Jamaica’s Banking System Avoids Zero-Balance Crisis

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A recent study has revealed that Jamaica’s banking system narrowly avoided a zero-balance crisis during the global financial crisis. The investigation found that institutions not adequately capitalized were closed by authorities before shareholder equity was wiped out, resulting in a prudential minimum being developed based on bank failures during the crisis period.

Study Findings

• Average z-score of failed banks at the point of failure using the z-Jamaica (RORAC) method was 7.94
• Average z-score of failed banks at the point of failure using the z-Jamaica (ROA) method was 3.07
• Financial system exhibited significant risk of insolvency leading up to the last quarter of 2004, which could be attributed to the fact that the financial system remained under distress and profitability was impacted by continued reforms beginning in 2000

Methodology

The study used macroeconomic variables to decompose the risk of insolvency for the Jamaican financial system. The research developed a Vector Error Correction Model (VECM) to forecast system insolvency risk.

Results

• The VECM was used to investigate four periods of importance, including an out-of-sample one-year-ahead forecast from the time of the study
• The results indicate that the model is a weak predictor of insolvency risk for both in-sample and out-of-sample forecasts
• However, viewing forecasted z-scores as a distance-to-default rather than in a discrete manner could provide more value to policymakers as an indicator of solvency risk and act as an early warning measure

Conclusion

The research provides valuable insights into the Jamaican banking system’s resilience during times of financial distress and highlights the importance of developing robust forecasting models to ensure financial stability. The study suggests that policymakers can use forecasted z-scores as a distance-to-default indicator to monitor solvency risk and take proactive measures to mitigate potential crises.

References

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