Belize: Selected Issues

Abstract

Belize: Selected Issues

A Review of Recent Efforts to Strengthen Belize’s Financial Sector1

A. Executive Summary

1. Belize’s banking system has continued to strengthen since the 2014 Article IV Consultation in June 2014. Non-performing loans (NPLs) continue to decline and their provisioning continues to improve. The banking systems’ ability to absorb losses continues to move in the right direction. Some banks reported losses recently because of higher expenses on provisioning, loan write-offs, and inability to make profitable use of abundant liquidity in the system.

2. The authorities continue to implement key recommendations of the 2011 FSAP mission. In addition to offsite examinations, they have conducted in 2014 full-scope onsite examinations of two banks, including the systemic one, and AML-focused onsite examinations of one bank and three credit unions. They are aiming to prepare bi-annual Financial Stability Report (FSRs), including quarterly stress tests of banks. With assistance from CARTAC, the authorities will use the newly completed consolidated supervision framework to effectively monitor group risk, group capital adequacy, group governance and regulatory arbitrage. Revisions to the Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) framework in early 2014 increased Belize’s compliance with the 2003 Financial Action Task Force (FATF) recommendations. As a result, Belize exited the Caribbean Financial Action Task Force (CFATF) monitoring process in May 2015. Important reforms are still needed to ensure effective implementation of the 2012 FATF standard. The authorities have prepared a financial crisis management plan with IMF TA, including bank resolution templates as well as an updated list of technical partners the authorities may call on at short notice to support their crisis management efforts.

3. Despite recent improvements, some banks’ balance sheets are still weak and exposed to adverse macroeconomic developments. Gross NPLs remain high and capital buffers may be overestimated because provisioning is still insufficient. The updated stress tests show that the banking system is stronger compared to the assessment made during the 2014 Article IV Consultation. Under the baseline scenario, fewer banks compare to last year would see their CARs fall below the regulatory minimum by 2020. Under high stress, the banking system could have capital shortfalls for a few years. The largest credit union appears strong enough to withstand a severe shock.

4. Efforts to strengthen the regulatory, supervisory, and crisis management frameworks as well as the financial infrastructure should therefore continue. As recommended during the 2014 Article IV Consultation, the supervision department of the Central Bank could benefit from examiners specializing in information technologies (IT) with the view of ensuring the integrity of banks’ IT systems. Asset quality reviews and forward-looking stress tests could complement current supervisory practices and improve Central Bank’s assessments of banks’ balance sheets. Given challenges faced with collateral valuation in the context of still illiquid market, the authorities should raise provisioning requirements to 100 percent on all loan losses, and cease the practice of requiring banks to write off the loan loss. The possibility of exemptions to limits on large exposures should be removed from the banking law and banks willing to extend large loans must raise capital for that purpose. The Central Bank should be able to enforce remedial action on banks without prior consultation with or approval of the Minister of Finance. Bank resolution and liquidation could become truly administrative actions and court approvals should be removed from the banking law. The latter should supersede company insolvency laws. A registry of moveable property would help deepen financial markets. The authorities should continue their support for greater coordination and cooperation among regional financial authorities.

5. The authorities agreed with the thrust of staff’s recommendations but continue to share different views on some issues. On regulation and supervision, the authorities are of the view that the current provisioning rules are prudent enough to safeguard the reliability of banks’ balance sheets, including capital buffers. The authorities do not agree with removing the possibility to grant exemptions to the limit on large exposures. In their view, the small size of the Belizean market would require extremely large and disproportionate capital injections to support large credit to the productive sector. This would put upward pressure on already high interest rates as highly capitalized banks seek to maintain their ROAs. On Central Bank autonomy, the authorities continue to agree with the idea of allowing the Central Bank to enforce remedial action on banks without prior consultation with the Minister of Finance in the case of increases in capital requirements. However, in the case of liquidation or cancellation of license of a systemic domestic bank, they continue to be of the view that at the minimum there should be some degree of consultation with the Minister of Finance given that the systemic risk and fiscal contingency falls on the government. The authorities did not commit to changing current provisioning rules but noted that provisioning requirements of 100 percent on all loan losses (secured or unsecured) was considered in the past. They decided that 50 percent provisioning for fully secured loan losses was prudent after discussions with banks, which were then given a certain number of years to provide for the legacy loans.

B. Introduction

6. This note reviews the strength of the balance sheets of large banks in Belize as well as progress made on financial sector reforms since the 2014 Article IV Consultation. It focuses on developments since then with additional insights on the strength of the largest credit union and constraints to stronger regional financial sector supervision.

7. Belize’s financial sector remains sizeable and continues to strengthen. Its composition and size remain broadly unchanged since the 2014 Article IV Consultation. Total assets increased only modestly in nominal terms but stood at about 159 percent of GDP at end-March 2015, reflecting projected higher nominal GDP growth. Banks’ balance sheets have been improving, including because of loan write-offs and new capital injection. Capital buffers have also been improving, though they may be overestimated because of still low provisioning.

8. Nonetheless, Belize’s financial sector continues to pose non-negligible financial stability and fiscal risks, which warrant continued close monitoring. Weaknesses identified during the 2011 FSAP mission and highlighted during the 2014 Article IV Consultation remain, including high NPLs, especially at a systemic bank. In addition to being overestimated, capital buffers may not be sufficient to absorb large but plausible losses. Since the 2014 Article IV Consultation, further progress has been made on the regulatory, supervisory, and crisis management frameworks. The recent decision by major international banks to terminate key correspondent banking relationships (CBRs) with Belizean banks is a new threat to financial stability. Progress on regional supervision and financial crisis management is held back mostly by weaknesses in the regulatory and supervisory frameworks of Caribbean countries. The refusal of another Caribbean supervisor to address a parallel banking issue with Belize remains a stumbling block for Belize’s participation in projects to strengthen regional supervision.

9. The remainder of the note is organized as follows. Section C presents recent financial sector developments and risks. Section D reviews banks’ balance sheets as well as the main sources of systemic risk to the financial system. Section E discusses the updated stress tests for the banking system, including a new model of banks’ profitability. Section F assesses the crisis management framework and regional financial supervision. Section G describes the next steps toward an even stronger financial system, including the authorities’ views. Concluding remarks are in section H.

C. Recent Developments in the Financial System and Risks

The composition and size of Belize’s financial system remains broadly unchanged since the 2014 Article IV Consultation. The authorities continue to address gaps identified by the 2011 FSAP mission, including consolidated supervision. Significant progress in AML/CFT allowed Belize to exit the CFATF ICRG monitoring process in May 2015. A directive was issued to address a difficulty for a fuel importer to acquire all its foreign exchange from any single dealer despite an adequate supply in the market. The recent decision by major international banks to terminate key correspondent banking relationships (CBRs) with Belizean banks has had a limited impact so far. Belize has made significant progress towards modernizing its national payment system (NPS).

Financial System Structure

10. The size of the Belize’s financial system remains broadly unchanged since the

2014 Article IV Consultation (Table 10). The financial system remains large relative to the size of the economy. Its assets stood at BZ$5.6 billion, equivalent to 159.2 percent of GDP at end-March 2015. In March 2014, financial system assets was BZ$5.4 billion (159.5 percent of GDP) implying an increase of 3.6 percentage points in nominal terms, which stems from increases in the assets of domestic banks (4.4 percent), credit unions (8.9 percent), and domestic insurance (6.3 percent). Except for the voluntary withdrawal of the license of a small private finance company late last year, the composition of the financial system remains broadly unchanged. The financial system continues to enjoy significant foreign presence. In March 2015, 5 out 6 of domestic banks are considered foreign-owned, with assets representing 54.3 percent of total assets of the financial system.

Table 1.

Belize: Financial System

article image
Source: Central Bank of Belize.
Table 2.

Belize: Deposits and Loans for Domestic Banks and Credit Unions (December 2010 - March 2015)

article image
Source: Central Bank of Belize.
Table 3.

Belize: Deposit and Lending Rates of Commercial Banks and Credit Unions

(In percent)

article image
Sources: Central Bank of Belize and Fund staff calculations.
Table 4.

