## 1abwea2023001

## Source details

**Canonical URL:** [1abwea2023001](https://www.imf.org/-/media/files/publications/cr/2023/english/1abwea2023001.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/cr/2023/english/1abwea2023001.pdf.md)
- [Structured JSON version](/-/media/files/publications/cr/2023/english/1abwea2023001.pdf.json)

---

### Mission and scope
- CARTAC mission conducted virtual meetings from 4 April 2022 to 11 April 2022 at the request of the Central Bank of Aruba (CBA).
- Purpose: assist the authority in developing their financial stability framework, gather views on main potential risks and vulnerabilities in the banking sector, assess ongoing financial stability work initiated in 2018, and discuss the CBA’s stress-testing framework.
- Meetings: CBA senior management and staff, representatives from commercial banks of Aruba, the Aruban Bankers’ Association, the Insurance Association of Aruba, and the Association of Aruban Realtors.
- A working group was created to prepare upcoming first meetings of a new Financial Stability Committee (FSC).

### Financial sector structure and vulnerabilities
- Size and composition:
  - Total financial sector assets: around 2.5 times the country’s GDP (end-2021).
  - Commercial banks: 5 institutions at end-2021, accounting for 49 percent of total financial sector assets; 3 banks owned 92 percent of total commercial bank assets.
  - Only branch was acquired in 2022, reducing number of commercial banks to four.
  - Insurance companies’ total assets: 41.5 percent of GDP.
  - Pension funds: Company PF 7 (12.6% of GDP); Civil Servants PF 1 (64.4% of GDP).
  - Deposit-taking institutions: Commercial banks 5 (130.5% of GDP), Credit unions 2 (0.4% of GDP), Mortgage bank 1 (7.3% of GDP), Other DTFI* 2 (8.2% of GDP).
- Concentration and structural vulnerabilities:
  - Tourism dependence: tourism-related industries’ total contribution to GDP: above 90 percent.
  - Informal economy estimate: about 15 percent of GDP in 2019.
  - Small economy leads to concentration risks (large institutions and large exposures) and potential unregulated consumer lending by non-financial corporations and retailers.

### Banking sector condition, risks, and market exposures
- Capitalization and liquidity:
  - Banks are generally well capitalized and hold ample liquidity buffers; capital adequacy and liquid assets to total assets ratios have been around double the regulatory minima.
- Profitability and asset quality:
  - Banks are profitable; pre-pandemic NPL ratio: 3.2 percent.
  - NPLs increased marginally to around 6 percent (end 2021) despite GDP falling by around 25 percent in 2020.
- Funding and market risk:
  - Loan to Deposit Ratio below 70 percent; regulatory limit for Loan to Deposit is 80 percent.
  - Market risk exposure low: no stock exchange, limited investment opportunities; excess liquidity held in local government securities or deposits at foreign parent banks.
  - FX risk limited due to a successful peg; net open position limit in effect; banks do not provide FX loans.
- Interest rate and real estate vulnerabilities:
  - Dominance of fixed term mortgage lending and government bond holdings make banks potentially vulnerable to a rise in interest rate.
  - Share of mortgage loans in household portfolio rose from 60 to 75 percent during the last decade.
  - Mortgages offered by other lenders: pension funds 14 percent; mortgage banks 10 percent; life insurance companies 4 percent.
  - Share of total mortgage loans to GDP increased from 27 percent in 2006 to 44 percent in 2021.
  - House prices increased significantly since the start of the pandemic in some regions; many non-resident investor purchases settled in cash, muting immediate increases in bank mortgage stocks.

### Pandemic response and temporary measures
- CBA temporary adjustments at pandemic start:
  - Reserve requirement lowered from 12 to 7 percent.
  - Capital adequacy ratio lowered from 16 to 14 percent.
  - Prudential liquidity ratio lowered from 18 to 15 percent.
- By end-2021 CBA removed these measures, restoring:
  - Reserve requirement to 12 percent.
  - Capital adequacy ratio to 16 percent.
  - Prudential liquidity ratio to 18 percent.
- Government implemented a financial support package for households and businesses.
- Banks implemented moratoria and individual loan restructurings; moratoria lifted by end-2021.

### Macroprudential framework, governance, and institutional recommendations
- Strategic direction:
  - CBA has formulated a comprehensive strategy for financial stability with a clear vision; implementation delayed by internal prioritizations and resource constraints.
  - Continue building functions that do not require changing the state ordinance while seeking ordinance change.
- Institutional set-up recommendations:
  - Create a Financial Stability Committee (FSC) as the designated macroprudential authority; initiate quarterly meetings in the second half of 2022.
  - Form a dedicated Financial Stability Department (FSD) with at least 3 FTEs to serve as preparatory body for the FSC.
  - Seek approval to change the ordinance of the CBA to include a specific financial stability mandate.
  - Proposed FSC composition: include the President and two Executive Directors as voting members; a Working Group prepares quarterly FSC meetings.
  - Start FSD with 1 FTE (one manager) and increase to 3-4 FTEs if resources permit.
- Macroprudential policy (MaP) development:
  - Develop a strategy on MaP: prioritize MaP tools based on vulnerabilities and data constraints; decide on combination of micro and macroprudential tools.
  - Prepare methodologies for chosen MaP instruments, including calibration of the Counter-Cyclical Capital Buffer (CCyB) and identification of Domestic Systemically Important Banks (D-SIB) for surcharges.
  - Consider borrower-based tools such as LTV and LTI/DTI/DSTI to broaden MaP toolkit.
  - Main output of FSD: produce an annual Financial Stability Report (FSR) covering recent financial sector developments, risks and vulnerabilities, and policy recommendations.

