Government spending spree oils banks

The government’s spending spree in the run-up to the presidential elections run off of 2008 provided commercial banks with liquidity as all the money was channelled through formal banks.

Banks had nothing else to offer because real interest rates were so low that cash-rich clients poured their money into the Zimbabwe Stock Exchange rather than the money market.

Because of the rush to the equity market, the industrial index rose by 527 million percent between January and 4 September 2008. The mining index was up 436 million percent.

Central bank governor Gideon Gono continued to accommodate the government’s demand for credit by printing money.

Full cable:

Viewing cable 08HARARE773, ZIMBABWE’S BANKS RIDING ON GOVERNMENT SPENDING

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RUEHGV/USMISSION GENEVA 1524

UNCLAS SECTION 01 OF 04 HARARE 000773 

AF/S FOR G.GARLAND 

ADDIS ABABA FOR USAU 

ADDIS ABABA FOR ACSS 

COMMERCE FOR BECKY ERKUL 

TREASURY FOR J. RALYEA AND T.RAND 

NSC FOR SENIOR AFRICA DIRECTOR B.PITTMAN 

STATE PASS TO USAID FOR L.DOBBINS AND E.LOKEN 

SENSITIVE 

SIPDIS 

E.O.12958: N/A 

TAGS: EFIN ECON PGOV ZI

SUBJECT: ZIMBABWE'S BANKS RIDING ON GOVERNMENT SPENDING 

REF: HARARE 0760 

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Summary 

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¶1. (SBU) The liquidity crisis that gripped Zimbabwe's banking sector 

at the end of 2007/early 2008 has abated thanks primarily to high 

election-related government expenditure. On the other hand, 

borrowings associated with the funding of these expenditures along 

with concessionary finance facilities offered by the Reserve Bank 

have led to explosive growth in money supply and hyperinflation. 

Commercial lending has almost dried up for lack of bankable projects 

and due to the Reserve Bank's pervasive subsidized lending, leaving 

bank assets dominated by zero-risk-weighted treasury bills. 

Consequently, credit risk within the banking sector is almost 

non-existent. In regard to recent new minimum capitalization 

requirements, banks have complied mainly by re-valuing their 

property at favorable, but deeply distorted, exchange rates, leading 

them to appear well capitalized, at least in the short term. Once 

the GOZ implements sound macro-policies and lending to the private 

sector resumes, however, they will need recapitalization and some 

consolidation within the sector can be expected. (End Summary) 

--------------------------------------------- 

Government Spending Resolves Liquidity Crisis 

--------------------------------------------- 

¶2. (SBU) John Mushayavanhu, Deputy President of the Banker's 

Association of Zimbabwe, told us that bank liquidity had improved 

dramatically in the past four months as a result of high government 

expenditure associated with the June 27 presidential run-off and 

post-election populist policies. Government spending is channeled 

through the formal banking sector and thus provides liquidity to the 

banks. The spending spree compensated for the banks' inability to 

offer real positive interest rates on deposits. Real interest rates 

are, in fact, so low that cash-rich clients pour their money into 

the Zimbabwe Stock Exchange rather than into the money market. 

Buoyed by the inflow, the Industrials index on September 4 had risen 

527 million percent since January 1 and the Mining Index was up 436 

million percent. 

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RBZ Applies Punitive Instruments 

-------------------------------- 

¶3. (SBU) Typical of monetary policy since Gideon Gono became Reserve 

Bank Governor, the RBZ continues to accommodate the government's lax 

fiscal policy. Government's demand for credit from the monetary 

banking sector has been the main cause of the exponential growth in 

Zimbabwe's money supply as the RBZ covers its losses from its 

quasi-fiscal activities by printing money. 

------------------------------------------ 

Punitive Statutory Reserve Requirements... 

------------------------------------------ 

¶4. (SBU) Notwithstanding that the RBZ itself is the source of 

monetary expansion, it has addressed the consequent problem of 

inflation by hiking bank statutory reserve requirements to levels 

well above the international norm. Statutory reserves serve as a 

fallback to depositors should a bank be threatened by a run on 

deposits. Mushayavanhu told us banks were lobbying for a 

substantial reduction in statutory reserves from the average of 

HARARE 00000773 002 OF 004 

about 50 percent to the internationally accepted level of around 10 

percent, since Zimbabwe already had in place a deposit insurance 

scheme to protect its depositors. (Comment: We don't expect the RBZ 

to lower statutory reserves by much, as the RBZ uses them to fund 

subsidized lending. End Comment) 

¶5. (SBU) In addition, the RBZ employs harsh terms for settling 

overnight accommodations for institutions that are either caught 

short or have excess funds at the end of any trading day. For 

institutions that are caught short, the accommodation rates are 

8,500 percent and 9,000 percent per night. Being caught with excess 

funds is equally onerous: The excess is swept into non-interest 

bearing 90-day non-negotiable certificates of deposits (NNCD). 

(Note: Until January 31, 2008, NNCDs had an even more punitive 270 

day maturity which had rendered liquidity management a nightmare for 

most banks. End Note). ZB Financial Holdings Chief Economist Best 

Doroh told us that bank borrowing from the RBZ had been the norm 

earlier this year until high government expenditure put the banks in 

a surplus position. 

