Paste your es4 THE REGIONAL PERSPECTIVE: A CASE STUDY ON TRINIDAD
AND TOBAGO
4.1. Introduction
Just like Suriname, T&T is also member of the CARICOM and the economies of both countries depend on exports of commodities. These countries also show geographic and cultural similarities. In relation to other CARICOM members their financial systems have been less vulnerable to external conditions, and so domestic credit in general has not been very sensitive to external pressures since the crisis.
The collapse of the Trinidad and Tobago-based CL Financial Holdings in 2009, the largest financial conglomerate in CARICOM, resulting from the crisis has placed the regulation of systemic financial institutions at the top of the regulatory reform agenda of T&T. The collapse of CLICO with its attendant contagion effects across the region, demonstrated how financial interconnectedness could spread crisis. As evidenced by annual reports and Financial Stability Reports of CBTT, several measures have been taken to improve the financial landscape. The aim of this chapter is thus to provide an overview of the regulatory and supervisory framework for systemic banks in T&T and to identify possible improvements for Suriname based on the results of this case study.
4.2. Descriptions and Analysis
Financial Soundness Indicators (FSIs)
T&T experienced weakened economic activity in 2015 and early 2016 due to the fall in energy prices and lower production levels. Nevertheless, this has not led to a material decline in any of the key FSIs of the banking sector. Commercial banks are licensed to conduct the business of banking under the Financial Institutions Act, 2008. The commercial banking sector in T&T is sound, as shown by the FSIs in Annex 14. The capital adequacy ratio stood at just over 20 percent at the end of 2015, which is well in excess of the minimum statutory requirement of 8 percent. Profitability was healthy in 2015, with return on equity of 18.2 percent and return on assets of 2.5 percent. Asset quality in the banking system improved further with non-performing loans falling from 6.3 percent of total loans in 2011 to 3.4 percent at the end of 2015. The improvement in credit quality resulted from banks undertaking a combination of loan restructuring, stronger collection efforts and loan write-offs primarily in commercial real estate. Persistent high levels of liquidity in the domestic financial system kept funding risks low for commercial banks. Liquid assets constituted 23.8 percent of commercial bank’s total
assets.
Regulatory and Supervisory framework
In the aftermath of the CLICO crisis, the CBTT intensified its efforts by close monitoring of institutions which could significantly disrupt the functioning of the financial system and the economy. Size, interconnectedness, substitutability and cross-border operations are utilized by CBTT for classifying domestically important financial institutions (CBTT, 2014). These institutions are subject to additional requirements with regard to capital, enhanced reporting requirements and resolution plans for having such a living will. CBTT has developed a risk-based framework based on the business models and risk profiles of these institutions, which are subject to more stringent supervision through frequent reporting to the central bank, enhanced corporate governance requirements and regular and focused stress testing. In 2015 regulatory oversight over four systemically important banks was increased through engagement and more intense surveillance. According to the FSR 2014, Republic Bank Limited is one of the four commercial banks that have been designated as systemically important. This bank was still a systemic bank in 2015. A subsidiary of Republic Bank Limited is located in Suriname.
CBTT is considering additional capital requirements for D-SIFIs. The current minimum capital adequacy ratio of 8 per cent has been in place since the enactment of the Financial Institutions (Prudential Criteria) Regulations in 1994. CBTT proposes an increased minimum capital adequacy ratio to 10 percent and a higher minimum capital adequacy ratio of 12 percent for banks that are deemed systemically important. Banks will also be subject to a higher minimum Tier 1 Capital Ratio of 7 percent and to a minimum ratio of common equity to risk weighted assets of 4.5 percent. T&T is planning to update its risk based Capital Adequacy Framework with Basel 2 standards and some elements of Basel 3. Under the revised framework banks will also be required to hold minimum capital for operational risk.
International liquidity standards, such as the LCR- to promote resilience to short-term disruptions and the NSFR- which encourages the maintenance of stable funding, will be adopted on a phased basis. Liquidity of banks is monitored by selected financial soundness indicators based on data received from banks.
The FSR 2015 highlights four key vulnerabilities in the financial system of T&T:
(1) heavy dependence on the energy sector;
(2) high level of household indebtedness;
(3) historically low domestic interest rates;
(4) rising financial interconnectedness in the Caribbean.
Despite the banking system’s direct exposure to the energy sector being minimal, challenges such as fiscal policy amendments, increasing unemployment and foreign exchange pressure may have a negative impact on banks, as they may tighten lending standards, resulting in a slowdown or reversal in credit growth (CBTT, 2015).