### Data, monitoring, and stress testing recommendations
- Data gaps and priorities:
  - Existing data sufficient to start systemic risk monitoring, but more granular, frequent, and timely data needed.
  - Collect granular household data on income, loan, value of collateral to facilitate calculation of LTV and DSTI or DTI.
  - Implement a credit register to lower monitoring cost, increase access to credit, and provide granular data.
  - Revise regulatory data template to capture vintage information and recent developments (LTV by time of loan origination, loan flows etc.).
  - Calculate Quarterly GDP.
  - Start collecting climate-related information to assess materiality of climate risk; climate risk monitoring will require climate and loan data by firm and location.
- Stress testing enhancements:
  - Extend coverage of stress tests to add interest rate risk and sovereign spread shock; run multi-factor shocks.
  - Use historical data on NPLs to choose an extreme but realistic scenario and combine with reverse stress testing if size of shock is uncertain; consider industry-specific shocks where relevant.
  - Map linkages between financial institutions and run contagion simulations including banks and non-bank FIs.
  - Use stress test results in the FSR, linking scenarios to assessment of risks and vulnerabilities.
  - Once Basel II is implemented, revise the current stress test template (currently considers only private sector credit risk and liquidity risk).
  - When granular household and firm data become available, use them for stress testing.
  - Develop satellite models linking credit losses and income statement items to macro-financial variables.
  - Implement a multi-period framework for stress testing.

### Key recommendations (priorities and timeframes)
- Create a Financial Stability Committee and initiate quarterly meetings in the second half of 2022. — Priority: High; Timeframe: Near term.
- Create a dedicated Financial Stability Department with at least 3 FTEs. — Priority: High; Timeframe: Medium term.
- Seek approval of a change to the ordinance of the CBA to include a specific financial stability mandate. — Priority: High; Timeframe: Medium term.
- Start producing an annual Financial Stability Report. — Priority: High; Timeframe: Medium term.
- Develop a strategy on MaP Policy: prioritize tools and decide on micro vs macroprudential mix. — Priority: Medium; Timeframe: Long term.
- Develop methodology for introducing macroprudential tools (CCyB, D-SIB surcharge, LTV and DTI/DSTI), including calibration and necessary data collection. — Priority: Medium; Timeframe: Long term.
- Collect granular household data on income, loan, value of collateral to calculate LTV and DSTI or DTI. — Priority: High; Timeframe: Medium term.
- Implement a credit register. — Priority: Medium; Timeframe: Long term.
- Revise regulatory data template to capture vintage information and recent developments. — Priority: Medium; Timeframe: Medium term.
- Calculate Quarterly GDP. — Priority: Medium; Timeframe: Medium term.
- Start collecting climate-related information to assess materiality of risk. — Priority: Medium; Timeframe: Medium term.
- Extend stress testing coverage (interest rate risk, sovereign spread shock), run multi-factor shocks. — Priority: High; Timeframe: Near term.
- Use historical NPL data for extreme but realistic scenarios and reverse stress testing; consider industry-specific shocks. — Priority: High; Timeframe: Near term.
- Map FI linkages and run contagion simulations including banks and non-bank FIs. — Priority: Medium; Timeframe: Medium term.
- Use stress tests in the FSR and link scenarios to risk assessment. — Priority: High; Timeframe: Long term.
- Once granular household and firm data available, use them for stress testing. — Priority: Medium; Timeframe: Long term.
- Develop satellite models linking credit losses to macro-financial variables and implement multi-period stress testing frameworks. — Priorities: Medium and Low; Timeframes: Long term.

### Selected quantitative indicators (preserved exactly as reported)
- Tourism-related industries’ total contribution to GDP: above 90 percent.
- Informal economy estimate: about 15 percent of GDP in 2019.
- Share of mortgage loans in household portfolio: rose from 60 to 75 percent during the last decade.
- Mortgages offered by other lenders: pension funds 14 percent; mortgage banks 10 percent; life insurance companies 4 percent.
- Temporary CBA measures at pandemic start: reserve requirement lowered from 12 to 7 percent; capital adequacy ratio lowered from 16 to 14 percent; prudential liquidity ratio lowered from 18 to 15 percent.
- Restored ratios by end-2021: reserve requirement 12 percent; capital adequacy ratio 16 percent; prudential liquidity ratio 18 percent.
- Deposit-Taking FI assets to GDP (2021): Commercial banks 130.5%; Credit unions 0.4%; Mortgage bank 7.3%; Other DTFI* 8.2%.
- Insurance assets to GDP (2021): Life 31.1%; Non-life 6.7%; Captive 3.7%.
- Pension funds assets to GDP (2021): Company PF 12.6%; Civil Servants PF 64.4%.
- Commercial banks accounted for 49 percent of total financial sector assets at end of 2021.
- Number of commercial banks at end-2021: 5 (three owning 92 percent of total commercial bank assets).

