Zimbabwe: Selected Issues and Statistical Appendix

The persistent deterioration in the Zimbabwean economy over the past four years poses significant risks to the health of the banking system. Indicators such as the capital adequacy ratio, the ratio of nonperforming loans to total loans, and indicators of profitability, do not yet indicate problems, but they are distorted; for instance, the reported high capital adequacy ratio does not signal the widespread and significant under-provisioning for nonperforming assets and the erosion of capital requirements by inflation; and the low ratio of nonperforming loans to total loans reflects highly negative real interest rates. A strong and effective prudential regulatory environment is essential to ensure that troubled banks are identified and dealt with in a timely manner. While the Banking Act of 1999 significantly enhanced the ability of the Banking Supervision Department (BSD) of the Reserve Bank of Zimbabwe (RBZ) to supervise banks, and the RBZ introduced a policy to deal with troubled banks in 2001, the regulatory environment suffers from key shortcomings. For example, the RBZ does not have the authority to close unviable banks, but requires permission from the Registrar of Banks in the Ministry of Finance and Economic Development, and the RBZ is not enforcing regulations in a consistent manner, for example, banks have been receiving liquidity support for extended periods of time.

Abstract

The persistent deterioration in the Zimbabwean economy over the past four years poses significant risks to the health of the banking system. Indicators such as the capital adequacy ratio, the ratio of nonperforming loans to total loans, and indicators of profitability, do not yet indicate problems, but they are distorted; for instance, the reported high capital adequacy ratio does not signal the widespread and significant under-provisioning for nonperforming assets and the erosion of capital requirements by inflation; and the low ratio of nonperforming loans to total loans reflects highly negative real interest rates. A strong and effective prudential regulatory environment is essential to ensure that troubled banks are identified and dealt with in a timely manner. While the Banking Act of 1999 significantly enhanced the ability of the Banking Supervision Department (BSD) of the Reserve Bank of Zimbabwe (RBZ) to supervise banks, and the RBZ introduced a policy to deal with troubled banks in 2001, the regulatory environment suffers from key shortcomings. For example, the RBZ does not have the authority to close unviable banks, but requires permission from the Registrar of Banks in the Ministry of Finance and Economic Development, and the RBZ is not enforcing regulations in a consistent manner, for example, banks have been receiving liquidity support for extended periods of time.

V. Vulnerability of Zimbabwe’s Banking System52

A. Structure of the Banking System

94. The Zimbabwean banking system consist of 42 financial institutions, comprising 17 commercial banks, 6 merchant banks, 6 finance houses, 8 discount houses, and 5 building societies (Table V.1).53 The banking system is dominated by commercial banks who, at end-December 2002, represented 64 percent of the banking system’s assets, and 62 percent of its liabilities. During 2002, the Registrar of Financial Institutions granted licenses to 5 new entrants, representing 3 new commercial banks (Barbican Bank, First Banking Corporation and Royal Bank), and CFX Merchant Bank and Premier Discount Company Limited.

Table V.l.

Composition and Ownership Structure of Zimbabwe’s Banking System

(as at end-December 2002)

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Source: Reserve Bank of Zimbabwe.

95. The deposit taking activities of commercial banks are the broadest, while other institutions are more limited. Merchant banks and discount houses can take call and time deposits only, finance houses can accept time deposits, and building societies can accept savings, fixed and share deposits. The deposits of commercial and merchant banks are subject to reserve requirements of 50 percent on demand deposits and 20 percent on time and savings deposits.54 Finance houses are required to place 5 percent of their deposits with the Reserve Bank of Zimbabwe (RBZ). Commercial and merchant banks are the only authorized dealers in foreign exchange. The major functions of the other institutions are: the provision of trade and corporate financing (merchant banks), the provision of hire purchases and lease financing (finance houses), and the provision of mortgage financing (building societies). Discount houses function as intermediaries by dealing mostly in short-terms assets such as treasury bills, bills of exchange and negotiable certificates of deposit.

