The macroeconomic environment has improved, reflecting the authorities’ efforts, supported by an IMF arrangement. Previously, years of high fiscal deficits, public enterprise borrowing, and financial sector bailouts led to rapid government debt accumulation, crowded out private credit, increased financial dollarization, and stifled economic growth. Fiscal discipline has been essential to reduce public debt (to about 100 percent of GDP). With government debt accounting for a sizable share of financial institutions’ assets, falling interest rates on government debt are leading to a search for yield. Also, entrenched structural obstacles, including high crime, bureaucratic processes, insufficient labor force skills, and poor access to finance still constrain economic growth. The authorities have made good progress in implementing the 2006 FSAP recommendations. Work on the regulatory framework has significantly advanced in several areas such as securities dealers’ activities, powers to the Bank of Jamaica (BoJ), payment systems, and the introduction of the centralized securities depository. However, the crisis management framework and risk-based supervision work has been lagging.

Abstract

The macroeconomic environment has improved, reflecting the authorities’ efforts, supported by an IMF arrangement. Previously, years of high fiscal deficits, public enterprise borrowing, and financial sector bailouts led to rapid government debt accumulation, crowded out private credit, increased financial dollarization, and stifled economic growth. Fiscal discipline has been essential to reduce public debt (to about 100 percent of GDP). With government debt accounting for a sizable share of financial institutions’ assets, falling interest rates on government debt are leading to a search for yield. Also, entrenched structural obstacles, including high crime, bureaucratic processes, insufficient labor force skills, and poor access to finance still constrain economic growth. The authorities have made good progress in implementing the 2006 FSAP recommendations. Work on the regulatory framework has significantly advanced in several areas such as securities dealers’ activities, powers to the Bank of Jamaica (BoJ), payment systems, and the introduction of the centralized securities depository. However, the crisis management framework and risk-based supervision work has been lagging.

Executive Summary and Key Recommendations

The macroeconomic environment has improved, reflecting the authorities’ efforts, supported by an IMF arrangement. Previously, years of high fiscal deficits, public enterprise borrowing, and financial sector bailouts led to rapid government debt accumulation, crowded out private credit, increased financial dollarization, and stifled economic growth. Fiscal discipline has been essential to reduce public debt (to about 100 percent of GDP). With government debt accounting for a sizable share of financial institutions’ assets, falling interest rates on government debt are leading to a search for yield. Also, entrenched structural obstacles, including high crime, bureaucratic processes, insufficient labor force skills, and poor access to finance still constrain economic growth.

The authorities have made good progress in implementing the 2006 FSAP recommendations. Work on the regulatory framework has significantly advanced in several areas such as securities dealers’ activities, powers to the Bank of Jamaica (BoJ), payment systems, and the introduction of the centralized securities depository. However, the crisis management framework and risk-based supervision work has been lagging.

The financial sector has significantly expanded since the 2006 FSAP and is now highly interconnected and dependent on foreign funding. The sector is dominated by large, complex and highly interconnected groups that operate in several jurisdictions.

The stress tests suggest broad resilience to solvency shocks, but the interconnectedness analysis points to high risk of contagion. The main risks to the financial system arise from exposure to natural disasters, the tightening of global financial conditions, and the possible reversal of fiscal discipline driven by reform fatigue. Under an adverse scenario of temporary economic recession, banks would be able to recover due to high profits and large buffers. A natural disaster shock could require large recapitalization needs of 3.3 percent of GDP. Insurance companies would also be able to recover relatively fast with a global repricing of the risk premium due to high profitability. At the group level, the large and complex intra- and inter-group direct exposures puts the system at risk via contagion.

In this context, priority should be given to intensified oversight and group-wide risk-based supervision, especially of groups with systemic connections. Implementation of Basel’s Pillar I on minimum capital requirements and Pillar II on the supervisory review process should help build enough buffers at the individual and group level based on inherent risk undertaken to ameliorate regulatory arbitrage. Active cooperation and coordination with other supervisors also in the region, and in particular, for those affecting systemic groups, should be strengthened; access to timely granular data, analyses, and monitoring is key. An effective macroprudential framework should build on strong micro-prudential foundations of supervisory oversight and go hand-in-hand with heightened commitment to transparency and accountability. Work reinforcing the resilience of securities dealers, the deepening of capital markets and broadening of instruments to manage credit, liquidity and market risks should continue.

Immediate efforts are needed to expand skilled supervisory resources. All supervisory agencies need to expand their capacity to fulfill their current mandate and new demands. Advances towards the adoption of international standards by 2020/21 will pose important challenges to the authorities and the industry and require further inter-agency coordination. The databases available also need to be strengthened to further facilitate the monitoring of risks of a complex group-based financial system, and to conduct informative and sound financial stability analyses and risk assessments.

Progress on the Special Resolution Regime for Financial Institutions and on the broader crisis management framework is welcome, but more needs to be done. The consultation paper issued last February 2017 addressed many complex issues requiring the attention of all safety net stakeholders in the economy. Ongoing engagement with the industry on this important effort will increase buy-in for the many changes that will result from adoption of a new resolution regime. Further work is ongoing for clarifying several key aspects (e.g., defining specific responsibilities in the new resolution framework, defining systemically important institutions, and funding) and properly sequencing the work on recovery planning, resolution plans, and resolvability assessments. System-wide preparation for a systemic crisis is also an area that requires attention.

Table of Main Recommendations

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I (immediate) = within one year; NT (near term) = 1–3 years; MT (medium term) = 3–5 years.

Macrofinancial Setting

1. The authorities have made considerable progress on the macroeconomic stabilization front, supported by IMF arrangements. Previously, years of high fiscal deficits, borrowing, and financial sector bailouts led to an unsustainable stock of sovereign debt (restructured in 2010 and 2013), crowded out private credit, financial dollarization,1 and stifled economic growth. Since then, fiscal discipline has helped reduce sovereign debt to about 100 percent of GDP (Figure 1 and Table 1) and interest rates on sovereign debt have fallen, resulting in a search for yield. With economic growth continuing to disappoint, reform fatigue could emerge as a risk. Structural obstacles include high crime, bureaucratic processes, insufficient labor force skills, poor access to finance, and exposure to weather shocks.

Figure 1.
Figure 1.

Jamaica: Macrofinancial Developments, 2006–17

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

Source: Bank of Jamaica and Staff calculations.
Table 1.

Jamaica: Selected Economic Indicators1

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Sources: Jamaican authorities; and Fund staff estimates and projections.

Fiscal years run from April 1 to March 31. Authorities’ budgets presented according to IMF definitions.

The new methodology uses trade weights for Jamaica that also incorporate trade in services especially tourism.

As of January 31.

Consolidated central government and public bodies’ debt, consistent with the Fiscal Responsibility Law. The most significant deviation from the

Central government direct debt, guaranteed debt, and debt holdings by PCDF, consistent with the definition used under the EFF approved in

Consistent with the Fiscal Responsibility Law (FRL), implementation of the FRL-consistent debt definition began in FY16/17. A backward series

The decrease in debt in FY15/16 partly reflects the PetroCaribe buyback operation that generated an immediate 10 percentage point reduction

Projections for 18/19 reflect the special distribution from PCDF to Central Government, ahead of its reintegration by end 18/19.

2. In recent years, the authorities have implemented important financial sector reforms, but strengthening the capacity to oversee risks in financial groups is crucial (Appendix II). The 2006 FSAP recommended strengthening the prudential framework for securities dealers, enhancing the oversight of conglomerates, the development and testing of crisis management systems, and improving the insolvency and creditor rights regime. Since then, progress has included the Insolvency Act in 2014, Bank of Jamaica Act (BoJA) in 2015, Banking Services Act (BSA) in 2014, the operationalization of the Financial System Stability Committee (FSSC) in 2016, and the production of the Financial Stability Report (FSR). Fund TA has supported efforts to enhance financial sector resilience.

3. The financial sector has grown rapidly and become more complex and interconnected. Over the past decade, Jamaica’s financial sector has tripled in assets, and the number of institutions has grown eight-fold (Table 2). Total assets now amount to about 180 percent of GDP. Nonbank financial institutions play a key role in financial intermediation. Conglomerate groups have financial sector activities that span banking, insurance, pensions fund management, collective investment fund (CIF) management, and securities dealers (Table 3). These groups often operate in multiple jurisdictions, especially in the Caribbean, searching for economies of scale and regulatory arbitrage opportunities in relatively dispersed and small markets.

Table 2.

Jamaica: Financial Sector Structure

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Sources: Prudential_Indicators as at 31 Dec 2005 and Prudential_Indicators as at 30 Jun 2017, Publisher: Bank of Jamaica; Statistical Institute of Jamaica, Publisher: Statistical Institute of Jamaica.

