A. Structure of the Financial Sector

The financial sector in the Caribbean is large relative to the size of the economies and dominated by banks, although non-bank financial institutions (NBFIs) are becoming important. The total assets of the financial sector, excluding offshore banks, amount to 124 percent of the regional GDP, with the banking system accounting for some 91 percent and non-bank financial institutions such as credit unions and insurance companies accounting for the rest. The Bahamas and Barbados have significant offshore banking sectors, equivalent to 72 times and 11 times their respective economies, far outstripping the size of the onshore sector. Some of the ECCU countries also have offshore banking sectors, although on a smaller scale of 45 percent of the sub-region’s GDP.

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Source: Country authorities and Fund staff calculations.Note: ECCU: as of end-2011, Jamaica: as of March 2012, Barbados: as of March 2012, Trinidad and Tobago: as of June 2012, The Bahamas: as of 2011, Belize: as of March 2012, Guyana: as of March 2012.

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The size of the onshore banking sector varies quite significantly across countries. The Bahamas has the largest onshore banking system, equivalent to 150 percent of its GDP, while Jamaica is at the other extreme, with a banking sector equivalent to just under 50 percent of its GDP. The ECCU’s banking sector, as an aggregate, amounts to about 176 percent of the union’s GDP. Foreign banks, primarily Canadian, play a leading role throughout the Caribbean, accounting for about 60 percent of banking system assets. European and U.S. banks are also important but their activities are concentrated in the offshore centers of the Bahamas and Barbados.

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The Caribbean: Dominance of Regional Banks

(Percent of of total banking assets)

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

Source: Bankscope and Fund staff calculations.Note: ECCU (June 2011); Trinidad and Tobago (March-April 2011); Jamaica (December 2010); The Bahamas (April 2011); Barbados (2010); Belize (September 2011); and Guyana (Republic Bank: 2010; and Scotia Bank: October 2011).

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Caribbean: Foreign Claims by Nationality of Reporting Banks, 2012Q3

(Immediate Borrower Basis, US$ billions)

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

Source: BIS International Banking Statistics.

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Credit unions are becoming increasingly important, especially as banks have tightened lending standards following the global financial crisis. While overall assets of credit unions amount to just 7 percent of regional GDP, their importance varies widely among countries. The largest credit union sectors are in Dominica (39 percent of GDP) and Montserrat (36 percent of GDP). Other countries with a significant credit union sector are Barbados (17 percent of GDP) and Belize (21 percent of GDP), while in Grenada, St. Vincent and the Grenadines, and St. Lucia they range from 13 to 19 percent of GDP. The insurance sector is dominated by regional conglomerates, and its assets account for about 17 percent of regional GDP. Sagicor, headquartered in Barbados, has the largest insurance network in the region with total assets estimated at US$5.3 billion. In addition to the Caribbean region, it also operates in Latin America, the United Kingdom and the United States. Guardian Life, headquartered in Trinidad and Tobago, has US$3.4 billion of assets under management. The largest insurance sectors are in the Bahamas, Barbados, Jamaica and Trinidad and Tobago.

The offshore banking sector is by far the largest with assets equivalent to 10.8 times the regional GDP, but concentrated largely in two countries. The Bahamas is the largest sovereign offshore financial center (OFC) in the region, and the fourth largest in the world after the Cayman Islands (a territory of the United Kingdom), Hong Kong SAR, and Singapore. Offshore banks account for 98 percent of the Bahamas’ US$598 billion financial sector, or 7,220 percent of the Bahamian GDP. To put this in perspective, Singapore’s financial system is only 1.5 times the size of the financial sector of the Bahamas, while its economy and population are 32 times and 15 times larger, respectively. Barbados is the other major sovereign OFC of the region, with US$47 billion in offshore bank assets, representing 87 percent of its financial system or 1,082 percent of GDP.

In contrast to the onshore banking sector, there is limited information on the non-bank and offshore banking sectors. The Caribbean Confederation of Credit Unions and World Council of Credit Unions publish annual data on credit unions, but this only covers the sizes of membership and broad balance sheet measures (e.g. assets, and loans), with little information on financial soundness indicators. Data on other non-bank and offshore financial institutions is even more scarce, restricting analyses of these sectors.

