The terrain is not smooth, a journey for the resilient

EQUITY AXIS

CURRENCY reforms, loading up compliance costs and renewed US and EU sanctions on the country, have seen banks having a limited scope of engagement with international financial institutions.

Due to sanctions, lenders elsewhere will indeed be looking to eliminate any exposure to the country and its banking sector.
Zimbabwe’s banking sector is vulnerable to sanctions because of the dominant role of the US and the US dollar in the global economy and even the domestic economy.

The US dollar is the preferred store of value, according to the banking public’s perspective. Sanctions restrict the smooth flow of goods and services as well as monetary transactions.

In the first quarter of 2019, South African banks severed their correspondent banking relationships with local banks, resulting in the country failing to import sufficient foreign currency notes. South African banks through their correspondent banking relationships with local banks feed the country with cash and are crucial to the stability of the local banking sector.

South Africa is Zimbabwe’s top trading partner and its de-risking from Zimbabwe as a result of both US and EU sanctions will have debilitating effects on both the stability and the strength of the local banking sector.

The wave of de-risking, if not managed well, may even reach catastrophic levels. It is normal, in the advent of sanctions, for other banks and countries to terminate their relationship with Zimbabwe and its banking sector. For most banking institutions in any jurisdiction, sanctions compliance is complex and fraught with risks.

The easiest way out indeed will be to terminate the relationship. For example, in 2016 Barclays Zimbabwe (now First Capital Bank) had to pay US$2,5 million to settle US claims that the bank processed transactions for government-backed entities in Zimbabwe that were subject to US sanctions.

Sanctions affect not only local banks but also banks that have relationships with these local banks. That is why banks normally de-risk from those jurisdictions that are under international scrutiny. The US Department of the Treasury’s Office of Foreign Assets Control (Ofac) in 2016 said in an enforcement release that Barclays, through its units in New York, the UK and Zimbabwe, helped the Industrial Development Corporation of Zimbabwe, a state-owned development institution, and individuals linked to IDCZ, to process 159 funds transfers valued at around US$3,4 million between July 2008 and September 2013 — hence the US$2,5 million penalty.

Apart from FCB, CBZ Bank was also investigated by the US Treasury Department’s Ofac regarding historical transactions involving a party that was subject to economic sanctions.

The country’s biggest financial institution was alleged to have perpetrated 15 127 violations of US sanctions on Zimbabwe. Initially, Ofac had put the penalty at US$3,8 billion before revising it downwards to US$385 million.

Such developments have a serious impact on both the perception of the country and banking sector among foreign investors. Given the prior breaches, most international banks will be reluctant to deal with local banks, given the continued US and EU sanctions.

Even beyond these US and EU sanctions, the banking sector’s structural vulnerabilities will continue to restrict their smooth operations. Huge exposure to government will not only worsen their risk premium in the eyes of foreign lenders but also affect their domestic activity. It is indeed positive that the government is implementing measures to correct its fiscal position, which over the years was an albatross to the banking sector’s viability.

However, positive effects of government’s fiscal consolidation may take long to materialise and, as such, 2019 is likely to be a difficult year for banks. Change in currency, introduction of Real-Time Gross Settlement dollar (RTGS$) and its subsequent devaluation may partly entail devaluation of banks’ asset bases.

Soaring inflation also entails loss of real earnings, given controlled lending rates that are way below annual inflation levels. As such, the banking sector outlook is highly dependent on government policy.

Private sector lending, which remained fairly flat during the whole of 2018 and in the first quarter of 2019, will continue subdued. The government, despite austerity, is still relying on the banking sector for its budget deficit financing, hence the crowding-out effect. The government’s ongoing funding gap continues to crowd out private sector borrowing in Zimbabwe.

Adverse weather and a disastrous 2018/19 farming season have also worsened the situation and it is difficult to see how the government will reduce the budget deficit from 11,9% of GDP 2018 to the targeted 5% of GDP by December 2019.

The government continues to be locked out of international markets, and, given already high arrears to multilateral lenders and US sanctions, will continue tapping into the domestic banking sector. While the government has targeted a reduction in the use of domestic financing in 2019, a little, if not insignificant, headway is expected.

This continued elevated lending to the government heightens banks’ asset sheet risks and downside risks to the wider economy.In December 2018, the banking sector’s claims on central government grew by 75% year-on-year, enabling fiscal stimulus and rapid money supply growth.

The banking sector is increasingly reliant on deposit funding, with foreign credit supply drying up as risks mount. As such, the use of customer deposits to fund government debt is fuelling inflationary pressures that will continue to constrain depositors’ spending power. The introduction of bond notes in November 2016, its expansion and the resultant introduction of a local currency, the RTGS$, further complicates the domestic banking outlook. This is indeed a difficult time for the sector which requires resilience to weather the storm.

While the ratio of non-performing loans (NPLs) fell to 6,8% by December 2018 from a peak of 20,5% in June 2014, this is largely due to the publicly funded Zimbabwean Asset Management Company (Zamco) absorbing much of the sector’s bad debt in recent years rather than an improvement in risk management. Furthermore, the NPL ratio is not fully reflective of the low quality of assets on banks’ balance sheets, as it does not factor in Treasury Bills (TBs), which are looking increasingly illiquid.

With the end to Zamco’s acquisition programme, banks are exposed to risks which require prudent risk management. There is a dearth of good-quality borrowing clients in the economy despite the productive sector’s well-known desperation for capacitation financing. Already, NPLs are showing an upward trend, which should be worrying to both the sector players and the authorities.

Loan-to-deposit ratios continue trending downward with recent figures showing a ratio below 31%, a 75% decline from three years ago.This is representative of the sharp decline in loans since the onset of the economic recession and liquidity crisis. It is also important to note that while deposits are showing strong levels of growth, very little is actually underwritten in hard cash, offering little support to funding.

Furthermore, a significant portion of deposits are short-term in nature, resulting in a continued cash crisis. Capital is also showing an upward trend.

However, this is misleading as very little of the banks’ capital structure is supported by reserves of hard cash, leaving the sector ill-prepared to meet withdrawal demands from depositors or stand currency shocks. It is prudent to say that with currency reforms and a resultant devaluation, there are capital losses which will affect banks’ operations.

Unlike other countries where their respective governments do not lean much on the banking sector for financing, Zimbabwe government’s constrained fiscal position leaves virtually no room for support to the banking sector.

While the creation of Zamco has helped the banks offload NPLs, any beneficial effect has been offset by the lack of cash repayments of outstanding TBs, which now form a substantial part of banks’ asset sheets.

The government is increasingly making forays into the banking sector seeking borrowing, aggravating the issue of limited sovereign support capacity.

A weak fiscal position, limited business in the sector due to lack of quality borrowing clients and increased isolation from the international community requires proper risk management. Indeed, banks are facing tough times and the terrain is not smooth. Resilience is key to weathering the storm.

Equity Axis is a financial media firm focussed on Zimbabwe and Africa businesses, economic and financial news analysis and data provision. This article first appeared in the 2019 Banks and Banking Survey organised by Zimbabwe Independent and financed by First Capital Bank

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