### Commercial banks - Financial Soundness Indicators, 2016-2020 (Table 3 — preserved exactly)
- Capital Adequacy Ratio (min 16%): 2016 28.1; 2017 30.3; 2018 32.1; 2019 31; 2020 33.2
- Return on Assets: 2016 2.1; 2017 1.7; 2018 1.7; 2019 1.3; 2020 0.3
- Return on Equity: 2016 15.1; 2017 11.5; 2018 10.5; 2019 8.1; 2020 2.2
- Loan to Deposit (max 80%): 2016 66.2; 2017 68.2; 2018 68.1; 2019 68.4; 2020 66.8
- Liquid assets to total assets (min 18%): 2016 30.6; 2017 28.6; 2018 29.8; 2019 29.3; 2020 33.7
- NPL ratio: 2016 4.4; 2017 4; 2018 3.9; 2019 3.2; 2020 5
- Large loans to regulatory capital: 2016 51.4; 2017 40.6; 2018 41.4; 2019 45.3; 2020 50.2

### Sizable government bond holdings and dominance of fixed-term mortgage (risk highlights)
- Tourism-related industries (including direct and indirect) contribute above 90 percent of GDP.
- The US accounts for 85 percent of the tourist flow.
- Major source of bank losses: credit risk, which tends to be systemic and subject to external shocks given heavy tourism dependence.
- Over the last 10-15 years lending rates declined due to increasing competition, relatively weak loan demand and excess liquidity; a significant rise of interest rate is considered unlikely but volatility could increase if structural excess liquidity conditions change.
- Households account for about 55-60 percent of total private sector lending (stable since 2006; data cover 2006-2020).
- Aggregate household leverage (household loans provided by commercial banks/GDP) moved between 30 and 40 percent in 2006-2020.
- LTV practices:
  - LTV of 60 percent for non-residents purchasing property on the island.
  - LTV of 70 to 80 percent of execution value for local mortgage buyers (Box states around 70 percent for local buyers).
- No credit register exists in Aruba; private register offer was not deemed sufficient due to lack of full coverage.
- Government debt/GDP ratio increased from 73 percent prior to the pandemic to 111 percent.
- Banking sector sovereign investments: 6.5 percent of total asset at the end of 2021 (aggregate level).
- Bank-by-bank differences: Canadian banks: very small or no investment in government securities (end of 2021); Other banks: keep 10-15 percent of their assets in government bonds.
- Current regulatory treatment: sovereign exposure enjoys preferential treatment (zero risk weight and no provisioning requirement) though this may change with introduction of Basel II Pillar 1.

### Building the financial stability framework while legal changes await
- Continue to build functions of the proposed financial stability framework that do not require a changed ordinance rather than waiting for law change (paragraph 32).
- The FSC requires an appropriate preparatory body; initially a working group plus a dedicated secretary from the statistics department will prepare the quarterly report to the FSC (paragraph 33).
- The current set-up spreads responsibilities across departments and divisions and is likely not an optimal long-run solution (paragraph 33).

### Establishing a dedicated Financial Stability Department (FSD)
- Staffing:
  - The new FSD should include at least 3 FTEs (paragraph 35).
  - Possible internal composition: one function dedicated to financial stability policy issues; one function responsible for data issues, modelling and systemic tools; the manager could act as editor of departmental reports (paragraph 35).
- Main outputs:
  - Produce an annual Financial Stability Report (FSR) as the main output (paragraph 36).
  - The annual FSR should include: overview of recent developments in the financial sector in Aruba; recent developments with respect to financial institutions and lenders; discussion of main risks and vulnerabilities facing financial stability in Aruba; policy recommendations.
  - Periodicity could be increased as experience is gained (paragraph 36).

### Data, reporting system, and stress testing — operational details
- Reporting system improvements:
  - A new reporting system is under development; currently banks report in pdf and data are manually input into excel; digitalized reporting will save time and improve accessibility and reliability (paragraph 41).
- Recommended data increases:
  - Household data by income categories (or by households) is crucial; CBA has started internal discussions with banks to gather household level data (paragraph 42).
  - Detailed distributions for calibration of MaP tools (e.g., distribution of LTV and DSTI) are required.
  - More detailed NPL data is advised to capture heterogeneity of credit risk across products and industries.
  - Climate risk monitoring requires detailed exposure by industry and location, plus climate and greenhouse gas emission data linked to lending (paragraph 45).
  - Additional housing market indicators to collect include transactions and house permits (paragraph 47).
- Stress testing current practice and enhancements:
  - Current practice: Supervision department runs ST annually for banks; scenarios considered: general credit shock (increase of NPL by 5, 15 and 25 percentage points), default on the largest exposures, and liquidity run scenarios; interest rate and FX shocks are not considered currently; contagion is not modelled (paragraph 49).
  - Scenario design advice: choose one or max 2 severe but realistic credit shocks; express scenarios in terms of shock on new NPLs; use historical episodes or reverse stress test if needed (paragraphs 50–52).
  - Additional enhancements: include interest rate shocks in ST given large repricing gap and government bond holdings; map inter-FI linkages and run contagion simulations; move from static, one-period ST to multi-period ST requiring macro forecasting models and satellite models (paragraphs 53–58).

*IMF CARTAC mission report — Preface and Executive Summary (content unit: 1abwea2023001).*

### Preface.................................................................................................................