Financial Sector Overview in the Caribbean Region

(1) Structure of Financial System: Total Assets

(US$ millions)

(1) Structure of Financial System: Total Assets

(US$ millions)

		ECCU	Jamaica	Barbados	T&T	Bahamas	Belize	Guyana	Caribbean total
Banks		9,509	7,268	5,768	17,891	12,100	1,319	1,590	55,445
	Local	4,232	3,468	0	N.A.	2,800	449	N.A.	10,949
	Foreign	5,277	3,800	5,768	N.A.	9,300	870	N.A.	25,015
Credit unions		682	803	730	1,524	300	306	21	4,366
Insurance companies		637	2,907	699	4,768	2,500	97	157	11,765
Securities firms		N.A.	5097	N.A.	N.A.	N.A.	N.A.	N.A.	5,097
Offshore banks		2,402	N.A.	47,390	N.A.	582,900	301	N.A.	632,993
Total		13,230	16,075	54,587	38,855	597,800	2,022	1,768	724,337

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(1) Structure of Financial System: Total Assets

(US$ millions)

		ECCU	Jamaica	Barbados	T&T	Bahamas	Belize	Guyana	Caribbean total
Banks		9,509	7,268	5,768	17,891	12,100	1,319	1,590	55,445
	Local	4,232	3,468	0	N.A.	2,800	449	N.A.	10,949
	Foreign	5,277	3,800	5,768	N.A.	9,300	870	N.A.	25,015
Credit unions		682	803	730	1,524	300	306	21	4,366
Insurance companies		637	2,907	699	4,768	2,500	97	157	11,765
Securities firms		N.A.	5097	N.A.	N.A.	N.A.	N.A.	N.A.	5,097
Offshore banks		2,402	N.A.	47,390	N.A.	582,900	301	N.A.	632,993
Total		13,230	16,075	54,587	38,855	597,800	2,022	1,768	724,337

(2) Structure of Financial System: Total Assets

(Percent of GDP)

(2) Structure of Financial System: Total Assets

(Percent of GDP)

		ECCU	Jamaica	Barbados	T&T	Bahamas	Belize	Guyana	Caribbean total
Banks		176	49	132	73	150	89	64	95
	Local	79	24	0	N.A.	35	30	N.A.	19
	Foreign	98	26	132	N.A.	115	59	N.A.	43
Credit unions		13	5	17	6	4	21	1	7
Insurance companies		12	20	16	19	31	7	6	20
Securities firms		N.A.	35	N.A.	N.A.	N.A.	N.A.	N.A.	9
Offshore banks		45	N.A.	1,082	N.A.	7,220	20	N.A.	1,080
Total		245	109	1,246	158	7,404	137	71	1,236

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(2) Structure of Financial System: Total Assets

(Percent of GDP)

		ECCU	Jamaica	Barbados	T&T	Bahamas	Belize	Guyana	Caribbean total
Banks		176	49	132	73	150	89	64	95
	Local	79	24	0	N.A.	35	30	N.A.	19
	Foreign	98	26	132	N.A.	115	59	N.A.	43
Credit unions		13	5	17	6	4	21	1	7
Insurance companies		12	20	16	19	31	7	6	20
Securities firms		N.A.	35	N.A.	N.A.	N.A.	N.A.	N.A.	9
Offshore banks		45	N.A.	1,082	N.A.	7,220	20	N.A.	1,080
Total		245	109	1,246	158	7,404	137	71	1,236

(3) Structure of Financial System

(Number of institutions)

Source: Country authorities and Fund staff calculations Note: ECCU: as of end-2011, Jamaica: as of March 2012, Barbados: as of March 2012, Trinidad and Tobago: as of June 2012, The Bahamas: as of 2011, Belize: as of March 2012, Guyana: as of March 2012.

(3) Structure of Financial System

(Number of institutions)

		ECCU	Jamaica	Barbados	T&T	Bahamas	Belize	Guyana	Caribbean total
Banks		40	7	7	8	8	5	6	81
	Local	14	2	0	2	3	1	3	25
	Foreign	26	5	7	6	5	4	3	56
Credit unions		57	44	35	129	10	13	25	313
Insurance companies		61	14	30	45	100	13	15	278
Offshore banks		N.A.	N.A.	54	N.A.	83	6	N.A.	143
Total		>200	65	126	182	201	37	46	815

Source: Country authorities and Fund staff calculations Note: ECCU: as of end-2011, Jamaica: as of March 2012, Barbados: as of March 2012, Trinidad and Tobago: as of June 2012, The Bahamas: as of 2011, Belize: as of March 2012, Guyana: as of March 2012.

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(3) Structure of Financial System

(Number of institutions)

		ECCU	Jamaica	Barbados	T&T	Bahamas	Belize	Guyana	Caribbean total
Banks		40	7	7	8	8	5	6	81
	Local	14	2	0	2	3	1	3	25
	Foreign	26	5	7	6	5	4	3	56
Credit unions		57	44	35	129	10	13	25	313
Insurance companies		61	14	30	45	100	13	15	278
Offshore banks		N.A.	N.A.	54	N.A.	83	6	N.A.	143
Total		>200	65	126	182	201	37	46	815

Source: Country authorities and Fund staff calculations Note: ECCU: as of end-2011, Jamaica: as of March 2012, Barbados: as of March 2012, Trinidad and Tobago: as of June 2012, The Bahamas: as of 2011, Belize: as of March 2012, Guyana: as of March 2012.

