## _cr15282

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### Executive summary — introduction and financial system profile
- TCI is a British Overseas Territory; the economy relies mostly on tourism.
- The financial system’s (largely offshore) assets amount to about 450 percent of GDP.
- The FSC is an integrated supervisor overseeing all financial institutions; the territory uses the U.S. dollar and does not have a central bank.
- Banks account for a large part of the system’s assets and include:
  - many small, niche U.S.-based reinsurance companies (PORCs) in the insurance sector;
  - banks that are branches or subsidiaries of foreign banks/holding companies; top four banks designated as D-SIBs.
- Key macro facts:
  - Population: 35,000
  - Nominal GDP: about US$ 800 million
  - GDP per capita (2014): around US$ 23,000
  - Financial system assets (all, in percent of GDP, 2014): 449
  - Banking assets (in percent of GDP): about 230
  - Credit to residents: just over 100 percent of GDP
  - Offshore insurers’ assets: about 11 percent of GDP
  - PORCs count (2014): 6,954

### Recent domestic financial distress and outcomes
- A severe recession starting in 2009 led to a sharp increase in nonperforming loans (NPLs).
- TCI Bank failed (early 2010); TCI Bank assets (2010): about 12 percent of GDP; depositors recovered about 40 cents to the dollar.
- In 2014 a local life insurer (BAFSL) was liquidated as a delayed consequence of CLICO’s failure; policyholders have recovered 20 cents to the dollar so far.
- Contagion to the rest of the financial system was limited.

### Bank soundness, risks, and stress-test findings
- System-level metrics and structural observations:
  - Total capital adequacy ratio (CAR) for the system stood at 30 percent in 2014 (regulatory minimum: 11 percent).
  - NPL ratio: 17.9 (system); construction sector NPL ratio: 78 percent.
  - Share of the top 10 borrowers in net credit: about 35 percent (high concentration).
  - Provisioning practices appear conservative; banks usually do not incorporate collateral value for provision calculations.
- Stress-test framework:
  - Top-down tests covering four D-SIBs (market share nearly 90 percent) using end-June 2014 data; solvency and liquidity scenarios applied.
- Selected solvency results and scenario impacts (reported exact values):
  - Baseline capital adequacy ratio, actual: 29.0
  - NPL ratio: 17.9
  - Adjustment for under-provisioning: adjusted CAR 21.1, change -7.9 percentage points
  - Raising provisioning with collateral: CAR 20.6, change -8.3 percentage points
  - Raising provisioning without collateral: CAR 19.4, change -9.6 percentage points
  - Increase in NPLs: NPL-ratios increase by 20 ppt, equal distribution of new NPLs: CAR 10.9, change -10.2 percentage points; share in total assets 38.34 percent
  - NPL-ratios increase by 20 ppt, system-wide provisioning rates: CAR 13.9, change -7.2 percentage points; capital shortfall volume 2401.6
  - Proportional increase in NPLs by 90 percent: CAR 17.5, change -3.6 percentage points; share in total assets 180.0
  - Sectoral shock to construction and property: CAR 18.8, change -2.3 percentage points; share in total assets 180.2
  - Largest exposure defaults: CAR 12.4, change -8.7 percentage points; share in total assets 1330.3
  - 5 largest exposure default: CAR -6.0, change -27.1 percentage points; number of banks below regulatory minimum: 4; share in total assets 10015.9
  - Inability of group affiliates to repay intragroup loans: CAR -0.6, change -21.7 percentage points; capital shortfall share in total assets 14324.0
- Liquidity stress-test highlights and exact outcomes:
  - Most liquid assets are deposits at foreign head offices; intragroup claims dominate FSC-defined liquid assets.
  - Cash-flow test and LCR-style tests show sensitivity to intragroup funding shocks and customer deposit runs.
  - Example scenario outcomes (selected reported figures):
    - Scenario 2 (medium intragroup/interbank shock): With cushion: liquidity gap 0.3 million USD; survival period 27/30; Without cushion: liquidity gap 103.2 million USD; survival period 6/30.
    - Scenario 3 (complete intragroup/interbank withdrawal): With cushion: liquidity gap 25.4 million USD; survival period 1/30; Without cushion: liquidity gap 177.4 million USD; survival period 1/30.
    - Scenario 6 (general bank run): With cushion: liquidity gap 3.8 million USD; survival period 21/30; Without cushion: liquidity gap 181.4 million USD; survival period 4/30.
    - Scenario 7 (deposit run + intragroup shock): With cushion: liquidity gap 58.3 million USD; survival period 6/30; Without cushion: liquidity gap 235.9 million USD; survival period 3/30.
  - LCR results:
    - Most banks’ LCRs fall below the 100 percent hurdle rate.
    - Liquidity shortfall for the system is about 35 percent of GDP under LCR with 75 percent cap on inflows; removing the cap reduces shortfall to about 30 percent of GDP.
    - Shortage driven by lack of eligible assets for HQLA; currently only cash qualifies as HQLA.
- Overall solvency/liquidity assessment:
  - Most banks have sufficient capital to write off legacy NPLs on aggregate and to withstand a range of adverse shocks, though large concentration or extreme scenarios can push CAR below regulatory minimum.
  - Liquidity resilience depends critically on timely availability of liquidity buffers at foreign head offices.
  - Key risks: credit and loan-concentration risks, real estate collateral valuation, and intragroup funding exposures.

### Intragroup transactions, consolidated supervision, and governance
- Intragroup transactions are significant for both banks and insurers; most liquid assets are held at foreign head offices.
- The FSC should closely monitor broad intragroup transactions and ensure capital remains dedicated to TCI operations.
- Consolidated supervision gaps:
  - Complexity and parallel-bank structures complicate group-wide assessment.
  - Recommendation to establish a supervisory college with key foreign regulators for comprehensive consolidated supervision, especially for a large bank with cross-border parallel structure.
- Governance and operational capacity:
  - Staff complement increased from 17 (2003) to 70 (2015); FSCO strengthened FSC independence in 2007.
  - Board is below strength and missing an insurance expert since 2013; Managing Director overloaded without Deputy MDs.
  - Deficiencies in Banking Ordinance include lack of requirement for advance notification of dividend payments to the FSC and imprecise definitions of related parties.

### Financial oversight: FSC status, needs, and supervisory practice
- Progress and remaining needs:
  - Major advances in operational independence and staffing; adequate staffing including experienced external consultants for banking supervision.
  - Outdated Banking Ordinance (BO) and Insurance Ordinance (IO) require urgent overhaul.
  - FSC has implemented a formal offsite supervision process and issued Guidelines; further capacity needed for risk assessment and communication.
- Supervisory operational shortcomings:
  - Onsite supervision is sporadic (three in the past five years) and narrow in scope; reports issued with 5-6 month lag.
  - Offsite analyses are backward-looking and limited to intermediate entities; need more forward-looking, consolidated analysis.
- Recommended supervisory improvements:
  - Enhance Board oversight and fill key Board and senior management positions.
  - Strengthen communication and consultation with industry.
  - Improve supervision and risk-assessment capacities of FSC staff; develop manuals and internal procedures for onsite inspections.
  - Require regular stress testing and comprehensive financial-statement analysis.
  - Ensure FSC is notified in advance of licensees’ dividend payments and has power to stop them in light of solvency concerns.

### Insurance supervision and policyholder protection
- Status and challenges:
  - Insurance supervision was dormant until 2008 and is now catching up; FSC has issued Guidelines, internal procedures, begun onsite and offsite supervision, and started issuing penalties.
  - Offshore PORCs are numerous and small; PORCs assets estimated about 5 percent of GDP; little regular financial information is collected on these insurers.
- Urgent weaknesses and recommendations:
  - Policyholder protection needs upgrading: strengthen FSC’s ability to realize assets to cover liabilities; require segregated statutory funds in TCI to back insurers’ liabilities.
  - Enact the Domestic Insurance Ordinance (DIO) and draft the International Insurance Ordinance (IIO) without delay; ensure FSC exclusive authority on dispensation decisions and increase enforcement power of central supervisory requirements.
  - Supervision should be extended to agents and brokers; consider licensing/certification requirements for intermediaries.
  - Government should consider providing financial support to British Atlantic Financial Service Ltd. (BAFSL) policyholders to protect credibility of life insurance for long-term savings; estimated maximum fiscal cost if all policyholders recovered in full: US$ 8 million (about one percent of GDP) versus average annual fiscal surplus of about US$ 48 million for three years since 2012.

