Isle of Man
Financial Sector Assessment Program Update: Financial System Stability Assessment

This paper presents the Financial System Stability Assessment Report on the Isle of Man (IOM). Financial sector regulation and supervision are generally of a high standard, and supervisory efforts are concentrated in those areas most relevant to the activities of financial institutions on the IOM. The Financial Supervision Commission (FSC) faces a conundrum because the major banks are subsidiaries of large international financial groups, to which they provide financing. The FSC is reconsidering to balance prudential requirements for liquidity and exposure to related parties against business needs that entail high exposures to the parent.


This paper presents the Financial System Stability Assessment Report on the Isle of Man (IOM). Financial sector regulation and supervision are generally of a high standard, and supervisory efforts are concentrated in those areas most relevant to the activities of financial institutions on the IOM. The Financial Supervision Commission (FSC) faces a conundrum because the major banks are subsidiaries of large international financial groups, to which they provide financing. The FSC is reconsidering to balance prudential requirements for liquidity and exposure to related parties against business needs that entail high exposures to the parent.

I. Introduction

A. Purpose of the FSAP Update

1. The ongoing refinement of the IOM’s regulatory framework in recent years and the growth in the financial sector have motivated an update of the assessment that was conducted in 2002 under the Fund’s OFC program and finalized in 2003. Furthermore, the recent integration of the OFC program into the FSAP (Executive Board meeting 08/48 on May 30, 2008) has widened the scope of the assessment to include stability-related issues. This report, therefore, covers both the regulatory and supervisory system—mainly for the banking and insurance sectors—and matters relating to the soundness of the financial system and its ability to cope with stress situations. The assessment is based on information available at the time of the September 2008 mission, updated to reflect documented regulatory and economic developments since then.

B. Context

2. The IOM is a British Crown Dependency, and as such it is not part of the United Kingdom (UK) and has its own parliament (Tynwald), legal and regulatory system, and tax regime.1 However, its economy is highly oriented toward that of the UK. There is a customs and value added tax union with the UK, and the pound Sterling is the currency.2

3. The Manx economy has performed well in recent years. Annual GDP growth has averaged over 8 percent over the last decade. Unemployment is negligible. Inflation has been in line with that of the UK, and in mid-2008 was about 4 percent. The government is required to budget for a surplus, which has allowed it to build up reserves. Average residential house prices rose fairly steadily at about 8 percent per year during 2003–07. The recent financial markets turmoil and the slowdown in Europe are likely to affect the economy going forward.

4. The basis of this strong performance was the growth of the financial sector. The main activities are banking, investment business, life and “captive” insurance, fund management, and fiduciary services (Statistical Appendix).3 Banking generates almost one-fifth of the IOM’s GDP, and the combined financial services makes up more than one-third; professional services, some of which are finance-related, make up another fifth of GDP.4 The IOM is in the middle range of OFCs by balance sheet size, being smaller than the other Crown Dependencies in banking, but larger in insurance.

5. Banking remains the largest component of the financial sector (Table 1). Most major British banks and building societies have operations on the IOM. In addition to two Manx banks, there are branches and subsidiaries from other European Union (EU) countries (mainly Ireland), and some other countries. Banks’ business models are diverse (Tables 2, 3, and 4). One major component is the collection of retail deposits from overseas (for example, from UK nationals working in third countries, and from non-EU nationals resident in the UK but not domiciled there) or from institutions such as trusts. These deposits are often on-lent to parent banks. The important deposit-collecting function of Manx banks is reflected in their simple balance sheet structure, with intra-group claims accounting for the vast majority of assets. Besides placement with parents and limited lending to the local economy, there is some lending to entities incorporated on the IOM with business elsewhere, and residential mortgages in the UK. Banks do not operate trading books and in almost all cases liquidity is managed by parent banks.

Table 1.

Isle of Man: Financial System Structure, 2003–2008

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Sources: FSC, IPA, Economic Affairs Division of the Treasury, and staff estimates.

1/ The 2003 banking data exclude overseas branches.

Based on 2006 Census data.

Insurance, banking, finance, and business services.

As of end-January 2009.

Table 2.

Isle of Man: Balance Sheet of Domestically Incorporated Banks


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Sources: FSC Quarterly Prudential Returns, Economic Affairs Bank of England Monthly Returns, and staff estimates.

Relative to 2006/2007 GDP of GBP1,817 million.

Table 3.

Isle of Man: Structure of Total Deposits, By Region 1/


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Sources: Economic Affairs Bank of England Monthly Returns and staff estimates.

On unconsolidated basis (i.e., excluding overseas branches and subsidiaries of domestically incorporated banks).

Relative to 2006/2007 GDP.

Includes financial institutions other than banks resident in the UK, Channel Islands, and the Isle of Man.

Table 4.

Isle of Man: Structure of Total Loans, by Region 1/


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Sources: Economic Affairs Bank of England Monthly Returns and staff estimates.

On unconsolidated basis (i.e., excluding overseas branches and subsidiaries of domestically incorporated banks).

Relative to 2006/2007 GDP.

Includes financial institutions other than banks resident in the UK, Channel Islands, and the Isle of Man.

6. The insurance sector comprises life assurance and captives (Table 5). The life business, which mainly provides unit-linked savings products (where market risks are borne by the policyholder), underwrites business mostly from policyholders in the UK, the Middle East, and the Far East. The captives include a diverse range of specialist companies. A dedicated regulatory framework for pension schemes was introduced in 2005; the sector is still small (See Table 1).

Table 5.

Isle of Man: Insurance Sector Indicators

(In GBP millions unless indicated otherwise)

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Sources: Insurance and Pensions Authority and staff estimates.

Defined as the mandated minimum stock of net available assets, which are computed as net assets minus reserves.

Defined as the difference between net available assets and the required minimum margin.

Excess solvency to the required minimum margin.

