An analysis of bank lending suspension

There has been panic in the corridors of the financial sector following a raft of measures aimed at controlling the growth in broad money supply by the reserve Bank of Zimbabwe.

These measures as addressed by the president on May 7 included among others, the suspension of lending by banks to the government, corporates and individuals.

The measures were put in place due to speculators’ increased round tripping behaviour between Zimbabwean currency’s two exchange rates — the interbank rate and the black market rate — which has been alleged to erode the local currency and fuel inflation.

The round-tripping trade, known as burning currencies in street lingo, works as follows: a business person borrows local dollars from a bank.

he or she converts the local dollars into the US$ at the official interbank rate say of 173 to 1. Then converts back the US$ to local currency at the parallel market rate of 450. After paying off the loan, he or she will have plenty of change to repeat the cycle.

Thus the business person makes huge profits from borrowing.

As alluded to by the central bank governor Dr John Mangudya, the temporary suspension was a necessary inconvenience as it will tame heavy borrowing from banks by corporates and individuals, who are largely using the money to manipulate the exchange rate, which he called currency attack.

Zimbabwe is not the first country to suspend bank lending. Another country that banned banks from lending to corporates and individuals was ethiopia on August 11, 2021.

The temporary suspension was made to prevent what the National Bank of ethiopia described as economic sabotage. The directive in ethiopia came amid a civil war in the country’s northern region as well as a rising inflation of 26,4% in July 2021, the highest rate in a decade for the country.

Furthermore, just like in Zimbabwe, the spread between the currency’s official and parallel exchange rates were widening.

however, a few weeks after that harsh decision was implemented, the National Bank of ethiopia changed course as it realised that banning banks from lending was only making things worse. Despite the ban, the local birr currency continued to weaken sending prices of basic goods and services soaring.

Also some foreign firms evacuated some of their staff while others closed shops.

Before making my analytical submission of the effect of the bank lending suspension measure, it is very important to understand how the banking sector operates.

Firstly, the core business of banking is deposit taking and lending. The lending function is what generates revenue and profits for banks.

Banks through “fractional reserve banking” or put simply through the lending process create money. Thus on a demand (businesses) and supply basis (banks), the business of banks is lending and if banks are not able to lend then they literally have nothing to do.

Secondly, on the other hand, businesses rely on borrowing for short-term financing and operational needs. They borrow to import raw materials, pay salaries, working capital requirements and machinery. Thus in a nutshell, bank lending is the core function of banks’ financial intermediation process.

A lot of questions are being asked whether temporarily banning banks from lending was a good move by the government to reduce broad money supply growth.

The answer to this is that the effect has already been and will continue to be negatively felt over the coming weeks months.

A lot of companies have already started suspending advance payments from their clients and thus alternatively introducing operations on a cash or payments basis. Tongaat hullet, the Zimbabwean agriculture and agri-processes business which focuses on sugarcane production, wrote a letter to farmers alerting them that they could not continue offering advance payments following a recent suspension of lending by banks.

Likewise, Surrey Group which is also Zimbabwe’s largest privately owned, integrated beef and chicken abattoir also wrote a letter to their customers informing them that they were no longer able to operate using credit facilities.

Wholesale Beef also updated their customers that they would no longer be able to provide credit terms for any purchase made in local currency and they would review the US$ credit limit and terms and all account purchases going forward will be in US$ accounts.

The consequence of the bank lending suspension is that it will affect companies as they cannot survive without working capital facilities.

Companies require working capital to restock, increase capacity utilisation and smoothen their cash flows. Thus a prohibition of companies to funding will undermine their operations and curtail growth which will trickle down to affect customers.

The prohibition to credit access will lead if not companies to scale down their operations leading to shortages of goods and price escalation thus a continued vicious cycle of weakening the local currency.

The decision to suspend bank lending will also worsen the current economic crisis and thus expose borrowers to predatory loans.

This effect will legitimise informal lending societies and the rise of loan sharks who will reap high profits due to high interest rates.

In compensation for loss of income, this effect could also push bank charges upwards as banks devise survival strategies.

Significant efforts have been put towards investment promotion in Zimbabwe to date.

The ban on bank lending however will have a negative effect on investor confidence and thus a step back in the “Zimbabwe is open for business” mantra as alluded to by the Zimbabwe National Chamber of Commerce.

Although in less than a week at the ZITF we were celebrating the increase in capacity utilisation and domestic industry growth, surprisingly as a way of countering the lending ban, the Minister of Finance Professor Mthuli Ncube on May 14, proposed measures aimed at improving access to affordable basic commodities in which he opened up imports of commodities by citizens through the lowering of import tariffs.

however this is a discussion for another day!

The road to exchange rate stability is rocky.

Trying to stop water coming out of a tap because the tank is overflowing will not solve the problem.

There are a lot of leakages which need to be plugged!

There is no need to cut corners, currency reforms are key if we are to meaningfully have a stable exchange rate. Growth in local currency which in turn is blamed for fuelling the parallel market cannot be attributable to bank lending alone, as the government is well known for injecting huge liquidity as and when it makes payments to local contractors.

The Government of Zimbabwe needs to urgently review the bank lending ban and consider a lot of submissions that have been put through from the business community.

It’s high time the game theory mood between government and the private sector came to an end.

There is a need for dialogue between the government and the business community so as to reach a lasting consensus.

Zuze writes in his personal capacity. His interests are in socio-economic policies, domestic resource mobilisation, mineral resource governance and taxation. These weekly New Perspectives articles published in the Zimbabwe Independent are coordinated by Lovemore Kadenge, an independent consultant, past president of the Zimbabwe Economics Society and past president of the Chartered Governance & accountancy Institute in Zimbabwe (CGI Zimbabwe). — kadenge.zes@gmail.com or mobile: +263 772 382 852.