eBusiness Weekly
Chris Chenga
In the International Monetary Fund (IMF)’s last Sub-Saharan Africa regional report that was issued in the fourth quarter of 2017, a key risk was highlighted in most countries’ banking sectors.
A “bank sovereign nexus” is when the banking sector is exposed to central government debt; in a manner where banks’ holdings of domestic sovereign debt amplify the transmission of sovereign risk to bank’s balance sheets. It is worth highlighting that a bank sovereign nexus is not an African phenomenon. It occurs in many situations where governments under debt stress risk defaulting on their obligations. For instance, the Euro-zone in the last recession went through this, much so, to an extent where the bloc tried financial instruments called “European Safe Bonds” that were meant to securitise government bonds.
They were not successful. However, just because a risk is not uncommon, that should not relax adroit governance from expending thought and research towards potential resolutions for that risk. Some suggestions are already out there. For instance, use of fiscal buffers by governments may work to mitigate sovereign risk exposure to their banking sectors. The use of fiscal multipliers can also be used in rationalisation of expenditures that often account for a large proportion of government debt. But these are all actions that can only be taken by policymakers in government and central banks; these aren’t actions that banks themselves can take to protect themselves from sovereign risk.
The bank sovereign nexus risk may not be taken so seriously in Zimbabwe by actual bankers at the moment. It is often simplified to a scenario where government has already been issuing treasury bills to banks, it has met its obligations on these TBs, and furthermore, there remains the option for banks to trade these TBs on the market.
In fact, with few profitable lending channels in the economy, domestic sovereign debt can be perceived, and in some regards justified, as a welcome alternative to private sector lending. But perhaps bankers need to take heed, as they could be benefitting from a scenario that owes an overextended goodwill to government, yet the economy remains vulnerable to other occurrences that may prove overbearing to this temporary sovereign discipline.
Many bankers in Zimbabwe will attest to the fact that cost of credit is relatively high in Africa. Locally, the high central lending rates make the proposition for banks to earn their own margins very low, considering the high costs of operation. It is commendable that many other governments and their central banks have recently shown awareness to the high cost of credit. Consider Ghana, which has brought central lending rates down five times in the last year alone.
The central bank of Kenya reduced its rate to the lowest in three years.This is good from a policymaking stand point. However, it is enabled by broad macro-economic occurrences that are favorable, for now. Ghana’s Monetary Policy Committee (MPC) cited plummeting inflation and stability of the Cedi as making the rate cuts conducive, and Kenya’s MPC also noted slowing inflation as encouraging the lowered rates.
It is important to conduct this presentation in a regional context because local bankers must understand that success in lowering rates in other countries is due to their greater control over macro-economic occurrences than our policymakers. In Zimbabwe, the central bank does not have significant discretion two very vital economic levers; currency exchange rate stability, and due to the economy’s productive dependence on imports, without a local currency there is less control over inflation.
Thus, it is very difficult to foresee the Reserve Bank of Zimbabwe (RBZ) lowering its lending rates anytime soon in similar manner to its peers in recent quarters. This means that with retained high interest rates in the foreseeable future, there will remain a high risk of non-performing loans, and the already existent low profitability in interest income.
Now, what makes sovereign risk conceivable is that with this limited policy capacity as explained, there are real external headwinds which may befall the Zimbabwean economy, particularly government. With the closing window of low borrowing costs in developing economies, borrowing costs are going to go up. In recent years, rates from East and West were as low at 1 percent, but they are to go upwards as monetary policy wears down in these regions, comparable benchmarks are 4 percent yields on US treasuries.
Moreover, tougher borrowing conditions come along with these higher rates. These factors put pressure on an already constrained government facing civil service and public provision discontent – indeed experience has taught us that the aforementioned temporary fiscal discipline we are seeing from government often falls on the wayside for political expedience.
Also, high rates in developed economies likely mean that US dollars may become scarcer — a scenario that elevates risk of inflation in our economy as already clinging under capacity industry is dependent on foreign currency for production. Indeed these fears may be exaggerated; or they may not — the RBZ and private banks hardly conduct such diligence to calculate regressions on these factors.
If there is merit to these fears, then for bankers, such occurrences suggest elevated the risk of defaults on already existing balance sheets, and less profitable credit opportunity within the economy. So while local bankers seem content that the bank sovereign nexus is not yet a significant risk, they should reduce their confidence apportion to policymakers and consider external headwinds that may further weaken market credit opportunities. It would be wise to research and implement their own actions to both improve costs of credit on the market, and identify profitable credit channels if lending will ever return to being their main business unit. Banks have been dependent on non-interest activities for profits.
However, with reduced credit in the economy, even the current clients utilising banking services are not going to grow. Indeed this is not to be cynical, but for bankers to take heed and accountability for foresight in their own sovereign risk mitigation.
Of course there is hope. Some good things can happen. There has to hope that government’s fiscal obligations are resolved at the earliest stage possible with foreign creditors. The lending facility by the CDC Group was a great gesture, and can be big time if well utilised.
Bankers however cannot operate and plan on optimism, it seems wiser to be conservative and just like their perspective on Government, focus on that which they can control.
