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THAT Zimbabwean companies are struggling owing to tight liquidity conditions in the country has been evident on the market since the adoption of multi currencies three years ago. A quick glance at public companies’ financial statements shows how they have been forced to accept expensive short-term borrowings. Earnings are eroded by finance charges; Rio Zim, RTG, Cairns etc. The list is long.
But despite the challenges affecting business, government has not bothered to deal with a major factor that exacerbates the liquidity problems; the absence of a lender of last resort in the market.
Since the adoption of multi currencies, the Reserve Bank of Zimbabwe’s lender of last resort (LOLR) function has not been restored. And government does not seem to be treating the matter with the urgency it deserves.
The restoration of the central bank’s LOLR role has been at a snail’s pace, with government committing paltry funds towards the purpose.
Finance minister Biti this week said he would allocate at least US$20 million towards the US$100 million LOLR fund he announced in his 2012 Budget statement to augment the US$7 million he had already availed to the Reserve Bank. The money would come from a US$112 Special Drawing Rights drawdown he intends to carry out soon with the International Monetary Fund.
However, the US$20 million to be allocated towards the LOLR purse is a drop in the ocean. It baffles the mind why Biti, who has been vacillating on drawing down the SDRs has not committed the US$112 million towards the LOLR. To make matters worse, previous draw downs on the SDR funds have not been accounted for in full.
Biti’s failure to empower the central bank’s LOLR role has seen local banks with excess cash lending to their peers at a premium, according to Gono. That goes to show the desperation in the financial sector and gravity of the need to empower the central bank as the LOLR.
The LOLR function is a preserve of a central bank and entails offering loans or liquidity support to banks experiencing liquidity challenges or are considered highly risky or near collapse. Owing to this problem, cash-rich individuals have assumed the role of the central bank and advanced exorbitant loans to hapless individuals and banks.
More worryingly, the very absence of the central bank’s role as the LOLR has resulted in the financial sector failing to consolidate stability attained when the country was dollarised in 2009.
Universally, the absence of a LOLR is not ideal for the stability of the financial system. International best practice requires that the LOLR pool in a dollarised economy should constitute between 50% and 150% of the banking sector’s capitalisation or 5% to 15% of the banking sector’s deposits.
Once the LOLR status is restored, the inter-bank market, which has been ineffective due to the non-availability of this much needed function, will start to play a critical role in the distribution of credit across the entire economy. The interbank market is a market in which banks extend loans to one another for a specified term.
If a bank cannot meet its liquidity requirements, it will need to borrow money in the interbank market to cover the shortfall.
Against a background such as ours, banks have nowhere to go should they need liquidity support, even if this is just overnight.
The central bank feels that a LOLR fund based on a proportion of the deposit base has a better relationship to potential liquidity developments on the market. When Biti last year announced in his 2012 budget statement that he would allocate US$100 million towards an LOLR fund, Gono applauded him, saying the establishment of an effective lender of last resort function would undoubtedly restore “some confidence” in the banking sector, and spur economic activity. Alas, the full amount for this very important function is yet to materialise.
Meantime the short-term nature of deposits has also not helped the situation on the liquidity front, with most banks resorting to lending short-term.Gono cautions that persistent liquidity challenges may lead to heightened systemic risk. It is generally accepted that an illiquid market increases the cost of credit and heightens default probabilities among borrowers. Non-performing loans are not good for any bank.
Biti needs to act.
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