Aruba’s Banking Sector: A Prudent Approach to Lending
The banking sector in Aruba has been operating with caution, avoiding external or wholesale funds and maintaining a Loan to Deposit Ratio below 70 percent. While deposit insurance is not currently in place, a draft bill has been submitted to Parliament to address this issue.
Low Market Risk Exposure
Aruba’s lack of a stock exchange and limited investment opportunities means that banks hold excess liquidity in local government securities or as deposits at their foreign parent banks. This reduces exposure to market risk. Additionally:
- The country’s successful pegged currency limits foreign currency (FX) risk.
- The net open position minimizes FX risk.
Interest Rate Sensitivity
While Aruba’s sizable government bond holdings and dominance of fixed-term mortgage contracts make interest rate movements a concern, a significant rise in interest rates is considered unlikely. Over the past decade, lending rates have been declining due to increased competition and limited credit demand.
Commercial Lending Trends
A shift in commercial lending patterns has been observed since the Global Financial Crisis (GFC). Banks are increasingly exposed to:
- Real estate industries
- Tourism-related industries
- Hotels and restaurants
The trade sector’s share of lending has declined, while hotels and restaurants have become a larger segment.
Non-Bank Lending
Non-bank financial institutions (NBFIs), such as insurance companies and pension funds, are active in the mortgage market, accounting for around 16-24 percent of total mortgages issued. Retailers and pawn shops are also increasingly offering consumer loans, which poses challenges to banks’ credit risk monitoring.
Single Name Concentration Risk
Despite single name concentration risk being a concern due to the small size of the country’s economy, banks have significant capital buffers that make them resilient to potential defaults by their largest borrowers. The Central Bank of Aruba has prudent regulations in place to limit individual exposures and large loans.
Stress Testing
The Supervision Department has conducted stress tests, which indicate that banks have sufficient capital buffers to withstand the failure of three to four of their largest borrowers. However:
- The impact of such a shock would be significant.
- Banks are prepared for potential defaults by their largest borrowers.
Overall, Aruba’s banking sector is characterized by caution and prudence, with banks focused on domestic lending and minimizing exposure to external risks. While there are challenges posed by non-bank lending and single name concentration risk, the sector appears resilient in the face of potential shocks.