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RBZ at the heart of banking crisis

By Gilbert Muponda

ZIMBABWE’S banking sector is under siege. Banks are being labelled all sorts of things as the scapegoat hunting season hots up.

P align=justify>Banks and other institutions have been accused of holding “non-core assets” and engaging in “non-core” activities. I believe this presents the authorities with a good sample to select appropriate whipping boys to open the latest round of scapegoat hunting.

The relevant question is how did it come to this? And why did all banks find it necessary to do it? Where were “the authorities”?

It has to be beyond personalities. It’s a national problem and has to be treated as such. Those familiar with the sub-prime mortgage problems in the US and those in the UK will be aware of the current Northern Rock crisis.

In the Northern Rock crisis the Bank of England has been forced to provide approximately £50 billion to one bank to avoid a collapse due to a run on deposits. In the USA, the Federal Reserve has had to inject billions of dollars.

In December all major central banks including the US Fed, Bank of Canada, Bank of England, Swiss central bank and European Central Bank used combined effort and resources to inject more than US$200 billion to stabilise the financial markets.

The point here is that banks and financial institutions cannot be allowed to fail. Their failure is symptomatic of a bigger underlying structural problem emanating from beyond the banking system.

The banking system developed when people deposited coins, precious metals and silver coins at goldsmiths for safe keeping, in return for a note for their deposit. Slowly the notes became a trusted medium of exchange and an early form of paper money was born, in the form of gold certificates and silver certificates.

Over time the notes were used directly in trade. The goldsmiths observed that people would never redeem all their notes at the same time, and exploited the opportunity to issue new bank notes in the form of interest paying loans.

These generated income — a process that enhanced their role from passive guardians of bullion charging fees for safe storage, to interest-paying and earning banks. When creditors (the owners of the notes) lost faith in the ability of the bank to exchange their notes back into coins, many would try to redeem their notes at the same time. This was called a bank run and many early banks either went into insolvency or refused to pay up.

Banks are required to keep on hand only a fraction of the funds deposited with them which allows the function of the banking business. Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks’ borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is
paid to depositors for use of their money.

If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money. For the economy and the banking system as a whole, the practice of keeping only a fraction of deposits on hand has an important cumulative effect.

Banks make money from various products and services. These include interest on loans, fees and margins on forex trades. It must be noted banks have to make money regardless of the operating environment. And for this to happen, banks have to develop various products and services that match their operating environment.

The foreign exchange (currency or forex) market exists wherever one currency is traded for another. It is by far the largest financial market in the world which includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions.

In many markets there are bureau de change which help mobilise foreign currency. In Zimbabwe, these were outlawed in one of the early “scapegoat hunting seasons”, when they were blamed for fuelling the black market.

The Zimbabwe forex market was further reduced by various regulations which essentially tried to centralise the market whilst simultaneously paying an unrealistic exchange rate. This action has deprived the banks of an important fee and income generating product and service. Banks would normally source forex, be its custodian and provide a ready and perhaps more transparent market for forex.

Banks generally knew the exporters and the importers. As such banks were better placed to match these participants’ requirements and earn a fee or some income in the process.

This can’t be viewed in isolation. The other main area a bank is supposed to make money from is on loans through interest income. The Reserve Bank of Zimbabwe (RBZ) has come up with various programmes providing subsidised funding. These facilities whose rates are as low as 25% include the Agricultural Mechanisation Programme, the Agricultural Sector Productivity Enhancement Facility and the Basic Commodities Supply-Side Intervention Facility.

These products directly competes with banks who are supposed to lend to the same clients and earn sufficient interest income to keep the banks afloat. In reality a bank cannot match this rate being offered by the RBZ, which has now been converted to a massive commercial bank. The only difference being it can lend money on a non-commercial basis with a net effect of taking the bread out of the commercial banks’ mouth.

The following is a general description how the forex market should work.

The forex market has various transactions including spot, forward and swaps. A spot transaction is an immediate delivery transaction. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. Spot has the largest share by volume in forex transactions among all instruments.

A forex forward contract is an agreement between two parties to buy or sell a currency at a pre-agreed future point in time. Therefore, the trade date and delivery date are separated. It is used to control and hedge risk, for example currency exposure risk (eg forward contracts on US dollar or Zimbabwe dollar). Its use broadens and deepens the forex market since participants will have more options to satisfy their forex needs.

One party agrees (obligated) to sell, the other to buy, for a forward price agreed in advance. In some forward transactions, no actual cash changes hands. If the transaction is collateralised, exchange of margin will take place according to a pre-agreed rule or schedule.

Otherwise no forex of any kind actually changes hands, until the maturity of the contract (but a commitment fee may be payable upfront). This secures the forex. These contracts are legally enforceable. It’s therefore important to have a strong and independent judiciary system which allows both parties to enforce their rights. The presence as in

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