### Macroprudential policy and real estate market focus
- FSC has started developing a macroprudential framework and identified SIFIs (top four banks) considering capital surcharges.
- Recommendations:
  - Devote capacity to comprehensive risk assessments and system-wide stability analysis, including stress testing and publishing a financial stability report eventually.
  - Monitor real estate markets; limits on loan-to-value ratios could be highly effective micro- and macroprudential tools.
  - Data collection: gather value of collateral per loan, loan-to-value ratios, haircuts applied by banks for provisioning purposes, and realized recovery rates in the real estate market.

### Bank resolution, depositor protection, and safety nets
- Key findings:
  - TCI lacks a quick, effective, and legally certain framework to deal with non-viable banks; FSC lacks sufficient powers to take control and exercise key resolution actions.
  - TCI does not have a central bank or lender-of-last-resort; local government borrowing constrained by U.K. limits.
  - Protecting small depositors is important, but preconditions for a Deposit Insurance Scheme (DIS) are not currently met.
- Core recommendations:
  - Establish a Special Bank Resolution Regime (SBRR) by law to empower the FSC to take resolution actions (remove senior managers, transfer/sell assets and liabilities, establish bridge bank, override shareholder rights) and ensure resolution actions cannot be overridden by courts (court may award monetary compensation).
  - Amend the Companies Ordinance and introduce depositor preference in bank liquidation using a two-tiered depositor preference favoring small depositors.
  - Create Special Purpose Reserve Funds (SPRFs) to hold a portion of total customer deposits in high-quality liquid assets, managed by an independent, highly rated, non-TCI third party, for protecting small depositors.
  - Seek firm funding commitments from parent banks; require support to be backed by specific liquid assets if parent is not well established.

### Crisis prevention, coordination, and contingency planning
- Recommendations:
  - Create a Financial Stability Committee composed of the Governor, the Minister of Finance, and the MD of the FSC to coordinate prevention and management of financial crises and to prepare/adopt a Strategy for Crisis Prevention and Management.
  - Introduce recovery and resolution plans and resolvability assessments for SIFIs; require recovery programs from all SIFIs and SIFI resolution plans by the FSC.
  - Review and update bilateral and regional MoUs to include crisis prevention and management protocols and resolvability assessments.
  - Explore alternative last-resort emergency funding options, including creation of an industry-participation Fund and access to lines of credit.

### AML/CFT and transparency recommendations
- Progress and concerns:
  - TCI has made substantial progress since its 2007 CFATF assessment; a national ML/TF risk assessment (with World Bank assistance) to be completed in 2015.
  - Capacity to ensure compliance with CDD obligations is limited; only a handful of AML/CFT onsite exams in past three years and no sanctions for CDD violations.
  - Legal-person transparency deficiencies: no obligation for companies incorporated in TCI but operating abroad to file legal-owner information with the company registrar; bearer shares abolished; discussions on a beneficial-ownership registry underway.
- Recommendation:
  - Strengthen framework to ensure current and accurate information on beneficial ownership of legal persons and arrangements established in TCI is available in a timely manner; enhance supervision of CDD implementation.

### High-priority recommendations (selected, with timing where provided)
- Conduct an external evaluation of the FSC Board. (ST) Para 35
- Fill all vacancies at FSC Board and senior management levels, and introduce and fill deputy Managing Director (MD) positions. (ST) Para 35
- Develop and devote capacity for comprehensive risk assessment of individual institutions and financial system-wide stability assessment, including stress testing, and communicate key messages. (NT) Paras 33,43,54
- FSC should be notified in advance of licensees’ dividend payments and have explicit power to stop them in light of solvency concerns. (ST) Para 31,40,46
- Complete preparation of and enact the new Banking Ordinance. (NT) Paras 35,40,41
- Continue progress toward BCP observance, particularly those addressing risk and its management, including better monitoring of real estate markets and collateral valuations. (NT) Paras 30,43,54
- Establish, by law, a Special Bank Resolution Regime. (NT) Para 57
- Amend the Companies Ordinance and introduce two-tiered depositor preference; establish a Special Purpose Reserve Fund to protect small depositors. (NT) Para 59
- Enact the Domestic Insurance Ordinance (DIO) and draft the International Insurance Ordinance (IIO) without further delay. (ST) Paras 35,46,52
- Consider financial support to British Atlantic Financial Service Ltd. (BAFSL) policyholders. (ST) Para 48
- Create Financial Stability Committee and prepare/adopt a Strategy for Crisis Prevention and Management. (ST/NT) Para 60

*Source: EXECUTIVE SUMMARY and selected sections, _cr15282 (IMF staff report).*

### EXECUTIVE SUMMARY ___________________________________________________________________________  5

### _cr15282 - EXECUTIVE SUMMARY ___________________________________________________________________________  5

### Introduction and Financial System Profile
- TCI is a British Overseas Territory; the economy relies mostly on tourism.
- The financial system’s (largely offshore) assets amount to about 450 percent of GDP.
- TCI is home to a large number of small, niche U.S.-based reinsurance companies; banks account for a large part of the system’s assets.
- The FSC is an integrated supervisor overseeing all financial institutions.
- The territory uses the U.S. dollar and does not have a central bank.

### Recent Domestic Financial Distress and Outcomes
- A severe recession that started in 2009 led to a sharp increase in nonperforming loans (NPLs).
- A large indigenous bank failed; depositors have so far recovered 40 percent of their claims.
- In 2014 a local insurance company was liquidated, a delayed consequence of the failure of a large regional insurer; TCI policyholders have recovered 20 percent of claims so far.
- Contagion to the rest of the financial system was limited.

### Bank Soundness, Risks, and Stress Tests
- Banks are foreign owned and operate a traditional business model with high capital buffers.
- Legacy NPLs remain high and credit has been contracting since the crisis; contraction is concentrated in the construction sector.
- Banks have sufficient capital to write off most of the existing NPLs on aggregate.
- Stress tests highlight the importance of:
  - credit and concentration risk together with real estate collateral valuation,
  - liquidity risks from customer deposits and, for some banks, intragroup funding.
- Most banks have sufficient capital to withstand a range of adverse shocks, but one bank shows signs of weak governance.
- Since most liquid assets are claims on group affiliates, ensuring their continued availability is key for managing liquidity risks.

### Financial Oversight: FSC Status and Needs
- Major advances have been made regarding the operational independence of the FSC and staffing.
- Outdated Banking Ordinance (BO) and Insurance Ordinance (IO) need urgent overhaul.
- Recommended actions to strengthen FSC functioning:
  - enhance Board oversight;
  - fill key positions at Board and senior management levels;
  - strengthen communication and consultation with the industry;
  - improve supervision and risk-assessment capacities of FSC staff.
- FSC progress in banking supervision:
  - adequate staffing including experienced external consultants;
  - formal offsite supervision process implemented;
  - a suite of Guidelines issued.
- Further action required:
  - FSC should be afforded prior notification of licensees’ dividend payments so that they may be stopped in light of any solvency concerns.
  - Continue progress toward greater observance of the Basel Core Principles (BCPs), particularly those addressing risk and its management.
  - Establish a supervisory college with key foreign regulators for comprehensive consolidated supervision of a large bank with a cross-border parallel bank structure.

### Insurance Supervision
- Formerly dormant insurance supervision is catching up rapidly; FSC has issued internal procedures and central Guidelines and begun issuing penalties; onsite and offsite supervision of insurers has started.
- Urgent challenges:
  - policyholders’ protection needs upgrading by strengthening the FSC’s ability to realize assets sufficient to cover all liabilities to policyholders.
  - government should consider providing financial support to policyholders of the recently failed life insurer to protect the credibility of life insurance for long-term savings.
  - New IOs should ensure FSC’s exclusive authority on all dispensation decisions; increase enforcement power of central supervisory requirements; maintain the attractiveness of TCI for international insurers.
  - Supervision should be extended to agents and brokers.
- Recommendation: Create statutory funds in TCI to segregate company assets that back up the liabilities of the insurers.

### Macroprudential Policy and Real Estate
- FSC is working on a macroprudential policy framework, beginning with identifying systemically important financial institutions and expanding capacity for macroeconomic analysis.
- FSC should develop and devote capacity for comprehensive risk assessments of individual institutions and system-wide stability, including stress testing.
- Monitoring the real estate market is essential; limits on loan-to-value ratios could be highly effective micro- and macroprudential policy tools.