96. Most of the banks in Zimbabwe are privately owned; public sector shareholding is limited to 3 commercial banks, 2 finance houses and 1 building society (Table V.1). Foreign participation in Zimbabwe’s banking system is spread through the total spectrum of banking sector activities. The four commercial banks with foreign ownership (Barclays Bank, Commercial Bank of Zimbabwe, Stanbic Bank and Standard Chartered Bank) hold 47 percent of assets and 61 percent of total deposits. Foreign-owned banks also play an important role in the provision of trade and corporate financing (holding 48 percent of assets and 29 percent of deposits), and in the provision of mortgage financing (32 percent of assets and 40 percent of deposits).

97. The importance of lending in banks’ portfolios has declined substantially since 1999 in view of the deteriorating macroeconomic situation, and the consequently higher credit risk. For commercial banks, the proportion of loans to total assets has declined from 38 percent at end-1999 to 29 percent at end-2001, while the proportion of securities and investment (for example, treasury bill and bills of exchange) rose from 7 percent to 32 percent. Similar trends are evident in the rest of the banking sector.

98. Banks can borrow through three facilities from the RBZ, namely through the repo facility to cover their settlements positions, through the overnight facility in order to ensure clearance of all settlements, and through the Temporary Liquidity Assistance plan (the terms and conditions of which are negotiated on a case-by-case basis).55 In the Monetary Policy Statement of November 2002, the RBZ announced that intra-day market positions would be accommodated through repurchase agreements, and end-of day short positions through the overnight window.56 An electronic payments system, the real time gross settlements system, was introduced in November 2002. To accommodate intra-day clearing, the RBZ initially gave each bank a Z$15 billion credit line. Some banks, however, habitually drew on this facility overnight, injecting too much liquidity into the market. Approximately 30 percent of transactions were being settled through the new system. The RBZ in early 2003 closed the credit line, now conducts two repos per day, and introduced penalty rates for secured and unsecured borrowing through the overnight facility (see footnote 3).

B. Regulation and Surveillance of the Banking System

99. The banking system of Zimbabwe is regulated in terms of the provisions of the new Banking Act of 1999, effective August 2000, as well as through guidelines issued by the Banking Supervision Department (BSD) of the RBZ. The Act provides for the registration and regulation of banks and the establishment of a deposit insurance scheme, but does not apply to the Post Office Savings Bank or building societies (although authority is granted to the Minister of Finance to extend the provisions of this Act to these institutions).

100. The Banking Act has strengthened the regulatory role of the RBZ and its ability to supervise banks and deal with problem institutions. Inter alia, it allows the RBZ to conduct on-site inspections and put distressed banks under curatorship, direct an institution to suspend all or part of its banking business, and impose monetary penalties. The Act also requires the external auditors of banking institutions to report to the RBZ irregularities identified during bank audits, allows the RBZ to review the work of the auditor, and makes monthly and quarterly financial reporting by banks a legal requirement.

101. However, previous advice from the Fund’s Monetary and Financial Systems Department (MFD) identified some critical areas which need to be brought into conformance with international best practices as elaborated by the Basel Core Principles for Effective Banking Supervision:57

  • currently, the licensing of new banks is vested with the Registrar of Banks in the Ministry of Finance and Economic Development; this should be consolidated with the regulation of banking institutions in a single office at the RBZ;

  • the extension of the Banking Act to all deposit-taking institutions;

  • the RBZ does not have the authority to adopt, implement and enforce prudential regulations provided for in the Banking Act; the RBZ should be granted authority to define such regulations without the approval of the Ministry of Finance; and

  • prohibiting the pledging of assets by banking institutions.

102. Responding to this, the RBZ drafted for consideration by the Minister of Finance and Economic Development amendments to the Banking Act and Banking Regulations to strengthen the supervisory capacity and efficiency of the BSD, including:

  • consolidation of the licensing and regulating functions in the RBZ,

  • granting of authority to the RBZ for the adoption, implementation and enforcement of prudential guidelines,

  • requiring new banking institutions to comply with any conditions before being allowed to commence operations,

  • providing for the registration of bank holding companies and consolidated supervision,

  • requiring agreement by the RBZ for significant mergers and acquisitions,

  • providing for the legal protection to the Registrar and bank supervisors in the execution of their duties, and

  • formally requesting the Minister of Finance to extend the provisions of the Banking Act to building societies and the Post Office Savings Bank.