Belize: New Provisioning Standards

(In percent)

article image
Source: Central Bank of Belize.
Table 5.

Belize: Financial Soundness Indicators 1/

(Domestic and international banks; in percent)

article image
Sources: Central Bank of Belize; and Fund staff estimates.

Includes BZ$43 million award to Belize Bank Ltd. by the London Court of International Arbitration (LCIA). The amount is being disputed by the government.

The required capital adequacy ratios for domestic and international banks are 9 percent and 10 percent, respectively.

In percent of statutory liquidity requirement.

Excludes BZ$43 million award by the LCIA.

Table 6.

Belize: Financial Soundness Indicators

(Credit Unions; in percent)

article image
Sources: Central Bank of Belize; and Fund staff estimates.

The standard minimum is 10 percent.

In percent of statutory liquidity requirement.

The standard minimum is 80 percent

The standard maximum is 5 percent

Annualized

Table 7.

Belize: Financial Soundness Indicators

(The Largest Credit Union; in percent)

article image
Sources: Central Bank of Belize; and Fund staff estimates.

The standard minimum is 10 percent.

In percent of statutory liquidity requirement.

The standard minimum is 80 percent

The standard maximum is 5 percent

Annualized

Table 8.

Belize: Largest Banks Capital Shortfalls Under Various Capital Adequacy Measures (December 31, 2014) 1/

(In thousands of U.S. dollars, unless otherwise indicated)

article image
Sources: Belize authorities; and IMF staff estimates.

Shortfalls in provisions are deducted from qualifying capital.

Capital adequacy ratios (CARs) are computed with risk-weighted assets (RWA) that uses weights prescribed by the Basel I agreement.

Capital adequacy ratios (CARs) are computed with risk-weighted assets (RWA) that uses weights prescribed by the Basel I agreement, with the exception of the weight on government securities, which has a weight of 10 percent instead of zero percent.

Cap/TA is the ratio of capital to total assets.

Table 9.

Financial Sector Risk Assessment Matrix

article image
article image
Table 10.

Belize: Structure of the Financial System 1/

article image
Source: Central Bank of Belize.

Except for the number of institutions, no data exists for the international insurance companies and other international companies.

Data from the seven largest credit unions.

11. As noted during the 2014 Article IV Consultation, the domestic banking system is still dominant in the financial system (Table 1). At end-March 2015, the banking system accounted for 80 percent of the financial system’s assets, equivalent to 127.3 percent of GDP. Domestic banks’ assets increased to BZ$3.1 billion, 87.5 percent of GDP from BZ$2.9 billion in March 2014 (Table 10). In the banking system, domestic banks hold a large proportion of assets (68.7 percent), deposits (69 percent), capital (72 percent) and loans (81 percent) (Table 2). The biggest bank in the domestic banking system in terms of assets holds roughly one-third of the assets (28 percent of GDP), deposits and loans. The second biggest bank in terms of assets holds 53 percent total capital of the domestic banking system. The assets of international banks (offshore), the second largest component of the financial system was broadly unchanged at BLZ$1.4 billion, representing 25 percent of financial system assets (about 40 percent of GDP). The international banking sector continues to be dominated by three institutions, which together accounts for three quarter of the assets.

12. The new public bank has increased lending having received additional funding from the government. Financed by Petrocaribe resources, new capital injection amounted to BZ$20 million, increasing the bank’s paid-up capital to BZ$30million as at March 2015. This has allowed the bank to rapidly expand its loan portfolio to BZ$24.4 million since it commenced operations in September 2013. The loans were for residential construction and real estate in line with the banks’ mandate to provide affordable mortgage credit for first time home owners, particularly teachers and public officers. Total loans represent 81.4 percent of the bank’s total assets. The bank recently reported a small portfolio of non-performing loans (BZ$0.26 million in March 2015). Meanwhile, it started accepting deposits in September 2014, which stood at BZ$1.3 million in March 2015.

13. Heritage Bank Belize plans to acquire the assets of First Caribbean International Bank Belize (FCIB). The transaction, which is subject to approval from the Central Bank of Belize and the Central Bank of Barbados, is expected to the completed in a few months. With assets totaling BZ$300 million in March 2015 (9.8 percent of domestic banks’ assets), FCIB is a small domestic bank and a branch of First Caribbean International Bank of Barbados, a Canadian bank ultimately owned by the Canadian Imperial Bank of Commerce (CIBC). Heritage bank, on the other hand, is a smaller domestic bank with assets of BZ$233 million (7.6 percent of domestic banks assets), which is majority owned by the biggest international bank in Belize worth BZ$378 million in assets (26.9 percent of international banks’ assets). The international bank is majority-owned by a privately incorporated holding company and partly owned by an international bank in Antigua. This impending acquisition would strengthen Heritage Bank’s balance sheet although the bank has not indicated how the purchase would be financed.

14. The credit unions sector is macro-critical, and remains the third largest component of the financial system. At end-March 2015, seven credit unions accounted for 14 percent of the financial system assets (23 percent of GDP). Compared to March 2014, credit unions registered increases in assets, loans and deposits of 6–8 percentage points. The sectors’ membership base continues to grow, and is close to half of Belize’s population. Membership is largely unrestricted with a minimum of 100 members, and a small registration fee. Moreover, the sector is very concentrated—a single credit union controls 64 percent of the sector’s assets, and 35 percent of membership. A second group of four mid-sized credit unions with assets between BZ$40 million-BZ$80 million holds 35 percent of the sectors’ assets, while the remaining two just have 5 percent. Today, about three small credit unions are insolvent, with assets amounting to BZ$1.76 million, representing 0.2 percent of credit unions total assets. One of the insolvent credit unions is under administration, and could be liquidated soon.

15. The largest credit union is bigger than most banks. With assets amounting to BZ$501 million, equivalent of 14.2 percent of GDP, the largest credit union is the fourth largest financial institution in Belize. It is bigger than three domestic banks and all international banks. It plays a significant financial intermediation role with a loan portfolio of BZ$302 million at end-March 2015. Besides controlling the credit union’s sectors assets, it holds 70 percent, 63 percent and 57 percent of the sectors’ capital, deposits and loans, respectively.

16. Credit unions in Belize offer financial services similar to those of banks although their objectives and prudential requirements differ. Unlike banks, the main objective of credit unions is to promote the economic well-being of its member-owners with a greater focus on saving. Credit unions are viewed as better suited to provide smaller scale unsecured lending at lower interest rates. The Belize credit union Act defines permissible activities for credit unions. They are subject to different prudential requirements compared to banks. Nonetheless, they accept deposits and provide services, which for the most part, are similar to those of banks (savings account, checking accounts, credit cards, ATM, mortgage lending, online banking, wire transfers, etc) and thus are exposed to the same financial stability risks. Indeed, credit unions and commercial banks offer competitive rates for deposits and loans (Table 3). Financial services and activities which pose risks that are similar should be subject to a similar regulatory regime, in order to mitigate the risk of regulatory arbitrage which could have dire consequences for financial stability.

Regulation and Supervision

17. The authorities are determined to keep the financial system under tight supervision. The Central Bank continued its risk-based approach to supervision and conducted several on-site examinations of banks and credit unions in 2014 and early 2015. In 2014, there were full-scope onsite examinations of two banks, including the systemic bank, and AML-focused onsite examinations of one bank and three credit unions. In early 2015, the Central Bank conducted on-site examination for one international bank and one credit union. Examining a domestic bank, the Central Bank found inconsistency in loan classification, which after correction saw the NPL to total loan ratio of that bank increase from 6.9 percent in June 2014 to 9.2 percent in September 2014. In another domestic bank, the examiners noted improvement in underwriting standards following the implementation of new policies and procedures. Meanwhile, the Central Bank has allocated resources to hire an in-house legal expert, who could also assist in banking supervision, and is searching for a suitable candidate.