7. The CIS sector has been growing rapidly in terms of both number of funds and assets under management (Table 6). Much of this growth is attributed to the institutional sector, including hedge funds. In most cases, Manx companies concentrate on back office and ancillary services for CIS, rather than active trading and determining the investment strategy.

Table 6.

Isle of Man: Securities Market Indicators

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Sources: FSC and staff estimates.

8. Providers of fiduciary services contribute importantly to the local economy. Services provided relate to the establishment or transfer of companies, acting as director or secretary, the maintenance of records and accounts, acting as a trustee, and administering trusts. More than 30,000 companies are registered on the IOM, and Manx corporate service providers (CSPs) and trust service providers (TSPs) administer many more companies and trusts. Sophisticated legal and accountancy services are available in the IOM.

9. The IOM has been able to attract these industries because of certain advantages that it possesses and that have been built upon by active policy (Box 1). However, shifts in demand for financial services, innovations in financial products, and competition between centers will necessitate the further evolution of the sector.

The Evolving Position of the Isle of Man as a Financial Center

The IOM as an international financial center enjoys certain comparative advantages. It is conveniently located to provide services to the London financial market, with which it has a generally similar legal and regulatory structure. The financial system has developed sufficiently that a wide range of quality supporting services (e.g., accountancy and lawyers) are available. The tax system—with zero taxation on most corporate profits (and 10 percent on banks’ profits), no capital gains or inheritance tax, and low personal income tax—facilitates tax-efficient asset management, for example, for undertakings involving persons or companies in several tax jurisdictions. Operating costs are reportedly somewhat lower than in other European financial centers, and the authorities have invested in supporting infrastructure. Importantly, the authorities have made clear that their policy is to maintain high and up-to-date standards of regulation and supervision to minimize reputational risk.

Yet, the financial sector will need to adapt as these comparative advantages evolve. Lower-cost centers are likely to attract more routine business, and competition from jurisdictions with the resources to subsidize firms’ operating costs may pose a challenge. In this connection, the relative decline in locally-administered retail CIS in favor of those oriented towards institutional investors is likely to continue. The establishment of new captive insurers has slowed significantly. Certain sectors may increasingly tend to become concentrated in a few jurisdictions. Changes in regulations and taxation rules in metropolitan centers, and especially the EU, pose a particular challenge: the IOM offers both the withholding tax and disclosure options under the EU Savings Directive. The 2005 introduction of withholding tax (initially at 15 percent) on interest income for EU residents does not seem to have slowed the inflow of deposits; the next prospective change is the increase in withholding tax to 35 percent in 2011. Slower growth in the financial sector and the UK economy generally could lower the sector’s trend growth rate. However, the current global crisis may induce banks to deemphasize wholesale and securitized funding and look more to mobilizing retail deposits, where the IOM’s comparative advantage lies.

II. Regulatory and Supervisory System

10. The 2003 OFC assessment noted that the jurisdiction had a comprehensive legal framework and supervisory structures that work well in practice, and had strengthened mechanisms for cooperation with foreign supervisors. The main prudential recommendations related to increasing the independence, accountability and resources of the supervisory agencies, and intensifying on-site supervision. Several specific recommendations were made in relation to individual principles.

11. Since then, the authorities have taken steps to address many of the issues raised (Appendix I and the accompanying Annex with ROSCs). However, the financial system has been evolving, and in some cases international standards and methodologies for their assessment have been modified.

A. Institutional Structure

12. Financial sector regulatory and supervisory agencies comprise the FSC and the IPA. The FSC is responsible for the regulation and supervision of all financial service providers except insurance companies (and insurance managers and general insurance intermediaries) and pension funds. It is also responsible for the companies’ registry. It currently has about 66 staff, about half of which work in the supervision division. The IPA is responsible for the regulation of insurance and pension companies, and associated service providers.

13. A considerable body of financial sector legislation has been passed since 2002 to keep the legal framework up-to-date and to consolidate provisions. The new Financial Services Act (FSA 2008) brings together most provisions on the functions and functioning of the FSC. The Insurance Act (IA 2008), which came into force on December 1, 2008, plays a similar role for the IPA. The Collective Investment Schemes Act 2008 streamlines legislation in this area and revises the classification of schemes. It is notable that the supervisory agencies have wide legal powers of intervention and sanction, although a court order is needed for more extreme action (such as the assumption of management) or action involving a non-regulated company or person. The agencies are in the process of updating secondary legislation to be consistent with the recent acts.

14. A cross-cutting issue is the independence and accountability of the supervisory agencies (Box 2). Both agencies operate with very considerable independence, and they have taken steps to further enhance accountability. Formally, however, some elements of dependence remains, notably regarding the dismissal of commissioners. The agencies have less budgetary independence than supervisors in many other countries (such as central banks engaged in supervision). The FSC is rightly reviewing the structure of fees on regulated institutions to align them better with the relative costs of supervision.

Supervisory Independence and Accountability

Both supervisory agencies operate independently. The agencies and political authorities are publicly committed to maintaining this independence. The recent memorandum of understanding (MOU) between the FSC and the Treasury (as the responsible part of government) emphasizes the FSC’s independence; an MOU between the IPA and the Treasury is in preparation. The importance of supervisory independence to the effectiveness of supervision and the IOM’s reputation as a financial center is universally recognized. The acknowledged professionalism and expertise of the agencies’ management and staff reinforce their freedom of action. While there is extensive consultation with industry groups, the agencies can and do introduce measures despite industry resistance when they judge that their regulatory objectives require it.

Legislative changes since 2002 have strengthened the agencies’ formal independence, but some de jure dependence remains. The FSA 2008 and the IA 2008 now have the effect that members of Tynwald are not eligible to be members of either regulator. However, the Tynwald has the right to vote to dismiss the FSC Commissioners for any reason, and the Council of Ministers can dismiss the IPA Board members without having to publish an explanation. Tynwald approval is needed for binding regulations, although in urgent cases this approval can be sought after regulations take effect. The provision allowing the Council of Ministers to “give direction” to the FSC in any matters affecting public interest has been removed. Rather, the Treasury can now “by order specify policies and strategies” to the FSC after consultation. Both agencies remain dependent on the government for their budgets, even though the FSC receives considerable revenue from the companies’ registry. The agencies’ staffing levels are set annually by the Treasury as part of the budget process, although both agencies have been able to increase staffing as responsibilities have expanded.

