J J A A M M A A I I C C A A ’ ’ S S F F I I N N A A N N C C I I A A L L S S Y Y S S T T E E M M : : I I t t ’ ’ s s H H i i s s t t o o r r i i c c a a l l D D e e v v e e l l o o p p m m e e n n t t Prepared by: GAIL LUE LIM Research and Economic Programming Division 2 Bank of Jamaica Copyright @ 1991 by Bank of Jamaica All rights reserved Published by Bank of Jamaica Nethersole Place Kingston, Jamaica, W.I. NATIONAL LIBRARY OF JAMAICA CATALOGUING IN PUBLICATION DATA Lue Lim, Gail Jamaica's financial system Financial institutions .Jamaica Title 332.1'097292 2. its historical development Banks and banking -Jamaica The Earlier Financial System 3 CONTENTS PAGE OVERVIEW 4 THE EARLIER FINANCIAL SYSTEM 5 BANKING SYSTEM UP TO 1969 5 The Currency Board 5 The Central bank 5 Commercial Banks 6 Other Financial Institutions 7 THE FINANCIAL SYSTEM – 1970s AND 1980s 9 The Central bank 9 Commercial Banks 10 Other Financial Institutions 11 Trust Companies Building Societies Life Insurance Companies Credit Unions Government Savings Bank People’s Cooperative Banks THE FINANCIAL SYSTEM – THE 1990s 15 The Central bank 16 Commercial Banks 21 Other Financial Institutions 24 Merchant banks Trust Companies Building Societies Credit Unions Life Insurance Companies Jamaica Mortgage Bank Development Banks People’s Cooperative Banks THE FINANCIAL SYSTEM 2000-2008 35 The Central bank 36 Commercial Banks 38 Other Financial Institutions 40 Merchant Banks Trust Companies Building Societies Credit Unions Life Insurance Companies Jamaica Mortgage Bank Development Banks People’s Cooperative Banks 4 OVERVIEW The development of the financial sector in Jamaica can be divided into four distinct periods. In the beginning, the establishment of financial institutions was influenced by colonisation and the need to provide banking services for merchants who sought to repatriate funds to their homeland, primarily Britain. Because Jamaica was essentially viewed as a source of wealth, as against a haven for savings, many banks which established branches in Jamaica repatriated profits to their head offices overseas. Domestic regulation of the many financial institutions operating in Jamaica was virtually non-existent, with the Currency Board’s only responsibility being the exchange of currency. There was also no participation by Jamaicans in the ownership structure of these foreign banks up to 1967. The establishment of the Bank of Jamaica (central bank) by the Bank of Jamaica Law (1960) and the enactment of the Banking Law (1960) were the first real attempts at a general regulation of banking business in Jamaica. However, in the early period, monetary policy was essentially passive as the authorities sought to ensure a smooth transition that would engender confidence and discourage capital flight. The second phase of development, 1970s-1980, was defined by instability in the international financial system and the ultimate collapse of the Bretton Wood’s system of fixed exchange rate, rapid growth in the level of financial intermediation and number of institutions and the impact of the OPEC oil crisis on the economy. With increasing inflation and a widening current account deficit, the pressures on the country’s foreign exchange reserves was extreme. Consequently Jamaica embarked on a relationship with the International Monetary Fund (IMF) with the first stand-by arrangement in 1973. Jamaica’s relationship with the IMF in the ensuing years defined the Central bank’s monetary policy direction and its relationship with the financial sector. Phase three, the period of the 1990s, can be defined as a period of financial liberalisation, financial sector crisis and financial consolidation. Notably, the high inflation environment which prevailed created a ‘bubble’ in the stock and real estate prices, providing expansionary opportunities for financial institutions. At the same time, weak internal management coupled with poor economies of scale led many financial institutions to take unnecessary risks in order to compete. With the sudden reduction in inflation brought about by demand management polices of the Central bank, many financial institutions faced with a mismatch of assets and liabilities were either forced to wind up or to consolidate their operations. Legislation governing the operations of financial institutions was also strengthened and banking institutions were required to take out deposit insurance in order to restore confidence in the financial sector. Concurrently, the Government created the Financial Sector Adjustment Company (FINSAC), acquired the bad debts of financially unsound financial institutions while selling the remaining good assets to other strong financial institutions. The commencement of the first decade of the 2000s marked a new era for the financial sector. The early years were characterized by consolidation, mergers and closures while there was