II The Financial System
Author: Mrs. Ruby Randall, Mr. Jorge Shepherd, Mr. Frits Van Beek, Mr. J. R. Rosales, and Ms. Mayra Rebecca Zermeno
Language:
English
Keywords:
OP; member government; government; CARICOM state; market; ECCB Area; ECCB holding; ECCB guideline; development bank; ECCB requirement; Currencies; Caribbean
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Abstract

The establishment of the Eastern Caribbean Central Bank (ECCB) in 1983 was the culmination of a long period of monetary cooperation dating back to 1950 when the British Caribbean Currency Board (BCCB) was created (Box 2). The BCCB, which functioned as a currency board proper and maintained a foreign exchange cover of 100 percent of the currency issue, was replaced by the Eastern Caribbean Currency Authority (ECCA) in 1965, when the Eastern Caribbean dollar (EC$) was introduced and pegged to the pound sterling at a rate of EC$4.80 = £1. Under the ECCA, the foreign exchange backing was set at 70 percent and then reduced to 60 percent in 1975. Following a series of depreciations of the pound, the Eastern Caribbean dollar was pegged to the U.S. dollar in July 1976 at the then prevailing market cross-rate of EC$2.70 per U.S. dollar. The parity has remained fixed at that level.

ECCB Institutional Framework

The establishment of the Eastern Caribbean Central Bank (ECCB) in 1983 was the culmination of a long period of monetary cooperation dating back to 1950 when the British Caribbean Currency Board (BCCB) was created (Box 2). The BCCB, which functioned as a currency board proper and maintained a foreign exchange cover of 100 percent of the currency issue, was replaced by the Eastern Caribbean Currency Authority (ECCA) in 1965, when the Eastern Caribbean dollar (EC$) was introduced and pegged to the pound sterling at a rate of EC$4.80 = £1. Under the ECCA, the foreign exchange backing was set at 70 percent and then reduced to 60 percent in 1975. Following a series of depreciations of the pound, the Eastern Caribbean dollar was pegged to the U.S. dollar in July 1976 at the then prevailing market cross-rate of EC$2.70 per U.S. dollar. The parity has remained fixed at that level.

Like the ECCA and the BCCB before it, the ECCB has the sole right to issue the common currency, and the member countries surrender their foreign exchange to the common reserves pool administered by the ECCB. Each country, however, has unrestricted access to the common reserve pool as long as it has the domestic currency to make it effective.5 All ECCB bank notes are coded according to the country to which they are issued. This enables the ECCB to allocate profits to the member governments taking into account the currency issued in each territory and to calculate imputed reserves for each as the sum of currency in circulation and its net claims on the government and the commercial banks in each territory.6

The ECCB is governed by two separate bodies: the Monetary Council and the Board of Directors. The Monetary Council consists of eight members, one minister appointed by each member state (each with one vote), and is the highest decision-making authority of the ECCB. The chairmanship of the Council is rotated every year. The Monetary Council meets three times a year and is responsible for providing policy guidance to management. The Board of Directors has ten members, including the Governor (who is the Chairman), the Deputy Governor, and one Director appointed by each participating government. It meets five times a year and is responsible for the general operations of the Bank, regional and international economic relations, and coordination of plans and programs. The Governor and Deputy Governor are appointed by the Monetary Council, normally for five-year terms, and can be reappointed.

A major reason for the creation of the ECCB was that member states wanted a central bank capable of playing a more active role in promoting the region’s development. Consequently, the objectives of the ECCB as stated in its charier are the regulation of money and credit; the maintenance of monetary stability; the promotion of credit and exchange conditions and a sound financial structure conducive to regional growth and development; and promotion of economic development of the member states. In practice, the principal objective of the ECCB’s monetary policy, and the primary benefit of the currency union, has been sustaining credibility of the fixed exchange rate regime, which has been central to the region’s price stability. Macroeconomic stability has in turn facilitated economic growth. Other clear economic benefits that member countries have derived from the currency union include risk-pooling through a common foreign exchange reserve pool,7 and the achievement of economies of scale in central bank operations through the spread of overhead costs.

