The Bahamas
Financial Sector Stability Assessment

This article is an overview of the structure of the Bahamian financial system. After the financial crisis in the United States, the Bahamian financial structure showed fragile growth. Tourism, the main source of income for the domestic economy, weakened owing to the U.S. crisis. The increase in oil prices was the key reason for the destroyed infrastructure. However, amidst the vulnerabilities, the banking sector showed stability with high capital and liquidity and sustained challenges; the insurance sector also showed significant improvement. The current financial framework needs to be strengthened, and the mission recommends several reforms to handle financial shocks.

Abstract

This article is an overview of the structure of the Bahamian financial system. After the financial crisis in the United States, the Bahamian financial structure showed fragile growth. Tourism, the main source of income for the domestic economy, weakened owing to the U.S. crisis. The increase in oil prices was the key reason for the destroyed infrastructure. However, amidst the vulnerabilities, the banking sector showed stability with high capital and liquidity and sustained challenges; the insurance sector also showed significant improvement. The current financial framework needs to be strengthened, and the mission recommends several reforms to handle financial shocks.

I. Macro-Financial Performance and Structure of the Financial System

A. Macro-Financial Context

8. The Bahamian economy has continued its recovery from the first wave of the global financial crisis. The economy has gradually picked up after a 5 percent decline in output in 2009 and GDP is expected to grow at about 2.5 percent in 2012, thanks to a rebound in tourism and large investment projects (see Appendix Table 8). The external current account deficit is expected to widen further during 2012–14, mainly reflecting considerable foreign direct investment (FDI)-related imports, notably in connection with the US$3.5 billion Baha Mar project. However, reserves remained reasonably strong at US$829 million at end-2012.1

9. Downside risks center in the tourism sector, on which the economy is highly dependent. Tourism is vulnerable to a weakening of the U.S. economy; a prolonged increase in oil prices; or a large-scale hurricane, especially one that destroyed key infrastructure. The recent increase in central government debt, which is expected to reach 54 percent of GDP by the end of FY 2012/13, constitutes a further potential source of risk, although the government has expressed its commitment to fiscal consolidation.

10. Monetary policy is centered on a fixed exchange rate with the U.S. dollar, while capital controls afford considerable scope for policy independence.2 After holding the discount rate steady for six years, the Central Bank of the Bahamas (CBoB) lowered it by 75 basis points to 4.5 percent in June 2011—against a background of subdued price pressures and an adequate reserves position—with a view to providing additional support to the struggling recovery.3

11. Domestic credit growth has weakened in recent years. It fell to 1 percent in 2011 from a peak of 14.3 percent in 2006 (Figure 1), reflecting the impact of the recession. The composition has shifted towards credit to the public sector, as the government expanded securities issuance to fund its fiscal needs. Holdings of government securities and loans to the public sector have increased to 14 percent of total bank assets in 2011 from 7 percent in 2006. More than 80 percent of total public debt is domestic and it is largely held to maturity by commercial banks, public corporations, and pension funds.

Figure 1.
Figure 1.

The Bahamas: Onshore Banking System Annual Credit Growth

(Percent)

Citation: IMF Staff Country Reports 2013, 101; 10.5089/9781484357675.002.A001

Source: Central Bank of The Bahamas.

B. Financial System Structure

12. The Bahamian financial system is large, reflecting the country’s longstanding status as a major OFC (Table 3).4 Total gross assets in the system were equivalent to 96 times GDP at end-2011. The Bahamas has one securities exchange with 19 issuers and capitalization of around 35 percent of GDP. There is no derivatives market. At end-2011, there were 271 banks and trust companies with active licenses, of which 155 were restricted (mainly nominee trust companies).5 Banks licensed in The Bahamas held US$595 billion in assets, with offshore banks accounting for 98 percent of the total. The overwhelming majority of assets are located outside The Bahamas, although some 80 percent of the assets of the onshore commercial banks are domestic.

Table 3.

The Bahamas: Financial System Structure

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Sources: Bankscope; Central Bank of The Bahamas, Company accounts; The Insurance Commission of The Bahamas; IMF(WEO); IMF staff estimates.

Institutions licensed as a public bank or a public bank and trust in The Bahamas.

The foreign branch operating as a commercial bank in The Bahamas has significant foreign assets but because of its business model these foreign assets are reported in the assets of the offshore banks.

Banks and trusts registered as resident financial institutions but that deal mainly with non-residents and savings and loan institutions that deal only in Bahamian dollars.

A restricted bank, bank and trust, or trust is an institution permitted to carry on business only for specified persons usually named in its license.

Assets and number of institutions are at end-2011 or latest available: banks, other local financial institutions and trusts are at end-2011; number of insurance companies at end-2011 and insurance companies’ assets at end-2010; credit unions are at end-2010; investment funds’ assets under management are at end-2009 and number of funds are at June 2011.

Notes:—indicates that the entity does not hold the type of assets.n.a. indicates that data is not available.

13. The economic contribution of the financial sector to the economy is significant. It is responsible for about 15 percent of GDP and some 9 percent of tax receipts, although the banking sector directly accounts for only 2.5 percent of overall employment.6 Most of the contribution comes from the onshore sector, despite its relatively small size in terms of assets. Offshore banking contributes less than 3 percent of GDP, employs only about ½ percent of the labor force, and contributes less than 1 percent of GDP to government revenues, as it does not operate in the mortgage market that garners most of the stamp taxes (Table 4).

Table 4.

The Bahamas: Economic Contribution of Banks and Trust Companies

(In B$ Million)

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Source: The Central Bank of The Bahamas.

Number of employees

14. The domestic (onshore) banking sector and the international (offshore) financial center are effectively segmented. Intra-group lending operations are very modest and offshore entities are prohibited from holding balances in Bahamian dollars except to finance local expenses, cannot invest in domestic securities and have limited exposure to domestic real estate markets given strict capital controls. Any lending facility offered to non-residents and secured by Bahamian dollar assets is subject to explicit authorization by the CBoB.7 Onshore commercial banks are allowed to deal in B$, but their foreign exchange (FX) transactions with residents are restricted within limits established under delegated authority from the central bank.8 Intra-group lending between the onshore and offshore sectors consists of a single onshore commercial bank that provides liquidity to two offshore affiliates (in compliance with statutory prudential rules).9 Direct ownership links between the offshore and onshore sectors are extremely limited. Commercial banks and other credit institutions need exchange control approval to make loans to residents in foreign currency.

15. Prudential rules apply equally to the onshore and offshore sectors, including on capital adequacy, liquidity, and large exposure ratios. However, capital adequacy rules do not apply to the large majority (by assets) of the offshore sector since well over 90 percent of the assets of the offshore sector are held in branches. All offshore entities must be licensed under regulations that include requirements for verifying that new licensees are subject to home country consolidated supervision and that the home country supervisor concurs with the establishment of the new licensee in The Bahamas. The CBoB maintains at least annual contact with home regulators of parent institutions and home regulators are invited to inform the CBoB of any information that should be highlighted to it. Licensees are required to prepare financial reports on a consolidated basis and the CBoB contacts either the licensee or the overseas regulator should any material concerns arise.

Onshore financial sector

16. Foreign-owned banks account for over three quarters of the onshore commercial banking sector’s assets. Of the eight onshore commercial banks, three are domestically owned while there are four subsidiaries and one branch of foreign banks. The sector is fairly concentrated with the three largest banks holding 68 percent of total assets.

17. Commercial banks are primarily funded by deposits and equity (71 percent and 18 percent respectively). Capital and interbank market funding is currently negligible. The share of equity funding has increased since 2003, partly due to conversion of foreign branches into subsidiaries, which resulted in liquidity provision from parents being converted into capital.

18. The commercial banks engage in traditional banking activities, primarily providing residential mortgages and consumer finance to Bahamian residents. The share of credit in banks’ assets was roughly 75 percent at end-2011, more than 90 percent of which was to the private sector (Figure 2). Domestic residential mortgages accounted for 41 percent of total loans to residents at end-2011. Exposure to the public sector has increased significantly since 2008 to 14 percent of total assets, driven primarily by lending to the central government. In the absence of a secondary market, two-thirds of government securities are held to maturity, mitigating market risks for banks. There is some evidence of rapid credit growth from credit unions and retailers, albeit from a very low base.

