The Financial Gleaner continues the series, 'Anatomy of a crisis', an examination of the 1990's financial sector crisis
"In trying to ensure a safe and sound banking system, it is a fundamental error to rely on regulation and supervision alone. If the banking system is structurally vulnerable and if the economic environment is highly volatile, no amount of regulation and supervision can prevent banking problems. Minimising macroeconomic volatility through sound fiscal and monetary policies, is the basis for a sound financial sector."
World Bank Report, "Wider Caribbean Financial Sector Review, May 26, 1998
AS MANY have contended, a clear relationship can be traced between existing economic conditions and many of the problems experienced by sections of the financial sector in Jamaica. Again, much of the responsibility falls at the feet of the Government, but even so, it bears noting that when faced with the same conditions, the principals of the island's foreign-based banks enjoyed vastly better fortunes than their local counterparts.
Was it simply a matter of a more prudent and conservative approach, kept in check by control systems in line with international standards? At the onset of the crisis, tightened monetary policies, high interest rates, and the related recession of the 1990's, exposed the maturity mismatch of assets and liabilities that had contaminated much of the sector.
Before buying into the theory that high-interest-rate conditions was the primary culprit of the crisis, therefore, one must question the quality of the sector's asset portfolio, the general composition of which pre-dated the onset of a period of climbing interest rates. Insurance companies had used short-term commercial paper to make long term investments, largely in real estate; and then rising interest rates reduced the relative return on these fixed assets, reducing the market value of said assets. Insurance companies started borrowing heavily from their connected banks to finance interest payments on short term deposits, and had to keep borrowing more as their investors withdrew funds in the face of greater perceived risks to those deposited funds.
Faced with this liquidity strain from the insurance sector on one hand, the banks also ran into a crunch with their own regular customers on the other. As the recession and declining sales reduced the ability of debtors to service increasingly costlier debt obligations, the already suspect loan portfolio of several banks began to crumble, and the domino effect began.
The first commercial bank to suffer severe liquidity problems was Century National Bank, and IMF reports reveal that a 1995 on-site inspection by the BoJ revealed a shortfall in assets of over $1 billion. By mid 1996, when Government imposed temporary management, the Century Group had amassed central bank overdrafts of over $4.3 billion (then nearly 2 per cent of GDP). This staggering overdraft figure was later to be matched by the Workers Bank group in 1998.
Rumours of insolvency sparked a run on Citizens Bank in December 1996, and in February 1997 there was a run on Eagle Commercial Bank. In the following month, the Eagle Group, and its accumulated debt, was to be sold to FINSAC, which had been created in January 1997. The sale price was one Jamaican dollar. In the early 1990's, the Government of the day had plunged headlong into liberalisation before creating an adequate policy framework along the way, and the many loopholes that emerged in the new dispensation fuelled the reckless expansion of the financial sector.
As one local analyst put it, " there is usually only one thing worse than doing the wrong thing, or doing nothing at all it is doing the right thing and doing it badly. In the management of the Jamaican economy, successive governments, especially this one, have been guilty of all three." One major flaw in the timing and sequencing of liberalisation was the fact that foreign exchange controls were lifted at a time when the Bank of Jamaica had negative foreign reserves, minus $443 million in 1991, and minus $67 million in 1992. Piloted by then Finance Minister P.J. Patterson, these controls started being dismantled in September 1990, in a period when the central bank was in no position to be a dominant player in the foreign exchange market, and could exercise little influence in maintaining a stable exchange rate. Directly under Mr. Patterson's watch, the weighted value of the local currency against its US counterpart skyrocketed from $7.90 at the end of September 1990 to $27.38 by the end of March 1992, fuelling an unprecedented surge in inflation to over 80 per cent for the 1991/92 fiscal year. This particular sequence of economic events played a key role in incubating the crisis that ensued, and both public and private sector Jamaican authorities, as well as all the regular commentators, seemed to have either underestimated or totally ignored the dangers. At a Rotary Club function at the Terra Nova hotel on Wednesday June 20, 1990, Grace Kennedy boss Douglas Orane stated clearly that under ideal circumstances, the country should first clear the arrears in foreign exchange allocations made by the central bank and have some reserves before embarking on such a liberalisation programme " He then went on to say, however, that, "Jamaica could not afford to wait for such an ideal situation " In the February 1994 issue of the now defunct Money Index magazine, then Bank of Jamaica Governor Jacques Bussieres also hinted at some concern about the timing of liberalisation, noting that it was " slightly different from the ideal pattern." Bussieres, however, stopped short of publicly recommending an alternate course of action.
While he discounts it as a major contributing factor because it had some pros as well as cons, Gladstone Bonnick acknowledges
that the 1991 liberalisation of the capital account in Jamaica is also among the reasons behind the crisis cited by several other observers. As Bonnick indicates, it seems to be a given that capital account liberalisation can be an attractive option for developing countries because of the benefits it can bring. What did not seem to be very clear to many until after the fact, however, is the gravity of the risks involved if that liberalisation is undertaken in the absence of the relevant safeguards.
The authorities cannot say no one warned them, however.
At a seminar on the Jamaican economy at the Jamaica Pegasus on July 1, 1992, former Barbados central bank Governor Courtney Blackman noted that, "the Jamaican economic liberalisation programme involving a floating exchange rate appears overly ambitious in the context of such a thin and shallow foreign exchange market - given the decision to embark on a programme of liberalisation, the authorities seem to have moved with undue haste - they have ignored the strictures of McKinnon that the restoration of fiscal stability must precede financial liberalisation." Waxing prophetic, Blackman also charged, " the implementation of an economic liberalisation programme is, at best, fraught with peril. In the context of an economy under stress for so many years, the Jamaican authorities can look forward to many anxious moments over many years, and her citizens to a really rough ride."
Most other warnings, however, came either too late or after the fact.
In a 1996 policy paper of the Bank for International Settlements (BIS), Changing Financial Systems in Open Economies: An Overview, economists Philip Turner and Jozef Van 't dack argue, " deregulation and reform of the domestic financial market should precede the liberalisation of the capital account of the balance of payments." IMF economist R. Barry Johnston, in a 1998 paper, 'Sequencing Capital Account Liberalisation and Financial Sector Reform' makes the following comments:
" as countries liberalise their capital account, and dismantle exchange controls, it may be necessary to introduce new laws and regulations, or update existing ones additional urgency should be attached to financial sector reforms when a country begins to liberalise its capital account, because of the pressures this will place on the domestic financial system.One element of such reforms will be to strengthen the environment in which markets can function through appropriate regulation and supervision."
A fact sheet on 'Financial System Soundness', published by the IMF and dated March 30, 2000, includes a list of "sources of financial system problems." Most of the listed factors sound like a pre-crisis checklist for the Jamaican scenario:
Weak internal governance in banks fosters excessive risk taking and leaves them vulnerable to macroeconomic shocks.
Financial deregulation, competition, and innovation can outstrip regulatory and supervisory capabilities as well as the capacity of banks to manage risks prudently.
Capital account liberalisation [that] occurs before supporting macroeconomic policies are in place and the soundness of the domestic financial system is assured.
Excessive corporate indebtedness and connected lending can lead to sudden deteriorations in financial institutions' asset quality.
