96310 FINANCIAL SECTOR ASSESSMENT JAMAICA APRIL 2015 LATIN AMERICA AND THE CARIBBEAN VICE PRESIDENCY FINANCE AND MARKETS GLOBAL PRACTICE This Financial Sector Assessment (FSA) summarizes the key findings and recommendations of the Financial Sector Assessment Program (FSAP) Development Module for Jamaica, based on the World Bank mission 1 that visited Jamaica from April 28 - May 9, 2014. The focus of the mission was to identify constraints to enhancing financial inclusion and provide recommendations for addressing them. The analysis covered the following areas: MSME finance, housing finance, rural/agriculture finance, payment systems and remittances, and consumer protection and financial literacy. 1 The team consisted of Alfonso Garcia Mora (Mission Leader/Lead Financial Sector Specialist), Bujana Perolli (Deputy Mission Leader/Financial Sector Specialist, MSME finance), Andrey Milyutin (Sr. Financial Sector Specialist, housing finance), Yoko Doi (Sr. Financial Sector Specialist, rural finance), Gynedi Srinivas (Sr. Payment Systems Specialist, payment systems and remittances), Fredesvinda Fatima Montes (Financial Infrastructure Specialist, credit reporting), and Sue Rutledge (Consultant, consumer protection and financial literacy). All team members are part of the Finance and Markets Global Practice. i Contents Page Glossary .................................................................................................................................... ii Executive Summary ...................................................................................................................1 I. Macroeconomic Environment And Financial Sector Landscape ...........................................6 II. Status of Financial Inclusion .................................................................................................7 III. MSME Finance ....................................................................................................................9 IV. Rural and Agriculture Finance...........................................................................................12 V. Housing Finance .................................................................................................................13 VI. Payments systems and Remittances...................................................................................14 VII. Credit Reporting Systems .................................................................................................15 VIII. Consumer Protection and Financial Literacy ..................................................................17 Table Table 1. Summary of Recommendations ...................................................................................4 Figures Figure 1: H-statistic, 2010..........................................................................................................7 Figure 2: Lerner index, 2010 .....................................................................................................7 Figure 3: Account and loan penetration (%) ..............................................................................8 Figure 4: Outreach Indicators in Jamaica and Peer Countries ...................................................9 Figure 5: Enterprises and Access to Finance ...........................................................................10 Annexes Annex 1: Detailed List of Recommendations ..........................................................................19 ii GLOSSARY Exchange Rate (as of May, 2014) US$ 1 = 110.60 JMC ATM Automated Teller Machine MoFP Ministry of Finance and Planning BoJ Bank of Jamaica MoIIC Ministry of Industry, Investment and Commerce BSA Banking Services Act MSME Micro, Small and Medium Sized Enterprise CCP Central Counter Party NBFI Non-Bank Financial Institution CEF Credit Enhancement Facility NDX National Debt Exchange CTMS Centralized Treasury Management System NHT National Housing Trust DBJ Development Bank of Jamaica NIS National Insurance System DTI Deposit Taking Institution NPCB National Peoples Credit Bank DTI Debt to Income NPL Non-Performing Loan EFF Extended Fund Facility NPSC National Payments System Council FSC Financial Services Commission of Jamaica PATH Programme of Advancement Through Health and Education GDP Gross Domestic Product PCB People’s Cooperative Bank GoJ Government of Jamaica PCG Public Credit Guarantee GSDA Government Securities Dematerialization Act PCSA Payments Clearing and Settlement Act HAJ Housing Agency of Jamaica POS Point of Sale IDB Inter-American Development Bank ROA Return on Assets IMF International Monetary Fund ROE Return on Equity JBA Jamaica Banking Association SDR Special Drawing Rights JDIC Jamaica Deposit Insurance Corporation SIPP Personal Property Act LAC Latin America and the Caribbean SME Small and Medium Sized Enterprise LTV Loan to Value SSS Securities Settlement System MFI Microfinance Institution MIDA Micro Investment Development Agency MLA Money Lending Act 1 EXECUTIVE SUMMARY 1. Jamaica has experienced 30 years of low economic growth and high fiscal deficits, with a significant impact on the development of the financial sector. The combination of slow economic growth rates and high level of sovereign debt issuance has limited the evolution of the corporate and financial sectors. The high ratio of financial assets to GDP is explained by the large proportion of sovereign debt on the financial sector’s balance sheet, which crowded out its primary function of lending to the economy. Despite credit growth of 11 percent for the last five years, credit to the private sector by deposit-taking institutions (DTIs) remains limited, representing only 29 percent of GDP (less than half the size of their balance sheet), whereas DTIs’ deposits represent 40 percent of GDP. Credit is concentrated in loans to households and medium/larger corporates. Lending to MSMEs is limited at 15 percent of the total portfolio of commercial banks. 2 Recent developments with the debt restructurings have reduced returns on government debt, and thus incentivizing banks to look into other opportunities. 2. As part of the overall growth and competitiveness reform agenda, the authorities have embarked on ambitious financial sector legislation reforms to address weaknesses. The authorities recently passed the Banking Services Act (BSA); drafted Credit Unions’ regulations; are working to reform the securities dealers sector, making less risky business models (collective investments schemes) available to securities dealers; are preparing a legal and regulatory framework to mitigate risks posed by the retail repo business model, as well as have undertaken significant financial infrastructure reforms to improve the credit reporting system, secured transactions, and insolvency framework. 3. Failure of Jamaica’s reform effort could have adverse regional repercussions, including through financial linkages. One economic channel through which this shock could be propagated is via the impact on the holdings of Jamaican Government bonds on financial institutions’ balance sheet, ultimately affecting related financial sector entities in other Caribbean islands. High exposure to sovereign debt remains the main risk for the financial system. Government instruments accounted for less than 20 percent of banks’ assets at end- 2013, and the 2013 debt exchange imposed direct losses on banks. Such risks are even more apparent for the securities dealers, which hold a large share of their assets in Government bonds. The drying up of secondary markets in government paper and the tightening of financial market liquidity, have heightened systemic liquidity risks, some of which are being mitigated by the central banks’ policy initiatives. 4. Opportunities should be leveraged to increase access to finance for both households and MSMEs. With only 2.7 million inhabitants, Jamaica has the highest proportion of formally banked adults among middle income countries in Latin America and the Caribbean (LAC). Seventy percent of households and most MSMEs have a bank account 2 Bank of Jamaica (BoJ) Credit Conditions Survey, 2013. 