Ewart S Williams: The paradoxes inherent in the role of central banks -
the case of the Central Bank of Trinidad and Tobago
Address by Mr Ewart S Williams, Governor of the Central Bank of Trinidad and Tobago, to
the British-Caribbean Chamber of Commerce, Port-of-Spain, 11 March 2009.
* * *
Thanks to the British Caribbean Chamber of Commerce for inviting me to address your forum
this morning.
My invitation listed a number of topics and the one that caught my eye was entitled, the
paradoxes inherent in the role of central banks; I would therefore wish to take this
opportunity to discuss the kinds of challenges that the Bank has been facing in the pursuit of
its mandate. I will couch the discussion in the context of two current macro-economic
challenges:
•
The current economic slowdown
•
The Clico/CIB crisis
Over the last few years, we have achieved rapid economic growth. However, as you know,
the Central Bank has had to face the specter of unacceptably high inflation.
Since 2008, the international economy has been in the grip of an unprecedented financial
crisis which has led to a pronounced global recession. Initially, like most developing and
emerging market countries, the region faced only limited contagion from the international
turmoil. However, as the international credit crisis persists, as commodity prices continue to
sag, and as the global recession gets deeper, the region is finding itself on the cusp of a
major economic slowdown with all its attendant consequences.
Several indicators point to a pronounced slowdown in the Trinidad and Tobago economy.
•
Activity in the energy sector has declined sharply, with several firms forced to
advance scheduled maintenance to contain layoffs.
•
All the main construction indicators are down - local sales of construction materials,
employment in construction : mortgage loans
On the demand side:
•
The index of retail sales is trending downwards.
•
Christmas and Carnival sales were much lower than last year.
•
Automobile sales and purchases of consumer durables are sharply down.
•
Several large firms (Mittal Steel, Digicel, Hilton Hotel) have announced layoffs.
• While reliable data are not available, the decline in regional and local demand could
be affecting manufacturing output and exports.
Of course, there is some encouraging news on the inflation front as:
•
Headline inflation has declined from a high of close to 15 per cent to 11.7 per cent;
and
•
Food prices seem to be coming down because of both external and domestic
influences; and
•
We are seeing a steady decline in real estate prices, in line with the cooling of the
property boom.
Most developed and emerging market economies are resorting to expansionary fiscal and
monetary policies to deal with a worsening world recession and sharp increases in
unemployment. As you know, the decline in energy prices initially prompted a reduction in
fiscal expenditures but as oil prices continued to fall the Government eschewed further
expenditure cuts, opting for a small amount of deficit financing.
The Central Bank has not yet moved to ease monetary policy, in part because inflation
continues to be unacceptably high and inflation expectations have not been sufficiently
contained. We need to be careful about an inflation spiral.
However, as noted earlier, anecdotal evidence suggests that the incidence of lay-offs in the
construction and services sector is increasing. As a practical matter, if layoffs and
unemployment continue to rise, both the fiscal and monetary stance may need to be
revisited and the pace of inflation reduction may need to be re-considered.
Of course, any temporary relaxation of the fiscal stance puts even greater pressure on the
government to achieve medium term fiscal sustainability. That's in fact the problem in the US
where President Obama's considerable efforts to provide fiscal stimulus to address the
recession will need to be matched by a similarly bold program to reduce the fiscal deficit in
the next few years.
On present projections, oil prices are expected to remain depressed for the remainder of the
year and the fiscal deficit will lead to an increase in government borrowing. The CL Financial
crisis will further add to our borrowing requirements. However, we are in a good position to
handle this since we have fiscal space, a relatively low level of public indebtedness and
considerable excess liquidity in the banking system.
We are in a similarly fortunate position as regards our foreign exchange reserves. Low
energy prices have significantly reduced additions to these reserves. Further, the
international credit crisis is affecting the normal credit lines that were available to banks such
that they need to depend more on foreign exchange from the Central Bank. In addition, the
global and domestic financial uncertainties may be contributing to some capital flight.