Total Assets (incl. contingent accounts). Total Assets and Liabilities reflected net of IFRS Provision for Losses and include Contingent Accounts (Customer Liabilities for Acceptances, Guarantees and Letters of Credit). In keeping with IFRS, Total Assets and Liabilities were redefined to include Contingent Accounts.

Gross Domestic Product at current market prices JM$700,276 and JM$1,758,449 for 2005 and 2016 respectively. Units: ‘ Millions of Jamaican dollars.

Merchant banks

At 9, 2017, there were 42 securities dealer companies, 3 individual dealers, 2 investment advisor companies and 2 individual investment advisors registered by the FSC to operate in Jamaica. Of the 42 securities dealer companies, 32 were recognized as core securities dealers while 10 dealers were recognized as non-core securities dealers. With regards to the core securities dealers 8 received primary dealer status from the BoJ, 13 were approved by the JSE as stockbrokers, 10 operated as FSC approved Collective Investment Schemes fund managers. 10 non- core securities dealers includes one (1) commercial bank, four (4) insurance companies, two (2) credit unions, one (1) pension fund management company, one (1) trust company and one (1) education savings plan company.

Table 3.

Jamaica: Financial System Groups

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4. Commercial banks appear to be well capitalized and profitable (Tables 4a and 4b). Banks’ business model is largely traditional, with large retail deposit funding and some wholesale funding structures, excess reserves at the BoJ, sovereign long-term securities, and a conservative lending policy, with the loan-to-deposit ratio at about 70 percent in 2017 (Figure 2). Banks’ profitability is healthy, with non-interest income (e.g., fees) accounting for almost a third of total revenue.

Figure 2.
Figure 2.

Jamaica: Deposit Taking Institutions’ Balance Sheet Structure, December 2017

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

Source: Bank of Jamaica and IMF staff calculations.
Table 4a.

Jamaica: Financial Sector Key Indicators

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Table 4b.

Jamaica: Financial Sector Indicators1

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Source: Bank of Jamaica.

Commercial banks, building societies, and merchant banks.

Data for 2013 refer to the September calendar quarter.

Percent of prescribed liabilities.

5. The nonbank financial sector is large and multi-layered. Gross assets were over 100 percent of GDP in 2017, including insurers, pension funds, securities dealers, asset managers, and collective investment schemes. Private pension funds have been growing fast (Table 2). Jamaica’s insurance sector is large and highly concentrated (four life insurances hold 99 percent market share). Securities dealers manage an asset portfolio of 33 percent of GDP and have significant retail rolling investment schemes (“retail repos”) (Figure 3). “Retail repo” means the offer of 1–2 month repurchase agreements to households or nonfinancial corporates, backed by long-maturity government bonds (implying a significant maturity mismatch). CIFs and pooled funds have been growing (Figure 4) on average 30 percent in the last two years, partly with injections from small retail investments that have been prohibited from being reinvested in repos.

Figure 3.
Figure 3.

Jamaica: Securities Dealers’ Activities Balance Sheet (2017) Rolling Investment Contracts (“Repo”) by Client

(As percent of “repo” liabilities, 2015–17)

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

Source: Bank of Jamaica and IMF staff calculations
Figure 4.
Figure 4.

Jamaica: Strong Growth in CIFs and Exempt Distribution

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

Sources: Authorities data and IMF staff calculations.

6. The financial sector is dominated by complex financial conglomerates that operate in multiple jurisdictions. Some large groups’ headquarters are based in jurisdictions with different oversight practices; cross-border linkages are concentrated in a few entities, and there is no consolidated supervision. Even with proper separation between bank and nonbank group members, reputational risks and direct and indirect exposures could be a source of contagion (Table 5). Common exposures to sizable public debt holdings by all segments of the groups and across financial institutions means that the stability of the financial system is closely bound to the discipline in public finances, sustainability of the macroeconomic outlook, and debt market dynamics.

Table 5.

Jamaica: Financial Sector Aggregate Exposures Network

(Figures represent borrowing as percent of all borrowing; borrowers in rows and lender in columns)

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Excludes DTI 1 and DTI 2.

Source: FSAP team and authorities’ data.

7. The secured money market in Jamaica is small. There is a primary market for government securities and a deep market for rolling investment contracts. A secondary bond market and a foreign exchange (FX) market are being developed.

8. The authorities have an ambitious financial inclusion agenda that was covered in the World Bank (2015) FSAP Development Module (see Box 1 and Appendix II). Financial inclusion policies should take into consideration the financial stability risks.

Risks and Vulnerabilities

9. The main risks to the financial system arise from exposure to natural disasters, tightening global financial conditions, and reform fatigue (see the Risk Assessment Matrix (RAM) in Appendix I). Delays in the reform agenda would erode confidence and fuel FX outflows. A tightening of global financial conditions could reduce foreign inflows including remittance inflows, which would dampen economic growth (through consumption and investment) and lead to rising nonperforming loans (NPLs). A natural disaster would cause protracted negative growth and large losses for banks and other financial institutions.

10. The large, complex, and highly interconnected structures make the financial sector particularly vulnerable to contagion. Risks arise from their concentrated ownership, related party and large group exposures, and off-balance sheet positions. Against this background, the Financial Sector Stability Assessment focused on resilience to solvency and liquidity shocks, direct and indirect exposures and interconnectedness.

A. Financial Conglomerates and Interconnectedness

11. The interconnectedness assessment found important links in the repo market and the large value payment system, significant counterparty exposures, and notable similarities in business models (Figures 5&6). The analysis used data on (i) direct exposures. (ii) indirect exposures via financial institutions’ balance sheet similarities and hierarchical clustering, and (iii) large-value payment system liquidity. (Appendix V).

Figure 5.
Figure 5.

Jamaica: Large-value Payment System Network Analysis

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

Source: Calculations based on Bank of Jamaica data.
Figure 6.
Figure 6.

Jamaica: Exposure Network Analysis

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

Source: Calculations based on Bank of Jamaica data.

12. The direct exposure network analysis showed a highly interconnected financial system with concentrated dependence on foreign funding (Table 5). The system displays significant interconnectivity across financial entities in the system, also by international standards, and with complex and sparse links. Foreign institutions play a central lender role, with links to about 33 percent of the participants in the network, and high intensity vis-à-vis a few systemically important DTIs. Failure to roll over borrowing from abroad would significantly impact the domestic exposure network.

13. Jamaica’s financial institutions show large overall indirect common exposures, especially across banks’ balance sheets. Balance sheet correlations are substantial among financial institutions pertaining to the same financial segment. The strongest correlation is in the DTIs segment (about 0.9 on average). DTIs balance sheets account for about 62 percent of assets and 64 percent of liabilities of the financial system—hence, common exposures to the financial system’s balance sheet are significant.

14. Four groups are systemic to the large-value payment system (see Figure 5). Over 80 percent of the large payments system network is accounted for by 18 financial institutions; four (DTIs in particular) account for about half of the transactions, with systemic implications for the financial sector. If any of these four institutions were to fail to participate in the large-value payment system, liquidity and asset exchanges among financial institutions as well as operations in the real sector could be extensively affected.

15. The authorities should further strengthen the resources and skills devoted to the assessment of risks arising from interconnectedness. Existing data limits a full assessment on cross-exposures. The authorities are building data sets to help strengthen their analyses along several dimensions, including (i) adopt mechanisms to comprehensively measure and understand financial stability risks associated to the large-value payments system; (ii) take advantage of the informational content of real-time gross settlement (RTGS) data for supplementing traditional analysis based on low-frequency data reported by financial institutions; (iii) develop tools to comprehensively measure, understand, and manage the risks that arise from DTIs’ and non-DTIs’ common exposures (e.g., sovereign exposures) amid different idiosyncratic and systemic shocks; (iv) expand and enhance the existing datasets and models that allows periodic measurement and analysis of direct and indirect exposures in the financial system; and (v) measure and monitor the extent to which events involving major global participants in the exposure network may impact the solvency and liquidity of financial institutions.

B. Deposit-Taking Institutions

16. Banks are broadly resilient on a solo-basis (Figures 7a and 7b and Appendix III). Under the adverse scenario with GDP growth declining to 0 percent,2 the banking sector’s aggregate capital adequacy ratio (CAR) would remain above the regulatory minima (about 13 percent) despite a sharp increase in NPL ratios across all sectoral loan balances and lower profitability. However, some banks’ CARs would fall below the 10 percent CAR regulatory minimum. Restoring it across all banks would require 0.7 percent of GDP.

Figure 7a.
Figure 7a.

Jamaica: Stress Test Scenarios for Deposit Taking Institutions

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

Source: IMF staff calculations.
Figure 7b.
Figure 7b.

