The Bank of Jamaica (BOJ) will be imposing stronger capital and liquidity requirements on the local banking sector in 2021.

As a prelude to the imposition, the BOJ has released a consultation paper the banking sector on its proposed capital and liquidity requirements which are contained in proposals for the Implementation of the Basel III Regulatory Capital Framework.

The new requirements come as the banking regulator is of the view that the current capital and liquidity requirements are no longer aligned with widely observed international regulations.

The BOJ has asked interested groups and parties to submit written comments to it no later than the close of business on February 15, 2021.  In making out a case for revising the current capital and liquidity requirements, the BOJ contends that the current approaches focus exclusively on credit risk and foreign exchange risk and leave aside the other market and operational risks that are likely to be significant when evaluated on a consolidated basis.

For that reason, the Central Bank is introducing a broader comprehensive Basel III, Pillar I approach capturing all risks, which would enhance the risk coverage of bank’s prudential framework.  Particularly, market risks other than foreign exchange and banking book interest rate risk, which are inherent in groups of companies comprising of non-Deposit Taking Institutions (DTIs) under a regulated Financial Holding Company (FHC).

BOJ expanding its capital requirements

Adopting a group-wide supervision approach necessitates that the BOJ expand its capital requirements and expectations for market risk management in order to address the risks, including market to market price and valuation risks that likely reside within a financial group. Similarly, the existing supervisory approach to operational risk management is fragmented and incomplete.

 As such, the BOJ is putting in place a more comprehensive approach to operational risk quantification and management. According to the 148 page consultation document, “this would require bringing together the various operational risk related expectations of the Bank into a single enforceable standard along with supporting requirements for industry collection of operational risk loss data.”

With this in mind, BOJ is undertaking the modernisation of the regulatory framework applied to banking groups, with a view to bringing the regime in line with global standards that were significantly enhanced in the reforms that followed the global financial crisis in 2007-2009, including a strengthening of prudential regulation for banks and the introduction of international standards for bank resolution.

The focus of the current consultation is on the prudential regulation of DTIs and FHCs and specifically, the capital they are required to hold in order to minimize the risk that financial institutions fail, causing damage to depositors/policy holders and the broader financial system and economy. The aim is to implement in Jamaica regulations that are consistent with the requirements recently introduced by the Basel Committee on Banking Supervision (BCBS), which will put Jamaica on the same footing as the standards applied in other advanced economies.

Higher standards will be applied under the new regime

In some cases, higher standards will be applied reflecting the particular structure and context of the Jamaican system. In this regard, the BOJ seeks consultation with the sector on the following elements introduced by the Basel III final reform package.

These are the definition of regulatory capital and the credit risk standardized approach. This approach seeks to improve granularity and risk sensitivity calibration of credit exposures while at the same time reduce excessive reliance on external credit rating with a more granular approach for unrated exposures. The BOJ will conduct a quantitative impact study on selected DTIs next year the outcome of which will help to further inform policy proposals on the Bank’s Basel III implementation plan.

According to the original BCBS timetable, the above revised standards will take effect from January 1, 2022 with a phase-in period of five years. However, in order to provide additional operational capacity for DTIs and supervisors to respond to the immediate financial stability priorities resulting from the impact of the coronavirus disease (COVID-19) on the global banking system, the implementation will be deferred by one year to start from January 1, 2023.

This timeline includes a transitional 12 month period. The proposed capital adequacy framework will provide the BOJ with the authority to make determinations on a case-by-case basis, in terms of members of financial groups that should be included or excluded from the scope of consolidation for the purposes of the capital adequacy framework.  A FHC which is itself a DTI will be required to comply with the proposed prudential capital adequacy requirements at both the standalone level and the consolidated group level.

FHCs will be under greater scrutiny

Under the proposed capital adequacy requirements, an FHC, whether non-operating or operating, will be required to ensure that sufficient regulatory capital is available to address the risks of the financial group and all its members. The sectoral regulatory capital requirements that govern individual entities in the financial group are proposed to remain applicable.

In addition to meeting its consolidated capital adequacy ratio requirements, each FHC will be responsible for ensuring that adequate capital and other financial resources are maintained for the operations of the financial group and that the group complies with its statutory and regulatory obligations with respect to capital.

This includes ensuring that each regulated entity in the financial group meets and maintains individual standalone and sector capital adequacy requirements and that the financial group maintains adequate capital on a group-wide basis that is commensurate with the risk profile of the group, and mitigates risks associated with the activities of members of the group.

Securities dealers under the microscope

The BOJ says it understands that securities dealers are subject to capital requirements set out by the Financial Services Commission. These guidelines prescribe, inter alia, a minimum capital requirement of 10% of risk-weighted assets, where the risk weighting considers credit, market, and operational risks.

The BOJ has invited this segment of the financial sector to submit feedback on its proposed approach that requires securities dealers to meet the FSC requirements on a solo basis, and the requirements set out in the BOJ’s consultative document on a consolidated basis. This with the understanding that decisions regarding the transferability of capital instruments will be done based on the criteria set out in this consultation paper.