The Current Supervisory Practices
The supervisory practices of the CBCS (the Bank) have been the focus of much public attention recently because various institutions under its supervision have been placed under the emergency arrangement.1 While this measure is a necessary tool for the
Bank to discharge its supervisory function effectively, questions have been raised about the proportionality of this intrusive and repressive last resort measure.
Critics contend that the frequent use of this measure by the Bank is tantamount to regulatory overreach. Note, however, that the law provides adequate provisions to insure the proper use of this measure. The Court can declare the emergency arrangement applicable only upon a request of the Bank after it has revoked the license of the institution under its supervision, and only after gaining the Court’s approval can this measure be applied.
These critics go on to note that in practice, however, this Court supervised system de facto will lead to the Bank’s unfettered use of this tool. They base their arguments on the fact that the emergency measure usually is requested on the premise that if not
granted immediately, a run on the institution in question will be the outcome. As a result, the counterparty will not get the necessary time to defend itself effectively against this impending measure. Thus, critics argue that the question remains whether the Court
has the necessary expertise to render a judgment expeditiously on this very nagging issue in a highly complex financial system.
Experience so far suggests that this Court supervised system has been quite effective. The emergency arrangement is a measure designed to protect the interests of depositors and creditors of an institution in financial distress. In the past, institutions placed under this measure were able to emerge from this arrangement and continue to operate. However, if not properly administered, this whole exercise may be futile.
Recent events may put this issue in the proper perspective.
1 The emergency arrangement is a provision in our banking supervision law whereby the Bank, to the exclusion of any other parties, exercises all powers of the Supervisory and Managing Board of Directors of the institution placed under the emergency arrangement.
Recently, shrouded in secrecy, three ministers of Curaçao (including the Prime Minister) urgently went to Holland for consultation with the Dutch Minister of Finance Mr. Hoekstra and the Minister of Interior and Kingdom Affairs Mr. Knops. The objective of the consultation by the three ministers (reported after the fact) was to discuss with their Dutch counterparts the need for further assistance to bring about a “quicker turnaround” of the economy. Given the pressure of the current economic situation on the country’s social and fiscal situation, a comprehensive approach is needed to deal with the problems facing the island—keeping the refinery operating, financing the cost overruns of the CMC, the increased poverty rate, need for fiscal consolidation, and so forth. Consistent with the recommendations I made early this year, the Curacao government apparently will approach the IMF for assistance in devising a program designed to improve the resiliency of our economy to achieve sound macroeconomic policies.
Based on an in-depth analysis of our economic situation, the Curaçao government will then approach the Dutch government for specific assistance. This sounds like a preamble for a Fund-supported program.
What was not reported, however, is that prominent among the topics allegedly discussed at the meeting in Holland was the state of the financial sector and its likely impact on the rest of the economy. To rescue an institution under supervision from a liquidity crisis and eventual collapse, it was argued that taxpayers will have to foot a bill to the tune of approximately NAf 450 million2 to mitigate the potential for fallout risk because of the systemic risks involved.
No one knows whether this premise is true. The "systemically important financial institution" theory asserts that certain financial institutions are so large and so interconnected that their failure would be disastrous to the greater economic system, and, therefore, they must be supported by government when they face potential failure. In 2010, Ben Bernanke cited several risks with this approach:
1. "If creditors believe that an institution will not be allowed to fail, they will not demand as much compensation for risks as they otherwise would, thus weakening market discipline; nor will they invest as many resources in monitoring the firm's risk-taking. As a result, too-big-to-fail firms will tend to take more risk than desirable, in the expectation that they will receive assistance if their bets go bad."
2. It creates an uneven playing field between big and small firms. "This unfair competition, together with the incentive to grow that too-big-to-fail provides, increases risk and artificially raises the market share of too-big-to-fail firms, to the detriment of economic efficiency as well as financial stability."
3. The firms themselves become major risks to overall financial stability, particularly in the absence of adequate resolution tools.
2 In the recent IMF Country Report No. 19/23, it is stated that “Curaçao and Sint Maarten need to urgently adopt a medium-term fiscal framework with a long-term debt anchor (paragraph 16). It went on to state in para. 19 that “additional structural measures would be needed to put the public debt on a sustainable downward path.” It boggles the mind that the current acting president of the Bank with an illustrious career in the fiscal department of the IMF proposes a measure that seems to run counter to IMF policy advice.