Household indebtedness amounted to about 44 percent of total loans as of end-2015, of which 41.5 percent was secured by real estate. This indicates that a decline in property values will have an impact on the value of banks’ collateral. In case of debtor delinquency, the likelihood of loss and deterioration of the real estate portfolio will increase. LTV ratios are around 75 percent for the purchase of residential land and building. In 2011, CBTT issued a regulatory form for comprehensive data related to the real estate sector. CBTT also conducted stress tests based on a fall in property prices. Stress test results indicate that the banking sector remains financially sound, even at a fall in property prices.
Domestic financial institutions are most heavily exposed to Barbados and St. Lucia. Many of these institutions hold regional sovereign debt and are interlinked through cross-shareholdings, mainly investments in subsidiaries and affiliates. Given the rising interconnectedness of regional financial entities, sovereign debt restructuring in the Caribbean can be a trigger for increasing domestic and regional financial stability risk. Exposures to CARICOM jurisdictions warrant ongoing monitoring. As mentioned in the FSR 2015, T&T will focus on effective cross-border supervision with regulatory cooperation and information sharing to mitigate these risks. This covers three regional initiatives of which the “Regional and National Financial Crisis Management Plans” is one of them. The two other regional initiatives are ongoing and include: Consolidated Supervisory Framework for Cross-border for Financial Groups and Loan Classification and Provisioning Harmonization Project.
According the FSR 2015, each jurisdiction must develop a national crisis management plan which will be incorporated into a wider regional plan. CBTT, with the approval of the Minister of Finance and the Economy, produced this plan and has subsequently been working as part of a task force comprising the Ministry of Finance and the Economy, the Deposit Insurance Corporation and the Securities and Exchange Commission to finalize the plan. The key features of the plan are designed to enable crisis preparedness and include: options for recovery and resolution of a SIFI in crisis; inter-agency communication, co-ordination and protocols; and identification of roles for each stakeholder in each identified option.
Furthermore, CBTT is spearheading an initiative to strengthen regional financial stability through development of a map which shows the financial interconnectedness among banks, insurance companies and other financial institutions in the region. Stress testing of these financial linkages will serve to identify the areas and extent of vulnerabilities associated with contagion risk and to develop appropriate buffers and responses to maintain regional financial stability. All of aforementioned efforts of T&T are good, and could be adopted by Suriname, if it is not done yet.
4.3. Own assessment
While T&T and Suriname partially follow Basel 1, 2 and 3 standards, the definitions of concepts and their measurement for capital- and liquidity ratios and other prudential ratios may vary between both countries. Differences between jurisdictions with regard to legislation and regulation, level of financial development, expertise, financial data and FSIs, must be mapped and discussed in a regional context. Regional regulatory organizations such as the Caribbean Group of Banking Supervisors may help to promote consensus for regional banking issues.
Tightening of prudential supervision means that supervision must be intensive, intrusive and more insistent. At the supervisory level, willingness must exist to directly intervene if problems occur with systemic banks. For a proper assessment of the risk profile of a large bank, the link between micro- and macro-prudential risks is of major importance. It appears that T&T is already focusing on a comprehensive macro analysis for determining the risk profile of systemic banks. Suriname has also initiated macro analysis, but there should be carried out more thorough analysis for a clearly reflection of the micro-macro link. This can include, for example, analysis of the risk of real estate, considering adopting higher risk weights for real estate loans and the imposition of additional requirements for D-SIBs.
Despite the legal obligation to maintain the confidentiality of individual banking information, regulators will have to strive for more transparency in the exercise of their supervisory function. This will also facilitate more effective supervision. Article 27 of the Banking Supervision Law, 2011 describes the disclosure requirement for banks about their capital and risk profile, but this part is still in progress. The CBTT website is transparent and contains a variety of aggregated data on commercial banks. There is not only actual data available, but also historical data can be obtained. Publicly available banking data on the website of CBvS must be improved by considering submission of more frequent prudential information on FSIs and, for example, the point of view of CBvS about a certain issue of a (systemic) bank.
Supervisors must ensure and require systemic banks to continue strengthening their capital position based on their risk profile and growth. This will make them less vulnerable to unexpected losses and can they keep continuing meeting the demand for credit in a responsible way. Systemic banks should also take initiatives to develop tools for improving their capital position, if needed.
Bankruptcy of large banks may increase the need for government support, especially if effective crisis instruments are not or not adequately developed and implemented. An effective crisis management framework is therefore required to intervene in time, to preserve critical functions and to reduce risks to the government and financial stability. Supervisors must encourage banks to establish their own recovery and resolution plans, which will help to reduce the complexity of banks during the process. T&T has already developed a national crisis management plan, while Suriname still is in the phase of preparing the banking resolution law. Suriname is behind the developments in T&T and will have to step up its development of a systemic framework for timely intervention and resolution.
