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Cablegate: Zimbabwe's Banks Riding On Government Spending

VZCZCXRO5358
RR RUEHBZ RUEHDU RUEHJO RUEHMR RUEHRN
DE RUEHSB #0773/01 2481509
ZNR UUUUU ZZH
R 041509Z SEP 08
FM AMEMBASSY HARARE
TO RUEHC/SECSTATE WASHDC 3377
INFO RUCNSAD/SOUTHERN AF DEVELOPMENT COMMUNITY COLLECTIVE
RUEHUJA/AMEMBASSY ABUJA 2052
RUEHAR/AMEMBASSY ACCRA 2255
RUEHDS/AMEMBASSY ADDIS ABABA 2375
RUEHRL/AMEMBASSY BERLIN 0904
RUEHBY/AMEMBASSY CANBERRA 1652
RUEHDK/AMEMBASSY DAKAR 2008
RUEHKM/AMEMBASSY KAMPALA 2429
RUEHNR/AMEMBASSY NAIROBI 4861
RUZEHAA/CDR USEUCOM INTEL VAIHINGEN GE
RUEAIIA/CIA WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHC/DEPT OF LABOR WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RHEFDIA/DIA WASHDC
RUZEJAA/JAC MOLESWORTH RAF MOLESWORTH UK
RHMFISS/JOINT STAFF WASHDC
RHEHAAA/NSC WASHDC
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

-------
Summary
-------

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.

--------------------------------
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.

--------------
No Credit Risk
--------------

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.

-----------------------------
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.

-------
Comment
-------

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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