2 but only 8 percent of households and 27 percent of SMEs have loans 3. Credit unions have about 1 million of members, offering a unique opportunity to increase access to credit. 5. Lack of access to credit and equity constrain MSMEs’ operations and growth, and ultimately their contribution to the economy. The absence of alternative products beyond credit lines or personal loans represents an obstacle for MSME activity. The financial sector barely lends to the agriculture sector with limited products designed for agriculture finance, and housing is predominantly financed with mortgage products that only a minority of the population can access. Alternative sources of finance that are particularly valuable for SMEs, such as factoring, leasing, and venture capital are limited, and should be developed and promoted. Similarly, specific instruments to facilitate access to finance for low income households and agriculture finance, should be designed, including micro-insurance and regular saving products. 6. High interest rates and low penetration of credit to households and MSMEs can be explained by high credit risk as a result of high information asymmetries in the market, as well as limited competition in the banking sector. Given the incipient situation of the three credit bureaus, financial institutions have not been able to accurately assess borrowers’ level of indebtedness and repayment capacity. As a result, credit activity has been low and highly concentrated in existing customers. In this context, and despite the low cost of funding and high requirements for traditional collateral, interest rates are high (except for mortgages targeted to the top quintile of the population). The existing partial credit guarantee scheme is an important instrument that can mitigate credit risks for lenders, and thus expanding access to finance for SMEs. However, its design should be revamped to ensure adequate incentives for lenders, sustainability, and reduction of moral hazard. 7. Policies that encourage competition in the banking sector should be considered, including promoting enhanced transparency and consumer disclosure that would enable consumers to compare products and quality of service amongst financial institutions, strengthening dispute resolution mechanisms, and expanding financial literacy. 8. Given the limited distribution channels for financial services in the country, policy reforms that encourage innovations in retail payments should be a priority. The current regulatory framework should be reviewed to encourage competition amongst bank and nonbank providers. At the same time, access to the domestic payments infrastructure should be widened. Measures to expand consumer choices and increase competition in retail payments systems should be considered. In addition, a strategy to transfer government payments via electronic mechanisms has the potential to bring unbanked beneficiaries into the financial sector. 9. The authorities should complete the establishment of a regulatory and supervisory framework for deposit-taking institutions proportionate to the risks and the activities they undertake. Bank of Jamaica (BoJ) should have overall responsibility for supervising and regulating all the lenders in the market, including credit unions and MFIs, in order to avoid 3 Global Financial Inclusion (Global Findex) Database, 2011; Enterprise Survey, 2010 3 regulatory arbitrage and other market distortions. Regulation and supervision should apply by type of service provided and commensurate to the risks posed rather than by type of institution. 10. The authorities have taken significant initiatives to improve the legal and regulatory environment and financial infrastructure that would contribute to enhancing financial inclusion. The Government has developed legislative reforms to improve the ease with which MSMEs do business and has improved regulation for deposit-taking institutions. In addition, significant efforts have been made to strengthen the financial infrastructure, including the establishment of credit bureaus, the modernization of the secured transactions legal framework and establishment of the movable collateral registry, and improvements to the insolvency and creditor rights framework that would facilitate corporate rehabilitations. Despite these significant reforms, further efforts are needed to: (i) enhance the credit reporting oversight and financial consumer protection framework, and adopt measures to encourage credit bureaus to compete in services and not in data; (ii) enhance the regulations of the movable collateral registry; and (iii) develop regulations for the insolvency law along with training of judges and insolvency administrators. 11. The impact of public policies has been limited and programs on housing, MSME finance, and agriculture finance would be welcomed to address market gaps, in support of financial inclusion. Public programs and initiatives to increase financing for MSMEs, agriculture and housing are insufficient and lack adequate coordination. A comprehensive national housing policy strategy should be developed, and a housing subsidy policy should be carefully designed to avoid distortions, leveraging the private sector by using different actions and instruments depending on the needs of low income households. The design of these programs should: (i) involve public and private market agents to avoid moral hazard; (ii) leverage public funds, and ensure a medium term impact; (iii) create a "level playing field" and avoid unfair competition among lenders; (iv) provide an adequate risk sharing framework, ensuring lenders retain “skin in the game” and government contingent liabilities are minimized; and (v) create specific instruments and policies to increase financial inclusion in rural areas. 12. The financial inclusion agenda also requires a comprehensive strategy on consumer protection regulation and supervision. There is fragmentation in the legal and regulatory framework for financial consumer protection. Consumers with low levels of financial literacy are particularly vulnerable. As financial inclusion expands and broadens the provision of formal financial services to more individuals, first-time consumers are at risk of unfair practices by financial institutions. These include complex fees for basic banking services, insufficient consumer protection from financial fraud in electronic banking, and the absence of an effective out-of court mechanism for resolving consumer disputes with financial institutions. A high-level task force that can supervise development of a comprehensive strategy and framework for financial consumer protection and financial education should be created. As part of the new framework, an independent statutory financial ombudsman could provide an effective agency to address financial consumer complaints, monitor trends in the practices of financial institutions and develop policy recommendations to address the weaknesses. Initiatives should also be taken to make consumer financial disclosure simple, standard and easy to compare. 