In furtherance of its objective to maintain confidence in, and promote the safety and soundness of, the domestic financial sector, the Central Bank on Friday published its Financial Stability Report for 2014.In the report, the Central Bank identified four key risks currently being faced by T&T's financial system: the impact of a sharp and persistent fall in energy prices; household financial stress and correction in house prices; a spike in long-term US interest rates; and debt restructuring by a Caribbean country.
Quite helpfully, the Central Bank report provides a heat map analysing the likelihood of each risk occuring and its potential impact on the stability of the financial sector.The important risk identified was "a sharp and persistent fall in energy prices." The probability of such an eventuality was described as very high and its impact high.
There is no doubt that the report contains useful information and insights into how the Central Bank carries out its mandate to maintain the stability of T&T's banks, insurance companies, pension plans, mutual funds and the National Insurance Board.But it could be that in concluding that "the most important risk facing the financial system in Trinidad and Tobago is a sharp and persistent fall in energy prices," the Central Bank took a surprisingly ahistoric approach to the issue of financial risk assessment.
It should be obvious that T&T has experienced "sharp and persistent falls in energy prices" before as this perfectly describes the experience of this country in the period from 1983 to 1990.Yet the historical evidence is clear that the main reason financial institutions in that period failed was not because of the decline in the country's main export earnings or even as a consequence of the fall in living standards suffered by thousands of households in that period.
Three banks failed here in the early 1990s because of the quality of the loans they made, the inadequacy of collateral they demanded and the flawed assumptions that were made about increasing incomes. At its core, the failure of financial institutions in this country has been about shortcomings in oversight and supervision of loans and a disregard of prudential guidelines.
It is this shortcoming–which can be described more broadly as a failure of corporate governance–that accounts (in part) for the collapse of the insurance company Clico and its sister company Clico Investment Bank.But the failure of internal supervision and oversight is not unique to T&T.
Jamaican financial institutions did not collapse like nine-pins in the early 1990s because the government there raised interest rates to combat skyrocketing inflation. They collapsed because of unrealistic valuations of real estate collateral, the mismatch between short-term deposits and longer-term loans and a proclivity to lend large sums of money to related parties.
In both the T&T and Jamaica cases, the financial institutions that conducted their business with probity, restraint and prudence survived the economic shocks, while those that did not conduct themselves in that way met their predictable demise...with consequences that are still being felt in Jamaica today.The history of the failure of financial institutions in the Caribbean suggests that the Central Bank should be focusing as much on internal controls and supervision as on the macro-prudential issues.
The discussion in the Financial Stability Report on loan-to-value ratios as a macro-prudential tool is very interesting but it needs to be quickly translated into policy after a short period of meaningful consultation.The Central Bank should also be reporting on whether the Government's failure to pass legislation introducing new regulatory regimes in the insurance sector, the credit union industry and among occupational pension plans is having any impact on the overall stability of the financial sector.
Finally, the Central Bank should have used the opportunity presented by this report to reflect on the lessons learnt from the collapse of Clico and CIB. It simply is about time.