The Reserve Bank of Zimbabwe (RBZ) recently released its first quarter review of the financial sector. There are growing signs of stability in the banking sector, but some risks remain.

There was marginal growth in deposits and loans in the quarter. The significant decline in profitability from US$50,8 million in the fourth quarter of 2014 to US$4m in Q1 2015 due primarily to loan impairments, is of concern. Non-performing loans (NPLs) declined marginally from 15,9% to 15,1% while the liquidity ratio improved from 39,8% to 34,4%. Cost-to-income ratio remains high and unsustainable for the sector at 97,55% given that 61% is the average for Sub-Saharan Africa.

The central bank governor John Mangudya, has done commendable work in attempting to restore financial sector stability against a rapidly deteriorating macro-economic environment. Growth has stalled and deflationary pressures have created a challenging environment for the financial sector.

Total deposits have grown steadily from US$4,7bn in December 2013 to US$5,3bn in March 2015 while total loans increased from US$3,1bn to US$4,1bn over the same period. The loan-to-deposit ratio has decreased significantly from the peak of 102,4% in December 2013 to 76,8% in March this year.

The distribution of loans — over 22% distributed to individuals and 26% to light and heavy industries — is worrying. Given the slowdown in economic activity, both the individual and industrial sector are expected to suffer.

NPLs are likely to increase in 2015 as economic conditions deteriorate. Interest rates remain high despite efforts by the RBZ governor to drive the cost of borrowing lower. Part of the issue is the perceived or actual high country risk, which affects the cost of funds for most banks. Zimbabwe is still alleged to be high risk with international banks still unwilling to provide lines of credit to Zimbabwe.

In order to mitigate increasing credit risk, banks have maintained high liquidity ratios with average prudential liquidity ratio of 34,4% as at the end of Q1 2015.

The establishment of Zimbabwe Asset Management Company (Zamco) is likely to mitigate some of this risk by acquiring secured NPLs from the banks. Work is already underway to acquire NPLs from some of the banks. A team of investment professionals have recently been hired by Zamco to work closely with banks to acquire secured NPLs totalling over US$350m.

Zamco target is to reduce NPLs to less than 5% over the next five to 10 years in line with international standards. This will go a long way in reducing risk and contributing to stability in the banking sector. Furthermore, the establishment of the credit reference system will address information asymmetry and credit culture.

Reflecting the challenges in the operating environment, banking sector earnings performance deteriorated as shown by a decrease in aggregate net profit from US$22,40m as at March 31 2014 to US$4,02 million for the quarter ended March 31 2015. The subdued earnings performance is also reflective of the conservative lending approach and a sub-optimal trade-off between high liquidity and profitability.

Of the 18 operating banking institutions, 13 institutions reported profits for the quarter ended March 31 2015. The losses recorded by the remaining institutions were attributed to high loan impairments due to deterioration in asset quality, lack of critical mass to cover operating expenses, refinancing costs of liquidity challenges and adjustments to reasonable and responsible pricing.

The banking sector in many respects reflects the state of the economy. Economic activity has stalled over the last 12-18 months creating significant challenges for the sector.

During the first quarter, two more banks collapsed, AfriAsia and Allied. I expect a further two or three more banks to fail over the next 12 months. The banks that have survived have a few things in common: good corporate governance, strong management, prudent lending practices and lack of insider loans.

Poor corporate governance and prevalence of insider loans, especially among local banks, has been the primary reason for failure. Lessons have been learnt, but much more needs to be done to restore credibility and stability in the banking sector.