4 Table 1. Summary of Recommendations Recommendations Agency Timeframe Overall Develop an umbrella financial inclusion strategy, covering key areas, MSME finance, housing finance, BOJ and other key stakeholders ST payments, rural finance, and financial consumer protection and literacy MSME Finance Review and revamp the PCG scheme to provide DBJ/MoFP ST adequate incentives for lenders to participate Encourage the development of financial instruments for MSMEs, by developing the legal and regulatory DBJ/MoFP ST framework and infrastructure: (i) factoring; (ii) leasing, and (iii) venture capital Ensure an adequate regulatory and supervisory framework for different lenders to guarantee a level MoFP/BoJ MT playing field for financial institutions providing the same activities Simplify documentation requirements for MSMEs and consider adopting measures in prudential regulations to BoJ MT incentivize lending to MSMEs Consolidate public programs for MSME finance to MoFP/ MoIIC MT improve efficiency and effectiveness Housing Finance Design a comprehensive national housing policy strategy MoFP/ MoTWH ST Establish uniform regulatory and supervisory framework BoJ/MOFP/MoTWH ST for housing finance lending Develop the legal and regulatory framework for long FSC/BoJ/MoFP MT term funding instruments Design a specific policy to introduce subsidies and incentives for low income and informal borrowers access MoFP/ MoTWH ST to housing finance Rural/Agriculture Finance Include agriculture finance as a key area in the overall financial inclusion strategy, including specific financial MoFP/MoA ST instruments, public policies and institutional framework Review the potential of warehouse receipts financing, including the appropriate legislation, regulatory and MoA ST supervisory oversight Develop micro-insurance regulations and guidelines FSC ST Payments and Remittances Increase the usage of retail electronic payments through: (i) deepening the payment infrastructure in rural areas, BoJ/MoFP ST (ii) revising the existing access criteria for the ACH; (iii) use the Centralised Treasury Management System 5 Recommendations Agency Timeframe (CTMS) for distributing Government welfare and pension payments Develop and implement a policy framework for opening of “no frill” accounts in banks for deepening financial BoJ MT usage Prohibit exclusivity arrangements with respect to remittance companies, non-bank electronic payment BoJ MT service providers and banks. and review the regulatory framework for the appointment of agents Credit Reporting Establish oversight framework for credit reporting BoJ ST Adopt measures to encourage credit bureaus to compete in services and not in data, and conduct onsite BoJ ST examinations to verify full data provision to the credit bureaus Enhance the consumer protection framework for credit BoJ MT bureaus Consumer Protection & Financial Literacy Create a high-level task force to supervise development MOFP/ of a comprehensive national plan on financial consumer ST BoJ/FSC/MoIIC/CAC/FTC/JDIC protection and financial literacy Consider establishing an independent statutory financial ombudsman MOFP/ BoJ/FSC MT Create standard and simple disclosure for consumer BoJ MT financial services Conduct regular surveys of consumer finance Statistical Institute MT ST - up to 1 year; MT- 1-3 years 6 I. MACROECONOMIC ENVIRONMENT AND FINANCIAL SECTOR LANDSCAPE 1. Over the past 30 years, Jamaica has experienced low economic growth and high fiscal deficits, with a significant impact on the development of the financial sector. In the last 30 years, Jamaica’s real GDP per capita has increased at an average of one per cent per annum. Natural disasters, financial shocks coupled with insufficient fiscal restraint, resulted in persistent public deficits financed through significant public sector borrowings. High borrowings led to both high financing costs with crowding out of private sector investments, and macroeconomic uncertainty driven by unsustainable public debt ratios (at about 147 percent by 2013). Nevertheless, Jamaica's macroeconomic performance is recovering. For fiscal year 2014, growth is estimated at 0.9 percent and for fiscal years 2015 and 2016, it is projected at 0.9 and 2.1 percent, respectively. 4 2. The Government of Jamaica (GoJ) has articulated a comprehensive program of reforms that includes fiscal consolidation and a strategy to promote private sector-led growth. The Government's economic reforms will be supported by a signed GoJ-IMF Extended Fund Facility Arrangement (EFF) in the amount of SDR 615.4 million (about US$932.3 million) for the period April 2013 to March 2017. The World Bank and the IDB, will also support the program, each having agreed to allocate US$510 million over the next four years. 3. The financial sector is fragmented with low competition and heavy concentration in lending to households and larger corporates. Deposit Taking Institutions (DTIs) account for 40 percent of financial sector assets 5 and are supervised by BoJ. Commercial banks account for 70 percent of the total loan portfolio of DTIs, while credit unions account for 10 percent. Concentration is high, with two banks holding over 75 percent of assets and deposits of the banking sector. Lending is primarily directed to households and larger corporates, with only 15 percent of total commercial bank loans granted to MSMEs 6. Non-Bank Financial Institutions (NBFIs) include non-bank securities dealers (23 percent of assets), insurance companies (11 percent), credit unions (3 percent), and pension funds (12 percent). Despite credit unions’ small share of total lending, their client base consists of a third of the population. In addition, there is a small microfinance sector, which is largely unregulated. MFI lending represents about 25 percent of the total lending of credit unions, and they serve a small client base (approximately 30,000 – 40,000 clients). 4. The Jamaican financial sector lags behind its regional peers in terms of competition. The banking sector was restructured following a severe financial crisis in the 1990s and this resulted in significant concentration. This is reflected by the H-statistic for Jamaica, which stands at 0.43 in 2010, well below its regional peers and the LAC average. 4 World Bank estimates as of December 2014. 5 DTIs consist of six commercial banks, three building societies, and two merchant banks. Commercial banks represent 76 percent of DTIs’ assets, building societies 22 percent, and merchant banks less than 2 percent. 6 BoJ Credit Conditions Survey, 2013. 7 Furthermore, the market power of banks, as measured by the Lerner index, has increased over time, reaching 0.40 in 2010, on the high end of its regional peers. 7 Figure 1: H-statistic, 2010 Figure 2: Lerner index, 2010 0.60 1.00 0.92 0.80 0.74 0.40 0.40 0.38 0.34 0.60 0.54 0.43 0.23 0.40 0.32 0.20 0.16 0.20 0.00 0.00 The Bahamas Jamaica Trinidad and LAC Dominican Dominican LAC Trinidad and The Bahamas Jamaica Tobago Republic Republic Tobago Source: World Bank calculations, Global Financial Development Database 5. The financial sector has been resilient with adequate profitability, capitalization, provisioning, and a relatively comfortable liquidity position, despite short term liquidity pressures. Despite the two debt restructurings, financial sector soundness indicators remain adequate, with DTIs exceeding the 10 percent minimum capital adequacy ratio (at above 15 percent as of end-2013). Non-performing loans declined to 5.4 percent of total loans at end- 2013. Banks are fairly profitable. Liquid assets represent about 25 percent of total assets. However, the national debt exchange (NDX) in February 2013 and the transfer of government deposits from banks to the Central Treasury Management System at BoJ, has resulted in short term liquidity pressures in the banking sector. Thus, BoJ’s liquidity facilities have helped the financial sector to weather this pressure. II. STATUS OF FINANCIAL INCLUSION 6. Jamaica has the largest proportion of formally banked adults among middle income countries in Latin America and the Caribbean (LAC), offering a significant opportunity to increase access to credit. More than 70 per cent of adults have a formal account, without any significant distinction between urban and rural areas. 8 However, only 8 percent of adults have a loan from a formal financial institution, and less than 10 percent have outstanding mortgage loans. Lack of access to credit is especially prevalent among low income households and rural areas. 7 In general, higher numbers for the H-statistic indicate higher levels of competition. The Lerner index directly measures market power. Higher values of this index indicate greater market power and lower levels of bank competition. 8 Findex, 2011. 