Antecedents of the ECCB

The antecedents of the ECCB date back to the development of the currency arrangements for the British colonial territories in the Caribbean. In the early days, notes issued by the foreign commercial banks operating in the region and coins issued by the United Kingdom were circulating concurrently. Starting in the 1920s, currency was also issued by three different Boards of Commissioners of Currency, in Trinidad and Tobago, British Guyana, and Barbados (which also served the Leeward and Windward Islands).1 At the West Indian Currency Conference in 1946, these countries agreed to establish a unified decimal currency system based on the West Indian dollar, and in 1950 they created the British Caribbean Currency Board (BCCB). The BCCB was given the sole right to issue notes and coins, and the mandate of keeping full foreign exchange cover to ensure convertibility at the exchange parity of 4.8 West Indian dollars for one pound sterling. Trinidad and Tobago withdrew from the BCCB upon independence in 1962 and established its own central bank. British Guyana did the same in early 1965.

The BCCB was replaced by the Eastern Caribbean Currency Authority (ECCA) in January 1965, the original members of which were Barbados, the Leeward Islands, and the Windward Islands except Grenada,2 which joined in 1968. The West Indian dollar was replaced by the Eastern Caribbean dollar with the same exchange parity. The foreign exchange cover was set initially at 70 percent. The Authority served as an advisor, banker, and fiscal agent to member governments and compiled financial and economic data on the members. Through the Clearing Agreement, the Authority provided commercial banks operating in the area with a facility for clearing interbank indebtedness. Banks also made use of a facility for surrendering foreign currency in exchange for interest-bearing deposit accounts.

Following the devaluation of the pound sterling in 1967, Barbados proposed that the Currency Agreement be amended to allow the ECCA to change the parity of the Eastern Caribbean dollar in the event of a devaluation of the pound. Such an amendment was never made, and in 1972, after the floating of the pound, Barbados established its own central bank. Following the withdrawal of Barbados, the ECCA’s headquarters was moved to St. Kitts. The foreign exchange cover was reduced to 60 percent in 1975. The ECCA shifted the link of the Eastern Caribbean dollar from the pound to the U.S. dollar in 1976. At the same time, there was an attempt to improve bank regulation by gathering information on commercial banks on a regular basis. The ECCA also assumed a broader role; for example, in 1977 it became a cosignatory for establishing the Multilateral Clearing Facility in the Caribbean Community and Common Market (CARICOM) replacing the existing bilateral clearing arrangement. The process of regional integration took another step forward with the creation of the ECCB in 1983.3

1 The Leeward Islands comprise Anguilla, Antigua and Barbuda, Montserrat, and St. Kitts and Nevis; the Windward Islands are Dominica, Grenada, St. Lucia, and St. Vincent and the Grenadines.2 Grenada initially formed a political union with Trinidad and Tobago and used its currency as legal tender until it joined the ECCA in November 1968.3 Regional cooperation in other areas included the creation of the Caribbean Free Trade Agreement (CFTA) in 1967 by Antigua and Barbuda, Barbados. Trinidad and Tobago, and Guyana, joined in 1968 by the Windward Islands, St. Kitts and Nevis, and Montserrat. The Leeward and Windward Islands formed the East Caribbean Common Market (ECCM) in 1968. CARICOM was established in 1973, superseding the CFTA. The Organization of East Caribbean States was established in 1981, superseding the ECCM.

Stability of the Eastern Caribbean dollar is maintained through strong foreign currency backing, as the Bank is bound by its Articles of Agreement to maintain the level of pooled reserves at not less than 60 percent of its demand liabilities.8 This implies a limit on domestic assets of 40 percent of Eastern Caribbean dollar-denominated demand liabilities. The Articles of Agreement stipulate that the ECCB may, at its discretion, extend credit to member governments under a number of specified lines, but subject to prescribed limits (Box 3). The sum of the maximum amounts the ECCB could lend under these credit lines, including the outstanding balances on the “special deposit” loans,9 typically exceeds the 40 percent global limit on domestic assets.

