Why BOZ should rein­tro­duce in­ter­est rate cap­ping

Zambian Business Times - - FINANCIAL MARKETS -

How­ever, with an ex­pan­sion­ary mone­tary pol­icy, in­ter­est rates started to ease - though at a slow trans­mis­sion pace to the econ­omy. Be­low is term struc­ture of Kwacha in­ter­est rates that show a de­cline or rather a down­ward shift in the yield curve from trea­sury bills el­e­vated at (19% -21%) and bonds above 25% as at 31 De­cem­ber 2016 to trea­sury bills now pay­ing (9% - 17%) and bonds within a 17%-19% bracket.

See graph be­low:

The graph be­low also shows the mone­tary pol­icy eas­ing ver­sus widen­ing of credit spreads be­tween 828bps to 1,916bps man­i­fest­ing in ris­ing av­er­age lend­ing rates to 29.4% a trend in­versely re­lated to a de­cline in bench­mark lend­ing rates. The mar­ket is still stressed and this is the rea­son NPLs have swelled to breach the pru­den­tial limit of 10%.

One would ex­pect that with the bench­mark lend­ing rate de­creas­ing, the av­er­age lend­ing rates would cor­re­late pos­i­tively but this has not been the case. What we ob­serve in a 20 com­mer­cial bank in­dus­try is more of an in­verse pro­por­tional re­la­tion­ship be­tween av­er­age lend­ing rates and the mone­tary pol­icy rate. (Lend­ing rate = Mone­tary Pol­icy Rate plus credit spread re­flect­ing level of risk of client). Ide­ally with more liq­uid­ity in the sys­tem our an­a­lysts ex­pected to see a cor­re­spond­ing rise in in­ter­est in­come line es­pe­cially from loans and ad­vances but in­ter­est­ingly, these lines de­clined by be­tween 8.5% to 23% break­down be­ing SBZ- 22.9%, BBZ-19.5%, SCB – 8.51% and ZCB – 5.2%. See his­togram be­low for trend.

Where did the liq­uid­ity go?

A look at the se­cu­ri­ties in­come line for most banks in the in­dus­try show a gen­eral rise in se­cu­ri­ties rev­enue from in­vest­ments in gov­ern­ment se­cu­ri­ties. Suf­fice to say the com­mer­cial banks ap­petite for gov­ern­ment debt rose sig­nif­i­cantly due to the struc­ture of the Kwacha yield curve.

See his­togram be­low:

Ac­cord­ing to the quar­terly fi­nan­cial state­ments pub­lished in the press, Zanaco had the high­est se­cu­ri­ties in­come of ZMW405mil­lion (121% in­crease from ZMW183mil­lion) fol­lowed by Stan­dard Char­tered with ZMW399mil­lion (50% in­crease from ZMW265mil­lion). Stan­bic earned ZMW357mil­lion (191% rise from zmw123mil­lion) and Bar­clays ZMW345mil­lion (181% in­crease from ZMW123mil­lion). Clearly the FY2017 re­ports show a ( YoY) in­crease in the in­ter­est in­come line from in­vest­ment in bills and bonds by sig­nif­i­cant quan­tum.

We can make in­fer­ence and con­clude that the ex­cess liq­uid­ity from re­lax­ation of statu­tory re­serves were locked up in gov­ern­ment se­cu­ri­ties to earn com­mer­cial banks in­ter­est in­come in two ways; the split for whose fi­nan­cial clas­si­fi­ca­tion which we don’t have a break­down for. How­ever, this in­come was booked on the bank­ing and trad­ing book lines.

Some com­mer­cial banks could have taken a view on com­pres­sion of the yield curve in Q4: 2016 and then length­ened du­ra­tion on trad­ing and bank­ing books for mark to mar­ket pur­poses in what we call in­ter­est rate trad­ing. In­ter­est rate trad­ing in­volves tak­ing po­si­tions in dis­count in­stru­ment to lever­age of pric­ing of the yield curve for trad­ing in­come pur­poses. When this hap­pens on the bank­ing book the in­come goes to an eq­uity re­serve ac­count. We call it an eq­uity re­serve ac­count be­cause cap­i­tal amounts are locked up in gov­ern­ment se­cu­rity as part of pru­den­tial re­quire­ments which then ap­pre­ci­ate or de­pre­ci­ate de­pend­ing on di­rec­tion of yield rates on gov­ern­ment se­cu­ri­ties. The eas­i­est way to make money on du­ra­tion is buy­ing as­sets when in­ter­est rates are high­est in an­tic­i­pa­tion that they will fall the ex­ist­ing po­si­tions will then be marked to mar­ket with gains posted to in­come state­ments. Most trea­sury de­part­ments with good in­ter­est rate traders make their money eas­ily this route. Clearly the Zam­bian yield curve com­pressed in the one-year pe­riod prov­ing op­por­tu­nity for most play­ers.