The agencies’ objectives have been clarified. The FSA 2008 specifies in some detail the objectives of the FSC, which covers client protection, the reduction of financial crime, and “supporting the IOM’s economy and its development as a financial center.” However, it does not have an explicit mandate to promote the stability of the financial system. Furthermore, there is no clear prioritization of objectives, despite the possibility of conflicts among them at least in the short term; such a multiplicity of supervisory objectives is common internationally. The IPA’s mandate is similar to that of the FSC, but it must only “have regard to the desirability of maintaining the competitive position of the island.” According to the Treasury-FSC MOU, the Treasury is to set the “Overall Regulatory Strategy,” but the MOU makes clear that this policy is much broader than individual regulations or enforcement action. Thus, while the overall objectives of financial sector policy are set by the democratically-elected Tynwald via government, the supervisory agencies have operational independence and “instrument independence” (i.e., they can set its policy instruments autonomously in order to achieve the given objectives).

Accountability mechanisms of both agencies have been enhanced since 2002. The agencies have to explain their actions to the Treasury and Tynwald on a regular basis (as formalized in the MOU). The Treasury has responsibility for checking that regulations are consistent with the legal framework, and for ensuring that operational budgets are properly carried out. Both agencies now publish comprehensive annual reports, which describe their objectives and activities, and include audited financial statements. They both publish additional material for the general public, and maintain websites giving access to regulations and other materials.

B. Banking Sector

15. The BCP assessment undertaken by the mission confirms the high standard of prudential regulation and supervision found in the 2003 assessment (Annex). The FSC has continued to strengthen its supervisory practice, for example, by establishing a comprehensive, but risk-based system of on-site visits and meetings with bank management. Good progress has been made in the implementation of Basel II.5 A minimum risk asset ratio (RAR) (the term used for the risk-weighted capital adequacy ratio, CAR) is assigned to each bank; in practice no bank has a minimum RAR below 10 percent. In addition, a trigger ratio for supervisory action is set at least 1 percent above the minimum RAR. However, the development of the banking sector may give rise to new challenges, and in particular the thorough on-site inspection of credit files must remain a priority. On-site visits and off-site monitoring generate a small, but significant number of recommendations from the FSC to banks to improve their compliance with regulations, and sanctions are imposed. The FSC also consults with bank auditors and receives their reports on a timely basis, though supervisory functions are not delegated to auditors. Close cooperation with home supervisors has been established and buttressed by numerous MOUs.

16. The major supervisory challenge for the FSC is how to deal with exposure to parent groups. The main business of banks on the IOM is the collection of deposits and channeling financing to their parents, and therefore they have very large exposures to related parties, and their liquidity is entirely dependent on that of their parents. Exposure to parents is more or less completely exempted from prudential limits, but recent events have demonstrated the large risks that are involved when a systemic crisis prevails. This conundrum has no easy solution. The prudential concerns that arise are mitigated by the FSC’s licensing policies, which have admitted mostly subsidiaries or branches of diversified groups from major jurisdictions. Nonetheless, the authorities are appropriately considering how to give more protection to local liquidity and solvency in case a parent group were to come under strain. The FSC could expressly confirm on a regular basis that parents continue to have the will and capacity to support subsidiaries. In addition, the FSC could seek more frequent updates from home supervisors of their assessment of group soundness.

17. Some more complex supervisory issues may become more salient as the financial sector evolves. Provisions for consolidated group supervision are relatively weak. Also, there are no predetermined criteria for judging major acquisition of financial and nonfinancial subsidiaries by banks. At present, the banks incorporated on the IOM do not have major subsidiaries and are largely owned by parent groups, so these issues are not pressing. However, in the future the occasion could arise when changes in group structure, led by a local bank, threaten to impede effective supervision.

18. International standards and best practice are being reviewed in light of the global financial turmoil and the authorities will in due course need to adapt changing standards to local conditions. Some of the global issues are not relevant to the IOM, but in particular measures on anti-cyclicality and liquidity may be applicable.

C. Insurance Sector

19. Insurance regulation has been strengthened since the 2003 assessment, as documented by the ICP assessment undertaken by the mission (Annex). As indicated above, the IPA now has a clear set of objectives and its governance has been changed to reduce the potential for political intervention. The IPA has developed its regulations, including new standards on valuation of life insurance liabilities and new AML/CFT requirements. AML/CFT has also been a focus of much of the IPA’s enhanced approach to on-site supervisory work.

20. Regulation is broadly in line with international standards, taking into account the business carried out on the IOM. The IPA’s approach has been developed with regard to IAIS standards and the international character of the IOM’s business. Thus, the IPA has been putting in place MOUs with home regulators and is exchanging information (and attending supervisory colleges and other meetings) extensively. Effective regulation is facilitated by the sound legal and institutional framework, and the availability of actuarial expertise locally and through the IOM’s connections to the U.K. profession. The IPA itself chooses to engage a major actuarial consultancy rather than to employ actuaries. These arrangements, and the cooperation between supervisors and actuaries, appear to work well.

21. There are some gaps in the framework of regulations, but the IPA is working to address most of them. A significant gap, which was also highlighted in the 2003 assessment, is in standards on corporate governance and related issues (including internal controls, risk assessment and risk management). However, the IPA is close to adopting new binding guidance setting out its expectations in these areas. It already covers governance and related issues in its on-site work (although, in life insurance, so far mainly in relation to AML/CFT controls) and has experience of successfully addressing weaknesses in these areas. Its extensive enforcement powers could also be used for these purposes.