Currency Backing and Limits on Credit to Member Governments

Stability in the value of the Eastern Caribbean dollar is maintained through strong foreign currency backing, as the Bank is bound by its Articles of Agreement to maintain, at all times, the level of pooled official reserves at no less than 60 percent of the value of its demand liabilities. This implies a global limit on domestic assets of 40 percent of demand liabilities, which the Bank then distributes to participating governments, over a range of credit categories. In practice, the ECCB has typically maintained a foreign exchange backing ratio in excess of 95 percent.

According to its Articles of Agreement, the ECCB is permitted to provide credit to member governments in the form of: (i) temporary advances; (ii) holdings of member state treasury bills; (iii) holdings of securities other than treasury bills; (iv) holdings of corporate bonds issued by corporations established under the authority of any participating government; and (v) the assumption of participating government “special deposit liabilities” to financial institutions.

The amounts of such lending are subject to the following rules:

  • Temporary advances to participating governments are intended for assisting with seasonal credit needs, and are limited to 5 percent of participating governments’ average annual recurrent revenue over the three preceding financial years. Such advances must be amortized over a period of no more than 12 months, and are debited from governments’ operating accounts.

  • ECCB holdings of treasury bills of participating governments that mature within 91 days of the date of their acquisition by the Bank must not exceed 10 percent of the estimated recurrent revenue of that government for that current year (based on the approved budget for the current financial year).

  • ECCB holdings of government securities maturing in no more than 15 years from the date of acquisition by the Bank must not exceed 15 percent of the currency issued and in circulation and other demand liabilities. In practice, the Bank bases this calculation on the average currency in circulation and other demand liabilities over the preceding 12 months, owing to seasonal variations and the varying deposit behavior of the commercial banks.

  • ECCB holdings of corporate bonds, which must mature within ten years from the date of acquisition by the Bank, are limited to 2 ½ percent of the average annual government revenue over the preceding three financial years.

  • The ECCB continues to service participating governments’ “special deposit” loans; the original amount assumed by the Bank was EC$75.7 million, and as of end-1998 this loan balance was EC$30.8 million.

Because the sum of the amounts calculated for these different credit categories usually exceeds the global credit ceiling, and because the Bank must also make provisions for its responsibility as the “lender of last resort” to the banking system, actual credit allocations, by type of individual credit category, are based on each member government’s share of total regional recurrent revenue. These individual country limits serve only as lending guidelines.

The Agreement authorizes the Bank to make secured advances to banks, but it does not specify the terms of the ECCB’s involvement as a “lender of last resort” in the event of bank crises.

At the beginning of each financial year (April 1), the ECCB’s monetary program allocates the global limit (calculated conservatively in relation to the monthly average of the monetary liabilities of the previous year) to the member governments in proportion to each government’s share of total regional recurrent revenue. The actual credit available to each government for the financial year is the amount of the allocation less all outstanding balances and arrears (Table 2). In practice, net new lending to governments has been minimal and on balance, the stock of outstanding credit declined during 1990–98 (Table 3), as member governments have been reluctant to borrow and the ECCB has been conservative in its allocation of credit, typically maintaining a foreign exchange backing ratio in excess of 95 percent (Table 4). In this way, the ECCB has room to exercise its responsibilities as “lender of last resort” to the banking system when necessary, and to lend to governments during natural disasters or other pressing circumstances.10

Table 2.

ECCB Area: Allocation of ECCB Credit to Member Governments 1998/991

(Millions of Eastern Caribbean dollars, unless otherwise indicated)

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Source: Eastern Caribbean Central Bank.Note: The total credit allocation or “fiduciary” (3), equal to 40 percent of average demand liabilities in 1997/98, is distributed in proportion to total recurrent revenue (1). The allocation of treasury bills is calculated separately and subtracted from (3) to yield the allocation of debentures (8). Total available credit (13) is the sum of the available balances of treasury bills (7) and debentures (10) less special deposits (11) and arrears (12).

Financial year April-March. Outstanding balances in columns (3) through (13) are as of March 31, 1998.

Table 3.

ECCB Area: Detailed Monetary Survey1

(Millions of Eastern Caribbean dollars)

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Source: Eastern Caribbean Central Bank.