### 1abwea2023001 - Preface

### Mission and scope
- CARTAC mission conducted virtual meetings from 4 April 2022 to 11 April 2022 at the request of the Central Bank of Aruba (CBA).
- Purpose: assist the authority in developing their financial stability framework, gather views on main potential risks and vulnerabilities in the banking sector, assess ongoing financial stability work initiated in 2018, and discuss the CBA’s stress-testing framework.
- Meetings: CBA senior management and staff, representatives from commercial banks of Aruba, the Aruban Bankers’ Association, the Insurance Association of Aruba, and the Association of Aruban Realtors.
- A working group was created to prepare upcoming first meetings of a new Financial Stability Committee (FSC).

### Major themes and findings

#### Financial sector structure and vulnerabilities
- Financial sector size and composition:
  - Total financial sector assets: around 2.5 times the country’s GDP (end-2021).
  - Commercial banks: 5 institutions at end-2021, accounting for 49 percent of total financial sector assets; 3 banks owned 92 percent of total commercial bank assets.
  - Only branch was acquired in 2022, reducing number of commercial banks to four.
  - Insurance companies’ total assets: 41.5 percent of GDP; life insurers dominate based on asset size.
  - Pension funds: Company PF 7 (12.6% of GDP); Civil Servants PF 1 (64.4% of GDP).
  - Deposit-taking institutions: Commercial banks 5 (130.5% of GDP), Credit unions 2 (0.4% of GDP), Mortgage bank 1 (7.3% of GDP), Other DTFI* 2 (8.2% of GDP).
- Concentration and structural vulnerabilities:
  - Tourism dependence: tourism-related industries’ total contribution to GDP is above 90 percent.
  - Small economy leads to concentration risks (large institutions and large exposures).
  - Informal economy estimated at about 15 percent of GDP in 2019; consumer lending possibly offered by non-financial corporations and retailers, increasing unregulated credit risk.

#### Banking sector condition and risks
- Capitalization and liquidity:
  - Banks are generally well capitalized and hold ample liquidity buffers; capital adequacy and liquid assets to total assets ratios have been around double the regulatory minima.
- Profitability and asset quality:
  - Banks are profitable; pre-pandemic NPL ratio at a moderate level (3.2 percent).
  - NPLs increased marginally to around 6 percent (end 2021) despite GDP falling by around 25 percent in 2020.
- Funding and market risk:
  - Loan to Deposit Ratio below 70 percent; regulatory limit for Loan to Deposit is 80 percent.
  - Market risk exposure low: no stock exchange, limited investment opportunities, excess liquidity held in local government securities or deposits at foreign parent banks.
  - FX risk limited due to a successful peg; net open position limit in effect; banks do not provide FX loans.
- Interest rate vulnerability:
  - Dominance of fixed term mortgage lending and government bond holdings make banks potentially vulnerable to a rise in interest rate.
- Real estate exposure:
  - Share of mortgage loans in household portfolio rose from 60 to 75 percent over the last decade.
  - Mortgages also offered by pension funds (14 percent), mortgage banks (10 percent) and life insurance companies (4 percent).
  - Residential house prices increased significantly in some regions since the start of the pandemic, driven by strong demand from non-residential buyers and higher construction costs; a large part of non-resident investor purchases settled in cash, limiting immediate mortgage stock increase.
  - Risk could increase if house price rise is sustained or accompanied by increasing lending, rise in leverage and LTV, or falling price of risk.

#### Pandemic response and temporary measures
- CBA temporary adjustments at pandemic start:
  - Reserve requirement lowered from 12 to 7 percent.
  - Capital adequacy ratio lowered from 16 to 14 percent.
  - Prudential liquidity ratio lowered from 18 to 15 percent.
- By end-2021 CBA removed these measures, restoring:
  - Reserve requirement to 12 percent.
  - Capital adequacy ratio to 16 percent.
  - Prudential liquidity ratio to 18 percent.
- Government implemented a financial support package for households and businesses.
- Banks implemented moratoria and individual loan restructurings; moratoria lifted by end-2021.

### Macroprudential framework and institutional recommendations
- Strategic direction:
  - CBA has formulated a comprehensive strategy for financial stability with a clear vision; implementation delayed by internal prioritizations and resource constraints.
  - CBA advised to continue building functions that do not require changing the state ordinance while seeking ordinance change.
- Institutional set-up recommendations:
  - Create a Financial Stability Committee (FSC) as the designated macroprudential authority; initiate quarterly meetings in the second half of 2022.
  - Form a dedicated Financial Stability Department (FSD) with at least 3 FTEs to serve as preparatory body for the FSC.
  - Seek approval to change the ordinance of the CBA to include a specific financial stability mandate.
- Macroprudential policy (MaP) development:
  - Develop a strategy on MaP: prioritize MaP tools based on vulnerabilities and data constraints; decide on combination of micro and macroprudential tools.
  - Prepare methodologies for introducing chosen MaP instruments, including calibration of the Counter-Cyclical Capital Buffer (CCyB) and identification of Domestic Systemically Important Banks (D-SIB) for surcharges.
  - Consider borrower-based tools such as LTV and LTI/DTI/DSTI to broaden MaP toolkit.
  - Main output of FSD: produce an annual Financial Stability Report (FSR) covering recent financial sector developments, risks and vulnerabilities, and policy recommendations.