22. Other gaps include powers and procedures for some aspects of group supervision, for the rare cases where this is necessary, and disclosure requirements. While the IPA has limited responsibilities at present as a host regulator, it needs to ensure that it can carry out effective group supervision for existing and potentially future insurance companies that are based on the IOM. The IPA also recognizes that, while information on the financial position of many IOM insurance companies is available (e.g., from parent groups), companies are not formally required to publish any such information. It is working with the industry on possible new disclosure requirements, taking account of IAIS disclosure standards.

23. The IPA is conscious of the need to maintain a flexible and responsive approach, including on resources, to meet future developments in insurance business and its regulation. The IPA’s resources are small in number (just 12 staff in total to cover insurance and pensions, although bolstered by access to actuarial consultants and cooperatively working with the local actuarial society). But it has recruited skilled individuals to assist in the development of its on-site work in particular. The IPA faces challenges in developing a response to the EU Solvency II initiative, which, while not binding on it, will affect most parent groups and set a new international standard. The IPA’s current resources could be stretched also by the development of major new lines of insurance business (there is interest in attracting reinsurance).

D. Collective Investment Schemes

24. The general approach to CIS regulation is to ensure the protection of more at-risk investors and the reputation of institutions operating on the IOM, while limiting the regulatory burden. To this end, the acknowledgement of regulation and supervision by well-regarded overseas authorities offers a form of “leverage” of the authorities’ efforts. For example, companies and funds listed on overseas exchanges will have stringent requirements on their prospectuses and reporting imposed by those exchanges, so there is assumed to be little need for extensive additional requirements.

25. The major recent change in the regulatory framework for CIS is the reorganization of CIS classes. CIS belonging to classes oriented toward small-value retail investors are most tightly regulated and supervised; the more a CIS is oriented toward sophisticated and institutional investors, the lighter the regulation in such areas as portfolio composition, disclosure, and reporting, but there are mechanisms to ensure that investors are aware of the risks involved and to prevent regulatory arbitrage.6 This approach has remained unchanged, but categories have been adjusted and streamlined; there are still some CIS “grandfathered” under the old classification scheme.7 However, the regulation of CIS managers and administrators does not differentiate by type of fund.

26. The IOM has become a signatory to the IOSCO Multilateral MOU, which the FSC can implement using the full range of its powers because it qualifies under the FSA 2008 as a mutual assistance agreement. In this connection, the FSA 2008 strengthened the FSC’s powers to investigate insider dealing and market manipulation, on its own behalf or on behalf of overseas authorities.

27. The authorities are aware that their reliance on overseas regulators requires that they keep up with regulatory changes abroad. The authorities will also need to remain vigilant for signs of regulatory arbitrage and abuse of the system, such as the marketing of lightly regulated CISs to unsuitable clients, which would be harmful to the IOM’s reputation even if no legal or moral responsibility is involved. Clients’ complaints (here and in life insurance) are likely to multiply when market conditions deteriorate, in part because misunderstood practices may become more contentious when returns are negative.

E. Company and Trust Service Providers

28. CSPs and TSPs do not present a major source of financial stability risk. CSPs and TSPs only manage client assets, and economic losses in this sector would not threaten the financial soundness of the Manx system. However, the sector brings reputation and AML/CFT-related risks, which the FSC regulates closely. From a supervisory perspective, the FSC focuses mainly on ensuring that directors and trustees fulfill their corporate governance responsibilities.

29. The Fiduciary Services Act 2005 set the framework for the regulation and supervision of TSPs. Related regulations, including “fit and proper” rules, are now in place, and enforced through reporting requirements and on-site visits. Many CSPs have acquired TSP licenses. Money transmission services now fall within the scope of regulation under the Regulated Activities Order 2008, which came into effect on August 1, 2008.

30. Owing to recent hirings, supervisory resources for this sector appear adequate. In 2007, fiduciary service providers accounted for 65 percent of all focused supervisory visits. Currently, 10 staff are responsible for licensing and supervising the 195 license holders and conducting on-site visits to them on a three-year rolling basis. However, in the future, the FSC could face again a trade-off between allocated additional resources to a more systemic sector, such as banking, rather than to a more labor-intensive sector, such as this one.

F. AML/CFT Provisions and Implementation

31. The IOM’s AML/CFT legal framework is broadly in line with the FATF Recommendations (Annex), having been upgraded significantly in the second half of 2008. Remaining deficiencies are mostly technical in nature and implementation is generally effective.

32. Money laundering (ML) is criminalized broadly in line with the international standard and most technical aspects of the Vienna and Palermo Conventions are complied with. All categories of predicate offenses listed in the international standard are covered. While the statutory sanctions for ML-related offenses are, in a formal sense, comprehensive, dissuasive, and proportionate, the sentences actually imposed by the courts appear rather low. The legal framework for seizure and confiscation is generally comprehensive. With regard to combating the financing of terrorism, the implementation of the relevant United Nations (UN) resolutions and EU Regulations follows that of the UK.

33. The FCU, in acting as the FIU, performs its role adequately. It receives a reasonable flow of suspicious transaction reports (STRs), mainly from financial institutions. Within the FCU, there is a clear separation between the intelligence and the investigative sides. However, the low number of cases in which STRs result in investigations or in prosecution raises an effectiveness issue that needs to be addressed. Additional resources are being provided to the FCU.

34. The IOM has brought its AML/CFT preventive measures largely into compliance with the FATF Recommendations and has formally adopted a risk-based approach. License-holders are required to conduct a risk assessment of their businesses and apply enhanced customer due diligence (CDD) required where higher risks are identified. The recently-enhanced requirements include those relating to conducting business with politically exposed persons (PEPs), and the controls over reliance which may be placed by the IOM financial sector on business introducers to conduct certain CDD measures. However, some available concessions go beyond a reasonable interpretation of the FATF Recommendations.