18. The Central Bank has implemented a number of reforms to strengthen credit unions, since it took over the responsibility of regulating and supervising the sector in 2005. Most recently in 2013, it implemented new loan classification and provisioning guidelines, broadly similar to the ones introduced for banks in December 2011. Before then, loan classification and provisioning for credit unions were not standardized (Table 4). Under the new loan classification system, loans that are up to 3 months past due are classified as non-performing. Non-performing loans are further categorized as doubtful (3–12 months past due) and loss (over 12 months past due). The implementation of the new rules showed provisioning to be understated for almost all the CUs. Unsecured loans classified as loss are required to be written off within 12 months2, while loans classified as loss but secured by mortgages must be written off within four years. The Central Bank continues to publish individual financial information of the seven large credit unions on quarterly basis.

19. Despite recent progress in credit union supervision, weaknesses identified during the 2011 FSAP mission remain. There are still no limits on large exposures although credit unions are required to reports such transactions to the Central Bank. The FSAP mission also recommended setting appropriate minimum CAR requirement, strengthening internal controls, and setting stricter administrative penalties for non-compliance. Revisions to the Credit Union Act of 2003, which are yet to be completed, are expected to address these issues, including strengthening the resolution powers of the Central Bank.

20. The Central Bank plans to harmonize its legislations in compliance with IFRS following IMF TA. Financal reporting by banks follows IFRS standards, except for provisiong for loan lossess which are guided by Central Bank directives. In April 2015, the IMF provided technical assistance to the Central Bank to address issues related to impairment loss recognition under IFRS. The authorities plan to revise the domestic banks and financial institutions act, as well as loan loss classification and provisioning regulations taking into account the TA recommendations.

21. In order to further strengthen the supervision of the non-bank offshore sector, the authorities are considering moving international insurance under the supervsion of the SOI. The sector is noted to be small with about 33 registered providers of international insurance services in 2015. Nothwithstanding, supervison of the sector, which is the responsibility of the International Financial Services Commission (IFSC) has been generally lax. Thus, as part of efforts to strengthen the IFSC, the supervisor of domestic insurance is expected to take over the supervisory responsibility of international insurance.

22. The authorities are developing a consolidated supervision framework. They are being assisted by CARTAC, and aim to enhance their capacity to monitor group risks, including for cross-border financial entities. In April 2015, the Central Bank issued a regulation, establishing minimum standards on corporate governance to be implemented by the Board and management of banks.

23. Recent progress in AML/CFT allowed Belize to exit the CFATF monitoring process in May 2015, but further efforts are needed to ensure effective implementation of the 2012 FATF standard (Annex II). As noted during the 2014 Article IV Consultation, Belize passed in February 2014 new important legislations and amended existing ones to ensure adequate compliance with international standards and obligations relevant to money laundering and terrorist financing. The CFATF) in its May 2015 plenary acknowledged the significant progress made by Belize in strengthening its AML/CFT regime and removed it from its monitoring process. However, this progress relates to technical compliance with the 2003 FATF standard, and important reforms are still needed to ensure effective implementation of the 2012 FATF standard.

24. The authorities are determined to effectively implement their AML/CFT framework. They insisted that their recent exit from the CFATF follow-up and monitoring process confirms the significant progress Belize has made on AML/CFT. They are strongly of the view that the recent favorable CFATF review of Belize’s AML/CFT framework and the termination of correspondent banking relationships with Belize do send contradictory messages and called for greater consistency in the assessment of AML/CFT frameworks. They are confident that future rounds of CFTAF mutual evaluations will only confirm the continuous progress Belize is making on AML/CFT.

Monetary and Exchange Rate Policy

25. The monetary policy stance remains unchanged since the 2014 Article IV Consultation. The Central Bank deploys a mix of direct and indirect policy tools to accomplish its monetary policy objectives. Direct policy tools may be used occasionally to set limits on interest rates, bank credit and Central Bank’s lending facilities. Reserve requirements remain the conventional monetary policy tool although the Central Bank is moving towards the use of open market operations to signal its policy stance. However, given the slow pace of credit growth, and increases in international reserves, it decided to keep the policy stance unchanged since the 2014 Article IV Consultation. Thus, the statutory and cash reserve requirements of domestic banks remained at 23 percent and 8.5 percent, respectively. The minimum interest rate on savings deposits is 2.5 percent. Government securities issued including for liquidity management have stayed at the same levels for a number of years: Treasury bills (BZ$175million), Treasury notes (BZ$136.5million) and Treasury bonds (BZ$10million).

26. Central Bank’s lending to the government has not changed much. At end-December 2014, it held Treasury bills of BZ$86.8 million, and Treasury bonds of BZ$10million, unchanged since the 2014 Article IV Consultation. Overdraft facilities extended to the government amounted to BZ$62.3million (equivalent of 7.2 percent of government’s estimated recurrent revenue for the previous fiscal year), compared with BZ$55.4 million at end-2013.

27. The Central Bank introduced a new directive in November 2014 to address difficulties faced by an importer in acquiring foreign exchange in a market that had no shortage of foreign exchange. The directive mandates commercial banks to supply foreign currency to a designated fuel importer (PUMA Energy Bahamas). The amount to be supplied by each commercial bank is being determined by the Central Bank using each commercial bank’s share of foreign assets in the banking system.

Financial Infrastructure

28. Major global banks have recently either terminated their correspondent banking relationships (CBRs) with many banks in the Caribbean, including Belizean banks or have threatened to discontinue them (Box 1). For Belize, five banks (59.2 percent of the banking system’s assets at end-March 2015) out of twelve saw at least one of their CBRs terminated, including the systemic bank (21.3 percent of the banking system’s assets at end-March 2015) and three international banks (21.5 percent of the banking system’s assets at end-March 2015). The affected banks have not been given any reason for the termination of the relationships, making it particularly difficult to find replacements. The new arrangements that have been put in place with the support of the Central Bank and major credit card companies (Visa and MasterCard) seem to be working as international financial transactions have not been disrupted as initially feared.

29. Belize has made significant progress towards modernizing its national payment system (NPS). The NPS Bill was presented to key stakeholders last year. The bill is in its final stages of drafting, and is scheduled to be submitted to Cabinet this year. Considerable progress was made in drafting accompanying regulations. A vendor has been selected to supply the automated infrastructure for the payment system, a critical part of the system. It is expected that, in 2015, the NPS legislation will be passed into law, and the installation of the system‧s infrastructure will commence.

30. Implementation of a new credit bureau is slated for 2016. The pace of implementation of this project has been slow following resistance from some segments of the society. The credit reporting draft legislation has been approved by cabinet and will be sent to parliament by the first half of 2016. The legislation will provide for the establishment of a credit reporting system in Belize, data protection and confidentiality, consumer rights and remedies, and the Central Bank’s power to oversee the system.

D. Banks’ Balance Sheets Developments and Risks

Since the 2014 Article IV Consultation, banks’ balance sheets have strengthened. All domestic banks except one have met the new provisioning requirements. The recent decision of some US banks to end correspondent banking relationships is a new threat to financial stability. Credit union’s balance sheets are improving following recent central bank efforts to tighten supervision of the sector.

The Banks’ Balance Sheet Development Since March 2014

31. The banking systems’ ability to absorb losses continued to move in the right direction since the 2014 Article IV Consultation (Table 5). The banking system’s ratio of non-performing loans (NPLs) (domestic and international banks) to total loans stood at 16.1 percent at end-March 2015, compared with 17.6 percent at end-March 2014. NPL ratios were generally in double digits and higher in international banks (24 percent of total loans) than in domestic banks (14.3 percent of total loans). NPL ratios are in single digits in three domestic banks. Provisioning improved further from 44.8 percent of total NPLs at end-March 2014 to 57 percent at end-March 2015. The ratio of NPLs net of specific provisions to total loans fell to 6.2 percent at end-March 2015 (9.4 percent at March 2014), while NPLs net of provisions to capital amounted to 29.6 percent (41.7 percent in March 2014). The new public bank reported NPLs of 1.2 percent of total loans for the first time in December 2014 since it started operation, although it has sufficient provisions (133 percent of NPLs) and capital buffers.