also a re-emergence of foreign bank dominance. Concurrently, many institutions sought to return to their core business while making significant efforts at improving corporate governance. The 5 assets of the financial system also experienced real growth. Financial institutions were also subject to greater scrutiny. In 2005, institutions involved in securities trading were placed the supervision of the Financial Services Commission (FSC) while deposit-taking financial institutions (DTIs) remained under the supervision of the Central bank. In 2008, financial institutions, particularly those operating in the securities market, were adversely affected by the spill-over effects of the global financial crisis. Whereas the impact on securities’ dealers was direct as many faced calls on their liabilities (margin and repo-arrangements) based on a sharp rise in the yields on GOJ sovereign bonds, the impact on the DTIs was less direct. In the case of the DTIs, which operated under strict prudential requirements, there was a greater impact from the deterioration in macroeconomic conditions which spurred an increase in non-performing loans. In response to the tight credit conditions and the increased demand for foreign currency, the Bank of Jamaica (BOJ) established a credit window for securities dealers unable to source funds to pay out these liabilities. The Central bank also provided intermediation for foreign and local currency “repo” arrangements with financial institutions as it sought to moderate demand pressures in the foreign exchange market. 6 THE EARLIER FINANCIAL SYSTEM BANKING SYSTEM UP TO 1969 A. THE CURRENCY BOARD Between 1939 and 1961, the currency authority in Jamaica was the Board of Commissioners of Currency. Established under the Currency Notes Law of 1939, the Board had statutory authority for the issue of currency notes of the Government of Jamaica. Prior to the establishment of the Currency Board, commercial banks issued their own notes under the Bank Notes Law (1904) which gave these notes legal tender status. Under Law 9 of 1954 the commercial banks were prohibited from issuing notes in their own name. The rights of Barclays Bank DCO were however preserved. The Law 10 of 1958 demonetised all commercial bank notes circulating in Jamaica. B. THE CENTRAL BANK Bank of Jamaica, established by the Bank of Jamaica Law (1960) commenced operations in May 1961 at a time when the country was experiencing a credit boom - hence policies were directed at limiting credit expansion and increases in imports without discouraging inflows of investment capital. Commercial banks were influenced by Bank of Jamaica through regular meetings of the Bankers' committee. With the establishment of the Central bank in 1960, legislation was also enacted for regulation of banking in Jamaica. The Banking Law (1960) represented the first real attempt at a general regulation of banking business in Jamaica. This law made it obligatory for any company wishing to carry on banking business in Jamaica to obtain a licence from the Minister of Finance, to fulfil minimum capital requirements, to make certain information available to the public and to the Inspector of Banks, to maintain reserves at the Bank of Jamaica, and to maintain a specific minimum ratio of liquid assets to deposit liabilities. In the management of the financial system, the Bank of Jamaica was careful to avoid any radical break with the past. Thus, in the initial period, management of the currency issue was allowed to continue with the policy of automatic exchange with sterling being maintained until August 1966, when the Bank of Jamaica Law was amended accordingly. In the earliest years of its development (1961-63), the Central bank was much concerned with maintaining the external equilibrium of the currency as a result of fluctuations in the Bank Rate in the United Kingdom. In 1963, when the Jamaican rate was on par with the U.K. there was an outflow of funds from Jamaica resulting in a fall of over $18 million in the foreign exchange reserves. This situation worsened in 1964, when the U.K. adopted a restrictive monetary policy leading to an increase in their Bank Rate. As a consequence, the Bank Rate in Jamaica was increased to discourage capital outflows. 