35. The IOM’s financial institutions are generally well supervised for AML/CFT purposes. The authorities plan additional AML/CFT on-site inspections, particularly for the banking and insurance sectors. CDD obligations for designated nonfinancial businesses and professionals (DNFBPs) largely mirror those for financial institutions. CSPs and TSPs are regulated and closely supervised by the FSC. The on-line gaming sector, while small, is subject to inherent challenges in relation to CDD. The company registration system is well developed.

36. The IOM authorities actively engage in international cooperation in this area. The range of available mutual legal assistance (MLA) is broad; requests are frequent and dealt with efficiently. Domestic coordination and cooperation is well developed, particularly through the initiatives of the Joint AML Advisory Group.

III. Stability Issues

A. Risk to the Financial System

37. Linkages to parent banks are a source of strength, but also create vulnerabilities, as seen recently. The close linkage of domestically incorporated banks to financially sound and well-managed parent banks, which could support their affiliates if need be, normally underpins the resilience of the Manx banking system. Furthermore, Manx operations account for a non-negligible share of net group funding, which further raises the likelihood of parental support in the case of stress, particularly if the shock originates in the IOM.8 Nonetheless, these linkages also present important concentration risk, which create vulnerabilities to financial problems at the group level. Thus, the problems of parent banks during the current global financial crisis has affected their Manx subsidiaries.

38. Another potential vulnerability relates to reputation risk if investors lose confidence in the soundness of Manx financial institutions. This could occur, for example, if investors withdraw their deposits owing to financial stress in another part of the financial system or parent bank. In addition, reputational risk could be realized if some event occurred on the IOM that affected its attractiveness relative to other financial centers. Such reputational risk extends beyond the banking system to the insurance and CIS sectors. The latter in particular is large and diverse, and recent scandals elsewhere are reminders of the possibility that agents will engage in dubious practices.

39. Other risk factors are less important for systemic soundness. Banks’ loan exposure to the nonbank sector is small relative to their balance sheet. A significant share of the loan portfolio is collateralized or guaranteed by the parent institution, reducing the role of credit risk. Less than half of banks’ non-interbank loans are channeled through the local economy (6 percent of total claims), but this exposure remains substantive relative to GDP (estimated at twice 2007 GDP). Financial institutions do not take large market positions or engage in very complex operations (which are handled by their parents), so exposure to market risk and certain operational risks should be small.

B. Performance and Stability Indicators

40. Recent global financial turmoil has severely affected the parent groups of banks on the IOM in the last quarter of 2008, until when the direct effect of the turmoil on banks (and other financial institutions) had been slight. Local banks have no significant exposure to the most affected asset classes, and the largely retail nature of their deposit base ensured that they were not affected by disruption in the interbank and securities markets. However, several of the UK and other EU banks and building societies that have local subsidiaries or branches have received various forms of assistance and in some cases have merged. At the very least, local banks will reduce staffing. More dramatically, difficulties encountered by one parent of a local bank led to the suspension of the latter’s license; it is now in liquidation. The FSC had already ensured that the local bank had transferred its assets from the head office to a UK subsidiary, but since that action was taken the UK subsidiary has been placed in administration. The payout to insured depositors is expected to be completed shortly; substantial government support to the DCS has been provided, although the final net cost is hard to estimate pending the resolution of the UK affiliate.

41. Profitability and capitalization has been very comfortable given low risk-weighted assets, but leverage has traditionally been relatively high (Table 7). The high risk-weighted CAR reflects the high share of intra-group loans that attract a low risk weight.9 The main underlying cause is the tax efficiency of booking profits and “warehousing” capital in the IOM. The average quality of assets is driven largely by the relatively low share of non-intrabank loans (16 percent of total claims), many of which are collateralized, and the normally low risk on intra-group loans. Nonperforming loans are minor and adequately provisioned. Banks’ main source of earnings is net interest income, which is derived from the transfer of customer deposits to their parent banks. Since the parents are mostly large diversified groups, income is steady and depends largely on transfer pricing.10

Table 7.

Isle of Man: Financial Soundness Indicators for the Banking Sector 1/

(in percent)

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Sources: FSC and staff estimates.

On consolidated basis, unless specified otherwise.

Excluding domestically incorporated branches and overseas branches.

On unconsolidated basis (i.e., excluding overseas branches and subsidiaries).

Excluding claims on parent banks.

Net interest income / interest bearing assets

Relative to captive insurance companies provided by large parent banks.

Relative to a range of product lines for funds, etc.

42. The banking sector as a whole usually exhibits ample liquidity given that claims on groups are mostly very short term. In some cases, banks’ assets are of shorter maturity than their liabilities. Standard liquidity indicators were falling through mid-2008, but strengthened at end-2008.

43. Likewise the insurance sector has been highly profitable relative to its low risk profile, and is particularly well-capitalized (See Table 5). Life insurance companies, which account for 80 percent of gross premium income, have achieved especially high returns in the wake of sharp increases in business. Solvency has remained comfortable: net assets available to meet the required minimum margin (RMM) exceed the RMM by five times over.11 The captive sector is even more strongly capitalized in aggregate. Many overseas insurance groups with operations in the IOM as well as parents of the captive companies choose to accumulate surpluses in the IOM company against future business growth or for tax management purposes.

44. In connection with the discussion of FSIs (and stress testing), it is worth noting that the supervisory agencies have a great deal of data on financial institutions, more of which could be compiled and analyzed for the system as a whole on a regular basis. A better statistical base would be useful for the authorities in tracking overall developments and conducting peer group analysis, and for outside observers and potential investors. It may be feasible to integrate information from prudential returns (taking care to preserve confidentiality) and other sources that are currently used, for example, to provide statistics to international organizations. Furthermore, it would be useful to collect more and more timely information on the balance sheets of the household and local corporate sectors, which may have large assets and liabilities abroad; their financial position may be of limited importance to the stability of the banking system, but matters for overall policy purposes (Table 8).12

Table 8.

