Caricom financial system remains strong
STRONG capitalisation and liquidity helped the region’s financial system to survive the onslaught of the financial crisis occasioned by the novel coronavirus pandemic, according to the Caribbean Regional Financial Stability Report (RFSR) for 2020.
The report, however, pointed out that the financial crisis also exposed weaknesses and highlighted risks in the management of both the financial system and the institutions that make it up.
Using the global financial crisis of 2007/2008 as a benchmark event, the report tracked the performance of the region’s financial system up to 2019, drawing comparisons with 2020 when most Caricom member states introduced measures to curtail the spread of the contagion.
The Great Recession a decade earlier prompted regulators in the region to introduce or strengthen capital adequacy and liquidity rules pertaining to deposit-taking institutions and insurance companies.
Capital adequacy, according to the Economic Times, refers to the ratio of a deposit-taking institution’s capital in relation to its risk-weighted assets (loans and other credit facilities) and current liabilities (deposits). It is decided by central banks and bank regulators to prevent commercial banks from taking excess risk and becoming insolvent in the process.
As such the RFSR outlines that, “Resilience built up over time in areas such as asset quality, capital adequacy and liquidity has also been a critical aspect of the strength of the financial system during this period as well as the reforms introduced to strengthen the regional financial stability architecture.”
In its review of the regional performance, RFSR indicators show a slight decline in capital adequacy and asset quality and more significant declines in profitability.
“Average capital adequacy in the regional banking system fell off slightly in 2020 but is still much higher than the regulatory minimum. Asset quality fell as non-performing loans (NPLs) increased from 6.2 per cent in 2019 to 6.8 per cent in 2020, but this is still much lower than the levels recorded in the aftermath of the international financial crisis in 2007/2008,” the report reads.
But while capital adequacy held up, the RFSR warns that a longer duration of the pandemic could place a strain on capital resources. To this end, it recommends that both financial institutions and regulators consider improving capital buffers.
At the start of the pandemic in 2020, as demand for consumer and commercial loans waned, banks recognised the possibility of an increase in delinquent loans as activities in some sectors slowed while others halted altogether. As a result, regional banking giants like CIBC FirstCaribbean and Scotiabank introduced loan payment moratoria to stave off an increase in non-performing loans (NPLs), which could have impacted their profitability.
The RFSR also highlights that long periods of lockdowns, as well as the suspension and resumption of lockdowns, “increased uncertainty, and the related losses in income for the household and business sectors have increased credit risks”. The extent of the credit risks, it adds, cannot be determined because of loan payment moratoria, government support measures, and the relaxation of the standards for problem loan classification, “but the potential for significant problems in the areas of asset quality and profitability in the financial sector represents one of the main risks to financial stability in the region”, the report states.
While the report recommends a scaling back on the moratoria on debt repayments, it found that an increase in NPLs could also erode the profitability of deposit-taking institutions.
Another risk it points out is the “unevenly distributed” impact that the COVID-19 shock had on the region. Service-based economies, especially those highly dependent on tourism, were far more affected by the pandemic than their commodity-based economies. This, the report says, will also create uneven recovery among countries, including improvement in employment.
Though oil- and gas-producing countries like Trinidad and Tobago and Guyana felt the impact of falling prices of crude at the start of the pandemic, they have since recovered due to the rebound in demand for such commodities as countries learn to manage living with the virus.
On the other hand, most tourism-dependent countries are still in recovery mode after having to deal with long durations of lockdowns and curfews, the suspension of cruise ship travel, spikes in COVID-19 cases and the emergence of new variants in major travel markets, and enhanced health and safety requirements for port entry, among other challenges.
“Problems on the loan portfolio from the tourism sector amongst the service-based economies is driving much of the fall in asset quality in the region. Moratoriums on loan payments have helped to restrain the growth in NPLs but the full extent of the NPL deterioration caused by the pandemic will only become evident when these end,” the report notes.
The RFSR also warned against cyber attacks and other cybersecurity risks as the pandemic has accelerated adoption of digital technology and the use of e-commerce, escalating sovereign debt and the interconnectedness of financial conglomerates operating in multiple jurisdictions and owning interest in other financial institutions.