Banks in Barbados risk write-offs if the local government defaults on its debt. Last week, the Barbados government attempted to preserve the liquidity of its international currency reserves, which have dwindled to $220 million, by suspending payments to international creditors.

Rating agency S&P cut the island nation’s long-term foreign currency rating to selective default (SD) from CCC+ after Barbados missed a coupon payment on its 2035 bond.

While Barbados has so far only suspended payments on external debt, the rating agency warned local creditors that “our ratings on Barbados reflect its selective default on its external debt obligations and our view that a default on its local currency debt obligations is a virtual certainty.”

CIBC FirstCaribbean, based in Barbados, disclosed earlier this year that it had an exposure of US$506 million to the government of Barbados through loans and securities.

The exposure of other banks is not known but banks operating in Barbados are required to hold 20 percent of their reserves in government securities.

Whether the banks would suffer direct losses as a result of a default is not yet certain.

A debt restructuring involving the extension of the maturity of local debt is also possible.

However, in CIBC FirstCaribbean’s second quarter results release, Chief Executive Officer Gary Brown said the decision by the government of Barbados to suspend payments on external commercial debts and to ask local creditors to roll over principal maturities on domestic debts “are likely to have an adverse impact on the credit quality of the Bank’s asset exposure to GOB [Government of Barbados] debt” on the financial statements.

“While our Q2/18 expected credit loss allowances reflected our expectations for a government debt restructuring under a range of scenarios, we will update these allowances in Q3/18 to reflect the June 1 announcement and additional clarity that may be obtained in the coming weeks,” Mr. Brown said. “We will continue to closely monitor the situation and work with key stakeholders until the restructuring agreements are concluded.”

Government debt in Barbados exploded in recent years and has now reached 175 percent of GDP if previously undisclosed liabilities are included.

The most recent 2017/18 fiscal deficit remains at 4 percent of GDP as a massive 60 percent of government’s expenditure is dedicated to supporting state-owned enterprises.

At the same time, economic output contracted by 0.7 percent in the first quarter of 2018.

A delegation by the International Monetary Fund, asked to provide assistance by the Barbados government, painted a bleak picture after visiting the island in early June and described the economic situation as “precarious.”

Bert van Selm, the head of the IMF delegation, said a substantial fiscal consolidation is needed to address the debt bubble and balance of payment risks.

Because tax receipts are comparatively high, the focus should be on cutting expenditure by containing wages, reforming pensions and the potential privatization of state-owned enterprises, he recommended.

“We also note the authorities’ decision to seek a restructuring of domestic debt and external debt to commercial creditors. An early and open dialogue with the country’s creditors, aiming to achieve an orderly debt restructuring process, is important,” Mr. van Selm said.