B. Recent Developments in the Financial Sector: Impact of the Global Crisis

The 2008–09 financial crisis had a mixed impact on the banking sector in the Caribbean: with banks in the ECCU, especially the indigenous banks, being particularly hard-hit, while banks elsewhere weathered the crisis relatively well (see Appendix 1 for selected financial soundness indicators).⁶

In the ECCU region, asset quality has deteriorated, with reported nonperforming loan ratios more than doubling from end-2007 to 14 percent at end-September 2012. With rising credit risk and declining liquidity, profitability has declined markedly for the entire sector, with the ratio of return on average assets falling to 0.7 percent at end-September 2012 (cumulative of four quarters) from 2.6 percent in 2007. Over the same period, the ratio of return on average equity fell by about 15 percentage points to 7.4 percent. The capital-to-risk-weighted-assets ratio for indigenous banks (18.4 percent as of September 2012) has remained well above the ECCB’s prudential threshold of 8 percent, although there is reason for caution, as this ratio is likely to be overstated given weaknesses in loan classification standards and low provisioning standards in the region.

The relative resilience of the banks in the non-ECCU region was in part due to high capitalization and sound profitability in pre-crisis years. Most banks also maintained sufficient liquid assets and were dependent on deposits and equity, which limited their funding risks. Nevertheless, banks’ loan portfolios began deteriorating by the end of 2009, and NPLs have risen since then, and some countries’ NPL ratios have remained over 10 percent. These developments have led to a reduction in profitability, but capital-adequacy ratios remain robust. High NPL ratios also led banks to be more selective in providing new loans. This behavior, combined with weak economic activity and high unemployment rates, resulted in sluggish credit growth in recent years.

Credit unions in many countries are also facing challenges in managing their credit risk related to NPLs. Some smaller credit unions have problem loan portfolios substantially in excess of prudential norms, but they are too small to pose a systemic risk to the overall financial sector. Inadequate regulation of this sector was one of the reasons behind rapid asset growth and the weak risk management framework. Insufficient information and the large number of institutions also pose challenges to supervision. In this context, some authorities (e.g., The Bahamas, Barbados, and the ECCU) are trying to strengthen the supervisory system of this sector.

Insurance companies have recorded lower premiums and experienced a reduction in investment income in recent years, reflecting weaker demand for insurance and the difficulties experienced by policy holders in making payments under low economic growth. In particular, the insurance sector was affected by the collapse of the CL Financial Group, the largest insurance company in the region. This group’s total assets were estimated at about US$16 billion, equivalent to around 30 percent of the Caribbean region’s GDP, operating in at least 28 countries. CL Financial was regarded as a successful example of financial integration of companies within the region. Weak corporate governance, high interest rate annuity products with corresponding high risk investments, and high leverage led to the collapse of the group, bringing significant spillover effects to the Caribbean region (see Box 1).

A. Interconnectedness and Financial Stability

The increase in global interconnectedness has given rise to a number of studies on the nature and implications of interconnectedness, especially for financial sector stability and systemic risk. Interconnectedness is seen in the literature as a “double edged sword” which, on the one hand, could increase risks, but on the other hand, could also help diffuse the impact of shocks given the scope for risk diversification in an interconnected “network.” For example, Allen and Gale (2005) argued that interconnectedness does not necessarily lead to increased contagion. They showed that, in the absence of financial frictions, more interconnectedness increases the scope for risk diversification, allowing any shock to be diffused through the entire network and thus minimizing the impact on any one particular institution or region. Leitner (2005) developed a model of financial networks in which linkages can spread contagion, but can also have positive effects because they may induce private sector bailouts, where liquid banks bail out illiquid banks because of the threat of contagion.

However, subsequent studies have found that, in the presence of financial frictions, higher interconnectedness increases the chances of contagion and systemic risk (Battistion, 2009, Gai and Kapadia, 2008, Minoiu and Reyes, 2011). Caballero and Simsek (2010) presented a model of fire sales and market breakdowns. They showed that shocks to asset prices make more banks within the financial network become distressed, which increases each (non-distressed) bank’s likelihood of being hit by an indirect shock.

This risk from interconnectedness was particularly significant in emerging and low income countries. Credit channels in these countries were impaired as pressures on large financial institutions resulted in a pullback of cross-border lending, notably trade finance activities, and a loss of parent bank support for local lending. Constraints on long-term funding severely limited local banks’ capacity in areas such as shipping and aviation trade finance, as well as infrastructure finance. Local asset markets (foreign exchange, equities, and bonds) came under renewed strains through capital outflows, deteriorating liquidity, and a re-pricing that could have a knock-on impact on local financing conditions.

