ZRC: An ambitious route bordering on the impossible

FINANCE minister Tendai Biti last week presented the state of the economy report for August, a review of the performance of the economy so far in the year. Unsurprisingly, the report was essentially a confirmation of the bad news the nation already expected; unmet revenue targets, a widening trade deficit, a disappointing agricultural season and a financial sector beleaguered with non-performing loans. Below par revenue performance is particularly worrying as the country is faced with important projects like the constitutional referendum which will need funding.
Embarrassingly, the solution proffered involves taking a begging bowl around the region.  Interesting as that is, what stuck out most in the minister’s address is the proposal for the resolution of the high levels of non-performing loans in the banking sector.

 
Alarmingly, it was revealed that non-performing loans average 8% of deposits for the whole banking sector but are as high as 50% if the top four international banks are excluded.

 
Not only is this figure unacceptably high, but it is way higher than what banks reveal in their financial results. It is no wonder authorities have been spurred into action. If their figures are correct then a banking crisis is imminent.

 
Banking is a confidence game and a run on banks will inevitably erupt if depositors feel their money is in danger. As a proactive response, the Ministry of Finance and alternative investment firm GEM Group, are mulling the establishment of a US$1 billion fund which will acquire the banking industry’s non-performing loans to protect depositors and restore confidence.

 
This would be done through the creation of the Zimbabwe Resolution Corporation (ZRC) which would be jointly owned by the ministry and GEM and run by the latter. ZRC would be funded through the issuance of a US$1 billion 10-year bond. Banks would then sell their non-performing loans to ZRC at commercial rates and cede all rights attached including claims on collateral.

 
The establishment of ZRC is a noble cause and a timeous one given that there is a real risk of a banking sector crisis. However, there are certain aspects of the structure of the proposal which perhaps need further scrutiny.

 
The first aspect which may need rethinking is that the bond which will fund ZRC will be guaranteed by the Ministry of Finance. Given how strained government finances are, it is highly unlikely that such a guarantee will instil confidence in potential investors and hence the bond issue may have no takers.

 
Government has been in arrears on payments to international financiers for years and is also failing to settle local suppliers on time. At half-year arrears due to local suppliers reportedly stood at US$179 million.

 
Government cannot therefore fail to settle that amount and be expected to guarantee US$1 billion. They simply do not have the financial muscle to back it up.

 
When a similar structure was put in place in Nigeria where they established the Asset Management Company of Nigeria, the Nigerian government had the capacity to pay. Even then there was a public outcry on why government was bailing out errant banks.

 
In Nigeria following the aforementioned public outcry, a sinking fund funded by the banks themselves was created to offset some of the cost to the government.

 
Similarly, a sinking fund will also be established locally to offset the cost to ZRC. This sinking fund will be funded through a 2% levy on each bank’s risk weighted assets. A negative aspect of such a structure is that the levy “punishes” those banks with more assets and those with better quality assets. Ironically, these are likely to be the banks with less non-performing loans and they will bear the cost of their peers’ errant ways.

 
Perhaps the biggest hurdle for the proposed bond issue is the sheer quantum of funds to be raised. In the Zimbabwean context US$1 billion is a lot of money. Put into perspective, it would dwarf any single investment made into the country in recent times.

 
If investors were not willing to bring money into the country to fund business, will they now fall over each other to buy the lowest quality loans? One of the lead investors listed is Afreximbank.
Afreximbank already has exposure to the Zimbabwean banking sector and may well be uninterested in further exposure. The proposal did not mention whether the potential investors had already been approached and if so what their response was.

 
Other target investors mentioned include South Africa’s Public Investment Corporation, Development Bank of Southern Africa and National Social Security Authority. Sovereign funds, local banks and private sector investors have also been listed as potential investors.

 
A potential pitfall for ZRC is the possibility that if the amount raised falls short of the targeted US$1 billion, then there may be favouritism in the disbursement of the fund. The proposal which has been distributed so far does not yet give much detail on exactly how the funds will be applied. If a small amount is raised and distributed clandestinely then the whole project may fall into disarray.

 
ZRC is definitely an ambitious project, perhaps bordering on the impossible. Should the project come to fruition, then it would be a good thing for the sector and the country as a whole. The involvement of GEM whose track record in Zimbabwe is soiled by their failure to deliver on promises to raise US$45 million for mining company Rio Zim certainly does little to instil confidence. If they pull this one off, then certainly that will prove their mettle.

 
Assuming ZRC is successful in cleaning up non-performing loans in the banking sector, the exercise should be followed up with an exercise which will rid the industry of the practices which are responsible for the bad loans to begin with.

 
In Nigeria this included blacklisting some bank executives. The same may be needed in our market.

 
Whatever method is used, ultimately bankers’ behaviour needs to be reformed. Another poser is how banks, particularly the smaller ones that cannot profit much from non-interest income, will make profit in a post-clean-up world.

 
Lending will have to be more prudent and perhaps banks will be forced to rationalise operations to remain profitable. Ultimately banks will have to fight for the few quality borrowers in the market and the ensuing struggle for survival may result in bank mergers and Zimbabwe losing its “overbanked” tag.