Managing NPLs for better asset quality

The dramatic expansion of the banking sector in the late 1990s culminated in the financial sector crisis, leading to the closure of a number of banking institutions.

FINANCIAL institutions such as banks play a linchpin role in an economy. Banks’ do credit risk profiles, and therefore, it is a policy concern considering how excessive exposure to credit risk can affect the whole financial system and the economy at large.

 The 2007-2008 financial crisis proved how fast excessive exposure to credit risk can weaken the banking industry as well as the economy. More often, banks are reported to have failed as a result of excessive exposure to credit risk through high levels of non-performing assets.

Financial analysts noted that credit risk is among the leading risks in commercial banks operating in Zimbabwe.

Banks credit risk profile determines the degree of pollution on the bank balance sheet through bad loans and advances on the assets side.

High credit risk brings dire outcomes not only to banks, but to customers and other stakeholders through exacerbated systemic financial fragility and spill over effects and its contagion effect as well as systemic risk.

Excessive exposure to credit risk led to episodes of bank failures in Zimbabwe both post and prior to adoption of the multi-currency regime.

This disrupted financial intermediation as well as the overall development process of the economy.

The Reserve Bank of Zimbabwe (RBZ) indicated that the impact of non-performing loans (NPLs) result in, inter alia, a decline in financial intermediation, erosion of bank assets and capital base, resulting in liquidity challenges and adoption of cautious behaviour, as confidence in the financial system declines.

All these outcomes negatively impact on financial inclusion in Zimbabwe.

Financial inclusion has an impact on reduction of poverty and income inequality while credit crunch has the potential to rise as banks with high NPLs become reluctant to take up new risks and create new loans.

Unavailability of credit to finance working capital and investments might trigger the secondround business failure.

This affects the quality of bank loans, which results in re-emerging banking failure.

A well-developed banking system allows for competition that impacts on interest rates and has an undoubtedly positive effect on investment activities that generate economic growth.

The importance of banking systems in contributing to economic development has been magnified in recent studies, which have shown that banks' performance and profitability contribute to countries' development.

The general view is that higher and sustainable real gross domestic product (GDP) growth usually translates into more income, which in turn improves borrowers’ capacity to service debts. There is, however, significant empirical evidence regarding the behaviour of NPLs, which are considered anti-cyclical.

Conversely, when there is a slowdown in the economy, the level of NPLs is likely to increase as unemployment rises and borrowers face greater difficulties in repaying their debts.

NPLs have, therefore, often been related to bank failures and financial crises in the world. They are part of the measurement of asset quality among lending institutions.

The benchmarks used for identifying NPLs are more varied across Sub-Saharan Africa, wherein some countries use quantitative criteria to distinguish between ‘‘good’’ and ‘‘bad’’ loans (for example, the number of days of overdue scheduled payments), while others rely on qualitative norms such as the availability of information about the client’s financial status, management ratings and perspectives about future payments.

The main roles of banks are to serve as the catalysts for savings mobilisation in the economy on the one hand and financing of investment and economic activity (both productive and consumptive) on the other.

They serve as platforms of transmission of financial impulses across and among internal sectors, propelling Zimbabwe’s interface with the rest of the world’s economic and financial systems.

Since the liberalisation of Zimbabwe’s economy in the late 1990s, there have been significant changes in the structure of the banking sector.

In the 1990s following liberalisation of the financial sector, there was a credit boom in which loans were issued without proper risk assessment or appropriately valued collateral.

The tightening of monetary policy to curtail high bouts of inflation during the period resulted in the reduction of aggregate demand which caused a slowdown in economic activity.

The reduction in economic activity resulted in the poor servicing of loans, which caused a spike in NPLs. NPLs/loans ratio peaked to levels never seen before.

In 2003-2005 at the crescendo of the Zimbabwean financial crisis, many commercial banks became insolvent. By end of December 2004, NPLs reached a staggering 28,9% (RBZ, 2005).

The dramatic expansion of the banking sector in the late 1990s culminated in the financial sector crisis, leading to the closure of a number of banking institutions.

The turbulence in the Zimbabwean financial sector on the back of serious liquidity shortages during the last quarter of 2003 necessitated the introduction of the Troubled Banks Fund (TBF) in December 2003 with the aim of safeguarding and minimising disruptive medium-term liquidity mismatches.

TBF served as a contingent pool from where banks that faced liquidity challenges accessed funding to stabilise their operations. The thrust was to ensure financial stability while the affected institutions put in place corrective and remedial measures to address the liquidity challenges.

Banks that accessed the TBF were required to operate under close supervision by the RBZ and also to provide a plan of measures to resolve their liquidity challenges

The monetary policy statement issued on December 18, 2003 marked a turning point for the Zimbabwean financial services sector. Amid fears of a deeper financial crisis in the whole banking industry through systemic risk, the central bank embarked on rigorous effort to instil discipline and bring sanity into the financial sector.

Some banking institutions were found to be unsafe and unsound, such that NPLs rose from about 15% in 2000 to nearly 30% in 2004. Resultantly, in 2004 nine financial institutions were placed under curatorship.

From the period March 2005 to December 2008, the banking sector, however, witnessed a decline in NPLs from 22,84% to 5,695, respectively.

Currently, aggregate NPL ratio is at 3,62%, which is still within acceptable territories. However, due to dollarisation, the deterioration rate has been alarming in the last two years.

It is high time the RBZ monitors this key matrix with a view to avoid yesteryear banking crises issues.


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