B. Stylized Analysis on Interconnectedness in the Caribbean Region

The widespread impact of the collapse of the CL Financial Group attests to the negative spillover impact of interconnectedness in the Caribbean and underscores the importance of preventing this in the future. There have been some efforts to study the interconnectedness in the Caribbean region (Worrell and Lowe, 2011, Panth et al, 2008). However, an in-depth analysis of the Caribbean region has been largely absent either because of the difficulty in obtaining sufficient data or because the region is not deemed as systemically important from a global perspective. Notwithstanding the limited data availability, this paper tries several different ways to model interconnectedness in the region and provides recommendations on financial sector reforms to minimize systemic risks, especially those posed by interconnectedness.

As in the rest of the world, financial linkages have continued to increase in the Caribbean region. Motivation for financial linkages includes risk diversification, search for higher yield and a desire to increase market share, as well as increased integration in the real sector, including effects from formal arrangements like the CARICOM Single Market and Economy (CSME). Financial conglomerates and other institutions with complex ownership structures tend to control a large market share simultaneously in several countries of the Caribbean. For example, the four largest banking groups (see Table) control about 75 percent of total banking sector assets in the region.

Major Financial Conglomerates With Cross Border Operations in the Caribbean As of end-2010

Source: Caribbean Center for Money and Finance Newsletter, March 2012

Major Financial Conglomerates With Cross Border Operations in the Caribbean As of end-2010

	Assets (US$ mil.)	No. of Caribbean Countries	Percent of Total Caribbean Banking Sector Assets
RBC Financial	11686	20	22
Scotia Bank	10145	21	20
First Caribbean International Bank	9766	18	19
Republic Bank	9315	6	14
SAGICOR Financial Group	4867	22	na
First Citizens Bank	4015	4	8
Guardian Holdings	3281	4	na
JMMB	1318	3	na

Source: Caribbean Center for Money and Finance Newsletter, March 2012

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Major Financial Conglomerates With Cross Border Operations in the Caribbean As of end-2010

	Assets (US$ mil.)	No. of Caribbean Countries	Percent of Total Caribbean Banking Sector Assets
RBC Financial	11686	20	22
Scotia Bank	10145	21	20
First Caribbean International Bank	9766	18	19
Republic Bank	9315	6	14
SAGICOR Financial Group	4867	22	na
First Citizens Bank	4015	4	8
Guardian Holdings	3281	4	na
JMMB	1318	3	na

Source: Caribbean Center for Money and Finance Newsletter, March 2012

In terms of market share (measured as percent of total assets of the banking sector), Scotia Bank dominates the banking sector in Antigua and Barbuda (23 percent), The Bahamas (28 percent), Grenada (23 percent), and Jamaica (32 percent). The other two Canadian banks—CIBC and RBC—also hold significant market shares in several Caribbean countries. The only large regional bank—the Trinidad and Tobago based Republic Bank—has a large presence in Guyana in addition to controlling nearly half the market share in its home country. The high level of concentration is partly due to the small size of individual countries as well as the region as a whole, and the presence of several branches or subsidiaries of the same financial companies across the region is a pattern often seen in small states.⁷ While the presence of Canadian banks has enabled the region to benefit from Canada’s strong supervisory and regulatory framework, this high degree of interconnectedness with foreign banks suggests that if a large shock were to hit the source country (a core node), the shock may reverberate through the links to the rest of the network and could pose a risk to several Caribbean countries simultaneously.

In addition, within the ECCU sub-region, the indigenous banking sector is interlinked through cross-shareholdings, the interbank market, and public sector exposures. The Eastern Caribbean Financial Holding Company, the parent company of Bank of Saint Lucia, is also a majority shareholder of Bank of St. Vincent and the Grenadines. Those two banks, along with the National Bank of Dominica, Antigua Commercial Bank and St. Kitts-Nevis-Anguilla National Bank, comprise the largest shareholders of Eastern Caribbean Amalgamated Bank (formerly Bank of Antigua). Many of the governments and national insurance schemes are also among the shareholders of indigenous banks. At the same time, many indigenous banks are exposed to the public sector. At end-2011, public sector exposure of indigenous banks reached over 20 percent of their total assets on aggregate, compared to about 5 percent for the foreign banks in the sub-region. Furthermore, the public sector is an important provider of deposits, accounting for about 30 percent of total deposits for indigenous banks (about 5 percent for foreign banks).⁸

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Total Assets in billions of US$; Share of Banking Assets in Host Country in percent

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

Source: Bankscope and Fund staff calculations.

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In terms of the non-bank sector, after the collapse of the CL Financial Group, Sagicor now has the largest insurance network with operations in 22 countries. While data on market share in individual countries are not available, Sagicor’s expansive network in the Caribbean suggests that it plays a critical role in the region. The two largest shareholders of Sagicor are the National Insurance Board of Barbados and Republic Bank Limited. The remaining shareholders are individuals and companies, mainly in the Caribbean region. In terms of credit exposure, Sagicor holds the bulk of its investment securities and lending portfolio in the Caribbean region, making it vulnerable to sovereign credit risk (see tables).⁹ In the case of Guardian Life, an insurance group headquartered in Trinidad and Tobago, 17 percent of total assets are in Jamaican dollars (see figures).