### Bank Resolution, Deposit Protection, and Safety Nets
- TCI should establish a Special Bank Resolution Regime (SBRR) by law to empower the FSC to take a whole array of resolution actions.
- FSC Ordinance should be amended so FSC’s resolution actions cannot be overridden by a court.
- Protecting small depositors is important, but TCI is not positioned to introduce a Deposit Insurance Scheme (DIS) now—preconditions for a DIS are not currently met.
- Alternative tools to protect small depositors:
  - depositor preference in bank liquidation (amend the Companies Ordinance (CO) and introduce two-tiered depositor preference),
  - creation of Special Purpose Reserve Funds (SPRFs) to hold a portion of total customer deposits in high-quality liquid assets earmarked to protect small depositors,
  - firm funding commitments from parent banks.

### Crisis Prevention and Management
- Establish a Financial Stability Committee with the MD of the FSC, the Minister of Finance, and the Governor to coordinate prevention and management of financial crisis, supported by information sharing and interagency coordination.
- Prepare and adopt a Strategy for Crisis Prevention and Management.
- Introduce recovery and resolution plans for systemically important banks.
- Review and update bilateral and regional MoUs, including actions and protocols for crisis prevention and management.
- Explore alternative funding sources as last-resort emergency funding.

### High-Priority Recommendations (selected from Table 1)
- Conduct an external evaluation of the FSC Board. (ST) Para 35
- Fill all vacancies at FSC Board and senior management levels, and introduce and fill deputy Managing Director (MD) positions. (ST) Para 35
- Develop and devote capacity for comprehensive risk assessment of individual institutions and financial system-wide stability assessment, including stress testing, and communicate key messages. (NT) Paras 33,43,54
- FSC should be notified in advance of licensees’ dividend payments and have explicit power to stop them in light of solvency concerns. (ST) Para 31,40,46
- Complete preparation of and enact the new Banking Ordinance. (NT) Paras 35,40,41
- Continue progress toward BCP observance, particularly those addressing risk and its management, including better monitoring of real estate markets and collateral valuations. (NT) Paras 30,43,54
- Establish, by law, a Special Bank Resolution Regime. (NT) Para 57
- Amend the Companies Ordinance and introduce two-tiered depositor preference; establish a Special Purpose Reserve Fund to protect small depositors. (NT) Para 59
- Enact the Domestic Insurance Ordinance (DIO) and draft the International Insurance Ordinance (IIO) without further delay. (ST) Paras 35,46,52
- Consider financial support to British Atlantic Financial Service Ltd. (BAFSL) policyholders. (ST) Para 48
- Create Financial Stability Committee and prepare/adopt a Strategy for Crisis Prevention and Management. (ST/NT) Para 60

*Source: EXECUTIVE SUMMARY, _cr15282 - EXECUTIVE SUMMARY ___________________________________________________________________________*

### INTRODUCTION

### INTRODUCTION

### FSAP request and supervisory context
- The authorities requested the IMF team to conduct the first Financial Sector Assessment Program (FSAP).
- Previously, TCI had a review of financial sector regulation and supervision in 2003.
- The Financial Services Commission (FSC), established in 2002, is an integrated supervisor overseeing all financial institutions.
- Since the 2003 assessment, the FSC has made substantial progress in improving its operational independence and staffing in line with the Fund recommendations (Appendix Table 1).
- Remaining challenges include further strengthening the oversight framework and FSC’s capacity.
- Recent failures of a systemically important local bank and a key life insurer revealed the need for establishing an effective resolution and safety net framework.

### Box 1 — Failure of Financial Institutions in TCI
- TCI Bank
  - TCI Bank was the only home-grown bank with assets of about 12 percent of GDP in 2010.
  - It started operations in 2005, offering retail, corporate, and investment services.
  - Most of its funding was local deposits.
  - The National Insurance Board had substantial equity and deposit exposures.
  - Many large real estate loans became nonperforming during the global financial crisis, leading to deposit outflows and eventual failure.
  - Without deposit insurance, other safety net tools (including lender of last resort), or U.K. support, depositors recovered only about 40 cents to the dollar.
  - Licensing, supervision, and management of the bank remain contentious, with discussions that the licensing decision was made inadequately in favor of having an indigenous bank and ongoing investigations concerning the preference for three large depositors over retail depositors.
- British Atlantic Financial Services Ltd. (BAFSL)
  - BAFSL was established in 2010, taking over the TCI operation of failed Bahamas-based British American Insurance Company (BAICO), which failed with its parent (Trinidad and Tobago-based CLICO).
  - BAFSL was licensed despite an inherited capital shortfall due to lost intragroup claims vis-à-vis BAICO because an external actuarial report assessed a chance to reduce policyholders’ losses under a new company.
  - Losses increased as BAFSL continued to guarantee returns on investments and a substantial amount of money was transferred from BAFSL’s restricted deposit to BAICO’s administrator.
  - Policyholders—mostly local public servants with modest income who contributed for retirement, in some cases for over 20 years—are expected to recover 20 cents to the dollar so far.
  - Policyholders were not properly informed of the transition from BAICO to BAFSL—both advertised as “BA.”

*Macroeconomic Background and Financial System Profile*

### A. Macroeconomic and Financial Context
- Population and GDP
  - Population of 35,000.
  - Nominal GDP of about US$ 800 million (Appendix Figure 1).
  - GDP per capita of around US$ 23,000 in 2014.
- Economic structure
  - Tourism (mainly from North America) generates more than half of GDP directly and indirectly.
  - The U.S. dollar is used as legal tender; TCI has no central bank.
- 2009 crisis and aftermath
  - Following an average annual growth of 12 percent during 2004–08, GDP contracted by nearly 20 percent in 2009 due to the combined effects of the global financial crisis, Hurricane Ike, and severe financial mismanagement by the TCI government discovered in 2009.
  - The United Kingdom took over the territory’s governance, provided short-term funding, and imposed fiscal austerity measures.
  - The government has been generating 3½-nearly 8 percent of GDP overall surplus since 2012, and public debt declined to 11 percent of GDP in 2014.
- Failures and losses
  - In early 2010, TCI Bank failed and was put into a lengthy court-ordered liquidation; depositors recovered only about 40 cents to the dollar.
  - A key local life insurer failed in 2014 as a delayed consequence of the failure of Trinidad and Tobago-based Colonial Life Insurance Company (CLICO) in 2009.
- Recovery and near-term outlook
  - Since the crisis, the economy has recovered gradually and the near-term prospect is favorable (Appendix Table 2).
  - Aggressive fiscal austerity starting in 2012 limited the recovery of GDP.
  - Moderate near-term growth is expected as fiscal surplus gradually declines and strong U.S. growth helps the tourism sector.
  - Economic recovery has led to a rapid turnaround of high-end real estate markets, though indicators remain below pre-crisis peaks (Figure 1).
- Sinking fund and debt guarantee
  - Much of the fiscal surplus has been set aside in a sinking fund to prepare for the repayment of US$ 170 million debts that will be guaranteed by the U.K. until 2016.
  - As of March 2015, the balance of the sinking fund was US$ 110 million, leaving the gap of US$ 60 million (7½ percent of GDP).