Figure 2.
Figure 2.

The Bahamas: Assets and Liabilities of the Onshore Commercial Banks

Citation: IMF Staff Country Reports 2013, 101; 10.5089/9781484357675.002.A001

Sources: Central Bank of The Bahamas; IMF staff calculations.1/ Excludes the Bahamian subsidiary of a North American bank registered as an onshore commercial bank because of the subsidiary’s specific business model and its large holdings of foreign assets that are funded with foreign liabilities. The subsidiary’s domestic assets are relatively small.

19. There are 10 other local financial institutions focused primarily on wealth management services to residents and non-residents. These institutions hold B$2.9 billion in assets, 97 percent of which are offshore. Most of the issuers on the stock exchange, the Bahamas International Securities Exchange (BISX), are financial institutions.10 Stocks are bought primarily by buy-and-hold investors, with the BISX averaging only two trades per day.

20. There is a small credit union sector with 10 institutions, B$272 million in assets and 27,700 members at end-2011. The sector is highly concentrated, with the largest institution accounting for 52 percent of total assets. The Bahamas Cooperative League acts as the credit unions’ umbrella association and provides central services to its members. Supervision is by the Department of Cooperative Development within the Ministry of Agriculture and Marine Resources, but will be moved to the CBoB after the merger, sale or liquidation of three very small and weaker credit unions with a combined shortfall estimated at about B$0.5–1.0 million.

21. The stock of Bahamian government securities has grown substantially since 2007, reaching 45 percent of GDP in 2011. Onshore commercial banks are the largest holders with 32 percent of outstanding volume at end-2011 (Figure 3). Commercial banks have absorbed 58 percent of net issuance since 2007. Foreign private capital markets absorbed another 39 percent as the government issued two large external U.S. dollar bonds in 2008 and 2009. The government securities market has a fairly evenly distributed maturity profile with an exceptionally long average maturity of around 14 years, thus limiting government rollover risk.

Figure 3.
Figure 3.

The Bahamas: Government Securities Investor Base and Maturity Profile

Citation: IMF Staff Country Reports 2013, 101; 10.5089/9781484357675.002.A001

Source: Central Bank of The Bahamas.

Pensions and insurance

22. The pension system in the Bahamas consists of a social security benefit, a separate plan for public sector employees, occupational pension plans, and individual retirement plans offered by financial firms. Approximately one fourth of the Bahamian workforce participates in occupational pension plans. The assets managed by these funds grew steadily, exceeding B$1.1 billion by 2007, but fell to under B$0.7 billion by 2011 due to the crisis, mainly because of recaptures by unemployed contributors. Private schemes are managed conservatively, with nearly half their assets in public sector securities and bank deposits. Pending the passage of occupational pension legislation, private pension funds are not currently regulated.

23. The insurance sector in The Bahamas, which is primarily domestic, has stagnated, although it has achieved high penetration levels. The sector is dominated by five nonlife insurers and four life insurers writing between eighty to ninety percent of the business. The economic crisis and the low interest rate environment reversed the growth experienced through 2008, with the insurance premium having declined in recent years to around the level of five years ago. With expenditure on insurance already equivalent to over nine percent of GDP, levels characteristic of advanced economies, prospects for further growth are limited. Confidence in the sector has been severely affected by the failure of CLICO (Box 1).

24. The Bahamas’ exposure to hurricanes requires high dependence on international reinsurers. The top five nonlife insurers reinsure 60 percent to 80 percent of their risk. More than 90 percent of the reinsurers used are A rated by A.M. Best and belong to the top 25 reinsurers globally. Insurers sell popular long-term products like whole life policies, which have been priced with assumed long-term fixed interest rates of 3 percent to 11 percent that will be difficult to achieve in the current environment, while other savings products include annual return guarantees. Only recently have the products started to be linked to domestic interest rates, implying insurers could be affected by negative spreads.

Investment fund industry

25. The Bahamas has a large investment fund industry. There are 713 registered or licensed funds, although this has declined from 803 in 2008 due to challenging market conditions and consolidation of some fund operations into foreign jurisdictions (Figure 4).11 The funds held B$86.6 billion of assets under management (AUM) at end-2011, down sharply from B$298 billion in 2007. There are only three fund managers located in The Bahamas, managing twelve funds, with the main business activity in this industry being fund administration.

Figure 4.
Figure 4.

The Bahamas: Investment Funds Licensed or Registered and Assets Under Management

Citation: IMF Staff Country Reports 2013, 101; 10.5089/9781484357675.002.A001

Sources: Securities Commission of The Bahamas

CLICO Bahamas Liquidation Update and Recommendations

CLICO Bahamas Limited (CBL) has been under liquidation since 2009. Actuarial calculations show liabilities of B$120 million with a significant shortfall in the value of the corresponding assets. CBL owns 100 percent of CLICO Enterprises Limited (CEL), a Bahamian-established investment company, and some small non-financial entities. 63 percent of CBL’s assets are a B$73 million loan to CEL. CEL used that money, in turn, to invest in Wellington Preserve Corporation (WPC), a Florida company that held 523 hectares of land in West Palm Beach, of which 238 hectares have been sold, netting B$10 million after taxes and fees.

Complex creditors’ claims need to be sorted out. Policyholders, banks and two affiliated companies, CLICO Suriname and CLICO Guyana have all filed claims against CBL. In addition, CLICO Trinidad, a Trinidadian insurer fully owned by Colonial Life Financial (CLF) (which is also the ultimate owner of CBL) is alleging a B$52 million claim against CEL and is trying to stop the $10 million from going to CBL for the benefit of its policyholders and other creditors. At the same time, CBL holds a guarantee of B$58 million for the loan made to CEL from CLF. Discussions are ongoing to offset such guarantee with the B$52 million claim.

The government of The Bahamas has committed to issue a guarantee of B$30 million to support policyholders. The government has encouraged policyholders of CBL to maintain their policies in place in the meantime and continue to pay premiums. Currently, CBL is paying all health insurance related claims and the life claims up to B$10 thousand per policyholder, with any outstanding balance being accrued until the liquidation is finalized.

Concerns and recommendations

The liquidation of CBL needs to be accelerated. Once the government guarantee is issued, immediate disposal of the life and annuities business should be started to avoid continuing to increase the liabilities as policyholders keep their policies in place due to the seemingly attractive returns. The disposal of the health insurance activity due to its shorter-term character and viability as an ongoing concern should be pursued independently of the life and annuities business. CBL, although still acting as an insurer, needs to update financial statements, which have not been issued since 2009.

Offshore financial sector

26. The Bahamas is host to large global international financial institutions. There are 98 banks and trust companies operating under public licenses in the offshore sector, including 24 euro-currency branches of foreign banks and trust companies and 74 Bahamian incorporated subsidiaries (out of which 56 are foreign-owned). Aggregate assets in the offshore banks amounted to US$583 billion at end-2011.

27. The business models of large international banks are diverse. Wholesale banking accounts for some 80 percent of assets of the total system. The largest entities act as a booking center for intra-group funding operations, and do not receive deposits or other funding from external third-parties.12 Some offshore banks offer overnight sweep accounts for a diversified customer pool outside of The Bahamas. A significant private banking/wealth management industry caters to sophisticated high and ultra-high net worth individuals domiciled globally, and its revenues stem from fee-based income, with the risks of asset deterioration borne by clients rather than by the financial institutions. Finally, some offshore banks undertake investment banking activity, assisting foreign affiliates of the parent company’s customers to raise working capital, often acting as a booking center for Latin American offshore business operations. The offshore sector is highly concentrated and branches account for the lion’s share of its assets (Table 5). Nine branches of global banks headquartered in Europe, the United States, and Brazil collectively account for over 90 percent of the offshore sector. These do not operate under the host country’s regulations on capital, since there is no required delegated capital situated in the branches.

Table 5.

The Bahamas: Largest Offshore Entities (In US$ million)

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Source: CBoB and IMF Staff estimates.

28. Offshore banks are primarily funded by intragroup cross-border funding, as well as non-resident deposits (Figure 5). The former is due to some large international banks operating a central treasury model, that is, the parent located in one jurisdiction grants its branches and subsidiaries in third jurisdictions access to the parent’s global pool of liquidity via The Bahamas. Such operations are located in The Bahamas for a variety of reasons, including local expertise, administrative ease, exchange control in the home jurisdiction, and in some cases, tax advantages.13

Figure 5.
Figure 5.

