They say extraordinary problems call for extraordinary solutions. In April 2022 the government of Zimbabwe shocked the world when they barred banks from lending. They assured us it was the only way to deal with the currency manipulation which was (is) rapidly devaluing the local currency.
The ban did not last long, in 10 days time banks were allowed to go about their core business again. However, a few companies were barred from accessing loans as the govt investigated their business practices further.
Those investigations were completed and let us look at what the government found out.
Outcome of investigation of abuse of commercial bank loan facilities by certain business entities
The FIU has completed investigations on possible abuse of loan facilities by 15 entities and has made the following findings:
1. The majority of the entities investigated have adopted business models based on arbitrage, whereby they make significant profit margins by borrowing at concessionary terms, stocking and then selling their products in US$ or in Zw$ at inflated parallel market exchange rates, thus enabling them to easily pay off the loans from a portion of the proceeds, and start the borrowing cycle again.
This is a problem the govt and the Reserve Bank of Zimbabwe created. All this comes from their insistence on maintaining the forex auction. They can call the parallel market exchange rate ‘inflated’ all they want but it is closer to the actual position than the auction rate.
The arbitrage opportunity only exists thanks to the disparity between the auction/willing buyer willing seller rates and the parallel market. Should the govt liberalise the official markets we would have one exchange rate, killing the arbitrage opportunity.
Does this excuse the businesses taking advantage of the situation? No. What started as a means to hedge against a fast depreciating ZW$ later became a business model. That cannot be defended.
However, we have to remember that these businesses need forex and do not get all that they need from formal channels. These businesses supplement the forex they get from operations, forex auction and bank loans with purchases on the parallel market.
If they don’t price their products using the ‘inflated’ parallel market rate they won’t be able to restock. See, these businesses have to accept the fast depreciating ZW$ and if they don’t mark up their prices accordingly, inflation will make restocking a problem.
2. Most of these entities generate significant revenues, in either ZW$ or US$ or both, which are sufficient to cater for their working capital requirements. Instead of using their own revenues, they opt to fund most of their working capital requirements from the concessionary loans.
The financial model we adopted glorifies credit. Every businessman worth their salt has read countless books advising that using your own money when you can get credit is stupid. So, I don’t understand why the RBZ is highlighting this. It’s not a secret that most businesses strive to be in that position.
3. Some of the entities investigated abused their access to loans by “multi-dipping” across several banks. In one example, an entity concurrently accessed ZW$6.5 billion worth of loan facilities from 12 of the 16 banks. Many other entities would have loan facilities running simultaneously at 5 or more banks.
Need I repeat myself. Whoever was managing these companies was doing a great job in the context of the financial model we use in Zimbabwe. Not to mention the currency situation which makes the 12/16 company my hero.
If banks were doing their due diligence and figuring that these overly leveraged companies were good for the loans then it was all good in my book.
We talked about the improving credit rating in Zimbabwe and one hopes the 12th bank that lended to that one company at the very least knew that their customer had loans from 11 other banks.
That said, it is ridiculous that one company would get loans from almost all banks whilst most of us had the loan door shut in our faces. Just saying.
4. There were instances, where the entities investigated, would access loans for their own working capital, but in reality for the benefit of third-party entities either within the same group or unrelated. There were also instances where a holding entity, with little or no operations of its own, would borrow heavily for subsidiaries, who themselves would be accessing similar cheaper loan facilities directly from the banks. Such arrangements are a form of abuse of the financial system for material benefit by taking advantage of cheaper borrowing and repaying when exchange rates have been depreciated.
I’m confused now. I thought business was all about taking advantage of cheap borrowing. I thought the public company only existed because of this – access to cheap finance.
We have long known that businesses only borrow from banks because it’s impractical to raise funding from shareholders for everything. Also, raising from shareholders results in share dilutions and what not.
Banks were a source of funding in spite of their high costs. Then the RBZ’s monetary policies somehow resulted in banks becoming a cheap source of funding. I can tell you right now, very few businesses would have bothered with going public if they could have raised funding from banks on the cheap.
In all this, the RBZ comes out blaming the businesses that have taken this route of abusing the system. Essentially saying, ‘we know that there is this source of cheap funding but please don’t adapt to this new economic development.
Who’s fault is it that the system is broken in the first place?