Jamaica: Adverse Scenario Solvency and Liquidity Stress Test Results1

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

Source: IMF staff calculations.1 The analysis and charts are underpinned by the April 2018 WEO assumptions.

17. The severely adverse scenario causes several banks’ CARs to fall well below regulatory minima (Figure 7c).3 the declines in capital are due to the negative impact on interest rates (and profitability) and on NPLs as a second factor. For the system, the aggregate CAR would fall to 5.1 percent. The required recapitalization injection would amount to about 3.3 percent of GDP.

Figure 7c.
Figure 7c.

Jamaica: Severe Adverse Scenario Solvency and Liquidity Stress Test Results1

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

Source: IMF staff calculations.1 The analysis and charts are underpinned by the April 2018 WEO assumptions.

18. Sensitivity analyses suggest that the banking system is vulnerable to counterparty risk, interest rate risk, and concentration risk.

  • Counterparty risk: Assuming each bank’s top three borrowers default with zero recovery, the system’s aggregate CAR would decrease to 0.7 percent one period ahead, with a recapitalization need of 4.8 percent of GDP.

  • Interest rate risk: The high share of banks’ holdings of long-dated government bonds results in significant vulnerabilities to interest rate volatility. A 300-basis point interest rate shock would reduce the systemwide CAR by 4.4 percentage points.

19. Asset-class concentration risk is high. Banks’ holdings of sovereign government bonds and of personal loans are significant. Under the adverse scenario, for some banks, concentration risk is large due to loan book concentration in tourism and financial services. For some other banks, large exposures to manufacturing, construction, and trade drive NPL growth.

20. The large exchange rate shocks considered in the assessment have negligible effects. This is due to the banks’ relatively covered position between FX assets and liabilities and significant financial dollarization. However, a significant rise in FX non-performing loans associated with currency movements would require increasing provisioning.

21. Banks’ reserves at BoJ are sizable and would allow them to withstand shocks to their funding. Banks hold large liquid assets both in JM$ and FX, at the BoJ. BoJ’s liquid asset ratio requirement in respect to domestic currency liabilities is 26 percent and 29 percent for FX liabilities; these could be readily available if needed. In the adverse scenario, over a five-day horizon, most banks would be able to withstand a proportional withdrawal run on banks’ liabilities for at least 2 consecutive days. After 4 consecutive days, most DTIs would need access to their liquidity balances at the BoJ and potentially to the BoJ’s liquidity facilities. Highly liquid banks would likely initially benefit from a “flight to safety” and reputation effects, which would delay any initial liquidity squeeze impact to their balance sheet.

C. Non-Bank Financial

Institutions Institutional Investors: Insurance and Pensions

22. Life insurers face challenges of declining interest rates on domestic sovereign bonds, while non-life insurers are exposed to catastrophe risks (Appendix IV).

  • With strict investment limits in place for insurers and other institutional investors, life insurers are holding 59 percent of their assets in Jamaican sovereign debt. Even though life insurance products do not typically feature interest rate guarantees, the sector’s profitability is declining albeit from rather high levels—the average return on equity during 2012–17 was 26 percent.

  • Non-life insurers are exposed to tail risks stemming from natural catastrophes as the country faces risk from hurricanes and earthquakes. However, in particular, for property insurance, retention levels are low, and more than 90 percent of the business is ceded to reinsurers abroad.

  • Both the life and the non-life sector are challenged by potential FX mismatches: While only few insurers offer products denominated in or linked to foreign currencies, many more companies hold non-JM$ investments, mainly in US$, exposing them to JM$ appreciation.

23. All insurers proved to be resilient in the assumed repricing of global risk premia (Figure 8, Appendix IV). While all companies stayed above the regulatory minimum thresholds of 150 and 250 percent for life and non-life insurers, respectively, within the current solvency regime the impact of the modelled sovereign shock is likely to be underestimated. The assumed shock to domestic sovereign spreads which reduces the value of bond holdings is compensated by a decrease in liabilities as the discount rate increases in line with higher expected investment returns—under a fully market-consistent valuation, the discount rate would need to be corrected for higher expected default rates in such a scenario.

Figure 8.
Figure 8.

Jamaica: Insurance Stress Test Results

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

Source: IMF staff calculations based on company submissions.Notes: Return on equity projections in Scenario 2 were only requested for the first year of the projection horizon.

24. General insurers face a substantial decline in their solvency ratios if a major hurricane strike the country (adverse scenario 2). From a median pre-stress solvency ratio of 261 percent and therefore barely above the regulatory minimum, the sector falls to 231 percent, but with large dispersion across companies. However, most companies stay profitable and is therefore expected to recover rather quickly after such an event.

25. Pension funds appear to have a relatively sound funding model. Pension funds are typically well-funded on current estimates. This is driven by high rates of member exit and long vesting rules which both leads to employer contributions being left in the plan when a member exits and takes only their own contributions. Solvency is also enhanced because there is no requirement typically to increase pensions each year by even price inflation.

26. While the sector is sustainable, many pension fund members risk receiving inadequate pensions. The flip side of good sustainability in Jamaica is poor adequacy—as many pension members who were at one time contributing receive little or nothing at retirement because they withdrew their benefits too early and others see the real value of their pension fall if funding is not adequate. This is a particularly critical issue in Jamaica given fears over the level of income provided by the National Insurance System.

Securities Dealers

27. The securities dealers sector can withstand significant shocks. Top-down stress tests conducted by the authorities using a range of adverse but plausible shock scenarios (e.g., equity prices dropping 20 percent, domestic interest rates changing by 3 percent) suggest that, while some brokers would fail, the significant majority of the industry is sufficiently capitalized to withstand adverse shocks.

28. Legal and operational risks inherent in the securities dealers’ “retail repo” business model have declined with recent reforms (e.g., the master repurchase agreement and underlying securities being held on trust). The introduction of a JM$1M minimum subscription threshold to reduce retail exposures has led to a 12 percent orderly reduction in aggregate repo holdings between end-2014 and 2017 but remain a very high proportion of dealers’ liabilities (Figure 3).

29. Securities dealers’ business models will need to evolve over the medium term to provide a wider range of intermediation services, especially with respect to corporate debt and equity products. In the immediate (1 year) and near term (1–2 years), from a financial stability angle, the focus should be on the implementation of the retail repo mismatch ratio to minimize maturity mismatch risk.4 In addition, the Financial Services Commission (FSC) should collect and analyse data on securities dealers’ over-the-counter (OTC) transactions.

30. The expansion of securities dealers’ intermediation activities into corporate debt or equity instruments will require:

  • A viable trade reporting or (preferably) secondary trading platform to aid price discovery;

  • A risk-based supervision framework and a fixed timeline for implementation;

  • Focus on developing liquid markets in these instruments, while ensuring that securities dealers enhance their liquidity management;

  • Implementation of effective group-wide supervision by the BoJ and FSC;

  • Review of the existing foreign exchange requirements to determine whether they place unreasonable impediments on the development of financial products which provide hedging capacity against the US$, especially for Jamaican corporates;

  • Review of the existing risk weightings for corporate debt and equity instruments;

  • If repurchase agreements are used to offer short term fixed interest products backed by long-term corporate debt securities to non-accredited investors, the same trust, standard master repurchase agreement, and mismatch ratio infrastructure should apply to manage the risks of that business.

Oversight Framework

A. Macroprudential Policy Framework

31. Jamaica has established a macroprudential policy framework. A high level inter-agency FSSC has been established by way of an amendment to the BoJA. The FSSC is tasked with producing regular financial stability assessments and providing recommendations to the BoJ on potential macroprudential policy actions. Final responsibility for the actions resides with the BoJ.

32. The BoJ has made good progress in establishing a system for monitoring of systemic risk. Important information gaps remain. In tandem with this work on indicators, the BoJ is also considering instruments to include in a “macroprudential policy toolkit” for mitigating and containing systemic risks across time and structural dimensions, including those found within Basel III. Finally, there is much work to be done to broaden and deepen financial markets so that institutions are better provided with the financial instruments that they need for managing their credit, liquidity and foreign exchange risks on a day-to-day basis.

33. To support the development of the macroprudential policy framework, the BoJ should develop a communication strategy. A macroprudential policy framework allows the BoJ to correct the mispricing of risks and associated misalocation of bank credit to the household and corporate sectors. The legitimacy of such powers requires that the public can understand what powers are being exercised in support of financial stability and why. A communication strategy should be developed to help convey the BoJ’s stability assessments clearly, link them to any policy action and manage public expectations about what these policies can achieve.

