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Credit and the Banking Sector

Sanderson Abel

It is important to realize that efficient allocation of savings through identification and funding of entrepreneurs with the best chances of successfully implementing innovative products and production processes are tools to achieve the growth objective as enunciated in the Zim Asset Program. With an average growth projection of 7.3 percent per year anchored on among others, growth in Finance and Insurance (6.4 percent, 6.2 percent. 6.2 percent, 8.1 percent and 10.3 percent) from 2014 to 2018, it is important that challenges of the banking sector are resolved especially those revolving around bank credit. 

Lending is a major line of business for many banking firms as they provide credit for a wide array of business purposes.  The process of lending represents despite being an important line of business for the banking industry, a key source of funds for the business sector.  Bank lending is critical across a wide array of industry sectors, ranging from retail trade to manufacturing. Commercial loans advanced by the banking sector represent an important source of funding for corporations, partnerships, and sole proprietorships that make up the business sector. This implies that the banking sector has a critical role to play in the economy providing some life blood to the various sectors of the economy.

Despite the banking sector playing a critical role in providing credit to the various sectors of the economy, the banks are now characterized by non-performing loans. The Monetary policy statement announced recently by the Reserve bank of Zimbabwe revealed that the banking sector’s average non-performing loans to total loans ratio (NPLs/TLs ratio) stood at 15.92% as at 31 December 2013. This implies that of the total amount of loans extended by the banking sector to the various sectors of the economy, for every $100 extended, about US$16 is not being serviced or is non-performing. In light of this the Central bank requires that banking institutions should set aside adequate provisions that reflect the level of credit risk in their loan portfolio.

The implication of this is that the potential funding by the banking system is seriously reduced. Resultantly, the problem of non-performing loans drags on the economy in the following ways: (i) disintermediation of bank-system lending caused by the erosion of banks' profitability (ii) stagnation of economic resources, such as labor and capital, in fields with low productivity and (iii) cautious behavior of corporations and consumers due to a decline in confidence in the financial system.

A look at some of the reasons behind the non- performing loans will shed light on the challenges that banks face.

A bank loan is a contractual agreement between the borrower and the Bank hence those who want to borrow should be clear of their obligations under the loan agreement. When an individual enters into a financial agreement with a lender, he/she will generally be provided with a credit contract. Credit contracts outline all of the details of a financial agreement. This will include the amount of the loan, the payment obligations of a borrower, and the interest that will be charged on a loan. Many of the disputes and complications that arise between creditors and debtors stem from borrowers failing to review all aspects of a credit contract. With the absence of a commercial court in the country to deal with challenges of contractual interpretation, the majority of bank clients have been borrowing knowingly that even if the default, it will take ages before the issues are resolved. This has seen some commercial dragging on for more than two years.

The deteriorating asset quality is also reflective of the adverse operating macroeconomic environment and institution-specific deficiencies. In addition, the mismatch between long-term funding requirements for the productive sectors and short-term volatile deposits has exacerbated asset quality vulnerabilities. What this has entailed is that the banks are usually willing to offer short term funding when the actual situation on the ground would require long term financing. Given that this type of financing is not suitable, production processes would not pick up leading to defaults as firms find themselves unable to recover the resources they would have sunk. 

The current multi-currency system has also come to pose the challenges leading to increase in non-performing loans. With the multi-currency system, the bulk of resources being loaned out by the banks are sourced offshore where the cost of the funds is high because of the country risk profile. Factoring in the interest rates on the money, country risk, the total cost of importation of the funds; the total cost of borrowing offshore is too high. Most of the firms, very hungry for resources, proceed to borrow sometime at the backdrop of cooked up books of accounts to prove capacity to repay the loan. A closer look at the reality would show that the cost of the funds will be above the return that the organisations would be realizing resulting in defaults at the end of the day. 

Some of the people in the country have now resorted to strategic defaults of credit advanced by both banks other service providers. A strategic default occurs when a solvent borrower chooses not to repay.  This has become the phenomena characterizing many service provision e.g. electricity, water, education credits and recently in the news loans advanced by the government to the youths, women and other sectors. This has become more of a coordinated thing leading to failure somehow. Coordination failure resulting from borrowers strategically delaying or defaulting on loan payments involves a breach of contract

Sanderson Abel is an Economist. He writes in his capacity as Senior Economist for the Bankers Association of Zimbabwe. For your valuable feedback and comments related to this article, he can be contacted on abel@baz.org.zw or on numbers 04-744686 and 0772463008