5. In some cases, loans were accessed as working capital, but diverted to third-party entities for purposes of funding purchases of foreign exchange on the auction on behalf of the funding entities.
This goes back to the arbitrage opportunity created by the RBZ-influenced forex action rate being significantly lower than the people’s exchange rate.
I know it is ‘frowned upon’ to use borrowed funds for purposes other than those for which you borrowed. That behaviour introduces risk to the lender that they didn’t factor in when they decided to lend.
No one wants to lend to someone thinking they are going to use the funds to restock their tuckshop only to hear they used the funds kumabhiza (gambling).
So, I agree that it was wrong for the businesses to divert borrowed funds to other uses. However, to be frank, I think the banks didn’t mind this. Mainly because companies that used the borrowed funds to deal in currencies would be in a better position to repay those loans than companies that used the borrowed funds to clear salary arrears.
The RBZ’s solutions
(i) No bank shall extend a loan to an entity or individual at an interest rate below the prevailing Bank policy rate.
Okay, this removes one area banks could have a competitive advantage but few should have problems with this solution.
(ii) Banks shall implement appropriate due diligence measures to ensure that borrowing by holding entities on behalf of their subsidiaries are properly justified and that the loans are used strictly for the intended purpose. Banks shall implement similar measures in the case where an entity borrows on behalf of an associated entity.
Another reasonable measure. I think neither the lender nor the borrower are ecstatic about it but it’s a fair measure. I don’t know if the banks that have been stripping their staff can implement the due diligence needed to ensure loans are used for the intended purpose.
(iii) Banks shall also –
(a) ensure effective credit risk management, including loan monitoring and enforcement of loan covenants, client visits and other measures to ensure that borrowings are used for the intended purposes; and
(b) ensure compliance with the prescribed prudential lending limits provided under the Banking Regulations SI 205 of 2000, and more particularly that:
-the aggregate of loans and advances outstanding at any time or any single obligor shall not exceed 25% of a banking institution’s capital base; and
–the aggregate of loans and advances outstanding at any time to any corporate group shall not exceed 75% of a banking institution’s capital base or 25% of any single member of such corporate group.
This is huge. The RBZ is implying that some banks were flouting these regulations. I wholeheartedly agree that banks should adhere to these limits. It is too risky to have one company hold 25% of all of a bank’s loans. A bank cannot be in the position where just one company defaulting leads to financial ruin.
We can’t have goldfish memories. We have seen some banks close shop in this country as a result of these kinds of lending practices. No matter how you square it, a bank disbursing 75% of its loans to one group is just nuts.
I know that it can be tempting to go with companies Econet, Delta and Innscor and ignore the riskier Museyamwa companies but even though it’s highly unlikely that the blue chip companies would default, it’s unwise to be tied to their performance to that extent.
(iv)The FIU shall monitor transactions on an ongoing basis to ensure that loan proceeds, as well as entities’ own revenues, are not diverted to the illegal foreign exchange parallel market and to take punitive action where abuses are identified.
(v) Whilst the suspension of lending to the investigated entities has been lifted with effect from 17 June 2022, any entity found to have actively engaged in exchange rate manipulation in order to derive illicit gains from loans shall also be referred for prosecution.
(vi)Boards of directors should enhance oversight on the management, reporting and performance of large exposures and group exposures.
(vii) The Bank will continue to monitor the effectiveness of banking institutions’ credit management practices and compliance with applicable laws and regulations.
Well done by the RBZ
I gotta say, I think the RBZ’s measures are reasonable. After the whole bank lending suspension we knew to expect anything from them but this time they surprised us in the right way. These measures are just prudent practices that banks should have been following anyway.
However, it should be mentioned that the findings they reported make it look like the drastic measure of banning bank lending for 10 days was not worth it. To be honest, most of their findings were pretty apparent to anyone with paying half attention to the Zimbabwean economy.
Seriously, we all could have told the RBZ that companies do not only borrow because their revenues can’t meet their working capital requirements. We didn’t need to ban bank lending to find that out.
In addition, the RBZ is working under the assumption that the forex auction and willing buyer willing seller policy are working as intended and that they reflect the accurate economic position. They blame those who take advantage of the arbitrage opportunities brought about by their policies.
Therefore the measures presented are flawed on arrival, they are band-aids and will do little to address the broken bones beneath the skin.