Includes Anguilla and Montserrat.

Includes social security systems.

Table 4.

ECCB Area: Condensed Balance Sheet and Backing Ratio

(In millions of Eastern Caribbean dollars)

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Source: Eastern Caribbean Central Bank.

Backing ratio defined as: (external assets - bankers’ fixed deposits)/demand liabilities.

The foreign assets reserve ratio is defined as: (ECCB external assets less bankers’ fixed deposits less liabilities to international institutions and central banks) divided by (demand liabilities less liabilities to international institutions and central banks).

ECCB Monetary Instruments

The ECCB’s Articles of Agreement authorize the Bank to use discount rates and rediscount rates, establish differential rates and ceilings for various classes of transactions, determine priority areas for credit distribution in cooperation with member governments, and establish a schedule of reserve requirements (including marginal required reserves), which can vary by deposit type.

Credit ceilings have never been used in practice, and since its inception the ECCB has maintained a uniform reserve requirement of 6 percent on all deposits. Prior to March 1994, commercial banks were required to hold, for four consecutive weeks, 6 percent of average deposits for the four preceding weeks. However, this requirement was modified in March 1994 when the ECCB adopted weekly maintenance periods and began basing required reserves on average weekly deposits. Commercial bank reserves are unremunerated, as are excess reserves if held in EC dollar deposits. Shortly after its inception, however, in a situation of high world interest rates, the ECCB began encouraging commercial banks to invest foreign currency within the region by remunerating bankers’ U.S. dollar deposits at internationally competitive interest rates.11 The ECCB moreover permits bankers’ deposits to be exchanged upon demand at the official cross-rate of EC$2.70 per U.S. dollar. This policy has helped to discourage bank capital outflows. During 1991–98, the three-month deposit rate was, on average, 0.3 percentage point lower than the LIBOR three-month rate (Table 5).

Table 5.

Selected ECCB and International Interest Rates

(Percent per annum)

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Sources: Eastern Caribbean Central Bank, and IFS.

Based on end-of-period rates.

Overdraft rate on government operating accounts.

Based on average Libor on U.S. dollars deposits over the fourth quarter.

In 1986, the ECCB created an interbank market to enable commercial banks with excess reserves at the central bank to make loans for periods of up to 30 days to banks with reserve deficiencies, boosting overall liquidity management.12 Borrowing banks are required to provide collateral (held by the central bank) in the form of fixed deposits, treasury bills, or other acceptable securities. Loans are brokered and guaranteed by the ECCB while the anonymity of both the borrowing and lending banks is preserved. This unique arrangement was designed, given the heterogeneous nature of the banking industry and the large disparity in bank size, to facilitate transactions regardless of bank ownership and size. Moreover, given the banking industry’s limited technological capability, the central bank’s involvement in the interbank market also helps to minimize banks’ search and information costs, as the ECCB matches bids and offers across member territories. The rates in this interbank market have been fixed by the ECCB since the inception of the facility. Borrowing banks pay a rate of 5.25 percent, lending banks receive 5 percent, and the ECCB retains the margin of 25 basis points to cover the cost of intermediation.

In 1988, the ECCB established a rediscount window for treasury bills, essentially a secondary market for treasury bills, as an inducement to commercial banks to invest in government securities. Through this window, the Bank makes its portfolio of domestic treasury bills, obtained under the existing credit lines to member governments, available to commercial banks at rediscount rates unchanged since the inception of the facility13 and discounts the bills at the banks’ discretion. Operations with commercial banks through the rediscount window do not violate existing ECCB country credit limits as all such transactions are currently conducted through the secondary market, and the volume is limited by the ECCB holdings of treasury bills.

The discount rate is intended to influence bank lending rates and thereby the level of economic activity by conveying the ECCB’s policy stance through the announcement effect, but in practice it has been changed infrequently. It was last altered in August 1996, when it was lowered from 9 percent to 8 percent. Because the discount rate is above the rediscount rate for treasury bills, banks do not use the discount window.14

Most commercial bank interest rates are unregulated; the ECCB established, however, a 4 percent minimum savings deposit rate in 1984 with the aim of encouraging small savers. Since this policy was first instituted, there have been instances when the interest rate on short-term time deposits was below the 4 percent minimum savings rate, indicating that the statutory minimum was effectively binding. The result has been an increased demand for savings deposits (see Table 3).

