BOJ mandates ongoing COVID stress tests for banks

JAMAICA’S BANKING system has adequate capital to absorb unexpected losses that might emerge as a result the COVID-19 pandemic, the Bank of Jamaica, BOJ, has concluded.

Still, the central bank, which undertakes supervision of commercial banks, merchant banks and building societies – which it classifies as deposit-taking institutions, or DTIs – said it has heightened surveillance of the system, with specific emphasis on those banks deemed systemically important.

The objective is to assess the resilience of the sector and to inform the central bank’s policy actions regarding preservation of financial system stability, said Deputy Governor Maurene Simms, head of the Financial Institutions Supervision Division of the BOJ.

The banking system has 11 players – one merchant bank, two building societies and eight commercial banks – valued at $1.8 trillion by assets. Those institutions are capitalised at $192 billion, as at December 2019, the latest BOJ data shows, which amounts to 10.7 per cent of total assets.

Altogether, these institutions hold $1.17 trillion of depositors’ funds, $1.07 trillion of which sits in commercial banks.

Last December, when the coronavirus was starting to emerge as a global problem, and months ahead of its detection in Jamaica, BOJ estimated the capital adequacy ratio for the banking system at 14.3 per cent – which outperformed the regulatory benchmark of 10 per cent.

Amid the pandemic, BOJ has instructed banks to conduct preliminary stress tests and risk assessments, incorporating COVID-19-related scenarios to determine the adequacy of capital and liquidity under those stress scenarios, Simms told the Financial Gleaner via email.

The deputy governor said that in instances where deposit-taking institutions are part of financial conglomerates, those COVID-19-related impact assessments are to be undertaken by the financial holding companies on their local and cross-border operations. Those stress tests should assess the management of risk and adequacy of statutory capital across the financial group on an ongoing basis, she said.

“As the pandemic unfolds, the bank will continue to engage the sector with respect to the outcome of their risk assessments and stress tests, particularly as they continue to refine and adjust these assessments as information regarding the duration and depth of the pandemic emerges,” she said.

Simms said those idiosyncratic “bottom-up” assessments – usually conducted by the banks themselves – are not made available to the public due to confidentiality constraints under the Banking Services Act. However, the central bank’s “top-down” stress tests on the sector, based on prudential reporting by DTIs, are published in its Financial Stability Report annually.

Stress scenarios

The top-down stress tests are conducted routinely to identify systemic risks, said the deputy governor, a process that includes hypothetical stress scenarios, in which capital adequacy is assessed after simulating adverse financial conditions.

The types of stress events considered include large but plausible foreign exchange and interest rate movements, significant depositor withdrawals, sharp increases in non-performing loans, and the simultaneous impact of extraordinary movements in each of the risk factors.

The central bank also assessed the impact of a propagation of shocks, where the failure of one institution affects others. For example, a bank may have loans to another institution and if the second institution fails then those loans become unrecoverable, creating potential problems for the lending bank, the BOJ said.

Simms pointed out that stress test results, published in the BOJ 2019 Financial Stability Report at the end of March this year, showed that capital adequacy ratios for the banking sector remain relatively unchanged after the simulations, indicating that the system was resilient to large shocks, including scenarios where there was a spike in non-performing loans, or NPLs.

These results were largely due to improved loan quality and stronger capitalisation for the review period, the central bank found.

Simms said NPLs to gross loans were 2.4 per cent as at February, at the onset of the COVID-19 outbreak, while provisions for loan losses was 109.4 per cent for the banking system.

“That is, the quality of the loan books of banks is very good going into this pandemic, and banks have provisions in place for every dollar of non-performing loans on each bank’s balance sheet,” she said.

Liquidity coverage ratios, or LCRs, was estimated at 182 per cent in February. The range of LCRs across the institutions ranged from 108 per cent to 295 per cent, Simms said.

“Further, the DTI sector demonstrated strong capital adequacy levels relative to the level of risks being undertaken,” said Simms.

“Banks, therefore, have adequate capital to absorb unexpected losses which may emerge as a result of the impact of the pandemic on their respective business models,” she said.

mcpherse.thompson@gleanerjm.com