Two facts are relevant here. (i) Interbank activities are small to nonexistent in the Curaçao banking market thus rendering interconnectedness negligible. (ii) Total assets of the banking sector amount to approximately NAf 13 billion with the bank under emergency measures representing a small percentage of the market.
These two facts raise the big question of whether any risks exist of a run on the bank and/or disastrous consequences to the greater economic system in case of a failure. In other words, is the institution in question too big to fail? Given the lack of interconnectedness and a concentration ratio of the three largest banks of almost 90%, no bank currently under the emergency arrangement is too big to fail.
In addition, given the sorry state of the fiscal situation, this solution (rescue of the institution in question by a bailout or nationalization by Government) will put an unnecessary heavy burden on the already high debt-to-GDP ratio. The approach that the CBCS adopted quite effectively in the past was one of a single point of entry. This involves funneling losses to the prospective buyer of the financial institution under distress. This approach creates a more level playing field in terms of resolution, depositor protection, and a host of other measures designed to create a more resilient financial system with greater certainty.
The objective of restructuring a bank through the use of resolution tools should be to safeguard public interests, including the continuity of the bank's critical functions (in the case of too big to fail), financial stability, and minimal costs to taxpayers. The current approach of shifting the burden to the taxpayers does not seem in line with this objective. In addition, the current fiscal position of both Curaçao and Sint Maarten brings the feasibility of this approach into question.3
Without bringing to task the effectiveness of the current supervisory practices4 of the CBCS due to confidentiality provisions, the question remains one of identifying a way forward without burdening the taxpayers to unwillingly pay millions of guilders to rescue a bank from a liquidity crisis and collapse.
3 To allow the Curaçao government to borrow NAf103 million, the government had to seek the favorable advice of the Cft. This loan, together with the NAf 450 million, would increase the debt-to-GDP ratio by more than 10 percentage points.
4 However, it should be noted that the paralysis created by the current management has rendered this emergency arrangement an exercise in futility.
The Case for a Deposit Insurance Scheme
The current banking legislation provides sufficient tools to deal effectively with a bank in financial distress. Since 1994, the current Banking Supervision Act (N.G. 1994, no. 4) calls for the establishment of a depositor insurance scheme. For a host of reasons, this depositors’ insurance scheme has not been implemented: first, the IMF discouraged member countries from adopting a depositor's insurance scheme to avoid the issue of moral hazard [IMF Financial Sector Assessment Program]. As a consequence, the establishment of a scheme has taken a backseat position. Second, when the Fund revisited its approach toward a deposit insurance scheme, CBCS started a consultation round with the sector, but to no avail. The Minister of Finance has been informed accordingly and advised to adopt a scheme without the consent of the sector. Third, in the aftermath of 10-10-10, the Dutch Ministry of Finance asked CBCS to delay the implementation of the scheme to include the banks operating on the BES islands. After this unnecessary delay, the Dutch Ministry of Finance went it alone by implementing its own scheme without CBCS.
In the meantime, a depositor insurance scheme has been devised by the Bank and awaits implementation. Rather than having the Curaçao taxpayers foot the bill, it is advised that this depositor's insurance scheme be capitalized with a Dutch loan under concessionary terms. Through a premium scheme levied on the banks, this loan can be paid off.
Under normal circumstances, the payout ratio would be subject to a ceiling.5 However, because of the position assumed by the Bank with the Bonaire branch (the Bank closed the Bonaire branch of a bank under emergency arrangement by paying creditors and deposit holders 100% providing an implicit guarantee to the rest of the creditors and deposit holders of a 100% payout ratio), the payout ratio will have to be 100%. It is not clear, however, who will be paying the difference between the eventual ceiling of a local deposit insurance scheme and a 100% payout ratio. If should definitely not be the taxpayers.
This adequately capitalized scheme then will be in a position to deal effectively with financial institutions in distress, helping to mitigate the disruption of financial institution failures, reduce moral hazard in the future, and lead to a better functioning market.
Dr. E. D. Tromp
November 10, 2019
5 In the USA, FDIC insured deposits are insured up to US$ 250,000.00 whereas Europe has a ceiling of Euro
100,000.00. In the case of Curaçao, a ceiling has not yet been established, but the actuarial calculations indicate a
substantially lower ceiling.