32. Notably, the banking systems’ reported capital adequacy ratios (CARs) increased but they are likely overstated (Table 5). The CAR was 23.7 percent at end-March 2015 compared with 21.6 percent a year ago. However, gross NPLs that are classified as losses, fully collateralized and free of provisioning before December 2011(about BZ$134 million at end-May 2015) are only provisioned at 50 percent. Banks have until November this year to pass the remaining provisions or face the prospects of writing them off, which would require the recapitalization of two banks.

33. The portfolio of NPLs in some domestic and international banks is still sizable. NPLs in the banking system remain concentrated in domestic banks. Gross NPLs in that sector stood at 73 percent of the systems’ total in March up from 69 percent a year ago. The systemic bank accounted for almost half of NPLs in domestic banks. Similarly, half of the NPLs in the international banks are in the largest bank, while the second largest bank accounted for 33 percent.

34. The banking system remains liquid and is returning to profitability. The system’s liquid assets in excess of statutory requirement, was 94.7 percent at end-March 2015 (104.3 percent in March 2014). In a small domestic bank, excess liquid assets have stayed above 200 percent of requirements since 2012, representing around 40 percent of the domestic banking system’s total. At the same time, that same bank has been reporting losses since 2010. Some banks reported losses recently because of loan write-offs, increased provisioning expenses and inability to make profitable use of liquidity in the system. Nevertheless, banks are now poised to return to profitability having met the provisioning requirements set by the Central Bank. The system’s ROA stood at 0.5 percent at end-March 2015.

Credit Unions’ Balance Sheet Developments

35. Assessment of financial soundness of credit unions follows a different set of prudential norms (Table 6). Parallel to the CAMELS standards used by banks, credit unions apply the PEARLS approach,3 which looks at, among others things, the effectiveness of financial structure, asset quality, protection for unexpected losses, and profitability. The objective is to safeguard credit union members’ savings from losses and to ensure that credit unions operate in a sound manner.

36. The NPLs of credit unions rose recently reflecting tightened regulations and supervision. Gross NPLs of credit unions stood at 9.2 percent of total loans at end-March (12.3 percent in March 2014), above the standard requirement of 5 percent. Notably, following the implementation of new classification and provisioning rules by the Central Bank in 2013, NPLs more than doubled (14 percent) in December that year. According to the new rules, loans that are 6–12 months past due are classified as doubtful and require 35 percent provisioning. Loans that are one year past due are classified as loss, and provisioning for secured and unsecured portions of such loans are 50 percent and 100 percent, respectively. At the same time, provisioning improved from 30.9 percent at end-2013 to 66 percent at end-March 2015. As a result, NPLs net of provisions fell from 9.7 percent of total loans at end-2013 to 3.1percent at end-March 2015.

37. Capital buffers are barely adequate relative to standards although the sector is extremely liquid and profitable. Net institutional capital—a measure of capital adequacy and effectiveness of financial structure—was 9.9 percent of total assets at end-March 2015 up from 8.8 percent at end-2013 but below the standard minimum of 10 percent. Net loans to total assets ratio4 stood at 63 percent in March 2015 below the threshold of 70–80 percent. Liquid assets have remained above 270 percent of statutory requirements since March 2013. Meanwhile, return on assets has averaged 4.5 percent since 2013.

38. The balance sheet of the largest credit union is relatively sound (Table 7). Its NPLs stood at 13.4 percent of total loans at end-March 2015 compared to 17 percent at end-2013. Reflecting improved provisioning, NPLs net of provisions was 4.5 percent at end-March 2015 (11.4 percent at end-2013). Its net institutional capital was 11.7 percent of total assets, slightly above the prudential norm. The systemic credit union is more liquid than others. Excess liquid assets rose to 416 percent of statutory requirements at end-March 2015.

Main Sources of Systemic Risks

39. Main threats to the banking system broadly remain as identified during the 2014 Article IV Consultation with loss of CBRs emerging as a new threat (Table 9). First, public debt is very high and this could increase the possibility of a debt distress. Since government paper represents a significant share of banks’ portfolios, including the systemic bank, losses on government paper would wipe out the capital buffers of many banks, including the systemic bank. This risk could nonetheless be mitigated by the fact that the Central Bank is the buyer of last resort of government paper as noted above. Second, some domestic banks still have low capital buffers (Table 8), and raising new capital to avoid a deterioration of their capital adequacy ratios could be a challenge, increasing the risk of public sector intervention. Third, major Belizean banks have received termination of correspondent banking relationships with U.S. banks and finding replacement correspondents is very difficult. Fourth, exchange rate shocks may lead to a rise in interest rates, which in turn would undermine repayment capacity and increase NPLs. However, this risk, which could be mitigated by capital controls, has a low likelihood of occurring. Fifth, given some banks’ exposures to agriculture, tourism, and export sectors, negative shocks in these sectors would have some low impact on financial stability. Finally, large exposures in the banking system deserve continued close monitoring by the Central Bank.

E. Assessing the Strength of Banks’ Balance Sheets

The updated stress tests show that the banking system appears stronger than at the time of the 2014 Article IV Consultation, partly reflecting lower loan write-offs, new capital injection in a weak bank and slightly improving profitability. Projected weak export performances would put upward pressures on projected NPLs. Under the baseline, fewer banks compare to last year would see their CARs fall below the regulatory minimum by 2020. Under high stress, the banking system could have capital shortfalls for a few years. The largest credit union appears to have enough capital buffers to withstand a severe shock.

40. The banking sector stress tests were updated by IMF staff in 2015 as part of the assessment of the risks and vulnerabilities of the financial sector. The stress tests are in two broad categories: the static and the forward-looking ones. The latter were conducted using a credit risk econometric model and three models of bank profitability under a baseline and two stress scenarios. Stress tests were conducted in cooperation with the Financial Sector Supervision Department of the Central Bank of Belize (CBB). The parameters and assumptions are broadly as in the 2014 exercise. In addition, staff assessed the strength of the largest credit union in Belize—applying the same methodology subject to data availability. The credit union was treated as a domestic bank. All stress tests were conducted using the end-2014 data. The results are summarized in Table 12.

Table 11.

Belize: Financial Soundness Indicators of the Banking System (Commercial Banks)

(In percent, unless indicated otherwise)

article image
Sources: Central Bank of Belize; and Fund staff calculations.
Table 12.

Belize: Stress Tests - Projected Banking System Capital Adequacy Ratios and Capital Shortfalls

article image
Sources: CBB data; and Fund staff calculations.

Refers to all banks in the banking system.

Effect of shift of loans to large borrowers from the performing to loss category.

Excludes Choice Bank Ltd. and Caye International Bank Ltd. as in the 2011 FSAP.

41. The static single-factor stress tests again looked at the impact of liquidity shocks, exchange rate shocks, credit risk, and credit concentration risk, due to lack of sufficiently detailed data to analyze other relevant risks. These tests adhere to standard practices of assessing these intermediation risks.

  • Liquidity shock. The liquidity stress test simulated the impact of a run on banks by its different classes of depositors. Results show that liquidity risk is still low, and improved slightly compared to 2013. The banking system could easily meet an outflow of deposits of around 50 percent over a month. It would take 40 days (35 days in 2013) for the banking system to completely exhaust its liquidity and 18 days (15 days in 2013) for the liquidity ratio to fall below the 23 percent mandatory requirement. Liquidity risks remains higher than the banking sector average for the two banks identified last year: one bank would see its liquidity ratio fall below the prudential ratio after only five days, and the other bank after six days. Meanwhile, it would take 20days for the credit union to breach the prudential ratio.

  • Credit risk. Two tests were applied. First, a “migration” stress test was applied by shifting 10 percent of current performing loans to “substandard” status, in addition 20 percent of “substandard unsecured” loans to “doubtful” status, and 20 percent of “doubtful” loans to the “loss” category. This “migration” shock lowered the system-wide CAR by 1.1 percentage points. However, the CAR of all the banks will remain above the minimum requirement. Last year, two banks were noted to face capital shortfall of about 0.1 percent of GDP each to meet the minimum CAR. Second, the impact of a “generic” stress test was analyzed by shifting 10 percent of current performing loans to the “substandard” category. The banking system’s CAR declined by 0.4 percentage point, lower than last year but no bank would face capital shortfalls.

