RURAL BANKS AND DOUBLE YOUR MONEY SCHEMES

I TOLD YOU SO! unless you live in a cave I'm sure you already heard the news about several Rural Banks belonging to a particular group (of companies), closing (or declaring a bank holiday) or being taken over by the PDIC. and if you happen to be a depositor or an investor well.....
actually this was foreseen coming as early as 2005, when this company started soliciting investments in our place, in fact it was even surprising it took this long before it blew all over.maybe it was because the size; the total assets of all the Rural Banks belonging to this "Group" comprised about 11% of the total assets of all the Rural Banks in the Country.

I was exposed to it first hand because it was also the same time I became involved in the financial markets as a financial consultant. I was also invited to be an investor, and to attend their seminar, it worked like this: They were offering a double-your-money-in five-years type of investment, and the icing on the cake was: the interest would be paid to you in advance (the moment you make your investment) in the form of post dated checks. Honestly, you don't have to be a financial expert or an accountant to see (from the business point of view)that the numbers just don't add up, it smelled like a pyramiding scam (and the news on TV confirms this). Some of my businessmen friends were asking me if it was safe or possible, to which my answer has always been in the form of a another question: "Where can you find a business that actually pays in advance the profit, before the business has even started to operate'? (because thats how it looked like) unfortunately some did invest, which just goes to show that when it comes to greed, even level headed people are not immune. (remember the current US sub-prime crisis?) and now, reps from "The Group" have the audacity to put the blame on the current US sub-prime crisis. below is an article that I emailed to my clients way back at the time when people started investing with "The Group", before the US sub-prime even exploded. Take note of the date of the article, and take heed-because this also concerns other Rural Banks, Financial Establishments or investment instruments as well.

ASK Dr. NOET
By Dr. Johnny Noet Ravalo
INQUIRER.net
Last updated 12:59pm (Mla time) 05/10/2007

What can you say about the 20% interest per annum paid by some rural banks? Interest is paid monthly, covered by the PDIC, tax exempt, with five years maturity. In five years, a time deposit of P1 million will double to P2 million plus? -- Geno Real
A rural bank in my place offers an interest rate of six percent for a regular deposit and as much as 10% for a time deposit. Is the risk worth taking? I will only deposit the amount covered by the PDIC, Where can I check the strength of a rural bank to evaluate the risk I may be taking? Chester Barcenas

Geno, Chester, your respective inquiries are quite similar so let me just take them together.What is probably being offered to you Geno is a double-your-money type of deposit. This takes advantage of a provision in the law that exempts 5-year deposits from the final withholding tax. With this tax break, you would only need an interest rate of 14.8 percent to double your money in five years.
What are the risks to these? The same law that exempts you from the withholding tax says that if you withdraw before the five years are up, you have to pay the tax. The risk here is whether you have enough resources elsewhere to keep you from withdrawing the money you put in the potentially 5-year deposit. If liquidity is an issue, the chances of doubling-your-money in five years are quite remote.

Oh, just to be safe Geno, please make sure that the bank is indeed offering you a deposit instrument that is duly covered by the Philippine Deposit Insurance Corp.In both of your questions, the deposit rate being offered is something you should think about. For banks to continue operating, its lending and investment operations have to earn a premium over the deposit rates it pays out.
Under present reserve requirements (that’s the portion of funds banks are required to keep as reserves), this premium would be roughly 27 percent. That means a 10 percent deposit rate translates to a 12.7 percent loan rate to fund itself. This is before taxes, before administrative costs, before regulatory fees and before any premium for taking the additional risks.

(To put it plainly, if the bank promises you a 20% interest rate, then they have to loan out that same money at least 35% just for them to pay that 20%interest rate with the additional 15% as “spread” -the percentage they charge for operational expenses of the bank, we’re not even considering the profit the bank also has to make for that same transaction. For such a small place, like Surigao-how many do you think can afford to pay such loan rates, and the bank has to loan out that money if they are to pay back the 20% interest rate that they promised- Nards)

Make a judgment if the deposit rates these rural banks are offering seem reasonable to you given its environment and business because, no matter how you spin the calculations, these are the hurdle rates the bank must face to continue doing what it is doing.
The insurance provided by PDIC is a safety net. It should not be counted on as a first way out. The insurance should not give you a false sense of security. The point here is a commonly cited tenet in risk management: 100 year wars do not happen often but they do happen. And when they happen, the chances of you outlasting the war aren't too bright either.
When all have been said and done, the ultimate issue goes back to something Chester asked. It would still be part of your due diligence to judge the stability of your potential bank. It is your money so take the pain to make an informed choice of which bank you can trust with your money.

It all boils down to "trust". Thankfully, this does not have to be a leap of faith since there are clear tangible issues that you can consider and evaluate. But it is also not an exact science. Ask around the place what people think of the bank. Some will like it, others will have their own gripes here and there.
Rafael B. Buenaventura, the former Governor of the Bangko Sentral ng Pilipinas and an internationally seasoned banker was often heard saying: if it sounds too good to be true, it probably is.
Take heed. That is very wise counsel from a man who I consider to have very, very few equals.

*Noet Ravalo is the first Filipino to earn a PhD in Economics from Boston University and is a macro-financial economist by practice and profession. He was chief economist of the Bankers Association of the Philippines until 2002 and has since been doing consulting work for multilateral and foreign agencies. His current engagements are with the Bangko Sentral ng Pilipinas and the PDS Group. Over the past 12 years, he has been asked to provide technical inputs to both the Senate and the House of Representatives on various economic and financial legislation, some of which will have big impact on Filipinos’ personal finances.