The Bahamas: Liabilities of the Offshore Banks

Citation: IMF Staff Country Reports 2013, 101; 10.5089/9781484357675.002.A001

Source: CBoB and IMF Staff calculations.

29. Despite sustained challenges to global banking from the financial crisis, offshore banking in The Bahamas proved resilient. A 15.1 percent contraction in balance sheets and a 10 percent decline in fiduciary assets in 2009 were due to lower market valuations and the sale of business lines as part of broader balance sheet deleveraging by global parents, but the trend was reversed as total assets picked up by 12.6 percent in 2011. The views expressed by the industry for its prospects are mixed. While heightened regulatory uncertainty due to ongoing global initiatives may lead to outflows from international financial centers, concerns over tax hikes on wealthy investors in other jurisdictions and heightened political risk in Europe could increase the attractiveness of The Bahamas as a global hub for international financial services.

C. Liquidity Management

30. Despite commercial banks’ holdings of substantial amounts of excess liquidity, the interbank market is inactive. The lack of high yielding domestic instruments and strict controls on foreign currency net open positions limit banks’ ability to take risky positions, leading them primarily to park excess liquidity in non-remunerated deposits at the CBoB. Banks have stopped actively bidding for fixed term deposits, and the consequent softening in deposit rates has led to a widening of interest margins since 2010.

31. Lower deposit rates have not fed into inflation amid subdued economic conditions and given the U.S. dollar peg. Given the current depressed state of demand, an autonomous surge in imports (as opposed to a pickup related to inward investment flows) appears unlikely. The CBoB monitors monthly how excess reserves may affect banks’ behavior and feed into macroeconomic aggregates. Nonetheless, the CBoB should step up efforts to forecast developments in excess reserves to prepare for a future period in which such reserves could translate into import surges, necessitating pre-emptive corrective action.

II. The Onshore Financial Sector - Risks and Resilience

A. Banking Sector

32. The Bahamian onshore banking system is profitable, has an extremely strong and high-quality capital base and high liquidity, and virtually no exposure to cross-border funding or FX risk.(Appendix Table 8).14 Commercial banks are subject to a target capital adequacy ratio (CAR) of 17 percent and a trigger CAR of 14 percent, much higher than international norms. Failure to meet the thresholds triggers supervisory intervention.15 At end-2011, the actual aggregate CAR was at about 28 percent, well above the CBoB’s required ratios, with Tier 1 capitalization at 25 percent.16 All banks reported CARs above the regulatory target of 17 percent at end-2011. Banks are somewhat heterogeneous though with one commercial bank’s CAR around 50 percent, while most were clustered around 20 percent (Figure 6). The ratio of liquid assets to total assets was around 20 percent at end-2011.

Figure 6.
Figure 6.

The Bahamas: Performance of Onshore Commercial Banks

Citation: IMF Staff Country Reports 2013, 101; 10.5089/9781484357675.002.A001

Source: Central Bank of The Bahamas; IMF staff calculations.1/ Excludes the Bahamian subsidiary of a North American bank registered as an onshore commercial bank because of the subsidiary’s specific business model and its large holdings of foreign assets that are funded with foreign liabilities. The subsidiary’s domestic assets are relatively small.

33. Banks remain profitable, although profitability has moderated, mainly due to increased provisioning expenses that have doubled since 2008 (Figure 7). Banks benefit from high net interest income that remained steady at around 5 ½ percent during 2007–11 despite the recession, and return on assets (ROA) is at the top of the range of Caribbean peers. Return on equity (ROE), at 17 percent since mid-2007, is more in line with Caribbean peers and broader international norms due to the high level of capital (Figure 8).

Figure 7.
Figure 7.

The Bahamas: Performance and Soundness Indicators of Commercial Banks

Citation: IMF Staff Country Reports 2013, 101; 10.5089/9781484357675.002.A001

Sources: Central Bank of The Bahamas; IMF staff calculations.
Figure 8.
Figure 8.

The Bahamas: Selected Peer Countries: Capital and Return

Citation: IMF Staff Country Reports 2013, 101; 10.5089/9781484357675.002.A001

Sources: Country authorities; IMF; IMF staff estimates.Notes: Data for The Bahamas at March 2012; data for other Caribbean countries at December 2011, except for Belize and Guyana at March 2012; Caribbean peers are Barbados, Belize, Guyana, Jamaica, Suriname, and Trinidad and Tobago; quantiles shown are for FSI-reporting countries based on latest available FSI data; The Bahamas is not an FSI-reporting country and is not included in the quantiles for the FSI-reporting countries.

34. A sharp rise in NPLs is concentrated in mortgages (55 percent) and commercial loans (24 percent). The severe decline in tourism due to the U.S. recession led to a rise in the NPL ratio from 3.8 percent in June 2007 to 12.8 percent in March 2012, higher than the Caribbean regional average (Figure 9). Loan quality appears to have been stabilizing since mid-2011 as tourism activity has picked up and large FDI projects have resumed. Nonetheless, delinquencies remain high at 19 percent of total loans and delinquencies greater than 180 days have increased, indicating deterioration within NPLs.

Figure 9:
Figure 9:

The Bahamas: Selected Peers: NPLs and Provisions

Citation: IMF Staff Country Reports 2013, 101; 10.5089/9781484357675.002.A001

Sources: Country authorities; IMF; IMF staff estimates.Notes: Data for The Bahamas at March 2012; data for other Caribbean countries at December 2011, except for Belize and Guyana at March 2012; Caribbean peers are Barbados, Belize, Guyana, Jamaica, Suriname, and Trinidad and Tobago; quantiles shown are for FSI-reporting countries based on latest available FSI data; The Bahamas is not an FSI-reporting country and is not included in the quantiles for the FSI-reporting countries.

35. High NPL rates on mortgages (14.9 percent at March 2012) partly reflect bank’s reluctance to foreclose on properties as house recovery values are low. By contrast, bank NPL rates on consumer loans (which are often unsecured) are only 7.8 percent since banks write these off after they are delinquent for 180 days. Commercial loans have the highest NPL ratio at 18 percent. Differing asset mixes help explain the significant variation of NPLs across banks, which range from 4.3 percent to 17.7 percent, with banks that have a larger share of mortgages reporting higher NPLs. Provisioning rates similarly vary from 23 percent to 126 percent with higher rates for those banks that have a higher share of consumer loans.

36. High NPLs do not pose an immediate threat to banks. The CBoB meets regularly with the banks and closely monitors the evolution of problem loans and collateral. It has pushed banks to be more aggressive in their collateral valuation practices, including accounting for the time cost of recovery. It also may require independent credit and collateral valuations for problem mortgages, based on onsite examination reviews, and especially where provisions do not appear to be realistic. Moreover, although mortgage collateral values are estimated to have fallen 20–30 percent, stress tests applied conservative haircuts of up to 60 percent and worst-case scenarios assume no offset from collateral. The tests indicate that banks’ very high capital ratios represent a significant buffer, although extreme credit shocks would pose challenges for those banks with weaker capital positions. There is some degree of uncertainty on the overall evolution of house prices since reliable indices are not available and there are relatively few transactions on which to base firm judgments. Hence, monitoring would be enhanced by the development of real estate price indices.

Stress tests

37. The resilience of seven of the eight onshore commercial banks was assessed through top-down (TD) and bottom-up (BU) stress tests (see Box 2 for details).17 Both sets of tests assessed banks’ solvency and liquidity risks using end-2011 data and resulted in similar findings. Stress tests were not conducted on the offshore banking system due to a lack of bank-specific balance sheet data.

