Financial Stability Report: A System Check | Barita Insights | April 12, 2021

The Bank of Jamaica (BOJ) conducts an annual assessment of Jamaica’s domestic financial system, which has been empirically proven to underpin economic growth for a country. This 2020 assessment, however, intrinsically carries more weight than previous reports, as this assessment was conducted during an unprecedented global pandemic. This pandemic caused by COVID-19 has been documented to have impacted lives, livelihoods and economies globally. As such, this assessment provides a key understanding of the workings of Jamaica’s financial system and provides us with the necessary insights to guide both our investment decisions and opinion of the financial conditions for Jamaica.

The Role of the Financial System

The financial system is comprised of multiple participants, but the highlight of this assessment is on financial intermediaries. Financial intermediaries are those entities that essentially allocate scarce financial resources towards the most productive sectors of the economy. These financial intermediaries include Deposit Taking Institutions (DTI’s) such as Banks, Securities Dealers (SDs) such as brokerages, Insurance Companies (ICs) and all other institutions that allow for the transmission of financial resources throughout the financial system. It is important to perform assessments of these institutions, as the free movement of capital to the most productive sectors is an important catalyst for economic growth. Left unchecked, events such as the Great Financial Crisis (GFC) will occur more often and with more severe consequences.

System Checks

Broad areas of the financial intermediaries were assessed and covered to essentially allow regulators to have a clear picture of the state in which the financial system is operating. Key findings from the assessment were:

❖ The results of DTIs’ aggregate stress tests showed that the sector was more resilient to hypothetical shocks applied at end-2020.

❖ Network analysis revealed a reduction in the risks to the financial system from interconnectivity. Specifically, there were improvements in the systemic risk score which indicated a reduction in contagion. Similarly, the fragility of the network, due to concentration improved marginally, as evidenced by reductions in the fragility score.

❖ Distribution, Professional and Other Services, Construction and Land Development, Tourism and Electricity accounted for the top five economic sectors that DTIs had exposures to at the end of 2019 and 2020. The Tourism Sector had the largest increase in exposure, accounting for 16.0% of DTIs’ loans to the corporate sector at the end of 2020, relative to 13.4% at the end of 2019, becoming their second largest exposure. DTIs’ largest exposure remained the Distribution Sector.

❖ Against the backdrop of the COVID-19 pandemic, asset quality for DTIs deteriorated during the review period. In particular, the ratio of non-performing loans (NPLs) to total loans, increased by 0.6 percentage points to 2.8% at the end of 2020, relative to the same period last year.

❖ Despite the deterioration in the overall local economic environment caused by COVID-19, subsequently leading to a large GDP contraction, institutions broadly remained compliant with all regulatory measures including but not limited to capital, liquidity and concentration limits. There remains adequate liquidity within the financial system and sufficient capital buffers in place.

Broad Implications

These findings demonstrate the resilience of our financial system in the wake of the COVID-19 pandemic. In particular, the financial institutions remain adequately poised to continue supporting the growth of the economy through the provision of capital. Also, given the high levels of capital buffers, there is adequate shock resistance built into the system, which supported the BOJ’s decision to remove the dividend restriction implemented at the heights of the pandemic. With improvements underway in the overall economy in the form of the vaccination program, increased levels of stopovers in our hospitality sector and increasing capital market activities, we believe that the necessary catalysts may be in place for a recovery in the financial sector. This will be shown in the form of lower provisions or expected credit loss (ECL) and potentially higher quality of earnings. This we expect will translate to improvements in our financial sector stocks which continue to trade at relatively low multiples when compared to the overall market. Given the importance of the financial system to the overall economy, this assessment gives improved confidence in the overall macroeconomic backdrop which will underpin Jamaica’s recovery from this economic slump. However, risks remain within the overall economy when one considers the concentration of exposure to relatively cyclical sectors. Notwithstanding, prudence by institutions and regulators will ensure stability remains over the long term.