WHITHER GOES INVESTMENT BANKING IN THE CARIBBEAN
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1. The Financial Crisis to date has claimed several venerable names and may yet claim more Investment Banks.
2. The Investment Banking Industry in the Caribbean is extremely important:
- Contribution of Investment Banking Sector
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- Emp – (1000 – 2000)- Profits – USD 200MM- Raising Capital - USD 1.5 Billion- Funding Projects - USD 250MM
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3. It is therefore natural to enquire and to
examine whether or not the Investment
Banking Industry in the Caribbean is exposed
in the same way or will be susceptible to
contagion via transmission mechanisms.
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HYPOTHESISThe current Financial crisis stemmed from a
deterioration in credit quality (sub-prime Loans)
which was exacerbated by Liquidity crisis in US
Investment Banks (which typically fund their
assets with wholesale short-term Liabilities) but
which was further compounded by Mark-to-
Market (MTM) Accounting convention.
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CAUSES AND AMPLIFIERSA. Sub-prime Lending and the Lowering of
Credit StandardsB. LiquidityC. Mark to Market AccountingD. Excessive LeverageE. Exposure to DerivativesF. Off Balance Sheet FinancingG. Inability to access Federal Reserve
FundingH. Lack of on-site supervisionI. Credit Rating Agencies
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SUB-PRIME LENDING AND THE LOWERING OF CREDIT STANDARDS
In a nutshell, global liquidity from China and
other current-account surplus countries was
directed towards the US and UK which then
inflated asset markets (especially housing)
which was plagued by poor regulation and
dangerous incentives.
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By contrast, Caribbean Investment Banks have little or no exposure to US Sub-Prime Loans, very little exposure to mortgages generally and are currently exhibiting non-performing ratios of less than 2.5%.
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LIQUIDITY
US Investment Banks are particularly
vulnerable to credit-market turmoil, because
they rely on funding from wholesale markets,
much of it short-term including over-night
funding in repurchase markets. This 4.5 Trillion
Market became unstuck during the crisis.
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Caribbean Investment Banks, unlike their
US and UK counterparts raise their liquidity
via deposits. Furthermore, if they ever run
into difficulty, they can go to their parents
which are usually commercial banks. Due to
their lower reserve requirements they are
often more competitive than their retail and
commercial counterparts.
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LIQUIDITY RISK This situation is further compounded by
the fact that there is what I have described
as a liquidity trap whereby, due to poor
transmission mechanisms. (from local to
foreign currency) local liquidity is actually
trapped in the local financial system and
keeps “slushing around” moving to where
it attracts the highest internal rates.
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REGULATORY ARBITRAGE
Regulatory Arbitrage means that because the
range of investment opportunity is limited for
regional institutional investors even more
liquidity is trapped in the system.
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MARK TO MARKET ACCOUNTING AND THE PREPONDERANCE OF TRADING ASSETS OF THE BALANCE SHEETS OF INVESTMENT BANKS
Fair value accounting can cause a downward spiral in prices by encouraging institutions to sell assets quickly and
forcing them to take write-downs that do not reflect the “true” value of the underlying assets.
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In respect of Caribbean Investment Banks,
although MTM accounting is in effect, the
component of their balance sheet which is
affected by this convention is still
relatively small when compared to North
America Investments Banks.
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EXCESSIVE LEVERAGEUS Investment Bank were allowed to leverage
their Balance Sheet to levels unheard of in the Caribbean.
The Leverage ratio of Bear Stearns rose from 26 Times (assets were 26 times equity) in 2005 to almost 30 times at the time of its collapse in 2008.
Under the FIA Trinidadian Merchant Banks are limited to 12 times their capital
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EXPOSURE TO DERIVATIVESAccording to the Economist Magazine (May 7,
2008) approximately half of the write-down of
banks was due to the exposure to derivatives
which contained synthetic exposures to sub-
prime assets (CDO’s) and credit default swaps. In the case of Caribbean Investment Bank,
this exposure is almost non-existent.