8 Figure 3: Account and loan penetration (%) Account at a formal financial Loan from a financial institution in the institution past year 80 16 70 14 60 12 50 10 40 8 30 6 20 4 10 2 0 0 Jamaica Dominican Trinidad Latin Jamaica Dominican Trinidad and Latin Republic and Tobago America & Republic Tobago America & Caribbean Caribbean (developing (developing only) only) Source: Findex, 2011 7. Similarly to households, almost all formal MSMEs 9 in Jamaica have access to checking or saving accounts, but the financial sector is scarcely used to finance their investments. Less than a third of firms have a bank loan or line of credit (well below the 48 percent average in LAC). 10 As a result, investments are mostly financed with own funds. Lack of funding has a negative effect on entrepreneurship, and overall business stability and employment. 8. High interest rates and low penetration of credit to low income households and MSMEs are driven by high credit risk, as a result of high information asymmetries, as well as insufficient competition in the banking sector. Lending rates average about 18 percent per annum and are twice as high for micro-entrepreneurs as for medium-sized firms. Credit unions and MFIs charge rates of above 50 percent annually for microenterprise loans. While three credit bureaus have been established recently, financial institutions still lack proper credit risk assessment tools as these bureaus are relatively new. In addition there is no public credit registry in Jamaica. Thus, credit activity is scarce, interest rates are high, and traditional collateral requirements are high. Furthermore, the informal economy (estimated at 40 percent of GDP) 11 has only access to credit unions and MFIs. 9. More than half of the population lives in rural areas and has limited access to finance. The agriculture sector contributes to about 6.5 percent of GDP and employs about 17 percent of the labor force. The availability of financial services in rural areas, especially for lower income households, small-scale farmers and entrepreneurs, is limited, becoming a bottleneck for generating economic activities and improving the livelihood of the rural population. 10. Penetration of traditional distribution channels (e.g. branches, ATMs) is low, and especially in rural areas. With 27 ATMs and 6 commercial bank branches per 100,000 adults 9 A national definition for MSMEs in Jamaica was established in 2011 under the Ministry of Industry, Investment and Commerce’s “MSME & Entrepreneurship Policy”. 10 Enterprise Survey, 2010. 11 The Informal Sector in Jamaica, Inter-American Development Bank (IDB), 2006. 9 and almost 5,000 POS terminals per million inhabitants in Jamaica, penetration is well behind countries like Bahamas, Belize, and Trinidad and Tobago. Figure 4: Outreach Indicators in Jamaica and Peer Countries Source: IMF Financial Access Survey, 2012 11. Alternative to credit products are limited. The absence of alternative products beyond credit lines or personal loans represents a hurdle for MSME activity. Factoring is not developed, it is not recognized as a financial service in the BSA, and leasing is scarcely used due to existing ambiguities. In terms of equity, there are not enough instruments available in the market. Venture capital is not developed. There are only 22 companies listed in the Junior Stock Market for SMEs with low liquidity and turnover ratios. Capital markets are also nascent and dominated by sovereign bond issues in the primary market, and repos in the secondary market. There are no specific instruments for agriculture finance and for low income households. Micro-insurance and mortgage insurance are almost nonexistent. 12. The outreach of public policies remains limited. Despite an ambitious package of legislative reforms to improve banking regulation, financial infrastructure, or ease doing business for MSMEs, public programs to increase financing for MSMEs and housing, or in rural areas, are scarce and lack sufficient coordination. Furthermore, improved financial consumer protection policies are needed to limit the vulnerability of consumers to abusive or unfair practices by financial institutions. The BSA has made provisions for a mandatory code of conduct for DTIs, but a comprehensive framework on consumer protection and financial literacy is needed. III. MSME FINANCE 13. MSMEs face access to finance constraints that limit their ability to invest, grow, create jobs, and contribute to the economy. According to the 2010 World Bank´s Enterprise Survey, access to finance is a major constraint among the top three business constraints reported by firms. Only about 27 percent of formal SMEs have a bank loan or line of credit. Several factors have constrained bank lending to MSMEs, including: banks have not saturated lending in the retail segment due to investment opportunities in low-risk instruments, lack of credit reporting systems, lack of reliable financial statements, lack of adequate collateral, the high level of informality (especially of micro-entrepreneurs), lack of bank strategies, processes, lending methodologies, and lack of alternative sources of finance, such as leasing, factoring, and venture capital. In addition to limited financing by banks, the supply of nonbank 10 sources of finance for MSMEs is limited, with credit unions providing mostly consumer finance and a small microfinance sector, charging interest rates of about 50 percent annually, and filling mainly a liquidity gap for micro-entrepreneurs. Figure 5: Enterprises and Access to Finance Proportion of firms with access to a bank loan or a line of Proportion of firms identifying access to finance as a credit, % (2010) major constraint, by size (2010) 80 50 47 68 70 45 41 60 56 40 48 47 35 31 32 50 29 29 40 30 40 25 21 27 26 28 20 30 15 11 20 10 10 5 0 0 All firms Small (5-19) Medium (20-99) Large (100+) All firms Small (5-19) Medium (20-99) Large (100+) Jamaica Latin America & Caribbean Jamaica Latin America & Caribbean Source: Enterprise Surveys, 2010 14. Several measures should be undertaken to encourage the development of alternative sources of finance for MSMEs, such as factoring, leasing, and venture capital. The recent modernization of the secured transactions reform is expected to encourage the development of movable asset based financing instruments. The authorities should work towards reviewing and revising the legal, regulatory, and tax framework for assignment of receivables, or developing a factoring law. In addition, consideration should be given to the development of an electronic factoring platform. To encourage the development of leasing, the legislative framework needs to be revised to remove ambiguities, and a leasing law should be considered. In addition, the eco-system (legal and regulatory framework, and infrastructure) for venture capital should be developed. 15. BoJ should consider reviewing its prudential framework and documentation requirements that could incentivize lending to MSMEs. As a result of AML regulations, banks require audited financial statements, proof of tax compliance, recommendation letters and other requirements from SMEs. A large share of the firms in Jamaica consists of small businesses and it is costly for such small borrowers to be required to submit audited financial statements. 12 Thus, the authorities can consider simplifying documentation requirements and modifying the existing prudential framework for banks to incentivize lending to small businesses. In addition, current prudential regulations for banks need to be adapted to take into account the range of movable assets introduced by the SIPP law. 12 The Enterprise Surveys of 2010 indicated that over 44 percent of formal firms in Jamaica were sole proprietors (compared to 31 percent in LAC). 14 percent of firms were LLCs (compared to above 40 percent in LAC), 12 percent partnerships, and 29 percent limited partnerships. 