Sagicor’s Key Investment Portfolio

(Total: US$ 3,599 million)

Source: Sagicor’s annual report (2011)

Sagicor’s Key Investment Portfolio

(Total: US$ 3,599 million)

Key Investment Portfolio	Amount (US$ million)	Share in Investment Portfolio	Credit Rating (S&P)
Government of Jamaica	1,123	31%	B−
Government of Trinidad and Tobago	144	4%	A
Government of Barbados	183	5%	BB+
Bank of Nova Scotia	130	4%	AA−
Government of USA	102	3%	AA+

Source: Sagicor’s annual report (2011)

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Sagicor’s Key Investment Portfolio

(Total: US$ 3,599 million)

Key Investment Portfolio	Amount (US$ million)	Share in Investment Portfolio	Credit Rating (S&P)
Government of Jamaica	1,123	31%	B−
Government of Trinidad and Tobago	144	4%	A
Government of Barbados	183	5%	BB+
Bank of Nova Scotia	130	4%	AA−
Government of USA	102	3%	AA+

Source: Sagicor’s annual report (2011)

Sagicor’s Lending Portfolio - Geographical Distribution

(Total: US$ 556 million)

Source: Sagicor’s annual report (2011)

Sagicor’s Lending Portfolio - Geographical Distribution

(Total: US$ 556 million)

Country / Region	Amount (US$ million)	Share in Lending Portfolio	Credit Rating (S&P)
Barbados	193	35%	BB+
Jamaica	129	23%	B−
Trinidad and Tobago	94	17%	A
Other Caribbean	75	13%	…
USA	65	12%	AA+

Source: Sagicor’s annual report (2011)

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Sagicor’s Lending Portfolio - Geographical Distribution

(Total: US$ 556 million)

Country / Region	Amount (US$ million)	Share in Lending Portfolio	Credit Rating (S&P)
Barbados	193	35%	BB+
Jamaica	129	23%	B−
Trinidad and Tobago	94	17%	A
Other Caribbean	75	13%	…
USA	65	12%	AA+

Source: Sagicor’s annual report (2011)

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Sagicor: Country Distribution of Shareholders

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

Sources: Sagicor’s annual report (2011)

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Guardian Life’s Currency Exposure

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

Sources: Guardian Life’s annual report (2011)

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Regional Insurance Companies’ Presence

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

Source: Annual reports of Sagicor Financial Group and Guardian Holdings.

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C. Quantitative Analysis of Interconnectedness

We applied a number of concepts and measures from network analysis to assess the interconnectedness in the Caribbean and its implications for financial stability.¹⁰ One of these measures is “in-degree interconnectedness,” which is measured by the recipient’s share of “active” links from sources to the total number of potential links, where a link is considered “active” if the stock of the recipient’s cross border liabilities is above 0.2 percent of the recipient’s GDP. By normalizing a link to the recipients’ GDP, this approach emphasizes the importance of a link from the perspective of a recipient rather than a source (see IMF 2011a). Thus, a higher in-degree index implies that the recipient on average has smaller exposure to its source countries, abstracting from the cross-border distribution of claims. This measure captures the notion of diversification in a network by emphasizing the importance of the link from the perspective of the recipient country. Another measure often used in the literature is the Herfindahl-Hirschman Index (HHI). This index measures the degree of “concentration” or the importance of links from the perspective of the source country, and complements the direct measure of interconnectedness (in-degree index) that does not distinguish sources by their sizes beyond the threshold. This is calculated by squaring the share of each creditor in a country’s foreign liabilities and then summing the resulting numbers, with higher numbers indicating greater concentration of sources.

International consolidated banking statistics from the BIS are used to calculate the two indices for the period 2001–2011. These data cover the international financial claims of banks in 25 reporting countries on a consolidated basis. They show the claims of domestically-owned banks, excluding the positions within the consolidated groups, broken down by type, sector of borrower, remaining maturity, and country of exposure. The data on the exposure by country of immediate borrower, which provides the quarterly stock of claims by the nationality of reporting banks, was used to assess the existence of links and the level of concentration between those reporting countries and the Caribbean countries.¹¹ Overall there has been a general increase in interconnectedness, with some setbacks since the global financial crisis.

The in-degree index is higher and has been increasing more markedly in The Bahamas and Barbados, likely reflecting their significant offshore financial sectors and inflows from Europe. While Belize also saw increases in the index in 2003 and 2007, its index has been on a downward trend in recent years. Much of these changes are due to the fact that the claims of some European and Latin American banks fluctuated around the threshold of “active” claims. Jamaica saw a rise in the index in the early 2000s as the claims from some of the existing source countries increased above the threshold of “active” links, but its index has been on a declining trend since 2004. The level of interconnectedness remained relatively stable over the last decade in the rest of the region.