“At­trac­tive­ness of the Kwacha yield curve is the sole causer of crowd­ing out ef­fect as banks face lesser risk lock­ing their liq­uid­ity in risk free as­sets that lend­ing at a time when av­er­age lend­ing rates and de­faults rates are fairly high in the in­dus­try.”

Busi­ness Times Lead An­a­lyst

Other play­ers could have locked in pa­per on their bank­ing books when the curve was el­e­vated this then al­lowed the com­mer­cial banks earn in­ter­est in­come. What makes it dif­fi­cult to an­a­lyze is the split be­tween trad­ing and bank­ing clas­si­fi­ca­tion which most com­mer­cial banks mix in one bucket dubbed in­ter­est in­come.

Mar­ket Note

We have used (4) banks as a rep­re­sen­ta­tive sam­ple to gen­er­al­ize re­sults to the en­tire 20 bank in­dus­try as these ac­count for over 60% both in prof­itabil­ity and bank bal­ances held with the bank of Zam­bia.

What stands out in this anal­y­sis of the big for banks is that, in the year 2017 the loan and ad­vances line slowed marginally ( YoY) giv­ing an op­por­tu­nity for se­cu­ri­ties in­come line to sig­nif­i­cantly to rise in an era of ex­pan­sion­ary mone­tary pol­icy. This was em­barked on in a move where the Min­istry of Fi­nance wanted to stim­u­late pri­vate sec­tor growth which halved in 2016 to 3.22% com­pared to 6.7% in good years. Tight­en­ing mone­tary pol­icy in De­cem­ber 2015 was a move aimed at align­ing fis­cal dis­lo­ca­tion with mone­tary pol­icy. Re­lax­ation of mone­tary pol­icy by slash­ing the pol­icy rate and eas­ing the statu­tory re­serve ra­tio was to sig­nal the in­ti­macy be­tween fis­cal and mone­tary pol­icy af­ter the cur­rency slide had been curbed, in­fla­tion was ar­rested to sin­gle digit and gov­ern­ment was work­ing to­wards fis­cal con­sol­i­da­tion as pre­scribed by the au­thor­i­ties. Com­mer­cial banks still grap­pled with ex­pen­sive cost of de­posits which made it dif­fi­cult to lend at ex­pected lower rates at a time when de­fault rates were high in the in­dus­try breach­ing the 10% pru­den­tial limit at 12.4%. With ex­cess liq­uid­ity af­ter the SRR was re­laxed, banks im­me­di­ate op­por­tu­nity was to in­vest in gov­ern­ment se­cu­ri­ties which is vivid in the fi­nan­cial state­ments for FY2017 de­pict­ing the per­for­mance of the com­mer­cial bank­ing in­dus­try. What makes it even worse is that in the 2016 bud­get the Min­is­ter of Fi­nance pro­nounced that gov­ern­ment would fi­nance more of its needs with do­mes­tic debt as op­posed to con­tract­ing in­ter­na­tional for­eign de­nom­i­nated debt. Last year De­cem­ber the Bank of Zam­bia an­nounced an in­crease in auc­tion size of bonds by 65% to ZMW1.65bil­lion. The sig­nal this move has sent to the mar­ket is that there’s a rise in gov­ern­ment ap­petite for debt to fund most of its needs es­pe­cially that IMF talks stalled. This move could fur­ther force yields higher and make it very at­trac­tive for banks to lock in liq­uid­ity and fur­ther crowd out the mar­ket at the ex­pense of do­mes­tic lend­ing. If this hap­pens then Zam­bia’s growth will be at risk.

“The Zam­bian yield curve com­pressed an av­er­age of 795bps on the short end – trea­sury bills and 626bps on the long end – bonds. Those that took long po­si­tions in gov­ern­ment pa­per in carry trades made their money.” Busi­ness Times Lead An­a­lyst

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