Bad Time to be in Banking

WITHOUT doubt the worst industry to be in at the moment is banking. Around the world banks stand accused, rightly so, of having caused the credit crisis in 2007 which eventually plunged the global economy into a recession. 

Since then several banks have closed, some were taken over by stronger ones whilst others are slowly recuperating under government assistance.

Some financial geniuses of yesteryear such as Allen Stanford currently face fraud charges while others, like, Bernard Madoff, are already serving time for similar offences.

Closer to home, Nigeria’s Central Bank (NCB) in August was forced to inject more than $2,5 billion into five banks to save them from collapse.

The NCB also fired those banks’ managing directors after discovering huge amounts of bad loans that had not been disclosed.

While they have not been directly affected by the credit crises, local banks are not in any better shape. Like their counterparts in other countries, they are also facing several accusations.

In the hyperinflation era, banks were being accused of abandoning core business and choosing to engage in speculative activities instead, in order to maximise returns.

Nine months into the multiple currency regime, banks still stand accused. This time they are being blamed for not offering credit to business and individuals. But is this allegation justified?

Deposits in the banks totalled US$706 million as at June 30 whereas advances were only US$263 million. The loan to deposit ratio of 37% is indeed too low but this should not be misconstrued as the banks’ reluctance to lend. As core functions, banks take deposits and lend the funds to borrowers for profits.

Usually the deposits are short term yet the borrowers by and large require loans for longer periods.

Financial institutions make money by skillfully managing the risk of transforming short term deposits into long term loans.

Mismatching assets and liabilities is possible when banks have a fallback. A bank which finds itself short towards the end of the day approaches its cash rich clients for money.

As a sweetener, banks usually offer higher rates than they would have been paying during trading hours. If it is still short, the next option will be the interbank market.

This is a market where banks borrow or lend each other money, usually overnight. If an institution still has a negative position after borrowing from its counterparts, then it resorts to the central bank’s overnight lending window which is the most expensive.

In the extreme, a bank’s paid up capital, which is termed tier 1 capital in banking parlance, becomes the last line of defence for stressed institutions.

It is therefore clear to see why banks currently cannot lend most of their deposits. This market does not have adequate fallbacks.

Presently no company is cash rich. The change over to multiple currencies meant all companies and people started from zero cash positions. Banks cannot, as a result, expect their clients to come to their rescue when they are short.

In addition the interbank market has not been functional since dollarisation for the simple reason that banks do not have enough dollars to transact. Furthermore, as was apparent at the onset of the credit crisis in the US, banks shun lending to each other when liquidity is tight.

The resuscitation of the electronic funds transfer platform, RTGS, has failed to encourage the interbank lending with banks opting to hold on to their deposits.

The foremost deterrent to credit creation in the economy by far is the lack of a lender of last resort.

Reserve Bank of Zimbabwe is unable to offer this service because it does not have foreign currency reserves. It is suicidal then for any bank to have mismatches because failing to settle an obligation when it is due can cause alarm among its depositors leading to bank runs.

Another sad reality is that most banks are technically insolvent with no paid up capital. Revaluation reserves, which are not distributable, are only what most banks have as shareholder’s funds.

In the event of huge default on their loans such banks will not be able to absorb the shock because they are already over leveraged.  Mindful of this shortcoming, banks are understandably limiting their loans to manageable levels with credit being provided only to stronger companies.

To any banker, it is risky to give credit to an ailing company because whilst it can be revived by the capital injection it can also go bust and fail to pay back.

Because wholesale deposits are practically being matched with loans, only strong businesses are currently getting bank credit. In the absence of risk free treasury bills, institutional depositors are demanding collateral security in the form of banker’s acceptances of blue chip borrowers.

More so, the wholesale market is a depositors’ market with the latter strongly influencing the tenure and interest rate of bank assets.  Matching implies that a bank has to create an asset, say a BA, whose term is similar to that of the deposit for easy settlement on maturity.

With 98% of the deposits being shorter than 30 days banks are unable to lend for longer. Equally, as long as depositors insist on high rates say 5% flat on 30-day money; lending rates will also remain high. Unless a bank has a cheap line of credit, or retail deposits, it cannot lend cheaply and for longer periods as demanded by business.

Until the deposits improve and the lender of last resort is restored, many banks will not be able to increase their loan to deposit ratios above 40%. As such, banks will continue to be viewed as unsupportive to industry, which may not be entirely true.

 

Ranga Makwata

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