IMF Publishes Reports Assessing Financial System Stability in Bahamas
IMF published a report on results of the Financial System Stability Assessment (FSSA) of Bahamas. IMF also published its staff report under the 2019 Article IV consultation, along with two technical notes and a report on the detailed assessment of observance (DAO) of Basel core principles for effective banking supervision (BCPs) under the Financial Sector Assessment Program (FSAP). One technical note covers assessment related to financial stability and stress testing while the other note is focused on financial inclusion, retail payment, and small and medium enterprises (SME) finance.
The FSSA report highlights that Bahamas appears to be resilient to the current threats to its financial stability, but action is needed to safeguard against potential weaknesses. The banking sector dominates the financial system and has focused on residential mortgages and consumer loans during a long period of economic stagnation. High aggregate capital and liquidity ratios serve as strong buffers against systemic shocks, but some individual banks have large amounts of problem assets that leave them vulnerable. The system-wide capital adequacy ratio (CAR) stood at 32%, well above the 17% regulatory target. The aggregate level is raised by a large foreign bank with over 50% of CAR. Despite capital levels being well above the regulatory minima, commercial banks with large nonperforming loan (NPL) stocks are potentially weak under severe stress conditions. The NPL ratio remains high at 9%, after peaking at 15.3% in 2013. The situation varies significantly across banks, with three institutions owning 61% of all NPLs. The large stock of restructured loans is at an increased risk of falling back into the nonperforming status.
Credit risk dominates the interest rate risk in a largely floating rate environment. Under the rising interest rates, debt-servicing capacity will fall, potentially boosting NPLs and lowering earnings. Top-down stress test scenarios were developed using local risks and vulnerabilities to assess solvency, liquidity, and contagion risks at the domestic banks and the two largest credit unions, which cover about 97% of all credit institution assets. Solvency stress tests suggest that the overall banking system is resilient to a range of adverse scenarios, but weaknesses widen under severe stress. The banking system shows resilience to market risk, while liquidity tests reveal a shortfall in one bank. Central Bank of The Bahamas (CBOB) has updated its capital regime and is now largely in line with the key aspects of Basel II standards. The required regulatory capital ratios are super-equivalent to Basel. Credit, operational, and market risks are now all captured in capital requirements and CBOB issued guidelines on Internal Capital Adequacy Assessment Process (ICAAP) in 2016 to address risks that not well-captured by the regulatory regime.
The report recommends that systemic risk oversight should be strengthened to address potential buildup of vulnerabilities. The authorities should consider implementing a macro-prudential capital buffer for banks. CBOB should consider introducing a macro-prudential capital buffer above a core common equity tier 1 requirement. CBOB is moving to a Basel III-compliant capital standard. The FSAP recommends a fixed macro-prudential capital buffer instead of a dynamic countercyclical capital buffer (CCyB). A CCyB designed to counter time-varying systemic risks would be difficult to implement, given the complex analytical and data requirements associated with its calibration. A static capital buffer (beyond the international minima) would require less timely data and analytical effort and would be relaxed only in the event of a significant shock. The overall banking supervision is effective, but CBOB needs to improve practices in some macro-critical areas. Given the key importance of NPLs, supervisors should continue strengthening industry practices on credit risk management, assessment of problem assets, loan-loss provisioning, and internal assessments of capital adequacy. The legislative reform of crisis management, resolution, and safety net needs to be completed, as the recent recapitalizations of a majority state-owned bank highlight the critical need to improve recovery and resolution procedures.
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Keywords: Americas, Bahamas, Banking, Insurance, FSSA, Article IV, FSAP, Technical Notes, Basel III, Systemic Risk, Stress Testing, Credit Risk, Macro-Prudential Policy, BCPS, Central Bank of Bahamas, IMF
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