7 In 1965, the Jamaican Bank Rate was not reduced in keeping with the reduction in the U.K. Rate. Thereafter, the Bank of Jamaica had to adopt measures to protect the reserves, because of the general weakness of Sterling and the prevailing high rates of interest in the U.K. In 1966, the U.K. Bank Rate was increased to seven percent. The Jamaican Rate went from 5 percent to 5½ percent and the outward Commission Rate went from 3/8 percent to 1/2 percent. In 1967, Sterling was devalued and this was followed by devaluation of the Jamaican currency. In order to ensure that the beneficial effects of the exercise accrued to Jamaica and were not absorbed in price increases, the Jamaican Bank Rate was increased from 5½ percent to 6 percent; the inward Commission Rate was reduced to 1/16 percent and the outward Rate increased to ¾ percent. The situation changed somewhat in 1968, in that the commercial banks had considerable excess liquidity due to substantial inflows of foreign funds resulting from the general instability of overseas money markets. The Bank of Jamaica then established the SPECIAL DEPOSITS FUND and the Bank Rate was lowered by 1 percent to stimulate borrowing for productive purposes. By 1969, the international monetary situation had become stable and funds once more began flowing from Jamaica. However, increasing interest rates overseas caused foreign firms operating here to borrow locally and because they were able to offer better securities than most Jamaican firms, they were given preference; the result was a diversion of funds from domestic to foreign owned enterprises. Because the expansion in credit grew at an enormous rate, the Central bank directed the commercial banks to restrict total credit to the level existing at the end of December 1969 and also to restrict credit to non-residents and foreign controlled firms. The commercial banks had to borrow from the Central bank because higher rates prevailing overseas made it less profitable for the head offices to lend in Jamaica, and in most countries there were restrictions on capital export. C. COMMERCIAL BANKS The Bank of Jamaica (no relation to the present Central bank) was the first commercial bank to operate in Jamaica. The bank was established in May 1836 by merchants in England with business connections in Jamaica. Whereas the House of Assembly granted the bank a charter of incorporation authorising a nominal capital of £300,000 and with limited liability, the United Kingdom Government subsequently disallowed the charter. Notwithstanding this, the bank continued to operate and prosper and by 1846 had six agencies in the island. The Colonial Bank, incorporated in England in 1836, commenced operations in May 1837 and at its inception introduced bank notes into the monetary system alongside the then existing island cheques issued by the Receiver General. In 1839 the Planters Bank was established primarily to cater for the needs of the sugar planters and by 1846 had eight branches operating. However, with deteriorating economic conditions and the bank itself over-extended, the institution was forced to liquidate operations in 1848. By 1864, the Bank of Jamaica, closely affiliated to the sugar industry, also succumbed to the deteriorating economic conditions and terminated its operations. With improvements in the economic conditions of the island in the late 1880's and increasing trade with Canada, many Canadian banks established branches on the island, 8 increasing the level of financial intermediation. The influx of new banks however did not seem to result in much competition for deposits. In fact many banks did not seek to mobilise saving and idle balances as they did to finance trade and imports, and for many years approximately 50 percent of funds raised on current and deposit accounts were by gilt-edged investments. However, the situation was undesirable as occasionally substantial amounts were applied directly from profits to write-down the value of investments. In 1926 Sterling's Bank commenced operations, but failed by 1927. With the failure of banks on the increase, and the lack of provisions to safeguard depositors, the Bank Laws were subsequently revised. Up until 1959 there were no American banks operating in the country. In 1960, however, First National City Bank established a branch in Kingston. Subsequently, two other banks with American connections commenced operating in Jamaica. By 1961 commercial banking was well-developed in Jamaica. The banks offered current accounts; time and savings deposit facilities, made advances for a wide variety of purposes and tendered a wide range of services. They were particularly active in financing of export agriculture, imports, hotel development and the provision of working capital for industry. They offered rediscounting facilities (mainly foreign bills). In the early days, the financial system was characterised by the ease with which Jamaican currency could be converted into sterling. Commercial banks' policies, in the absence of a central bank were determined primarily by their head offices overseas. At the end of 1961, net foreign indebtedness to overseas head offices amounted to US$12.8 million. The participation of Jamaicans in the ownership of these foreign banks was however non- existent prior to 1967 when a system of "pure" branch banking operated in Jamaica. In December 1966 the Bank of Nova Scotia was incorporated in Jamaica with 25 percent of shares sold to the Jamaican public, representing the first local participation in a foreign bank. At the end of 1969, the list of commercial banks operating in Jamaica was as follows: Bank of Nova Scotia Barclays Bank DC Canadian Imperial Bank of Commerce Bank of London & Montreal Limited First National City Bank of New York Jamaica Citizens Bank These banks were branches of international banks and together had 106 branches across the island with main offices in Kingston. 