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Dangerously high interest rates

The risk to banks when they increase lending rates but maintain a short tenure for repayment, is to place the companies they lend to under greater strain. There must be a tipping point when an increase in interest rates beyond some hurdle actually prejudices the bank itself by making default more likely. Of course the interest rate charged to companies who borrow depends on their risk of default, and for that reason Delta is able to acquire much cheaper funding than Star Africa, but in extreme cases such as that which prevails in Zimbabwe, there has to be a limit. It can become imprudent for banks to lend at rates in excess of 20%, knowing full well that a glitch in the company’s operations will result in their being unable to meet their obligations. Indeed, banks should also be aware that the collateral these companies pledge in order to access their loans can often take a long time to be transferred, or can be worth far less than initially assumed.

The risk of companies defaulting on their loans can put a lot of strain on these banks’ balance sheets. Take the loan-to-deposit ratio of some of these institutions: Interfin has lent 108.1% of its total deposits; NMB has lent 100.4%; TN Bank is at 96.0%; Trust is at 100.1%. If a loan comprising a major component of one of these banks’ total book became non-performing - or alternatively, if a large number of small loans became non-performing at the same time – banks with high loan-to-deposit ratios may struggle to meet their depositors’ demands. Over a period like Christmas, when most peoples’ salaries are withdrawn very quickly to spend on presents, entertainment or holidays, this struggle may become evident. Whether the queues outside banks over Christmas were related to this we cannot say, although the Bankers’ Association of Zimbabwe denied this vehemently.

Some of the largest banks in terms of deposits are generally the foreign-owned banks: Barclays, Stanbic, Standard Chartered being the most notable. With the threat of indigenization looming and the general level of risk in the market, these companies are not willing to increase their loan book to ease the liquidity crisis, or lend to the banks who have high loan-to-deposit ratios. Barclays lent just 29.3% of its deposits in its latest financials, while Standard Chartered lent 58.4%.

Another factor that has left banks vulnerable is the composition of banks’ funding. Zimbabwean banks have a very narrow funding base, as the bulk of the funds are short term deposits. For example, CBZ’s deposits for the half year to June 2011, amounted to $772 million, of which $633 million is on demand and $98.8 million is for the period between 1-3 months. The few offshore credit facilities are also not cheap as the fund providers put a very high risk premium on Zimbabwe. Lending rates from these type of funds are naturally expensive as they include a risk margin designed to cover the expected losses.

The African Development Bank takes a different angle when approaching the problem of high interest rates – in their December economic review, they showed that the disparity between lending and deposit rates was widening, and this was dampening the already weak savings culture in the country. Weighted average base lending rates rose from 12.6% per annum in September to 13.1% by October at commercial banks. Merchant banks charged an unchanged but extremely high 19.6%. Three month deposit rates remained unchanged at 8.6%. The spread between lending and deposit rates in Namibia, Botswana and South Africa is said to be around 5%, compared to Zimbabwe’s massive 20%. In their report, the African Development Bank highlighted that long term bank deposits actually declined in October, reflecting the level of risk inherent in Zimbabwe’s economy.

A development likely to ease fears in the economy is the allocation of $100 million in this year’s Budget to the Reserve Bank, so that it can resume its role as a lender of last resort. This will significantly ease liquidity constraints as banks can access these funds in order to meet pressing obligations. It is unclear whether or not this money has materialized though, and we await further announcements in this regard.

Even if the RBZ is to get the $100 million, there is need to craft a lasting solution to the current crisis. Perhaps what the country needs to focus on is the creation of a credit bureau. A credit bureau will reduce the uncertainty that banks have on whether or not somebody applying for a loan is going to repay the loan or not. When a bank has information on the track record of the loan applicant in re-paying their loans it helps in the decision to lend, at a reasonable cost and lengthier tenure. With a bureau in place, decent borrowers should then see interest on their loans drop to reasonable levels.

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Jan 31, 2012
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