Financial Sector Liberalisation in Jamaica

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Transcript of Financial Sector Liberalisation in Jamaica

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    Chapter 1

    Introduction and Overview

    (1) Project Aim

    The Jamaican financial sector saw rapid growth in the 1980s. By the mid-1990s,

    however, the system collapsed resulting in a massive government bailout to the

    tune of some J$80 billion. Many argue that the process of financial sector

    liberalisation that commenced in 1985 is largely to be blamed. The aim of this

    paper is to examine the process of financial sector liberalisation and the role it

    played in the demise of the Jamaican financial sector.

    (2) Liberalisation Defined

    Liberalisation, in the general sense, means making less strict. From a financial

    perspective, liberalisation, often used interchangeably with deregulation, is the

    freeing up of established government rules and a move towards an environment

    determined more by market forces. Market discipline is substituted for the hand

    of the government with the aim of creating a more efficient marketplace.

    Liberalisation is achieved by deregulation and through the process of

    privatisation; privatisation being the exposure of the public sector production

    process to free market forces. The emphasis of this project is on the process of

    deregulation of the Jamaican domestic and Foreign Exchange (FX) market

    designed to remove market distortions and improve efficiency.

    (3) The General Contents of the PaperTo put the paper in proper perspective, liberalisation that commenced in 1985 is

    contemplated against the historical background of the financial sector going

    back to the 1960s. Close attention is also paid to economic environment

    preceding liberalisation and its evolution over the years.

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    Introduction and Overview

    The process of financial sector liberalisation was embarked upon with good

    intentions in mind but today the debate rages on as to its role in the collapse of

    the Jamaican financial sector. While there are compelling arguments linking

    liberalisation to the decline of the financial sector, others argue that other

    factors, such as the ineptitude of managers and directors were solely responsible

    or played just as important a role.

    The purpose of the study is to examine whether the objectives of the Financial

    Sector Reform Program (FSRP) were achieved, to outline the impact of

    liberalisation on the system and to look at other factors that could havecontributed to its decline.

    The massive fallout in the financial sector saw the intervention of the Jamaican

    Government through the Financial Sector Adjustment Company (FINSAC). With

    the important role played by this organisation, its projected impact on the

    Jamaican economy and its budgetary resources in the years to come, the

    paper would not have been complete without an appreciation of

    Governments bailout plan.

    Many other countries (developed and developing alike) have undergone the

    process of the financial liberalisation. To establish some parallel with the

    Jamaican experience, similar reforms in other regions (mainly Japan) have been

    examined.

    (4) Reasons for the ResearchPresently, there is very little literature documenting in a very structured way, the

    liberalisation process. Further, since the collapse there has been no formal

    investigative structure to look into the crisis and the causative factors. The

    research will not only prove useful in providing a better understanding of

    financial sector liberalisation in Jamaica and its role in the banking crisis, but also

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    Adrian Keys 3

    Introduction and Overview

    in developing appreciation of current trends in the sector and broader macro-

    economic environment. The information will prove useful to academics, bank

    personnel, and even to the regulatory bodies.

    (5) Focus on the Banking Sector

    Finally, the paper contemplates financial sector liberalisation from a broad

    perspective and its impact on financial intermediaries and markets. However, for

    focus and clarity, particular emphasis is placed on the analysis of its effect on the

    Jamaican banking sector. The emphasis is on its state prior to liberalisation, its

    subsequent growth, the collapse and the aftermath.

    (6) The Organisation of Financial Systems

    The essence of financial sector liberalisation is dependent on how financial

    systems are organised and their structural characteristics. Chapter 2 examines

    financial systems and it also takes a more detailed look at liberalisation. It closes

    with a historical perspective of the Jamaican financial system.

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    Chapter 2

    Financial Systems

    (1) Introduction

    The paper as outlined in the first chapter examines the collapse of the Jamaican

    financial system and the role played by liberalisation in its demise. This chapter

    puts financial systems and the role of its functional units into perspective and

    describes briefly the regulation process. Oftentimes, financial systems are

    regulated to the point where they prevent free interplay of market forces. The

    process of economic liberalisation, which is used to free these forces, is also a

    focal point of this chapter. Liberalisation of the finance sector in Jamaica

    commenced in 1985. The latter half of the chapter looks at its historical

    development going back to the 1960s and up to 1991.

    The year 1991 is used as a marker, as the second phase of the liberalisation

    process (as will be shown) commenced at just around that time.

    (2) What is a Financial System

    A financial system essentially serves to move funds from those with surplus funds

    to those with a shortage of funds. In developed countries, such as the United

    States, the financial system typically comprises lenders (savers), financial markets,

    financial intermediaries, and borrowers (spenders). This structure is represented in

    Exhibit 1.

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    Financial Systems

    Indirect Finance

    FinancialIntermediaries

    FUNDS FUNDS FUNDS

    Lenders (Savers) Borrowers (Spenders)1. Households Financial 1. Business Firms2. Business Firms FUNDS Markets FUNDS 2. Government

    3. Government 3. Households

    4. Foreigners 4. Foreigners

    Direct Finance

    Exhibit 1Flow of Funds through the Financial SystemSOURCE: Frederick S. Mishkin, An Overview of the Financial System, Chapter 3, Money, Banking, andFinancial Markets, 1989 (Scott, Foresman and Company, 1989), p. 43.

    As shown in Exhibit 1, funds flow from lenders to borrowers either directly or

    indirectly. In direct finance, funds are borrowed directly from lenders by selling

    them securities (claims on the borrowers future income or assets). The indirect

    method involves a middleman or financial intermediary that stands between the

    lenders (savers) and borrowers (spenders).

    (3) Financial Markets and Intermediaries

    Financial markets and intermediaries are two of the functional units making up

    the financial sector. These include Debt and Equity Markets, Primary and

    Secondary Markets, Exchanges and Over-the-counter Markets, Money andCapital Markets and Depository, Contractual and Investment Institutions. Exhibit

    2 below illustrates differing types of units.

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    Financial Systems

    Types of Financial Markets Types of Financial Intermediaries

    Debt and EquityPrimary and Secondary

    Exchanges and Over-the-CounterMoney and Capital

    Depository Institutions (Banks)Commercial BanksSavings & Loan Associations

    Mutual Savings BanksCredit Unions

    Contractual Savings InstitutionsLife Insurance Companies

    Pension FundsFire and Casualty InsuranceCompanies

    Investment IntermediariesFinance Companies

    Mutual FundsMoney Market and Mutual

    Funds

    Exhibit 2Financial Markets and IntermediariesSOURCE: Frederick S. Mishkin, An Overview of the Financial System, Chapter 3, Money, Banking, andFinancial Markets, 1989 (Scott, Foresman and Company, 1989), Portion extracted from p. 51.

    (4) Regulation of Financial Systems

    Financial systems are usually tightly regulated by agencies under specific

    legislation. In the United States, for example, the financial system is among the

    most regulated sectors of the economy. Regulation is designed to accomplish

    the following:

    Provide information to investors so that they are able to determine how safepotential investments are.

    Ensure the soundness of the financial system to protect investors anddepositors and funds they have invested.

    Improve control over monetary policy such as in the control of money supplythrough reserve requirements.

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    Financial Systems

    Encourage home ownership to develop a more politically involvedelectorate, more responsible citizens and, ultimately, a more stable society.

    (5) The Process of Economic Liberalisation

    Economic liberalisation is the act of reducing government-imposed constraints

    on the behaviour of actors in the economy. It concerns:

    Programme and sector aid that promotes policy and institutiona