. In general, Philippine banks will continue to generate profits, albeit at a slower pace compared to their performance in 2007. More significant, their lending activities continue to grow by double digits, compared to the credit crunch in the U.S.

So, lack of sophistication bad? Not necessarily.