Keeping the Ship Steady. Why Financial Stability Matters to You

Do you have a bank account? An account at a credit union? An insurance policy? A pension plan? Then financial stability matters to you.

“Financial stability is about the smooth functioning of the financial system,” explains Central Bank of Barbados Governor Cleviston Haynes. As for why Barbadians should pay attention, he points out that “all of our savings are effectively stored in the financial system, whether it be through banks, insurance companies where we pay our premiums, our pension funds. And it’s important that these institutions are able to function during good times as well as in bad times.”

For this reason, promoting financial stability is one of the two objectives that form the Central Bank of Barbados’ mandate. Specifically, the Central Bank works to ensure that systemic risks – those with the potential to affect the entire financial system and not just a single entity – do not occur, and that if they do, they are managed, mitigated, and eliminated.

Oversight 

So how does the Central Bank work to ensure financial stability? The first way is through microprudential supervision, looking at the activities and performance of individual financial institutions. Governor Haynes explains that while issues at a single entity may not in and of themselves have the power to affect the overall system, the fears generated by news of those issues could wind up doing just that.

“If one institution faces difficulties, the public may believe that that is a systemic problem, and that they need to go and get their money. Therefore, we have to be able to manage the system in such a way that there is not a run on the institutions that would undermine financial stability even though there was no problem originally.” In other words, fears of a problem could create a problem, just as rumours of a shortage of a product could prompt higher than usual demand for it, which ultimately leads to an actual shortage.

The Central Bank also does macroprudential supervision, examinations of the entire sector. It conducts stress tests, which are simulations that measure financial institutions’ ability to withstand specific adverse situations, often using extreme scenarios that are unlikely to occur.

Collaboration

Collaboration with other financial regulators is also critical to protecting the stability of Barbados’ financial system. The Central Bank regulates the island’s commercial banks and finance and trust companies, with commercial banks alone accounting for more than half of the financial system’s assets. But there are other players in the system: credit unions, insurance companies, pension funds, and mutual funds.

The Central Bank works closely with their fellow regulator, the Financial Services Commission (FSC), to monitor the stability of the entire system. “We need to have a holistic view because one of the things we have is a certain interconnectedness of financial institutions. Credit unions will have some of their savings at commercial banks. Insurance companies will have some of their savings at commercial banks. So, if something untoward happened to the banking system, it could also impact the credit unions or the insurance companies.”

The reverse is also true. Other types of financial institutions can have loans with commercial banks, so if there is an issue within that sector, it can spillover to the banking sector.

Pre-emptive and Corrective Measures

There are safeguards in place to proactively address matters related to financial stability. Commercial banks, for example, are required to maintain a certain amount of capital based on their assets and how risky they are perceived to be. Governor Haynes explains the reason for this. “There will be shocks. That is why you have buffers. So that if there is a shock, they can withstand that shock with the buffers they have built up over time.” He likens them to the international reserves that Barbados maintains.

And if a bank falls below that level? “It may be that they need to inject more capital. They may need to divest themselves of some assets. Depending on the circumstance, we would have to work with them to make sure that they are adequately capitalised at all times.”

At a financial system level, the Central Bank can take measures to protect against behaviours that could endanger stability. “If perhaps we felt that the financial system was expanding credit too quickly, we could try to put policies in place that would impact all institutions so as to slow the pace at which credit was growing.”

Why It Matters

So why should all of this matter to you? Two reasons.

The first is personal. “You place your funds in a financial institution on the basis of trust. You want to know that if you want your funds, you can go and get those funds… You want to be able to get loans. And if these institutions are not functioning the way that they ought to function, then you may not be able to get your funds when you need them.”

And there are national considerations as well. An unstable financial system, or even one that is perceived as unstable, could impact Barbados’ ability to access international funding when it needs it. And that has implications for Barbadians’ lives and livelihoods.

Every year, the Central Bank of Barbados and the Financial Services Commission publish the Financial Stability Report, which assess the health of Barbados’ financial system and gives a breakdown of the performance of each sector.