103. The capacity of the BSD to supervise the banking system is constrained by a lack of personnel and experience. As of March 2003, it had 38 staff members supervising 40 banking institutions (authorized staff level of 48), after losing 10 experienced personnel over the last 1-1½ years. The BSD conducts both off-site monitoring and on-site examination. To address the situation, the BSD has emphasized staff training and manages a cadet training program.

C. Health Indicators of the Banking System

104. Capital Adequacy. Bank capital is clearly defined in the Banking Act and Banking Regulations (Statutory Instrument 205 of 2000) and appears to comply with International Accounting Standards. The RBZ applies three minimum capital adequacy ratios (CARs), which have been implemented in Zimbabwe beginning in 1998:

  • a leverage capital ratio of 6 percent (core capital over total assets),

  • a minimum core risk-based capital ratio of 5 percent (Tier 1 capital over total risk-weighted assets), and

  • a minimum total risk-based capital ratio of 10 percent (total capital over risk-weighted assets).

105. The reported CARs for the different categories of financial institutions are substantially higher than the prudential minimum ratio of 10 percent (Table V.2), although most declined significantly during 2002. Furthermore, Agribank reported negative capital of nearly 20 percent, and the ratio fell below the required minimum in one other commercial bank and one finance house at end-2002. Also, the analytical value of these CARs has been reduced by under-provisioning and inflation. Provisioning for nonperforming assets falls short of requirements, especially among commercial banks and building societies (Table V.3). The capital base of banks has been eroded by inflation. Following adjustments in August 1999, minimum capital requirements were increased by 400 percent on January 19, 2003; during this period, however, inflation was 1,123 percent. The new minimum requirements remain very low - for commercial banks it is the equivalent of US$0.6 million as of March 2003 at the new official exchange rate of Z$824 per US$1.58

Table V.2.

Capital Adequacy Ratios 1/

(In percent)

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Source: Reserve Bank of Zimbabwe.

Total capital over total risk weighted assets.

Table V.3.

Provisioning for Adversely Classified Loans

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Source: Reserve Bank of Zimbabwe.

106. The sharp contraction in real output and worsening of macroeconomic instability is not yet reflected in the reported quality of banks’; assets (Table V.4). For the banking system as a whole, the ratio of nonperforming loans (NPLs) to total loans declined from a level of 17.2 percent in 1999 to only 6.7 percent in 2002.59 Similar trends are observed for the different categories of financial institutions. However, three commercial banks and one building society reported NPLs of about 20 percent of total loans at end-2002. The decline in the NPL ratio also reflects the low interest rate environment and the write-off of loans.

Table V.4.

Nonperforming Loans

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Source: Reserve Bank of Zimbabwe.

107. A few banks have considerable large exposures (individual loans constituting more than 10 percent of capital). According to RBZ regulations, and in line with international practices, the sum of all large exposures should not exceed 800 percent of a bank’s capital. However, at end-2002, one merchant bank exceeded the regulatory maximum by a large margin (1,650 percent), and three commercial banks reported large exposure ratios of more than 500 percent

In terms of sectoral exposure, the banking system has reduced its exposure to the agricultural sector–reflecting the implementation of the government’s fast-track land reform program (Table V.5). Nevertheless, the exposure of merchant banks rose again in 2002, and represented around 8 percent of their portfolio. Commercial and merchant banks have large exposure to the manufacturing and distribution sectors, both of which have been severely affected by the contraction in output.

Table V.5.

Sectoral Exposure of the Banking System

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Source: Reserve Bank of Zimbabwe.

