Wilberne Persaud, Business Columnist

Persaud

I begin with a quote from "Jamaica Meltdown: Indigenous Financial Sector Crash 1996": Paul Chen-Young, CEO of the Eagle Group - the first bankrupt entity acquired by FINSAC for $1.00 - presents the case for the financial sector as a victim of circumstances created entirely by the government's monetary and macroeconomic policy.

The title of Chen-Young's piece is in itself instructive: "With All Good Intentions: The Collapse of Jamaica's Financial Sector". Firstly, there is the appeal to objectives, ends and not means. 'Intentions' of the institutions' principals and management were 'all good.' Secondly, no distinction is made between the indigenous and foreign-controlled entities.

He suggests that "... the economic climate that prevailed in the 1990s contributed to the downfall of the sector. Inappropriate and inconsistent monetary policy created hardships, resulting in the inability of borrowers to repay loans, inadequate returns on investments to cover funding costs, and falling values in investment portfolio and property values - Fluctuations in monetary policy and the resulting inflation, along with a 0.3 per cent average annual growth rate in gross domestic product (GDP) between 1990 and 1997, created an unfavourable operating environment for business and made it difficult for them to service their debts. Ultimately, the problems spilled over into the financial sector.

Actual bedrock

Dr.Chen-Young turns causation on its head. These are not problems that 'spilled over into the financial sector.' Rather, these elements provide the actual bedrock upon which any financial sector is built and with which it must continuously cope. Surely banking executives and risk assessment managers must consider the economic and business environment in which they, and more importantly, their clients, operate. It is indisputable in the industry that loans ought not to be approved independently of consideration of the potential borrower's ability to repay, credible cash flow projections, and evaluation of risk. Indigenous bankers seemed to be of the view that real estate collateral, even when patently illiquid and booked at inflated prices, was good cover for loan default risk. Banks never, in their assessments of borrowers and their projects, rely on collateral to repay loans.

Liquidation of pledged collateral is always a last resort. Further-more, any risk assessment procedure worth the name would in addition also include forecasts of policy positions, economic performance, and demand for the products or services which the loan proceeds are meant to fund. Dr. Chen-Young blames these conditions that, in his interpretation, can only be viewed as creeping up in the dark to create a mugging of the financial sector rather than admitting that the sector's failure to engage in prudential management, together with its 'get-rich-quick mentality' - contributed to, or perhaps mandated, the failure of inefficient businesses.

Even more telling is the fact that many of these failed businesses were operations of connected parties. "It is also, as indicated earlier, particularly awkward for this view that the foreign-controlled banks did not collapse. When viral or bacterial contamination of a pond with two species of fish occurs, and only one succumbs, the only explanation for the survival of the other must be that the survivor was 'putting up resistance' and had immunity - however attained.

Government's economic policy did indeed contribute to the crash, but not at all in the way Chen-Young depicts. One of the reasons for the sector's collapse was the very policies that allowed indigenous financial services to grow so fast in the first place. Divestment of financial services in the late 1980s and early1990s to inadequately capitalised domestic entities could be viewed as the foundation of potential problems - which, to be sure, were not inevitable.

Oversight role

But failure to foresee the problems that could derive from outmoded, inappropriate, and ineffective legislation for the new situation was unfortunately coupled with inadequate regulatory supervision. Previous to this, the overseas head offices of foreign commercial banks performed the oversight role. It must be pointed out that this oversight role, and the way it was performed - a holdover from the colonial period - tended to dictate a conservative financial climate, a climate hostile to innovation, a climate perhaps hostile even to prudential risk taking. This, of course, would act as a drag on economic growth and development. But it was as well a climate that, clearly, would tend to preclude a financial crisis.

Once the innovative interventions of the indigenous institutions began to emerge, the historical experiences of other countries should have been seen to be important, and regulatory changes should then have become a prime part of government's policy. Tightening monetary policy to curb the credit boom and halt inflation, enacting legislation to provide more prudential arrangements after the fact simply precipitated the bubble's burst.

The ultimate cause

Dr. Chen-Young also focuses on part of the ultimate cause of the crash without noting its importance in discussing the rules for declaring a loan non-performing. He points out that "... the largest domestically owned bank (National Commercial Bank) was forced to classify J$13.5 billion of its loans as non-performing. This amounted to nearly four times the bank's capital base of J$3.8 billion, and FINSAC came to the rescue by purchasing these loans as well as a J$7 billion loan due from the bank's parent, Mutual Life Insurance Company." [sic]

Given the widespread practice of ever-greening loans, this view is unsustainable. The banks were accruing interest on loans and booking profits on assets (the bad loans) on which no payments had been made for six months and which never stood a chance of ever being repaid. One particularly significant feature Dr. Chen-Young's comment reveals but omits to highlight is the absence of proper regulatory control. How can a bank's parent company or, for that matter, any single borrower be allowed to amass loans to the tune of multiples of 'the bank's capital base'?

Worse, this significant contributor to the crisis - loans to connected parties - was neither regulated nor policed.

Non-performing loan

One of National Commercial Bank's parents, Mutual Life Assurance Society, was indeed allowed to have a non-performing loan equivalent to twice the bank's capital base. But this tendency was by no means unique in the system. Life of Jamaica owned Citizens Bank, Crown Eagle Life Insurance was grouped with Eagle Commercial Bank, Island Life Insurance Company and Victoria Mutual Building Society owned Island Victoria Bank. All of these banks either had large loans to their parent or associated companies to cover policy encashment in the 1990s, or were significantly exposed in large and costly real estate and other projects gone sour."

Given all these pieces of evidence adduced, it is surely unsustainable to hold that the ultimate cause of the crash was monetary and fiscal policy. Rather it must be related to the indigenous financial services sector's decision making process within the context of government policy and the then ruling legislation and supervisory regime.

Part III looks at Chen-Young's claim that FINSAC was a total failure.