Stress Test Scenarios and Methodologies

The solvency tests covered credit risk, credit concentration risk and market risk. Single factor tests based on a balance sheet approach measured the impact of a deterioration of loan quality, sectoral concentrations, a default of large borrowers, and shifts in the yield curves in domestic and foreign currency. Behavioral and regulatory responses were modeled through payout ratios and loan restructurings. Banks were allowed in some of the tests to use collateral, after conservative haircuts, to offset losses.1

Macro stress tests assessed potential short- and medium-term risks from five scenarios: (i) a baseline scenario based on the April 2012 IMF World Economic Outlook (Scenario 1); (ii) a global recession, which would have spillover effects to The Bahamas through a slowdown in tourism receipts (Scenario 2); (iii) a substantial and prolonged increase in oil prices due to a supply shock, which leads to a slowdown in tourism receipts and an independent effect on NPLs through a decline in disposable income (Scenario 3); (iv) a slowdown in FDI flows (Scenario 4); and (v) a large-scale hurricane which would cause a disruption in tourist arrivals (Scenario 5).

The macro scenarios were calibrated using econometric and statistical methods. The impact of tourism receipts, oil prices and FDI flows on GDP growth was based on the CBoB macro model, whereas the impact of the hurricane scenario on tourism and GDP growth was calibrated on historical data. The macro-financial projections were derived from IMF staff regression estimates that link bank-level NPLs to lagged GDP growth, the real T-bill rate, and the oil price index. The macro shocks were assumed to occur in the second half of 2012 and their impact to gradually decrease over the next several years. Each scenario simulated light, medium and severe shocks, roughly corresponding to one, one and a half and two standard deviations from the baseline, which resulted in different trajectories for banks’ NPLs and CARs (Figure 10).

1 Collateral was considered in the credit risk stress tests that focused on the entire credit portfolio. However, a breakdown of collateral by loan classification categories and sectoral exposures was not available and so the stress tests on loan migrations and sectoral credit risk abstracted from collateral effects. The large exposures credit risk stress tests also took a more conservative approach and abstracted from collateral coverage. When collateral was considered in the bottoms-up large exposures credit risk tests, the impact on capital was minimal since the collateral provided adequate coverage.
Figure 10.
Figure 10.

The Bahamas: Macro Stress Test Outcomes

(In percent)

Citation: IMF Staff Country Reports 2013, 101; 10.5089/9781484357675.002.A001

Source: National authorities and IMF staff estimates.

38. Solvency stress tests suggest that the banking system as a whole is in a position to withstand a range of adverse scenarios. Of five scenarios tested, the one involving a combined shock to tourism revenues and oil prices would have the most severe impact. This would lead in the worst-case outcome to an increase in already high NPLs of almost 100 percent, but even under this scenario, the system’s CAR would remain above the regulatory trigger of 14 percent.18 Nevertheless, there are pockets of vulnerabilities and some banks with higher NPLs and lower capital, including a large bank, would breach the regulatory 14-percent benchmark.19 The risks from a large-scale hurricane appear significantly mitigated by the practice of relying on reinsurance proceeds to quickly rebuild damaged infrastructure.

39. Sensitivity analysis revealed credit risk as a key source of risk for the banking system. The analysis modeled the impact of NPL increases of up to 300 percent on banks’ profitability and internal capital generation through reduced net interest income and higher provisioning. The tests adjusted the baseline CAR for a fraction of restructured loans which are likely to return to NPL status.20 There is some heterogeneity among banks. While the system’s CAR is able to absorb a 100 percent increase in NPLs, this outcome is affected by a large outlier with a CAR of 51 percent. Excluding this bank, the system’s post-shock CAR would stand at around 11.5 percent (Table 6) and under more severe shocks would fall below the 8 percent Basel minimum. However, it should be recognized that increases of NPLs of 100 percent or greater are very severe in light of the initial high level.

Table 6.

Summary Stress Test Results: Sensitivity Tests

(In percent, unless indicated otherwise)

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Source: National authorities and IMF staff estimates.

Excluding one bank with a 51 percent CAR.

The stress test conservatively abstracts from future profits and collateral recoveries.

Impact on exposures in domestic and foreign currency. Based on a duration gap analysis that measures the impact on capital.

40. The banking system is fairly robust against concentrations in mortgage lending. At around 15 percent, mortgage NPLs are already high so that, as with NPLs more broadly, a 100 percent increase in NPLs would constitute a significant shock. Mortgage risk stress tests conservatively assumed new NPLs would be 100 percent provisioned and did not take into account offsets from future profits and collateral recoveries. Still, a 100 percent increase in NPLs on mortgage loans pushes only one bank below a 14 percent CAR and none below 8 percent, and leaves the system’s CAR at 21 percent, or 16.7 percent excluding the bank with an initial CAR of 51 percent. More severe tests combining shocks to real estate and tourism-related loans (since the quality of these tend to be correlated in economic downturns) would drive around one third of the banks below the 14 percent regulatory trigger ratio, although again, these tests did not take into account collateral coverage.

41. Market risk is limited, with only modest risk arising from fluctuations in interest rates. Currency and equity price risks are contained due to banks’ limited exposures. Market risks stemming from holdings of government securities are also limited as these are generally held to maturity and both bank loans and government securities are issued mainly at adjustable rates.

42. Banks’ liquidity positions are more sensitive to deposit outflows than wholesale funding shocks due to their dependence on customer deposits (Table 7). The system could cope with deposit outflows of 5–10 percent of total deposits (although some banks with lower liquidity buffers appear sensitive to shocks to the deposit base), but larger deposit outflows may present some challenges, although such scenarios have a low probability. Nonetheless, banks could tap official liquidity since the CBoB is committed to redeem all government securities at full value.

Table 7.

The Bahamas: Liquidity Stress Test Results

(In percent unless indicated otherwise)

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Source: National authorities and IMF staff estimates.

43. Spillover risks are generally insignificant. Domestic bank lending to other onshore financial institutions is negligible. Default risk through interbank exposures is also negligible given very limited interconnectedness within the interbank market. Financial stability concerns from potential financial distress in foreign parent banks appear likely to be muted since international banks transact with overseas counterparties with no material exposure to commercial entities within the jurisdiction and the financial safety net is restricted to the onshore banking sector. In addition, the direct impact of the offshore financial sector on the real economy is limited.

44. The potential for reputational and other risks stemming from the offshore sector or a foreign parent falling into difficulties seem to be manageable. Vulnerabilities are mitigated for offshore institutions by the CBoB’s supervision of their governance, data retention, and know-your-customer activities. Risks from a foreign parent would appear to be mitigated by the high capitalization of onshore banks. The forthcoming AML/CFT assessment will help the authorities to identify any steps that might be needed to contain domestically-sourced reputational risk stemming from money laundering or terrorism financing activities.

B. Insurance Sector

45. Nonlife insurers are managing underwriting risk well. Combined ratios (claims and expenses over premiums) below 100 percent indicate soundness. The ratio of liabilities to equity is low (below two) and solvency ratios are above regulatory requirements. Investments are liquid in accordance with the type of liabilities underwritten by nonlife insurers. Government bonds and cash are the preferred investment instruments with three insurers having over 70 percent of their assets in these classes of investments. Reinsurance is available at a reasonable cost and, as noted, more than 90 percent of the reinsurers used are A-rated by AM-Best and belong to the top 25 reinsurers globally. Reinsurance has proven effective, with quick claims payments made on several occasions, including in 2011 after Hurricane Irene.

46. Asset-liability matching for long-term products needs attention. Liabilities are discounted using the projected performance on the existing investment portfolio for the discount rate. The majority, if not all investment, is local due to exchange control restrictions. Insurers hold high levels of mortgages due to a lack of fixed rate long term local investment instruments. This lack, if combined with a further reduction in interest rates, would create significant strains in the sector. Advances in risk-based supervision should help to capture such vulnerabilities and may lead to requirements for insurers to increase their technical reserves.

C. Capital Markets

47. The securities market is small and illiquid. Although most large Bahamian companies are listed, secondary market trading activity is very limited. Institutional investors are faced with a shortage of viable assets for investment other than real estate and Government of The Bahamas bonds. Exchange control provisions have resulted in a stock market that is effectively closed to overseas investors and issuers.

III. Financial Sector Oversight and Infrastructure

48. Since the 2004 OFC assessment, there has been clear and material progress in key areas of financial sector oversight.21 Most importantly, the approach to regulation and supervision, including with respect to AML/CFT supervision, has been shifting to risk-based approaches, with some agencies already approaching global best practices.

