We saw it coming
I penned the article below for the Zimbabwe Independent Banks and Banking Survey published in September last year. I saw it coming although I received a tongue
-lashing from bankers, one of whom is a senior executive at one of the banks currently facing difficulties.HISTORY, we are told, has this uncanny habit of repeating itself. Whilst a lot might, for the uninitiated, look to have taken place since the last mini-banking crisis which started at the end of 2003, it is a case of being the more things change, the more they stay the same. We are saying this because a number of conditions that preceded the 2004 banking crises are also obtaining in the market right now.
But before we discuss these conditions, we need to answer the question; what is a crisis? According to a paper prepared by Asli Demirgüç-Kunt and Enrica Detragiache in 1998 on behalf of the World Bank, a banking crisis is “an episode in which a large number of banks suddenly become illiquid or insolvent”. A bank is illiquid if it cannot meet the calls for deposits by its customers and is insolvent if accumulated losses erode all its capital. A major crisis is one in which a substantial fraction of the banking system is endangered.
The first half of 2003 saw a rapid acceleration in the annual inflation rate which started the year at roughly 200% and had reached 600% by December. On the exchange front, the peg on the Zimbabwe dollar continued with the rate set at $824 to the US dollar. However, a thriving parallel market existed, with the rate starting the year at $1 400 and closing at $6 000 (figures in old dollars). Banks were alleged to be major players in this market.
From a policy perspective, there appears to have been some form of paralysis with the banking system basically trading rudderless. There was a biting cash shortage, as the inflation spiral caught the central bank unawares and the huge transaction demand had to be eased by the introduction of several high denomination notes.
The negative real returns spurred on by a loose monetary policy framework on the money market are nothing new. The returns on the treasury bills that were in issue in the market was hugely negative, even on a compounded annual basis. The result was a very buoyant stock market, which moved from 103,5 points (revalued) and by mid-year had reached 277,30 points, thus showing a return of 168%. This was however below the monthly compounded official inflation rate of 198,2% for the six months. The second half showing was much more impressive, the market racing to 714,25% by end of November, having notched a record 103% gain in July. This equated to a massive 11 months return of 590%. Shares had convincingly surpassed the compounded monthly inflation rate for that period of 512,7%.
Banks were rumoured to be large players in the stock and foreign currency markets. The more adventurous sought to hedge themselves against the rampaging inflation by acquiring physical trading assets and motor vehicles in addition to taking positions is foreign currency and equities. There was also a lending boom, as companies borrowed heavily in the face of negative interest rates.
As a result of these activities and the rapid revaluation of the assets acquired most banks, particularly the indigenous ones, recorded some breathtaking interim results. A closer look at the financials released by particularly indigenous showed a huge propensity to succumb to a liquidity and interest rate crunch. The banks had hugely ‘liability’-sensitive balance sheets and were particularly susceptible to both liquidity and interest rate risks. Moreover, most of the assets were not trading assets and neither were they securitised, hence the banks were incurring losses on the ‘book’ but were making up with asset revaluations.
December 2003 was a watershed month as interest rates suddenly became positive, the foreign currency market stagnated, and asset prices, particularly cars and vehicles, also slowed down. There was a serious liquidity crunch and most banking institutions found themselves battling with mounting losses as liabilities repriced upwards at a faster rate than assets. The result was that losses were recorded. ENG Capital fell by the wayside and Century Discount House was closed.
Before drawing parallels between 2003 and 2007, we show the two scenarios separately to emphasise the relationships between the benchmark yields on money market instruments and annual inflation.
Not only are the situations that the banks find themselves in similar but 2007 is worse in as far as the level of negative real returns is concerned. All the other trend patterns are not too dissimilar. Inflation has moved from the chronically high inflation phase into a proper hyper-inflationary phase. In terms of policy, money supply remains not only expansionary but growing at a very fast pace. Real returns on the money market are hugely negative, with one year treasury bills currently yielding 340% per annum in an environment where the official inflation rate is expected to be on the other side of 20 000% by December 2007. The exchange rate remains fixed whilst on the ‘other’ market the Zimbabwe dollar has taken a beating. The rate on the parallel market opened the year at roughly $3 000 to the Greenback and by half year was estimated to be trading at $190 000.
The property market is not far behind the ball game. Neither has the stock market disappointed, surpassing all the benchmarks by a respectable margin. The industrial index went up by 7 469% whilst the Zimbabwe dollar depreciated by 6 567% in the same period. The most pessimistic inflation estimate is showing 4 033% for the monthly compounded rate. The buoyancy of the stock market cannot be attributed to the activities of traditional investors alone but the entrance of a new breed of investors, banks included.
In comparison to 2003, the only difference is that, there isn’t a credit boom going on. The funds that would ordinarily found their way into loans and advances are ostensibly being channeled into real assets.
The tell tale signs are the huge movement in profit levels which coincide with a rally in the stock market. The other ‘mark of the beast’ as it were is the huge profits on asset revaluations and the consequent movement in fixed asset values as well as other assets.
Banks for this interim period to June 2007 will report phenomenal results. In similar fashion to 2003, most of the balance sheets are huge liability sensitive, with liability durations being far much shorter than asset maturity profiles. As a consequence, the banks are exhibiting the systematic vulnerability as they did in 2003.
In conclusion, the ingredients for a liquidity crunch and interest rate induced bank difficulties are in place, what is left is the trigger. In 2004, it was the change in monetary policy at the end of 2003 which saw interest rates becoming positive, resulting in a severe credit and liquidity crunch. Asset prices also collapsed as interest rates became positive.
Back then in 2003/04 the bad luck event was the tightening of the monetary policy, the bad policy was the change from negative real interest rates whilst the bad banking was the investment decision.
Like the Norwegian case, we leave you to determine what the bad luck event will be, what the bad policies are and how bad banking practices feature in the equation.