Caribbean Warned To Put Measures In Place To Deal With Increased Financial Integration

WASHINGTON, D.C. CMC – Caribbean countries have been warned that while increased financial integration has facilitated the flow of funds and allowed regional countries to overcome scale constraints, the increased interconnectedness has also built systemic risks and increased the likelihood of contagion.

An International Monetary Fund (IMF) Working Paper examining the “Financial Interconnectedness and Financial Sector Reforms in the Caribbean” notes that financial sector linkages have increased continuously in the Caribbean with cross border capital flows and financial conglomerates dominating the financial system.

The paper said this has occurred largely through foreign banks’ dominant presence, mainly by Canadian banks, and foreign participation in insurance markets and pension funds, securities trading abroad and direct borrowing of domestic firms in international markets.

However, it notes that most of these developments have been without any formal agreements, with the exception of the Eastern Caribbean Currency Union (ECCU), where there is a common central bank and common stock and government securities markets.

Barbados, Jamaica, Organization of Eastern Caribbean States (OECS) and Trinidad and Tobago, also have an agreement to cross list securities on their stock markets.

“While increased financial integration has facilitated the flow of funds and financial intermediation, and allowed the Caribbean countries to overcome scale constraints, the increased interconnectedness has also built systemic risks and increased the likelihood of contagion,” said the authors of the paper, Sumiko Ogawa, Joonkyu Park, Diva Singh, and Nita T.

They said this was evident most recently when the collapse of the Trinidad-based conglomerate, CL Financial Group sent repercussions throughout the Caribbean region.

“The collapse of the CL Financial Group highlighted two important broader issues. First, there is little information and systematic analysis of the interconnectedness between financial institutions and the systemic risks arising from this interconnectedness.

“Second, there is a critical need for financial sector reforms, including to: (i) enhance supervision on both banks and non-banks, and harmonize supervisory standards; (ii) develop a coordinated approach to supervision; and (iii) ensure closer cooperation and information sharing among supervisors.”

The paper which investigates the degree of interconnectedness in the financial sector and the vulnerabilities posed by such interconnectedness, also discusses the current state/structure of institutional arrangements for financial sector supervision in the different countries in the region and the reforms needed to strengthen supervision and contain spill over effects in the event of negative shocks.

“In light of the interconnectedness of the financial sector, reforms should aim at enhancing supervision that transcends national boundaries. Harmonized supervision and cooperation on supervisory and regulatory issues, including deposit insurance and crisis resolution frameworks at the regional level, are seen as critical to prevent regulatory arbitrage and strengthen financial sector stability.

The authors note that the increased financial sector interconnectedness of the Caribbean region, manifested through the presence of large banking groups and financial conglomerates, can be positive provided the regional authorities take steps to prevent the systemic risk that can come with such interconnectedness.

“Moreover, the operation of subsidiaries and branches across several jurisdictions, some of which lack strong consolidated supervision frameworks, could potentially lead to regulatory arbitrage or underestimation of risks.”

They said financial sector reforms aimed at bolstering and harmonizing prudential regulations in the region in line with international best practices, the enhancement of financial sector supervision to include cross border linkages through consolidated supervision, increased cooperation and information sharing across supervisors in the region, and the establishment of deposit insurance and crisis resolution frameworks will be critical to maintain financial sector stability and minimize the repercussions of any negative shocks.