BANK failures and the increase in non-performing loans has been exacerbated by a weak supervisory framework to rein in errant bankers, a new report has shown.
CHIEF BUSINESS REPORTER
According to the Zimbabwe Economic Policy Analysis and Research Unit (Zeparu) the absence of that supervisory framework created moral hazard (adverse incentives) among bank owners whereby they act contrary to the interests of their creditors, mainly depositors or government especially where deposits are implicitly insured.
“In this regard, banks gamble with depositors’ funds through lending at high interest rates to high-risk borrowers, which if unsuccessful will adversely affect the solvency of the bank. Bank owners have an incentive to undertake such strategies if they have limited liability,” Zeparu said in a latest report, Financial Liberalisation and Crisis: Experience and Lessons for Zimbabwe.
“In this case they will only bear a portion of the downside risk while gaining in huge profits if the gamble succeeds.”
It said depositors (or deposit insurers) gain little when the venture succeeds, but bear the huge costs if it fails.
Zeparu said the inability of depositors to monitor bank owners adequately, because of asymmetric information and free rider problems allows bank owners to undertake high-risk investments (not fully compensated for by deposit–rate risk premium).
“It can be argued that bank failures and accumulation of non-performing loans that have been evident in recent years in Zimbabwe had their origins to moral hazard problems, in particular, insider lending,” it said.
Zeparu said liberalising the bank licensing regime in an environment where the supervisory and regulatory framework is not strengthened can facilitate moral hazard (or adverse incentives) among bank owners.
It said the expectations that government would bail out a distressed bank may weaken incentives of bank owners to manage their asset portfolio prudently.
“For example, following the collapse of United Merchant Bank in 1998, some banks were exposed because of UMB’s fraudulent sale of fake Cold Storage Company Bills.
“In response to this crisis the Reserve Bank of Zimbabwe (RBZ) put in place temporary liquidity arrangements under which short-term secured funding was made available to banks experiencing temporary liquidity problems,” it said.
“Similarly, the RBZ took over the management of Zimbabwe Building Society which was seriously undercapitalised. These measures were consistent with the Implicit Deposit Insurance Policy of the Government at the time.”
Zeparu said such measures built in expectations that may have lowered incentives for depositors to choose only those banks with a reputation for prudent management and for banks to enhance risk management.
Zeparu said moral hazard becomes even more acute when a bank lends to projects connected with its own directors or managers (insider lending).
“In such cases the incentives for imprudent lending are greatly increased because all the profits from the project are internalised whereas that part of the loss incurred by depositors is externalised,” Zeparu said.
Banks that were closed in the past 10 years had the same ailments—concentrated shareholding, weak corporate governance, owner-managed or controlled and insider loans, which all turned out to be non-performing.
There was also the siphoning of depositors’ funds through related party loans to the main shareholders and their associates “akin to a declaration of dividends by shareholders from depositors’ funds”.
The central bank responded by closing or putting the affected institutions under the care of a curator in what observers said was a matter of closing the stables when the horses have already bolted.