11 16. The regulatory environment for microfinance should be improved to provide a level playing field amongst financial institutions providing microfinance, in order to promote competition and reduce the risk of regulatory arbitrage. The proposed Credit Unions regulations and the Micro-Credit Act are a welcome development. The current draft Credit Union regulations, to be issued under the “Bank of Jamaica Act,” are at the final stage of development, and will provide BoJ with oversight responsibility over credit unions. The authorities should ensure that the final regulations take into account the credit unions’ unique characteristics, in terms of liquidity and reserve requirements, provisioning, and other areas. In addition, microfinance companies remain largely unregulated, and thus progress towards a Micro-Credit Act is encouraged. The absence of a regulatory framework over the activities of microfinance may hinder the growth of the sector. Given BoJ’s role as the supervisor of DTIs, and its new upcoming authority of supervising credit unions, BoJ should also consider undertaking non-prudential supervision of credit-only MFIs. Since these MFIs are non-deposit taking, non-prudential supervision would be appropriate to improve transparency in the market. 17. While the authorities have undertaken significant reforms to strengthen the enabling financial infrastructure, further efforts are needed. These reforms comprise: (i) the establishment of three credit bureaus 13; (ii) the modernization of the secured transactions reform including legal reforms through the enacted Personal Property (SIPP) Act, and the establishment of the movable collateral registry; and (iii) and the adoption of the Insolvency Law. Despite significant reforms, further efforts are needed in these areas to: (i) complete implementation of credit reporting oversight and enhance the consumer protection framework; (ii) enhance the regulations of the movable collateral registry, along with undertaking an outreach campaign to increase awareness and usage of the registry, and stakeholder training; and (iii) develop regulations for the insolvency law along with training of judges and insolvency administrators. 18. While several government programs for MSME finance have been put in place to address a market gap, a review and consolidation of these programs is encouraged. Such consolidation would result in improved efficiency and effectiveness of public finance programs for MSMEs. The Development Bank of Jamaica (DBJ) provides financing to MSMEs mostly through on-lending via financial institutions. 14 Funds are provided at interest rates in the range of 10-13 percent to clients involved in the productive sectors and the service sectors. In addition to DBJ, EXIM bank and the Self-Start Fund provide direct lending, and the Micro Investment Development Agency (MIDA) provides wholesale lending to SMEs. 19. There is also an existing partial credit guarantee scheme designed to mitigate lenders’ credit risk, but it has not been sufficiently utilized by financial institutions. Experience has shown that with an adequate financial and operational design and attractive products, PCGs can contribute to improved lending terms and conditions for MSMEs, especially in a context characterized by the lack of credit information. DBJ set aside J$250 13 Two credit bureaus are operating, the third one was licensed in 2014. 14 DBJ’s lending to MSMEs constitutes almost half of credit unions portfolio to microenterprises, and 2 percent of banks’ lending to MSMEs. 12 million capital with a 2x maximum leverage to provide partial credit guarantees to financial institutions. The maximum guarantee is established at J$ 10 million (US$ 100,000) or 50% of the loan. The scheme charges a fee of 2%, for covering 50% of the loss par i passu after financial institutions have exhausted their recovery efforts. The design and operational model of the PCG scheme should be reviewed and revamped to provide adequate incentives for lenders to participate, including establishing it separate from DBJ, establishing premiums that are adequate for the risk coverage provided, a simple and efficient claims procedure, and other adequate operational design features. 20. The authorities are also encouraged to implement measures in other areas that would improve access to finance for MSMEs. These include: providing capacity building to institutions that provide business training to SMEs, evaluating measures of formalizing SME activity, and systematically collecting data on the size and needs of the MSME segment. IV. RURAL AND AGRICULTURE FINANCE 21. Availability of financial services is limited for low income households and for farmers in rural areas, where about half of the population lives. Natural disasters combined with a lack of access to credit have limited investment in new crops and technological improvements. In Jamaica, most agriculture is done by small scale farmers. The sector’s contribution to the economy represents approximately 6.5 percent of GDP and 17 percent of the labor force, while lending to the sector represents 4 percent of banks’ total lending portfolio. In addition to the traditional agriculture specific risks (weather, diseases, and vulnerability to prices), lack of adequate land collateral in rural areas increases credit risks for banks. 22. Agriculture requires the development of specific financial products and services. Micro-insurance is underdeveloped in Jamaica. The authorities aim to draft separate regulations for micro-insurance, which is a welcomed development. This regulation should simplify the approval process, enable the environment for market players to develop micro- insurance products, and allow the expansion of delivery channels to offer micro-insurance products in a more cost effective way. In addition, specific instruments, such as warehouse receipt financing and a low cost entry level saving products for the lower income segments should be explored. About 70 percent of people living in rural areas have a bank account, however its usage is discouraged by fees and required minimum balances. A high mobile phone penetration should be leveraged to provide innovative financial services through mobile phones, hence improving financial inclusion in rural areas. 23. The authorities should include agriculture finance as one of the areas of the broad financial inclusion strategy, exploring specific instruments, public policies, and institutional framework. A coordination of policies intersecting both the financial and agriculture sectors is needed to enhance access to finance for the agriculture sector. 13 V. HOUSING FINANCE 24. While Jamaica has a relatively sophisticated mortgage market, extended under prudent and standard market practices, a large proportion of the population is excluded from mortgage finance. The majority of the portfolio is concentrated in three building societies and a public savings and loans agency, the National Housing Trust (NHT). 15 Lending by the NHT constitutes 50 percent of all national mortgage market and comprises almost all the portfolio targeted to lower-income and self-employed borrowers. The legal and regulatory framework for the mortgage market is well developed, including prudential supervision of the private lenders by the BoJ 16. Public and private mortgage insurance exists, although its use is not mandatory. The low income and the informal segment have limited access to housing loans. The informal segment of the population is particularly excluded, as they cannot access loans from the private or the public savings and loan institution. Only NHT provides loan products that can be affordable for salaried borrowers with a below average income 17. Jamaica still faces a housing shortage, especially in the lower income segment. 25. Half of the land parcels are not registered, affecting the poor disproportionately. The high costs of obtaining and transferring titles discourage households from registering their rights, and thus limiting their ability to obtain mortgage finance. However, there are a number of initiatives to support titling for the lower income households, including via the Housing Agency of Jamaica (HAJ) in the form of a subsidy. 