B. Microprudential Supervision

34. The BoJ is fully empowered under the BSA to supervise financial groups with a DTI but does not yet impose prudential standards on a consolidated basis. The dominant role played by large financial conglomerates underscores the importance of effective consolidated and group supervision. Preparatory work is underway. As contemplated by the BoJ, further action is now needed to license Financial Holding Companies (FHCs), impose prudential standards on a consolidated basis (solvency, liquidity, large exposures, and related parties), collect prudential data on a group-wide basis, establish and enforce fit-and-proper standards for owners and senior management of parent companies, and strengthen regulations on internal control and risk management while ensuring compliance with these provisions on a consolidated basis compulsory.

35. In addressing financial groups risks, consolidated risk-based supervision remains a critical priority. The BoJ has taken first steps towards the implementation of a risk-based supervision methodology (Annex I). These recent steps applied to one DTI are in the right direction, and should be extended to FHCs and to all its business entities (including all DTIs) as well as intensified to manage interconnectedness and contagion risks (see Risk and Vulnerabilities Section). Yielding the benefits of the risk-based approach to FHCs will hinge on (i) the availability of adequate skills and resources in all regulatory agencies, and (ii) the time needed to adjust resources and practices beyond the solo institution approach currently applied.

36. Also, coordination among supervisors will prove critical in the implemetation of group-wide risk-based supervision. Areas of further work will need to cover timely and enhanced granular data sharing mechanisms, regular collaboration and information exchanges between different agencies at the technical level, consistency of regulations (including interpretations), and cooperation between the BoJ and FSC through joint rule-makings and intensified oversight, notably through joint onsite inspections. Efforts on cross-border supervision should be intensified with more MoUs signed between the domestic and foreign supervisors.

Banking Supervision

37. Considerable progress has been made since the last FSAP in 2006 (Appendix II). Owing to the BSA passed in June 2014, the architecture of the supervisory framework has been substantially improved, with critical supervisory functions being transferred from the Ministry of Finance and Public Service (MoFPS) to the Governor of the BoJ. The current legal framework gives the BoJ powers to license DTIs and FHC, conduct ongoing supervision and undertake timely corrective action. The BSA gives the BoJ a broad range of powers to address individual situations where DTIs do not comply with laws and regulations or where DTIs engage in unsound practices. Permissible activities for DTIs, licensing, transfers of ownership, and mergers and acquisitions are appropriately defined and controlled. The BoJ carefully assesses compliance with prudential regulations. Valuable information is shared among banking regulators in the Caribbean region.

38. The BoJ’s inability to issue binding prudential regulations constitutes a limitation. The BoJ has over the years introduced several standards of sound practices which are intended to guide DTIs’ practices. While these standards do not by themselves have the force of law, they cover key aspects of supervision (e.g., corporate governance, internal control, fit and proper assessments, credit risk management, liquidity management). Including more streamlined standards of sound practices in the binding set of rules would enhance the BoJ’s ability to use preventative measures to address risk management issues. The BoJ should be empowered to leagally enact legally enforceable prudential rules.

39. The BoJ needs to intensify oversight. Adopting a more intrusive approach to DTIs’ risk management processes, corporate governance, and internal control will be important. Shortening the timelines for providing recommendations to DTIs and performing a thorough follow-up on remediation progress will further enhance the effectiveness of its supervisory approach.

40. Capital and liquidity requirements are no longer aligned with international widely observed regulations. Several elements of the framework are prudent (minimum level of the ratio, composition of Tier I), but the calculation of capital requirements still reflects the analytical methodology of the Basel I framework. Current methodology focuses exclusively on credit and FX risks and leaves aside other market and operational risks that are likely to be significant under a consolidated basis approach. Introducing a broader comprehensive Pillar I approach capturing all risks, a thorough Pillar II methodology, a surcharge reflecting the systemic importance of DTIs, as well as a minimum quantitative prudential liquidity standard would enhance the risk coverage of the prudential framework and complement BoJ’s efforts to foster convergence with international standards.

41. While related party and large exposures are well defined and controlled through statutory requirements, large exposure limits need to be changed to meet current and prospective international standards. The BSA provides a comprehensive and transparent definition of exposure, and counterparties to capping credit risk concentration and limiting exposure to related parties. International standards for large exposure to a group of connected accounts are stricter (25 percent rather than 40 percent of capital base), but the BoJ in cooperation with the FSC is already consulting on proposals to bring the regime in line with international standards. Further action is also required in implementing prudential standards on a consolidated basis.

42. Loan loss provisions are currently calculated using a conservative rules-based approach imposed by the BoJ (i.e., automatic triggers for loan classification, minimum provisioning percentages for each category). The forthcoming implementation of IFRS 9 raises new challenges. A better alignment with international accounting standards is desirable, and defining a transition period, as intended by the BoJ, would be prudent considering the complexities associated with the calculation of expected credit losses and the limitations on historical information that may be needed. The BoJ should, however, be transparent to the DTIs about how it will use the current regulatory provisions regime in an IFRS 9 environment. The BoJ should also develop its technical capabilities and provide a clear set of definitions (non-performing exposures, forebearance, and restructured loans).

Insurance Supervision

43. There has been significant progress in the area of insurance supervision. Strengths of the supervisory framework for the insurance sector encompasses surveillance, inspection and enforcement powers, information sharing and cooperation powers, a rather comprehensive supervisory reporting, and strong corporate governance framework (e.g., fit and proper), as well as the regular dialogue with the Insurance Association of Jamaica.

44. However, there are still significant weaknesses to be addressed, These include aspects of FSC’s independence from the government (balanced against accountability); the need to have formal mechanisms to support group-wide risk assessment and supervision; a supervisory approach that is rather compliance-based and less proactive, and that instead should move towards risk-based and forward looking assessments; as well as the need to modernize life insurance liabilities as well as solvency regime. The shortage of skilled staff is a major challenge.

45. The current regulatory framework needs to be modernized to keep up with the risks and challenges the insurance sector is facing. The framework for the valuation of long-term liabilities as well as the solvency regime were originally adopted based on the Canadian regime. Life insurers have some discretion in valuing their liabilities, and the parameters used to calculate required capital underestimate the volatility observed in the Jamaican financial market. The adoption of IFRS 17, planned for 2021, should be introduced in combination with a modernized risk-based solvency regime, allowing for consistency between valuation and capital adequacy and supporting consistency of the prudential framework. In the meantime, binding regulations for asset-liability management should be introduced and the regular stress testing framework should be extended also to general insurers. Additionally, establishing consolidated supervision, including for cross-sectoral groups, is a priority.

Pension Supervision

46. The regulatory framework for pension funds is relatively comprehensive, but gaps in resources, enforcement, and coverage remain. Jamaica has the foundations for a sound pension system with clear legislation and regulation, a functioning court system, and the required industry and professional support. But the FSC’s capacity to adequately regulate and supervise 399 active pension plans, many very small, and with 27 licensed pension administrators and 28 licensed investment managers is limited. Chances of fraud and errors—a key consideration ahead of any investment liberalization—could be large. Also, there are some parts of a Risk-Based Model in place, but resources for pension regulation need to be strengthened. Breaches of important rules, such as self-investment of a pension plan in the sponsor seems to persist for many years without resolution, suggesting lack of adequate supervisory focus.

47. Reform of the investment regulations is perhaps the most pressing pension policy issue (Box 3). A number of regulations constrain pension funds’ investment opportunities: (i) permitted locations of foreign assets (currently constrained to the U.S.A., Canada, and the U.K.); (ii) total foreign asset allocation limits; (iii) domestic asset allocation limits (allow new investment categories). Two additional restrictions on concentration limits and related party limits, however, broadly follow international best practice, and support the soundness of the sector.

48. From a financial stability perspective, FX investment opportunities should be gradually broadened to enhance diversification and returns. The phase-in should be aligned with strengthened risk management, regulatory capacity and cooperation, and the deepening of capital markets.

  • Foreign investment locations for pension plans to invest could be widened to add OECD countries and exposures to emerging markets and frontier markets through well-known multi-country index funds.

  • There is scope for a gradual increase in the FX investment limits. The process should be consistent with enhanced data collection, enforcement capacity, risk management frameworks in place, and cooperation among supervisors. Recent FSC stress testing work does not find significant impact of FX investment liberalization. However, changes to investment limits for nonbank institutions, including insurance and pension funds to avoid regulatory arbitrage, should be gradually designed along with enhancements in the supervision capacity of the authorities. The gradual relaxation of investment limits would be preceded by full institution-by-institution assessments of FX and JM$ exposures, assuring micro- and macroprudential regulations are in place, and intra- and inter-group spillovers are assessed. This will require upgrading supervisory capacity, data reporting and collection, and assesments.