### Data, monitoring, and stress testing recommendations
- Data gaps and priorities:
  - Existing data sufficient to start systemic risk monitoring, but more granular, frequent, and timely data needed.
  - Collect granular household data on income, loan, value of collateral to facilitate calculation of LTV and DSTI or DTI.
  - Implement a credit register to lower monitoring cost, increase access to credit, and provide granular data.
  - Revise regulatory data template to capture vintage information and recent developments (LTV by time of loan origination, loan flows etc.).
  - Calculate Quarterly GDP.
  - Start collecting climate-related information to assess materiality of climate risk; climate risk monitoring will require climate and loan data by firm and location.
- Stress testing enhancements:
  - Extend coverage of stress tests to add interest rate risk and sovereign spread shock; run multi-factor shocks.
  - Use historical data on NPLs to choose an extreme but realistic scenario and combine with reverse stress testing if size of shock is uncertain; consider industry-specific shocks where relevant.
  - Map linkages between financial institutions and run contagion simulations including banks and non-bank FIs.
  - Use stress test results in the FSR, linking scenarios to assessment of risks and vulnerabilities.
  - Once Basel II is implemented, revise the current stress test template (currently considers only private sector credit risk and liquidity risk).
  - When granular household and firm data become available, use them for stress testing.
  - Develop satellite models linking credit losses and income statement items to macro-financial variables.
  - Implement a multi-period framework for stress testing.

### Key recommendations (extracted priorities and timeframes)
- Create a Financial Stability Committee and initiate quarterly meetings in the second half of 2022. — Priority: High; Timeframe: Near term.
- Create a dedicated Financial Stability Department with at least 3 FTEs. — Priority: High; Timeframe: Medium term.
- Seek approval of a change to the ordinance of the CBA to include a specific financial stability mandate. — Priority: High; Timeframe: Medium term.
- Start producing an annual Financial Stability Report. — Priority: High; Timeframe: Medium term.
- Develop a strategy on MaP Policy: prioritize tools and decide on micro vs macroprudential mix. — Priority: Medium; Timeframe: Long term.
- Develop methodology for introducing macroprudential tools (CCyB, D-SIB surcharge, LTV and DTI/DSTI), including calibration and necessary data collection. — Priority: Medium; Timeframe: Long term.
- Collect granular household data on income, loan, value of collateral to calculate LTV and DSTI or DTI. — Priority: High; Timeframe: Medium term.
- Implement a credit register. — Priority: Medium; Timeframe: Long term.
- Revise regulatory data template to capture vintage information and recent developments. — Priority: Medium; Timeframe: Medium term.
- Calculate Quarterly GDP. — Priority: Medium; Timeframe: Medium term.
- Start collecting climate-related information to assess materiality of risk. — Priority: Medium; Timeframe: Medium term.
- Extend stress testing coverage (interest rate risk, sovereign spread shock), run multi-factor shocks. — Priority: High; Timeframe: Near term.
- Use historical NPL data for extreme but realistic scenarios and reverse stress testing; consider industry-specific shocks. — Priority: High; Timeframe: Near term.
- Map FI linkages and run contagion simulations including banks and non-bank FIs. — Priority: Medium; Timeframe: Medium term.
- Use stress tests in the FSR and link scenarios to risk assessment. — Priority: High; Timeframe: Long term.
- Once granular household and firm data available, use them for stress testing. — Priority: Medium; Timeframe: Long term.
- Develop satellite models linking credit losses to macro-financial variables and implement multi-period stress testing frameworks. — Priorities: Medium and Low; Timeframes: Long term.

### Selected quantitative indicators (preserved exactly as reported)
- Tourism-related industries’ total contribution to GDP: above 90 percent.
- Informal economy estimate: about 15 percent of GDP in 2019.
- Share of mortgage loans in household portfolio: rose from 60 to 75 percent during the last decade.
- Mortgages offered by other lenders: pension funds 14 percent; mortgage banks 10 percent; life insurance companies 4 percent.
- Temporary CBA measures at pandemic start: reserve requirement lowered from 12 to 7 percent; capital adequacy ratio lowered from 16 to 14 percent; prudential liquidity ratio lowered from 18 to 15 percent.
- Restored ratios by end-2021: reserve requirement 12 percent; capital adequacy ratio 16 percent; prudential liquidity ratio 18 percent.
- Table 3 — Commercial banks - Financial Soundness Indicators, 2016-2020:
  - Capital Adequacy Ratio (min 16%): 2016 28.1; 2017 30.3; 2018 32.1; 2019 31; 2020 33.2
  - Return on Assets: 2016 2.1; 2017 1.7; 2018 1.7; 2019 1.3; 2020 0.3
  - Return on Equity: 2016 15.1; 2017 11.5; 2018 10.5; 2019 8.1; 2020 2.2
  - Loan to Deposit (max 80%): 2016 66.2; 2017 68.2; 2018 68.1; 2019 68.4; 2020 66.8
  - Liquid assets to total assets (min 18%): 2016 30.6; 2017 28.6; 2018 29.8; 2019 29.3; 2020 33.7
  - NPL ratio: 2016 4.4; 2017 4; 2018 3.9; 2019 3.2; 2020 5
  - Large loans to regulatory capital: 2016 51.4; 2017 40.6; 2018 41.4; 2019 45.3; 2020 50.2
- Deposit-Taking FI assets to GDP (2021): Commercial banks 130.5%; Credit unions 0.4%; Mortgage bank 7.3%; Other DTFI* 8.2%.
- Insurance assets to GDP (2021): Life 31.1%; Non-life 6.7%; Captive 3.7%.
- Pension funds assets to GDP (2021): Company PF 12.6%; Civil Servants PF 64.4%.
- Commercial banks accounted for 49 percent of total financial sector assets at end of 2021.
- Number of commercial banks at end-2021: 5 (three owning 92 percent of total commercial bank assets).

