(Editor’s note: This essay is from a speech delivered by Jose B. Fernandez Jr. during the management lecture series at the Asian Institute of Management in 1981. At that time, he was still chairman, president and chief executive officer of Far East Bank and Trust Company and was also concurrently a member of the board of trustees of the Asian Institute of Management. This paper is reprinted with the view that the lessons of the past continue to be relevant in our present time.)

One who is often moved deeply by another’s hunger is a modern-day fable about how a food company solves the problem of improving the flavor of its frozen fish products by having a predator induce healthy exercise in fish kept in water tanks prior to being frozen. Being at one level a lesson on the necessity for an interdisciplinary approach to a problem—for it took the company’s chemists, engineers and ichthyologist to solve it—the fable is primarily an illustration of how the best comes out from exposure to a naturally adverse environment.

When I think about the unique solution to the problem depicted in this fable, I am reminded of the Philippine financial system because, first, I share the view with many others that the environment for financial institutions is not an easy one these days; and second, I believe that while some may need an external helping hand in order to survive the difficult setting, others will pass the test on their own and emerge from the struggle as stronger institutions that have been made more fit by healthy exercise.

In general, financial institutions are not immune from the effects of the long-standing inflationary pressures that affect all of us today and which, by cumulating each year, progressively worsen our situation. Whether absorbed from abroad or by our own making, inflation exercises a complete and final impact on financial institutions which cannot quite be shifted to clients. Among the non-transferable effects are the deflation of the real equity cushion in the balance sheet and the anomalous configurations that balance sheets are forced to assume once profits are threatened by cost pressures.

In addition, the current regulatory environment calls for keener competition in both the funding and lending sides of the business, pursuant to the package of legislation passed in the middle of last year concerning reform in the banking system and in compliance with the corresponding implementing circulars of the Central Bank. Mandated competition may be difficult for some banks to take, but it is doubly hard to take when some of the components of regulation are not completely thought through or when implementation and compliance are not uniformly observed, or when the system is bisected into compliers and non-compliers. Then once the game starts, ability will be a poor match to cunning.

All of these mean that the task of managing financial institutions today demands the mental alertness of the fish that escapes the predator in the fable. In the bank where I work, the implications of the changes in the environment have been—as for sure they must have been in the other banks as well—deliberated upon at length. If I were to summarize the outcome of our deliberations, it is that the times require us to be always on our guard, and sometimes, to make difficult decisions that test the relationship between us and our friends.

In the functional area of loan portfolio management, for example, we constantly take stock of the kind of balance we seek between satisfying our clients on the one hand and observing classical credit principles on the other.

The main idea underlying classical credit principles is that a corporation borrows only to take advantage of an extraordinary business opportunity. Corporations are supposed to take wherewithals necessary to conduct their ordinary business and they must not depend on the continued confidence of their lenders in order to survive.

And yet the realities of the times force firms to borrow even for everyday needs. Initially, inflation cuts the real value of their working capital, which forces firms to borrow funds to fill the gap. But firms discover that the cash inflow for the succeeding periods get to be committed to debt service and so again the need for further borrowings arises. Borrowings become particularly burdensome when they are made at high interest rates which, as we all know, tend to increase for as long as inflation persists.

Friendship and long-run relationships are put to the test when we effect changes in the client composition of the portfolio as a result of our deliberations. And when, as a final test, we contract portfolio levels.

In the sourcing side of our business, we have had to weigh various lawful alternative measures in defense of deposits when apparent policy blindspots caused disintermediating financial assets to be more attractive than deposits. In the matter of our use of deposit substitutes, which is the functional area of responsibility of our Treasury Group, the difficult question of short-run disadvantages versus long-run gains has had to be resolved.

A major transformation in the function of the Treasury Group is expected to take place now that interest rate ceilings have been lifted for savings and time deposits and for deposit substitutes. These financial liabilities do not anymore differ from each other substantially, and will result in a wider Treasury viewpoint which embraces deposits as well. Likewise, as ceilings on loans are removed, the involvement of Treasury in the pricing of loans will cover the whole balance sheet.

Another area of bank operations that has kept us on our toes is trust management. On the one hand, the moribund state of the equities market precludes substantial investments in shares. In the immediate past, in fact, most institutional funds in the country undertook a program of divestment in equities. A fundamental explanation for this is rooted in the same inflationary climate mentioned earlier. The volatility of world commodity prices as well as possible substantial changes in the cost side of “profit and loss” have made it impossible to arrive at reasonable estimates of corporate earnings. The uncertainty depresses the market.

On the one hand, in the matter of fixed income investments, the yield expectations of fund owners have paralleled those of interest income earners in that they agree that yields or interest rates must surpass the inflation rate if any real income is to be earned from an investment or deposits. Oftentimes, these yield expectations lead to the neglect of risk considerations. Fund managers are pressured to find low-risk high yield situations which is clearly an impossible task.

But we have drawn the line and pointed to our fiduciary obligations as the operative principle in our trust operations. We risk a measure of our growth by doing so, but then we believe that we will gain a lot of respect in return.

A superior information system is of course necessary to support the basic stance we have adopted. So far, I have not attempted to speak about fancy management techniques and I do not have the intention of doing so in discussing our information system.

In the bank, we are endeavoring and to a certain extent have made the necessary initial steps to transform our current reporting system, which is one geared towards the historical accounting of the stewardship function of management to one which would serve as better by laying emphasis on performance measurement, self-analysis and strategic planning. This system encompasses financial, environmental client-related and planning information. It makes use of traditional as well as management-oriented accounting methods. And apart from the usual balance sheet and income statement reports, it has a supplementary analysis of assets and liabilities, as well as quality, liquidity, interest rate sensitivity, performance ratios and so forth. It analyzes data on non-financial costs, taxes and other matters of managerial concern such as unit performance, profit contributions and the like. It incorporates techniques used in manufacturing operations when they are applicable, such as transfer pricing, budgetary planning, break-even analysis, standard costs and capital budgeting.

Many of these developments in information systems are not new-found concepts. We make use of them as the need arises, but because they are very expensive to extract manually, our utilization has, so far, not been frequent. They will be economically feasible with the application of computer facilities, and these we have committed to purchase soon.

I believe that as a bank improves its information system, it will be able to perceive events as they happen. Its epistemology will be upgraded in terms of time dimension in the context of our fable. It will be able to sense even the slightest flick of the predator’s fins and thus take to immediate flight.

But beyond epistemology—beyond perception, beyond flight—is the necessity for the old-fashioned gift of being able to face facts squarely which when exercised by management, tints the decision with the color of courage. A bank survives the environment by not willing beyond itself, by being frank with its clients about the limits of what it can and cannot do.

It is easy for banks to have the bottom slide from under them. A little carelessness, a little lack of candor, can prove to be calamitous as the experience of some banks in the system shows. In order of magnitude, a typical commercial bank account is oftentimes significant compared with a bank’s annual profits and it takes only a handful of mistakes to bring to naught a bank’s efforts in a given year.

On the other hand, the marginal returns from an extra amount of care and foresight can be significant. If the effort serves one in good stead during bad times, it follows that it will also serve him well during interesting, if not good, times.