Regulation and bank failures in Zim

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In last week’s article I urged, as in many articles before, that executives of failed banks should be brought to account and those that are found to have acted wrongly to the prejudice of depositors should be punished. This drew a lot of significant interest from some former directors, staff and creditors. There were some who seemed to query why I was silent on the role played by the regulators and auditors in the demise of the banks in Zimbabwe.

Daniel Ngwira,Chartered Accountant

Regarding the role of auditors, it is high time that auditors, who do not report the shenanigans they would have seen in their client’s banks during audits, should be penalised. It is easy for an auditor to see signs that a bank could be going down and those auditors who remained silent throughout the famous bank failures in the country may need to be followed to give an account.

I am quite sure I mentioned in the article that Trust Bank accessed accommodation at 300%. This rate, compounded daily, would run into several thousands and would therefore not be sustainable to any bank, regardless of how strong their balance sheet may be.

That said, while the rates were punitive, it should be noted that the lender-of-last-resort or the accommodation facility, is never intended as a permanent source of capital or liquidity. When a bank finds itself accessing the accommodation window incessantly, then it means that it has a big capital structural breach which needs to be urgently sorted through capital injection. Short of this, the bank should consider surrendering its banking licence or the central bank should consider various remedial and other measures, including curatorship, closure and liquidation.

Quite often, banks find themselves accessing expensive accommodation funds because they would have misrepresented their position to the regulators. A case in point is that of Rapid Financial Services, a small but then up-and-coming discount house which went under at the peak of the financial crisis in Zimbabwe. While its collapse was inconsequential compared to entities such as ENG Capital, the fact remains that depositors lost money.
The financial services firm had potential to grow. Some bankers did not appreciate that they could be saved through honesty. CFX Bank, in the dollarised environment, was honest with the central bank that its capital position had been eroded to the extent that it needed an injection. The central bank supported the bank by giving it more time to look for capital. That worked and the bank had Finance Bank of Zambia as a serious suitor. It was then taken over by Interfin Financial Services.

A closer look at the collapse of this entity and many others point to the fact that it was largely because the respective shareholders wanted to cling on to their larger shareholdings and thereby have more control. The shareholders were not deep-pocketed. In fact, most of the indigenous banks benefited from the government’s benevolence and policy which promoted the entry of local businesspeople into the banking sector. Inroads were made, but as the sector became more sophisticated with growing debate, at the time, as to whether the sector was overbanked or not, the local bankers missed an opportunity to consolidate their banks and build an entity in the form of Absa of South Africa where several small banks came together in 1991 to strengthen their balance sheets.

These banks included United, Allied, Volkskas, Sage and Bankorp (including Trustbank, Senbank and Bankfin).

In the past, the regulators (Reserve Bank of Zimbabwe) have not been too keen to close banks as it was always thought this would destabilise the financial markets through severe loss of investments and depositors’ funds as well as loss of confidence. Essentially, there were some banks which were considered to be too big to fail not only in Zimbabwe, but globally. It was felt that allowing certain big banks to go into liquidation could ignite a systematic risk and related failure and thus disrupt the entire economy.

Many never imagined that a financial behemoth such as Trust Bank would be allowed to fail when smaller banks like Metbank would survive. Neither did anyone imagine that the British Bank of Credit and Commerce International (BCCI) or Barings Banks would. Perhaps the biggest story of modern times is the fall of Lehman Brothers in 2008. It was the fourth biggest investment bank in America and was founded in 1850 by three brothers namely Henry, Emmanuel and Mayer.

Moving into the dollarised environment, few thought that Interfin Bank, which had such a huge balance sheet, supported by regional banks such as Afreximbank and PTA Bank in tens of millions of United States dollars as well as government funds running into millions, could be allowed to falter. Indeed the bank ran into one of the longest curatorships in the country’s recent history, perhaps only competing with FNBS, a purple building society which went under due to lack of adequate capital, limited long-term deposits and poor corporate governance.

In the aftermath of the global financial crisis, this position has been altered. In the US, the Dodd-Frank Act was enacted to correct some of the wrongs which had caused bank and market failures. The purpose of the Act was to foster stability through promoting accountability and transparency in the US financial system. There was discontent over the years that taxpayer dollars had been used to bail out reckless bankers who speculated with depositors’ funds. The piece of legislation aimed at ending this mentality of “too big to fail”. Essentially, the Act seeks to protect customers from banking malpractice.

It is interesting to note that the same piece of legislation is now being blamed by US President Donald Trump for restricting bank lending and therefore restricting credit creation. The reason why the legislation is found wanting in this regard is that it imposes more strict capital requirements to the financial institutions. This has made borrowing more expensive for consumers. As bankers now know that they will not have access to taxpayer money in the event that they fail, they have motivation to build their retained earnings so that they can be cushioned in times of market upheaval.

In the five years I was a banking lecturer at the Graduate School of Management, University of Zimbabwe, I used to emphasise that whenever a bank engages in non core banking activities, speculating with depositors’ funds and poor corporate governance, it risked going under. My favourite examples were Barings Bank and BCCI. It is interesting to note that legislation such as Dodd-Frank (US), the Vickers Report (UK), the Barnier-Liikanen Rule (EU) and the Volcker Rule (US as part of the Dodd-Frank Act), has forced the splitting of the universal bank into commercial and investment banking entities.