The Central Bank has the resources to meet the increased foreign exchange demands.
Central Bank sales so far this year (over US$300 million) are more than double those for the
comparable period of last year.
The Central Bank stands ready to meet all foreign exchange demands for its gross reserves
which now stand at around US$9 billion, the equivalent of eleven months imports. With that
level of reserve cushion, rumours of an impending devaluation are misguided.
I would like to make some comments about the challenges that the Central Bank, as
Regulator, faces in a rapidly evolving financial system.
Several analysts have put the blame for the CLICO/CIB financial collapse squarely on
inadequate regulation by the regulator, the Central Bank. Of course, this is what happens
whenever there is financial stress. Invariably, the finger is pointed to the Regulator.
Inadequate or the absence of regulation has been blamed for the collapse of financial
institutions in the United States, as well as for the Madoff and Stanford scandals; the FSA
has been faulted for the demise of the Northern Rock and the other failed institutions in the
UK and the list goes on and on.
If you look across the world, it seems that regulators are busy trying to resolve some sort of
financial calamity. But regulation of financial institutions is not new. Regulation has been in
existence for over one hundred and fifty years. So why have Regulators not mastered the job
of regulation. Well, I could think of three reasons:
1. Rapidly evolving innovation and creativity in terms of services and products being
offered by financial institutions.
2. The recognition that risk taking should not be totally outlawed since under certain
conditions it could benefit consumers.
3. The fact that laws cannot legislate good behaviour or by extension, good
governance.
4. An ideological shift towards free markets and minimal regulation.
How does this relate to CL Financial and CLICO.
CLICO, in many ways, was a pioneer and a path-breaker on the local financial scene. For
years it led in the provision of insurance services in Trinidad and Tobago and indeed in the
region. For the most part, CLICO's expansion proceeded under conditions of limited
regulation as the Office of the Insurance Supervisor, in the Ministry of Finance, lacked the
resources to act as a Regulator.
As you know, in the early days insurance companies collected premiums and invested the
proceeds in government securities and in mortgages. Over time, as incomes and the
demand for savings-products increased and as our local capital markets did not expand in
step, insurance companies had to look further afield for investment opportunities.
CLICO
was the leader in this endeavour.
By the time the insurance industry was transferred to Central Bank in mid-2004, CL
Financial, with CLICO as its main financial company, had already become a major
conglomerate in Trinidad and Tobago and in the region with 60 subsidiaries, operating in
several fields, and spread over 20 countries - in the Caribbean, Central and North America
and Europe.
The official data showed that CL Financial was an extremely strong and profitable
conglomerate and that CLICO was the centerpiece of the Group. It was clear that the Group
had major vulnerabilities, the most notable being the excessive amount of related-party
transactions.
From the beginning, we recognized that regulation of the insurance industry, which was
accustomed to being unregulated, was always going to be a major challenge. And we knew
that CLICO, being the biggest company, would be in the forefront of this process.
Financial regulation is most effective when you have the confluence of a number of factors
including an adequate legislative and regulatory framework; an effective supervisory
system; including highly trained regulators; a regime of supporting and supportive
institutions such as the accounting and auditing profession and support from an informed and
vigilant investor community - or market discipline.
Even with all these pieces in place, any licensee who is committed to exploiting loopholes, to
taking excessive risks with policyholders' and depositors' funds, and to bending the system
could go undetected for a while and in so doing could do a lot of damage.
Our insurance legislation dates back to 1980 and is very archaic. By way of example:
•
CLICO, with assets in excess of over $24 billion, only requires capital of $3
million. This compares for example with banks which must have capital equivalent
to a minimum of 8 per cent of its assets. Thus, a bank
of CLICO's asset size would
have at least $2.0 billion of capital; regulatory capital requirements for the
insurance industry is only now being developed.
•
Even when the Central Bank formally took over regulation of the industry, the
legislation had limitations with respect to on-site supervision (and formally it
still does not);
•
While the legislation did not restrict related party transactions, there were significant
deficiency or loopholes and this was, perhaps CLICO's greatest vulnerability; and
•
It is silent on the issue of actuarial methodology, which allowed companies to use
their own standards which could result in a lower Statutory Fund requirement.