  • Sectoral credit stress tests. These tests analyzed the impact of a 25 percent increase in NPLs (i) across all sectors, (ii) in the sugar sector, (iii) in the citrus sector, (iv) in the banana sector, (v) in the citrus, sugar, and banana sectors combined, and (vi) in tourism and related sectors. The impact of sectoral shocks remains marginal. An increase in NPLs by 25 percent across all sectors would lead to a decline in domestic banking systems CAR by 1 percent of GDP, and the CARs of all banks would remain above the minimum requirement. Two banks appear particularly exposed to sectoral credit risks. The first bank would see its CAR fall by 1.3 percentage points following shocks to tourism, citrus and banana sectors. The CAR of the second bank would decline by 1.6 percentage points following shocks to the tourism sector.

  • Large loan exposure. A range of stress tests were carried out to assess the banking system’s exposure to large borrowers. By large borrowers, it is meant those with a loan in excess of 10 percent of the bank’s capital. The analysis considered three scenarios: (i) default by top ten borrowers of each bank, (ii) default by top five borrowers of the banking system (iii) default by top ten borrowers of the banking system. In the first scenario, where each individual bank’s top ten large exposures that are performing migrate into loss status, all banks except two, same as last year, would face negative CARs. The CAR of the banking system would also become negative but would require a smaller capital injection of about 14.8 percent of GDP (16.4 percent of GDP in 2013) to meet the 9.0 percent mandatory requirement. In the second scenario, where the performing loans of the top five borrowers from the banking system migrate into loss status, the CAR of the banking system would also turn negative and three banks would require recapitalization amounted to 3.0 percent of GDP (3.2 percent in 2013) to meet the mandatory capital adequacy requirement. In the third scenario where the performing loans of the top ten borrowers of the banking system are migrated to loss, capital injection for the same three banks would amount to 3.9 percent of GDP (4.5 percent in 2013).

42. Three forward-looking models were also used to assess the impact of a continued and persistent decline in economic activity on banks’ loan quality and capital buffers. First, a credit model is estimated to project NPLs, using the IMF staff medium term projections for the growth of exports and total bank loans and assuming no change in the monetary policy stance.1 Then, the first of the three forward-looking models is simulated. This model further assumes that banks’ capital before deductions of shortfalls in provisioning remain at their end-2014 level in nominal terms throughout the projection period. Intuitively, it means that banks make zero profit and no new capital is injected. Using projected NPLs, the CARs are projected after deducting provisioning shortfalls from capital buffers. The results show that under the baseline, low-stress and high-stress scenarios, the banking system’s CAR would remain above the prudential requirement throughout the projection period. However, under the baseline scenario, the CARs of two domestic banks would fall below the requirement by 2020. Last year, one international bank was noted to require additional capital to meet the regulatory minimum CAR in all projection years under the baseline scenario. However, following the sale of an important real estate asset (US$23 million) in December 2014, which boosted the capital of that bank, no capital injection is required under the baseline scenario. Under the low stress scenario, the CAR of two domestic banks and two international banks would not remain above the regulatory minimum throughout the projection period. Furthermore, if shocks materialize under the high stress scenario, the CAR of only two banks would remain above the regulatory minimum. The credit union is estimated to be adequately capitalized under the three scenarios.

43. In the second model, bank capital is projected using return on equity. This model is simpler and differs from the second model used in the 2014 stress tests, which projected key elements of banks’ income statement to obtain the bank capital. Here, retained earnings for each projection year for each bank under the three scenarios are estimated after adjusting projected returns on equity to account for losses that would arise from loan write-offs in the future. Subsequently, the resulting projections of retained earnings are added to (or, in the case of losses, deducted from) capital buffers of the previous year assuming no payment of dividend. In the baseline and low stress scenarios, the CARs of the banking system would remain above the standard requirement over the projection period but the system would become undercapitalized by 2019 under the high stress scenario. Under the baseline scenario, two domestic banks and one international bank would fail to meet the requirement at various times. Except for three banks, the rest would need to be recapitalized at different times under the low stress scenario. In the high-stress scenario, three banks would need capital injection throughout the projection period with their CAR turning negative, while two others would also need to be recapitalized at some point over the period. The credit union would remain adequately capitalized under the three scenarios.

44. Similar to the second model, the third one projects capital using returns on assets. Capital is projected by adding retained earnings after taxes to the previous period’s capital while assuming no payment of dividend. Similar to the second model, retained earnings for each projection year are obtained after adjusting projected returns on assets to account for losses that would arise from loan write-offs in the future. Under the baseline scenario, the banking system’s CAR would rise over the projection period with only two domestic banks failing to meet mandatory requirements. In the low-stress case, negative capital of most banks implies the CAR of the banking system will fall below the requirements by 2020. In the high-stress scenario, the banking system would become undercapitalized in 2017 and face negative CAR in 2019–20. Only one bank would remain adequately capitalized throughout projection years. The CAR of the credit union would rise throughout the projection period under the three scenarios.

F. Crisis Management and Regional Financial Supervision

Belize continues to develop its framework for handling potential crisis. Progress on regional supervision and financial crisis management is held back mostly by weaknesses in the regulatory and supervisory frameworks of Caribbean countries. For Belize, the refusal of another regional supervisor to address a parallel banking issue with Belize remains a stumbling block for its participation in projects on regional supervision.

Macro-Prudential Surveillance and Crisis Management

45. The authorities’ latest financial stability report highlighted the weaknesses in domestic banks. The updated financial stability report for March 2014 identified as risks deposit and loan concentration, and the still-high liquidity in the banking system. Large loan exposures—loans above 10 percent of capital represented 28 percent of total loans in March 2014. Deposit exposures—20 largest depositors accounted for 38 percent of total deposits in the domestic banking system. Deposit concentration is reported to be above 60 percent in two domestic banks. Furthermore, quarterly stress tests conducted by the Central Bank indicated the need for some institutional strengthening of capital to build resiliency. The financial system is found to be most vulnerable to large loans and related-party shocks. However, recent delays in the completion of financial stability reports were mainly due to capacity constraints which are being addressed. A database that will facilitate production of future reports is being finalized.

46. A recent CARTAC TA assisted in strengthening the analytical capacity of the FSU. The aim of the TA, which took place in February 2015, was to review the draft FSR with a view to assisting the Central Bank upgrade its analytical content, and produce a publishable version. The TA also assisted in strengthening stress testing.

47. Information sharing on financial stability issues is set to improve following recent MOUs between the Central Bank and other supervisors. In July 2014, the Central Bank signed an MOU with the Financial Intelligence Unit (FIU) for information exchange. A similar one was also signed with the SOI in the second quarter of 2015.

48. The authorities have prepared a financial management plan with IMF TA. This includes bank resolution templates as well as updated list of technical partners they may call upon on short notice to support crisis management efforts.

Regional Financial Supervision

49. Similar to the case of Belize, financial sector supervision across the Caribbean is fragmented. Except for Suriname that has a single supervisor with responsibility for oversight of the entire financial system, others have separate supervisors for different segments of the financial system. Besides creating regulatory gaps, a separate institutional arrangement tends to complicate coordination and information sharing not only at the national level but also at the regional level. However, there are ongoing efforts toward a more integrated approach to financial sector supervision. For example, all ECCU countries have moved supervision of the nonbank financial sector to single regulatory authorities while the ECCB continues to supervise the domestic banking system. Nonetheless, it is generally agreed that for any model to work, a high level of coordination and information sharing within a single supervisory agency, and among relevant agencies and authorities both domestic and foreign, is required.

50. Cross-supervisor communication and coordination is emerging at the national level. Institutional arrangements, such as a Financial Stability Committee (FSC), which facilitates the assessment of systemic risks to the financial sector and coordinates policy responses across supervisors, is in place in a limited number of countries. Such frameworks are helpful in information exchange but appear to be more developed in Jamaica and The Bahamas.