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OFF BALANCE SHEET FINANCING AND EXPOSURE TO SIV’SUS Investment Banks accounting under US
GAPP, typically allowed for SIV’s which are akin
to a “shadow banking system” in which short-
term funding was raised (at lower interest
rates) and later invested in long-term higher
yielding assets.
Quite often these structures were not
consolidated
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and therefore provided a false sense of security in
terms of the bank’s capital adequacy ratio. Citi had
more than 83 Billion in SIV’s in September 2008.
Caribbean Investment Banks typically use IFRS. In
this regard, IAS 39 and SIC 12 would require these
enterprises to consolidate any “SIV” or SPV once they
retained an economic interest in the enterprise.
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INABILITY TO ACCESS (IMMEDIATELY AVAILABLE) EMERGENCY FINANCING FROM THE FEDERAL RESERVE Because US Investment Banks did not come
under the jurisdiction of the Federal Reserve they
did not have access to Federal Financing.
Investment/Merchant Banks in the Caribbean are
regulated by the Central Bank and by virtue of
this, have access to Central Bank Financing via
the repurchase market
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REGULAR BANK SUPERVISIONBecause regional banks fall under the
supervision of the Central Bank, they are
subject to regular on-site inspections by the
regulators.
US Investment Banks were not subject to such
routine regulation which would have alerted
the authorities to the impeding danger.
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THE ROLE OF CREDIT RATING AGENCIES The legitimacy and stamp of approval of Credit
Rating Agencies undoubtedly contributed to the
crisis.
As these assets began defaulting the Credit Rating
Agencies downgraded these assets further
exacerbating the situation on account of the MTM
accounting convention thereby forcing further sales.
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In the case of Caribbean Investment Banks and
Institutional Investors Credit Rating Agencies
played and plays no such role. Indeed, Pension
Funds are mandated as to what investments
they can invest in statutorily so that you do not
have this vicious cycle and therefore no
compulsion to sell.
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CARIBBEAN INVESTMENT BANKING MODEL Regional Projects Requiring Financing Up
to USD 250 MM
Non-Investment Grade Projects
Projects with a pay-back period of 10-20 years
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Basic Infrastructure financing (Toll Roads, Airports, Seaports, Hydro-plads)
Local Private Placement Issues
144 A Issues
REG: S. Issues
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PROFILE OF INVESTORS
LOCAL INSTITUTIONAL INVESTORS
LOCAL BANKS
US INSTITUTIONAL INVESTORS
CENTRAL AMERICAN INSTITUTIONAL INVESTORS
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CARIBBEAN INSTITUTIONAL INVESTORS
HNW INDIVIDUALS
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WHITER GOES CARIBBEAN INVESTMENT BANKING Notwithstanding The remotest of nexus.
To Its US and European Counterparts The Investment Banking Industry In The Caribbean Is At A Critical Juncture
CLICO / CIB Bailout (US 1-2 BN)- Not Related to US Financial Crisis- Related Party Lending- High Cost Resource Mobilisation Strategy
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Collapse Of Stanford Banking Group
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THE MULTINATIONALISATION OF
THE REGIONAL BANKING SECTOR
In the recent past several highly
profitable indigenous financial
organisations have been targeted by
Foreign Banks. At least one has been
taken over.
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Invariably, the purchasers of these bank tend to
be much more “risk averse” than their
predecessors with a propensity for “white good”
financing. This is done to the detriment of
Development Financing.
Quite simply they gravitate towards Retail
Banking and tend not to be developmental or
transformative in their approach to financing.
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INABILITY/RESTRICTION ON SELLING SECURITIES TO US INSTITUTIONAL INVESTORS Due to the meltdown in the US, due
to the imposition of new and “higher “
standards US Institutional Investors
are now less likely to purchase
regional securities. (Approximately
USD 150-200MM in regional
securities were being sold into the US
before the crisis.
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REGULATORY OVER REACH
Having seen finance wreck havoc, the
temptation would be to bind it in a regulation.
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THANK YOU.
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