Financial Institutions15

The onshore financial institutions as a whole held EC$8 billion in assets as of mid-1997. The bulk was held by commercial banks (72.5 percent of total assets in the region), with the remainder held by the social security funds (16 percent), credit unions (5 percent), development banks (3 percent), life insurance companies (2 percent), and general insurance companies (1.5 percent).

Historically, the financial systems of the Eastern Caribbean states have been dominated by commercial banks. The market comprises 44 banks; 23 branches of foreign-owned banks, 17 private local banks (including locally incorporated subsidiaries of foreign banks), two government-owned banks (one each in St. Lucia and St. Vincent and the Grenadines) and two government-controlled banks (one each in Dominica and St. Kitts and Nevis) (Table 6). The industry is heterogeneous in ownership as well as in scale of operations, with the smallest banks maintaining assets of under EC$50 million in 1997, while the largest have assets in excess of EC$300 million. With the rapid rise in their numbers since independence, locally incorporated banks now account for more than 50 percent of total bank assets.

Table 6.

ECCB Area: List of Commercial Banks by Territory

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Source: Eastern Caribbean Central Bank.

Includes locally incorporated subsidiaries of foreign banks.

The government of Grenada began privatizing this bank in 1992. The government currently holds 10 percent of the shares.

This bank was privatized in 1996.

Formerly the Nevis Co-operative Bank.

The World Bank has identified two major constraints on the financial system of the ECCB region: fragmentation and fractionalization.16 Intraterritory fractionalization stems from the proliferation of small-sized, inefficient financial institutions characterized by scale diseconomies that, in the case of commercial banks, contribute to high interest rate spreads (Table 7). Financial fragmentation also prevents the best allocation of resources, producing poorly diversified, small-scale institutions that are characterized both by high costs and a limited capacity to diversify risk.

Table 7.

ECCB Area: Weighted Commercial Bank Interest Rates1

(Percent per annum)

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Source: Eastern Caribbean Central Bank.

Annual averages shown are based on end-of-quarter rates.

The sources of interterritory fragmentation include the tendency of local financial institutions to constrain their investment to their host country—reinforced by tradition, and a number of established licensing, disclosure, and tax procedures; legal restrictions, including the Alien Landholding Acts, which restrict foreign (including intra-OECS) ownership of domestic assets such as real estate and majority equity ownership positions in local enterprises: differential tax policies for residents of each country and nonresidents, such as the application of withholding taxes on the payment of profits and interest to nonresidents and foreigners, and tax exemption of interest on government securities and on domestic bank deposits for residents only in most member states; and prohibitions on residents’ purchases of foreign currency securities or real estate abroad, as well as other limits on outward capital flows.17 Table 8 summarizes capital account restrictions pertaining to the ECCB member states (as of end-December 1997) and shows the great disparity in the nature and extent of the restrictions on both residents of other member states and residents from outside the region. Many of these restrictions are in the process of being revised as part of legislative reforms being undertaken to support the development of a single financial space (see Chapter III).

Table 8.

ECCB Area: Selected Current and Capital Account Restrictions

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Source: IMF Exchange Arrangements and Exchange Restrictions: 1998 Annual Report.Notes: “Yes” connotes that there is a restriction or control; “no” implies chat the particular measure is not restricted or controlled; and “n.a.” means that the information is not available.

The social security systems account for the next largest share of financial assets in the region. Although the systems are not fully funded, they have acquired sizable surpluses, since participation is mandatory, and the plans and the populations are relatively young. Most of these resources are either held in commercial bank deposits—largely government securities mostly at government-owned banks but also other financial institutions—or in fixed income instruments. Thus, the funds are sometimes used to finance the government, either directly or indirectly.

