Since the banking
crisis of 2004 confidence in the financial system has been at the deep
unenviable scale of fragility. Profound issues ranging from governance to
structural composition of banks led to the inevitable collapse of several
institutions eroding depositor confidence along the way. Contrary to popular
assertion and belief that most of the issues bedevilling Zimbabwe’s banking
sector were confined to the Zim dollar era, same problems continue to be felt
to this day. The outcome has always been the same. Confidence in the banking
sector is fragile!
Just like the retail
sector has witnessed a new revolution in the form of vendors, the financial
sector in Zimbabwe is facing its own in the form of shadow banks. There is no
clear cut definition for shadow banks but the general understanding of this
term revolves around institutions that act within the scope of traditional
banks but do so outside regulation and in some cases supervision. This concept
was first coined by an economist called Paul McCulley back in 2007.On a global
scale shadow banks hold assets approximately worth over USD70 trillion. In the
United Kingdom, shadow banks are worth 400% of the country’s Gross Domestic
Product (GDP) even though they are much smaller than conventional banks.More germane to
Zimbabwe, some so called “microfinance” institutions are now basically
operating as shadow banks. In a rather mundane style most microfinance
institutions have played a distinct form of a zero sum game where fragility of
depositor confidence in the mainstream financial system has been their
splendent gain.
In general microfinance
institutions are supposed to confine themselves to the provision of microcredit
to the lower end of the consumer chain which is typically made up of low income
groups and small businesses that are supposedly shun by mainstream banks. On
the contrary, most microfinance institutions are moving into spheres like
structured finance, asset and trade finance, investments (often using pyramid
schemes), securitization and even mortgage based lending. This is the reason
why they have become shadow banks in themselves because all such activities are
preserved for the regulated mainstream banking system.
Of what scale are
shadow banks corrosive to the economy?
The sub-prime mortgage
crisis which culminated into the great recession of 2007-2009 was partly caused
by some shadow banks which were actively trading in credit default swaps and
other derivatives which were loosely regulated. This in itself shows the great
magnitude of convulsions which may be caused by shadow banks to the economy. Shadow
banks in Zimbabwe have the potential of crowding out mainstream banks in the
provision of credit, particularly consumer and small business loans. In a
normal economy financial institutions are supposed to make the bulk of their
income through credit but with the current situation where shadow banks are
sprouting at a greater scale, mainstream banks are surely poised to lose. According
to the International Monetary Fund’s (IMF), Global
Financial Stability Report 2014, shadow banks are outstripping mainstream
banking sector growth in emerging economies and in a number of contexts they
induce a soporific effect on financial intermediation.
Firms largely depend on
mainstream banking and if the credit market sways to shadow banks the situation
becomes pernicious to the whole economy. Most microfinance institutions in
Zimbabwe aim to generate returns as quickly as possible. The paradox of this
notion is only understood by proprietors of that industry but two apparent
facts may best explain this. It’s either they are horribly greedy or they are
“rightfully” doing what has to be done in an economy oppressed by crisis and
illiquidity. Lending rates in most shadow banks or microfinance institutions in
Zimbabwe are pegged at an overwhelming 20%+ rate per month!! As if that is
enough, most of these institutions have got loan tenures which don’t run beyond
three months. There is an extra
ordinary divergence with the mainstream banking system where personal loans,
for example, are priced at 15-22% per annum with most tenures tied to the loan
amount. This divergence creates a pricing matrix and gap in the credit market.
Ultimately consumers suffer especially in Zimbabwe’s complex scenario where
shadow banks hold sway. Mainstream banks at some point will be forced to review
their pricing upwards and contract tenure so as to remain competitive in terms
of income. Ultimately these price distortions stifle credit demand.
Shadow banks are not
built on robust risk management policies and tenets. This in itself is a major
threat to the financial system and the economy as a whole. Unlike mainstream
banks which have risk management statutes and programs, although they sometimes
flout them, shadow banks are mainly driven by profit and as such ignore certain
risk mitigation measures. The Basel Accord stipulates that conventional banks
hold certain amount of capital to cover operational, credit and liquidity risk
but on the contrary shadow banks see no need of holding such buffer because
every dollar they hold is for investment. As a result most of the shadow banks
are susceptible to severe risk which can ultimately lead to collapse. A lesson
on this is the great recession of 2007-2009 which saw the folding of many
shadow banks in the developed world as a result of risk.
What safety net do
shadow banks have?
This is a very
pertinent question considering that insurance in matters to do with finance is
important. It’s regrettable that the Reserve Bank of Zimbabwe cannot perform
its lender of the last resort duties but all things being equal they should
have been performing this function on mainstream banks. Apart from the central
bank, most regulated commercial banks in Zimbabwe have institutional investors
as shareholders, most of which are capable of acting as safety nets. The
picture is critically diametrically opposed in the case of Zimbabwe’s shadow
banks where most of them are solely owned meaning that they are not tied to
reliable and concrete safety nets. It becomes a problem considering that most
shadow banks in Zimbabwe are taking in collateral in the form of assets and
property.
What happens when they fold?
Conventional banks are
subject to disclosure through various instruments like financial statements and
annual reports. Shadow banks have no obligation to do so and as a result they
can evade a lot of scrutiny and liabilities. This is especially corrosive in an
economy like Zimbabwe where significant funds are tied up in shadow banks. No
one knows their capital adequacy, profits, losses or the amount of bad loans
they have.The uncontrolled growth
of shadow banks can also petrify the approach to which monetary authorities
determine policy. It is apparent that shadow banks can lead to the tightening
of banking regulations. Robert Shiller, a co-recipient of the 2013 Nobel prize
for Economics argued that, Lehman Brothers, a US investment bank was a shadow
bank and after it collapsed in 2009 the US financial system saw unprecedented
financial regulations. Tightening of regulations clearly hobbles the dynamism
of the financial sector especially when such petrification is induced by shadow
banks.
In as much as shadow
banking is corrosive, if conducted abstemiously and within proper rules it can
be of fundamental importance to financial sector growth. However, because of
the impudent manner in which most of them are run it is only wise to be
cautious!
