Keenan Falconer | The financial sector: Striking the right balance

The Gleaner's Editorial on Monday, April 13, made an important intervention as it discussed the ideal role of the financial sector in advancing Jamaica's development prospects.

It noted that as the country experienced a structural shift towards a larger service-based economy and away from mostly goods-producing sectors, “finance expanded in both scale and social importance. Before the financial sector collapse of the late '90s, the number of financial institutions rose from 67 to 105 in 1995. Meanwhile the financial sector output reached 14.7 per cent of GDP in 1994. Jamaica became 'overbanked'.”

This point is sometimes overlooked in discussions on the financial sector meltdown of the period and offers a timely reminder. As the economy aimed to stimulate greater economic activity, rapid financialisation resulted in the growth of the sector, outpacing the ability of existing regulations to effectively govern it.

Liberalisation occurred not only in the context of removing capital and foreign exchange controls at the beginning of the decade but also featured prominently in the issuance of licences to operate in the sector. Jamaica was to later play catch-up with a series of financial reforms and the establishment of several regulatory institutions at the turn of the Century.

The fundamental lesson from events three decades ago is that policies and legislation should continuously be in lockstep with developments in the financial sector and where possible get ahead of them. Among others, Jamaica is still trying to navigate the complexities involved in adopting Basel capital requirements, implementing a Special Resolution Regime (SRR) for non-viable financial institutions and most recently manoeuvring the Twin Peaks Model of Risk-based Supervision.

At the same time, more stringent regulatory requirements in response to the 1990s meltdown may have also diminished risk appetite somewhat over the years, with the result being capital that largely flows to the safest investments with the most consistently guaranteed returns. Those may not necessarily always be in the productive sector.

Coupled with general risk perception and the volatilities to which these sectors are exposed, funds may be redirected to more consumption-based activity. The upshot has been a “system that still appears better suited to circulation than transformation” and one that “generates returns through passive intermediation and fees”, as The Gleaner puts it.

Today, the financial sector's contribution to GDP has been halved since the 1990s. Recent reforms will see incremental adjustments to investable limits for the pensions and insurance sub-sectors which may assist with gradually unlocking some capital in a prudent manner.

Ultimately, if finance is to be a key lever for more robust economic activity by facilitating greater productive enterprise, the regulatory environment must strike the right balance between managing risk and encouraging innovation.

- Keenan J. Falconer, MSc. (Dist.), JP, is an economist with the UN Jamaican Economy Panel. Email feedback to keenanjfalconer20@gmail.com and columns@gleanerjm.com