Zimbabwe’s banks have slowed down on lending to the private sector while accumulating more sovereign paper, an undertaking which clearly shows the relationship between government debt, private sector lending and banks’ sovereign paper holding.
A reality check: over the past few years, the government has been struggling to meet its financial obligations with some issued Treasury Bills (TBs) being rolled over. However, banks have been increasing their holdings of these TBs despite clear signs that the government may default.
In his 2019 budget statement, Finance minister Mthuli Ncube indicated that, apart from the 2019 budget deficit of ZW$1,6 billion, financing needs may reach ZW$6,5 billion as a result of maturing TBs and the projected overdraft. In recent months TB issuances have increased to over ZW$1,5 billion since reintroduction of the auction system against a revised expected budget deficit of -ZW$6 billion. Given the constrained fiscal space, government is most likely to roll-over some maturing TBs or replace them with a longer-dated sovereign paper.
This is a technical default which otherwise would act as a warning to banks that are holding TBs. Government default on TBs and any sovereign paper damage banks and the real economy as banks respond by slowing down on lending to private sector. Commercial banks’ exposure to government has grown above the ZW$10 billion mark whilst lending to private sector has remained stagnant at ZW$5 billion. This clearly shows how government debt and default can be transmitted to the private sector.
A closer look at the banking sector shows that sovereign paper holdings is large for those banks that issue fewer loans. When the government defaults or roll-over the TBs, average holdings increase but more concentrated in large banks. It is the large banks such as CBZ, Standard Chartered and Stanbic that are holding the majority of sovereign paper. It is not a problem for banks to be heavily exposed to government.
However, it should be noted that during defaults, there is a large, negative and statistically significant correlation between banks’ sovereign paper holdings and subsequent lending activity. A one dollar increase in sovereign paper is associated with as high as a 0,60 dollar decrease in bank loans to private sector.
Furthermore, about 90% of this decline is accounted for by the average paper held by banks before the default takes place. Only 10% of this decline is explained by the additional paper acquired in the run-up to and during default.
These observations support the notion that banks’ holdings of sovereign paper are an important transmission mechanism of sovereign defaults to banks lending to private sector. TBs and all forms of sovereign paper should be very liquid assets that play a crucial role in banks’ everyday activities, like storing funds, posting collateral, or maintaining a cushion of safe assets. Because of this, banks hold a sizeable amount of this paper in the course of their regular business activity. When government default strikes, banks experience losses and subsequently decrease their lending to private sector to manage the remaining liquidity. During these default episodes, moreover, some banks deliberately hold on to their risky paper while others accumulate even more.
This behaviour could reflect the banks’ reaching for yield or it could be their response to government moral suasion or bailout guarantees. Whatever its origin, this behaviour is largely concentrated in a set of large banks and is associated with a further decrease in their lending the private sector.
Balance sheet analysis of banks such as CBZ, StanChart and Stanbic supports this notion. Generally, sovereign paper holdings, regardless of whether they are accumulated before or during sovereign default events, contribute to transmitting the effects of defaults to private loans. It is the private sector that suffers through limited access to loans and limited source to finance long term capital projects.
Gwenzi is a financial analyst and managing director of Equity Axis, a financial media firm offering business intelligence, economic and equity research. — firstname.lastname@example.org