The Philippine banking industry was opened to (limited) foreign entry in 1994. The liberalization measure was justified on the basis of enhanced competition. While it was observed that foreign bank entry brought about a slight deconcentration in the banking industry, there appears to be no systematic reduction of bank spreads. On the contrary, bank spreads (using alternative measures) were observed to increase in the period 1994-97, indicating that the relative profitability of banks have improved in the midst of foreign bank entry. This paper offers an alternative explanation to the ‘puzzle’ of widening spreads. The high interest rate policy (due to sterilization) kept lending rates high. On the other hand, there was little incentive for banks to compete for deposits through higher deposit rates because they had ready access to cheaper funds overseas owing to policies of promoting pegged exchange rates. Towards the latter part of the 1990s, a narrowing of spreads was observed. Interestingly, the narrowing of spreads was accompanied by a reversal of the macroeconomic policy stance in the 1994-97 period. The paper thus argues that the prevailing macroeconomic incentives matter in the determining outcomes of liberalization measures.