As the Bank and the industry proceeded to work on a new Insurance Act, we tried to achieve,
by moral suasion, what would have been mandatory under appropriate legislation. Thus for
instance:
•
We insisted on on-site inspections of CLICO;
•
In the face of concerns about risk management and inadequate controls, we insisted
on the appointment of independent directors and other measures to improve
corporate governance;
•
Concerned about the excessive reliance on short-term funding, the Bank required
CLICO to cease sale and the renewal of a particular deposit product;
•
After facing resistance for many years, in early 2008, the Bank sought to enforce
compliance with "the admissible asset regulations" that put restrictions on related
party transactions on the balance sheet and in the Statutory Fund. Most companies
had been adhering to the regulation. CLICO was one of the few that did not fully
comply.
Some analysts (critics) have asked - why did the Bank not intervene in CLICO before? To
this I affirm that for all the inherent vulnerabilities:
•
CLICO met its Statutory Fund requirements in 2004, 2005, 2006; by our calculation
there was a statutory fund deficit in 2007. However, up to the time the crisis broke,
CLICO was challenging our calculation.
•
CLICO had been given a clean bill of health by its auditors each year since 2004,
when it came under Central Bank's regulatory control in 2004. (You may have read
that Madoff used a small obscure firm to audit its books.
CLICO's auditors was a
highly recognized international firm).
•
AM Best the renowned international rating agency for insurance companies
downgraded CLICO in 2007 from A- to B+++; B+++ is still a solid rating for an
insurance company.
•
CLICO posted healthy "bank" profits in each year since 2004.
With these credentials, intervening in CLICO, notwithstanding its inherent vulnerabilities,
would have been difficult to justify. It would certainly have prompted a long dragged out
legal battle which could have had serious knockon effects both for CLICO and for the
rest of the financial system. With slow progress being made via moral suasion and with
new legislation on the way the case for intervention was even less defensible.
There is no doubt that new legislation has taken far too long to come into being. This has
been due, in part, to a fairly crowded legislative agenda and the shortage of legal drafting
skills in the public sector. I should note however, that the consultation process has
dragged on for much longer than expected because of a certain reluctance of the
industry to accept changes that have become standard in other jurisdictions.
Clearly some sections of the industry have been intent on jealously protecting the status-quo,
resisting change even when this has meant bringing us in line with international best
practices.
And then there are the consequences of limited market discipline. For all its tremendous
growth over the last several years, CLICO has remained a private company which has
shielded the company from the kind of scrutiny (through, for example the submission of
quarterly accounts) to which public companies are exposed.
I would want to posit that the CLICO/CIB crisis represents a case of "systemic failure" from
which we all can take invaluable lessons.
Clearly we need to upgrade our legislation as a matter of urgency. It is hoped that the
recent international financial crisis as well as the recent stresses in both the credit union and
the insurance industry would convince industry participants of the need for modern legislation
to cope with a modern financial sector.
Two, directors and management need to take seriously their fiduciary obligation to protect
depositors'/policyholders' funds. Independent directors have a special obligation to provide
checks and balances and play a "whistleblowing role", if necessary.
Three, external auditors must also recognize their fiduciary responsibilities and must be held
accountable. The self-regulatory bodies must set and enforce the highest auditing standards.
That's the legacy of Enron and World com.
Four, as Regulator we need to continue to upgrade our skills and quickly achieve the level of
competence in the insurance regulation as we have achieved in bank regulation. Of course,
we have been in bank regulation for close to fifty years whilst we have only recently been
doing insurance.
The CLICO/CIB crisis is a major setback for the financial sector in the region. We have been
able to contain the contagion but the challenge of strengthening market confidence and
ensuring that the cost to taxpayers remains minimal in the medium term is ongoing.
The CLICO/CIB collapse should be a lesson that serves to strengthen our financial system
for the next several years.