26. Government policies and initiatives in the housing finance sector are fragmented. Jamaica does not have a comprehensive housing policy and strategy, although a housing policy is currently under development. A number of existing public agencies, such as NHT, HAJ, and Jamaica Mortgage Bank (JMB) are statutory bodies regulated by their own acts, and supervised by Ministry of Transport, Works and Housing and the Office of the Prime Minister. 27. In order to improve mortgage finance, the authorities should consider several measures. These include: (i) formalizing a comprehensive national housing strategy with the goal of expanding access to the underserved segments; (ii) establishing a uniform prudential regulatory framework for all housing finance market actors, regardless of their corporate format or shareholder composition, (iii) assessing the efficiency of public resources and institutions to facilitate housing finance for the low income households, and modifying the existing direct subsidies; (iv) encouraging long term funding channels to the housing finance sector, particularly to the lower income segment to complement savings as the only current source of funding for mortgages, including establishing a comprehensive legal and regulatory mortgage asset securitization framework; (v) support flow of private capital for developers and housing finance to the lower income and informal borrowers by establishing incentives and 15 NHT is a trust with funding from mandatory employer and employee contributions as well as voluntary savings by the self-employed. 16 BoJ supervises commercial banks and building societies, but not NHT. 17 NHT offers lower than market interest rates and affordability products, e.g. loans for land plots and modest starter homes. 14 legal instruments for private capital to participate in low-income developer finance; and (vi) enhancing the utilization of mortgage insurance as a tool of increasing housing affordability. VI. PAYMENTS SYSTEMS AND REMITTANCES 28. Jamaica has a well-developed payment and settlement infrastructure. Payment and settlement systems play a crucial role in fostering financial inclusion and in contributing to financial stability and containing systemic risk. In Jamaica, all systemically important payment systems, funds leg of the securities segments (Government and capital markets), net settlement files from the retail Automated Clearing House (ACH), the payment card switch MultiLink, are all settled in the JamClear-RTGS system. 29. The authorities have made significant progress in strengthening and harmonizing the legal framework for payment systems and the Government securities market, as per international standards and in line with the National Payment System (NPS) reform strategy. In 2010, as part of the reform strategy, the Payments Clearing and Settlement Act (PCSA) and the Government Securities Dematerialization Act (GSDA) were enacted. The PCSA provides a legal basis for netting, finality and irrevocability of payments, and provides the BoJ with statutory powers of oversight over the payment and settlement systems in Jamaica. The GSDA provides the statutory basis for the immobilization and dematerialization of Government and BoJ securities, and enables their trading and settlement through electronic book-entry. 30. With regards to the corporate securities market, the legal framework in terms of the Securities Act (1993) should be harmonized with the GSDA and strengthened. The Securities Act (1993) could be revised and amended to provide a legal basis for the immobilization and dematerialization of corporate securities and for establishing a statutory mandate for the JSCD to function as a securities settlement system (SSS) and as a central counterparty (CCP). A noteworthy feature is that the Act provides for the segregation of customer assets. The Financial Services Commission has the regulatory and oversight powers over the corporate securities market. 31. The operations of the Government and corporate securities markets remain under-developed. Government T-bills are not dematerialized and the auction process for the Government securities market is in the process of being integrated with other BoJ systems, for a seamless DvP mode of settlement. Efforts are underway to fine-tune the roadmap for phasing out retail repos in Government securities. The authorities plan to submit to the industry the legal and regulatory framework to establish a Trust to hold the underlying securities on the retail repo clients’ behalf. Adequate risk management measures as outlined in the Principles for Financial Market Infrastructures need to be put in place to contain credit and liquidity risks in respect of the JCSD’s functioning as a CCP and SSS. 32. While cash and cheques continue to be the dominant payment modes, BoJ is pushing forward a shift in electronic payments. Although there is a range of retail electronic payments available and increasing, cheques remain the most widely used non-cash payment instrument. Usage of cards is limited as well, with only 40 percent of the population holding a 15 debit card. The penetration of distribution channels, be it electronic or through mobile technology, remains scarce. Recently, the BoJ approved two pilot projects of non-bank payment service providers using mobile technology. 33. In order to facilitate financial inclusion and provide an impetus to the use of retail electronic payments, BoJ is stepping up its regulatory efforts. In 2013, BoJ issued “Guidelines for Electronic Retail Payment Services”, permitting both banks and non-bank payment service providers to provide retail electronic payments, including through agents. Simplified KYC requirements have been prescribed for users to avail retail electronic services from non-bank service providers. The Guidelines require non-bank payment service providers to deposit customer funds in specialized trust accounts in deposit taking institutions regulated by BoJ, with bankruptcy remote provisions. They also provide BoJ the right to prohibit exclusivity arrangements in the interest of development, access, and utilization of electronic retail payment services. In addition, BoJ should consider designing a strategy, in coordination with all relevant stakeholders, to foster greater use of electronic retail payments, expand consumer choices, increase competition in retail payments systems, and bring a shift in Government payments to electronic payment mechanisms. 34. BoJ should undertake a comprehensive review of its regulatory framework for the remittances sector to align it with General Principles for Remittances and enable the sector to provide innovative retail remittance products to the beneficiaries at competitive prices. The average percentage costs of sending remittances into Jamaica by the Jamaican diaspora are significantly higher than the global average percentage costs. A review should be conducted of the licensing procedures for appointment of sub-agents, which are burdensome and limit the reach of the sub-agent network, and the exclusivity arrangements in the remittances market stifle market competitiveness. BoJ should also consider carrying out a study weighing the costs and benefits of allowing remittance companies to be direct participants in the domestic payments system infrastructure. 