108. Despite the difficult environment in which they have to operate, most financial institutions improved their profitability in 2002 (Table V.6). However, the widespread under-provisioning for nonperforming assets distorts the profitability indicators, and the return on equity was significantly lower than inflation. The main source of income for the banking system is high interest rate spreads, as well as fees and commissions and foreign exchange operations, reportedly including in the parallel market. There has been considerable political pressure on banks to reduce the interest rate spreads which would have an adverse impact on banks’ earning capacity. The National Economic Revival Program (NERP) of February 2003 stated that the Government would institute measures to narrow the high spreads “in line with international best practices”, and would review upwards deposit interest rates for the benefit of savers; the proliferation of service charges levied on depositors is also to be reviewed.

Table V.6.

Profitability of the Banking Sector 1/2/

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Source: Reserve Bank of Zimbabwe.

Net interest margin is calculated as the ratio of net interest income to interest earning assets.

Cost to income ratio is calculated as the ratio of total expenses to total income.

109. The liquidity ratios for all financial institutions at end-2002 were significantly higher than the prudential level of 10 percent (Table V.7).60 However, the calculation of the liquidity ratio (total liquid assets over total liquid liabilities) overstates the actual liquidity situation of the banking system since liquid assets include treasury bills that have to be deposited at the RBZ to secure temporary borrowing from the RBZ, or have been pledged as security for deposits.

Table V.7.

Liquidity Ratios 1/

(In percent)

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Source: Reserve Bank of Zimbabwe.

Total liquid assets over total liquid liabilities.

110. Some banks have experienced substantial liquidity shortages, and frequently borrow from the RBZ. Seven institutions have received substantial liquidity support from the RBZ for an extended period of time (during 2002, this support varied between ZS4.0 billion and Z$l1.4 billion), and at rates that have been below the prevailing rate on short-term treasury bills.61 These developments raise questions about the temporariness of liquidity support and the underlying causes; RBZ guidelines call for funds to be made available only to banks that are solvent and viable; on a short-term, temporary basis; at a penalty rate of interest (2.5 percentage points above the 91-day treasury bill rate); and that are secured by eligible assets.62

111. The quality of risk management varies considerably among banks. According to the BSD, the majority of foreign-owned banks and well-established banks are managing the risks posed by the unstable macroeconomic environment by limiting lending to quality creditors and by either lending only against collateral, or not at all, to counterparties in the interbank market. Other banks, however, exhibit an aggressive risk taking stance in order to gain market share, or realize short-term profits.

112. The principal risk for the banking system appears to be credit risk as a return to positive real interest rates could seriously affect the ability of many debtors to repay. This risk could be exacerbated by the extent to which borrowed funds have been applied for speculative purposes. At the same time, the risk also depends on the extent to which a rise in interest rates would go hand-in-hand with price and exchange market liberalization.

113. Interest rate and foreign exchange risk for the banking system as a whole appear to be limited. In view of the severe shortage of foreign exchange in the economy, the foreign exchange assets and liabilities of the banking system are not substantial, and at end-December 2002 accounted for about 2 percent of total assets. The banking system as a whole furthermore had a long position in foreign exchange amounting to Z$2.4 billion. Interest rate risk, stemming from maturity mismatches, are in principle mitigated by the prevailing high interest rate spreads, and by banks’ policy to reprice loans and assets at high frequencies.63

D. Dealing with Troubled Banks

114. Under the provisions of Part DC of the Banking Act (Act 09/99), the RBZ introduced a Troubled and Insolvent Banks Policy in November 2001. The objective is to restore troubled, but viable, banks to a healthy condition, and to remove unsalvageable banks expeditiously from the system. The policy provides for informal and formal regulatory actions. Informal actions include:

  • Board Resolutions are officially adopted by the board of directors of the institution concerned, and contain a plan of action to address deficiencies within a defined time period (such actions are often drafted or suggested by the RBZ),

  • Commitment Letters are like Board Resolutions, but entail a formal letter from the board of directors of the troubled institution to the RBZ, outlining a specific plan of action and timetable for accomplishment, and

  • Memoranda of Understanding are more formal as the corrective actions are prescribed by the RBZ, and then adopted and signed jointly by the board of directors of the troubled institution and the RBZ.

