APPENDIX: Stress Testing of the Banking System
66. Stress tests were conducted on all deposit-taking institutions (DTIs) using end-2004 data to identify potential vulnerabilities. The tests were designed and carried out in conjunction with BoJ staff. The BoJ has considerably enhanced its capacity to perform quantitative risk analysis and introduced, among other tools, a stress testing exercise as part of its regular vulnerabilities assessment. The analysis assessed DTIs’ resilience to both credit and market (interest rate, exchange rate, equity prices) risks. The calibration of shocks took into account historical variability in relevant variables. However, macroeconomic scenarios proved hard to design because the trend recovery in bank balance sheets since the 1996/97 financial crisis obscures the link between fluctuations in macroeconomic variables and bank profitability and asset quality. Absence of consolidated data for financial conglomerates also limited analysis of potential contagion effects across the financial system. Preliminary bank profit and balance sheet data for 2005 suggest that the broad conclusions of the stress tests would not alter with more recent data.
ANNEX: Observance of Financial Sector Standards and Codes—Summary Assessments
About half the capitalization reflects foreign-listed firms. Domestic listings have slightly outperformed the full JSE index.
Not included in the sector are three development banks, which do not take deposits and which are supervised by various ministries. A case can be made for bringing some of them under the supervision of the BoJ, particularly the Jamaica Mortgage Bank, which has potentially risky exposure to property development and mortgage insurance, although its balance sheet is relatively modest.
Zero risk-weight is assigned to government securities. However, even with a 100 percent risk-weighting, CARs for banks would range from 6 percent to 23 percent, with only one commercial bank and one merchant bank falling below the 10 percent minimum.
Loans above two-thirds of property value are typically insured by the borrower through the Jamaica Mortgage Bank thus transferring some of the risk away from building societies. The ultimate guarantor of the Jamaica Mortgage Bank is the government.
In particular, the BoJ has been using powers to enforce holding company structures on conglomerates that contain a DTI. See also section IV A below.
Their resemblance to pure intermediation products prompted the BoJ to prohibit such distribution in other cases and clarify that it would use powers under the BoJ Act to prevent issuance of similar products in foreign currency. Before allowing further expansion of sales through banking affiliates, insurers should demonstrate adequate risk management capabilities and full disclosure of the products’ risks. They should be subject to strong supervisory oversight in both areas.
All dealers met all their obligations when interest rates spiked up by about 18 percentage points in 2003, but a number of dealers came under stress and some had to liquidate their securities inventory at considerable loss.
One building society has some 39 percent of its investment portfolio in equities, but corresponding sizable unrealized capital gains are not included in its regulatory capital.
Discussions with audit firms indicated that weaknesses in quarterly accounts of securities firms often result in the restatement of annual audited accounts, undermining the risk ratings of firms and off-site supervision.
Absent information on the fair value of securities, the authorities plan to allow firms to compute margins with reference to a “dirty price” only if they maintain the initial margin and are able to mark the underlying asset to market.
The widespread problems in the UK pension industry in the early 2000s, and recent problems in retirement funds offered by US airline and automobile companies are illustrative.
Jamaica’s compliance with the Financial Action Task Force (FATF) 40+9 principles was assessed by the FATF-style regional body (CFATF) in April 2005. A Report on the Observance of Standards and Codes (ROSC) will be issued shortly.
Under the surrender requirement, authorized foreign exchange dealers and cambios are required to sell 5 percent of their gross purchase of foreign exchange to the BoJ. In addition, the government sells to the BoJ the proceeds of its foreign borrowing and bauxite operators sell foreign exchange directly to the BoJ.
All DTIs, except for one commercial bank and two building societies, have positive cumulative repricing gaps.
There are no prudential requirements against open positions, but the capital adequacy regulations require capital coverage of 10 percent of the higher of the aggregate of all net long and all net short foreign currency positions.
It is not clear how to calibrate the default rates. However, doubling the steepness of the assumed default profile does not change the results qualitatively.
Legal restrictions on banks’ holdings of equities also limit their exposure to the stock market.
The Assessment was undertaken by Mr. Emilio Sarcedoti and Ms. Inutu Lukonga as part of the joint IMF/World Bank FSAP missions that took place May 9–20 and July 6–14, 2005.