49. Financial sector supervision is carried out by the three prudential regulators (the CBoB, the SCB, and the ICB). In addition, the Compliance Commission supervises the AML/CFT framework for financial sector businesses that are not subject to prudential supervision. Supervisory coordination is undertaken through the Group of Financial Service Regulators (GFSR) which includes as members all four supervisors. Representatives of the government attend GFSR meetings. Members are signatories to a Memorandum of Understanding (MoU) allowing information sharing as needed to effectively supervise the financial sector. The MoU outlines the arrangements for consolidated supervision of the single conglomerate/group in The Bahamas, including, but not limited to, regular communication, monitoring of capital and inter-group transactions and to some extent mutual decision-making regarding supervisory approvals and reprimand. The GFSR meets at least on a quarterly basis, but ad-hoc working groups meet more regularly as required.

A. Banking

50. Compliance with the Basel Core Principles for Effective Banking Supervision (BCP) is good. The CBoB has made significant enhancements to its supervisory process and regulatory guidance since the 2004 OFC assessment. The blend of onsite, offsite, and quarterly supervisory discussions with the banks that the CBoB considers as systemic provides coverage of the significant banking risks. Guidelines establish benchmarks for the classification of credits and for specific and general provisions, and the CBoB’s assessments of compliance with credit risk management and impaired assets requirements is in compliance with BCP requirements.22

51. To the extent there are shortcomings, they relate to the need for additional guidance that is warranted in some risk areas. Draft guidance on interest rate, market, and operational risks should be finalized and implemented. Although the CBoB performs consolidated supervision based on its broad legal authority, guidance on consolidated supervision would enhance transparency to the market and aid examiners in their work.

52. A risk-based supervisory approach is nearing full implementation. The approach supports the Basel II capital guidelines’ Pillar II process. Components of the system include: (i) categorizing banking risks into four categories (business risks, controls, oversight, and governance and financial soundness); (ii) categorizing banks into four impact categories based on size, fiduciary assets, number of employees, and Bahamian dollar deposits; and (iii) risk rating the individual risks of the banks on a scale from one to five. All these elements are analyzed to develop a risk mitigation program for the supervision of each bank. Supporting the offsite supervisory aspect, an electronic reporting system to collect and compute financial indicator ratios has been in place from 2010. The system is being enhanced to include market risk reporting effective September.

53. The CBoB supervises both banks and trust companies,23 and onshore and offshore supervision follow the same principles. A number of different banking licenses exist. Distinctions among them relate primarily to the onshore/offshore nature of banking business in The Bahamas, although some types of licenses are legacy related. The CBoB closely supervises both sectors but, consistent with risk-based principles, adjusts the scope of supervision to reflect the risks of each sector and each bank, and their systemic importance. A regime of information sharing, including with foreign supervisors, and regulatory colleges supports CBoB supervision.24

54. The CBoB has well-trained and dedicated staff in its banking supervision department. However, it needs to review its staffing complement, with particular emphasis on recruiting specialist staff where it currently lacks in-house expertise.

B. Insurance

55. Insurance supervision in The Bahamas has significantly improved in recent years. New insurance legislation was enacted in 2009 and the ICB was established with a highly qualified staff and the power and independence to properly supervise the industry. The ICB has powers to make rules and to enforce and take regulatory action against insurers and intermediaries for violations of the Insurance Act and regulations. The ICB has already undertaken a major clean up of non-active insurers and a range of other measures that have positively impacted the insurance market, including the introduction of penalties that dramatically lowered overdue premium receivables, financial requirements for insurers, brokers and agents, quarterly supervisory meetings with insurers, and annual stress testing for life insurers. However, there is need for recapitalization of one insurer and the liquidation of CLICO and its sister insurer BAICO should be handled in a manner that maintains as much as possible the credibility of the ICB as the supervisor of market solvency.

56. The ICB has an independent Board. However, the first Board members terms’ coincided with each other as well as with the national election schedule, presenting challenges to continuity and possibly to the independence of the Board. A new board was appointed in July 2012.

57. There is currently sufficient reinsurance capacity and the ICB is strongly engaged in reinsurance supervision. Solvency oversight reflects appropriate supervisory review of the adequacy and efficiency of insurer risk transfer strategies given the size, nature and complexity of the business. It also includes reinsurance considerations in determining capital adequacy. Any shortage of reinsurance capacity could limit the ability of local insurers to provide coverage in the jurisdiction and options to mitigating a shortfall in reinsurance capacity could be given consideration, such as the issuance of catastrophe bonds.

58. Fully implementing a consistent risk-sensitive solvency framework should be a high priority. The current solvency regime uses a simple factor-based test and not risk-based capital. The ICB is aware of the drawbacks of such a simplistic solvency regime and for large insurers, it has required independent actuaries to calculate the minimum capital requirement based on the Canadian solvency regime.

59. Risk-Based Supervision (RBS) is still in its initial stages and essential onsite and offsite supervisory tools need development. The ICB has only recently developed a standardized QRS and is making progress in developing ladders of intervention for progressive escalation of regulatory and remedial intervention. The ICB commenced comprehensive onsite examinations in September 2012. In addition, market conduct enhancements are needed to improve consumer protection.

C. Capital Markets

60. Compliance with the International Organization of Securities Commissions (IOSCO) Principles is generally high, although some weaknesses need to be resolved. The new SIA has reinforced the supervisory powers of the SCB and secured its independence and the SCB is now better resourced. The SIA also provides an effective framework for the sharing of information and cooperation between the SCB and other regulators, domestic and foreign. Recent amendments to the SIA are intended to enable the SCB to become a full signatory to the IOSCO Multilateral Memorandum of Understanding (MMoU).

61. The SCB is converting its powers into a practical regulatory methodology. The full impact will only become apparent at the end of 2012 and into 2013 as these initiatives are implemented. Compliance and its enforcement will create challenges for the SCB, licensed firms, the corporate sector, and the legal and accounting professions.

62. Supervision consists of a mix of off-site review and on-site inspections, periodic and “for cause.” On-site inspections are comprehensive, tailored to match the business models of particular categories of licensees and require the exercise of judgment by examiners. The coverage of some categories of locally domiciled professionals in the investment funds industry (such as fund managers and custodians) is insufficient.

63. Regulation of the investment funds industry has not kept pace with regulatory developments globally. The current governing legislation is a disclosure-based regime and does not provide sufficiently for the SCB to set mandatory asset management standards. Also, the SCB could take a more proactive stance in its due diligence and by expanding the scope of its inspections.

D. Pension Funds

64. Occupational private pension funds are not yet regulated. There is pending high level legislation to regulate the fast growing industry with the main objectives being to reduce abuses, lock-in retirement savings and allow for portability. Occupational pensions will not be mandatory and the legislation does not prescribe the form of pension plans that will be allowed. This is appropriate as it allows for free negotiation between employers and employees.

65. Regulation will be urgently needed for proper implementation of the bill. The bill addresses concentration, liquidity, and liability matching requirements for defined benefit plans. Strict licensing procedures will be of paramount importance to create a sound system.

E. Payments and Securities Settlement Systems

66. Major reforms started in the early 2000s have placed the Bahamian payment system closer to best international practices. They include among others: (i) the creation of a large-value real-time gross settlement system (RTGS) in 2004; (ii) the establishment of The Bahamas Automated Clearing House (BACH) in 2010 for check and direct credit/debit clearance; (iii) a new Payment Systems Act (PSA) brought into force in 2012 providing the legal basis for the CBoB’s oversight of, and the settlement finality in, the payment system; and (iv) the creation of the National Payment Committee, as an advisory body to the CBoB, the composition and responsibility of which is currently under discussion.

IV. Crisis Management and Financial Safety Net

67. The current framework for financial crisis management and resolution requires strengthening. With the Bahamian financial system suffering only modest and indirect spillovers from the global financial crisis, crisis management, resolution, and safety net frameworks were not tested. The authorities are committed to filling gaps in the framework expeditiously by developing the NFCMP.

68. The CBoB is the primary financial agency responsible for crisis management and the financial safety net. The financial safety net consists of CBoB authority to extend emergency liquidity assistance (ELA); a DIC which has authority to provide financial assistance to troubled institutions; and access to the payment system. The DIC’s operations are carried out by CBoB employees via secondment of staff and the provision of administrative services. The CBoB’s licensing, supervision, and regulation of financial institutions supports these crisis management and safety net functions, including the role of acting as an early warning system for financial problems. It is planned that supervision of credit unions will be added to the CBoB’s duties by the end of the first quarter of 2013.

