Panel Discussion:“Revisiting the Financial Conglomerate Model -

The Trinidad Experience”The Trinidad Experience”

Catherine KumarPresidentBankers Association of Trinidad & Tobago Limited May 28, 2009

3rd Biennial International Conference on Business, Banking & Finance

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Road MapRoad Map

1. Regional Financial Landscape – The Background2. Previous Financial Business Models3. Major Risks Inherent in the Model4. Expected Benefits of Expansion 5. Expansion Options6. Financial Conglomerate Structures 7. Attendant Risks 8. Moral Hazard9. Financial Critical Success Factors10. Institutions Act 200811. The Way Forward

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Regional Financial Landscape-BackgroundRegional Financial Landscape-Background

• Has its moorings in plain vanilla commercial banking dominated by small local subsidiaries of large Canadian Banks

• Nationalization of these subsidiaries closely followed

• Product suite was limited and capital markets were still a concept

• Provided the impetus for the transformation of the regional financial landscape to go beyond commercial banking and to include activities such as:-

o Merchant Banking o Investment Bankingo Trust Serviceso Stock and Fixed Income Security Brokerage and Trading o Financial Advisoryo Insurance and Pension Funds

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Previous Typical Financial Business ModelsPrevious Typical Financial Business Models

• Basic Business models:-

Banks: Deposit taking institutions which earn profits principally from the lending of funds

Insurance Companies: Life Insurance: Insurance premia (net of statutory fund

requirements) generally invested in long term assets

General Insurance: Net premia invested quality short term assets

Pension Funds: Both insured and deposit administration contracts and investments in long-term assets

Banks and Insurance Companies were generally stand alone entitiesBanks and Insurance Companies were generally stand alone entities

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Major Risks Inherent in these ModelsMajor Risks Inherent in these Models

• Liquidity risk –arising from asset/liability mismatch

• Credit risk – both from a loan portfolio and investment book perspective

• Concentration risk – markets were small and exposure to key credits were becoming significant– Continued growth in profitability was capped by limited market

size and emerging signs of saturation.

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Expected Benefits of ExpansionExpected Benefits of Expansion

• Presented regional financials with a new realm of opportunities namely:-

o Ability to grow balance sheeto Ability to diversify revenue streams away from the vagaries of

domestic or home markets and reduce concentration risko Ability to expand product suite to include previously

untraditional business lines e.g. brokerage, capital markets, high end real estate and commodities etc.

o Regional financials were able to pursue comparatively higher return investments, thereby enhancing revenues and profitability

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Expansion OptionsExpansion Options

• Mergers and Acquisition– Successfully used by a number of indigenous and regional

financial institutions during their expansion phase.

• Portfolio investments– Utilized as a stepping stone into a new market without attracting

the initial start-up costs

• Establishing a greenfield “mortar and bricks branch” in the new market

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Financial Conglomerate StructuresFinancial Conglomerate Structures

• Can be subdivided into:-

– Pure Financial Conglomerate• Consists of a group of financial companies providing a

variety of near to full range of financial services

– Mixed Financial Conglomerate• Group of companies with different business lines i.e. financial

and non-financial• Group is usually headed by a non-financial entity that is not

regulated by a financial services regulator• Financial companies are imbedded within the structure

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Attendant RisksAttendant Risks

• Business Risk:

– Understanding of varied businesses in the Group

• Corporate Governance Risk:

Increasing complexity of the conglomerate structure may be too great for risks to be managed.

– Brings to bear issues such as:-Human Resource Does the organization possess the necessary wide skill set at the Board and/or operational level to fully understand the type or level of risks involved?

ProcessesDoes the organization have systems and procedures which reflect its complexity and allow for convergence into one platform, where necessary?

• Legal and Reputational Risk.

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• Regulatory Risk:

– The Regulators also face challenges in the relevance of its structures, monitoring and regulatory approach with similar emphasis on its HR skill set and processes.

– Regulators encounter challenges given that conglomerates span over a number of industry sectors, some of which are not actively regulated or not regulated at all.

– Regulatory Arbitrage.

Attendant Risks Attendant Risks Cont’d

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• Contagion Risk:

– Created by the diverse and wide geographical reach of the conglomerate structure

– Exacerbated by the regional integration and interdependence of our markets

Attendant Risks Attendant Risks Cont’d

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TOO BIG TO FAILTOO BIG TO FAIL

Moral HazardMoral Hazard

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Financial Institutions Act 2008Financial Institutions Act 2008

Type of Risk FIA 2008 Response

Corporate Governance Risk • Requires the establishment of policies and procedures for transactions with connected parties and employees.

• Mandates the establishment and maintenance of information on credit exposures

Regulatory Risk • Capital Adequacy, solvency requirements are applicable to the licensee on an individual basis and on a consolidated basis where the licensee has subsidiaries or companies over which it has significant control

• Establishment of a financial holding company.

Contagion Risk • Banks restricted to banking and business of a financial nature• Restriction on assets that can be held by licensee including:-

– No more than 25% of the capital base in property development companies

– No more than 10% of the capital base in insurance companies

• Restriction on the activities of financial holding companies

Represents the regulatory response in part to the risks attaching to the financial conglomerate modelRepresents the regulatory response in part to the risks attaching to the financial conglomerate model

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Critical Success FactorsCritical Success Factors

• The financial conglomerate model has worked where there is:-

o Strong corporate governanceo A clear understanding of the business risks within the groupo Robust enterprise-wide risk managemento A long term organization view (as supported by culture) of

creating value as opposed to reaping short term gainso The ability of organization to quickly assimilate acquisitions

and realize promised benefits and synergieso The maintenance of positioning within one’s respective area of

core expertiseo Minimized exposures to connected parties o Understanding of the risks associated with new markets and

the mitigation of same

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The Way ForwardThe Way Forward

• Roll out new legislation for the regulation of the insurance, pension funds, credit union sectors and securities industry throughout the region.

• Require the cross-border sharing of information and resources by all regulators in the region.

• Silo financial activities from non-financial activities by restricting the ability of financials to depart from their core area of expertise.

• Cap the exposure to connected parties within a financial group. (FIA 2008 recommends 10% of capital base).

• Secure experts/highly skilled resources for the Regulatory Authorities.

• Continue the discussion on the pros and cons of an integrated supervisor with a view to arriving at a regional position.

• There has been much discussion throughout the region on convergence of financial legislation and regulations but the industry awaits some feedback to the many comments provided to date.

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Thank YouThank You