4.4. Final remark
Systemically important financial institutions have an important weight in the Caribbean region. Cross-border interconnectedness has increased enormously in recent years. In this context, T&T is still undergoing a more comprehensive and regional approach to financial supervision and regulation. This country has also taken steps to increase the resilience of the financial system against adverse shocks by reforming its legislative, regulatory and supervisory framework.
At this moment, systemic banks are subjected to an increased supervision by the reporting of additional data, and the execution of multiple on-site inspections. Imposing additional capital buffer requirements to systemic banks is still in progress. The new capital buffer requirements as elements of Basel 3 will be adopted on a phased basis. CBTT has not yet implemented the international liquidity standards, but is managing liquidity risk by means of FSIs.
Because of the rising interconnectedness within the region, CBTT continues to strengthen its supervisory framework for consolidated supervision. This would require a greater degree of information sharing and coordination between central banks.
Alongside the progress made, there is still more work to do to align policies and processes with relevant international best practices and standards. This applies particularly for Suriname that is behind in adopting a number of developments in comparison to T&T.
5 CONCLUSIONS AND RECOMMENDATIONS
5.1. Conclusions
• The international policy framework for systemic banks is aimed at increasing the resilience and on improving the resolvability of systemic banks. To reduce the risk of systemic banks, these banks will have to maintain structurally higher capital buffers, whereby both the quantity as the quality of core capital should be increased. In addition, also liquidity requirements should be imposed on systemic banks, in order to avoid that the lender of last resort often need to provide liquidity support and that the deposit guarantee must be actually applied, although the latter is not always sufficient to guarantee creditors of systemic banks. Furthermore, systemic banks must have well-designed recovery and resolution plans, wherein measures should be formulated to keep upright in a severe crisis. Another way to increase the resilience of systemic banks is intensifying prudential supervision of these institutions.
• Given the small-scale of the banking sector, the failure of any bank in Suriname may have systemic implications. For this reason, each bank can be categorized as a systemic bank. However the characteristics of the three larger banks, which account for about 80% of the banking sector total assets, are associated with more risks. Large banks carry a greater risk, and create more systemic risk, when they have lower capital and less-stable funding and when they are involved in more complex market-based activities (IMF, 2014). Failures of large banks may lead to greater disruption of the financial system relative to failures of small banks. Furthermore IMF’s research explains that the failure of large banks may also generate more liquidity stress in the banking sector. Due to the larger scope of activities of large banks relative to small banks, their activities may not be replaced easily by the small banks, and the marginal cost of taxpayer support may increase in the volume required. For large banks traditional banking regulation alone is not enough, which is why additional regulation based on risk considerations need to be applied for large banks.
• International standards and best practices are used by the CBvS to improve and strengthen its supervisory policy. Although this is an important step forward, the legislation and regulations should be tightened up on several points, such as higher capital buffer requirements for systemic banks and crisis management. The necessary measures regarding adequate monitoring of systemic banks are shown in the recommendations.
• Micro- and macro-economic distortions can lead to problems in the banking sector with the result that financial stability may be jeopardized. Non-performing loans could rise and may worsen the capital position of large banks if negative macroeconomic shocks abruptly turn the economy. These banks may be forced to restructure and mitigate credit facilities if they have not built sufficient capital buffers in an economic upturn. Because the central bank has an important role to play in monitoring the principles and standards at the micro and macro risks, it is important to identify the risk profile of each bank, and to determine and reassess the degree of systemic relevance. This makes it possible to carry out more intensive and effective supervision.
• Macro-economic cyclical fluctuations may have a decisive influence on banks' internal operations, that’s why a close connection between macro and micro supervision is necessary. Not only good capitalization is important but also strong corporate governance and targeted risk management at banks are required.
• There has been gradual progress in the supervisory framework of both Suriname and T&T. Both countries are in an ongoing process for shifting to risk-based approaches. Main findings in both countries concern:
– Differences in conception of prudential regulations, such as differences in the risk-based capital requirements.
– BIS’ standards. Both countries are following elements of Basel 1, 2 and 3, but the application and compliance with the standards and regulations is not the same in all cases. Although key FSIs of T&T are more prudent than those of Suriname, they may not always be suitable for comparison purposes, because of the variety in definitions and calculation methods.
– Incomplete state of the resolution framework. Regarding crisis management, Suriname is now preparing a Banking Resolution Law and T&T is focusing on the ongoing regional and national financial crisis management plans.
– Delayed introduction of DGS. T&T has already implemented a deposit guarantee scheme, while Suriname still is in a phase of a draft law for deposit insurance.
– Differences in the type, scale and complexity of banks. T&T banks have more subsidiaries and branches across several jurisdictions in the region, while there is only one foreign subsidiary active in Suriname. So, T&T is threatened with a higher level of interconnectedness and consequently more systemic banks.
