The BOJ has updated its guidelines regarding the classification of certain forms of collateral.
BOJ cracking down!
Lending market shake-up coming with new rules
The Bank of Jamaica (BOJ) has revised its minimum capital requirements applicable to deposit-taking institutions (DTIs) or banks in how they classify collateral of certain assets.
When a bank lends to a customer, the loan is either unsecured — which means that the bank relies on the borrower’s creditworthiness — or the loan is secured, which means that there is a form of collateral that the bank can claim in the event the borrower defaults on their obligations.
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Unsecured loans tend to carry higher interest rates than secured loans where the bank has some form of collateral to offset the risk taken to lend to a borrower.
Collateral can take different forms, like a property, a vehicle, life insurance, cash, a personal or corporate guarantee, or marketable securities such as stocks or bonds. Sometimes, owners of companies might pledge their ordinary shares as collateral to a bank to secure a loan.
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Each bank will have its different methodologies or criteria in deciding how much money to lend against the value of the collateral while complying with the BOJ’s published standards. This might involve a 50 per cent loan-to-value, which means that a bank will lend up to $500,000 for $1 million of ordinary shares in a publicly listed company. However, the BOJ has revised their guidelines for DTIs related to this form of collateral.
“Consistent with the provisions of paragraph 139 of the Standard of Sound Practice on Minimum Capital Requirements, as well as the guidelines specified under the Standard of Sound Practice on Problem Asset Management, Provisioning Requirement and Accounting for Expected Credit Losses, the value of collateral utilised by licensees to secure a loan should not be dependent on the financial performance of the borrower or any related party of the borrower.
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“Recall that the purpose of collateral is to secure/offset the value of an exposure (loan) in the event of counterparty default. However, in cases where ordinary shares are pledged as collateral, the exposure would not be adequately secured, as declining business value or the failure of the entity that pledged the shares as collateral would result in a deterioration or total loss of value of the collateral,” the BOJ stated.
The financial sector regulator added: “Therefore, the bank advises that the use of shares of subsidiaries or other related parties as collateral will result in applicable credit facilities being treated as unsecured under the revised capital adequacy framework (ie the Standard of Sound Practice on Minimum Capital Requirements).”
This is a major development since it might push some borrowers to the capital markets to source their borrowing needs. It also impacts DTIs with these types of loans on their books since unsecured and secured loans receive different forms of treatment from a capital adequacy standpoint.
An unsecured loan tends to have a higher capital charge when calculating capital adequacy. This simply means that a bank has to reserve more capital on their books to be compliant with their capital adequacy guidelines. A secured loan will carry a smaller capital charge and leaves the bank with more capital to lend or use in its daily activities.
“Bank of Jamaica is developing a Standard of Sound Practice on Problem Asset Management, Provisioning Requirements, and Accounting for Expected Credit Losses [for licensees under the Banking Services Act]. Under this SSP, the credit risk of various exposures will be continuously evaluated and classified accordingly,” the BOJ stated on its work to improve the classification of loans amongst banks ahead of the Basel III implementation.
While there are no readily available indicators for what percentage of banks books are secured or unsecured, the BOJ’s change has pushed some banks to re-engage some borrowers to find a more amenable solution through the potential pledging of different forms of collateral or seeking to renegotiate terms. This comes at a time when the BOJ’s own data shows that more loans are being recognised as past due amongst DTIs.
According to the BOJ’s data, the gross value of past-due loans (one month to three months) increased eight per cent from $44.45 billion to $47.90 billion in 2024. This figure peaked at $58.02 billion in July after the passage of Hurricane Beryl before decreasing to $47 billion in August.
The figure stood at $51.22 billion in November 2024 before closing 2024 below $50 billion. The bulk of past-due loans were amongst individuals and/or households which stood at $28.95 billion. Professional and other services saw a 39 per cent jump to $3.34 billion in December, a step down from the $5.64 billion figure in November.
However, that decrease in the past-due figure might be due to some loans moving from the past-due category to being classified as non-performing loans (NPLs), which covers loans that are late beyond 90 days. Overall NPLs grew five per cent in 2024 from $35.53 billion to $37.33 billion. The individuals and/or households category grew 13 per cent to $27.68 billion.
Despite the increase in past-due loans and NPLs, it still represents a smaller fraction of the overall lending market for DTIs, which increased six per cent to $1.50 trillion at the end of 2024. That growth was supported by an increase in residential mortgages, which grew by 15 per cent from $407.63 billion to $468.67 billion.
According to the BOJ’s Guidance on Problem Asset Management and Provisioning Requirements, a credit facility must not be restructured more than twice in a five-year period for a mortgage and personal loans, and not more than twice over the life of commercial loans. Thus, banks do not have significant of latitude to restructure loans too many times since these must be reported to the BOJ.
Those BOJ guidelines on problem assets and the Banking Services Act (BSA) also dictate how quickly a bank must dispose of collateral seized by a bank. An example can be with reference to Section 53 (I) of the BSA, which states that foreclosed properties must be disposed of within three years of them being acquired. Thus, as more properties in upscale communities and luxury vehicles like Porsche Cayenne and BMW X1’s are repossessed and put up for sale, the banks are under the clock.
The BOJ is currently working on getting itself ready for the twin peaks regulatory model which it hopes to implement over the next two years. The BOJ noted that its pilot in prudential regulation of one insurance company was completed in 2024 and it expects to complete prudential regulation examination of two securities dealers within the first half of 2025.
The Financial Services Commission (FSC) completed its market conduct examination of one DTI in 2024, with the name mentioned in a GOJ 2024 filing to the United States Securities & Exchange Commission (SEC). The special resolution regime (SRR) is currently being tabled in the Senate under the name Financial Institutions (Resolution) Act 2024.
Part XXII of the Banking Services Act, 2014 treats the issue of enforcement as it relates to unsafe practices and prompt corrective actions. As such, the BOJ has an enforcement unit within the Financial Institutions Supervisory Division.
The seventh schedule of the BSA provides further clarity in this area and describes a list of enforceable offences under the BSA and the associated penalties that apply. For example, as per section 84(1)(a), every licensee shall submit the prescribed documents (including audited financial statements) to the supervisor not later than 90 days after the end of each financial year. A licensee that contravenes section 84 of the BSA commits an offence and, on summary conviction in a Resident Magistrate’s Court, is subject to a fine not exceeding $1,000,000 as indicated under the seventh schedule of the BSA,” the BOJ explained on its enforcement capacity and fines that can be doled out to regulated entities.
