The Absorption Ratio as an Indicator for Macro-prudential Monitoring in Jamaica

The systemic monitoring of the financial system often utilizes indices created from the aggregation of various financial and economic variables. This paper uses the principles components technique as an alternative to variable aggregation when creating a stability indicator for the Jamaica banking system. Based on this principal components approach, the paper: i) measures changes in the extent of common risk exposure over time ii) identifies periods in which this common exposure became a systemic concern iii) identifies systemically important institutions and sectors. The results demonstrate that Jamaica’s financial system has demonstrated varying periods in which common exposure was a systemic concern. During these periods there was varying contributions to common exposure by institutions but the foreign exchange and equity markets were identified as key market drivers.