More Action Needed to Resolve Problem Loans in the Caribbean

IMF Blog, October 31, 2017

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The share of nonperforming loans to total loans more than tripled in many Caribbean countries from 2007 to 2016.
Nonperforming loans are defined as loans that are 90 days or more past due.
The share of nonperforming loans in total loans peaked between 15–20 percent—up from a pre-crisis average of 5 percent and compared to 3–4 percent in Latin America.
Banks on average resolved only 16 percent of nonperforming loans in their portfolios in 2013-2015.
Problem loans are concentrated mainly in personal, construction, and tourism loans.

High nonperforming loans constrain the availability of credit as banks tighten lending standards and focus on cleaning up balance sheets.
The decline in bank lending from worsening asset quality can persist, with effects lasting up to five years.
Limited access to credit threatens investment and durable growth in the region.
High nonperforming loans raise banks’ borrowing costs and reduce profitability, increasing vulnerability to shocks and posing potential risk to financial stability.
Evidence suggests banks with low profitability, capital, and efficiency also tend to suffer from weak asset quality, creating a vicious cycle.

Weak economic recovery is a major factor but not the only impediment.
Lack of distressed debt markets to move problem loans off bank balance sheets.
Deficient legal frameworks and weak enforcement of debt contracts:
- Resolving insolvency cases takes 2.7 years on average.
- Courts specializing in insolvency cases do not exist in many jurisdictions.
Difficulties in valuing collateral and supervisory gaps reduce incentives to recognize losses and write off loans.
Absence of credit and asset registries undermines the ability to assess debtors’ liabilities and wealth, price risk, and value collateral, creating pricing gaps between buyers and sellers of distressed debt.
Social and cultural factors (for example, reluctance to buy a neighbor’s foreclosed property) further discourage resolution.

Pursue sound economic policies to support growth and employment so borrowers can repay loans.
Strengthen effective supervision to prevent buildup of problem loans and require banks to hold adequate provisions to facilitate recognition of losses.
Use supervisory frameworks to provide incentives for banks to write off unrecoverable loans, including through higher capital charges and time limits to carry problem loans on balance sheets.
Remove information gaps that hinder valuing risk and collateral and create pricing gaps:
- Develop well-functioning public credit and asset registries to improve credit-underwriting and facilitate debt workouts.
- Example: In Jamaica, the increased use of credit bureaus since 2014 has incentivized borrowers to preserve good credit ratings, helped loan recoveries, and reduced new nonperforming loans.
Reform insolvency and debt-collection regimes:
- Improve judicial systems, establish specialized courts experienced in resolution, and expand use of fast-track and out-of-court debt-restructuring mechanisms to reduce resolution time and facilitate disposal of problem loans.
Develop a domestic market for distressed assets:
- Establishing a pan-Caribbean nonperforming loan market can create economies of scale and help address cultural and social obstacles to resolution.
- Introduce asset management companies to jump-start the market, building on limited regional experience (as in The Bahamas).

Design, prioritization, and sequencing of reforms should reflect country circumstances.
Small Caribbean states would benefit from coordinating reforms to address regional institutional constraints.
Ongoing initiatives cited as integrated efforts include creating a regional asset management company and credit bureaus, enhancing insolvency and debt-enforcement regimes, and establishing guidelines for collateral valuation in the Eastern Caribbean.

Source: Kimberly Beaton and Inci Otker, October 31, 2017 (IMF blog post).