115. Formal actions, or “Corrective Orders”, entail a plan imposed unilaterally by the RBZ to correct deficiencies. Corrective orders can include appointment of an advisor or supervisor; placing a bank under management of a curator; suspending a director, officer or employee; amending, suspending or canceling a license; and closure and liquidation. Since 2000 the RBZ had to take corrective action in the case of three financial institutions. In two of the cases, the problems were resolved through the recapitalization of the banks by their owners and the appointment of new boards of directors and management teams. In the most recent case, a curator was appointed by the RBZ to investigate the source of the problems, to assess the financial position of the institution, and to suggest a course of action.

116. Deposit Protection Scheme (DPS). In Zimbabwe, the establishment of a DPS was provided for in the 1999 Banking Act and it is scheduled to become effective on July 1, 2003.64 A Deposit Protection Board consisting of the Governor and two Deputy Governors of the RBZ, and three members nominated by contributing institutions has been set up. The DPS will be funded through contributions by all registered banking institutions; provision is made for an initial contribution to enable the DPS to meet any demands until the payment of the first annual contribution. Determination of the classes of deposits to be protected, the extent of protection, and the size of individual contributions are to be determined by the Board. Provision is made for the submission of financial data (normally submitted to the RBZ and Registrar of Banks at the Ministry of Finance and Economic Development) to the Board by registered banks and their auditors, and curators where applicable. The Board can request additional data on protected deposits and the financial situation of contributing members, and undertake additional inspections in cases where the solvency of a contributing institution is suspect. Market players welcomed in principle the decision to establish a DPS, but were concerned about the cost implications for the banking system, namely that the larger, prudently managed banks would have to subsidize smaller banks, and that the scheme may need to compensate for oversights in BSD’s supervision of the banking system.

52

Prepared by Louis Erasmus.

53

The financial system in Zimbabwe comprise deposit and nondeposit taking institutions; the former includes the Post Office Savings Bank (whose activities are restricted to the acceptance of savings and fixed deposits), while the latter consists of pension funds, insurance companies, and unit trust funds.

54

The statutory reserve requirement on demand deposits was raised from 30 percent to 50 percent with effect of February 1, 2001, while that on time and savings deposits was reduced from 30 percent to 20 percent.

55

Secured borrowing through this facility attracts a penalty rate of 20 percentage points above the repo rate, while unsecured borrowing attracts a further penalty rate of 20 percentage points.

56

Prior to November, the policy reference rate was the Bank Rate, i.e. the rate at which the RBZ provided overnight accommodation to the banking system.

57

MFD Technical Assistance mission of May 1999.

58

It was raised from ZS100 million to Z$500 million. For merchant banks the minimum capital requirement was raised from Z$60 million to Z$300 million; for discount houses, from Z$40 million to Z$200 million; and for finance houses, from Z$60 million to Z$300 million.

59

Nonperforming loans comprise substandard loans (past due more than 90 days, but less than 180 days), doubtful loans (180 days to 360 days), and loss loans (360 days and more).

60

Liquid assets consist of notes and coins, balances with the RBZ other than required reserves, balances with domestic and offshore banks, treasury bills, quoted local registered securities issued or guaranteed by the government with a maturity of up to six years, negotiable certificates of deposit, and other liquid assets. Liquid liabilities consist of total deposits and other liabilities and debt that are due in one year or less.

61

Five banking institutions have been receiving such support for at least two years, while the other two have been receiving support for eighteen months.

62

The provision of liquidity support is covered in Section 59 of the Banking Act (Act 09/99), and elaborated in Banking Circular No. 01–98/BSD on Liquidity Support and Lender of Last Resort Facilities.

63

Lending rates are adjustable, and rates on existing loans can thus be modified in line with changes in the cost of funds (principally stemming from an adjustment in the monetary policy stance.

64

Part XII of the Banking Act (Act 9/99); the arrangements for its establishment were elaborated in Statutory Instrument 29/2003.