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INTRODUCTION Recent direct Government intervention in Jamaica's financial sector began in December 1994 when the Minister of Finance assumed temporary management of the Blaise Financial Entities. This was followed by the assumption of temporary management of the Century Financial Institutions in July 1996. In the same month, representatives of the life insurance industry approached Government and requested assistance to address problems which had emerged in the sub-sector. As a result of the Blaise and Century interventions and the request for assistance by life insurance companies, a team was asked to determine the extent and nature of the financial sector's problems and to develop appropriate solutions. The team was of the view that the problems in the banking and life insurance sectors were caused by a mismatch of asset and liability maturities, diversification away from core business, high operating costs and financial conglomerates. Mismatch of Asset and Liability Maturities Banks used deposits and insurance companies sold deposit-like policies to fund the purchase of long-term assets such as real estate. This approach to financial management represented a departure from traditional bank (or deposit liability) and insurance management. With tighter liquidity management and the attendant low inflation, much closer scrutiny of the maturity profiles of assets and liabilities is demanded of managers in the financial sector. Many domestic financial insitutions did not have the necessary risk and financial management capabilities to carefully assess the risk. As a result, they were left holding real estate and other long-term assets that could not be easily disposed of to meet their short-term obligations. Diversification Away from Core Business Banks and life insurance companies tended to invest in enterprises that were outside the scope of their core business. This had the following implications:
Because of these factors, depositors funds were placed at risk even where affiliated non-core businesses were potentially lucrative. High Operating Costs Many financial entities faced high fixed costs particularly in respect of real estate and employee compensation. In the insurance sector, a related problem stemmed from compensation arrangements for sales agents with significant up-front commissions that delayed returns on insurance policies to later years. These factors impacted negatively on the profitability of life insurance companies and banks as well on the costs of their services to the public. Financial Congolomerates Groups of financial entities emerged to take advantage of regulatory arbitrage (in respect of taxes and reserve requirements) between different types of financial institutions. As part of this trend, major life insurance entities began to own banks. When faced with liquidity problems, these life insurance companies would induce the banks to provide loans often on favourable terms and in excess of legal lending limits. Task Force Recommendation Based on the depth of the problems, the high level of linkages between the banking and the insurance sectors, and the level of lending to connected parties emerging from the analysis, the task force recommended that Government should intervene. The team specified that this intervention should be comprehensive and should address the problems of liquidity and insolvency as well as problems related to weak management, the structure of ownership and control and the regulatory framework. The Government of Jamaica established FINSAC in January 1997 to undertake these functions. Upon its formation, FINSAC embarked upon a three-phased course of action - intervention, rehabilitation and divestment.
The first phase required FINSAC to infuse fresh capital into ailing banks and life insurance companies in exchange for equity and board seats. This phase, which FINSAC has now largely completed, has left FINSAC with equity and/or board seats in four of the island's nine commercial banks, five of its twelve life insurance companies and two merchant banks. For each of these financial institutions, FINSAC's capital contribution has ensured that its depositors or insurance policyholders are protected. In addition, through conditionalities attached to its interventions, FINSAC reduced the interrelationships between banks, insurance companies and other financial sector entities, including "connected-party" lending. A substantial portion of FINSAC's assistance is in the form of Government guaranteed securities. Government has retained the option to service the interest by issuing additional securities. Over time, FINSAC expects to service and recover most of the amounts which have been provided or committed to the financial sector through the disposal of assets and collateral it now holds. REHABILITATION The goal of FINSAC's second phase -- the Rehabilitation Phase -- is to sustain depositor and policyholder confidence in Jamaica's insurance and banking sector. This requires more transparent and market oriented relationships between Jamaican banks and borrowers. Through its intervention, FINSAC requires entities to strengthen credit evaluation systems, financial management and loan portfolio management and to implement superior internal accounting controls. As part of the rehabilitation, FINSAC committed to purchase the non-performing loan