Isle of Man: Financial Soundness Indicators for the Nonbanking Sectors

(in percent)

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Source: Isle of Man authorities.

C. Stress Test Results

45. Stress tests were performed to assess the resilience of banks and insurance companies to a variety of shocks. The methodologies and shocks were chosen in consultation between the FSC, IPA, and the FSAP team (Appendix II). The shocks were based on historical stress scenarios, periods of heightened volatility, and historical distributions of key macro variables for peer economies. Estimation was performed both “top down” by the authorities with the FSAP team, and “bottom up” by individual commercial institutions.


46. The main potential areas of concern relate to concentration risk and spillovers from parent banks, which, however, are difficult to capture quantitatively. If, hypothetically, banks had to provision for claims on parents, 10 percent provisioning of their claims on the parent, for example, would wipe-out the capital base of the Manx banking sector. Moreover, major shocks to parent banks are likely to be correlated with a general economic downturn, which would affect the loan portfolio. However, the impact of a major problem in a parent bank with a Manx affiliate would be highly nonlinear, with limited impact on the affiliates in the case of mild stress and disastrous consequences in the event of extreme stress. For example, the resilience of Manx affiliates to liquidity strains hinges upon parent banks’ ability to provide adequate day-to-day liquidity and other financial guarantees when needed. This, however, may be particularly difficult if the cause of the deposit drain is related to the parent bank’s solvency or liquidity.

47. Stress tests confirmed that the Manx banking system exhibits considerable resilience against other large shocks (Table 9).13 Credit risk is not a dominant risk factor, as shown in test C1, where all banks reported a less than one percentage point change in their CAR. These results reflect banks’ relatively small (non-interbank) loan portfolio and partly the way in which the shocks were calibrated. Where available, banks were asked to double their probability of default or shock their three largest (non-intra-group) exposures, all of which started from very low levels; owing to limited data availability, the FSC assumed a 1 percent default on the banks’ total (non-intragroup) loan portfolio. For sensitivity analysis purposes, stronger but more concentrated shocks were conducted on particular credit sub-categories. Although the results were more substantive, they confirmed banks’ overall resilience to credit risk. For example, a macroeconomic shock that leads to a 10 percent default on banks’ mortgage loan portfolio (many of which relate to properties off the IOM) would reduce the aggregate CAR by 124 basis points but leave it comfortably above the minimum. At most one small bank would be severely affected under this scenario and require support from its foreign parent.

Table 9.

Isle of Man: Stress Test Results for the Banks

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Sources: FSC and staff estimates.

Unweighted average across the twelve banks.

Modeling spot risk (i.e., impact on net assets, RWA, and income).

3/ Modeling translation risk (i.e., shock absorbed fully by asset valuation effect)

If PDs are not available, default of the largest three exposures excluding the parent bank.

Assuming a 50 percent recovery rate, in line with regulatory risk weights applied to assets.

Based on aggregated data, including branches.

48. Market risk is similarly moderate, due to only small active position-taking and various group transfer pricing and other maturity and currency matching arrangements.14 The banking system exhibits ample liquidity buffers to absorb a dramatic deposit drain. A number of banks would have difficulty meeting a rapid withdrawal of almost all short-term deposits under the strong assumption that parent banks do not provide support—so again the vulnerability relates to exposure to parents. The effects of shocks to securities market were negligible.


49. Stress tests confirm that the Manx life insurance sector exhibits considerable resilience against shocks (Table 10). The results principally reflect the sector’s limited exposure to risk: most business is unit-linked, and therefore display many of the features of a mutual fund. Hence, key risks are either low (in the case of mortality risk) or borne by policyholders (market risk). The effects of shocks to mortality risk are therefore negligible and insurers have limited credit and property risk.

Table 10.

Isle of Man: Stress Test Results for the Life-Insurance Sector

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Sources: IPA and staff estimates.

Net admissible assets to required minimum margin (coverage ratio is 100 if admissible asset equal minimal margin).

Unweighted average across the eight life-insurance.

50. Other market risk shocks have a more significant impact, especially where they involve changes to the fund values. Insurance companies must hold reserves equal to the difference between future expenses and expected future charges, most of which are linked to funds under management. The present value of future expenses is sensitive to movements in interest rates (higher rates lead to higher discounting of future expenses), while future charges are sensitive to changes in fund values and hence all market movements. Hence, stresses that reduce fund values have a significant impact on solvency. But the results show that, on average, minimum requirements are still comfortably covered in all the tests. In practice the IPA expects firms to meet a margin of at least twice the formal minimum, but this level is also well-covered after the shocks. While results may vary by company, it appears that in aggregate the existing solvency approach in the IOM for unit-linked business is typically more prudent than the one expected on the Solvency II basis.

D. Intervention and Contingency Planning

Intervention powers, resolution procedures, and safety nets

51. The authorities have broadly adequate powers to direct and ultimately intervene in a troubled financial institution, although there is no special legal framework for the resolution of financial institutions. While there is no automaticity in intervention, banks are aware that they will be requested to take remedial action if their CAR falls to within one percentage point of the required minimum. Experience elsewhere suggests that it is useful to have a dedicated bank insolvency regime. For example, it may be helpful to have special provisions for “purchase and assumption,” so that bank deposits and matching assets can be quickly transferred to a healthy bank.

52. The coverage of the IOM’s DCS is unusually extensive for a small, internationally-oriented jurisdiction, and relative to the domestic economy (Table 11). After recent amendments, bank deposits are 100 percent insured up to GBP50,000 per individual depositor and GBP20,000 for other depositors. Investors in authorized (i.e., retail) CISs and life insurance policyholders are protected by separate schemes. All schemes cover residents and nonresidents investing or depositing through the IOM offices of locally incorporated institutions, and depositors in IOM branches of institutions from abroad. In case of need, the DCS would be funded ex post by the remaining banking institutions that are members of the scheme. However, already the recent pay-outs to depositors in a relatively small bank required a substantial contribution from the government.

