Here is the converted article in Markdown format:

Credit Shock Impacts Provisioning for NPLs and Loss in Interest Income

A recent study by the Bank of Jamaica has revealed that a credit shock could have devastating consequences on the country’s financial stability. The report, which was released as part of the Financial Stability Report 2023, found that an increase in interest rates would lead to an increase in non-performing loans (NPLs).

Consequences of Credit Shock

According to the study, a 1% increase in interest rates would result in a 1.8% increase in NPLs. This means that if interest rates were to rise by 125 basis points, as assumed in the report, NPLs could increase by approximately 20%.

Aggregate Stress Test

The credit shock is just one of several stress tests applied to the financial system to assess its resilience to potential shocks. The aggregate stress test simulates the impact of a combination of interest rate, credit, liquidity and equity risk shocks on the capital adequacy ratio.

Other Stress Tests

In addition to the credit shock, the report also examined the impact of an assumed withdrawal of 20% of deposits from financial institutions. This scenario tested the system’s ability to withstand a sudden loss of liquidity.

Results of Stress Tests

The results of the stress tests revealed that both sectors (deposit-taking institutions and securities dealers) were generally resilient to the contemplated increases in Government of Jamaica (GOJ) bond yields. However, the post-shock capital adequacy ratio (CAR) for DTIs declined marginally by 0.8 percentage points, while the CAR for securities dealers sector declined by 2.0 percentage points.

Stress Testing Shocks

Here are the stress testing shocks applied:

Stress Testing Results

Here are the results of the stress tests:

Market Risk Stress Test Results

[Figure 1.6: Market risk stress test results showing post-shock CARs for DTIs and securities dealers]

Credit Risk Stress Test Results

[Figure 1.7: Credit risk stress test results showing post-shock DTI’s CARs]

Conclusion

The findings of the study are significant as they highlight the need for financial institutions to maintain strong levels of capitalization and liquidity to withstand potential shocks. The report also underscores the importance of effective risk management and regulatory oversight in ensuring the stability of the financial system.