*Source: Central Bank of Aruba and CARTAC mission findings as presented in the Preface and Executive Summary of the report.*

*IMF CARTAC mission report — Preface and Executive Summary (content unit: 1abwea2023001).*

### 9. Sizable government bond holdings and the dominance of fixed term mortgage

### 9. Sizable government bond holdings and the dominance of fixed term mortgage

### Major risks and economic context
- Tourism-related industries (including direct and indirect) contribute above 90 percent of GDP.
- The US accounts for 85 percent of the tourist flow.
- Major source of bank losses: credit risk, which tends to be systemic and subject to external shocks given heavy tourism dependence.
- Over the last 10-15 years lending rates declined due to increasing competition between lenders, relatively weak loan demand and excess liquidity; a significant rise of interest rate is considered unlikely but volatility could increase if structural excess liquidity conditions change.

### Household sector exposure and leverage
- Households account for about 55-60 percent of total private sector lending (stable since 2006; data cover 2006-2020).
- Aggregate household leverage (household loans provided by commercial banks/GDP) moved between 30 and 40 percent in 2006-2020—fell following the GFC and then recovered to the pre-GFC level.
- Mortgages increased within household portfolios: share of mortgage loans rose from 60 percent to 75 percent over the last decade, with mortgage lending picking up especially after 2015.
- Mortgages in Aruba are held at fixed interest rates (i.e., fixed-rate mortgage stock).
- Mortgages are full-recourse loans.
- Household financial access and behavior (2021 household survey):
  - 50 percent of surveyed households have access to basic financial services.
  - Almost 60 percent indicate they have a savings account.
  - Only 1 in 3 households makes savings on a regular basis.
  - Less than 6 percent of surveyed households hold stocks and bonds.

### Mortgage lending standards and market structure
- Commercial banks: largest market share in mortgages at 75 percent.
- Pension funds: 14 percent; mortgage banks: 10 percent; life insurance companies: 4 percent.
- Share of total mortgage loans to GDP increased from 27 percent in 2006 to 44 percent in 2021.
- LTV practices:
  - LTV of 60 percent for non-residents purchasing property on the island.
  - LTV of 70 to 80 percent of execution value for local mortgage buyers (Box states around 70 percent for local buyers).
  - Life insurance companies offer more generous LTV requirements conditional on purchase of life insurance.
- The Central Bank of Aruba (CBA) has not yet started to collect LTV and DTI data.

### Non-bank lending, shadow banking, and data gaps
- Non-bank FIs (insurance companies and pension funds) offer mortgages; their share moved between 16-24 percent in 2006-2020.
- Retailers and pawn shops increasingly offer consumer loans; their share of the consumer lending subsegment is estimated around 10 percent.
- Shadow banking and lending outside bank-like regulation can increase risk-taking and challenge banks’ credit risk monitoring.
- No credit register exists in Aruba; private register offer was not deemed sufficient due to lack of full coverage.
- Implementation of a credit register would lower monitoring costs, increase access to finance and provide useful data for CBA monitoring and MaP.

### Commercial lending composition and concentration
- Structural shift in commercial lending (2006-2021):
  - Trade sector’s share fell from almost half (pre-2012) to 13 percent by 2021; outstanding stock also fell significantly.
  - “Real estate and renting” sector tripled its share, reaching 38 percent by 2021.
  - “Hotels and restaurants” industry more than doubled its share.
- Single-name concentration risk exists due to country size, but stress tests indicate banks have enough capital buffer to withstand failure of the (3-4) largest borrowers, although the impact is large.

### Sovereign exposure and sovereign vulnerabilities
- Government debt/GDP ratio increased from 73 percent prior to the pandemic to 111 percent (due to need to take credit from the Dutch government).
- Financial institutions in Aruba are the main buyers of government debt.
- Banking sector sovereign investments: 6.5 percent of total asset at the end of 2021 (aggregate level).
- Bank-by-bank differences:
  - Canadian banks: very small or no investment in government securities (end of 2021).
  - Other banks: keep 10-15 percent of their assets in government bonds — described as sizable exposure.
- Current regulatory treatment: sovereign exposure enjoys preferential treatment (zero risk weight and no provisioning requirement) though this may change with introduction of Basel II Pillar 1.

### Interlinkages between financial institutions
- Direct interlinkages can be contagion sources; more data and deeper analysis are needed.
- Observations:
  - Banks do not have majority interest in other FIs; reputational risk from ownership is limited.
  - Foreign subsidiaries hold assets at the parent but do not rely on group funding; parents are highly rated, and regulatory rules limit deposits placed at parent banks.
  - Given large liquidity buffers, the interbank market is thin.
  - Non-life insurance companies keep 65 percent of their assets in bank deposits; life insurance companies keep 10 percent of their total assets in bank deposits.
  - CBA requires banks to report all their exposure with other financial institutions; the only missing element is claims from resident non-bank FIs.