– The banking sectors of both countries are exposed to loans that are secured largely by real estate. CBTT has implemented a ‘Residential Real Estate Mortgage Market Guideline’, while there are no measures taken yet for an effective monitoring of real estate loans and in appreciation of the value of these assets in Suriname.
– T&T is focusing on a higher level of stress testing in relation to stress tests that are conducted by Suriname.
– Both Suriname and T&T are identifying systemic banks according Basel standards.
• Unfortunately, while all the recent literature addresses ways to strengthen the supervisory regimes, there remains the problem of implementation and the cost of implementing such regimes. In small banking systems and for central banks it may take more time for the supervisory function to be adequately staffed and fully trained. And for banks, the cost of compliance with a large and complex array of supervisory requirements becomes onerous. So, the recommendations of international bodies should be adapted to fit the local capability. Rather than to rely on models and numbers the focus should be on qualitative analyses. The numbers are symptoms or indicators of potential problems, but the job of the supervisor is to look underneath the numbers as to the causes of them, and to do so before they create unsolvable problems.
5.2. Recommendations
• Higher capital buffers should be imposed for identified systemically important banks. This is important because problems in these banks not only put financial stability at risk, but also the functioning of the economy. Issuing of new shares can also help strengthening the capital over the coming years. Buffer strengthening means there will be little or no room for dividend payments and if dividends will be temporarily restricted, the marketability of these shares becomes difficult. The central bank should therefore take this into account in its policy.
• Policies and procedures for quantifying and applying the high capital buffers have to be developed.
• Suriname must put the legal and regulatory framework for crisis management in place. Effective crisis instruments are needed for enabling a timely intervention when a systemic bank is failing, to preserve critical functions of such a bank and to reduce the risks for the government and financial stability. It also contributes to reducing the complexity of banks. Guidelines for crisis prevention and management should be developed, and banks should be encouraged to create their own recovery plan.
• CBvS must promote the implementation of the DGS and Credit Bureau in Suriname. The absence of deposit insurance and the lack of systemic bank resolution frameworks add complexity and may delay the process in intervention and resolution of a failing bank.
• As a key part of general contingency planning, CBvS must consider establishing a contingency plan for emergency liquidity in the foreign currencies in which the banking system operates.
• CBvS must consider imposing higher capital standards for banks regarding real estate loans, given the high concentration of these types of loans in commercial banks’ loan portfolios.
• CBvS must ensure that banks have proper capitalization and targeted risk management. This can be supported by an understanding of the effects of different scenarios and initiating business strategies. Continuity analyses and appropriate stress tests are useful in making the resulting material risks visible, quantifiable and isolated.
• The effectiveness and implementation of the new regulations for banks in Suriname must be assessed and where necessary further improved in line with the new internationally accepted norms and standards. Differences in prudential regulations and inadequate information sharing across countries must be reduced, because this could lead to insufficient understanding of systemic risk. Greater regional cooperation is needed to strengthen financial sector stability in the region.
• Monitoring of actual information and developments should be increased. In addition to regular prudential reports, also management information may be requested on a regular basis. CBvS should communicate more frequently with the Supervisory Board and other key staff members and external auditors of banks on relevant information concerning the developments at the bank. This could apply for all banks, but especially for banks when they are facing problems with their solvency and liquidity.
• The interaction between micro prudential supervision and macro prudential analysis must be promoted. In the risk analysis of individual banks, macro prudential risks must also be taken into account in cooperation with the Financial Stability Department. Cooperation and knowledge sharing between the Banking Supervision- and Financial Stability Department in the fields of risk analysis and stress tests must also be promoted.
• Transparency of banks in Suriname must be improved by imposing the obligation for publishing key performance indicators in accordance with article 27 of the Banking Supervision Law, 2011. Greater transparency in banks’ disclosure and more frequent reporting of financial soundness indicators would facilitate more effective supervision.
• The framework for the functioning of an effective capital market must be set up and the Law on the Capital Market should be applied sufficiently.
• It is often difficult for consumers to picture the various financial products and their underlying risks. Consumers must consequently be protected with the aim that banks grant credit to consumers in a responsible manner, partly to prevent excessive lending. It allows therefore large mortgages to be prohibited with respect to the real value of a house. The crisis has shown that customers possessed loans they did not understood and which were far above their ability to repay the loans.
• Membership of Suriname in the CARICOM Single Market Economy (CSME) should contribute to possible strategic alliances between Surinamese banks and foreign institutions with a good reputation. This may lead to utilizing institution’s possibilities and resources without participating in each other’s capital, but it may be more intense when institution’s exchange a minority shares in each other’s capital.
• The aforementioned efforts made by T&T regarding higher capital buffer requirements, monitoring of interconnectedness, more intensive supervision, establishment of crisis management plan and implementation of a deposit guarantee scheme are good progresses and should also be adapted by the CBvS in the short-term.