This was precipitated by the fact that investment activities have been at the centre of the crisis. The Vickers Report requires that the capital and stability of retail banks within a group be quarantined and safeguarded from the riskier activities of the investment banking arm. Investment banking arms do not have access to cheap deposits, hence the past reliance on retail deposits from retail group entities. The Vickers Report requires that creditors of the riskier investment banking arm cannot claim from the retail arm in case of insolvency. This stops banks from speculating with retail deposits.

In cases where they would have lost money during speculative activities, they cannot endanger the access to loans by small retail customers as the retail arm is now separated. Both the Volcker Rule and the Liikanen Rule have the same effect as the Vickers Report. Regulators felt that retail customers were being unjustifiably exposed to risks due to the excessive activities of investment banking.

While regulators do have their gaffes, it should be noted that the game is played by players and referees cannot be blamed for having a player score an own goal. In Zimbabwe, the unwinding of ZABG Bank after court battles and the out of court settlement agreements may be proof that some mistakes were made by the regulators. But before those mistakes were made, the players had taken actions that had ruined the position of their banks.

That said, it can be argued that if the regulator had not made errors of judgment, the banks could have survived.

While shareholders of Trust, Royal and to some extent Barbican, may cry over lost value even when ZABG was dismantled to give back the assets to the original owners, it should be noted that the biggest loser was the depositor who got worthless shares and never got back value after the dismantling of the amalgamated banks.

I was reminded by a very senior and once respected member of the financial sector that perhaps Zimbabwe lost an opportunity by not having a commission of enquiry on the collapse of banks. I agree with this view. Some of the mistakes could easily have been avoided after such enquiries. There is an argument that only one side of the story was heard and it is that of the regulator. The failed banks have not been given an opportunity to be heard. Perhaps they need to create opportunities for themselves.

When a bank goes into creating fake bankers’ acceptances traded in good faith by the entire market, who is to blame when the bubble bursts? When a bank sends a return to the central bank misrepresenting its liquidity position, in some cases claiming that it has US$20 million in cash to boost its liquidity ratios, who is to blame when such a bank cannot even pay US$1 to its depositors? When a bank receives money from the government to disburse US$20 million for the Zimbabwe Economic Trade Revival Facility (Zetref) and then converts everything except for a mere US$2 million into own use, who is to blame? Why did the central bank remain anaesthetised when it saw a bank lending over 60% of its deposits to its own shareholders and related parties? When the central bank learnt that there was an agreement between a principal shareholder and a financier to pay a monthly preferred dividend to a financier using depositors’ funds, what did they do about it? This is a private arrangement between a shareholder and a funder, but depositors had to pay for this. Why? What did the central bank do when they learnt that the same financier held shares as security for the same transaction without the approval of the Reserve Bank of Zimbabwe (RBZ)?
All the above is true of Interfin Bank. The bank created fake paper, misrepresented its financial position to the regulator. But there are more questions. Where was the regulator looking when they received fake liquidity returns which were in contradiction with the bank’s BK8, statement of assets and liabilities?
As the Ministry of Finance knew that the Zetref funds were held up in Interfin Bank, what steps did they take to salvage value? What action did the regulator take when they learnt of fake bankers’ acceptances and evidence of double-dipping? Why did the central bank not move in quickly to protect regional banks who were owed millions of dollars? These are such important financial partners to the country. Readers may be interested to know that some of the top decision-makers at the RBZ struggled to withdraw money from their bank accounts at Interfin Bank. Some had non-performing loans (NPLs). Some of these loans were netted off against overvalued assets to the prejudice of depositors. These people had the power to close the bank sooner to protect depositors, but they chose not to. The question is why?
It then appears that regulation played a role in the collapse of banks when it delayed or never put some banks under curatorship or when there were overreactions due to high emotions. These banks include Renaissance, Kingdom, Tetrad, Interfin, Trust (the second time around) and Allied, to mention just a few. Delaying placing a bank under curatorship or closing it altogether puts in jeopardy chances of creditors recovering meaningful sums of money.

In 2004, the RBZ was very swift in moving in to close banks. This helped protect depositors. During the multi-currency regime, it can be noted that the central bank was extremely slow in taking action against weak banks. The case of how Tetrad went into judicial management exposes how slow the apex bank has been in responding to a crisis in the banking sector in the multi-currency regime. But Tetrad shareholders must not blame the RBZ when it had an NPL book of 99% of the entire book and much of it (76% of the unsecured loan book was with related parties) being in the hands of related parties who did not secure their loans. Why should the central bank be blamed for Tetrad’s under-reporting of the insider loans? In my judgment, the regulators have a much lesser role in bank failures than the shareholders and directors.

Ngwira is a chartered accountant, former bank treasurer and former university lecturer. He holds finance and business qualifications. — daniel.ngwira@gmail.com/ cell: +267 73 113 161.

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