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No Credit Risk 

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¶6. (SBU) Doroh and Mushayavanhu each commented that bank lending on 

commercial lines had all but collapsed since introduction of the 

RBZ's concessionary facilities. Barclays bank and CFX bank half 

year results, for example, show that advances fell by 94 and 96 

percent respectively between June 2007 and June 2008.   Not only was 

there a dearth of bankable projects due to the poor macroeconomic 

environment, but most loans and advances were made under the RBZ's 

Agriculture Sector Productivity Enhancement Facility (ASPEF) and 

Basic Commodity Supply Side Intervention (BACOSSI) facilities at 25 

percent interest per annum. With the official rate of inflation for 

June 2008 at 11.2 million percent, and the actual rate in the 

billion percent range (reftel), the real return on concessionary 

lending is deeply negative. 

¶7. (SBU) Moreover, government borrowing from the monetary banking 

sector through treasury bills (TBs) has left the sector holding 

significant amounts of very low yielding (currently 340 percent per 

annum) TBs, for lack of acceptable alternative assets. Financial 

results show that, on average, bank loans and advances accounted for 

only 15 percent of the total assets of the banking sector at end 

December 2007-a very low percentage considering that loans and 

advances constitute the core function of banks. In addition, of this 

small amount, the bulk was ASPEF and BACOSSI lending. 

¶8. (SBU) Doroh and Mushayavanhu each said separately that banks were 

also involved in very short-term lending through bankers acceptances 

at rates between 25 and 30 percent either overnight or for up to 30 

days as a way of avoiding locking up funds for 90 days in the RBZ's 

non-interest bearing NNCDs. Mushayavanhu explained that credit risk 

was therefore non-existent as the loan book did not contain doubtful 

clients who might default on their obligations. Doroh shared this 

view, stating that ZB Bank screened lending rigorously to minimize 

default risk. 

¶9. (SBU) Doroh said that banks indulged in non-core activities to 

preserve their capital base and hedge against inflation: They bought 

and sold shares on the stock exchange, traded in property, and 

traded in foreign exchange. Indeed, Fulton Chibaya, the Chief 

Executive Officer of Genesis Bank told us that the partial 

liberalization of the foreign exchange market introduced on April 

HARARE 00000773 003 OF 004 

30, 2008 had contributed to resolving the banks' liquidity problems 

as they could sell foreign exchange when short on any trading day. 

He also noted that banks with immobile assets and shares were 

turning out high unrealized profits through fair value adjustments 

thereby boosting their balance sheets. Although the liquidity 

situation had improved, Doroh said the challenge of poor returns 

nevertheless remained. 

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Minimal Foreign Exchange Risk 

----------------------------- 

¶10. (SBU) Zimbabwean banks do not extend foreign currency loans 

because of the binding foreign exchange constraint in the economy. 

As a result, foreign exchange risk is minimal except for banks' 

difficulty in obtaining foreign exchange to pay for computer 

hardware and software licenses. In that regard, in the past year 

U.S. debt collectors have called on post to express interest in a 

half dozen cases in which Zimbabwean banks and telecommunications 

companies could not access foreign exchange to pay for their IT 

licenses. 

------------------------ 

Fraud Poses Greater Risk 

------------------------ 

¶11. (SBU) Mushayavanhu viewed internal fraud as the major risk 

facing banks in the prevailing hyper-inflationary environment, as 

salaries have collapsed in real terms. Godfrey Kanyenze, Director 

of the Labor and Economic Development Research Institute of Zimbabwe 

(LEDRIZ) concurred, and added that the collapse in earnings had also 

triggered massive skills flight. 

--------------------------------------------- ---- 

Higher Capital Requirements Pose Little Challenge 

--------------------------------------------- ---- 

¶12. (SBU) Mushayavanhu said that as of June 2008 all banks had met 

the new minimum capital requirements effective September 1, 2008 of 

US$12.5 million for commercial banks, US$10 million for merchant 

banks and building societies, US$7.5 million for Finance and 

Discount Houses, and US$2.5 million for Asset Management Companies, 

calculated in local currency at the inter-bank exchange rate. Most 

of the banks held properties that had been revalued in US$ terms, 

allowing them to meet the new capital requirements easily. James 

Mushore, co-founder of NMB Bank, told us that NMB, for example, had 

met the requirement in this way. CBZ Holdings' Finance Director 

Never Nyemudzo indicated that CBZ Bank was sitting on a capital base 

of US$42.48 million and its building society on a base of US$48.96 

million. Mushayavanhu stated that most banks had capital adequacy 

ratios of 200 percent, which is ridiculously higher than the Basel 

standard of just about 10 percent, indicating that the banks are not 

deploying their assets effectively. 

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Comment 

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¶13. (SBU) Banks are currently enjoying the benefits of high market 

liquidity stemming perversely from high government expenditure, but 

the downside risks associated with a return to sound macroeconomic 

policies are high. Government expenditure will inevitably fall and 

money market conditions tighten, forcing banks to manage liquidity 

more prudently. Lending to the private sector will also likely pick 

HARARE 00000773 004 OF 004 

up as companies borrow to upgrade plant and equipment. To the 

extent that interest rates will rise in the first instance, 

increased lending will bring with it interest rate risk as well as 

credit risk. Moreover, we foresee a massive devaluation of the 

Zimbabwe dollar to offset the high inflation differential between 

Zimbabwe and its trading partners. Banks are likely to obtain 

foreign lines of credit for their clients, which will require that 

they set aside some capital to cover foreign exchange risk. 

Clearly, when Zimbabwe undertakes the necessary reforms and banks 

re-engage in their core businesses, they will have to recapitalize 

substantially and return to active asset and liability management to 

remain viable. In this regard, some consolidation within the sector 

is likely given the sharp contraction of the economy over the past 

ten years. Small indigenous banks, in particular, are likely to 

merge in order to raise required capital. End Comment. 

MCGEE

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