51. There are differences in the quality of bank supervision across the Caribbean which hinders regional cooperation. It reflects to some degree the structure of the banking sector and the level of supervisory capacity across countries. Foreign banks and large regional banking groups are more dominant in some countries, while the financial sector in some countries are more advanced. These differences can impede effective consolidated and cross-border supervision, as well as effective crisis management across the region.

52. Some Caribbean supervisors lack sufficient autonomy to fulfill their mandates. Similar to the case of Belize, the Ministry of Finance in some countries can interfere in banking sector supervision through refusal to approve certain decisions made by the Central Bank. However, some countries in the region are taking steps to strengthen central bank independence.

53. The Caribbean Group of Banking Supervisors (CGBS) is the main body responsible for regional cooperation. The CGBS was established in 1983, with a mandate to enhance and coordinate the harmonization of the bank supervisory practices in the English speaking Caribbean, to bring them in line best practices. It has been formally accepted as a regional grouping under the Basel Committee for Banking Supervision. Its membership comprises banking supervisors from sixteen regional jurisdictions, including CARICOM and non-CARICOM countries.

54. Cooperation among supervisors has improved following a regional MOU, but further efforts are needed to eliminate information asymmetries. The region took an important step toward enhanced collaboration in 2011, with regulatory authorities signing a multilateral Memorandum of Understanding (MOU) on the exchange of information, cooperation and consultation. However, not all financial regulators of the countries participating in the MOU, are signatory to the agreement, leading to potentially important coverage gaps. The signatories are primarily the bank regulators of the participating countries. Efforts to strengthen regional collaboration should be extended to the supervision of financial institutions with important cross-border activities. In particular, the regional MOU appears restricted to information sharing and could be broadened to specify the principles for supervisory cooperation on financial institutions with cross-border activities.

55. The region should consider strengthening regional resolution regime after national authorities have established sound bank resolution regimes. The CGBS is developing a regional financial crisis management plan for the banking sector. As a first step, a national crisis management plan has to be established across countries. In this context, supervisors of banks with regional operations need to consider close cooperation and information exchange with home supervisors when designing their domestic crisis management plan.

56. The CGBS was tasked by regional central bank governors to investigate and recommend measures to resolve a parallel banking dispute between Belize and Turks and Caicos Islands (TCI) on 27 May 2011. On 22 November 2014, the CGBS finally presented its findings to the governors which confirmed that a parallel structure was deliberately created by TCI, in violation of a bilateral MOU they previously signed with Belize. Guyana then introduced a resolution to regional governors to suspend the Turks & Caicos Financial Services Commission from all CGBS activities until the situation is properly addressed. While all governors have accepted the findings of the CGBS, the majority, including those jurisdictions who headed the CGBS investigation, lack the political will to support the Guyana resolution.

57. The Central Bank of Belize has signaled its agreement to the regional crisis management plan being developed by the CGBS but has not yet signed the related regional MOU. This is due to the CGBS’s continued reticence on the widely supported Guyana resolution to hold TCI accountable for the creation and continued support of a parallel banking structure. The FSCTCI continues to contravene international best practice by approving the establishment and maintenance of a parallel banking structure which poses a risk to Belize‧s financial system. Hence, Belize is doubtful of the practical benefits of participating in the MOU and the ability or willingness of the CGBS to hold regional participants accountable for violating its terms and conditions. They reiterated that progress on regional supervision and financial crisis management is being held back due to the refusal of another regional supervisor to address a parallel banking issue with Belize.

G. Recommendations for a Stronger Financial System

58. The following measures are key to a stronger financial system in Belize:

Banking regulation and supervision

  • Assess the true strength of banks balance sheets through asset quality reviews (AQRs). Priority for this measure is high and it should be implemented immediately to assess the extent of banks’ problems. Central Bank examiners only review a small share of banks’ assets and a reputable international auditor would complements reports from banks internal and external auditors.

  • Order weak banks to raise capital. Priority for this measure is high and it should be implemented immediately to contain vulnerabilities in banks’ balance sheets. Delaying such orders would magnify these vulnerabilities going forward and undermine the authority of the Central Bank.

  • Complement current static stress tests of banks with forward-looking ones. Priority for this measure is high and it should be done immediately. The current stress tests do not take into account the evolving outlook of economy and bank profitability. The Central Bank could refine models of bank profitability that are used in this note.

  • Strengthen the supervision and legal capacity of the Central Bank. Priority for this measure is high and it should be implemented immediately. Information Technologies (IT) Examiners must be hired by the Central Bank to review banks’ IT systems and help ensure their integrity. In-house legal experts must also be hired by the Central Bank.

  • Establish criteria for defining systemic banks. No criteria are given as to why five of the six domestic banks are considered systemic. The authorities referred to: BCBS’s “A framework for dealing with domestically systemically important banks” (www.bis.org/publ/bcbs224.pdf).

  • Remove the possibility to grant exemptions to the limit on large exposures. This recommendation of the 2011 FSAP should be implemented as soon as possible. Banks must increase capital if they want to extend large loans. Stress tests indicate that banks are extremely vulnerable to default from their large borrowers. They should gradually reduce such large exposures and a transition period can be introduced on a case by case basis.

  • Continue preparing financial stability reports (FSRs). Continue to prepare FSRs including quarterly stress tests of banks that fully take shortfalls in provisioning into account. Continue monitoring weaknesses highlighted in the latest FSRs, including the need for some institutional strengthening of capital to build resiliency, the still high liquidity, as well as the high concentration of loans and deposits. Adequate resources should be given to units in charge of preparing such reports.

  • Strengthen consolidated supervision. With the latest technical assistance from CARTAC on the consolidated supervision framework, the authorities should start monitoring group risk, group capital adequacy, group governance and regulatory arbitrage.

  • Raise provisioning requirements. For all loan losses (secured and unsecured), gradually increase provisioning to 100 percent and discontinue the practice of requiring banks to write off the loan loss. Allow a reasonable transition period during which dividend distribution is strictly forbidden and management fees contained.

Central bank autonomy

  • Enable the Central Bank to enforce remedial action on banks without prior consultation with or approval of the Minister of Finance. This recommendation of the 2011 FSAP should be implemented as soon as possible. The Minister of Finance approval is still needed for the revocation of licenses of domestic banks. This undermines the Central Bank’s authority and creates moral hazard.

Crisis management and bank resolution framework

  • Make bank resolution and liquidation truly administrative actions. This is a medium priority measure, which could be implemented in the near-to-medium term. In particular, court approvals should be out of the banking law and the latter should supersede company insolvency laws.

  • Set up a financial safety net. Priority for this measure is high and it should be implemented immediately. It could be done through the deposit insurance scheme envisaged in the Financial Management Plan or through a Recovery and Resolution Fund.

  • Establish standard safeguards to the use of the Emergency Liquidity Assistance Facility and set conditions applicable to all. Priority for this measure is high and it should be implemented immediately. Treatment of banks should not be on a case-by-case basis.

  • As part of the crisis management plan, continue to implement an MOU to facilitate coordination and information sharing among the regulators—the central bank, MOF, SOI, and the IFSC. Priority for this measure is high and it should be implemented immediately

  • Continue to update the list of technical partners. This is could support crisis management efforts in the event of financial crisis

Financial infrastructure

  • Set up a moveable property registry. This recommendation of the 2011 FSAP should be implemented as soon as possible to support deepening of financial markets.

  • Review the opportunity to remove the interest rate floor on savings. This measure should be implemented as soon as possible. The current floor may be raising the cost of financial intermediation, thus contributing to hampering the deepening of financial markets.

AML/CFT

  • Continue to effectively implement the AML/CFT framework. Important reforms are still needed to ensure compliance and effective implementation of Belize’s AML/CFT regime in line with the 2012 standard (Annex II).

59. The authorities agreed with the thrust of staff’s recommendations but continue to make some dissenting observations:

  • On regulation and supervision, the authorities do not agree with removing the possibility to grant exemptions to the limit on large exposures. In their view, the small size of the market would require extremely large and disproportionate capital injections to support large credit to the productive sector. This would put upwards pressure on already high interest rates as highly capitalized banks seek to maintain their ROAs.