  • Perceptions of regulatory forebearance should be avoided, with an appropriate sanctioning by the relevant authority. Data suggest that funds have been exceeding the regulatory limit for some time and a gradual raising of the limit (to, say, 10 percent) would entail a relatively minor impact on aggregate FX placements given any impact would have been already absorbed in the balance of payments. In any case, the capacity to monitor the implementation of the current regulatory limit and enforceability capacity needs to improve.

49. The consolidation of the pension sector would strengthen its capacity and alleviate existing challenges. Small funds face gaps in expertise, capacity (in a broader sense), and governance structures necessary for undertaking good investments and exploiting economies of scale in pension administration and investments. FSC faces challenges given the very small size of most plans. For example, in the U.K. (with thousands of small schemes) estimated administrative costs per member rise dramatically for small schemes.

50. The FSC should finalize the newly developed stress testing methodology and integrate it into its risk-based methodology. Significant efforts have been made to develop the stress testing methodology that has enhanced supervision in general and to assess the investment policy liberalization. The process should be completed—and embedded into the supervisory approach. The FSC should also finalize its guidelines for risk management with the enhancements implicit in the new investment regulation and stress testing methodology.

Securities Supervision

51. BoJ and FSC should focus on risk-based consolidated supervision and market conduct. Implementation plans have been drafted and a long-term TA project is about to commence. In this context, it is important to finalize the manuals for risk-based supervision. Training of staff on RBS need to be intensified to be more proactive, courageous to make judgements and able to defend their point of view. The FSC also needs to strengthen the horizontal analysis of the market (business models, building peer groups, identify outliers, dynamics within the market).

52. The FSC enforcement of regulations needs to be stepped up. The FSC relies in part on complaints from the public to identify potential enforcement cases, but the complaint numbers are relatively low, suggesting that the public does not know where to complain. Enforcement based on complaints is inevitably reactive. Enforcement activity is often directed to prudential rather than conduct issues. There is, therefore, a need for the enforcement activities to be more proactively targeted at emerging risks. In this context, transparency and communication are important to give the public and industry confidence in the system.

53. In the near term, there is a need to strengthen the regulatory framework for securities dealers in three ways:

(i) Continue and complete the retail repo reforms through the staged introduction of the mismatch ratio—the proposed liquidity-based ratio should be used as a monitoring tool while the impact of the mismatch ratio on liquidity works through the system;

(ii) Introduce the revised large exposure regime to improve resilience against contagion;

(iii) Introduce formal arrangements for group-wide supervision of conglomerates which include securities dealers, both within the FSC and between the BoJ and FSC.

54. In the medium term, once pre-conditions are met, to serve economic development and investor needs, and as sovereign debt issues reduce, securities dealers should be able to intermediate in a wider range of financial instruments, in particular corporate debt and equity instruments, commencing with JM$ and then US$.

55. However, because of the risk of poor liquidity with new financial instruments, there are three pre-conditions to be met in the near term before previous medium-term recommendations can be fully applicable: (i) the development of the risk-based supervision framework and firm timeframe for introduction; (ii) FSC collects data on securities dealers’ OTC trading as part of normal data collection; and (iii) a trade reporting mechanism is put in place to assist price discovery and systemic risk monitoring.

56. Fintech, crowd funding and, cryptocurrencies are currently at an embryonic level, but the authorities should develop guidance to the industry. The authorities seem to be following Fintech developments, especially crowd funding and initial coin offerings (ICOs) but have not yet developed a regulatory framework. The FSC has also begun to examine the regulatory changes that may be required in this context. While the current developments in this area are not a major financial stability concern, the authorities need to issue guidance to the industry and assess risk-based supervision on a case-by-case basis. Before considering new digital asset trading platforms for crypto assets trading the authorities should first address gaps in the current infrastructure,

57. including the secondary trading infrastructure and reporting platform of sovereign bonds, as well as risks and benefits of new proposals in a context of resource scarcity.

Cooperative and Credit Union Supervision

57. The authorities are in the process of bringing credit unions under BoJ supervision. The bank licensing process for credit unions should be carefully sequenced and managed with a properly designed communication strategy. Before granting access to the deposit insurance scheme the BoJ will need to assess licensing criteria are met by each institution and conduct a rigorous asset quality review of all credit unions to diagnose potential capital needs (Annex II). Agreement will be needed on incorporating the current credit union stabilization fund to the deposit insurance fund.

C. Financial Integrity

58. Jamaica was assessed against the 2012 Financial Action Task Force (FATF) standard in 2015. The mutual assessment report (MER) concluded that Jamaica had taken many steps since the 2005 assessment to strengthen its AML/CFT framework, but that important shortcomings remained both in terms of technical compliance with the standard and effectiveness of the AML/CFT regime.5 The MER also identified deficiencies with respect to, inter alia, understanding of ML/CFT risks, combatting terrorism financing framework, AML/CFT preventive measures framework, transparency and beneficial ownership of legal persons and arrangements, and supervisory activities.

59. Jamaica has since taken important steps to address some deficiencies and should continue its efforts to establish an effective AML/CFT regime. Since the 2015 MER, the 2014 BSA has entered into force establishing strengthened supervisory powers, the International Trusts and Corporate Services Act was adopted, and amendments related to transparency of beneficial ownership were brought to the Companies Acts. Proposed amendments to the Terrorism Prevention Act and the Proceeds of Crimes Act are expected to further strengthen the legal framework. Building on the 2016 ML/CFT National Risk Assessment (NRA), the authorities are carrying out with the assistance of the World Bank, a comprehensive NRA expected to be completed in 2019. The authorities are also in the process of establishing a risk-based approach to AML/CFT supervision of DTIs and cambios with IMF technical assistance. Sustained efforts are required to address pending shortcomings with the FATF standard, including to strengthen AML/CFT preventive measures obligations and ensure their enforceability, enable consolidated supervision of financial conglomerates, ensure the transparency of legal entities and support efforts to fight organized crime.

60. Pressure on correspondent banking relationships (CBRs) have stabilized, albeit with remaining fragilities, in particular, for money services businesses and micro-finance entities. Domestic banks continue to experience pressures and restrictions imposed on CBRs, in particular with respect to the handling of cash and clearing of checks. These restrictions on local banks affect their ability to service cash-intensive businesses such as money services businesses and micro-finance entities. Despite those challenges, growth in remittances and foreign direct investments has not been impacted. The authorities have engaged with foreign regulators to communicate efforts to address perceived risks and are in the process of implementing the recommendations resulting from the 2015 AML/CFT MER.

Crisis Readiness, Management, and Resolution

61. MOFPS is the resolution authority for DTIs under the BSA. The FSC does not have any significant resolution powers (as opposed to the power to initiate a winding up proceeding under the Companies Act) for those entities it supervises. DTIs and insurance companies are specifically excluded from the 2014 Insolvency Act unless the appropriate regulator gives written consent for the application of the Act.

62. The BoJ has enforcement powers for entities licensed under the BSA (DTIs and FHCs) that include the power to appoint a temporary manager and to revoke an institution’s license. In addition to these powers the BoJ may recommend to the MOFPS that it make an order vesting a licensee’s shares and subordinated debt in the Accountant General under Section 114 of the BSA (a vesting order). The BSA specifies the effects of the entry of such an order including providing MOFPS with the power to carry out transactions to sell to or merge the licensee with a buyer. Certain time limits apply to these actions after which MOFPS must apply to the court for a winding up order.

63. Work is underway to modernize the resolution framework for financial institutions. The bank resolution regime in Jamaica is the subject of significant reforms. A consultation paper was jointly published by the members of the Financial Regulatory Committee (FRC) in February 2017. It is an ambitious initiative that will require substantial resources and close cooperation by all safety net regulators to implement its provisions. After receiving public comment, a proposal was submitted to the Cabinet in July 2017 and in October approval was given for drafting instructions to be prepared and issued to the Chief Parliamentary Counsel to prepare legislation to establish a Special Resolution Regime (SRR) for FIs. The proposal is to be submitted to Parliament in 2019.

64. The new framework proposes a hybrid approach to resolution. There are two separate parts to the new framework being proposed for the resolution of financial institutions (currently including DTIs, insurers and securities firms).6 The first part, the special Resolution Regime (SRR), will apply to all DTIs and certain other FIs deemed systemically important. The SRR will be an administrative resolution mechanism. The second part, the Modified Insolvency Framework, will apply to other nonviable/insolvent FIs and any residual portions of an entity subject to the SRR.

65. The independence of the resolution authority will be addressed. BoJ’s function as resolution authority (RA) will be operationally separate from its regulatory and supervisory functions under the BoJA and the BSA. The RA will be given the power to appoint one or more entities to assist in the performance of its functions under the statute with certain specified legal capacities and competencies (for example, the ability to secure financing and hold and deal with shares of FIs and other companies).

