BOSSES of some of the major securities dealers operating in Jamaica have taken issue with some of the assumptions of the International Monetary Fund’s (IMF) assessment of the sector, denying claims that a financial sector meltdown could result from what the multilateral institution says are minimum-capital adequacy requirements, coupled with ‘lax controls’.

The IMF also cites the detrimental extent of financial conglomeration present within the Jamaican financial sector which in effect means that if one arm fails , it is likely to bring down the entire institution with it.

Securities dealers are undercapitalised

In documents obtained by Caribbean Business Report, the IMF posited that “the dealers are not well capitalised — prudential regulation has not properly recognised these inherent risks — and lax controls on margin operations have allowed some dealers to become overleveraged.”

The IMF document further reads: “Recent stress tests undertaken by the BOJ (Bank of Jamaica) confirm that the dealers do not have sufficient capital to withstand meaningful shocks to the GOJ (Government of Jamaica) market. In addition, given the extent of financial conglomeration in Jamaica, these vulnerabilities could have negative spillovers that could threaten financial system stability.”

Need for improvement

Members of the local financial sector admit that there are some areas that need improvement, but insist that the sector has performed creditably over the years and particularly during the global financial sector meltdown of 2008-2009 when many international financial institutions came under severe pressue.

Others claim that financial conglomeration may also indicate a strength and not a weakness as indicated.

Currently capital adequacy requirements for securities dealers as stipulated by the Financial Services Commission (FSC) are: 10 per cent for its tier one and tier two capital to risk weighted asset ratio, and six per cent for the total asset ratio. The IMF has recommended broad-based reforms of the local financial sector, particularly the securities dealers sector, one such being an increase in the capital adequacy requirement of financial institutions.

Review to take place

George Roper, Deputy Executive Director of the Financial Services Commission told Caribbean Business Report that the existing framework for securities dealers would be reviewed with the technical assistance of the multilateral agency.

Capital adequacy in Jamaica is just fine

However, Patrick Ellis, Group chief financial officer of JMMB said that this move should be considered in conjunction with the other stipulations which govern the sector.

“We believe the current capital requirements for the securities dealers are sufficient given the fact that the current regulation requires that entities invest clients’ capital in approved securities (Government of Jamaica). If there is a change in the investment framework established by FSC and BOJ, then an increase in the margin requirements could follow.

“We are not aware of any securities dealers that are not adequately capitalised,” Ellis said while noting that JMMB’s capital adequacy stood at 38.7 per cent.

“We would like to note however, that during the entire period of the global crises, all financial institutions in Jamaica effectively weathered the storm.”

The FSC has also confirmed this assessment. Based on the latest quarterly filings from licensees the dealers are adequately capitalised. According to Roper, up to September 2009 securities firms as a whole were adequately capitalised with the ratio of capital to total assets at 9.6 per cent compared to the FSC minimum benchmark of six per cent. The ratio of tier one and tier two capital to risk weighted assets stood at 53.8 per cent compared to an FSC minimum benchmark of 10 per cent.

“This outturn compares with ratios of capital to total assets and tier one and tier two capital to risk weighted assets of 8.2 per cent and 39.6 per cent, respectively at end-December 2008, at the height of the global financial crisis. Thus, capital adequacy has been improving in 2009 and for the sector as a whole, is above current regulatory benchmarks,” Roper disclosed.

He added that the IMF’s diagnosis of the financial sector problems are indications of the need for improvement in the FSC’s existing regulatory framework, rather than as a “widespread failure on the part of licensees to meet regulatory requirements”.

Problem with requirements not dealers

Steven Gooden, VP Investments and Trading, at National Commercial Bank’s Capital Markets, (NCBCM) agrees that the problem is with the requirements and not the dealers. He said that the current capital adequacy and margin requirements are general and do not adequately account for risks tied to the varying types of assets that form the basis of repurchase agreements.

“For example, the margin requirement applicable to a fixed rate instrument that matures in 20 years is the same as that of a similar instrument that matures in a year and has a better risk profile,” Gooden said.

“The requirements should be dynamic to properly account for the risk assumed by the institution and the ‘repo’ clients. Such an enhancement, provided they are practical, are welcomed,” Gooden said.

Investment outflow

Another point of divergence with the IMF’s assessment is the effect an outflow of investment would have on the sector and related companies of local institutions. The IMF predicts that the dealers would not be able to withstand even a ‘modest degree of investment outflow’ and that this could spill over to the other institutions within the respective groups.

“Many of the dealers are part of financial conglomerates and their financial weakness would become a serious problem for related parent banks, as well as other financial affiliates,” the multilateral agency reported.

However Gooden assets, to the contrary, NCBCM, being a subsidiary of the local commercial bank giant NCB, would be well protected. Gooden outlined that as at December 31, 2009 NCBCM’s capital base was J$9 billion, its capital to asset ratio at 12 per cent, exceedS the FSC’s requirement. “This makes us one the best capitalised securities dealerS in the market. Furthermore, we have the backing of one the largest banking groups as measured by capital ($42 billion) in Jamaica,” he declared.

Ellis added that given the fact that local institutions managed successfully through the crisis, investor confidence has actually improved, not waned and therefore the financial system has remained stable as a result. He pointed out that JMMB grew by over five per cent during the 2008-2009 crisis period.

“Any potential impact would be manageable. In addition, all JMMB affiliates are subject to the same rigorous criteria implemented at the parent company level. Therefore, any potential impact would be mitigated effectively,” Ellis said.

Anya Schnoor, Senior VP for Wealth Management and CEO of Scotia DBG, shrugged off the suggestion of a contagion effect on the Group of a possible meltdown in the securities market. “Scotiabank Group is the largest and best capitalised of all financial entities in Jamaica,” she said. She went on to add that given the successful completion of the JDX and the recent rating upgrade to B- by Fitch, overall confidence in the market has been boosted and the institutions should be adequately protected, once the government implements the fiscal reforms as stipulated by the IMF.

The recently concluded Jamaica Debt Exchange, which saw a 100 per cent participation from local financial entities, and 99 per cent from all sectors combined, presented one potential challenge to the securities dealers sector, where the institutions’ gains from the net interest income from GOJ bonds was a major source of income and profitability.

However, securities dealers including Scotia DBG, Jamaica Money Market Brokers (JMMB), National Commercial Bank Capital Markets (NCBCM), Capital and Credit Financial Group, Guardian Asset Management, Pan Caribbean Financial Services and Mayberry, have all indicated that the JDX would have a minimal effect on the equity and profitability of their respective companies.

Scotia DBG reported net effect of 1.15 per cent or $94 million reduction in equity as a result of the Exchange. Mayberry reported an impact of less than one per cent on the capital of the company, while JMMB indicated that the projected impact on equity and profitability would be minimal. The exception to the rule, Barita Investments, which recently listed on the Jamaica Stock Exchange, reported a 20 per cent reduction in projected income levels as a result of the contraction in net interest income. However, the securities dealer also reported that the impact on its balance sheet would be ‘negligible’ as the liquidity and capital adequacy levels would remain intact.