69. The breadth of the financial safety net is clearly demarcated and covers only the onshore banking sector. The deposit insurance system covers only Bahamian dollar deposits in onshore banks.25 The lack of deposit insurance coverage for credit unions constitutes a gap in the financial safety net and should be remedied, as intended, after the sector has been cleaned up and come under the supervision of the CBoB.26 The ELA facility is appropriately confined to onshore banks and supervision resources are also properly targeted toward onshore financial institutions through more frequent examinations. If offshore institutions become troubled, CBoB would work with the home country supervisor to facilitate a resolution, but safety net support would have to be provided by the home country government, although there are as yet no explicit ex ante agreements with foreign supervisors to provide such support. The continued exclusion of the offshore sector from the safety net is appropriate, given its large size relative to the economy’s domestic resources and its very limited potential for spillovers to the domestic economy and financial system.

A. Crisis Management

70. The authorities have committed to implementing an effective crisis management plan. However, there is currently no formalized plan in place that lays out a framework for coordinated decision making and clarifies roles and responsibilities among the MoF, CBoB, DIC, and the non-bank financial supervisors in case of a crisis. The CBoB has taken the lead in considering the range of topics that must be addressed to make such a plan complete.

71. The development of an NFCMP has commenced. The plan should, as envisaged, create or task a body to facilitate the coordination of action and communication during a crisis. It should define the roles and responsibilities of the main institutions and authorities in the event of a crisis. In addition, the legal framework needs to be reviewed to ensure that the relevant officials have sufficient legal authority to undertake the actions envisaged in the plan. The plan should include an explicit mechanism for financial assistance to troubled institutions beyond current DIC powers, but should make explicit the sequencing of the sources of any capital support, with primacy placed on contributions by the parent company and, in the case of a foreign-owned subsidiary, the home country government. The CBoB should update its 1991 guidelines on the discount window, through which ELA would be provided, to develop procedures specifically to address a system-wide liquidity crisis.27 Procedures should also be developed on communications among the authorities in the case of a crisis.

B. Systemic Risk Management

72. A Systemic Risk Surveillance Committee (SRSC) has been constituted to monitor financial stability of the onshore banking sector and oversee system-wide stress testing. At present, it is self-contained within the CBoB but a representative of the MoF should be more directly involved in an observer role on a periodic basis.28 The CBoB has begun development of an inaugural financial stability report on systemic risk. The first such report should be issued by the end of the first quarter of 2013.

73. The CBoB has designated all onshore commercial banks as systemic for the purpose of supervision, but there also needs to be a more narrowly tailored definition to determine which banks would be eligible for solvency support or other extraordinary intervention. An impact analysis might classify only a small number, if any, of the eight onshore banks as systemic in this latter sense.29

74. The powers to provide financial assistance under law need to be clarified and appropriately circumscribed. Currently, the legal provision for financial assistance such as solvency support is granted to the DIC, with resources derived primarily from the DIC and the Government, as deemed necessary. However, the DIC does not currently appear to have the financial capacity to provide such financial assistance for medium to large scale single institution resolutions, much less for a systemic crisis, and while it has powers to issue bonds, it is not clear it could do so successfully in a systemic crisis. The ability of the DIC to draw upon government resources should be made both more concrete and appropriately circumscribed.30 Consideration should also be given to how the failure of a systemically important financial institution not currently insured under the DIC would be addressed.

C. Deposit Insurance

75. A system of deposit insurance has been in existence since 1999.31 The level of coverage at B$50,000 is in line with similar jurisdictions and protects approximately 96 percent of depositors by number. The system would benefit from a number of operational changes including to: strengthen transparency and disclosure, undertake a deeper examination of the level of equity capital, reconsider the time allowed for payment of depositors, develop a strategic planning process and identify backup sources of funding (Box 3).

D. Receivership, Resolution, and Liquidation

76. The legal provisions for receivership and resolution would benefit from consolidation that would give clarity about the boundaries of the specific resolution powers available to the CBoB and DIC. There are two separate legal frameworks for receivership and resolution of commercial banks operating in the domestic market, one under the BTCRA and one under the Protection of Depositors Act (PDA).32 While the risk of overlap is ameliorated by the provision under the PDA that the DIC must comply with the directions of the CBoB and must act on its advice, the risk of confusion would be minimized by consolidation into a single framework.

77. Additionally, operational procedures should be in place for these functions that goes beyond the general language contained in the statutes. Winding-up procedures are court-based under the Companies Act and not specific to financial institutions. Administrative procedures specific to the complexities of bank operations should replace those under the Companies Act.

Deposit Insurance Corporation Operational Recommendations

The operations of the DIC do not currently demonstrate a strong model of transparency and disclosure, shortcomings that the Chairman of the DIC intends to address. The coverage of deposits and the DIC’s role in assuring the safety of deposits is not widely known. A public awareness strategy will address this by updating the DIC’s website to provide the public with a FAQ tab, relevant laws and regulations, financial audited statements, examples of claims that can be made and payable by the DIC and other related information.

Although the deposit insurance system is structured to operate as an ex-ante or pre-funded system, the DIC seems unlikely to have sufficient equity capital to absorb losses in the case of a significant bank failure.1 The required balance of the Fund should be determined through a strategic planning exercise that would analyze the impact of a failure of a singular bank or multiple banks. Following this, the Fund balance should be bolstered through an increase in the annual premium paid by banks.

The allowable period of time for payment of depositors under law in the case of a bank failure is well beyond standard international practice. The DIC has six months to initiate payment of depositors and there is no deadline for completion. If there was a bank failure in the future, the intention of the DIC would be to pay depositors within a month. The recent international trend has been toward reducing this compensation period and a shorter period should be codified in keeping with this trend.2

The DIC has been granted operational authority to borrow, but backup sources of funding have not been identified. In the past, the DIC issued five year bonds to fund the payment of depositors. However, in a crisis, this may not be feasible and prearranged access to backup sources of borrowing is desirable, whether from the central bank, MoF or private sources.

1 An ex ante funding system involves the advance accumulation and maintenance of a fund to cover deposit insurance claims. The fund consists primarily of premiums collected from the members of the deposit insurance system.2 For the relevant European Union standards on timely payment of depositors see Directive 2009/14/EC of the European Parliament and of the Council of March 11, 2009 amending Directive 94/19/EC on deposit guarantee schemes as regards the coverage level and the payout delay http://eurlex.europa.eu/smartapi/cgi/sga_doc?smartapi!celexplus!prod!CELEXnumdoc&lg=EN&numdoc=32009L0014

Appendix I: The Bahamas: Risk Assessment Matrix

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Appendix II: Stress Testing Matrix (STEM)

A. Credit Risk Stress Tests

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The stress tests covered the onshore sector. One bank with small onshore operations is excluded since most of its activity is in the offshore segment, whereas the onshore and offshore activities were reported together in the data.

B. Liquidity Risk Stress Tests

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C. Interest Rate Risk Stress Tests

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Appendix Table 8.

The Bahamas: Selected Economic Indicators

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Sources: Central Bank of The Bahamas; Department of Statistics; Ministry of Finance; UNDP Human Development Report; CIA World Factbook and Fund staff projections.

Revised national accounts data.

The 2011 figure is based on November survey and the 2012 figure is based on May survey.

The data refer to fiscal years ending on June 30.

The data refer to calendar years.

Appendix Table 9.

The Bahamas: Financial Soundness Indicators of the Onshore Banking System

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Sources: Central Bank of The Bahamas; IMF staff estimates.

Annexes: Observance of Financial Sector Standards and Codes—Summary Assessments

This Annex contains the summary assessments of the Central Bank of The Bahamas’s observance of financial standards and codes. These assessments help identify the main strengths of the supervisory, regulatory and market infrastructure framework in managing potential risks and vulnerabilities in the financial system. They also point to areas that need strengthening and further reform.

These summaries are based on detailed assessments of the following international standards:

  • Basel Core Principles (BCP) for Effective Banking Supervision – by José Tuya (external expert) and Michael Deasy (external expert).

  • IAIS Insurance Core Principles (ICP) – by Rodolfo Wehrhahn (IMF) and Christina Urias (external expert).

