Issues for the Caribbean Shelton Nicholls Resident Adviser on
Financial Stability Caribbean Regional Technical Assistance Centre
(CARTAC) Credit Union Workshop St. Vincent and the Grenadines
August 20-22, 2014. Sunset Shores Hotel, St. Vincent and the
Grenadines
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1.Financial Stability: An Important Mandate 2.Key Elements of a
Financial Stability Risk Architecture for the Caribbean 3.Financial
Stability- State of Play 4.Key Financial Stability Matters for
Policy Focus: An Agenda for the Region 5.Conclusion
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What is Financial Stability? Much discussion, but no single
definition around which there is unanimity. A financial system is
in a range of stability whenever it is capable of facilitating
(rather than impeding) the performance of an economy, and of
dissipating financial imbalances that arise endogenously or as a
result of significant adverse and unanticipated events (Gary
Schinasi, 2004). Financial Stability is a multi-dimensional
Concept.
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Facilitate efficient and smooth allocation of resources
inter-temporally and spatially between savers and investors.
Efficient and Smooth Allocation of Resources Enable forward-looking
risks to be continuously assessed, reasonably priced and
effectively managed. Effective Management of Forward-looking Risks
Be able to contain and absorb financial and economic shocks with
minimal disruption to financial and economic activity. Absorption
and Dissipation of financial and economic shocks Some Consensus
around Schinasis Principles
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Financial Stability and Monetary Stability therefore share an
interdependent relationship: A stable financial system is necessary
for sustainable GDP growth and low inflation. Sustainable growth in
the economy with stable prices will also make the economy less
prone to financial instability.
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Decline in National Output and Incomes Increased Fiscal
Expenditures Balance of Payments Deficits Exchange Rate
Instability
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Global financial crisis and the reverberations from the
collapse of a key regional financial conglomerate (CL Financial)
have brought to the fore the importance of systemic risks and the
need to develop a macro-prudential policy framework in the
Caribbean region. Systemic Risks: The risk that an event could
trigger a loss of value or confidence in a substantial portion of
the financial system resulting in adverse nation-wide and
region-wide effects. No fully agreed upon risk assessment framework
for financial stability exists globally. Various elements needed
for a unified framework are still being elaborated and developed by
international bodies (IMF, BIS, ECB, FSI) and academic
institutions.
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Banks Ins. Comp/Pens. Funds Credit Unions Securities Firms
Interbank Mkt Forex Mkt. Capital Mkts (Equity, Debt)
Legal/Regulatory Systems Payments Systems Clearance Systems Deposit
Insurance Financial Institutions Financial Markets Financial Infra
Structure Financial Sector Components Financial Sector Components
Sources of Risk Sources of Risk Endogeneous Risks Exogeneous Risks
Endogeneous Risks Exogeneous Risks Endogeneous Risks Exogeneous
Risks Risk Assessment Micro-Prudential Macro-Prudential
Micro-Prudential Macro-Prudential Micro-Prudential Macro-Prudential
Major Risks Major Risks Credit Liquidity Reputational Credit
Liquidity Reputational Counterparty Asset Price Misalignment Market
Reputational Counterparty Asset Price Misalignment Market
Reputational Payment Operational Regulatory Reputational Payment
Operational Regulatory Reputational Risk Metrics Risk Metrics FSIs
EWIs Stress Tests Flow of Funds FSIs EWIs Stress Tests Flow of
Funds Contagion Matrices Financial Model (Macro, DSGE) Network
Analysis Contagion Matrices Financial Model (Macro, DSGE) Network
Analysis Risk Mitigation Risk Mitigation Crisis Management
Regulatory System (Single, Multiple) Crisis Management Regulatory
System (Single, Multiple) Business Continuity Robust Network and
ICT Platform Business Continuity Robust Network and ICT Platform
Source: Prepared by Shelton Nicholls.
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Endogeneous Risks Institutions-Based: Financial Risks (Credit,
Market, Liquidity, Interest Rate, Currency). Other Risks
(Operational, Concentration, Reputational, Business Strategy,
Capital Adequacy). Market-Based: Counterparty risks, credit risks,
contagion risks. Infrastructure-Based: Clearance, Payment and
Settlement Risks. Macroeconomic Risks Macroeconomic Imbalances
(Fiscal Deficits, Balance of Payment Deficits) Event Risks Natural
Disasters, Political Events, Large business failures Exogeneous
Risks Source: Schinasi (2006)
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Risk Assessment of Financial system requires: Identification of
major sources of risks Endogeneous (shocks generated and amplified
within financial system) Exogeneous (shocks arising from outside
the system) Assessment of Nature of the Risk Macro-prudential
(driven by common exposures, interconnectedness, interdependence
from Endog. and Exog. Shocks). Micro-prudential (addresses risks in
individual financial institutions arising from Endog. and Exog.
Shocks).