  • On Central Bank autonomy, the authorities agreed with the idea of allowing the Central Bank to enforce remedial action on banks without prior consultation with or approval of the Minister of Finance in the case of increases in capital requirements. However, in the case of liquidation or cancellation of license of a systemic domestic bank, they are of the view that at the minimum there has to be some degree of consultation with the Minister of Finance given that the systemic risk and fiscal contingency falls on the government.

  • On the interest rate floor, the authorities do not agree that the floor on interest rates on savings is raising the cost of financial intermediation. They noted that evidence has shown that the interest rate spreads have widened after the reduction in the interest rate floor on savings. Moreover, they are of the view that in a fixed exchange rate system, a differential is required between international and domestic interest rates to discourage capital flight.

  • On Loan Loss provisioning, the authorities did not commit to changing current provisioning rules but noted that provisioning requirements of 100 percent on all loan losses (secured or unsecured) was considered in the past. They decided that 50 percent provisioning for fully secured loan losses was prudent after discussions with banks, which were then given a certain number of years to provide for the legacy loans. The authorities are strongly of the view that the value of collaterals for secured loans are inflated and is thus a disincentive to a timely disposal. They greatly appreciated recent IMF TA on loan classification and provisioning and will give due consideration to the TA mission’s recommendations.

H. Concluding Remarks

60. Belize financial system strengthened since the issuance of the 2014 Article IV Consultation report. NPLs continue to decline, and provisioning and capital adequacy ratios have also improved, reflecting steadfast implementation of financial sector reforms by the Belizean authorities. The Central Bank continued its risk-focused approach to supervision and conducted several on-site examinations of banks and credit unions. They aim to prepare bi-annual Financial Stability Report (FSRs), including quarterly stress tests of banks. With assistance from CARTAC, the authorities will use the newly completed consolidated supervision framework to effectively monitor group risk, group capital adequacy, group governance and regulatory arbitrage. Significant progress in the strengthening of the Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) framework in line with the 2003 FATF standard allowed Belize to exit the CFATF ICRG monitoring progress in May 2015. Important reforms are still needed to ensure effective implementation of the 2012 FATF standard. They have prepared financial crisis management plan with IMF TA, including bank resolution templates as well as an updated list of technical partners the authorities may call on at short notice to support their crisis management efforts

61. Nonetheless, significant weaknesses remain in the financial system, which the authorities must continue to address. NPLs remain high and capital buffers are underestimated because provisioning is still insufficient. The Central Bank should immediately conduct an asset quality review of all banks to assess their true strength, and raise provisioning standard to 100 percent for all loan losses. It should also hire personnel to monitor banks IT systems and ensure their integrity. Weak banks should be ordered to raise more capital. Limits on large exposures must be enforced and banks that plan to extend large loans must raise enough capital to ensure that their large exposures remain within prudential limits. Efforts to modernize the financial infrastructure should be accelerated. Strengthening the land and moveable property registries would greatly support these efforts.

Termination of Correspondent Banking Relationships in the Caribbean

Major global banks have recently either terminated their correspondent banking relationships (CBRs) with many banks in the Caribbean, or have threatened to discontinue them.1 In the termination notices, the affected banks have not been given any reason for the termination of the relationships, making it particularly difficult for them to seek out replacement correspondents. It is believed that this phenomenon is related to the enforcement of global regulatory standards such as on AML/CFT and prudential regulations. As a result, some customers, business lines, markets and jurisdictions are evidently being perceived as too risky and costly in terms of compliance, and are therefore being cut off. Already at least 10 banks in the region in five countries have (as of June 2015) lost all or some of their CBRs, including two central banks. In Belize, the banks that have already lost major CBRs are of systemic proportions, with assets amounting to more than half of the domestic banking system’s total assets or about 50 percent of GDP. In other Caribbean countries, the affected banks so far are either not systemic or have other ongoing CBRs. Nonetheless, the potential loss of vital CBRs has emerged as a major risk for all Caribbean banks.

The loss of CBRs could have destabilizing effects on financial and economic stability in the Caribbean. All international transactions conducted through the affected banks (which now have to use other local banks that still have CBRs, including local central banks) are disrupted, if not discontinued. These include the processing of financial instruments (i.e. cash, checks, money orders, wire transfers, credit and debit cards, and letters of credit) that are critical for key transactions such as remittances, tourism, international trade and foreign direct investment. Such disruptions affect local banks’ incomes directly as they lose significant revenue-generating businesses, but also indirectly, at least on a temporary basis, as they hit the economy as a whole and therefore banks’ customers. Even when some local banks manage to maintain their CBRs, they may not have the capacity to process a sudden increase in the volume of new transactions, especially wire transfers, coming from other local banks that lost their CBRs. This can result in significant delays in the processing of these transactions.

The impact of the loss of CBRs has been contained so far in the Caribbean, partly because of measures taken by Caribbean authorities. In Belize, the new arrangements that have been put in place with the support of the Central Bank of Belize (CBB) and major credit card companies seem to be working as international financial transactions have not been disrupted as initially feared. The banks that lost their CBRs are sending their customers to other banks to do wire transfers. The CBB is processing their cash documents and can also process their wire transfers using its own CBRs, though the increasing volume of these new transactions will likely pose a challenge to the CBB. In other Caribbean countries, specific measures have yet to be taken to address the loss of CBRs as disrupted transactions can be processed by other banks, including foreign banks. Some concern arises though in some cases where affected banks have had to replace traditional correspondent banks with other banks that are not household names. In other cases where termination has been threatened, there has been a significant upgrade in the promptness and quality of replies to request for information from external authorities. The Caribbean authorities are also working toward greater financial integration and stronger national financial systems and AML/CFT frameworks.

1 A correspondent bank is a financial institution that provides services, generally on behalf of a foreign financial institution. A correspondent bank can conduct business transactions, accept deposits, cash checks or money orders and gather documents on behalf of the other financial institution.

Annex I. Status of Implementation of FSAP Recommendations

article image
article image
article image
article image
article image
article image

Annex II. Toward an Effective AML/CFT Regime in Belize

After having been publicly listed for its AML/CFT shortcomings by the Caribbean Action Task Force (CFATF) in May 2013, progress made by Belize in improving the AML/CFT framework was acknowledged by the CFATF in May 2015. However, this progress relates to formal compliance with the 2003 Financial Action Task Force (FATF) standard and the CFATF did not assess effective implementation of the 2012 FATF standard. In particular, the authorities are urged to continue enhancing the operational independence and effectiveness of the financial intelligence unit (FIU), develop a framework for the risk-based AML/CFT supervision of all reporting institutions, and enhance the transparency of legal entities and arrangements.

A. Background

Belize’s 2011 AML/CFT assessment identified significant shortcomings. The 2011 CFATF Mutual Evaluation Report noted a number of deficiencies, including with respect to preventive measures, supervision of financial and non-financial institutions, operational independence of the FIU, and transparency of legal persons and arrangements. Since 2011, the CFATF has been working with the country to address the identified deficiencies. Due to insufficient progress, the CFATF issued a public statement in November 2013 calling on member countries to consider taking counter measures against Belize and planned to refer Belize to the FATF International Cooperation Review Group.

Despite the 2013 CFATF listing, improvements in the AML/CFT framework were not significant until early 2014. The Fund’s Legal Department provided Belize with AML/CFT TA in 2012 and 2013. Staff’s recommendations included (i) strengthening the AML/CFT regulatory and supervisory framework and practices for domestic and offshore banks and non-bank financial institutions by the introduction of a risk-based approach (RBA) to AML/CFT supervision by the Central Bank of Belize (CBB), (ii) improving the institutional framework to ensure national cooperation and coordination between relevant entities and institutions, and (iii) enhancing the analytical and operational capability of the FIU. As a result, Fund staff decided to end the AML/CFT TA project with Belize due to the absence of progress made in implementing regulatory and institutional reforms that were initiated under the project, in particular in terms of risk-based supervision, and in developing the operational capacity and independence of the FIU.