The concentration index is on a declining path or remained relatively low in larger Caribbean economies, reflecting greater diversity in financial linkages. The HHI index is generally higher in countries less interconnected due to a small number of links playing significant roles, as in the case of Guyana where the claims from Mexico increased to over 90 percent of overall claims in recent years¹². Changes in the size of claims from one source country can have a significant impact: for example, the spike in the index for Barbados in 2006–07 reflects the increase in claims of UK banks, and for Belize in 2003, the increase in claims from Switzerland.

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Indices of Network Connectivity

(BIS Consolidated Foreign Claims by Nationality of Reporting Banks)

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

Source: BIS and Fund staff calculations.

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We also analyzed the Coordinated Portfolio Investment Survey (CPIS) database, which reflects year-end data on portfolio investment holdings (equity and debt securities) reported by participating economies. Among the countries included in this study, only The Bahamas and Barbados report these data.¹³ The analysis (2001–10) confirms the results from the BIS data, that is, that interconnectedness has generally increased in the last decade in the Bahamas and Barbados.

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Network Connectivity: In-degree Index

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

Sources: CPIS and Fund staff calculations.

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Both countries’ high network connectivity reflects their status as offshore financial centers as well as their financial sector’s strong linkages with foreign financial institutions in other jurisdictions. In The Bahamas, most funds are originated in Brazil, Italy, Japan, Switzerland, and the U.S., while Ireland, Luxemburg, the U.K., and the U.S. are the main fund providers to Barbados.¹⁴ Despite relatively high interconnectedness, the contagion risks to the onshore banking system may be limited, given the strong regulation separating onshore banking activities from offshore sectors.

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Bahamas’ Interconnectedness with the global financial sector

(US Dollars, Millions)

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

Source: CPIS data (2010).

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Barbados’ Interconnectedness with the global financial sector

(US Dollars, Millions)

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

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D. Implications for Systemic Risk

Notwithstanding dominant foreign ownership, the banking sector has been relatively resilient to external shocks. This stability can be attributed to the following mitigating factors: first, the largest four banks in the region are well capitalized and their assets remain liquid; second, the top three banks are part of an international network of Canadian banks whose share of foreign activities is largely made up of local currency claims¹⁵ (see figure about Canadian banks’ claims on Trinidad and Tobago) and they are not dependent on wholesale funding markets; third, the banking sector’s expansion into the overseas market has focused on traditional retail and commercial banking. However, the collapse of the CL Financial Group highlighted that interconnectedness of financial groups across countries poses significant risks, as shocks can be easily transmitted through the network. In this context, the significant level of concentration within the regional banking sector also represents potential contagion risks associated with distress within one of the large banking groups (see box 2 for additional linkage through regional stock markets, where some of the regional financial institutions are cross-listed).

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Canadian Banks’ claims on Trinidad and Tobago

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

Sources: Bank of Canada (Banking and Financial Statistics).Note: Claims include deposits, loans, and holding of securities.

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While the above mentioned banks provide resilience to the regional banking system, the operation of subsidiaries and branches across several jurisdictions, some of which lack a strong consolidated supervision framework, could lead to insufficient understanding of systemic risks, due to differences in prudential regulations and inadequate information sharing across countries. The indigenous banking sector in the ECCU is embarking on an extensive restructuring and consolidation effort, aimed at strengthening and promoting the stability of the financial system, but the bulk of the impact of this effort is likely to be contained within the ECCU region itself.

The interconnectedness with the global financial system also has implications for some countries’ vulnerability to external shocks, including from the global deleveraging process. The BIS data shows that foreign banks’ claims are more than 100 percent of GDP in a few countries, with a higher portion of international claims (a combination of direct cross-border lending and credit by bank subsidiaries in foreign currency). The overall picture suggests that in a few countries, the impact on credit and output would be greater under a large and disorderly deleveraging process (see Appendix 2 for more detail about BIS data).

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Foreign Banks’ Claims in the Caribbean

Citation: IMF Working Papers 2013, 175; 10.5089/9781484307830.001.A001

Sources: BIS international banking statistics (2011) and Fund staff calculations.Note: International claims = direct cross-border lending plus credit by foreign bank subsidiaries in foreign currency. Local claims in local currency = credit to residents by foreign bank subsidiaries in local currency

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With respect to the offshore financial sectors in the Bahamas and Barbados, these are insulated from the onshore banking system, thus limiting the risk of contagion. “Chinese walls” exist between affiliated on- and off-shore banks, and there are strict legal prohibitions against transactions between the onshore and offshore sectors. That said, the offshore sector is increasingly receiving greater international scrutiny to reduce illegal tax evasion, address issues related to regulatory loopholes, and strengthen the fight against money laundering and financial terrorism. The heightened regulatory uncertainty brought about by ongoing global regulatory reforms poses key challenges, which may lead to a revised strategy by major financial groups to move away from international financial centers.