### B. Financial System Profile
- Overall size and composition
  - As an offshore financial center with no income and capital gain taxes, TCI has large banking, insurance, and asset management sectors with (mostly offshore) assets of about 450 percent of GDP (Table 3).
  - Banks are the largest sector by assets, at about 230 percent of GDP and credit to residents stands just over 100 percent of GDP.
  - The insurance sector’s assets are about 11 percent of GDP, but it is the largest by number because of niche U.S. manufacturer-owned offshore reinsurance companies called Producer-Owned Re-insurance Companies (PORCs).
  - The asset management industry is large relative to the economy but relatively small compared to other U.K. overseas territories.
  - Financial market activities are limited; there is no domestic interbank, wholesale funding, or capital market, including government bonds.
- Table 3 highlights (2008–2014)
  - Number of banks: 9 (2008), 9 (2009), 8 (2010), 8 (2011), 8 (2012), 7 (2013), 7 (2014).
  - Offshore reinsurers (PORCs): 3,565 (2008), 4,000 (2009), 4,700 (2010), 5,095 (2011), 5,494 (2012), 6,161 (2013), 6,954 (2014).
  - Nominal GDP (in millions of USD): 863 (2008), 703 (2009), 687 (2010), 729 (2011), 716 (2012), 736 (2013), 797 (2014).
  - System assets (banks and insurers, in percent of GDP): 252 (2009), 251 (2010), 250 (2011), 265 (2012), 247 (2013), 239 (2014).
  - System assets (all, in percent of GDP): 449 (2014).
- Banking sector structure and funding
  - Ninety percent of the system’s assets are held by three Canadian banks and one British–Belizean bank (Figure 2).
  - All banks are branches or subsidiaries of foreign banks or foreign holding companies.
  - For supervision and reporting purposes, branches are treated similarly to subsidiaries and are required to hold notional capital dedicated to local operations.
  - All top four banks have both domestic and international licenses without much firewall in between.
  - The FSC designates the top four banks as domestic systemically important banks (D-SIBs).
  - About 60 percent of D-SIBs’ assets are linked to domestic loan risks because equity investment is linked to domestic loans; remaining assets are mostly liquidity up-streamed to foreign head offices.
  - Key sources of funding: resident deposits, capital, and external funding (intragroup funding and nonresident deposits).
- Offshore wealth management banks
  - The other three banks (one from Panama and two from Switzerland) specialize in offshore wealth management, attracting wealthy nonresidents mostly European, partly for tax reasons.
  - Almost half of banks’ deposit accounts show a balance of at least US$ 100,000.
  - Deposits are typically placed with foreign group members.
- Credit patterns
  - About 90 percent of loans outstanding are to residents, mostly to households, followed by private businesses.
  - Loans are concentrated in personal property, real estate, and, to a lesser extent, construction and land development.
  - Credit has been contracting since the economic crisis; contraction concentrated in the construction sector while banks extended credit to other sectors in 2011-12 (notably real estate).
  - Credit growth weakened again when drastic fiscal austerity started in 2012, indicating weak credit growth has been mostly driven by demand factors.
- Insurance sector
  - The offshore insurance sector continues to grow rapidly: over 7,000 firms, mostly PORCs, and 800 new licenses were issued in 2014.
  - PORCs are small; their assets are estimated to be about 5 percent of GDP.
  - Little financial information on these insurers is collected regularly by the FSC.
  - The domestic insurance market is served by foreign branches; only two insurers out of 17 domestic insurers are incorporated in TCI.
  - There are 11 non-life insurers accounting for nearly 90 percent of premium income.
  - Property insurance accounts for 67 percent of non-life insurers’ gross premiums, but 90 percent are reinsured.
  - The main life insurance business is credit life.
- Asset management industry
  - Most assets are managed for nonresident clients investing in foreign assets, though some domestic activities exist.
  - Two trust companies and two mutual funds primarily focus on investment in TCI real estate (including mortgage funds).
  - Total assets were around US$ 140 million (less than 20 percent of GDP) in 2014.
  - Without adequate safeguards, large redemptions may weigh on real estate markets.

### Key statistics (selected, as presented)
- Population: 35,000
- Nominal GDP: about US$ 800 million
- GDP per capita (2014): around US$ 23,000
- Government surplus since 2012: 3½-nearly 8 percent of GDP
- Public debt (2014): 11 percent of GDP
- TCI Bank assets (2010): about 12 percent of GDP
- Deposit recovery for TCI Bank depositors: about 40 cents to the dollar
- Policyholder recovery (BAFSL/BAICO): 20 cents to the dollar
- Sinking fund target debt: US$ 170 million
- Sinking fund balance as of March 2015: US$ 110 million
- Sinking fund gap: US$ 60 million (7½ percent of GDP)
- Financial system assets (all, in percent of GDP, 2014): 449
- Banking assets (in percent of GDP): about 230
- Credit to residents: just over 100 percent of GDP
- Offshore insurers’ assets: about 11 percent of GDP
- PORCs count (2014): 6,954
- Mutual funds assets under management (2014): 210; administrators 3 (Table 3 entries)
- Total assets of banks (2014, in millions of USD): 1,820
- National Insurance Board assets (in millions of USD): 123 (2008), 132 (2009), 144 (2010), 162 (2011), 176 (2012), 184 (2013)
- Loans to private sector trends shown in Figure 3 (annual growth percent, 2009–2014)
  - Total loans, Construction, Real estate growth rates depicted (see Figure 3)
- Balance sheet structure of top four banks (as of June, 2014) (Figure 2): assets and liabilities composition including Cash equivalent 2 percent; Foreign bank 29 percent; Nonresident loans 8 percent; Resident loans + equity 58 percent; Other domestic 3 percent; Liabilities: Nonresident deposits 14 percent; Group funding 18 percent; Resident deposits 46 percent; Capital 18 percent; Others 4 percent.

*Risks and Vulnerabilities*

### A. Risk Assessment
- External shock exposures
  - Heavy dependence on tourism from the United States and, to a lesser extent, Canada; a North America recession would have a considerable and prolonged impact, though the likelihood of a near-term U.S. recession is currently low.
  - TCI has suffered from hurricanes, but compared to most Caribbean islands it has better physical infrastructure, which limits storm impact.
  - Tighter U.S. monetary policy and related financial market volatility would increase dollar financing costs and availability, but negative effects seem not to be large.
  - External debt appears to be limited to the government’s borrowing guaranteed by the U.K. and its nonguaranteed loans from other official sector lenders.
  - Large hotels and resorts typically receive external funding from parent companies and sometimes from local banks.
- Institutional anchors and mitigation of domestic policy risk
  - Monetary policy is anchored by using the U.S. dollar as legal tender.
  - The United Kingdom is expected to hold a tight grip on TCI’s public finances even after the expiration of the government debt guarantee in 2016, providing institutional anchors for economic stability.
  - Many institutional reforms made since 2009 will remain.
- Financial-sector-specific risks
  - Banks and insurers are dominated by foreign-owned companies with large intragroup transactions, making them vulnerable to spillover risks from distress of foreign group entities.
    - Parent bank distress seems unlikely for the majority of the banking sector, which is owned by highly rated Canadian parent banks well supervised by the home country regulator.
    - Assessing group-wide health is difficult when a bank is held by a nonfinancial holding company or has a parallel bank structure.
    - The risk of group entity distress is more acute for domestic insurers because most are branches of insurers from the Caribbean region (especially the Bahamas, Barbados, Bermuda, Cayman Islands, and Trinidad and Tobago), as seen with the CLICO case.
    - Spillover risk from offshore insurers owned by U.S. manufacturers seems negligible given each is small with no TCI operations.
  - Weak governance history among local financial institutions, as evidenced by failed institutions with issues in local management capacity and FSC’s ability to address problems promptly.
  - Some existing institutions (particularly those headquartered in the Caribbean) have complex, nontransparent ownership structures (including parallel banks) that challenge consolidated supervision.
  - Rising compliance costs have led some global banks to discontinue correspondent bank services with offshore financial centers, which could immediately close down affected banks’ international operations.

*Italic: Source: _cr15282 - INTRODUCTION (IMF staff content).*

### 17.      Outward spillover risks generally appear small. Foreign exposures of TCI banks are small

### 17. Outward spillover risks generally appear small. Foreign exposures of TCI banks are small

### Outward spillover risks — summary
- Foreign exposures of TCI banks are small for most banks.
- An exception could be the British–Belizean bank; intragroup linkages (including nonfinancial entities) are hard to map fully.
- TCI-domiciled domestic insurers do not have overseas operations and are too small to affect groups’ performance.
- Spillovers through offshore PORCs seem limited: PORCs are small, have straightforward and low-risk insurance characteristics, and their parents are manufacturers, not financial institutions.

### B. Vulnerability Analysis — Banks: key findings
- Total capital adequacy ratio (CAR) for the system stood at 30 percent in 2014, above the regulatory minimum of 11 percent.
- High CAR levels are mainly driven by the third largest and three wealth management banks with 45-60 percent CAR.
- NPL ratio has increased by more than 15 percentage points since the crisis; construction sector NPL ratio is 78 percent.
- NPL ratio for the system remains at almost 20 percent.
- Share of the top 10 borrowers in net credit is about 35 percent (high loan-concentration risk).
- Profitability remains weak due to provisioning needs and subdued interest margin; aggregate CAR has been declining.
- Provisioning practices appear conservative (banks usually do not incorporate collateral value for provision calculations).
- Legacy NPLs could weigh on credit and economic growth, especially if write-offs and additional provisions lead to capital shortfalls.
- (Equity) investment assets seem to be linked to NPLs for one bank.

### B. Vulnerability Analysis — Banks: liquidity structure and risks
- All top four banks have domestic and offshore operations.
- Aggregate liabilities: about two-thirds are residents’ deposits and capital, one-third is external funding including intragroup funding and nonresidents’ deposits.
- Most liquid assets are deposits at foreign head offices and a small amount of cash due to lack of government debt and an underdeveloped private capital market.
- External liquid assets nearly match external funding, so resilience to systemic liquidity shocks depends on timely availability of liquidity buffer at head offices.
- TCI does not have a central bank and therefore no lender-of-last-resort function.
- No tool to manage liquidity in the system through a cycle such as a reserve requirement.