Credit unions are the third largest group of financial institutions. There are 75 credit unions that—with the exception of one relatively large institution in Dominica with a market share of almost 25 percent—are micro-entities with less than EC$5 million in assets. About half their lending is for consumer loans, one third for mortgages, and the remainder is for loans to business and agriculture. Supervision of credit unions is not undertaken by a centralized body, but is carried out by the Registrars of Cooperatives of each state.

The region’s state-owned development banks were established to provide medium- to long-term financing primarily for government-initiated projects that might be considered unattractive by the banking system. Since their primary source of funds is deposits of short- to medium-term maturity, commercial banks tend to specialize in short-term collateralized lending, which is not considered suitable for project financing. With more than half of commercial bank credit going to the trade and distribution sectors, as well as loans for personal use, development banks aim to assist the agricultural, manufacturing, and other production sectors to promote economic diversification.

Some development banks have been plagued by nonperforming loans—partly because of difficulties encountered in making adequate feasibility assessments in the case of projects with long gestation periods of approximately three to five years. In response, the Caribbean Development Bank (CDB) has financed institutional strengthening programs to restructure the management and operational practices of several development banks, based on the principle that they should operate according to commercial standards with international best practices for governance and management, capitalization and financing, and regulation. Under such programs, investment decisions are made by a professional and independent board of directors, and bank managerial operations are overseen by external auditors.

Life insurance and general insurance companies account for the remaining share of the region’s financial assets. Providers of general insurance tend to specialize in property insurance, linked to catastrophe coverage (including fire and natural disasters) under comprehensive home and commercial policies, as well as in auto insurance. Local companies reinsure up to 85 percent of the risk they underwrite with foreign companies and earn commission based on reinsurance premiums. The current regulation and supervision of this industry needs to be strengthened, with focus on the adequacy of capitalization to cover the 15 percent of risk retained by local insurers and on the reliability of the foreign companies responsible for the other 85 percent.18 This is of particular concern given the recent substantial increase in new entrants into the industry (because of rising profitability associated with an increase in reinsurance premiums), that in turn has resulted in greater industry fractionalization.

The life insurance industry, dominated by two major companies, has grown over the past decade because of the expansion in mortgage lending (as mortgage holders are typically required to purchase life insurance). Industry participants have argued that a broader availability of investment securities would facilitate insurance rate reductions by enhancing the yield of their portfolios, and stimulate the demand for various insurance products. The industry, therefore, seems well-poised to benefit from the new investment opportunities created by the ECCB’s money and capital markets development initiatives.

Regulatory Framework

Legal Requirements

The ECCB’s regulatory and supervisory jurisdiction over commercial banks and other licensed financial institutions (including finance companies and offshore banks affiliated with local banks) is established in the 1983 ECCB Agreement Act (Articles 4 and 35), as well as in the Uniform Banking Act (UBA) approved by member governments in 1991. The Banking Act was amended in 1993, broadening its scope to include all licensed nonbank financial institutions other than credit unions and insurance companies. In 1993, an amendment to the 1983 ECCB Agreement gave the central bank emergency powers to intervene in failing financial institutions that are of systemic importance.19 In such situations, the ECCB now has power to investigate and to take whatever steps necessary to protect depositors, including the confiscation and sale of assets. The ECCB does not have direct supervisory jurisdiction over nonbank financial institutions not licensed under the Banking Act, such as credit unions, offshore banks with no local onshore affiliation, insurance companies, development banks, and other financial institutions that are regulated by different acts and authorities in the national territories.

In an attempt to harmonize the regulatory framework faced by credit unions and other cooperatives, member countries are in the process of ratifying the “Harmonized Cooperatives Societies Bill.” Approval has been obtained in the case of Antigua and Barbuda, Dominica, Grenada. St. Kitts and Nevis, and St. Vincent and The Grenadines, but is still pending in the other three territories. In addition, there is ongoing research, being conducted by an insurance advisor, to develop an appropriate regulatory framework for the insurance industry.

Legal requirements faced by all licensed financial institutions include a minimum paid-up capital requirement, the maintenance of a statutory reserve fund, restrictions on lending to related parties, a restriction on large credit exposure, restrictions governing the nature of bank investments, and satisfaction of a reserve requirement.