66. The specific responsibilities in the new resolution framework are not yet finalized. While the roles of the authorities in resolution will be strengthened as a result of the proposed changes, the specific responsibilities of the various authorities will only become clear once the new resolution regime is drafted, adopted, and operationalized. The proposed new framework establishes BoJ as the resolution authority for DTIs/FHCs and any non-DTI deemed systemically important; the FSC will continue to have powers to deal with non-DTIs that are either insolvent, facing imminent insolvency, or is being wound up. The new framework will also allow for the appointment of a Resolution Administrator (RAdmin) which could be the JDIC or the FSC. In this context:

  • The resolution framework reforms need to be properly sequenced. Detailed standards to classify systemic/non-systemic institutions, the applicable priority scheme for claims under the SRR and how a bridge institution would be established and under what rules need to be adopted.

  • Recovery planning is not underway and BoJ should develop guidance for financial institutions to assist them in preparing such plans, including for financial groups.

  • JDIC’s access to funds for its operations as a resolution administrator is not clear; this is being addressed at the SRR drafting stage. There is a deposit insurance fund (i.e., a pay box) with reserves at about 5.5 percent of insured deposits. However, there are no formal arrangements in place for a dedicated back-up funding system.

67. The authorities have not prepared formal contingency plans for dealing with a systemic crisis such as was experienced in the mid-1990s. No systemic simulation exercises to assess the authorities’ ability to deal with a systemic crisis have been undertaken. A systemic crisis contingency planning and simulation exercise agenda should be pursued as part of normal business practice in due course. Also, the draft 2014 Emergency Liquidity Facility Policy should be reviewed and finalized; it has not yet been used.

Creditor Infrastructure

68. The credit-to-GDP ratio is relatively low and credit to the economy is not effectively intermediated (Figure 9a). Though credit has recently recovered to its trend level, the credit-to-GDP ratio is still low compared to Jamaica’s peers in the Caribbean and many other emerging markets, which are typically in the range of 40–60 percent.

Figure 9a.
Figure 9a.

Jamaica: Bank/DTI Credit to GDP Ratio by Selected Countries, 2016

(In percent)

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

69. Overall, the formal credit environment in Jamaica appears to support access to credit for consumers and corporates, but not micro, small and medium enterprises (MSMEs). Although bank lending to consumers is expanding (Figure 9b), this appears to be primarily secured with traditional types of collateral, such as motor vehicles. Unsecured lending is typically issued to prime customers known to the financial institution or to public servants. Most lending to the MSME sector is taking place via still unregulated micro-finance institutions (MFIs) and credit unions, which lend to medium sized corporates, also not fully regulated. The credit reporting system built recently should facilitate creditor risk management, but financial institutions are not fully utilizing it, partly because of informational gaps. In addition, the effectiveness of the secured transactions law can be enhanced together with an effective communication and public awareness strategy on the opportunities opened by the Insolvency Act and related insolvency regime to the industry. Given the rapid growth of lending by unregulated financial institutions, strengthening the monitoring of such entities would be important.

Figure 9b.
Figure 9b.

Jamaica: Composition of DTI Consumer Loans

(In billions of JM$, 2006–2017)

Citation: IMF Staff Country Reports 2018, 347; 10.5089/9781484387825.002.A001

Source: FSAP Team and Authorities’ Data.

70. The 2015 World Bank FSAP Development Module covered capital markets deepening. One of the key recommendation included the development of movable asset-based financing instruments (e.g., factoring, leasing, and venture capital). More recently IMF TA provided detailed recommendations on the primary dealer system, strengthening sovereign debt markets benchmarks, and developing the secondary market.

The World Bank FSAP Development Module, 2015

The World Bank (2015) assessment noted that credit to the private sector by DTIs remains limited, despite a high proportion of formally banked households. This lack of access to credit and equity constrain MSMEs’ operations and growth, and ultimately their contribution to the economy. The authorities have taken significant initiatives to improve the legal and regulatory environment and financial infrastructure that would contribute to enhancing financial inclusion, including the establishment of credit bureaus, the modernization of the secured transactions legal framework and establishment of the movable collateral registry, and improvements to the insolvency and creditor rights framework that would facilitate corporate rehabilitations. To further strengthen the framework, key findings and recommendations include:

(i) enhance the credit reporting oversight and financial consumer protection framework, and adopt measures to encourage credit bureaus to compete in services and not in data;

(ii) enhance the regulations of the movable collateral registry; and

(iii) develop regulations for the insolvency law along with training of judges and insolvency administrators.

Alternative sources of SME finance beyond credit lines or personal loans, such as factoring, leasing, and venture capital are limited. Specific instruments to facilitate access to finance for low income households and agriculture finance, should be designed, including micro-insurance and regular saving products.

High interest rates and low penetration of credit can be explained by high credit risk owing to information asymmetries, as well as limited competition in the banking sector. Financial institutions have not been able to accurately assess borrowers’ level of indebtedness and repayment capacity and credit activity has been low and highly concentrated in existing customers. In this context, and despite the low cost of funding and high requirements for traditional collateral, interest rates are high. Policies that encourage competition in the banking sector should be considered, including promoting enhanced transparency and consumer disclosure that would enable consumers to compare products and quality of service amongst financial institutions, strengthening dispute resolution mechanisms, and expanding financial literacy.

Additional recommendations included enhancing housing policy strategy, retail payments innovation and consumer protection. The Development Module FSAP recommended that (i) a comprehensive national housing policy strategy be developed, (ii) policy reforms that encourage innovations in retail payments be a priority and the current regulatory framework reviewed to encourage competition amongst bank and nonbank providers; and (iii) the financial inclusion agenda also requires a comprehensive strategy on consumer protection regulation and supervision.

Source: World Bank – Jamaica Financial Sector Assessment, April 2015.

Insurance and Pension Funds FX Investment Limit Regulation1

The 2006 investment regulations impose a range of quantitative limits at the level of asset classes, related parties, individuals and foreign exchange (FX) exposure with some differences depending on the vehicle through which the assets are invested. Plan assets can be invested directly, through a ‘segregated fund’ where an investment manager has the mandate for one fund only, or through a range of pooled funds. A Type I pooled fund can only manage assets of pension plans. They are bound by exactly the same rules as pension plans in terms of asset allocation limits—except that Type I plans are exempt from the concentration limits (5 percent) and related party limit (10 percent). These features were subject to confusion among several market participants and in previous reviews of the pension system. Next are Deposit Administration Contracts, run by insurers but following the 2006 regulations, which are also exempt from the concentration and related party limits like Type 1 funds. They are supervised by the insurance teams and subject by the BoJ 5 percent ceiling on foreign investments. Type II pooled funds—open-ended investment funds, mutual funds, collective investment schemes (CIS), unit trust, and any investment fund, other than a Type I Pooled Fund—are subject to the concentration and related partly limits. But for CIS’s the BoJ has relaxed the original 5 percent FX restriction and can now have FX investments up to 25 percent.

Quantitative limits on FX investments were set in the 2006 regulations at 20 percent of the total portfolio; these were over-ridden by a BoJ intervention to reduce the exposure to 5 percent for all pension investments except via CISs, with a limit of 25 percent. The foreign exchange regulations also specify that only investments in the U.S., Canada and the U.K. are permitted. The BoJ issued a Discussion Paper in 2015 showing its support for removing restrictions on pension plans (so they could invest 20 percent of assets in foreign securities as originally envisaged) and insurance companies in the medium term (3 years) but noted a range of concerns about liberalizing. These included the impact on ‘system stability’ due to the impact on FX reserves, increasing yields on Government of Jamaica (GoJ) securities if demand from pension funds or insurance companies were to plummet and the impact of any volatility in the bond market on plans to reform the retail repo market. The Paper also noted that liberalization for pension plans and insurance companies would have to follow that for CIS for whom the BoJ had liberalized the 5 percent restriction on FX holdings to 25 percent. The Paper also highlighted the potential for regulatory arbitrage caused by the permission given to one investment manager to offer exposure to foreign currency returns more than 5 percent or even 20 percent of total assets in the pool because the pension plan investors were using Jamaican dollars to buy Jamaican dollar denominated units and receiving Jamaican dollar returns and hence were not judged by the BoJ to be breaching its 5 percent ceiling. However, the BoJ only gave this clarification to one investment manager—leaving the others subject by the 5 percent limit until they either receive a similar clarificatory letter from the BoJ, or the 5 percent limit is increased.

1 The investment of pension plan assets DACs is subject to the investment regulations. Similar to Type I pooled funds, DACs are exempt from the general concentration and related party limits (regulations 17 and 34).