  • IOSCO Principles and Objectives of Securities Regulation – by Richard Britton (external expert).

Annex I. Basel Core Principles for Effective Banking Supervision

A. Introduction

1. This assessment of the Basel Core Principles for Effective Banking Supervision (BCP) was conducted from July 9 through July 24, 2012. As agreed with the authorities, the supervisory framework was assessed against the BCP methodology issued by the Basel Committee on Banking Supervision (BCBS) in October 2006. The CBoB is the sole supervisor of the banking system and as such, the assessment covers only the CBoB. An OFC assessment was conducted in 2004; however, the grading is not comparable to this assessment as the principles and methodology were revised in 2006. The assessment was performed by consultants Michael Deasy (formerly with the Central Bank of Ireland) and José Tuya (formerly with the Office of the Comptroller of the Currency, USA).

2. Since the IMF OFC Assessment in 2004, there have been significant reforms implemented. In its efforts to implement international standards, the CBoB has increased its focus on anti-money laundering, tightened the licensing process and made reforms in its banking supervision approach. Important features of the new supervisory and regulatory regime now include broader and more uniform supervision of bank and nonbank financial activities and stronger mechanisms for international cooperation among Bahamian authorities and their foreign counterparts. The CBoB has implemented a risk-based bank rating system to aid in the targeting of supervisory activities to the higher risk areas.

3. In conducting the assessment a number of information sources were reviewed and significant reliance was placed on the authorities’ self-assessment. The self-assessment was thorough and facilitated the BCP review. In addition to reviewing the self-assessment, the assessors reviewed the responses to a questionnaire sent to the authorities as part of the information gathering process which requested more detailed information to support the self-assessment. The BCP assessment included meetings with CBoB supervisory, legal and policy staff and meetings with commercial banks, the bankers’ association, the accounting association, an accounting firm and the MoF. Open access was provided to review inspection reports, licensing and enforcement documents and on-line presentations on the supervisory process so that assessors could evaluate that a review of bank compliance with requirements was effected by the CBoB.

4. The assessors appreciated the collaboration and hospitality of the CBoB. The staff always made itself available to discuss the principles and greatly facilitated the BCP assessment. Coordination of meetings, obtaining additional information and responding to ad hoc inquiries was managed in an extremely efficient and professional manner.

B. Background

5. The financial system is exceptionally large, reflecting the country’s role as a major OFC. It comprises domestic and offshore banks and trust companies, insurance companies (both domestic and external), pension funds, credit unions, and other nonbank intermediaries. At end-2011, there were 271 banks and trust companies with active licenses, of which, 155 are restricted (mainly nominee trust companies). Banks licensed in the Bahamas hold B$595 billion in assets (76 times GDP). Offshore banks account for some 98 percent of the total. The CBoB is the home country supervisor and responsible for consolidated supervision of, three indigenous, deposit-taking commercial banks.

6. The Bahamas is the fourth largest OFC (after the Cayman Islands, Hong Kong SAR, and Singapore). At end-2011, Bahamian banks held 12 percent of all foreign assets held by banks in OFCs worldwide. In March 2012, the foreign assets of offshore banks registered in The Bahamas amounted to US$501.2 billion.

7. The domestic (commercial/onshore) banking sector and the international (offshore) financial center are essentially fully segmented, with claims limited to a very modest amount of intra-group lending operations. Offshore entities are prohibited from holding balances in Bahamian dollars except to finance local expenses and cannot invest in domestic securities. They have extremely limited exposure to domestic real estate markets amid strict capital controls enacted by the CBoB, although occasionally they may assist high net worth individual clients in acquiring real estate in The Bahamas.

8. Commercial banks are primarily funded by deposits and equity (71 percent and 18 percent respectively). Capital market and interbank market funding is currently negligible. The share of equity funding has increased since 2003, partly due to conversion of foreign branches into subsidiaries. The corresponding capital injections accompanying the subsidiarization have replaced liquidity provision from parents.

9. The commercial banks engage in traditional banking activities, primarily providing residential mortgages and consumer finance to Bahamian residents. Domestic residential mortgages account for about 23 percent of the banks’ assets. Other loans, including consumer, commercial and non-resident loans, accounted for about 36 percent of the total assets in March 2012. Exposure of the commercial banks to the public sector has increased significantly since 2008 to 14 percent of total assets, as the commercial banks have absorbed a large part of government securities issued since then.

10. Financial supervision is performed by three separate institutions: the CBoB, the Insurance Commission of The Bahamas (ICB), and the SCB. Supervisory coordination takes place through regular meetings of the GFSR, consisting of the CBoB, the SCB, the ICB, the Inspector of Financial and Corporate Services, and the Compliance Commission. The GFSR is chaired by the CBoB and has been working towards greater harmonization of the regulatory system.

11. The Bahamian economy has continued its recovery from the global financial crisis. A collapse in tourism led to a 5.4 percent decline in output in 2009, but the economy has gradually picked up and GDP is expected to grow about 2.5 percent in 2012, due to a rebound in tourism and to large foreign and public investment projects (including the US$3.5 billion Baha Mar project). Substantial FDI-related imports and higher oil prices will widen the external current account deficit in 2012, but reserves are expected to remain reasonably strong. Downside risks to growth stem from the country’s high dependence on tourism, which could be disrupted by a weakening of the U.S. economy, a prolonged increase in oil prices, or a large-scale hurricane.

12. The Bahamas has a well-developed legal framework that provides adequate support for banking supervision. The CBoB can operate independently and has the authority to impose sanctions, take preventive corrective action and resolve weak banks, including revocation of the license. A deposit insurance system is in place to protect Bahamian dollar deposits.

13. A credit bureau system is not operational in The Bahamas. The authorities are reviewing options for the establishment of a credit bureau to enable banks to better determine a prospective borrower’s total indebtedness. A draft Credit Reporting Bill, 2012 has been prepared and is currently under review by the authorities.

C. Findings

14. Significant changes have occurred in The Bahamas financial system and the supervisory regime in recent years. There have been amendments to the CBoB Act, 2000 (CBBA) and the Bank and Trust Companies Regulation Act (BTCRA) to broaden the CBoB information sharing authority, and strengthen supervisory enforcement powers. A risk assessment process was introduced in the last quarter of 2010 which reviews all risk areas and assigns ratings to aid in establishing supervisory priorities. Shell banks are no longer permitted to operate in The Bahamas.

15. The onshore banking system is well capitalized, liquid, and profitable, but credit risk should continue to be monitored closely, especially in view of ongoing economic uncertainties. High NPL ratios remain the key challenge for the onshore banking system, particularly for mortgages, which constitute over half of NPLs. However, the authorities remain vigilant about the potential impact of NPLs on bank capital and have substantially improved credit risk monitoring of onshore commercial banks. Requirements and practices on provisioning and asset impairments are in compliance with international standards. Nonetheless, there is some degree of uncertainty on the overall evolution of house prices since reliable house price indices are not available and there are relatively few transactions on which to base firm judgments, although independent valuations are required for problem mortgages

16. There is no obvious near-term threat to bank stability since banks are very well capitalized (both in terms of quantity and quality of capital), profitable, and highly reliant on deposits and equity, which substantially limits funding risks. Stress tests confirm that the commercial banks can withstand severe shocks in terms of both solvency and liquidity, though banks are heterogeneous in their performance.

17. Capital ratios are calculated in accordance with Basel I. However, since 2005 the Central Bank has been steadily and progressively working on completing the requirements for compliance with Basel II Pillar II—Supervisory Review. As of last quarter of 2010, the commencement of the roll-out of the enhanced risk based framework (incorporating the comprehensive risk assessment tool), formalized the CBoB’s approach with Pillar II expectations.

18. There have been significant enhancements to the risk management guidance issued to banks and the supervision of those risks. Nonetheless, because capital ratios are calculated in accordance with Basel I, there is no specific capital cover for specific risks, e.g., market risk, operational risk, etc. The level of ratios among the banks, however, is very high and would compensate for the lack of specific cover for these risks. CBoB will be implementing the capital charges for market risks commencing the third quarter of 2012, thus completing the requirements for full compliance with Basel I. To date its risk based framework meets the expectations for Basel II-Pillar II as it relates to certain aspects of Supervisory Review. Pillar III-Minimum Disclosures is due to be implemented before year-end 2012. Focused efforts will be given to consulting and implementing Pillar I requirements by the beginning of the third quarter of 2013. Regarding Basel III, banks have been sensitized to the requirements and CBoB intends to consult the stakeholders regarding its positions on same by end 2013.