  • The minimum paid-up capital requirement for newly established locally incorporated banks is EC$5 million. The applicable minimum paid-up capital requirement for nonbank financial institutions is determined by the relevant ministry of finance in consultation with the ECCB, but it should not be less than EC$1 million. Foreign branch banks (namely, existing branches of foreign banks) are subject to an assigned minimum capital requirement of 5 percent of the branch’s deposit liabilities, applied annually. This requirement is satisfied by the provision of a “letter of comfort” from the parent institution certifying that the assigned capital is being held in the books of the head office on behalf of each branch bank.

  • Financial institutions are required to maintain a Statutory Reserve Fund equivalent to 100 percent of paid-up capital, and to transfer a minimum of 20 percent of annual profits to the Statutory Reserve Fund account until the fund is equal to the paid-up capital.

  • Financial institutions are prohibited from providing unsecured credit to directors, external auditors/examiners and persons holding 10 percent or more of shares in the institution, except if a waiver is granted by the minister of finance after consultation with the ECCB. Credit facilities granted to such individuals cannot be provided at rates more favorable than those offered to other customers. Financial institutions are also prohibited from lending against their own shares.

  • The stock of unsecured loans to any individual or group of related individuals must not exceed 15 percent of a bank’s unimpaired capital and reserves, but this restriction can be waived if loans are secured by acceptable collateral valued at 20 percent or more of the loan amount, and/or upon a decision by a country’s minister of finance after consultation with the central bank.

  • The Banking Act contains provisions that limit the nature of banks’ commercial activity, including constraints on buying real estate, except for purposes of business expansion, and ownership interests in business ventures.

  • Licensed commercial banks must comply with the 6 percent reserve requirement, on both Eastern Caribbean dollar and foreign currency deposits.

Prudential Guidelines

The ECCB first introduced prudential guidelines conforming to international best practices (as defined in the Basel Committee’s banking supervision guidelines) in November 1994. These guidelines are, in many cases, more stringent than the requirements of the UBA. The prudential guidelines have been adapted over time20 and at present they govern large credit exposures, provisioning requirements for nonperforming loans, an aggregate limit of 10 percent on the ratio of nonperforming assets to total assets (this limit has been in effect since 1987), the suspension of interest on nonperforming assets, and compliance with capital adequacy standards adapted by the CARICOM Bank Supervisors from the Basel Committee guidelines.

  • Prudential guidelines on large credit exposures, issued in 1994, are consistent with the Basel Committee’s 1991 recommendations and require financial institutions to limit their exposure to any single individual or group of related persons to 25 percent of paid-up capital and reserves irrespective of the security provided.21, 22 Institutions found to be in violation of this are required to take immediate action to either reduce the exposure or increase the level of “Tier I capital” (see below).

  • Under the “harmonized approach” to loan provisioning introduced in 1995, at least 70 percent of each financial institution’s credit portfolio is subject to an annual review, at which time the quality of each loan is assessed and a grade is assigned that has associated with it a minimum provision level. This assessment is based on such criteria as the regularity and promptness and timeliness of debt-service payments; the presence and quality of collateral and/or other securitization; the degree of sensitivity to economic conditions; and the quality of the supporting loan documentation. Loans are then assigned the following labels, with the corresponding provisions: “pass,” requiring no provision: “special mention,” requiring no provision; “substandard” but fully secured by cash or government securities, which requires no provision; “substandard” with no securitization, requiring a 10 percent provision: “doubtful,” requiring a 50 percent provision; and “loss,” requiring a 100 percent provision. In addition, a maximum tolerable limit of 10 percent on the ratio of nonperforming or “unsatisfactory” assets to total assets was established. Loans are classified as nonperforming when they have been in arrears for 90 days or more.