35. Shifting government welfare payments and pensions to electronic payment mechanisms through the Government’s Centralized Treasury Management System (CTMS) provides an opportunity to bring unbanked beneficiaries into the formal financial system, encouraging savings and a reduction in administrative costs. It is estimated that a third of the Government’s social payments is spent on administrative costs to disburse benefits due to the large volumes of checks and a larger number of paper pension vouchers, under the Ministry of Social Security and Labour’s PATH and NIS programs. To date, only a small percentage of beneficiaries receive benefits using pre-paid cards, since its introduction in 2009. The Government, in coordination with relevant stakeholders, should further streamline procedures and put in place mechanisms for electronic benefit transfer schemes through greater utilization of CTMS in respect of the PATH and NIS programs, thereby saving on administrative costs and improving efficiency of the system. VII. CREDIT REPORTING SYSTEMS 36. The credit reporting system in Jamaica is composed of three credit bureaus, two of which were licensed in 2012, and the third one in 2014. The number of subjects in the 16 credit bureaus at end-2014 represented approximately 14 percent of the population in Jamaica. BoJ is the main overseer of the credit reporting system. Although there is no credit registry, BoJ plans to enhance its financial data collection system, which will serve their supervisory purposes. The main legal aspects of credit reporting activities in Jamaica are covered under the Credit Reporting Act (2010), complemented by related Regulations and BoJ Directions. 37. The data submission process to the credit bureaus is taking place at a slower pace than expected, with signs of data fragmentation. The credit bureaus are collecting data from some banks and other creditors. However, some important participants in the market are not yet providing data to the credit bureaus, due to technological requirements and modifications needed in their systems. There are users who request credit reports, but do not provide credit information to the credit bureaus. If lenders are not able to access information in a comprehensive manner due to data fragmentation, the benefits of credit bureaus will be undermined. Data fragmentation could result from the development of different data structures for credit information, and the adoption of data supply agreements that are exclusive to one of the credit bureaus. Thus, measures should be adopted to encourage credit bureaus to compete in services, and not in data, and current information sharing arrangements should be reviewed to ensure the absence of anti- competitive practices amongst certain creditors. In the absence of clear guidelines, credit bureaus may choose to compete on obtaining unique credit data, rather than on quality of service and price. 38. BoJ should complete the implementation of its oversight function, sharpening the policy objectives, while ensuring the best balance between competition and cooperation in the credit reporting market. To achieve this goal, the oversight function should consider aspects related to consumers’ rights compliance, financial stability, security measures, data quality, anti-competitive practices, fair conditions to participants, efficiency of systems, use of data, entry and exit criteria, management of risk, governance and ownership, and access to public databases. Instruments of oversight range from moral suasion to on-site inspections, from regulation to cooperation, and from sanctions to the direct provision of credit reporting services. Consideration should be given to creating a Credit Information Task Force/Council to identify the needs of the credit reporting system. 39. The authorities should further enhance the consumer protection framework for credit bureaus. While the consumer protection framework in place for financial services is limited with no Data Protection Act, there is a Data Protection Bill currently under discussion to be adopted in Jamaica in the near future. Several measures should be undertaken to improve the practices of credit bureaus and build consumer confidence in the credit reporting system, including, inter-alia: instructing some credit information providers to stop the practice of asking consumers to request credit reports prior to applying for their loans, and to publish on their websites information regarding consumer rights; allowing consumers to access their reports online; keeping records of consumer inquiries regarding their own data; including a standard consumer consent clause for credit applications; and others. 17 VIII. CONSUMER PROTECTION AND FINANCIAL LITERACY 40. Rapid expansion in financial services – combined with low levels of competition and weak “shopping around” practices by consumers – raises the need for strong protection of financial services users. The provision of financial services to previously unserved (or underserved) consumers will bring first-time consumers into formal financial services, highlighting the need for consumer education and protection. While legislative changes have strengthened the anti-fraud framework (although Jamaican-based lottery scams remain a source of concern for international law enforcement bodies), a comprehensive National Financial Consumer Protection and Financial Literacy Program with high level political support should be designed, in collaboration with the financial supervisory agencies, the civil society organization, industry associations and members of the academic community. In addition, monitoring and evaluation measures could be identified in order to report on success in implementation and suggest further improvements. 41. Jamaican consumers complain about a wide range of unfair business practices by financial institutions, with the single most common complaint being the calculation of account balances. The absence of a standard methodology for calculating effective interest rates makes comparison shopping difficult. 18 Furthermore the common use of bank-defined “market conditions” to reset interest rates impedes the ability of consumers to calculate interest due. Several actions are recommended towards increasing transparency in setting interest rates and strengthening and simplifying standard disclosure on common financial services. Regular surveys of consumer finances would also be helpful. 42. The institutional structure for financial consumer protection remains fragmented and the existing dispute resolution mechanisms across the financial sector are inadequate to meet the needs of Jamaican consumers. Following the recent enactment of the BSA, the BoJ intends to create a Department within the Financial Institutions Supervisory Division with responsibility for monitoring and enforcing compliance with the code and dealing with consumer complaints. Under the FSC Act, the FSC receives and investigates complaints (and enforces compliance with the legislation) for private pensions, securities, and insurance. However, for financial institutions outside the supervision of the BoJ or the FSC, no financial supervisory agency is responsible for consumer protection. Furthermore, the slow court process and high court fees discourage consumers, while out-of-court mechanisms are still in their infancy. One solution would be an independent financial ombudsman, covering all consumer financial services but limited to small maximum amounts. The ombudsman could be created by statute or by financial industry associations. Following best practice worldwide, the ombudsman could be funded by a levy on financial institutions rather than by government financial support. Such an ombudsman could provide a “one stop shop” for individuals to present complaints and inquiries about financial services. The work of a financial ombudsman 18 The Banking Services Act of June 2014 calls for the establishment of a standard methodology for calculating effective interest rates. 18 should be complemented by a national program of financial education to ensure that consumers understand their legal rights and obligations in using financial services. 