### Insurers — soundness and linkages
- With the exception of one insurer, reported solvency ratios are high, over twice regulatory requirements; solvency definition is weak compared with international standards.
- Reported profitability is high but does not reflect total operational costs incurred by home office.
- Life insurance sector is under stress with BAFSL’s liquidation, which could affect sector credibility for long-term savings.
- Over 90 percent of insurers’ assets are held in bank deposits.
- Property insurance dominates non-life business; 90 percent are reinsured, mainly by major global reinsurers through home offices.
- Health of TCI banks and global reinsurers could affect domestic insurers.

### C. Bank Stress Test — Framework
- FSAP team conducted top-down stress tests covering the four D-SIBs with a market share of nearly 90 percent using end-June 2014 data.
- Data include domestic and offshore exposures and cross-border intragroup transactions.
- Solvency tests: single-factor sensitivity tests on provisioning adequacy, various credit shocks (including intragroup claims), interest rate shocks, exchange rate shocks.
- Limited macroeconomic and long-term supervisory data constrained full macroeconomic scenarios; assumptions chosen based on expert judgment and crisis experience.
- Reported CARs were adjusted for under-provisioning and misclassification of loans as equity investments.

### C. Bank Stress Test — Solvency results (high-level)
- System can absorb effects of adjusting for under-provisioning: adjustments reduce system CAR by 7.9 percentage points but CAR remains over 20 percent; effect concentrated in smaller banks.
- Deterioration of existing NPLs reduces system CAR by 0.7-4.7 percentage points; effect concentrated in one bank with high stock of NPLs.
- Generalized credit shocks reduce system CAR by 2.3-10.2 percentage points. An NPL ratio increase of 20 percentage points (comparable to TCI’s 2009 experience) could reduce system CAR below regulatory minimum; likelihood assessed as currently small given strong near-term U.S. growth outlook.
- Credit concentration: default of the largest five borrowers, with 50-100 percent haircut on collateral, reduces system CAR by 2.3-27.1 percentage points and can push CAR below regulatory minimum in some cases.
- Intragroup credit risk: inability of group affiliates to repay intragroup loans would reduce one Canadian bank’s CAR below the regulatory minimum because it up-streams liquidity to head offices substantially.
- Foreign currency and interest rate shocks are of minor importance for all banks.

- Selected baseline and stress numbers (as reported):
  - Baseline capital adequacy ratio, actual: 29.0
  - NPL ratio: 17.9
  - Adjustment for under-provisioning 1/: adjusted CAR 21.1, change -7.9 percentage points
  - Raising provisioning with collateral 2/: CAR 20.6, change -8.3 percentage points
  - Raising provisioning without collateral 3/: CAR 19.4, change -9.6 percentage points
  - Increase in NPLs: NPL-ratios increase by 20 ppt, equal distribution of new NPLs 4/: CAR 10.9, change -10.2 percentage points; share in total assets 38.34 percent
  - NPL-ratios increase by 20 ppt, system-wide provisioning rates 5/: CAR 13.9, change -7.2 percentage points; capital shortfall volume 2401.6 (in percent of GDP reported in table cells)
  - Proportional increase in NPLs by 90 percent 7/: CAR 17.5, change -3.6 percentage points; share in total assets 180.0
  - Sectoral shock to construction and property 7/9/: CAR 18.8, change -2.3 percentage points; share in total assets 180.2
  - Largest exposure defaults 10/: CAR 12.4, change -8.7 percentage points; share in total assets 1330.3
  - 5 largest exposure default 10/: CAR -6.0, change -27.1 percentage points; number of banks below regulatory minimum: 4; share in total assets 10015.9
  - Inability of group affiliates to repay intragroup loans: CAR -0.6, change -21.7 percentage points; capital shortfall share in total assets 14324.0

  (Footnote indicators and scenario definitions correspond to the original stress-test table methodology.)

### C. Bank Stress Test — Liquidity tests and results
- Two liquidity stress tests conducted: cash-flow test and calculation of Basel III Liquidity Coverage Ratio (LCR) as reference.
- Cash-flow test hurdle rates: (i) bank fails if cash outflows in 30 days > available liquid assets plus cash inflows; (ii) bank fails if it breaches FSC liquidity ratio.
- LCR measures high-quality liquid assets (HQLA) over total net cash outflows; FSC has not adopted LCR; Basel rule generally applied at group-consolidated level.
- Test assumptions broadly follow LCR but with adjustments reflecting lack of domestic safety net and conservative assumptions for nonresident deposits.
- In cash-flow tests, liquid assets defined by FSC include all assets with maturity less than 30 days; LCR excludes intragroup claims (the biggest component of banks’ liquidity per FSC definition) from HQLA and caps inflow use at 75 percent of outflows.
- Cash-flow test highlights vulnerabilities to intragroup funding shocks and, to a lesser extent, customer deposit runs; results sensitive to availability of cash inflows from illiquid assets.
  - Canadian banks, especially those relying on intragroup funding, are more vulnerable to funding shocks (scenarios 2 and 3) and generalized funding shock (scenario 7); total liquidity shortfall amounts to over 7 percent of GDP in severe scenarios.
  - Generalized deposit run (scenario 6) causes distress to one bank, primarily via resident depositors.
  - Only one bank relies visibly on nonresident deposits; near dry-up of nonresident deposits (scenario 5) does not produce liquidity shortfall for system though the bank may breach FSC requirement.
  - Domestic interbank market freeze (scenario 1) poses no stress to the system given limited activity.

- Cash-flow test reported example results (with/without cushion from illiquid assets):
  - Scenario 1 (dry-up of interbank market): Net cash flow > 0 for all; survival period 30/30 days.
  - Scenario 2 (shock affecting interbank and intragroup funding, medium stress): With cushion: failed bank A; liquidity gap 0.3 million USD; survival period 27/30; banks in breach A, B. Without cushion: failed banks A, B, C; liquidity gap 103.2 million USD; survival period 6/30; banks in breach A, B, C.
  - Scenario 3 (complete withdrawals of interbank and intragroup funding within a month): With cushion: failed banks A, B; liquidity gap 25.4 million USD; survival period 1/30; banks in breach A, B. Without cushion: failed banks A, B, C; liquidity gap 177.4 million USD; survival period 1/30; banks in breach A, B, C.
  - Scenario 6 (general bank run without enforced penalties for term deposits): With cushion: failed bank B; liquidity gap 3.8 million USD; survival period 21/30; banks in breach B. Without cushion: failed banks A, B, C; liquidity gap 181.4 million USD; survival period 4/30; banks in breach A, B, C.
  - Scenario 7 (shock to interbank market and bank run by depositors): With cushion: failed banks A, B; liquidity gap 58.3 million USD; survival period 6/30; banks in breach A, B. Without cushion: failed banks A, B, C; liquidity gap 235.9 million USD; survival period 3/30; banks in breach A, B, C.

- LCR results:
  - Most banks’ LCRs fall below the 100 percent hurdle rate.
  - Liquidity shortfall for the system is about 35 percent of GDP under LCR with 75 percent cap on inflows.
  - Removing the cap on inflows reduces shortfall to about 30 percent of GDP.
  - Shortage driven by lack of eligible assets for HQLA; currently only cash qualifies as HQLA.

### D. Overall Stability Assessment and Recommendations
- Near-term resilience:
  - Most banks appear able to write-off legacy NPLs and withstand a range of likely adverse near-term scenarios.
  - Despite large legacy NPLs, stress tests indicate high capital can absorb substantial write-offs without breaching minimum capital requirement, partly due to conservative provisioning practice.
  - Marked recovery of the real estate market should limit overall losses from write-offs including collateral sale receipts, limiting negative feedback loops from banking sector to credit and economic growth.
  - FSC should remain vigilant in monitoring banks’ asset quality.

- Key risks:
  - Credit and loan-concentration risks are the most relevant potential sources of risk.
  - A severe recession similar to that of 2009 may push system CAR below requirement, though unlikely in near-term given strong U.S. economy.
  - Loan-concentration risk could be damaging, especially with real estate market distress.

- Recommended data and supervisory actions:
  - Value real estate collateral adequately and gather data in this area, including loan-to-value ratios.
  - Collect data such as: value of collateral per loan, loan-to-value ratios, haircuts applied by banks for provisioning purposes, and realized recovery rates in the real estate market.

