Barbados should brace for future financial fallout from the CLICO debacle it is now trying to resolve.
A group of International Monetary Fund economists believe that while a new type of supervision based on forecasting the likelihood of such crises before they happen was necessary, resolving the current problem which dates back to 2009 would “weigh on economic activities in the region”.
In a new working paper on the topic Financial Interconnectedness and Financial Sector Reforms In The Caribbean released today, Sumiko Ogawa, Joonkyu Park, Diva Singh, and Nita Thacker of the IMF’s Western Hemisphere Department also said strong financial linkages across the region necessitated reform aimed at bolstering regulations.
In the case of CLICO, which Barbados and other islands, including St. Lucia, are trying to resolve, the IMF team suggested that whatever the outcome challenges would remain.
“Most Caribbean authorities have been forced to intervene on this issue, in order to minimise the negative impact to policy holders and creditors. While these actions can contribute to stabilising the financial system in each jurisdiction, they may also increase the risk of “moral hazard” in market participants’ behaviour,” they said.
“This clearly suggests that an ex ante approach (based on forecasts) to mitigating systemic risk, through consolidated risk-based supervision, is crucial to ensure financial stability.
“The authorities’ bailout might entail significant fiscal resources, adding pressure to already high public debts in many Caribbean countries. Increased fiscal burdens, along with other debilitating factors such as sluggish tourism sectors and elevated commodity prices, will weigh on economic activities in the region,” the economists cautioned.
The researchers said the CLICO episode “highlighted a number of gaps in financial sector supervision and related safety nets in the region”.
“CLICO’s failure revealed its inadequate risk management and weak corporate governance system,” they noted.
“The existing supervisory framework was not adequate to detect the company’s excessive risk-taking activities and complex related party transactions in a timely manner, implying the need for more sophisticated supervision of financial conglomerates.” And with Barbados and a number of its neighbours heavily dependent on the financial sector, the IMF economists said this could be a double edged sword.
“Financial sector linkages have increased continuously in the Caribbean with cross border capital flows and financial conglomerates dominating the financial system,” they pointed out.
“While the greater interconnectedness can heighten systemic risks and likelihood of contagion, it can have positive impacts provided the regional authorities take steps to prevent the systemic risk.
“In this context, financial sector reform measures aimed at bolstering and harmonising prudential regulations in line with international best practices, the strengthening and enhancement of financial sector supervision to include cross border linkages through consolidated supervision, increased cooperation across supervisors in the region, and the establishment of deposit insurance and crisis resolution frameworks will be critical to maintain financial sector stability and minimise the repercussions of any negative shocks,” they advised. (SC)