Ceteris Paribus: Face of banking sector, a collapsing economy?

When a loan becomes non-performing, it negatively impacts both the lender and the borrower.

DESPITE remaining below threshold, the Zimbabwe banking sector overall non-performing loans recorded a significant jump in 2023 to 3,62% as of end of September, from 1,41% as of September 30 2022, according to data from the Reserve Bank of Zimbabwe (RBZ).

The maximum benchmark for non-performing loans is set at 5%, and a jump towards this threshold is a close call to concern, but how did we get here? Non-performing loans refer to those that borrowers have failed to repay according to the agreed terms, or bank loans that are subject to late repayment. This can occur due to various reasons such as economic downturns, company failures, high imports, poor repayment collection methods, insider loans, high interest rates, poor credit management or poor credit assessments, or borrower insolvency.

When a loan becomes non-performing, it negatively impacts both the lender and the borrower. Therefore, an increase in non-performing loans in Zimbabwe as reflected in the data from the central bank indicates challenges at macro-economic level, and worth interrogating. One of the primary factors contributing to an increase in non-performing loans between 2022 and 2023 is a downturn in economic activities. In a bid to curb an inherent economic woe in Zimbabwe, inflation, the RBZ introduced measures to tighten liquidity, which would mitigate overall spend and speculative currency trading.  Resultantly, businesses faced challenges such as declining sales, reduced cash flows, and subsequently reduced flow of cash in the economy. These factors made it difficult for borrowers to meet their loan obligations, leading to a surge in non-performing loans over the period. In line with the measures above, the RBZ went on to increase ZW$ interest rates in a bid to curb speculative borrowing induced by the arbitrage opportunity in currency trading.

The increase in borrowing costs imposed a financial strain on borrowers, delaying the repayment of loans while subsequently increasing the level of bad debts.  On the other hand, the measures introduced by the RBZ were more a reflection of policy inconsistency. This was also followed by an intense political atmosphere towards the presidential elections, which led to uncertainty post the elections.  Political instability and sudden policy changes significantly impact borrower repayment capacity. Uncertainty surrounding government policies or regulations tends to disrupt business operations and affect cash flows negatively, which also weighed on overall spend in the economy. While these factors were weighing on individuals’ capacity to pay, other developments within the economy were also emanating at a faster pace. The economy was highly informalising, with more than 80% of the economic activities being in the informal sector.

Informal economic activities encompass unregulated or partially regulated transactions that occur outside the purview of government oversight. These activities often involve cash-based transactions, self-employment, and small-scale enterprises that operate without proper registration or adherence to legal requirements. Year-on-year to September 2023, 4,58% of the total bank loans were directed towards this sector.

The rise in informal economic activities, statistically, posed challenges for financial institutions regarding loan repayment rates. Entities engaged in this sector often lack proper documentation or collateral required by banks when seeking credit facilities.

As a result, there are weak legal frameworks and ineffective enforcement mechanisms around the recovery of loans from these players.  Since this sector is highly volatile, it is also inherently vulnerable to external shocks that hinder lenders' ability to recover defaulted loans promptly. Additionally, irregular income streams associated with informal work makes it challenging for borrowers engaged in such activities to maintain consistent repayment schedules. The unstable operating environment in Zimbabwe also poses a threat to adequate credit assessment and risk management practices by financial institutions.

Lenders fail to accurately evaluate borrowers' creditworthiness or overlook warning signs that indicate potential repayment difficulties. Insufficient due diligence has resulted in granting loans to entities with limited repayment capacity.

Duma is a financial analyst and accountant at Equity Axis, a leading media and financial research firm in Zimbabwe. — [email protected] or [email protected], Twitter: TWDuma_

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