B. Progress Achieved in Strengthening the AML/CFT Framework

The authorities did step up their efforts in strengthening the compliance of their AML/CFT framework with the 2003 FATF standard since February 2014. In February 2014, Belize approved six laws and three regulations, including (i) comprehensive amendments to the Money Laundering and Terrorism Prevention Act (MLTPA), which included the establishment of the National Anti-Money Laundering Committee as a statutory body to advise the Minister of Finance and co-ordinate national AML/CFT efforts; (ii) amendments to the FIU Act to strengthen its operational independence, enhance security of tenure for the FIU Director and minimize opportunity for political interference by requiring that the FIU Director can be removed only by the Governor General for misbehavior and after recommendation by an advisory council; (iii) memoranda of understanding (MOUs) between the CBB and the FIU, and between the Corozal Free Zone Management Agency and the FIU, and (iv) new regulations to more fully articulate the supervisory regime applicable to Designated Non Financial Business Professionals (DNFBPs) and to set out details regarding the constitution and procedures of the National AML Committee.

The CFATF recognized progress made by the Belizean authorities. In May 2014, the CFATF public statement noted that Belize had made significant progress in addressing its deficiencies. In May 2015, the CFATF acknowledged that Belize has significantly improved its level of compliance with the FATF standard, and decided to remove the country from the CFATF Follow-up and Review processes.1

C. Next Steps toward an Effective AML/CFT Regime

Additional effort is needed to effectively implementing Belize’s AML/CFT regime in line with the 2012 FATF standard. While the laws and regulations are likely to assist Belize in achieving a higher level of technical compliance with the FATF Recommendations, it is not yet possible to assess any improvement that may have taken place in the overall effectiveness of Belize’s AML/CFT regime. Some of the measures necessary for Belize to develop an effective AML/CFT regime include: (i) continuing to enhance the operational capacity and the effectiveness of the FIU by maintaining the operational independence of the Director and, in general, continuing to enhance its ability to undertake its core functions and to prioritize the allocation of its resources across it various mandates, (ii) continue to develop the capacity of the CBB to implement a RBA to AML/CFT supervision including the use of tools that would allow CBB to assess institution’s inherent risk as well as the quality of their risk management, (iii) ensuring the operational capacity and the effectiveness of the AML/CFT supervision of the International Financial Service Commission and the Supervisor of Insurance, and (iv) strengthening the implementation of AML/CFT preventive measures by DNFBPs (i.e. notably lawyers, notaries, accountants, and trust and company service providers), and enhancing the risk-based AML/CFT supervision of those professions. In addition, international initiatives to address money laundering and tax evasion might challenge Belize’s business model and have adverse impact on the financial system and domestic economy. In this context, the authorities are urged to strengthen, where necessary, and effectively implement the legal and regulatory framework in line with the 2012 FATF Recommendations, including with regard to the transparency of international business companies and trusts, the coverage of serious tax crimes as predicate offenses to money laundering, and the framework related to national and international cooperation.

The authorities reported progress in effectively implementing their AML/CFT legislation, including before 2014. They insisted that the CBB instituted a pilot project in October 2012 whereby a Risk Based Approach (RBA) tool, Financial Risk Assessment Return 1 (FRA R1), was introduced to select institutions and this tool was implemented system wide in September 2013. They also mentioned training and AML-focused onsite examinations of various entities, and increased human and financial resources for the FIU. The CBB and the FIU have been conducting training workshops, seminars, and outreach to the financial community and DNFBPs over the past year. According to the authorities, this outreach and feedback efforts have also resulted in improvements in the quality of STRs received. Financial intelligence is also reported to have been disseminated spontaneously to relevant authorities abroad.

References

  • Caribbean Financial Action Task Force, 2015, “Public Statement,Port of Spain, Trinidad and Tobago, May 28th. Available https://www.cfatf-gafic.org/index.php/member-countries/a-d/belize/318-jurisdictions-which-exited-the-follow-up-and-icrg-monitoring-belize

    • Search Google Scholar
    • Export Citation
  • Caribbean Financial Action Task Force, 2014, “Public Statement,Miami, Florida, May 29th. Available here: https://www.cfatf-gafic.org/index.php?option=com content&view=article&id=1662%3Acfatf-public-statement-miami-florida-may-26th-2014&catid=609%3Apublic-statements&Itemid=663&lang=en

    • Search Google Scholar
    • Export Citation
  • Caribbean Financial Action Task Force, 2013, “Public Statement,Freeport, the Bahamas, November 20th. Available here: https://www.cfatf-gafic.org/index.php?option=com content&view=article&id = 1630%3Acfatf-public-statement-freeport-the-bahamas-november-18th-2013&catid=609%3Apublic-statements&Itemid=663

    • Search Google Scholar
    • Export Citation
  • Caribbean Financial Action Task Force, 2013, Belize: Fifth Follow-Up Report, November

  • Caribbean Financial Action Task Force, 2011, Belize—Mutual Evaluation Report: Anti-Money Laundering and Combating the Financing of Terrorism, July.

    • Search Google Scholar
    • Export Citation
  • Central Bank of Belize, 2015, Financial Infrastructure Development, National Payment System and Credit Reporting System: Project Summary Update.

    • Search Google Scholar
    • Export Citation
  • Central Bank of Belize, 2012, Financial Management Plan for Banks and Financial Institutions (draft), July

  • Central Bank of Belize, 2014, Annual Report and Statements of Accounts

  • Central Bank of Belize, 2014, Quarterly Financial Stability Report, June

  • Central Bank of Belize, 2013, Annual Report and Statements of Accounts

  • Central Bank of Belize, 2013, Quarterly Financial Stability Report, August

  • Central Bank of Belize, 2012, Annual Report and Statements of Accounts

  • Central Bank of Belize, 2011, Annual Report and Statement of Accounts

  • Government of Belize, 2013, Domestic Banks and Financial Institutions Act (No. 16 of 2012)

  • Central Bank of Belize, 2012, Central Bank of Belize (Amendment) Act

  • Central Bank of Belize, 2010, Treasury Bills (Amendment) Act

  • Central Bank of Belize, 2010, International Banking (Amendment) Act

  • Central Bank of Belize, 2003, Central Bank of Belize Act, Chapter 262, Revised Edition

  • Central Bank of Belize, 2003, International Banking Act, Chapter 267, Revised Edition

  • Central Bank of Belize, 2003, Treasury Bills Act, Chapter 83, Revised Edition

  • Central Bank of Belize, 2003, Credit Unions Act, Chapter 314, Revised Edition

  • Central Bank of Belize, 2000, International Business Companies Act, Chapter 270, Revised Edition.

  • Central Bank of Belize, 2000, International Insurance Act, Chapter 269, Revised Edition.

  • IMF, 2014, Belize: Financial Sector Surveillance Note, June (Unpublished).

  • IMF, 2012, Eastern Caribbean Currency Union: Selected Issues, IMF Country Report No. 12/130 (Washington: International Monetary Fund).

  • IMF, 2011, Belize: Financial System Stability Assessment, October (Unpublished)

  • IMF, 2004, “Belize: Assessment of the Supervision and Regulation of the Financial Sector—Review of Financial Sector Regulation and Supervision, IMF Country Report No. 04/373 (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation
  • IMF and World Bank, 2011, Belize—Financial Sector Assessment Program: Stress Testing Technical Note, September.

1

The main authors of this note are Joel Okwuokei and Jacques Bouhga-Hagbe (all WHD), with very valuable inputs from the Central Bank of Belize.

2

The Central Bank may allow up to 24 months.

3

The PEARLS approach was developed by The World Council of Credit Unions.

4

The net institutional capital/total assets and net loans/total assets ratios, both measures of the effectiveness of financial structure, have significant impact on growth, profitability and efficiency of credit unions.

1

This model was designed and estimated during the 2011 FSAP, and involved dynamic panel estimation with bank-specific fixed effects over the period 1997Q1 to 2011Q1. The dependent variable—ratio of annual change of NPLs to total loans lagged over four quarters—was estimated as a function of the lagged dependent variable, the lagged change (over four quarters) of the required cash reserve ratio, and the contemporaneous change in total export values over the previous year.