43. The BSA will help to strengthen market conduct supervision of banks and building societies. This will include an enforceable code of conduct applicable to commercial banks, merchant banks, and building societies. However, the rest of the financial services sector remains largely without conduct codes. The establishment of conduct codes for all parts of the financial services sector, with monitoring mechanisms, is advised. Annex 1: Detailed List of Recommendations 19 Recommendations Agency Timeframe MSME Finance Legal and regulatory framework Ensure an adequate regulatory and supervisory framework for different lenders to guarantee a level MoFP/BoJ MT playing field for financial institutions providing the same activities. Simplify documentation requirements for MSMEs and adopt prudential regulations to incentivize lending to MSMEs (for example, BoJ could enable banks to treat business loans below a certain amount as consumer loans, for the purposes of information BoJ MT and provisioning requirements; adapt prudential regulations to take into account the range of movable assets introduced by the SIPP law) Alternative Financial Instruments for SMEs Develop a factoring law, and review/revise the legal, regulatory, and tax framework for assignment of receivables. In addition, consider an electronic MoFP/DBJ ST / MT factoring platform. Review the legislative framework for contradictions MoFP ST that inhibit leasing expansion Conduct awareness campaign for financial institutions and SMEs, on factoring and leasing as MoFP/MoIIC/DBJ MT useful instruments Develop the legal, regulatory framework, and MoFP/BoJ ST infrastructure for the development of venture capital. Secured Transactions, Insolvency Framework Improve collateral registry regulations. Collateral ST registry/Companies Office Conduct capacity building of stakeholders to maximize the benefits of the new system MoFP/MoIIC ST (communications campaign, stakeholder trainings). Develop insolvency regulations. MoIIC/MoJ MT Conduct trainings of judges and insolvency MoJ MT administrators. Public Programs 19 Work is underway for the implementation of several of these recommendations, including for the development of a venture capital ecosystem, consolidation of the institutional framework for MSME lending, provision of financial services through mobile phones, provision of capacity building to SMEs, and enhancement of the regulatory framework for the movable collateral registry and insolvency legislation. 20 Recommendations Agency Timeframe Review and revamp the PCG scheme to provide DBJ/MoF ST adequate incentives for lenders to participate. Provide capacity building to SMEs to improve their MoICC MT bankability, through JMDC and business associations. Consolidate public programs for MSME finance MoF, MoICC MT (through DBJ, Exim bank, Self-Start Fund, MIDA, and others) to improve efficiency and effectiveness. Other Collect comprehensive data on the SME sector, and MoICC, Statistical Institute MT conduct a demand survey on business finance. Evaluate measures to reduce informality. MoF/ MoICC MT Housing Finance Develop a comprehensive national housing policy strategy, combining housing/infrastructure and finance elements, with robust data collection and MoFP, MoTWH ST analysis action plan for the housing finance and real estate markets. Establish a uniform regulatory and supervisory framework for all lenders, including: prudential measures to maintain quality and expand mortgage lending, statutory and regulatory enforcement of BoJ, MoFP, MoTWH ST robust corporate governance, significantly improved data collection and reporting, uniform leverage, ALM and provisioning treatment of housing finance assets, uniform consumer and investor disclosure. Develop the legal and regulatory framework for longer term funding instruments, consider the establishment of a legal and regulatory mortgage FSC, BoJ, MoFP MT asset securitization framework Design a specific policy to introduce subsidies and incentives for low income and informal borrowers. Incentives should fit with overall housing strategy MoFP, MoTWH ST and focus on property development location and target borrower demographic, while maintaining prudent credit risk oversight. Assess the efficiency of public resources and the institutional framework to facilitate housing finance MoFP MT for low income households, leveraging public resources. Support flow of private capital for developer and housing finance to the lower income and informal MoFP MT borrowers. Enhance the utilization of mortgage insurance as a MoFP ST tool of increasing housing affordability. 21 Recommendations Agency Timeframe Rural/Agriculture Finance Conduct a detailed diagnosis of the supply and demand for agricultural finance at the country level MoFP/MoA/MoT/ BoJ/FSC ST to inform the rural and agriculture finance policy directions. Develop a framework to collect data and information on financial provisions in rural area and for MoFP/MoA ST, MT agriculture sector. Review the potential of warehouse receipts financing: including the appropriate legislation, MoFP/BoJ/MoT ST, MT regulatory and supervisory oversight. Expand the agents’ network and encourage new means of offering financial services, such as through BoJ ST mobile phones. Develop entry level saving products without regular account maintenance fees for the lower income BoJ ST segments, including microenterprises and small farmers. Develop micro-insurance regulations and guidelines. FSC MT Payments and Remittances Deepen the payment infrastructure in rural areas, revise the existing access criteria for the ACH, and use the Centralized Treasury Management System BoJ/MoFP ST (CTMS) to distribute Government welfare and pension payments. Consider measures to expand consumer choices and increase competition in retail payments. Measures include barring exclusivity arrangements, exploring BoJ MT the possibility of locating ATMs in post offices, and developing and implementing a policy framework to open “no frill” accounts in banks. Undertake a comprehensive review of the regulatory framework for remittances, the appointment of sub- agents and design a coordinated approach, in line with the General Principles for Remittances. Prohibit BoJ MT exclusivity arrangements with respect to remittance companies, non-bank electronic payment service providers and banks. Develop a comprehensive strategy to reduce administrative costs and improve efficiency of the direct benefit transfer schemes, such as PATH and BoJ/Government ST NIS through retail electronic payment products. The government should collaborate with BoJ and other stakeholders to bring about a shift in G2P payments 22 Recommendations Agency Timeframe to electronic payment modes within a defined time frame Credit Reporting Complete establishment of a formal oversight BoJ ST function at BoJ, sharpening the policy objectives. Establish a “Credit Information Task Force/Council” to identify the needs of credit information and BoJ ST establish goals. Adopt measures to encourage credit bureaus to compete in services and not in data, and review the current information sharing arrangements to ensure BoJ ST the absence of anti- competitive practices among certain creditors. Enhance the consumer protection framework for BoJ MT credit bureaus. Consumer Protection and Financial Literacy Create a high-level task force to supervise development of a comprehensive national plan on MOFP/BoJ/FSC/MoIIC/JDIC ST financial consumer protection and financial literacy, adopt the national program. Consider the establishment of an independent statutory financial ombudsman to provide a “one stop shop” for individuals to present complaints and MOFP/ BoJ/FSC ST inquiries about financial services. Finance the ombudsman with a levy on the financial services sector. Strengthen, and simplify, standard disclosure on common financial services, including key facts BoJ/JBA MT statements. Conduct timely surveys of consumer finances, and an BoJ/FSC/Statistical Institute MT in- depth baseline survey of financial literacy. Set up a toll-free hotline for financial consumer BoJ MT complaints and inquiries. Establish codes of conduct for all parts of the MOFP/ BoJ/FSC MT financial sector and monitor compliance. Adopt a Data Protection bill. MOFP MT Publish timely price surveys of commonly used BoJ/FSC ST financial services to encourage comparison shopping. ST - up to 1 year MT- 1-3 years