Front Matter

Front Matter Page

© 2011 International Monetary Fund

January 2011

IMF Country Report No. 11/1

Guernsey: Financial System Stability Assessment—Update

This update to the Financial System Stability Assessment on Guernsey was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on December 16, 2010. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Guernsey or the Executive Board of the IMF.

The policy of publication of staff reports and other documents by the IMF allows for the deletion of market-sensitive information.

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Front Matter Page

INTERNATIONAL MONETARY FUND

Guernsey

Financial System Stability Assessment Update

Prepared by the Monetary and Capital Markets Departments

Approved by José Viñals

December 16, 2010

This Financial Sector Stability Assessment (FSSA) is based on the work of an IMF Financial Sector Assessment Program (FSAP) Update mission to Guernsey, March 1-10, 2010. The initial FSAP took place in November 2002. The Update team comprised Ian Tower (mission chief) and Christian Schmieder (both MCM/IMF), Su Hoong Chang (insurance supervision expert), Peter Kruschel (BaFin, banking supervision expert), and Keith Bell (banking supervision expert). The main findings were:

  • Guernsey’s financial sector has weathered the crisis relatively well. However, one bank had to be put into administration due to financial distress of its parent bank, and some insurance companies and investment firms went out of business. Going forward, vulnerabilities could result mainly from intra-group contagion, credit concentration, and liquidity risk.

  • The powers of the Guernsey Financial Sector Commission (GFSC) have been strengthened in recent years, and the vast majority of recommendations of the 2003 FSAP have been implemented. Measures included granting stronger enforcement authority, enhancing independence, closer cooperation with home supervisors and, in overall terms, ensuring adequate staffing.

  • Further strengthening of enforcement powers and more comprehensive off-site analysis for all sectors is needed, as is financial stability analysis. In this context, the collection of pertinent data to monitor the solvency of parent companies and large exposures on an ongoing basis is key.

  • The uncertainty about the revision of tax systems and global reforms in regulation could have important implications. The granting of new licenses should be strengthened. The newly established deposit insurance system should be kept under review in the light of evolving international standards, and its limitations must be carefully communicated to depositors.

The main authors of this report are Ian Tower and Christian Schmieder, with contributions from the members of the team.

FSAP assessments are designed to assess the stability of the financial system as a whole and not that of individual institutions. They have been developed to help countries identify and remedy weaknesses in their financial sector structure, thereby enhancing their resilience to macroeconomic shocks and cross-border contagion. FSAP assessments do not cover risks that are specific to individual institutions such as asset quality, operational or legal risks, or fraud.

Front Matter Page

  • Glossary

  • Executive Summary and Policy Agenda

  • I. Macroeconomic and Financial setting

    • A. Purpose of the FSAP Update

    • B. Context

    • C. Financial Sector Structure

    • D. Outlook

  • II. Stability Issues

    • A. Vulnerabilities of the Financial System

    • B. Performance and Stability Indicators

    • C. Stress Test Results

    • D. Financial Stability Policy

  • III. Financial Sector Oversight

    • A. Banking Sector

    • B. Insurance Sector

    • C. Investment Business

    • D. Trust and Company Service Providers

    • E. AML/CFT Provisions and Implementation

    • F. Other Issues

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

    • A. Basel Core Principles for Effective Banking Supervision

    • B. Assessment of Observance of the Insurance Core Principles

  • Tables

  • 1. FSAP Update—Key Recommendations

  • 2. Financial System Structure, 2003-09

  • 3. Balance Sheet of Banking System, End 2009

  • 4. Risk Assessment Matrix

  • 5. Financial Soundness Indicators for the Banking Sector

  • 6. Solvency Stress Test Results for the Banking Sector

  • 7. Liquidity Stress Test Results for the Banking Sector

  • 8. Summary of Compliance with the Basel Core Principles—Detailed Assessments

  • 9. Recommended Action Plan to Improve Compliance with the Basel Core Principles

  • 10. Summary of Compliance with the Insurance Core Principles

  • 11. Recommended Action Plan to Improve Observance of Insurance Core Principles

Glossary

AML/CFT

Anti-Money Laundering/Combating the Financing of Terrorism

AIFM

Directive on Alternative Investment Fund Managers

BCP

Basel Core Principles for Effective Banking Supervision

BU

Bottom-Up (Stress Test)

CDS

Credit Default Swap

CED

Commerce and Employment Department

CIS

Collective Investment Scheme

CISX

Channel Island Stock Exchange

DCS

Depositor Compensation Scheme

DNFBPs

Designated Nonfinancial Businesses and Professionals

EDF

Expected Default Frequency

EU

European Union

FATF

Financial Action Task Force

FIS

Financial Intelligence Services

FSC Law

Financial Services Commission (Bailiwick of Guernsey) Law

FSI

Financial Soundness Indicator

FX

Foreign Exchange

GAAP

Generally Accepted Accounting Principles

GBP

Great Britain Pounds

GDP

Gross Domestic Product

GFSC

Guernsey Financial Services Commission

IAIS

International Association of Insurance Supervisors

ICC

Incorporated Cell Company

ICAEW

Institute of Chartered Accountants in England and Wales

ICP

Insurance Core Principles

IFRS

International Financial Reporting Standards

IMF

International Monetary Fund

IOSCO

International Organization of Securities Commissions

LOLR

Lender of last resort

NPL

Non-performing Loans

ML

Money Laundering

MLA

Mutual Legal Assistance

MOU

Memorandum of understanding

OSCA

Own Solvency Capital Assessment

PCC

Protected cell company

POI Law

Protection of Investors (Bailiwick of Guernsey) Law

ROE

Return on Equity

ROSC

Reports on Observance of Standards and Code

SIV

Structured investment vehicle

SPV

Special purpose vehicle

TD

Top-down (Stress Test)

TIEA

Tax information exchange agreements

UK

United Kingdom

Executive Summary and Policy Agenda

This report updates the findings of the 2003 assessment under the Offshore Financial Center (OFC) program, while concentrating on priorities going forward. The focus is on financial regulatory policies and financial stability.