### Housing market dynamics and risks (Box 1 highlights)
- Housing stock: around 48,000 houses.
- Many non-resident investors settle purchases with cash, muting immediate increases in bank mortgage stocks despite rising house prices.
- House prices increased significantly since the start of the pandemic driven by strong demand from non-residential buyers and higher construction costs due to covid-related supply constraints; recent increases concentrated in more affluent areas.
- Rise in house prices could become a risk if sustained, potentially causing credit losses if house prices fall and households default.
- Mortgage equity withdrawal seems not very prevalent.
- Main financial stability risk from mortgages: credit losses from household defaults following a real economic shock with falling house prices, rather than immediate interest rate pass-through to household consumption.

### Climate risks
- Physical and transition climate-related risks can lead to financial stability risks and need monitoring.
- CBA has conducted research relating to physical climate risks and organized initial discussions on transition-related risks, but transition risks have not crystallized in quantifiable outputs.

### Macroprudential framework, governance, and tools
- Current legal framework: Central Bank Ordinance does not include a mandate for macroprudential policy; CBA’s mandate currently microprudential.
- Four departments at CBA undertake financial stability-related work across supervision, research, and statistics.
- A working group presented plans for a financial stability framework in 2018; a revision of the Ordinance to include a financial stability mandate requires parliamentary approval.
- CBA strategic plan 2021-2025 (“Dilanti Biento”) aims for a solid financial stability policy framework, based on a legal mandate, by 2025.
- Proposed governance:
  - Financial Stability Committee (FSC) within the CBA proposed as macroprudential authority; FSC to include the President and two Executive Directors as voting members.
  - A Working Group prepares quarterly FSC meetings; first meeting expected in the second half of 2022.
  - Plan for a Financial Stability Department: start with 1 FTE (one manager), with gradual increase to 3-4 FTEs if resources permit.
- Data and indicators:
  - Proposed toolkit includes financial soundness indicators for systemic risk; CBA can collect bulk of data but needs to collect LTV and DTI data.
- Existing prudential instruments and parameters:
  - Minimum reserve requirement currently equal to 18.0 percent of liabilities with a maturity less than 2 years.
    - Note: The CBA decided to raise the Reserve Requirement from 14 percent to 16 percent as of 1 March 2022 and further to 18 percent from 1 April 2022 in order to reduce commercial banks excess liquidity.
  - Minimum prudential liquidity ratio: 18 percent (ratio of liquid assets to total assets).
  - Minimum risk-weighted capital adequacy ratio (CAR): set at 16 percent of risk weighted assets when introduced.
  - Large-exposure rule: maximum exposure to one client or a group of connected clients at 25 percent of the sum of Tier I and Tier II capital; can be raised to 35 percent under exceptional circumstances and only for well-collateralized loans to clients with an excellent financial position.
  - Exemptions: exposures to the local Government, as well as short-term (< 1 year) investments with financial institutions are exempted from the large-exposure rule under specified conditions; banks required to periodically evaluate the financial position of these institutions.

*Source: 1abwea2023001 - 9. Sizable government bond holdings and the dominance of fixed term mortgage*

### 32. While changing the state ordinance of the CBA can take time, the CBA should

### 1abwea2023001 - 32. While changing the state ordinance of the CBA can take time, the CBA should

### Building the financial stability framework while legal changes await
- Continue to build the functions of the proposed financial stability framework that do not require a changed ordinance rather than waiting for the law to be changed (paragraph 32).
- The Financial Stability Committee (FSC) requires an appropriate preparatory body; initially a working group plus a dedicated secretary from the statistics department will prepare the quarterly report to the FSC (paragraph 33).
- The current set-up spreads responsibilities across departments and divisions and is likely not an optimal long-run solution (paragraph 33).

### Establishing a dedicated Financial Stability Department
- A dedicated Financial Stability Department is recommended as a more permanent preparatory body for the FSC (paragraph 34).
- Resource constraints delayed establishment: creation of a payment system department after the 2018 strategy and expenditure cuts during covid-19 delayed the Financial Stability Department (paragraph 34).
- Historical regulatory ratios noted in the text:
  - The CBA decided to reduce this requirement to 15 percent in response to covid.
  - The CBA decided to reduce this requirement to 14 percent in response to covid but has since end 2021 returned the requirement to 16 percent. (footnotes in the source)

### Recommended staffing and core outputs
- Staffing:
  - The new Financial Stability Department should include at least 3 FTEs (paragraph 35).
  - Possible internal composition: one function dedicated to financial stability policy issues; one function responsible for data issues, modelling and systemic tools; the manager could act as editor of departmental reports (paragraph 35).
- Main outputs:
  - Produce an annual Financial Stability Report (FSR) as the main output (paragraph 36).
  - The annual FSR should include:
    - Overview of recent developments in the financial sector in Aruba.
    - Recent developments with respect to financial institutions and lenders.
    - Discussion of main risks and vulnerabilities facing financial stability in Aruba.
    - Policy recommendations.
  - Periodicity could be increased as experience is gained (paragraph 36).