*Source: IMF staff analysis as presented in the Turks and Caicos Islands FSAP chapter.*

### 31.      However, the FSC should closely monitor broad intragroup transactions. This is

### _cr15282 - 31.      However, the FSC should closely monitor broad intragroup transactions. This is

### Intragroup transactions, liquidity, and governance
- For both banks and insurers, intragroup transactions are significant; substantial amounts of assets are kept at foreign head offices, making them vulnerable to the distress of group entities (although such likelihood seems low for Canadian banks, which constitute the majority of the system).
- Banks keep most of their liquid assets as deposits at parent banks—these are not counted as HQLA in LCR—and some banks also rely on parent-bank funding.
- While TCI—as a host economy—is not required to adopt LCR, ensuring the continuing liquidity support of parent banks is critical for managing liquidity risk.
- The FSC should closely monitor broad intragroup transactions, especially when there is concern over financial institutions’ governance.

### Consolidated supervision and supervisory collaboration
- The FSC should ensure consolidated supervision of complex financial groups, examining:
  - the solo performance of their TCI operations, and
  - that of their relevant affiliates,
  - using the power to request necessary information stated in the FSC Ordinance (FSCO).
- The FSC should liaise with external auditors and closely collaborate with other key supervisors by establishing a “supervisory college.”
- The FSC should ensure that the bank capital remains dedicated for TCI operations. High capital is the key buffer, but there have been cases where dividend payouts to parent were larger than retrained earnings.
- The FSC currently does not have the explicit power to restrict or stop dividend payments; the current Banking Ordinance does not even require banks to notify the FSC in advance about any kind of dividend payouts.

### Domestic contagion and interconnectedness
- Domestic contagion risk is limited due to the lack of domestic interbank and capital markets; linkage between insurers and banks is limited to insurers’ exposure to banks through restricted deposits.

### Offsite risk analysis and stress testing
- The FSC should strengthen capacity for offsite risk analysis, including stress testing.
- More attention should be devoted to comprehensive financial statement analysis.
- Regular stress tests on systemically important banks would help identify weaker banks that should have priority in the onsite inspection process.

### FSC institutional capacity, governance, and independence
- Staffing and resources:
  - Staff complement increased from 17 persons in 2003 to 70 in 2015.
  - The FSCO was overhauled in 2007, giving the FSC financial independence, ample financial resources, and strengthened supervisory power.
- Board and governance issues:
  - The Board is below strength, missing an insurance expert since 2013.
  - Implementing the FSC’s 2012–2016 Action Plan has been slow.
  - Much of the FSC’s management work falls on one Managing Director (MD), without qualified Deputy MDs.
  - Recommendations for the Board:
    - undergo a self-assessment and appoint at least one director with insurance expertise;
    - ensure execution of the FSC’s medium-term Action Plan;
    - expedite an organizational review and authorize and appoint key senior managers;
    - meet with the Minister of Finance and industry representatives regularly;
    - rotate the FSC’s external auditors periodically.
- Operational independence and technical decision-making:
  - The FSC’s independence is strong overall; legal protection for Board and staff and financial independence are strong.
  - The Governor has Regulation-making power; certain technical decisions remain with the Permanent Secretary, Finance, or the Governor (e.g., the IO allows the Permanent Secretary, Finance, to grant a licensee dispensation to place risk with an unlicensed insurer). The IO should be amended so that only the FSC can make such technical decisions.
- Communication:
  - Current practice lacks continuous and constructive dialogue with the financial industry.
  - Financial-services legislations do not explicitly require consultation before a Regulation is passed; the FSC should formalize a consultation process and develop a continuous relationship with the industry.
- Cross-border collaboration:
  - Close collaboration with foreign supervisors is critical given a foreign-dominated financial system.
  - Current MoUs cover jurisdictions relevant for domestic insurers but not for one bank with parallel-bank structure.
  - The FSC should establish a “supervisory college” for close cross-border collaboration and ensuring consolidated supervision for parallel banks.

### Banks: legal framework and supervisory instruments
- Use of legal powers:
  - The FSC has legal power to set Regulations and conduct supervision, though not all power has been fully used.
  - The FSC has used its Regulation-making power only sparingly; the Board’s power to issue a regulatory Code has remained unused.
  - The FSC has extensively used Guidelines, which can be issued without the consultative process required for a regulatory Code. Failure to follow Guidelines could still lead to enforcement or disciplinary actions.
  - The FSC has powers to require information (including regarding a person connected to a licensee) and to conduct compliance visits to both holding companies and subsidiaries.
- Deficiencies in the Banking Ordinance (BO):
  - No requirement for the FSC to receive prior notification of a licensee’s payment of a dividend so that it may be stopped; there has been a case where a bank paid dividends to its parent bank well beyond current-year profits.
  - Other deficiencies: (i) an imprecise definition of related and connected parties; (ii) an insufficiently stringent cap on equity holdings of other undertakings; (iii) lack of requirement for a bank auditor to inform the FSC of matters affecting the wellbeing of the bank.
- Reform:
  - Preparation and enactment of the new BO should be completed urgently. The current draft (widely circulated in 2014) addresses many deficiencies, including advance notification of dividend payments and the role of external auditors.
  - The draft would provide the FSC power to make rules, including prudential rules and rules on banks’ involvement in nonregulated activities. These rules should remain in the final draft.
  - Rules could require banks to prepare and keep up-to-date recovery plans satisfactory to the FSC and to obtain FSC approval before making material changes.
  - The supervisory instruments of a regulatory Code and Guidelines now in the FSCO would be included in the new BO.
  - IMF review of the next revised draft is strongly recommended.

### Supervisory operational performance (banks)
- Onsite and offsite supervision limitations:
  - Onsite supervision is sporadic (three in the past five years).
  - Onsite focus has been narrow (credit and AML/CFT defenses), despite the need to examine whole balance sheets as indicated in stress tests.
  - Reports are issued with substantial time lag (5-6 months).
  - Knowledge transference from external consultants in past inspections seems limited.
  - Offsite analyses appear backward-looking and narrowly focused; perimeter of analysis is limited to the intermediate entity just above TCI’s branch or subsidiary, without expansion to the entire banking conglomerate.
- Recommendations to improve effectiveness:
  - Develop capacity for comprehensive risk assessments and onsite and offsite inspections with additional staff training.
  - For offsite supervision: develop a more sharpened investigative attitude and a more forward-looking perspective.
  - For onsite supervision: increase knowledge transference from external consultants and expand coverage to all areas of material risk and its management for better observance of the BCPs.
  - An annual plan of onsite inspections should be drawn up; the Board should be informed of progress.
  - Inspection reports should be issued within 21 days of exit.