The development of Guernsey’s economy depends on the performance of the financial sector.1 Financial services account for nearly 40 percent of the economy. The financial sector is diverse, with interrelationships between different services. Collective investment schemes (CIS) rather than banking make up the largest sector. There is a significant insurance sector, particularly captive insurance. Many regulated companies (including banks) provide administration, trustee, and custodial services to CIS. There are many thousands of trusts and companies serviced on the island. Banks support the other sectors with deposit and lending services and with letters of credit to captive insurance companies. However, most assets of the banks are claims on their parent group companies.

While the insurance and investment sectors were also affected, the financial crisis has had a particular impact on banks, because of stresses at their parents. Most notably, the Guernsey subsidiary of an Icelandic bank was placed in administration when it was unable to draw down funds placed within its group. In 2009, economic growth dropped to -2 percent in response to the global downturn.

The authorities have responded to the crisis with significant reforms. The GFSC has strengthened its approach to banks’ exposure to parents, disclosure requirements, exposure limits for some banks, and contingency planning. A depositor compensation scheme (DCS) has been introduced.

Going forward, several pockets of economic vulnerabilities remain. Stress tests were performed to assess the resilience of banks and insurance companies to a variety of shocks. For banks, the main potential areas of concern relate to concentration risk and spillovers from parent banks and, to a lesser degree, macro-financial risks that could materialize through the foreign exchange (FX) rate risk and asset price risk channel. By contrast, the life insurance sector exhibits considerable resilience against shocks, but the losses observed in 2008 indicate that the sector should be carefully monitored and risk-sensitive solvency indicators have to be made available on a timely basis.

Besides, there are some structural challenges for the financial sectors in the Crown Dependencies. In this context, the corporate tax regimes of all three Crown Dependencies are under review. This is creating uncertainty for some businesses. Guernsey is committed to the maintenance of an internationally competitive regime and retention of tax neutrality for financial products.

Dealing with these vulnerabilities and challenges will require preventive measures and mechanisms to deal with problems that may arise. In addition to the area of taxation the authorities will also have to deal with changes in regulations (particularly EU, including for banks and non-banks), which could have important implications for Guernsey.

Financial sector regulation and supervision are of a high standard across all sectors, reflecting enhancements to powers and resources in recent years. The mission conducted detailed assessments of observance of the Basel Committee Core Principles for Effective Banking Supervision (BCP), and the International Association of Insurance Supervisors Insurance Core Principles (IAIS ICP). The recommendations of the 2003 OFC assessment with respect to these standards and the International Organization of Securities Commissions (IOSCO) Principles have been implemented. A separate mission conducted the detailed assessment of observance of Guernsey’s level of compliance with the Financial Action Task Force (FATF) 40+9 Recommendations. The results of the Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) assessment will be elaborated upon in a separate report. The level of observance of these principles is high in terms of both laws and regulations and supervisory practice.

There is comprehensive supervision of the insurance, investment and trust, and company services sectors. Insurance solvency regulation has been strengthened through the introduction of the Own Solvency Capital Assessment (OSCA). In the investment sector, regulation has been enhanced by new conduct of business requirements. The framework governing funds that may be established in Guernsey has been reformed, supporting a reorientation to funds aimed at professional investors. There is effective regulation of trust and company services, but more economic data should be collected on the value of trust and company assets.

The GFSC’s powers have been strengthened in recent years. It can now issue discretionary financial penalties, for example. The regulator’s independence from government, already strong, has been reinforced, while preserving its accountability. It cooperates with the home supervisors of institutions active on the island. The GFSC has effective enforcement for banks. The GFSC appears to be adequately resourced, but needs more resources for cross-sector work, particularly for the analysis of risk using regulatory data and other information.

The GFSC has developed a strategy for addressing financial stability risks at banks, but preventive and resolute policy measures will be essential to deal with the potential vulnerabilities and challenges ahead. Key elements include a more cautious approach to granting new banking licenses. Although bank subsidiaries (versus branches) do enable more direct supervisory control, branches can be accommodated where the parent is one of the strongest international groups. The GFSC needs to (a) be ready to progressively limit exposures of a bank (subsidiary) to its parent, as strains become apparent; (b) improve corporate governance at financial institutions; and (c) engage even more extensively with supervisors of the parent groups, while recognizing the practical limits on such cooperation, especially in time of stress.

The establishment of the DCS is welcome, but its limitations must be carefully communicated to depositors. The importance of the proposed measure is underscored by the liquidity risks discussed in the text, the deposit-based nature of banks, and the large size of the banking sector in relation to the economy (close to 8,000 percent of GDP). However, unlike in most other (large) jurisdictions (and international best practice), the scheme does not provide that depositors will always be fully compensated in a certain amount and the target payout time is longer than elsewhere. The approach should be reviewed in the medium term in the light of developing international standards.

Guernsey should review its institutional arrangements for addressing financial stability issues. Consideration could be given to establishing a forum devoted to monitoring financial stability and coordinating policy. Within the GFSC, financial stability work could be supported by dedicated resources covering the full scope of GFSC responsibilities.

Table 1.

Guernsey FSAP Update—Key Recommendations

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Guernsey: Financial System Stability Assessment-Update
Author: International Monetary Fund