News Column

Non-Performing Loans a Key Challenge for the Banking Sector

September 3, 2014

Sanderson Abel

Rising levels of non-performing loans (NPLs) in Zimbabwe continue to exert strong pressure on banks' balance sheet, with possible adverse effect on banks' lending operations. Since the onset of the multi-currency system, NPLs in the country has increased to an average of 18,5 percent from just above 2 percent in 2009.

It is becoming very clear now that at this juncture the surge in NPLs has become an immediate destabilising factor for the recovery of the economy.

The feedback effects from the banking system to economic activity undermine a sustained recovery and may pose significant vulnerabilities going forward.

Acknowledging the gravity of the problem, the Reserve Bank of Zimbabwe Governor Dr John Mangudya has accorded the resolution of the NPLs problem top priority as enunciated in the recently announced Monetary Policy Statement.

There are many reasons why as country and the policy makers should be worried NPLs given this is not only a monetary phenomenon but it also impact heavily on the real sector.

The impact of the real economy on NPLs is mainly explained by weakening the borrowers' capacity to repay their debt, while the feedback from NPLs to the real economy is often identified through the credit supply channel.

For instance high NPLs increase the uncertainty regarding the capital position of the banks and therefore limit their access to financing.

This in turn increases the banks' lending rates and thus contributes to lower credit growth. In our situation, the success of the Zim Asset programme hinges on the availability of resources hence any obstacle to financing should be dealt with.

With NPLs of 18,5 percent representing around $700 million, it reflects that there are sectors that are being deprived of resources to the same magnitude.

It should be noted that NPLs lowers the banking sector capital as a result of provisioning. This also contributes to lower credit supply, and therefore may have implications for economic activity.

Another channel in which NPLs drag the economy is through disintermediation of the banking sector.

One of the mechanisms by which the problem of non-performing loans drags on the economy is that banks' intermediary function declines as non-performing loans erode banks' profitability.

Banks play an important role of allocating and distributing people's savings for use in most productive investment.

Their intermediary function is essential for economic activity as it enhances the productivity and efficiency of the economy as a whole.

If banks' amount of disposal of non-performing loans continues to exceed their profits, it will reduce banks' net worth and lower their risk-taking capacity, making it difficult to invest funds in risky projects and to realize potentially productive businesses. In this way, the problem of non-performing loans lowers banks' intermediary function.

Another challenge is when the banks hold non-performing loans for a long time without disposing them.

In this case banks incur costs other than the amount of disposal of non-performing loans. That is to say, by continuing to hold non-performing loans, or assets that do not generate returns, banks would lose returns that they would have earned if they had collected the loans (this is called "opportunity cost").

Hence the opportunity cost of holding non-performing loans by the banks is the returns that bank could get if that money had been put to productive use. This cost affects both the bank and the economy at large.

With all these challenges of NPLs, corporates and individuals should learn to understand that lending is a major line of business for banking firms as they provide credit for a wide array of business purposes.

The process of lending represents a key source of funds for the business sector while being an important line of business for the banking industry.

The process of credit should not be disturbed through defaulting by borrowers. It is important that borrowers should understand that lenders only make loans when they think they'll be repaid.

Your credit history is important in helping you qualify, since it shows how you've used loans in the past.

Good credit means you're more likely to get a loan at a reasonable rate. Failure to repay a loan can destroy your credit rating, making it difficult or impossible to get loans in the future.

It should be noted that failure to honour your loan obligation has severe and long-lasting consequences, including the following:

The bank can immediately demand repayment of the total amount due on the loan.

The bank will attempt to collect the debt and may charge you for the costs of collecting.

Your credit rating will be damaged, which will make it difficult for you to make purchases such as a car or house.

You may be taken to court where you will be forced to pay

As you undergo court processes you tend to incur high costs and unnecessary inconveniences

Your salaries or wages or company accounts may be garnished to recover your owing to the lenders

Defaulting on loan obligations may result in the defaulter being less able, to borrow again in the future from banks and other credit institutions

It is hence important for the prosperity of both the country and the banking sector that all economic agents should deal with the NPL problem in a holistic manner so that resources are freed to productive sectors.

Sanderson Abel is an Economist. He writes in his capacity as Senior Economist for the Bankers Association of Zimbabwe. He can be contacted on or on 04-744686, 0772463008.

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Source: AllAfrica

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