### Insurance sector: structure, supervision, and policyholder protection
- Domestic insurers and branches:
  - Prevalence of branches poses special challenges; branches have only an insurance manager and assigned brokers or agents domiciled in TCI; bulk of operation and control is carried outside the jurisdiction.
  - Host supervision requires (i) strong collaboration with foreign home supervisors, and (ii) adequate policyholder protection.
- FSC insurance department capacity:
  - Insurance supervision was dormant until 2008; since then, the FSC has issued several Guidelines and internal procedures and begun issuing penalties; both onsite and offsite supervision has started.
  - Implementation of the many Guidelines requires significant effort from the supervisor and industry.
  - The FSC should develop manuals and internal procedures for onsite inspection and supervisory processes incorporating the host nature of supervision.
  - The FSC should further develop staff capacity for onsite and offsite supervision of branches; training should include analysis of home office risk management and internal controls, and conditions of distribution agreements.
- Regulatory weaknesses and IO reform:
  - Many central supervisory requirements are specified as Guidelines (weaker enforcement power than Regulations).
  - The new domestic IO should be enacted urgently to incorporate stronger enforcement power.
  - Framework for policyholder protection is insufficient.
  - Regulation is silent on the type and amount of insurers’ technical reserves.
  - There is no Regulation on reinsurance; quality depends on home office programs. The FSC should require a minimum level of credit standing for reinsurers allowed to protect branches.
  - Licensees are not required to notify the FSC of dividend payments in advance; the FSC lacks explicit power to suspend dividend payments in light of solvency concerns.
- Policyholder protection specifics:
  - The FSC needs to strengthen its ability to realize assets to pay liabilities owed to policyholders; lack of a protection scheme was highlighted by the BAFSL case.
  - The FSC has a Guideline requiring local insurers to hold restricted deposits (weaker than a Regulation).
  - Insolvency law provides only lower priority to policyholders just above shareholders; policyholders should be given higher preference.
  - The new domestic IO should require a segregated statutory fund in TCI earmarked for policyholder payout in insolvencies or liquidations.
- BAFSL case and fiscal considerations:
  - TCI government should consider financial support for policyholders.
  - BAFSL should not have been given a license with an initial capital shortfall; TCI policyholders were not properly informed of the transition from BAICO to BASFL and were not given the opportunity to opt out at acquisition.
  - BAICO’s restricted deposits that should have been kept for policyholders were used to pay fees to the liquidator.
  - Currently, the government appears to have sufficient fiscal space: even if all policyholders were to recover dollar for dollar, total funding needed is only US$ 8 million—about one percent of GDP—compared to the average annual fiscal surplus of about US$ 48 million for three years since 2012.
- Intermediaries and market conduct:
  - Insurance intermediation requires a license, but no qualification other than demonstrating insurance experience.
  - The FSC should evaluate certification requirements for brokers and agents (e.g., passing an exam).
  - Offsite supervision of brokers is limited to annual re-registration; brokers are not inspected. A new Guideline requires brokers and agents to submit audited annual financial statements; the FSC should initiate onsite inspection of brokers.
  - A new Guideline issued in March 2015 sets market conduct requirements for domestic insurers and intermediaries; the FSC should develop an implementation plan and an awareness program for insurance consumers and analyze structure and resources needed for market conduct supervision.
- Offshore insurers:
  - Offshore insurers do not receive extensive monitoring, but are deemed low-risk for TCI, except for reputational risk; mostly low-risk PORCs.
  - U.S. supervisors require collateral for reinsurance placed in TCI and extensive reporting for tax purposes.
  - The FSC, as home supervisor, should maintain sufficient due diligence on AML/CFT and properness of offshore insurers’ key persons; data produced for U.S. authorities should be collected and statistics created.
  - Training for supervision of captives, protected cells, and PORCs would be useful.
  - About 50 percent of the FSC annual budget is from fees paid by offshore insurers, which could lead to lean regulation to attract activity; regulation should be maintained at a proper level to avoid criminal activity while retaining attractiveness.
  - The international IO should be adopted following modern principles for offshore insurance business.

### Macroprudential policy framework
- The FSC has started to develop a macroprudential policy framework, but focus should be geared more toward real estate markets.
- The FSC has identified systemically important financial institutions (SIFIs, top four banks) and is considering capital surcharges. However, capital surcharges may not be binding given the high capital ratios.
- Caps on loan-to-value ratios could be an effective micro- and macroprudential tool, given TCI’s dependence on real estate market fluctuations.
- The FSC should devote staff capacity to areas more directly related to financial stability, including:
  - compiling macroeconomic data (the FSC’s quarterly economic review provides information appreciated by the industry),
  - monitoring real estate markets,
  - conducting stress testing,
  - eventually publishing a financial stability report to facilitate communication with industry and public officials.

### Bank resolution and safety nets
- Current options for TCI to manage a distressed bank and a systemic financial crisis are limited:
  - Use of U.S. dollar and the borrowing limit of local government imposed by the United Kingdom anchor economic policies imply the territory does not have a central bank to provide emergency liquidity.
  - Public bail-out of a systemic bank will be difficult if it hits the borrowing limit set by the United Kingdom.
  - Nevertheless, other tools can be effective for managing bank distress and crisis.

*Italic: Excerpt from _cr15282 (IMF), pages 27–32.*

### 56.      TCI currently lacks a quick, effective, and legally certain framework to deal with non-

### _cr15282 - 56.      TCI currently lacks a quick, effective, and legally certain framework to deal with non-

### Bank resolution and Special Bank Resolution Regime (SBRR)
- Finding: TCI currently lacks a quick, effective, and legally certain framework to deal with non-viable banks.
- Finding: The FSC does not have sufficient powers for effectively taking control of a non-viable bank and exercising key resolution actions; a bank can be wound up only through court-directed liquidation, slowing down the process.
- Recommendation: Introduce a Special Bank Resolution Regime (SBRR) by law.
  - The law should provide the legal basis for the FSC to develop indicators to determine the viability of a bank and to start taking resolution actions before the bank becomes insolvent.
  - The law should empower the FSC to directly take a whole array of resolution actions (such as removing senior managers and restructuring) and resolution tools, including:
    - transfer or sell selected assets and liabilities,
    - establish a bridge bank,
    - override rights of existing shareholders.
  - Fundamental element: resolution actions by the FSC should not be overridden by the court, though the court may award monetary compensation for any aggrieved parties.
- Cross-reference: Financial Stability Board, Key Attributes of Effective Resolution Regimes for Financial Institutions, October 2014, especially Attribute 3.14

### Protection of small depositors
- Finding: Protecting small depositors is important, but TCI is not currently positioned to introduce a deposit insurance scheme (DIS).
  - A DIS can function properly when key preconditions are met, including (i) a strong supervisory framework and (ii) an SBRR.15
  - Progress has been made in the supervisory framework area, but little has been done with the SBRR.
- Recommendation: Urgently introduce alternative depositor-protection tools that do not require a DIS:
  - Depositor preference:
    - Modify the Companies Ordinance and introduce depositor preference in a bank liquidation.
    - Use a “tiered” depositor preference that provides additional preference for small depositors.
  - Special Purpose Reserve Fund (SPRF):
    - An SPRF holds a portion of total customer deposits in high-quality liquid assets, with an independent, highly rated, non-TCI third party16 with the exclusive purpose of protecting small depositors in cases of failure of the particular bank.
    - The bank must not be allowed to withdraw money from the SPRF for reasons other than paying out to small depositors.
  - Funding commitments from parent banks:
    - Most TCI banks are foreign banks; efforts should be made to ensure TCI banks obtain firm commitments for support from their parent banks in case of financial distress.
    - If the parent entity is not a well-established bank, the financial commitments should be backed by specific liquid assets as specified by the FSC.

### Crisis prevention and management
- Finding: Although the FSC is in charge of oversight of all financial institutions, it needs to coordinate with other agencies to prepare for and manage systemic financial crisis.
- Recommendation: Create a Financial Stability Committee to share relevant information, discuss views, coordinate actions on a regular basis, and coordinate actions and communications with foreign regulatory authorities.
  - Committee composition: should include the Governor, the Minister of Finance, and the MD of the FSC or their representatives, with support from more technical-level groups.
  - Task: Establish a Crisis Management Strategy that sets general tasks and protocols for crisis prevention and management.
  - In case of an actual crisis: the Committee should design and approve a specific crisis-management plan to deal with the crisis.
- Recommendation: Strengthen MoUs with foreign regulators and supervisors:
  - Existing regional and bilateral MoUs with foreign supervisors should address crisis prevention and management strategy.
  - MoUs should provide a legal basis for the performance of resolvability assessments at the group level, taking into account cross-border actions and effects.
- Recommendation: At individual institution level, require recovery and resolution planning and resolvability assessments:
  - The FSC should require all SIFIs to prepare recovery programs and present them to the FSC for consideration, comments, and approval.
  - The FSC should prepare SIFI resolution plans that specify actions in case the institution needs to be resolved.
- Recommendation: Identify last-resort alternatives for official financial assistance for systemic crisis:
  - TCI lacks typical lender-of-last-resort facilities without a central bank.
  - Local government borrowing is subject to the ceiling imposed by the U.K. government.
  - Authorities should explore funding alternatives as a last resort for emergency funding, including the creation of a Fund with industry participation and access to lines of credit.

### Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT)
- Finding: TCI has recently made substantial progress in improving its AML/CFT framework since its 2007 CFATF assessment.
- Finding: TCI is currently undertaking a national assessment of its ML/TF risks with the assistance of the World Bank, to be completed in 2015. The authorities are encouraged to use the findings to guide national AML/CFT policies.
- Concern: Capacity of regulatory authorities to ensure compliance with customer due diligence (CDD) obligations is limited:
  - Only a handful of on-site examinations for AML/CFT compliance have been conducted over the past three years, and no sanctions have been imposed for violations of CDD obligations.
  - Supervision over financial institutions and designated nonfinancial businesses and professions (e.g., lawyers) should be enhanced, particularly regarding obligations to identify and verify beneficial owners of assets.
- Finding: Framework for transparency of legal persons and arrangements appears inadequate and may facilitate increased ML/TF risks:
  - Deficiency: lack of obligation on companies incorporated in the territory, but operating abroad, to file information on legal owners with the company registrar.
  - This and potential shortcomings in CDD implementation may affect ability of competent authorities to obtain relevant information and exchange it with foreign counterparts.
  - Positive steps: abolition of bearer shares and discussions on possible establishment of a registry of beneficial ownership.
- Recommendation: Continue to strengthen the framework to ensure that current and accurate information on the beneficial ownership of legal persons and arrangements established in TCI is available in a timely manner.