### Macroprudential (MaP) strategy and tool sequencing
- Develop a Macroprudential Policy strategy to prioritize which MaP tools to introduce and in what order, accounting for vulnerabilities and data constraints; include a roadmap and cost-benefit analysis for tool selection and sequencing (paragraph 37).
- Data needs for specific tools:
  - Introducing a Counter-Cyclical Capital Buffer requires more data, including quarterly GDP, which the CBA does not currently collect (paragraph 37).
  - Without more granular, timely GDP data there is risk of misleading signals for buffer decisions (paragraph 37).
- Prioritization between microprudential and macroprudential tools should be part of the plan (paragraph 37).
- Prepare methodologies and data preparations for chosen MaP instruments, including:
  - Methodology for introduction and calibration of the Counter-Cyclical Capital Buffer.
  - Identification methodology for systemically important domestic banks (D-SIB) to set separate capital or liquidity surcharges.
  - Start collecting quarterly GDP data to support eventual CCyB introduction.
  - Consider borrower-based tools such as LTV and LTI to broaden the MaP toolkit (paragraph 38).

### Assessing data availability for systemic risk analysis
- Key data types required for systemic risk monitoring (paragraph 39):
  - Macro and financial data
  - FSI for banks and other FIs
  - Credit development, interest rates, lending standards
  - Sectoral data on household, non-financial companies, sovereign
  - Housing market (residential, potentially also commercial)
  - Interconnectedness between financial institutions
  - Climate data
- Current data strengths and gaps (paragraphs 40–47):
  - Coverage of macro data is sufficient, though GDP and unemployment data are available at an annual frequency only.
  - Bank regulatory reports provide extensive coverage of FSIs, interest rates, repricing gap, bilateral exposure between FIs, large exposure, and decomposition of changes in NPL stock.
  - Sectoral data is scarce; the CBA regularly conducts a household survey which can be utilized.
  - Granular data for NFC would be available from the tax authority, but the tax authority is not allowed to share those data.
  - The staff calculates a residential property price index (RPPI) since 2012.
  - Most FSI bank data are available since 2006, which may be insufficient for some macro-financial modelling (paragraph 46).
- Reporting system improvements:
  - A new reporting system is under development; currently banks report in pdf and data are manually input into excel; digitalized reporting will save time and improve accessibility and reliability (paragraph 41).
- Recommended increases in data granularity and frequency (paragraph 42):
  - Household data by income categories (or by households) is crucial given vulnerability of lower income groups; CBA has started internal discussions with banks to gather household level data.
  - Detailed distributions for calibration of MaP tools (e.g., distribution of LTV and DSTI) are required.
  - More detailed NPL data is advised to capture heterogeneity of credit risk across products and industries.
- Other data notes:
  - CBA collects monthly data on interest rate risk (new loans resident only, new deposits in time buckets, maturity gap including all assets and liabilities); market analysis on the bond portfolio will be possible once the new data reporting is implemented (paragraph 43).
  - Distribution of LTV over the entire stock may not signal timely increases in LTV for new loan flows; share of new NPLs is a better proxied measure of true credit risk than the observed NPL ratio (paragraph 44).
  - Climate risk monitoring requires detailed exposure by industry and location, plus climate and greenhouse gas emission data linked to lending (paragraph 45).
  - Additional housing market indicators to collect include transactions and house permits (paragraph 47).
  - Mapping bilateral exposures between banks and other FIs is facilitated by existing regulatory reports (9A and 9B) which provide almost full coverage (paragraph 48).

### Stress testing (ST) recommendations and current practice
- Current practice (paragraph 49):
  - Supervision department runs ST annually for banks.
  - Scenarios considered: general credit shock (increase of NPL by 5, 15 and 25 percentage points), default on the largest exposures, and liquidity run scenarios.
  - Staff uses a simplified version of the IMF Stress Tester 3.
  - Interest rate and FX shocks are not considered currently; contagion is not modelled.
  - ST results are submitted to the Executive Committee and discussed with banks.
  - During covid, semiannual STs were conducted with different methodology (assumptions on shrinking loan portfolio, loss of interest payments).
- Scenario design recommendations (paragraphs 50–52):
  - Choose one or max 2 severe but realistic credit shocks rather than many ad hoc scenarios; historical episodes can help calibrate scenarios; reverse stress test if historical episodes are inappropriate.
  - Express scenarios in terms of shock on new NPLs instead of level or change of overall NPL ratio; use the CBA’s report on sources of change in NPL stock (upgrades, movements between classification groups, new NPLs, write-offs) but check its reliability.
  - Collect long time series by bank, industry and loan product to capture heterogeneity in credit risk for more tailored scenarios; mortgages and consumer loans differ meaningfully.
- Additional stress testing enhancements (paragraphs 53–58):
  - Use sector-specific shock combinations to test sectoral concentration risk (e.g., housing market shock, sectoral impacts like covid-19).
  - Given large exposure to interest rates (large repricing gap, government bond holdings), include interest rate shocks in ST even if a rise is currently considered unlikely (paragraph 54).
  - Once direct linkages between FIs are mapped, run contagion simulations; the interbank market is thin but contagion should be considered depending on mapping results (paragraph 55).
  - When granular household and firm data become available, run separate household and corporate sector STs; existing household survey may be used though last survey occurred during the pandemic (paragraph 56).
  - For macroprudential purposes, use multifactor shocks and scenarios linked to assessment of relevant risks and vulnerabilities; consider two-way feedback effects between real economy and financial sector (paragraph 57).
  - Move from static, one-period ST framework to multi-period ST on the long term; this requires macro forecasting models and satellite models to forecast banks’ balance sheets and capital (credit growth, credit losses, net interest income) (paragraph 58).

*Source: Excerpt from the provided IMF chapter/section content.*

---


_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1abwea2023001.pdf_