Box 2.

Interconnectedness through Stock Markets

Companies’ cross-listing is another dimension of financial integration. Some large companies, especially financial firms, in the Caribbean region have multiple listings across several stock exchanges. In particular, Barbados, Jamaica, and Trinidad and Tobago show relatively higher percentage of non-local firms in their stock exchanges. The correlation analysis for historical market prices shows that co-movements are strong in the case of companies listed in Jamaica and Trinidad and Tobago as well as those listed in Barbados and Trinidad and Tobago.

Cross-Listed Companies as of July 2012

Source: Individual Stock Exchanges.

Cross-Listed Companies as of July 2012

Country	Stock Exchange	Total Firms	Local Firms	Cross-Listed Firms	Percent of Cross-Listed Firms
ECCU	ECSE	13	11	2	15.4
The Bahamas	BISX	20	19	1	5.0
Barbados	BSE	22	16	6	27.3
Guyana	GASCI	14	13	1	7.1
Jamaica	JSE	39	31	8	20.5
Suriname	SSX	11	11	0	0.0
Trinidad and Tobago	TTSE	34	23	11	32.4
Total		153	124	29	19.0

Source: Individual Stock Exchanges.

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Cross-Listed Companies as of July 2012

Country	Stock Exchange	Total Firms	Local Firms	Cross-Listed Firms	Percent of Cross-Listed Firms
ECCU	ECSE	13	11	2	15.4
The Bahamas	BISX	20	19	1	5.0
Barbados	BSE	22	16	6	27.3
Guyana	GASCI	14	13	1	7.1
Jamaica	JSE	39	31	8	20.5
Suriname	SSX	11	11	0	0.0
Trinidad and Tobago	TTSE	34	23	11	32.4
Total		153	124	29	19.0

Source: Individual Stock Exchanges.

Selected Cross-Listed Companies and Correlation of Share Price Movements

Source: Individual Stock Exchanges.

^* significant at the 5 percent level.

Selected Cross-Listed Companies and Correlation of Share Price Movements

Cross-Listed Company	Home Exchange	Other Exchanges where Listed	Correlation	No. of observations
Firstcaribbean International Bank Ltd	Barbados	BISX	0.4457*	25
		JSE	0.5897*	382
		TTSE	0.9171*	84
		ECSE		0
Trinidad Cement Limited	Trinidad	BSE	0.9630*	15
		JSE	0.8998*	72
		ECSE	0.1503	11
		GASCI	…	na
Jamaica Money Market Brokers Ltd.	Jamaica	BSE	0.3527	5
		TTSE	0.3776*	424
Neal & Massy Holdings Ltd.	Trinidad	BSE	0.9669*	41
Guardian Holdings Ltd.	Trinidad	JSE	0.7641*	92
Sagicor Financial Corporation	Barbados	TTSE	0.9720*	642
		LSE	0.8129*	614
Fortress Caribbean Property Fund	Barbados	TTSE	…	na
National Commercial Bank of Jamaica Ltd.	Jamaica	TTSE	0.8763*	764
Scotia Investments Jamaica Ltd.	Jamaica	TTSE	0.6918*	345
GraceKennedy Ltd.	Jamaica	BSE	0.6619*	43
		TTSE	0.8947*	621
Capital and Credit Financial Group Ltd.	Jamaica	TTSE	0.8562*	145

Source: Individual Stock Exchanges.

^* significant at the 5 percent level.

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Selected Cross-Listed Companies and Correlation of Share Price Movements

Cross-Listed Company	Home Exchange	Other Exchanges where Listed	Correlation	No. of observations
Firstcaribbean International Bank Ltd	Barbados	BISX	0.4457*	25
		JSE	0.5897*	382
		TTSE	0.9171*	84
		ECSE		0
Trinidad Cement Limited	Trinidad	BSE	0.9630*	15
		JSE	0.8998*	72
		ECSE	0.1503	11
		GASCI	…	na
Jamaica Money Market Brokers Ltd.	Jamaica	BSE	0.3527	5
		TTSE	0.3776*	424
Neal & Massy Holdings Ltd.	Trinidad	BSE	0.9669*	41
Guardian Holdings Ltd.	Trinidad	JSE	0.7641*	92
Sagicor Financial Corporation	Barbados	TTSE	0.9720*	642
		LSE	0.8129*	614
Fortress Caribbean Property Fund	Barbados	TTSE	…	na
National Commercial Bank of Jamaica Ltd.	Jamaica	TTSE	0.8763*	764
Scotia Investments Jamaica Ltd.	Jamaica	TTSE	0.6918*	345
GraceKennedy Ltd.	Jamaica	BSE	0.6619*	43
		TTSE	0.8947*	621
Capital and Credit Financial Group Ltd.	Jamaica	TTSE	0.8562*	145

Source: Individual Stock Exchanges.