Annex I. Report on Observance of Standards and Codes: Basel Core Principles

A. Introduction

1. This assessment of the implementation of the Basel Core Principles for Effective Banking Supervision (BCP) in Jamaica has been completed as part of the Financial Sector Assessment Program (FSAP).

2. This FSAP has been undertaken by the International Monetary Fund (IMF) in 2018, at the request of the Jamaican authorities. 1 The assessment reflects the regulatory and supervisory framework in place as of the completion of the assessment. It is not intended to analyze the state of the banking sector or crisis management framework, which are addressed by other assessments conducted in this FSAP.

3. An assessment of the effectiveness of banking supervision requires a review of the legal framework, and detailed examination of the policies and practices of the institutions responsible for banking regulation and supervision. The assessment focused on the regulation and supervision by the Bank of Jamaica (BoJ) of the Deposits-Taking Institutions (DTIs) and did not cover the specificities of regulation and supervision of other financial intermediaries.

B. Information and Methodology Used for Assessment

4. This assessment was performed against the standard issued by the Basel Committee on Banking Supervision (BCBS) in 2012. Since the previous BCP assessment, which was conducted in 2006, the BCP standard has been revised. The revised Core Principles (CPs) strengthen the requirements for supervisors, the approaches to supervision, and the supervisors’ expectations of banks through a greater focus on effective risk-based supervision and the need for early intervention and timely supervisory actions. Furthermore, the 2012 revision placed increased emphasis on corporate governance and supervisors’ conducting sufficient reviews to determine compliance with regulatory requirements and thoroughly understanding the risk profile of banks and the banking system. This assessment was thus performed according to a significantly revised content and methodological basis, compared to the BCP assessment carried out in 2006.

5. Compliance with the BCP was assessed and rated against the essential criteria of the BCP. To assess compliance, the BCP Methodology uses a set of essential criteria (EC) and additional criteria (AC) for each principle. The EC were the only elements by which to gauge full compliance with a Core Principle (CP). The AC are recommended as the best practices against which the authorities of some more complex financial systems may agree to be assessed and graded. The assessment of compliance with each principle is made on a qualitative basis. The assessment of compliance with each CP requires a judgment on whether the criteria are fulfilled in practice. Evidence of effective application of relevant laws and regulations is essential to confirm that the criteria are met.

6. The assessment team held extensive meetings with BoJ officials, as well as the Minister of Finance, the banking industry, and other relevant counterparts who shared their views with the assessors. The team also reviewed the framework of laws, regulations, and supervisory guidelines. The BoJ provided self-assessments of the CPs and comprehensive questionnaires filled out by the authorities. The BoJ also facilitated access to supervisory documents and files, staff, and systems.

7. The assessment team appreciated the excellent cooperation, including extensive provision of internal guidelines, supervisory files, and reports. The team extends its thanks to staff of the BoJ staff who responded to the extensive and detailed request promptly and accurately during the assessment at a time when supervisory staff were burdened by many supervisory and regulatory initiatives related to consolidated and risk-based supervision.

C. Preconditions for Effective Banking Supervision2

8. Sustained fiscal discipline and a multitude of supply-side reforms have helped establish macroeconomic stability in Jamaica. Macroeconomic fundamentals have been steadily improving, which is reflected in high employment levels, a well-anchored inflation, and a primary surplus exceeding 7 percent of GDP since 2013/14. However, DTIs operate in a low growth environment (real GDP growth has averaged 0.9 percent in the last four years).

9. Building on the progress so far in strengthening the macro-economy, the Jamaican authorities are seeking to establish an effective financial stability framework. The important first step of establishing institutional arrangements is complete. A high level inter-agency Financial System Stability Committee (FSSC) has been established by way of an amendment to the BoJ Act. The FSSC is tasked with producing regular financial stability assessments and providing recommendations to the BoJ on potential macroprudential policy actions. Final responsibility for the actions resides with the BoJ who now faces the challenging task of operationalizing the macroprudential policy framework. While good progress has been made, there are still many information gaps to be closed before an early warning system is in place. In tandem with this work on indicators, the BoJ is also engaged in a search for instruments to include in a “macroprudential policy toolkit” for mitigating and containing systemic risks.

10. The current framework for crisis management does not provide sufficient tools for the resolution of the complex financial conglomerates that are predominant in Jamaica’s financial sector and does not establish one resolution authority for such institutions. To address such shortcomings the authorities have proposed a two-part solution: an administrative resolution framework for all DTIs, and a modified insolvency framework for all other financial institutions with the BoJ acting as the resolution authority. Drafting instructions for the former have been prepared and sent for transmission to the Office of the Parliamentary Counsel while such instructions are not complete for the latter initiative although both proposals are to be submitted for adoption by Parliament in early 2019. In this context, much work is needed to have an operational system for financial institution resolution in place within the proposed timeline.

11. The deposit insurance framework, managed by the Jamaica Deposit Insurance Corporation (JDIC), broadly conforms to international best practices. Although the JDIC is part of the institutional framework for system-wide crisis preparedness there has not been any contingency planning for a systemic crisis. There is a plan for a crisis simulation exercise to be conducted in 2019 under the auspices of the Financial Regulatory Committee (FRC) which is aimed at facilitating information sharing, cooperation and collaboration among domestic authorities on regulatory matters.

12. Transparent information is provided by DTIs to the public. Given Jamaica’s adoption and implementation of IFRS and in particular IFRS 7 (Financial Instruments: Disclosures), DTIs are required to disclose their financial statements to enable users to evaluate the nature and extent of risks arising from financial instruments to which the entity is exposed and its management of those risks.

D. Main Findings

Responsibility, Objectives, Powers, Independence, Accountability (CPs 1–2)

13. Considerable progress has been made since the last FSAP in 2006. Owing to the Banking Services Act (BSA) passed in June 2014, the architecture of the supervisory framework has been substantially improved, with critical supervisory functions being transferred from the MoFPS to the Governor of BoJ. The legislation has established a clear allocation of responsibilities for the supervision of financial institutions between the BoJ and the Financial Services Committee (FSC). The legal framework gives the BoJ powers to authorize DTIs and FHCs, conduct ongoing supervision and undertake timely corrective action. The BoJ has a broad range of powers provided for in the BSA to address individual situations where DTIs do not comply with laws and regulations or where DTIs engage in unsound practices.

14. Whilst the architecture of supervision has been improved, the BoJ’s inability to issue binding regulations constitutes a limitation. Minimum prudential requirements for DTIs are primarily to be found in the banking law itself and in the supplementary Regulations and Supervisory Rules which, upon a proposal from the BoJ’s Supervisory Committee, must systematically be subject to consultation of the MoFPS and affirmative resolution from the Parliament. The BoJ has over the years introduced several standards of sound practices (SSP) which are intended to serve as guidance to DTIs. While these standards do not by themselves have the force of law, they deal with key aspects of supervision (corporate governance, internal control, fit and proper assessments, credit risk management, liquidity management, etc.). Furthermore, breaches of provisions included in these standards cannot lead directly to enforcement action. They have to be viewed as constituting unsafe and unsound practices. Also, the guidance notes are not as detailed and prescriptive as the Regulations already issued by the BoJ.

15. Supervisory resources are stretched and insufficient for the range and nature of the tasks the BoJ must carry out for effective supervision. The BoJ has not yet quantified the impact of risk-based supervision and carry out a mapping of the skills that are required. The legislation does not include express prohibitions against members of the Supervisory Committee and senior supervisory staff from holding any position of responsibility in a supervised entity for a determined period after they demit office.

Ownership, Licensing, and Structure (CPs 4–7)

16. Permissible activities for banks, licensing, transfers of ownership, and bank mergers and acquisitions are appropriately defined and controlled. The permissible activities of DTIs supervised by the BoJ are well defined leaving little doubt as to the status of institutions using the word bank in their name. The BSA provides an adequate basis for the BoJ to approve or reject major acquisitions or investments by a DTI. The BoJ also has well established supervisory practices to limit and monitor risks arising from such acquisitions. Entry to the banking business, either through a de novo license or a change in ownership or an acquisition are controlled by the BoJ using consistent, well defined criteria to evaluate, as appropriate, the investor’s financial capacity, management strength, suitability and business plan viability.

Methods of Ongoing Supervision (CPs 8–10)

17. The BoJ carefully assesses compliance with prudential regulations. The BoJ uses a reasonable range of techniques and tools to implement its supervisory approach, which also includes monitoring of macroeconomic and sector-wide developments. It employs a mix of on- and offsite supervisory elements to assess the risks that DTIs are running and has broad information gathering power. However, while thorough analyses of the risks taken by the banking system as a whole have been conducted on a regular basis, the offsite assessment is not sufficiently analytical and does not compare banks with peer groups and / or the banking sector. Further, the assessment of the risk profile of each individual DTI as part as offsite supervision has been rather limited and the frequency of on-site examination rather low.