9 D. OTHER FINANCIAL INSTITUTIONS a. Trust Companies The trust companies commenced their operations in Jamaica in the early 1960s as commercial bank affiliates. At the end of 1969, only one trust institution (West Indies Trust) operated independently of commercial banks. The development of these institutions in the 1960s coincided with the start of the building boom when there was a high demand for residential mortgages. The resources of these institutions consisted mainly of local deposits, bank borrowing and share capital subscribed by the parent commercial banks. Their lending activities were concentrated in long term mortgages although the lending activities of the non-affiliated company were more varied and included some consumer credit and other short-term credit normally provided by commercial banks. b. Building Societies The building society movement also expanded significantly during the credit boom period of the early 1960s as demand for mortgage financing grew considerably. Between 1961 and 1969 the number of such institutions grew significantly notwithstanding a number of mergers of the smaller companies to facilitate expansion in their operations. c. Life Insurance Companies A rapid expansion of the life insurance companies also coincided with the boom of the building and construction sector. For example, between 1960 and 1963 total premiums paid on life insurance policies grew at a faster rate than the levels of savings in commercial banks. The insurance companies in turn invested a significant proportion of these savings in government securities and in 1963 were responsible for 18.6 per cent of Local Registered Stocks (LRS) issued that year. The support of local stock issues by life insurance companies in particular provided considerable assistance to the development of the capital market as encouraged by Bank of Jamaica. During FY1964/65, the Government introduced a number of measures affecting the insurance industry in continuation of its policy of strengthening and improving financial institutions. Included in these efforts was the Motor Vehicle Insurance (Third Party Risk) Amendment Act of 1964 which was enforced on July 16 and which required the registration of all motor vehicle insurers in Jamaica. d. Credit Unions The first credit union in Jamaica commenced operations in 1941 with 98 members. In 1942, the Jamaica Co-operative Credit Union League was established. By the end of 1969 the number of institutions had grown to 132. The credit union movement was seen as important to the provision of cheap funds to low income earners as well as to provide a source of financial advice for small upcoming business entrepreneurs. In addition, these institutions were exempt from income tax, a factor which also propelled the growth of these institutions. 10 e. Government Savings Bank The Government Savings Bank (GSB) was established in 1870 to control and operate a number of private banks then in existence. The bank, with a great network of branches (later through the postal services) provided a place of safe-keeping for the funds of the many peasants in the early plantocracy. In 1932, the GSB was organised as a separate government department with its own management and staff appropriate to the needs of a savings bank. By 1957, the investment policy of the bank was altered, enabling it to invest its deposits in Local Registered Stocks issued by the Government of Jamaica instead of other Commonwealth securities. With the expansion of commercial banking in the 1960s however, the growth of these institutions slowed significantly as the foreign owned institutions brought with them more sophisticated financial services and improved returns on savings. At March 1960, the level of deposits of the GSB was J$9.5mn while loans and withdrawals were J$10.3mn and J$9.2mn, respectively. By 1968 the level of deposits had only grown to J$11.6rnn while loans and withdrawals were $17.5mn and $11.0mn, respectively. f. People’s Cooperative (PC) Banks The first People’s Cooperative bank was established in Christiana, Manchester (rural Jamaica) on 19 April 1905. The initial modus operandi of the PC bank was to act as a banker, bill discounter and dealer in stocks, shares, bonds mortgages, debentures and other securities as well as to provide advances for cooperative and agricultural programmes. In the early years, membership and savings grew rapidly, coinciding with the expansion of the agriculture sector (sugar cane). By the end of the 1960s the financial system was comprised of: Commercial Banks Trust Companies Building Societies Life Insurance Companies Credit Unions Government Savings Bank People’s Cooperative Banks The medium-term market was virtually non-existent with commercial banks meeting such loan demands through short-term overdrafts. [...]