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Measurement of Risk (Risk Metrics) Micro-Prudential Measures
(CAMEL, CARAMEL, PEARLS for individual financial institutions)
Macro-Prudential Measures FSIs, EWS Macro-Stress Tests Network and
Interconnection Matrices and Maps Macro-econometric Link Models,
DSGE Models Financial Contagion Matrices
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Effective Risk Mitigation through: Complementary
macro-prudential and micro-prudential regulation (a major
blindspot). Crisis Preparedness Plan and Strategy. Robust
Information, Communication and Technology platform (including
robust computer networks and flexible databases). Business
Continuity framework and Plan for the financial sector.
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Region is making some progress with putting in place FSI
indicators (both core and enhanced) for the Banking sector.
Significant effort is however required in developing and compiling
FSIs and EWIs for non-banks, life and non-life insurance companies,
credit unions and pension funds. Systemic risk and macro-prudential
regulation of the system as a whole remains a potential Achilles
heel unless more rapid progress is made with macro-prudential
surveillance.
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Stress Tests have been conducted in the banking systems of most
Caribbean countries - Trinidad and Tobago, Barbados, Suriname,
Jamaica, Belize, OECS, Guyana. Most of the Stress Tests have been
directed at single factor shocks with an emphasis on one component
of the financial system (banking). [Exception: Jamaica has
conducted stress tests of insurance and credit union sectors]. No
combined stress tests have been developed that examine the impact
of Endog. Shocks (e.g. interest rate declines) on the entire
financial system (banking, insurance, pension funds and credit
union sectors) in national financial system s and across the
region.
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Banking Sector : Economic stagnation has led to a sharp rise in
the Non- Performing Loans to Total Loans (NPL/TL) ratio which
hovered at just under 10.0% in 2012. But Banks maintained
sufficient liquidity and had robust capital adequacy provisions.
High NPL/TL ratios in Belize, Barbados, ECCB and the Bahamas.
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Credit Union Sector: FSIs collected for the credit union sector
remain quite sparse although this sector is quite important in some
regional jurisdictions such as Barbados and the ECCU. Even sparse
data show that credit risk in this sector is above the PEARLS
target.
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Life Insurance Segment: Medium underwriting and asset quality
risks for the life insurance sector. Data remain sparse and
difficult to compare meaningfully across the region. Non-Life
Segment: High combined ratios (loss ratio and expense ratio) may be
signaling some difficulty in an environment of low investment
yields.
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Short Term: Rapidly improve collaborative efforts in building
FSIs for non-banks, insurance, credit unions and securities firms
that operate in onshore national and regional economy. Build
integrated database for regional financial conglomerates and SIFIs
and develop consolidated FSI database for the Caribbean. Develop a
financial interdependency matrix to map interconnections of SIFIs
at both a national and regional level.
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Short Term (contd): Establish an appropriate institutional
framework and support structure for macro-prudential surveillance,
regulation and policy making). Develop and extend macro stress
tests beyond banking sector to other key areas, especially
insurance and the securities market. Conduct at least one
significant region-wide stress test for banking and insurance
sectors. Develop appropriate Communication Strategy to report and
warn of impending risks (FSRs, Conferences/Workshops, etc).
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KEY AREASACTIONS 1. Legal Regulatory/Mandate Need to Ensure
Legal Mandate for Financial Stability is established. 2.
Organisational/Institutional Arrangements Need for a System-wide
Oversight Committee or Regulatory Policy Council that is focused on
macro-prudential policy and financial stability. 3.
Macro-Prudential Policy FrameworkNeed to establish a
macro-prudential policy framework with clear terms of reference.
Building capital buffers Contain build-up of vulnerabilities over
time, in sectors and across the system.
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KEY AREASACTIONS 4. Operating Framework for Financial Stability
Assessing Systemic Risk (Assess imbalances, Map out linkages in the
system) Design Macro-prudential tools to contain systemic risks
(countercyclical capital buffers and provisions, sectoral capital
requirements, Loan-to-value limits, Debt-to- income limits,
risk-weighting of highly connected sectors, liquidity coverage
ratios, net stable funding ratios, reserve requirements, ) 5.
Financial Safety Net/Crisis Preparedness Plans Design appropriate
financial safety net (deposit insurance, financial stability fund
or levy) Preparation of national crisis preparedness plans.
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IMF BASLE COMMITTEE BASLE COMMITTEE IAIS IOSCO WOCCU IOPS FATF
REGIONAL CENTRAL BANKS REGIONAL CENTRAL BANKS OTHER REGULATORY
BODIES CAIR CAPS CGSR CACS CFATF CGBS CCMF RFSCC CCBG COFAP
REGIONAL REGULATORY STRUCTURE IN RELATION TO INTERNATIONAL
FINANCIAL STABILITY ARCHITECTURE
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Long Term: Re-establish national flow of funds matrices and
build an integrated flow of funds matrix for the region. Develop a
financial contagion matrix for the region. Build a quarterly
regional link model (dynamic macro- econometric financial model) to
detail linkages between the national and regional financial sectors
and the regional economic system.
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Regulators may not be able to prevent the emergence of the next
financial crisis, but must place themselves in a position to
mitigate its destabilizing effect. Developing a Risk Assessment
Framework for the Caribbean regional financial sector based on
Macro-Prudential principles is the place to start and the way to
go.
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CARTAC stands ready to help countries enhance their financial
stability and macro- prudential frameworks.