Liquidity challenges loom as banks face statutory hurdles

Banks face a huge challenge in meeting minimum statutory requirements as substantial portion of their funds are tied up in investment instruments and loans, which are less liquid and take longer to convert into cash.

The Reserve Bank of Zimbabwe’s Monetary Policy Committee last Friday raised the statutory reserve requirements to 30 percent for US dollar and ZiG as part of a broader tightening of monetary policy to control money supply.

Prior to the increase, they were pegged at 15 and 20 percent for US dollars and ZiG respectively.

Statutory reserve is a requirement imposed by a central bank requiring banks to hold a certain percentage of their deposits as reserves.

The reserves cannot be used for lending or other commercial activities and its primary purpose is to act as a buffer to meet unexpected withdrawals or demands for funds, help to protect banks from financial difficulties by providing a cushion against losses and control money supply.

While the increase in statutory reserve requirements has several potential impacts, the Bankers Association of Zimbabwe, a lobby group representing local banks, has highlighted an immediate and significant challenge.

Due to the substantial portion of their funds that are currently tied up in investment instruments and loans, banks may struggle to meet the increased reserve requirements.

This could limit their ability to lend and provide other financial services, potentially impacting economic activity.

“Banks are unable to meet the statutory requirements due to liquidity constraints as funds are tied in TBs, loans, (gold) coins and other investments,” a statement issued by BAZ after meeting the RBZ governor Dr Jonh Mushayavanhu on Tuesday said to deliberate on the recent MPC policy measures.

Even before the recent increase in statutory reserve requirements, some industry players had already expressed concerns about the high levels of these requirements.

They argued that the statutory requirements were limiting banks’ ability to lend, exacerbating liquidity constraints, and hindering economic growth. This was particularly problematic in a context where the economy was already facing challenges.

In its analysis of the Mid Term Monetary Policy statement, FBC Holdings said by requiring banks to hold a large portion of their deposits as reserves, the central bank was limiting the amount of money available for lending.

“This helps in controlling inflation through money supply moderation,” said FBC. “However high reserves limit the amount of funds available for asset creation thereby stifling aggregate investment and economic growth.

“High reserve requirements have also been worsening liquidity conditions in the economy,” the bank added.

Prominent economic analyst, recently noted that central bank’s tightening measures aimed at reducing the money supply and stabilising the exchange rate was contributing to liquidity constraints in the economy.

While printing money was not inherently harmful as long as it aligns with demand, the focus on draining the market to stabilise the rate was creating challenges.

By imposing strict measures, the analyst said the central bank was essentially creating an “economic fast.”

He said just as fasting leads to weight loss, the measures were causing the economy to lose momentum.

“Again, it creates a problem because you are actually winning stability at the expense of economic growth.

“You are putting yourself in a position of fasting and when you know what it does when you fast, you lose weight and the economy is losing weight.”

According to the BAZ, high statutory reserve requirements are dampening economic activity by constraining businesses’ access to credit, hindering their ability to invest, expand operations and create jobs.

While the tightening of liquidity through measures like increased statutory reserve requirements can help reduce exchange rate volatility, this can also have the unintended consequence of discouraging the use of the domestic currency.

Individuals and businesses may be more inclined to hold foreign currency as a store of value or for transaction purposes, leading to a decline in the demand for the local currency.

The BAZ has also expressed concerns about the recent increase in the policy rate from 25 percent to 35 percent, a move it believes could deter investment and expansion as the cost of accessing capital becomes more expensive.

The BAZ also recommended that the central bank consider staggering the increase of statutory reserves to 30 percent and allowing repurchase agreements (repos) on Treasury bills, savings bonds, and coins.

Some analysts, however, said while increasing statutory reserves may impose short-term liquidity challenges on banks, it was a necessary step to ensure the financial system’s overall stability.

They argue that a higher reserve requirement can act as a buffer against potential shocks and protect depositors’ interests.

“The primary purpose of a central bank is to maintain the stability of the monetary system, and this includes preventing excessive credit expansion,” Getrude Raire, a former dealer with a local commercial bank said.

It warned of a potential increase in non-performing loans, as higher interest rates may make it difficult for borrowers to repay their debts.

On the move to allow greater exchange rate flexibility, BAZ said the ZiG would now be more influenced by market conditions, including speculation, which could result in more frequent or wider fluctuations in the exchange rate.

This was likely to lead to an increase in the local prices of goods and services.

If market conditions remain unfavourable, such as high inflation, low investor confidence, or trade imbalances, the ZiG may depreciate rapidly, leading to higher costs for imports and inflationary pressures on goods priced in foreign currency.

BAZ further noted that it was essential to ensure sufficient foreign exchange reserves to meet demand, which can be limited by minimising the creation of local currency.

A significant weakening of the exchange rate could result in higher prices for imported goods, driving inflation higher in an economy already struggling with price instability.

Consumers would face increased costs for essentials like fuel, food, and other imports priced in foreign currency.

While a more flexible exchange rate regime may be viewed positively by foreign investors as it reduces the risk of sudden devaluations and allows them to assess currency risk more accurately, short-term volatility may still make investors cautious.

“History does not work in our favour as the market holds inhibition around the local currency as long as the confidence levels remain low,” said BAZ.-ebsinessweekl