BANKS will adopt a cautious approach to lending thereby reducing credit growth in the economy as the loan default rate rises, a leading research firm has warned.
Statistics from the Reserve Bank of Zimbabwe (RBZ) showed that the ratio of non-performing loans (NPLs) to total loans increased to 16, 96% as at March 31 2014, up from 15,92% as at December 31 2013.
An NPL is when payments of interest and principal are past due by 90 days or more, or at least 90 days of interest payments have been capitalised, refinanced or delayed by agreement.
In a research note, MMC Capital said the deteriorating economic fundamentals in Zimbabwe have been the chief contributor to the sector’s worsening NPL ratio as most borrowers were failing to service their debts due to deteriorating macroeconomic fundamentals.
It said the cutback on lending “will have a huge bearing on the economy as the reduced credit supply will lead to working capital challenges and in many instances businesses will fail to fund capital expenditure”.
“The net result will be a decline of private gross fixed capital formation and private consumption which in turn will negatively impact economic growth,” MMC said.
“In a high NPL environment, banks increasingly tend to carry out internal consolidation to improve the asset quality rather than distributing credit.”
This means that companies won’t get financing to re-equip and will be stuck with obsolete machinery pushing up the cost of production. This ultimately makes local products uncompetitive.
MMC said the high level of NPLs requires banks to raise provision for loan loss, a move that will decrease banks’ income and reduces the funds for new lending.
It said the cutback of loans constraints the corporate sector as they have difficulties in expanding their working capital, curtailing their chances of resuming normal operations or of growing.
“Unavailability of credit to finance firms’ working capital requirements and investments might trigger the second round business failure which in turn exacerbates the quality of bank loans, resulting in the re-emergence of banking failure,” MMC said.
It warned the worst case scenario for rising NPLs was that it would triggeran endless vicious liquidity spiral.
“As a result of poor economic condition and the depressed economic growth, the level of NPLs increase, leading to a weaker corporate sector, thereby causing bank reluctance to provide additional credit,” MMC said.
“With insufficient capital, the production sector is further weakened, resulting in decreases in aggregate demand. Borrowers’ financial conditions become worse off, leading to more NPLs- a vicious cycle indeed.”