*Source: IMF staff report content provided in the supplied document.*

### Appendix Table 3. Financial Soundness Indicators and Bank Balance Sheet Structures

### Appendix Table 3. Financial Soundness Indicators and Bank Balance Sheet Structures (concluded)

### Liquidity indicators
- Liquid assets as percent of total assets: 13.1, 15.0, 15.3, 27.9, 29.9, 30.3
- Liquid assets as percent of short-term liabilities: 21.7, 22.7, 21.3, 38.2, 39.4, 40.1
- Foreign currency loans as percent of total loans: 0.3, 0.3, 0.4, 0.6, 0.6, 0.4
- Foreign currency liabilities as percent of total liabilities: 3.6, 3.8, 5.0, 5.2, 4.2, 3.4
- Deposits as percent of assets: 54.4, 54.6, 58.0, 59.7, 59.4, 61.8
- Loans as percent of deposits: 137.8, 124.6, 107.5, 97.2, 85.7, 87.2
- FX loans-to-FX deposits: 3.0, 2.2, 2.8, 3.5, 4.3, 3.8

### Sensitivity to market risk
- Off-balance sheet operations as percent of assets: 5.1, 4.2, 3.1, 2.3, 5.5, 5.3

### Source and data notes
- Source: FSC.
- Note: End of period, September for 2014. Other sectors include Agriculture, Fisheries, Quarry Works, Public Utilities, Entertainment, Professional Services, Public Administration, Personal Loans (not related to property acquisition) and in some cases loans to overseas residents. Data are compiled following Basel I, and on unconsolidated basis, covering the TCI operations of foreign banks.

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### Appendix Table 4. Banking Sector Stress Testing Matrix

### Banking Sector: Solvency Risk

- 1. Institutional Perimeter
  - Institutions included: 4 largest banks (D-SIBS)
  - Market share: 90 percent
  - Data and baseline date: Supervisory data; Cut-off date as of Q2 2014

- 2. Channels of Risk Propagation
  - Methodology: Balance sheet sensitivity analysis
  - Satellite Models for Macro-Financial linkages: None
  - Stress test horizon: Static (as of June 2014)

- 3. Tail Shocks — Sensitivity analysis (credit risk)
  - Adjustment for under-provisioning. Adjustments are made to determine the true value of capital because the current level of provisioning falls short of regulatory minima set by the FSC. 1 Moreover, minimum provisioning levels of other countries with similar banking systems are used to gauge the appropriateness of TCI’s minimum levels.
  - Worsening of existing NPLs. TCI’s loan classification framework follows a five-bucket system, with the last three buckets (“substandard, doubtful, loss loans”) being considered NPLs. Current classification practices seem to create backlogs in buckets with lower provision requirements. This test aims at assessing the impact on capital of a downward migration of existing NPLs within the three NPL buckets.
  - Shocks to performing loans. Credit-risk shocks envisaged are up to 90% increase in NPLs and up to 20 percentage points in NPL ratios of banks’ total loan portfolio.
  - Sectoral shocks and loan concentration. Loans are concentrated in a few economic sectors, in particular to (private) property and construction. Sectoral credit-risk shocks are applied to those sectors, increasing NPLs up to 20%. In addition, concentration risks in the loan portfolio are examined by assessing banks’ resilience to defaults of the top 1 to 5 largest borrowers, using different levels of collateral haircuts.
  - Footnotes: 1 See FSC Statement of Guidance: Loan Classification and Provisioning. 2 There is no cap on large exposures, but a legal requirement for banks to obtain the prior approval of the FSC before granting a credit that will exceed 25 percent of their paid-up capital.

- Market Risk (solvency)
  - Foreign exchange risk. Direct foreign exchange risk tests assess banks’ resilience to appreciations of 20% and 30%, respectively, based on historical movements of the US$/GBP exchange rate (translating to two and three standard deviations). NPLs are not affected, as almost no loans in FX are outstanding. Interbank linkages are assessed by assuming the default of interbank loans.
  - Interest rate risk. A parallel shift in interest rates of 150 and 300 basis points is assumed. Data on the re-pricing structure of assets and liabilities were not available; the maturity structure was used as a proxy instead.

- 4. Risks and Buffers
  - Risks/factors assessed: Comprehensive coverage of solvency risks
  - Credit risk: credit losses in loan book (including provisions), including intragroup exposures
  - Market risk: interest rate risk, foreign exchange risk
  - Behavioral adjustments: None

- 5. Regulatory and Market-Based Standards and Parameters
  - Calibration of risk parameters: Based on actual point in time (historical highs) and proxies in the region; Expert judgment due to data limitation for a macro modeling
  - Regulatory/Accounting and Market-Based Standards: Basel I (current standard)
  - Regulatory requirement (CAR) of 11%

- 6. Reporting Format for Results
  - Output presentation: System-wide and bank-by-bank CAR

### Banking Sector: Liquidity Risk

- 1. Institutional Perimeter
  - Institutions included: 4 largest banks (D-SIBS)
  - Market share: Nearly 90 percent
  - Data and baseline date: Supervisory data; Cut-off date as of Q2 2014

- 2. Channels of Risk Propagation
  - Methodology: Implied cash flow test for 30 days.
  - Basel III liquidity coverage ratio (resilience for 30 days).

- 3. Risks and Buffers
  - Risks:
    - Short-term wholesale funding risk (interbank and intragroup)
    - Withdrawal of various types of customer funding (including nonresident deposits)
    - Maturity mismatch/rollover risk
  - Buffers:
    - FSC-defined liquid assets (stock and inflows of assets that mature within 30 days, which are mostly intragroup claims).
    - No central bank facilities or reserve requirements.
    - 95% of liquid assets are available each day and 1% of non-liquid assets can be liquidated per day; alternative scenarios assume non-liquid assets cannot be liquidated at all within 30 days.
    - LCR-defined high-quality liquid assets (HQLA, which excludes intragroup claims).
    - Cash inflows within 30 days (including intragroup claim maturing within 30 days) only up to 75% of total expected cash outflows. This requires that a bank must maintain HQLA equal to at least 25% of gross cash outflows.
    - No central bank facilities or reserve requirements
    - LCR-set haircuts are applied to the liquid asset buffer.

- 4. Tail Shocks
  - Size of the shock — Baseline runoff rates:
    - Baseline run-off assumptions are mostly taken from LCR, which uses 10% for retail and SME deposits not covered by deposit insurance (assumed for resident demand deposits).
    - For some types of funds, more conservative assumptions than in the LCR standard are applied: (1) withdrawal of term deposits with a maturity greater than 30 days; (2) assuming higher run-off rates for non-resident sight deposits (40%, which is the same rate as unsecured wholesale funding provided by non-financial corporations not covered by a deposit insurance scheme; time deposits receive 20%).
  - Stress scenarios (build on tailored LCR assumptions and impose additional stress on various funding sources):
    1. Complete dry-up of interbank funding within 30 days.
    2. Medium stress on intragroup funding and interbank funding (56% funding withdrawal within 30 days).
    3. Complete dry-up of intragroup funding and interbank funding within 30 days.
    4. Bank run for demand and time deposits (time deposits are withdrawn at the same rate as demand deposits).
    5. Run on nonresident deposits (demand and time)—over 90% of demand deposits and 70% of time deposits are withdrawn within 30 days.
    6. General bank run on all type of deposits (52% are withdrawn within 30 days).
    7. Deposit run + shocks on intragroup and interbank funding.
  - No scenarios are examined.

- 5. Regulatory and Market-Based Standards and Parameters
  - Regulatory standards/ hurdle rate:
    - [1] Economic survival: a bank fails when cash outflows in 30 days are larger than available liquid assets plus cash inflows during the same period.
    - [2] FSC liquidity requirement: a bank fails when its liquid assets fall below 12% of total deposits liabilities.
    - Basel III LCR ratio (HQLA/total net cash outflows) with hurdle rate of 100%.

- 6. Reporting Format for Results
  - Output presentation:
    - [1] Survival period in days (minimum and maximum); number of banks that fail the test.
    - [2] Days until breach of regulatory liquidity requirement; number of banks below the liquidity threshold of 12%.
    - LCR ratio and liquidity shortfall in percent of GDP.

*Source: IMF staff summary of Appendix Tables 3 and 4 (as provided).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15282.pdf_