Table 11.

Isle of Man: Depositors Compensation Scheme 1/

(end-September 2008)

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Source: Financial Services Commission.

31 out of the 41 licensed banks participate in the depositor compensation scheme.

Wholly-owned Manx bank (i.e., overseas branches or subsidiaries).

Domestically incorporated bank with foreign ownership.

Branches in IoM of banks incorporated overseas.

Computed as the sum of 100 percent of net deposits (i.e., total deposits net of offsetting loans) of GBP20,000 and below for non-individuals, plus GBP 20,000 for each non-individual depositor with net deposits over GBP20,000, plus 100 per cent of net deposits of GBP50,000 and below for individual depositors, plus GBP 50,000 for each individual depositor with net deposits over GBP 50,000.

53. The authorities’ recent changes to the DCS have brought the system more into line with those now prevalent in the EU, but further refinement may be needed. The current DCS displays most of the desirable characteristics of deposit insurance (such as quick payouts). Nonetheless, when the current severe strains in global financial markets have eased, the authorities should reexamine the DCS to ensure that contingent liabilities are in line with the resources that are effectively available. The DCS is, legally, a contingent liability of the banks themselves, which pay premia, but in the event of a large pay-out they may be reluctant to pay for compensation to the depositors of a failed competitor; they have the option to relocate. The government might assume liability for any large pay-out, but fiscal resources are small relative to the financial system. One approach would be to limit deposit insurance coverage to truly local deposits, which approach would contain the contingent liability, facilitate the achievement of adequate pre-funding, and ensure that social objectives are met. In this connection, depositors need to be made aware in advance of the main features of the scheme; otherwise uncertainty in this area may undermine depositors’ confidence.

Contingency planning

54. The authorities have rightly recognized the need to plan for contingencies in the financial sector, and preparations have begun. The starting point for any contingency planning should be a clear understanding of objectives, constraints, and risk factors. In this regard, the authorities may wish to enhance their stress testing capacity in order to calibrate possible stress scenarios. Some of the considerations that should go into the design of contingency plans and associated stress tests include:

  • (i) The large financial exposure of local institutions to their parent institutions, and their operational dependence on them;

  • (ii) The absence of a lender of last resort (LOLR) facility or other mechanism to provide banks with liquidity, given the monetary union with the UK. Fiscal resources are relatively small;

  • (iii) The high probability that, in a crisis situation, home supervisors will devote low priority to timely cooperation with the Manx authorities and minimizing costs to the IOM;

  • (iv) The limited ability of the authorities to track developments overseas in real time, for example, because they cannot monitor the payments system; and

  • (v) The dependence of most banks’ business models on the attractiveness of the IOM as a low-cost, low-risk location through which to channel resources to their parent institutions and, to a much more limited extent, other investments.

55. The FSC is rightly taking the lead in contingency planning, but other agencies will have to be involved. In particular, the Treasury will have responsibility for the possible mobilization of resources; the FSC-Treasury MOU provides a framework. Equally important, the authorities will need to strengthen in advance arrangements for cooperation and communication with the home supervisors of institutions represented on the IOM. Consideration could be given to developing arrangements that parallel or are linked to those envisaged under the EU’s June 2008 MOU on financial crisis management (e.g., on early notification of strains and possible participation in relevant cross-border stability groups).

Annex—Observance of Financial Supervision Standards and Codes—Summary Assessments

This Annex contains the summary assessments of standards and codes in the financial sector. The assessment has helped to identify the extent to which the supervisory and regulatory framework is adequate to address the potential risks and vulnerabilities in the financial system.

The following detailed assessments were undertaken:

  • Basel Core Principles for Effective Banking Supervision—by Mr. Kruschel (BaFin) and Mr. MacDonald (consultant).

  • The IAIS Insurance Core Principles—by Mr. Tower (IMF/MCM).

  • The FATF 40+9 Recommendations for AML/CFT—by Mr. Donovan (IMF/LEG), Mr. Clemmer, Ms. Dunker, Ms. Kelaart-Courtney, and Mr. Verhelst (consultants), and approved by Mr. Hagan.

The IOM’s compliance with the international supervisory standards is generally high, and most of the issues raised in the 2003 assessment have been addressed.

A. Basel Core Principles for Effective Banking Supervision

56. The regulatory system and prudential supervisory practice have been improved, building on the high standard found in the 2003 assessment. Laws and regulations are kept up-to-date. The FSC has continued to strengthen its supervisory practice, for example, by establishing a comprehensive, risk-based system of on-site visits. Good progress has been made in the implementation of Basel II. Cooperation with home supervisors has been enhanced and buttressed by numerous MOUs. The FSC’s operational autonomy has been reinforced. The major supervisory challenge is how to deal with exposure to parent groups.


57. This assessment of implementation of the BCPs was undertaken as part of an IMF FSAP Update for the IOM in 2008, and in particular was prepared during an IMF mission that visited the IOM during September 2008. This assessment follows-up on an earlier BCP assessment performed in the context of the 2002/2003 IMF OFC assessment of the IOM.

Information and methodology used for assessment

58. The assessment of compliance with the BCPs was made on the basis of a study of the legal and regulatory framework, and detailed discussions with relevant authorities and stakeholders. The assessment was conducted in accordance with the Basel Committee’s revised Core Principles Methodology (October 2006). The assessment team is grateful for the very good cooperation received from the IOM authorities. This included the comprehensive provision of documentation and extensive supplementary information, and the FSC’s self-assessment of compliance with the BCPs.

Institutional and macroeconomic setting and market structure—overview

59. The IOM is a self-governing Crown Dependency. However, it is in a monetary and customs union with the UK. The authorities have followed a strategy based on sound public finances, creation of a stable and efficient tax environment (“tax neutrality”), and the maintenance of the island’s reputation as a safe and reliable jurisdiction for locating business. This last element has been particularly important for the development of banking and other financial activities.

