The loan-to-deposit ratio (LDR) has remained relatively low for the past three years for Zimbabwean commercial banks averaging 45 percent over the period against an international threshold level of 70 percent. Although it has peaked, at a slow rate, since the beginning of 2021 to date on the back of a relaxed operating environment, the share of loans and advances in total deposits remains at low historic levels which can prove to have implications both for economic development and, conduct and efficacy of monetary policy by the central bank. The ratio reached its lowest in the third quarter of 2020 at just 27 percent. The low ratio has been a result of depressed loan growth coupled with an exponential increase in deposit growth and can have negative effects for banks’ margins and the economy at scale. PwC’s major banks analysis reveal that the combined loan-to-deposit ratio stood at 87 percent in September 2022 for South African banks compared to 46 percent recorded in the same period for Zimbabwe’s commercial banks.
The lack of lending growth given the available deposits has led to banking sector institutions realizing lower interest income from their core business of extending loans and advances which accounted for just 19.17 percent of total banking income mix while non-interest income accounted for over 79 percent (from 51 percent recorded in 2021) with fees and commission constituting 22.6 percent for the first six months of 2022.
The shift in focus by the banking sector institutions from extending loans and advances towards generating their income from non-interest generating activities such as fees and commissions, although this may also imply exorbitant charges by banks to their customers, results in reduced impact of monetary policy stance on monetary aggregates by the central bank. The bank policy and medium term accommodation interest rates hike by RBZ in June to 200% and 100%, respectively, which became effective on July 1st this year were meant to discourage speculative borrowing by making borrowing expensive and thus by implication reduce money supply (that is, reduce banks’ creation of additional deposits through lending activities) in the process. This policy action by the central bank may realize a low upside in achieving its intended objectives given that banks are only lending on average 45 percent of total deposits against the standard benchmark. This is on the backdrop that the intermediate target has to put a tight leash on banks’ ability to create deposits through lending. Therefore monetary policy becomes ineffective in achieving its key mandate of low and stable inflation if subject banks are not fully focused on executing their core business. The high interest rate hikes in such an environment with low loan-to-deposit ratio therefore tend to have unintended consequences, that is, punishing the innocent productive sector through these outrageous rates and reducing credit to the private sector.
Money supply has been increasing since the beginning of the year from ZW$470 billion in January to stand at ZW$1,917 billion as of September. However, although the rate of increase in money supply has decreased from 33 percent in August to recording a 19 percent jump in September, still very high for a month-on-month change, it begs the question why money supply has marginally responded to the central bank interest rate change. Thus, coupled with the low loan-to-deposit ratio, it follows that commercial banks have been creating deposits through either investment asset purchases or through FCA loan deposits or a combination of both.
It has become increasingly evident that financial sector development plays a pivotal role in driving economic development for any economy. Financial market development promotes growth through capital accumulation and technological progress by increasing the savings rate and financial intermediation coupled with an efficient allocation of capital. Zimbabwe can therefore draw several key lessons from ensuring that the country’s financial sector is fully developed especially given its vision 2030 upper middle income economy status. Transferable deposits (demand) account for over 90 percent of broad money supply (M3) with time deposits accounting for just under 10 percent. This proportion between the two monetary aggregates has important implications for monetary policy. Firstly, the low drive in time deposits is indicative of a low saving/investment drive or appetite by economic agents largely a result of low deposit rates on time deposits which were however recently reviewed to 80 percent although the deposit rate is still way lower than the inflation rate which stood at 268 percent as of October. This paralyses the Bank’s ability to mop up excessive liquidity in the market through time deposits and issuance of certificates of deposits (both negotiable and non-negotiable). Secondly, the depressed share of time deposits in money supply implies that commercial banks have less funds at hand for lending purposes (although traditionally banks do not require deposits in order to lend, instead they create deposits through lending by simply crediting a customer with electronic funds/deposits). It is therefore imperative for the government to always maintain interest rates which ensure positive real interest rates so as to make borrowing and lending lucrative for the banking sector, thus increasing the loan-to-deposit ratio, and ultimately retain the interest rate as the most effective monetary policy tool at the disposal of the Reserve Bank.
Given the low interest rates prevailing in the market as set out by the benchmark rate against the current inflation rate, it leaves little room for savings growth in the economy due to negative real interest rates. Banks therefore reduce the total funding they lend out in terms of loans and advances as the high inflation proves the lending activity to be unprofitable. In particular, the low interest rates gives rise to adverse selection and credit rationing in the market as a response mechanism by the banking sector. It is against this background that the central bank makes concerted efforts to identify key drivers of the witnessed increase in deposits in order to implement tailor made monetary policy measures.