NEARLY 30 years ago, Jamaica’s economy went into a tailspin as financial institutions went belly-up with only the Government available to rescue the sector, and at great cost to taxpayers. Eventually, the cost of that rescue ballooned to 42 per cent of the country’s gross domestic product (GDP). Today, that would be the equivalent of about $1.4 trillion — more money than the $1.3 trillion the Government plans to spend on everything this fiscal year, from roads to schools, health care, security and public sector salaries, and so on.

It’s a cost the Government has determined taxpayers should not bear again, and before the end of this month, will table a Bill that will outline a special resolution regime (SRR) that will guide how failed or failing financial institutions will be rescued to prevent them from posing a risk to the financial sector and, by extension, the entire economy.

“The legislaion will deal with the issue once and for all, [ensuring] that tax payers are not called on to pay the cost of failed financial institutions,” Nigel Clarke, Jamaica’s minister of finance, said in the House of Representatives on Tuesday.

The legislation to outline how failed or failing financial institutions will be rescued is expected to be “dense”, Clarke told the House. A consultation paper outlining the proposals to be considered was circulated amongst financial institutions in October last year.

It outlined that a fund will be created to rescue failed institutions without resorting to taxpayers bearing the cost. It pointed out that if the Government makes itself available to bail out failed institutions, that “implicit government support contributes to weakened market discipline, as financial institutions may not be willing to internalise the costs associated with greater risk-taking”.

These financial institutions will bear the cost themselves, with the resolution of failed institutions to be carried out by the Bank of Jamaica (BOJ), which has been identified as the “appropropriate” resolution authority that will be given “the necessary tools and powers to carry out an orderly resolution, which is needed to stabilise confidence in the financial sector and ensure the continuity of critical financial functions of a failing or likely to fail financial institution.

But, what will be the cost of that package?

“For Jamaica, a resolution fund target of 1.5 per cent of GDP ($40.1 billion) was estimated as reasonable,” the consultation paper outlined. It said that figure was chosen “due to the relatively significant size of Jamaica’s financial sector, high levels of conglomeration and interconnectivity within the sector, tempered by current safeguards implemented since the country’s past experience with its own banking crisis, which represented approximately 42 per cent of GDP in the 1990s.”

The paper pointed out that this resolution fund will be able to recapitalise some small to medium-sized entities, but not the largest institutions of the sector. Consequently, additional funding will be required to ensure viability of the entire system.

Notably, this resolution fund target amount is approximately 18 per cent larger than the existing $33.9 billion fund that insures consumers’ deposits through the Jamaica Deposit Insurance Corporation (JDIC) at the end of 2022.

The resolution fund is expected to see deposit taking institutions (DTIs) paying an annual premium equivalent to 11.7 per cent of average profits over a ten year period with that to be reduced to 7.8 per cent of average profits over a 15-year timeframe. Securities dealers would incur similar per-profit expenses as DTIs, with annual premiums accounting for 10.9 per cent of average profits comparable to 7.3 per cent over 15 years. For insurance companies, 10-year annual premiums represented an average 3.1 per cent of profits across 10 entities to be reduced to 2.1 per cent over 15 years. This was largely reflective of the generally low contribution factor of insurance companies due to their smaller share of the market. These additional costs will eventually be passed on to consumers.

Resolution powers

It is proposed that the BOJ should initiate resolution of financial institution based on an assessment, which implies that an institution is, or likely to become, no longer viable. This is likely to be anchored in the level of capitalisation and liquidity assessed against pre-stipulated benchmarks in laws and regulations. And, the entity to be resolved will be determined by the central bank, if its assessment finds that an institution is failing or likely to fail, and no alternative private measures would prevent such a failure within a reasonable time frame.

Its intervention will be broad-based, and include removing and replacing senior management and directors and recover monies from responsible persons, including claw-back of variable remuneration; the appointment of an administrator to take control of and manage the affected financial institution with the objective of restoring the entity, or parts of its business, to ongoing and sustainable viability. It will also be able to operate and resolve the financial institution, including exercising the powers to terminate contracts, continue or assign contracts, purchase or sell assets, write down debt and take any other action necessary to restructure or wind down the financial entity’s operations.

Critically, the central bank will also have the power as the resolution authority to override rights of shareholders of the financial institutions in resolution, including requirements for approval by shareholders of particular transactions, in order to permit a merger, acquisition, sale of substantial business operations, recapitalisation or other measures to restructure and dispose of the financial institution’s business or its liabilities and assets.

As proposed now, it could also transfer or sell assets and liabilities, legal rights and obligations, including deposit liabilities and ownership in shares, to a solvent third party, notwithstanding any requirements for consent and even impose a moratorium with a suspension of payments to unsecured creditors and customers and effect the closure and orderly liquidation of the whole or part of a failing institution with timely payout or transfer of insured deposits within seven days.

This resolution will not only affect financial institutions, but will extend to non-financial entities within financial groups and all may not be wound up, with some, given circumstances, could be put in a temporary bridge institution to be operated until a sale could be effected or, in other cases, a “bail-in” could be implemented of a single entity within a group if the funds are available internally to do so.

Clarke said in bringing legislation to deal wih the issue of resolving failed or failing financial institutions, the aim is to plug the gap in the regulatory framework that recognises the property rights of shareholders of failed financial institutions over the society’s rights for a secure and stable financial system. This flaw he argued, was exposed by the recent ruling in the case of who should be responsible for winding up the fraud-hit Stocks and Securities Limited (SSL).

“People have stolen money, stolen $3 billion and the judgement is that the property rights of the shareholders trumps the society’s need for financial sector stability. If people understand the implications of that judgement,” he continued, before stopping midsentence to plead, “Therefore as legislators, our responsibility is to make sure that we plug that gap in legislation, and regulation to ensure that it is very clear that you have property rights when you are functioning properly and you are not posing a risk to the financial system. But at the moment that it becomes apparent that you can pose a risk to the stability of the financial system, your property rights have to be subordinated to the rights of the Jamaican people having a stable financial system.”