60. The FSC is the sole supervisory authority for banks operating on the IOM. It operates within a supportive legal framework and is empowered, subject to approval by parliament (Tynwald), to issue legally binding regulations for banks’ operations. The banking law was recently revised. Consequently, the legal basis for banking regulation is now located in the FSA 2008. In general, the FSA 2008 made few substantive changes to the FSC’s legal powers, which it has used effectively to issue comprehensive and effective bank regulations. These were contained in the Banking (General Practice) Regulatory Code 2005 (the Code) at the time of the assessment. However, at the beginning of 2009 they will be replaced by new requirements contained in the Financial Services Rule Book 2008 (the Rule Book) which the FSC has already issued under the FSA 2008.15 At the time of the assessment the FSC was revising its guidance for banks to take account of the revised provisions in the Rule Book.

61. Macroeconomic developments have been generally favorable for the development of the banking system. Annual GDP growth has averaged over 8 percent over the last 10 years. Unemployment is negligible. Inflation has been moderate.

62. Banking continues to be the largest component of the financial sector, generating almost one fifth of the island’s GDP. Since 2003, banks’ total assets more than doubled from GBP 33.5 to GBP 68.1 billion. With the exception of two Manx banks, all banks are branches and subsidiaries from EU countries (mainly the UK and Ireland) and some other countries.

63. Banks’ business models are diverse. However, one major element of most models is the collection of retail deposits from overseas (for example, from UK nationals working in third countries, and from non-EU nationals resident in the UK but not domiciled there) or from institutions such as trust services providers, which place clients’ funds with banks on the island. As a consequence, intra-group claims account for over 70 percent of customer deposits. Besides placements with parents, there is limited lending to the local economy, some lending to entities incorporated on the island with business elsewhere, and residential mortgages in the UK. Banks do not operate trading books and in almost all cases liquidity is managed by parent banks.

64. The recent global financial markets turmoil has had a significant impact on the Manx financial system.16 At the time of the assessment, the impact was still small. However, since September 2008 a number of UK banks with operations on the island have undergone various forms of intervention, and the local subsidiary of a non-EU bank has had its license suspended and possibly will be wound up. The full implications of these events will take time to be determined.

Preconditions for effective banking supervision

65. The IOM has its own legal system separate from the UK, with laws being made by Tynwald. The legal system, which is based on common law, is highly developed and well-regarded, notably in regard to expertise on financial sector matters. A full range of high-quality legal, accounting, and other business services are available on the island, and the payment system is integrated with that of the UK.

66. The IOM has a deposit protection scheme, which was amended shortly after the time of the assessment. Currently, maximum compensation is 100 percent of deposits up to GBP50,000 per individual depositor and GBP20,000 for other depositors. Inter-bank deposits and those of the failed bank’s shareholders and directors are excluded from protection. There is no LOLR facility.

Main findings

67. The IOM has maintained and improved on the generally very high standard of compliance with the BCP, which was noted in the previous assessment. The FSC is commended for its proactive stance in establishing and enforcing high standards for banking supervision, which have contributed to the maintenance of the IOM’s good reputation as an international banking centre.

68. A significant change since the previous assessment concerns the enhanced operational autonomy of the FSC. The Treasury now has a limited ability to specify broad policies and strategies for the FSC, leaving day-to-day operations and case-specific issues to the FSC. This arrangement may be viewed as a means to maintain some democratic control over the direction of financial sector policy generally. There is no tradition in the IOM—and indeed no evidence—of any political or governmental interference in the performance of supervision ever having occurred.

69. Other elements supporting the FSC’s autonomy have been broadly enhanced. There is a new requirement for board members that they not be members of Tynwald or civil servants. Public accountability requirements for the FSC have also been improved, and the FSC uses a variety of vehicles to explain its actions and policies. However, Tynwald’s approval is still required for new (or amended) regulations made by the FSC.

70. The FSC’s present staff levels for banking supervision, although relatively small, appear to be broadly adequate. However, the FSC’s expenditure forms part of the government’s budget and requires the FSC to obtain approval for any increase in staff or other expenditure, which may limit its ability to react to contingencies. The supervisory staff are highly trained and respected for their professionalism by commercial bank management and accounting firms.

71. The FSC’s supervisory approach is risk-based, and incorporates both desk-based work and on-site visits. A risk profile is assessed for every bank, together with an impact rating based on the bank’s size. These factors are then combined to determine the amount of resources the FSC should apply to its supervision of any one bank. In addition to routine “business meetings” with banks, the FSC uses its risk assessments to prioritize other on-site work. These take the form of “focus visits” in which the FSC examines specific areas (for example, internal controls) of a bank’s risk profile. In addition, the FSC conducts programs of visits across all banks to assess particular risks (themes) and banks’ ability to mitigate these risks.

72. The FSC has continued to incorporate best international practices into the supervisory function. With guidance from the authorities, Basel II has now been adopted by all banks, save one which has been allowed to postpone until January 2009. As the financial system develops, it may be necessary build up capacity in such areas as consolidated supervision, which is currently of little import given the structure of the banking system.

73. The FSC has adequate powers to ensure compliance with its regulations and other orders, and it uses these powers when the occasion demands. A broad and flexible range of sanctions are available. The FSA 2008 has given the FSC powers to petition the court for the appointment of a person to manage a bank’s business.

74. The major risk factors facing the IOM, which have been given prominence by the global financial crisis, relate to large exposures toward parent banks. Close relationships with parent banks are risk-mitigants in normal times, but operate as powerful risk transmittal mechanisms when the parents come under severe stress. These exposures to related parties generally dominate local banks’ balance sheets, which gives rise to major solvency and liquidity risks. The authorities recognize these concerns and the threats which they represent to overall financial stability. The FSC is commended for its proactive approach in addressing these concerns. Nonetheless, the importance of these risks require that the authorities prioritize the further development of relevant regulations and supervisory practice.

Table 12.

Summary Compliance with the Basel Core Principles

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