18. The BoJ has taken firsts step towards improving its supervisory approach by initiating the implementation of a risk-based supervision methodology. A well-designed risk-based methodology has already been defined. Under the risk-based supervision framework, the assessed risk profile of a licensee will determine the frequency and intensity of monitoring. It is important to remain cautious as only one DTI is currently supervised under the new methodology. Nonetheless, the first results look promising. A thorough analysis of the risk profile was performed by offsite examiners. The quality of on-site work has also improved substantially, with a clear focus on governance, risk profile and risk management framework; findings were detailed and substantiated.

19. The recent enhancements are in the right direction, although some time needs to be given to yield results and others need to be materially intensified to achieve the desired goal. Successful implementation requires adequate staffing, a revision of the examiner guidance assessing licensee’s credit risk processes, governance and internal control, and refocus on core supervisory functions. As the BoJ matures and develops its experience with risk-based supervision, the authorities should reconsider whether it is still appropriate to approve ex ante all new products designed by DTIs and conduct fit and proper evaluations for all DTIs officers, managers and key employees.

Corrective and Sanctioning Powers of Supervisors (CP 11)

20. Despite the vast range of corrective measures and powers that the BoJ enjoys based on the BSA, evidence of effective application of these new powers is somewhat limited. The BoJ has considered so far more effective to get DTIs to agree to an action plan for completing corrective actions. Applying gradual responses rather than immediately resorting to more coercive measures is not questionable per se as long as tools and processes are in place to (i) addresses supervisory concerns with banks in a proactive and timely manner, including formal communication and escalation to senior management and the DTIs’ Boards as appropriate, and (ii) ensure adequate and timely follow-up of actions taken by DTIs. In this regard, it was noted that the process of providing recommendations to DTIs based on on-site examinations was lengthy, which weakens its effectiveness, and remediation progress were insufficiently monitored and documented.

Cooperation, Consolidated and Cross-Border Banking Supervision (CPs 3, 12–13)

21. The BoJ is fully empowered under the BSA to supervise financial groups but does not yet impose prudential standards on a consolidated basis. Preparatory work is underway. As contemplated by the BoJ, further action is now needed to better understand the overall structure and tisk management of the bank, banking group, and the wider group, review the main activities of parent and affiliated companies, implement the process for the licensing of FHC, impose prudential standards on a consolidated basis (solvency, liquidity, large exposures, related parties), collect prudential data on a group-wide basis, establish and enforce fit-and-proper standards for owners and senior management of parent companies, and strengthen the regulations on internal control and risk management while making compliance with these provisions on a consolidated basis compulsory.

22. In terms of cooperation between regulators, significant achievements have been accomplished in the recent years, but further enhancements are necessary. Instruments for cooperation and collaboration, such as Memorandum of Understanding (MoUs), are in place to exchange information with all relevant domestic authorities and a large number of foreign supervisors. A Financial Regulatory Committee (FRC) has been established in Jamaica, and the BoJ participates in several colleges of supervisors with foreign counterparts. There is long tradition of information sharing among regulators in the Caribbean region. Conversely, the assessment team was not provided with sufficient evidence confirming the effectiveness of cooperation arrangements with the FSC. Aggregate system-wide information is exchanged, but no joint inspections have been conducted and there are have been limited attempts to understand risks arising from intra group transactions.

Corporate Governance (CP 14)

23. The BoJ should also adopt a more intrusive approach to corporate governance. The BoJ uses its on-site inspection process for the determination of the status and effectiveness of corporate governance in the banking sector and for the oversight of Boards in individual risk areas. Governance is duly included in the scope of on-site inspection. However, the BoJ did not provide sufficient evidence of action taken to address weaknesses identified by examiners in Board oversight and committees’ structures. Moreover, the BoJ has organized a limited number of formal meetings with executive and non-executive Board members in order to discuss the strategy, risk appetite, risk policies, risk profile and the way they oversee senior management.

Prudential Requirements, Regulatory Framework, Accounting and Disclosure (CPs 15–28)

24. Capital requirements are no longer aligned with international widely observed regulations. Several elements of the framework are prudent (minimum level of the ratio, composition of the Tier 1 capital), but the calculation of capital requirements still reflects the analytical methodology of the Basel I framework, thereby focusing exclusively on credit risk and foreign exchange risk and leaving aside the other market risks and operational risk that are likely to be significant when measured on a consolidated basis. Although the BoJ has the general power to increase capital adequacy ratio requirements, it has not yet elaborated a comprehensive methodology to determine capital surcharges reflecting the risk profile using a Pillar II approach. In practice, the BoJ applies a crude approach which requires the two largest DTIs to maintain minimum capital at least 2.5 percent above the general 10 percent requirement. The authorities are also encouraged to increase transparency around the main drivers of the decision to determine capital surcharges reflecting the systemic importance.

25. Loan loss provisions are currently calculated using a conservative rules-based approach imposed by the BoJ. Minimum provisioning percentages are imposed for the exposures classified in various categories defined under a draft regulation which is considered by DTIs and legal auditors as binding. Provisions calculated based on regulatory requirements that exceed the amounts required under the accounting standards are transferred from retained earnings to a non-distributable loan loss reserve, leading to prudent NPLs coverage ratios (higher than 100 percent).

26. The forthcoming implementation of IFRS 9 in Jamaica raises new challenges. Going forward, the BoJ would like a period of experience with IFRS 9. While a better alignment with international accounting standards is desirable, the definition of a transition period, as intended by the BoJ, would indeed be prudent considering the complexity of the calculation of expected credit losses. However, it is unclear whether the BoJ intends to keep the existing provisioning regime as a backstop or just as a benchmark in an IFRS 9 environment and how it will operationalize the use of a regulatory floor. Clarification is therefore needed, as well as the establishment of safeguards to be used during the transition period should the BoJ decides to change the loan loss provisions rules so as to be better aligned with internal standards (technical capabilities to assess the methods employed by DTIs to calculate expected credit losses in accordance with IFRS 9, legal powers to require changes in valuation, impact study).

27. While related party and large exposures are well defined and controlled, large exposure limits will need to be changed to meet international standards. The BSA provides a comprehensive and transparent definition of exposures and counterparties for the purpose of capping concentrations risk and limiting exposure to related parties. International standards for large exposures are stricter (25 percent rather than 40 percent of capital base), but the BoJ in cooperation with the FSC is consulting on proposals to bring the regime more in line.

28. While qualitative guidance on liquidity risk management has been issued, there are no quantitative minimum prudential liquidity requirements. The qualitative guidance on liquidity risk management needs to be updated. A binding standard that incorporates the BoJ’s work on what constitutes a sound liquidity contingency plan should be established. It is noted that the current liquid asset requirements imposed on banks are not prudential in nature.

29. Market risks other than foreign exchange and banking book interest rate risk are inherent in groups of companies comprising securities dealers under a regulated FHC. Adopting a group wide supervision means the BoJ will have to expand capital requirements and expectations for market risk management in order to address the marked to market price and valuation risks that likely resides in securities dealers.

30. The supervisory approach to operational risk management is fragmented and incomplete. A more comprehensive approach to operational risk quantification and management, would require the bringing together the various operational risk related expectations of the BoJ into a single enforceable standard along with supporting requirements for industry collection of operational risk loss data.

31. Accounting and disclosure frameworks in Jamaica standard help facilitate market discipline and could be better leveraged by the BoJ. The forthcoming risk-based framework for on-site supervision would benefit from a regular sharing of perspectives with bank external auditors who use a risk-based approach to external audits that identify material and emerging risk.

Abuse of Financial Services (CP 29)

32. Concerning AML/CFT, efforts to strengthen the legal and supervisory frameworks should continue. The applicable Guidance notes do not have the force of law. The BoJ has already made considerable strides in combatting abuse of financial services and is working towards establishing a well-structured risk-based AML/CFT supervision program. that sets measurable targets for banks to cure identified compliance deficiencies.

Table 1 offers a principle-by-principle summary of the assessment results, while recommendations to improve the effectiveness of regulatory and supervisory frameworks are summarized in Table 2.

Table 1.

Jamaica: Summary Compliance with the BCPs

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Table 2.

Jamaica: Summary of Recommendations

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Annex II. Report on Observance of Standards and Codes: Core Principles for Effective Deposit Insurance

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Short Term: 6–12 months; Medium Term: 1–2 years.

Appendix I. FSAP Risk Assessment Matrix1

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The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

Appendix II. Implementation of Previous FSAP Recommendations, Preliminary Assessment

Stability Module

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Source: Authorities.