... and development funds In light of the high interest rates which prevailed in the system even after the hurricane, this less expensive source of funds became even more 17 attractive Trafalgar Development Bank The Trafalgar Development Bank, Jamaica's first privately owned development bank, commenced operations in May 1985 The Bank offers medium and long term loans, lease financing as well as project development. .. portfolio of the PC banks was very modest 18 THE FINANCIAL SYSTEM – THE 1990S By the beginning of the 1990's the financial system in Jamaica comprised of: Commercial Banks Merchant Banks Trust Companies Finance Houses Credit Unions Building Societies Development Banks Agricultural Credit Bank (Government) National Development Bank (Government) Trafalgar Development Bank (Private) People’s Co-operative.. .FINANCIAL SYSTEM IN THE 1970S AND 1980S Against a background of instability in the international financial system during the early 1970s, there was rapid growth in the level of financial intermediation through establishment of new institutions in Jamaica during this period By the end of 1979 the financial system had expanded to include: Merchant Banks... government securities as it too was affected by the prevailing high interest rate environment f Development Banks Agricultural Credit Bank / National Development Bank Both the Agricultural Credit Bank (ACB) and the National Development Bank (NDB) were established in 1981 These institutions, born out of the Jamaica Development Bank which commenced winding-down operations soon after, were created primarily... contributed to the failure of some financial institutions in the late 1990s A THE CENTRAL BANK (BANK OF JAMAICA) The role of the central bank in directing orderly growth of the financial system was paramount in the 1980s and early 1990s In a context where rules for entry to operate specific financial institutions were fairly relaxed, there was not only the emergence of new financial institutions, but expansion... development of new product offerings Many players with little or no financial market experience or qualifications saw the financial sector as an opportunity to make exorbitant profits Further, sharp differences in the rules governing the activities of the different institutions had significant influence on the activities of many institutions and eventually impacted on the overall soundness of the financial. .. risks, one of the factors contributing to the financial sector crisis in the latter half of the 1990s, as they sought to find innovations that could enable them to capitalise on weaknesses in the regulatory environment Therefore, by 1994, in context of liberalisation and deregulation, there was a noticeable reshaping of the financial system The so-called “pure” financial institution had all but disappeared... Concurrently, regulation of the Jamaican financial sector, up to 1996 (in the period running up to the financial sector crisis), was largely undertaken from a purely institutional standpoint, that is, legislation was institution specific Commercial banking institutions were governed by the Banking Act (which was subsequently amended in 1992)1; non-bank/licensed financial institutions - The Protection... deposit resources among financial institutions continued throughout the 1970's as economic conditions worsened With credit expansion in the second half of 1973 generating serious inflation, the monetary authorities were forced to place restrictions on the operations of financial institutions As a consequence, guidelines were issued restricting trust companies and other specified financial institutions... Export Import Bank (EXIM-formerly JECIC) Financial sector expansion in the 1990s must be viewed in the context of the prevailing macroeconomic environment which was characterised by high inflation, marginal GDP growth, high interest rates and a depreciating exchange rate Growth in financial intermediation was also facilitated by the relaxation of controls under the financial liberalisation programmes of . Jamaica's financial system Financial institutions .Jamaica Title 332.1'097292 2. its historical development Banks and banking -Jamaica The Earlier Financial System. restore confidence in the financial sector. Concurrently, the Government created the Financial Sector Adjustment Company (FINSAC), acquired the bad debts of financially unsound financial institutions. Life Insurance Companies Jamaica Mortgage Bank Development Banks People’s Cooperative Banks 4 OVERVIEW The development of the financial sector in Jamaica can be divided into four