19. CBOB has a cohort of knowledgeable and dedicated staff in place. At the same time it should consider recruiting additional staff, particularly specialist staff, to meet the demands of an ever increasingly complex supervisory environment.

Annex Table 1.

The Bahamas: Summary Compliance with the Basel Core Principles—ROSCs

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Annex Table 2.

The Bahamas: Recommended Action Plan to Improve Compliance with the Basel Core Principles

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D. Authorities’ Response to the Assessment

20. The CBoB would like to convey its appreciation to the IMF FSAP Mission for this comprehensive and balanced assessment of The Bahamas’ compliance with the Basel Core Principles for Effective Banking Supervision. The assessors broadly recognize that The Bahamas has in place a very strong legal and regulatory framework for banking supervision, and we appreciate the assessors’ recommendations that guidelines and policies be further enhanced to reflect our current supervisory practices which, in themselves, are commensurate with international best practices. These expectations are aligned with the CBoB’s ongoing commitment to ensure the robustness of our regime.

21. As recognized in the assessment, a number of initiatives are already underway that will allow The Bahamas to enhance its banking supervision legislative regime and policy framework.

22. The Bank intends to have the draft Banks and Trust Companies Regulation (Amendment) Bill, 2012 enacted and to bring the draft Banks and Trust Companies (Administrative Monetary Penalties) Regulations, 2012 (the Regulations) into force in the near future, given that the industry consultation on the drafts is now complete. The draft Bill will strengthen and clarify the Central Bank’s existing penalties enforcement regime by empowering the Central Bank to impose administrative monetary penalties or fines on any person or licensee in respect of the contravention of the Banks and Trust Companies Regulation Act, 2000 (the Act) or regulations made under the Act.

23. The proposed amendments to the Act also include enhanced fit and proper requirements, new provisions relating to controllers of licensees, and new provisions which would empower the Central Bank to impose prohibition orders against persons performing regulated functions, where such persons do not, or no longer, meet the Bank’s fit and proper requirements.

24. When enacted and brought into force, the draft Banks and Trust Companies Regulation (Amendment) Bill, 2012 and the draft Banks and Trust Companies (Administrative Monetary Penalties) Regulations, 2012 will enhance the Central Bank’s compliance with Basel Core Principles.

25. The CBoB has worked aggressively over the years on the Risk Based Supervisory Framework, which has established the foundation of our approach to Pillar II requirements under the Basel II regime. A significant next step will be the alignment of this framework with the broader initiation of the Basel II-ICAAP program. The CBoB has made tremendous strides toward implementation of its market risk regime, having recently piloted the reporting forms and guidance notes with all the licensees that met the de minimis threshold. Also, the CBoB is at an advance stage of releasing, in final, its guidance document on Interest Rate Risk, which has already undergone the industry consultative process.

26. In the immediate future, the Central Bank will commence industry consultation on several key draft policy guidelines, i.e., Market Risk, Operational Risk and Minimum Disclosures. The latter of course, will set out the minimum requirements for Pillar III disclosures. Given the number of work streams underway, we are optimistic that, in the coming weeks and months, we would have successfully implemented these outstanding policy development initiatives. To ensure that we are able to deliver on our planned enhancements to banking supervision, the CBoB is already assessing its supervisory resource requirements and, at the same time, leveraging technology to achieve efficiency savings.

Annex II. Observance of the IAIS Insurance Core Principles

A. Introduction and Scope

27. This report is a full assessment of The Bahamas’s compliance with the Insurance Core Principles (ICPs) of the International Association of Insurance Supervisors (IAIS), as adopted in October 2011. The review was carried out as part of the 2012 Financial Sector Assessment Program (FSAP) assessment of The Bahamas, and was based on the regulatory framework in place, the supervisory practices employed, and other conditions as they existed in July 2012. The assessment was carried out by Mr. Rodolfo Wehrhahn, Technical Assistance Advisor in the Financial Supervision and Regulation Division, a part of the Monetary and Capital Markets Department, IMF and Ms. Christina Urias, former Insurance Commissioner, Consultant.

28. Regulation and supervision of the insurance industry in The Bahamas is the responsibility of the newly established Insurance Commission of The Bahamas (ICB). The ICB is the ultimate supervisory authority of the insurance sector that includes insurers, brokers, agents, salesmen, underwriting managers and external insurers (see External Insurance Act 2009). This assessment focuses on the ICB.

29. The assessment is based solely on the laws, regulations, and other supervisory requirements and practices that were in place at the time of assessment. Ongoing regulatory initiatives are noted by way of additional comments. The assessors met with staff from the ICB and the Ministry of Finance (MoF), insurers, industry associations, professional bodies and audit firms. The assessors are grateful for the full cooperation extended by all.

B. Executive Summary

30. Insurance supervision in The Bahamas has significantly improved in the past few years, fostered by the enactment of insurance legislation in 2009 and the creation of the ICB with a highly qualified staff and the power and independence to properly supervise the industry. The amount of infrastructure and processes created in the short time since enactment is commendable. Actions taken by the ICB have already had a very positive impact on the insurance market in The Bahamas. These include the following: (i) a major clean up of non active insurers has taken place; (ii) the overdue premium receivables have dropped dramatically with the introduction of a penalty for receivables beyond 30 days; (iii) financial requirements for insurers, brokers and agents have been put in place and have been enforced; (iv) quarterly supervisory meetings with insurers are taking place; and (v) annual stress testing is required for life insurers.

31. Risk-based supervision (RBS) is still in its initial stages and essential onsite and offsite supervisory tools for proper supervision need development. Also a standardized risk sensitive solvency framework needs to be fully implemented. The ICB is aware of the drawbacks of such a simplistic solvency regime and for the large life insurers it has required independent consultant actuaries to calculate the minimum capital requirement (MCR) based on the Canadian solvency regime. The ICB is making progress in developing ladders of intervention within its solvency framework for the exercise of progressive escalation of regulatory and remedial intervention.

32. ICB needs to enhance its market conduct supervision to improve consumer protection regulation. The ICB’s consumer protection activities are only just beginning and disclosure requirements are under development that will allow the ICB to obtain, track and analyze the nature, scope and quantity of consumer complaints and identify the companies involved. Insurers are required to establish procedures to provide disclosure of information to customers and to deal with customer complaints, but there are no specific requirements for claims handling practices.

C. Summary of Observance of the Insurance Core Principles
Annex Table 3.

The Bahamas: Summary of Observance of the Insurance Core Principles

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D. Recommendations and the Authorities’ Responses
Annex Table 4.

The Bahamas: Recommendations to Improve Observance of ICPs

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E. Authorities’ Response to the Assessment

33. The ICB welcomes the detailed assessment of the observance of the IAIS Insurance Core Principles (ICPs) conducted by the IMF through the FSAP mission. The assessment has been particularly encouraging at a critical time where the acknowledgment of our accomplishments by the IMF validates the significant progress we have made in insurance supervision over the last three years. We consider the findings of the FSAP an important benchmark as we continue to develop a robust supervisory and regulatory framework consistent with international standards and best practices. The assessors have given specific commendation for the enactment of insurance legislation and the establishment of the ICB with qualified staff, authority and autonomy to provide effective supervision. Significant improvements in supervisory infrastructure and processes were also recognized as noteworthy achievements.

34. Many of the recommendations of the FSAP have already been under consideration by the ICB, and we have developed a plan to implement most of these initiatives over the near to medium term. Some of the others can readily be incorporated into our plan and we have prioritized these as appropriate, given our resources and ongoing work plan. Below we highlight our response to some of the more notable recommendations made in the report.

Principles on the Supervisor and Cooperation (ICPs 1–3, 25–26)

35. The majority of the recommendations made with respect to the captioned principles are already incorporated into the ICB’s three year work plan and we will continue our efforts to formalize our internal processes, develop guidelines and improve our systems. We continue to strengthen our relationship with our local and regional regulators and have been recently elected to positi