^* significant at the 5 percent level.

Note: There is a caveat in this analysis because some stocks are not traded regularly and therefore the number of observations is very low.

Main Weaknesses in Supervision and Regulations

There has been gradual progress in key areas of financial sector oversight in many Caribbean countries. Most importantly, the regulation and supervision has been shifting to risk-based approaches. Supervisory capacity is improving with better trained staff, and regulatory coverage is strengthening to include the non-banking sector such as credit unions and insurance companies. Nevertheless, there is still room for further improvement in regulation and supervision, albeit to varying degrees for each country. Some weaknesses include (i) outdated regulations (e.g., asset classification and provisioning), (ii) deficiency of prudential rules, (iii) incomplete state of risk-based supervision framework, (iv) weak framework for consolidated supervision of banking groups and financial conglomerates, and (v) more room for cross-border home/host cooperation. (see Appendix 3 for each country’s key prudential standards).

• Outdated regulations: In some countries, the regulation addressing loan classification and provisioning does not include off-balance sheet items, investment securities, and other exposures. In addition, real estate collateral is treated very generously even if there is no liquid market to sell it, understating NPLs and the need for provisions on banks’ balance sheets, and overstating income, assets, and capital.

• Deficiency in prudential rules: In many countries there are no aggregate limits on banks’ large exposures, although there are limits in some countries on exposure to single persons or entities. Furthermore, the definition of a group of connected borrowers in the legislation is often not broad enough for supervisors to identify the ultimate beneficial owner and affiliates of borrowers. The insufficient risk management system for addressing single large credit exposures and related party lending could hinder effective tracking of underlying risks.

• Incomplete state of resolution framework: Although the authorities have tools for enforcement in place, resolution processes are not effectively implemented in some cases (e.g., slow progress in resolution of CLICO). More transparent procedures and a systemic framework are required to ensure timely intervention and resolution. Some countries have deposit insurance, but limits vary.

• Limited consolidated supervision: In some countries there is no explicit legal framework providing a basis for effective consolidated supervision, while in others the scope of consolidated prudential reporting does not include the financial group. The upshot of this is a heightened risk of contagion and the inability of the supervisors to properly monitor related party transactions or gauge the overall health of financial conglomerates in the region.

• More room for cross-border cooperation: There is some room for expanding information exchange and policy cooperation between host and home supervisors. In particular, for large regional financial groups, a lack of information sharing on the comprehensive risk profile could prevent supervisors from understanding potential risks in the financial system.

A. Banking Sector

The crisis has highlighted the importance of financial sector supervision to ensure financial stability. It has also shown that embedding a cross-border dimension in national financial sector policies is critical, as national financial stability may also depend on the policies and institutional framework of other countries. This is being increasingly recognized by policymakers in the Caribbean, and countries in the region are updating the framework for financial sector supervision to incorporate some of these new realities (see Box 3). The increasing concentration, size, and influence of bank holding companies and financial conglomerates suggest that harmonizing regulatory and supervisory frameworks and conducting consolidated supervision would be desirable to prevent regulatory arbitrage. Greater regional cooperation would also help the countries benefit from economies of scale and address capacity problems in the region. While supervision and regulatory standards are still largely country specific, countries are entering cooperation arrangements through signing of Memoranda of Understandings (MOUs) that lay out the framework for exchanging information. In addition, the College of Banking Supervisors and the College of Insurance Supervisors meet periodically and share information. Looking ahead, reforms in the following areas would help to strengthen financial sector stability in the region.¹⁷

B. Non-Banking Sector

The failure of CL Financial Group demonstrated the extent of regional interconnectedness through large NBFIs and the need to strengthen supervision of these institutions. Adequate information was not collected regarding contracts with affiliates or outstanding arrangements. While some efforts are being made to collect information on credit unions, it needs to be extended to include the broader non-banking sector, and the frequency of the coverage needs to be improved to enable the timely assessment of financial soundness. Without a prompt and effective resolution framework, many risk-averse investors rushed to request redemption of their funds, leading to a collapse of subsidiaries.

In this context, a more systemic approach toward large and complex non-bank financial conglomerates is crucial for financial safety. Regular exchange of information between supervisory authorities, and the establishment of MOUs for cross-border resolution frameworks could be steps in the right direction. The authorities also need to require financial groups to report their financials on both a consolidated and solo basis. Legislative provisions are needed to ensure that the structure of financial groups does not hinder the supervision and resolution process. Also, the authorities’ supervision and risk-monitoring of credit unions should be strengthened, especially for countries where credit unions are assuming important roles in providing credit to the domestic economy. With respect to OFCs, in order to safeguard the reputation of financial centers and prevent potential contagion risks, the supervisory bodies should strengthen the capacity of staff to deal with the complexities of the sector, and establish closer working relationships with the home supervisors of foreign banks.