  • Under guidelines for the suspension of interest on nonperforming assets, banks are required to stop accruing interest on accounts that are 90 days or more in arrears, unless there is adequate security and full collection is expected within three months. Except in the case of loans to government or loans with a government-guarantee, banks are prohibited from accruing interest on overdrafts when the approved limit has been reached or when credits to the account are insufficient to cover interest accruals for at least a three-month period. In the case of government and government-guaranteed loans, accrual of interest is permitted up to the limit of the guarantee or up to the value of the collateral. A loan’s accrual status is restored when all the arrears of principal and interest have been paid, and, in the case of overdrafts, accrual status is restored when the account is operating within the approved limit and all interest arrears have been cleared. Accrued, uncollected interest should be reflected in an “interest in suspense” account on the balance sheet.

  • There are also guidelines governing the conditions under which loans and advances can be renegotiated because of weaknesses in the borrower’s financial position or the emergence of payment arrears. These guidelines include considerations about the borrower’s ability to service the loan under the new conditions and the adequacy of supporting securitization.

  • Locally incorporated commercial banks are required to maintain the ratio of Tier I (or “core”) capital to risk-weighted assets at a minimum of 8 percent.23 This capital adequacy ratio was adapted by the CARICOM Bank Supervisors from the Basel Committee guidelines, with the aim to be somewhat more stringent than the Basel Committee. The latter was drafted with larger and better diversified banks in mind, and requires a ratio of total qualifying capital (Tier I and Tier II24 capital less investments in financial subsidiaries not included in the group consolidation) to risk-weighted assets of 8 percent.

  • The ECCB guidelines also specify a liquidity requirement, namely that the ratio of Tier I capital to deposits be not less than 1:20.

ECCB requirements are either in line with or exceed international best practices (although there are no requirements for foreign exchange exposure). Box 4 shows ECCB commercial bank prudential requirements and compares these requirements with the Basel Committee recommendations and with the 1996 recommendations made by the IMF’s Monetary and Exchange Affairs Department in the context of its technical assistance.25

Monitoring

Monitoring compliance with these requirements is undertaken by the ECCB’s Bank Supervision Department, which is organized into three units: on-site examination, off-site surveillance, and supervisory actions. The latter also monitors the activities of all financial institutions, including those not licensed under the Banking Act. The Banking Supervision Department provides technical assistance in capacity building to the national entities supervising credit unions and insurance companies. It also works closely with the various supervisory authorities of the member territories on the regulation of offshore banks without local onshore affiliation, and provides guidance as needed.26

On-site inspections of the locally incorporated banks are conducted every 18 months under normal circumstances, although the frequency is increased in the case of weak institutions. Loan portfolios are evaluated by ECCB bank examiners for the amount and terms of the loans, evaluation of the projects being financed, the quality of collateral, and the timeliness of debt-service payments by borrowers. If a commercial bank is found to be in violation of ECCB prudential guidelines, a “memorandum of understanding” or “letter of commitment” is signed between the bank and the ECCB stipulating a schedule of corrective actions to be taken within a specified time. The ECCB then does a follow-up inspection upon implementation of the required corrective actions. However, as discussed below, the ECCB lacks the legislative authority to issue cease and desist orders outside of the emergency powers stipulated in the ECCB’s Amendment Order No. 48 of 1993. This is particularly relevant since the emergency legislation is applicable only in the event of a systemic banking crisis.

Prudential Requirements for Commercial Banks

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See Bank Soundness and Macroeconomic Policy, by C. J. Lindgren, G. Garcia, and M. I. Saal, IMF (1996), p. 187.

Off-site reporting requirements for commercial banks include the provision of balance sheets (monthly); a report on loans and advances by sector (quarterly); the provision of detailed information on bank investment portfolios, including type, currency, country of issue, interest rate, and maturity date (quarterly); income statements (quarterly); annual reports; large exposure and liquidity schedules (quarterly); and information on past-due and nonperforming loans and other problem credits (quarterly). There are separate reporting requirements for investments administered by banks as fund managers.

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Cover The Eastern Caribbean Currency Union
The Eastern Caribbean Currency Union
Institutions, Performance, and Policy Issues
Author: Mrs. Ruby Randall, Mr. Jorge Shepherd, Mr. Frits Van Beek, Mr. J. R. Rosales, and Ms. Mayra Rebecca Zermeno
ISBN:
9781557758941
ISSN:
0251-6365
Publication Date:
11 Aug 2000
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781557758941.084
Pages:
65