portfolios of some banks in exchange for FINSAC Bonds. The banks will act as FINSAC's initial collections agents for the loans and have agreed to step-up their collections and workout efforts to maximize FINSAC's return on the portfolios. By June 1998, with the assistance of the Inter-American Development Bank (IDB), FINSAC will also establish an internal unit for the collection of certain loans and for the monitoring of the third-party collections agents. By their nature, non-performing loans are of uncertain value and difficult to manage. FINSAC's goal in purchasing the non-performing loans is to improve the banks' balance sheets, replacing them with FINSAC Bonds guaranteed by the Government of Jamaica. This will restore depositor confidence and make the banks more marketable for divestment. A number of countries with financial sector difficulties have taken this approach. Purchasing the loans does not in any way relieve the banks of their obligation to manage and collect the loans or debtors their obligation to repay. Instead, through FINSAC, these obligations will be intensified. Significant steps have been taken to better regulate the banking and insurance industries. In October 1997, amendments to the Banking, Financial Institutions and Building Societies Acts were passed by Parliament providing faster and broader powers of intervention to the supervisory authority. Amendments include:
In March 1998, Parliament passed the Deposit Protection Act which will establish the Jamaican Depositor Insurance Protection Corporation. This institution will insure deposit liabilities up to a maximum of $200,000. The operation of this scheme will make the continued operation of FINSAC unnecessary and will ensure that small depositors are protected without putting pressure on the budget. The process of strengthening the regulatory framework will continue in FY 1998/99 as bills to amend the Bank of Jamaica Act and the Industrial and Provident Societies Act are being debated in Parliament. In addition, FINSAC has launched a project to reform the insurance supervision agency. The project, jointly funded by FINSAC and the IDB, will rationalize and upgrade the Office of the Superintendent of Insurance (OSI), introduce new laws to regulate insurance companies and pension funds, and computerize the financial reporting by insurance companies and pension funds to the OSI. Ultimately, the OSI will be able to conduct timely computerized analyses of the financial health of insurance companies and detect early warning signs of financial instability. Moreover, with new and graduated enforcement powers, the OSI will be able to respond quickly and appropriately to deteriorations in the liquidity or solvency position of insurers. The project, to be completed in the year 2000, will ensure strong regulation of the insurance sector and instill confidence in policyholders. DIVESTMENT FINSAC's third and final phase -- the Divestment Phase -- is already underway. This phase involves the quick, orderly and transparent return of assets held by FINSAC to the private sector. FINSAC is examining divestment approaches and seeking potential purchasers for its bank and insurance company holdings. The institutions will be divested with a view to maximising the selling price and ensuring that the resultant configuration of the financial sector (the number and size of financial institutions and their ownership and capitalization) is optimal. In addition to the direct sale of its holdings in financial institutions, FINSAC is working to sell collateral assets -- hotels, small non-core businesses and real properties -- owned by the assisted financial institutions. This will ensure that the financial institutions continue to have the liquidity required to meet their depositor, policyholder and pension fund obligations as they fall due. It will also improve the chance of accelerated repayment of FINSAC assistance and the payment of dividends on FINSAC's equity holdings. For the collateral assets, FINSAC will conduct due diligence, value the assets, prepare offering memoranda targeted at local and/or international markets as appropriate, propose divestment structures and identify suitable investors. FINSAC receives funding from the IDB for local and international real estate advisory services in connection with the structured divestment of large hotels. FINSAC expects to complete due diligence, valuation and structuring of the sales of these properties by June 1998. CONCLUSION The most significant difficulties in the financial sector have been identified and appropriate remedial measures have been implemented. Through Government intervention, the financial sector difficulties have been weathered with no appreciable capital flight. Though deposits shifted between banks, they remained in Jamaica. Through FINSAC's rehabilitation efforts and an improved regulatory environment, Jamaica's financial sector is returning to stability. Government's intervention has resulted in the protection of savings of thousands of depositors, pensioners and workers whose pension funds are invested and managed by an insurance company. The re-emergence of confidence in a stable financial sector will facilitate the mobilisation of savings for investment which will lead to economic growth and development. || Previous | Table of Contents | Next ||
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