The impact of non-performing loans on bank lending by commercial banks in Zimbabwe

The 2007-8 global financial crisis which started in United States of America and spread across the world resulted in the recognition that the quantity of non-performing loans (NPLs) is related to bank failures and the financial status of a country (Vatansever and Hep��en, 2013). As a result, the relationship between NPLs and the quality of bank assets has increasingly gained prominence in recent years in view of its impact on the lending behavior and overall condition of the banking sector. The deterioration in the quality of bank loans has been identified as one of the major causes of banking sector instability (Demirguc-Kunt, 1989; Bar and Siems, 1994).
In Zimbabwe the levels of NPLs has been increasing since the adoption of the multi-currency in 2009. The growth in NPLs led to a decrease in credit growth which has undermined economic recovery prospects. NPLs are identified as one of the causes of economic slowdown through their adverse impact on loan dispersal (Hou, 2007).
Prior to dollarization, the operating environment was difficult for banks, as the economy experienced hyperinflation, high levels of money supply growth, distorted prices and acute foreign currency shortages. The decade-long decline in the Zimbabwean economy significantly affected the country’s banking sector through deterioration of bank assets and increase in non-performing loans.
The high levels of NPLs resulted in banks carrying out internal consolidation to improve asset quality rather than distributing credit (Kueger and Tornell, 1999). Consequently, banks had to make provisions for loan loss thus reducing funds for new lending.
O’Brein and Browne (1992) note that on the supply side, the decline in credit is exacerbated by deterioration in asset quality and stricter attitudes of regulators. The need to re-build capital also entail that banks cut down on lending (Hou and Dickinson, 2010). On the demand side, the slowdown in economic activity and loss of purchasing power by individuals resulting them being unable to qualify for or access loans and a slowdown in lending. This view is supported by Baul et al, (2002), whose study found out that that credit creation is impacted by both macroeconomic variables as well as internal structures.
Asantey and Tengey (2014), argued that bad loans had a negative effect on bank lending potential in Ghana. These findings were also supported by Appiah (2011) and Awunyo-Vitor (2012). Bad loans do not only limit lending but have multi-dimensional effects that include reducing profitability among commercial banks, a deterioration of bank assets, erosion of bank capital, efficiency problem for banking sector and at the government level, can pose challenges to the pursuit of macroeconomic stability and growth objectives.
Statistics from the Reserve Bank of Zimbabwe show that non-performing loans has generally been on the high side even prior to the adoption of the multi-currency system in 2009. Over the period 2000 to 2006 non- performing loans averaged 21.4%. The use of the domestic currency entailed the existence of the lender of last resort window and hence the banking sector had access to liquidity support from the Central Bank and was able to continue extending credit even for speculative purposes (RBZ, 2003).
Following the tightening of the accommodation window by the Central Bank post-2003 NPLs declined to 5.7% in December 2008. In addition, the hyper inflationary environment that prevailed over this period, reduced or wiped off debts and hence the lower NPLs.
Following the adoption of the multi-currency system in 2009, the level of non-performing loans were below 2% but trended upwards 16% by December 2014. On a banking subsector by subsector analysis, for the period ending June 2012, merchant banks recorded the most pronounced deterioration, with the ratio increasing from 1.33% to 38.2%. The commercial banks ratio grew from 1.82% to 12.34%., with building societies registering a rise from 0% to 3.1%. This resulted in the growth in the NPLs to 12.28%.
Reflecting the rise in NPLs, credit to the private sector, followed a downward trend since December 2010, falling from falling 139.6% to 1.3% in 2014. The fall in growth in private sector credit was also against a background of limited domestic resources and subdued foreign lines of credit, (RBZ, 2014). The slowdown in lending is also due to the difficult macroeconomic environment, which saw real economic growth declining from two digit levels post-2009 to 3.2% in 2014.
High NPLs therefore cause deterioration in a Bank’s asset quality, resulting in a decline in banks’ lending activities. The high level of NPLs is, therefore, a significant risk in the banking sector in Zimbabwe, whose impact on credit developments can be a drag on the economy.
PROBLEM STATEMENT
The significant increase in the level of NPLs experienced by the banking sector since the adoption of the multi-currency regime in February 2009 has the potential to contribute to financial instability as well as slow down overall economic growth. Zimbabwe has experienced a decline in credit to the private sector from 139.5% in 2010 to 4% in 2014, while real GDP has also slowed down to 3.2% in 2014 down from double digit growth rates registered over the period 2010-2012.
In its Banking Sector Report for the quarter ending March 2015, the Reserve Bank of Zimbabwe highlighted that credit risk is the major risk facing the banking sector as evidenced by the average non-performing loans to total loans (NPL/TL) ratio of 15.19% as at 31 March 2015. Further, the banking sector registered a decline in aggregate net profit from $22.40 million in the quarter ended 31 March 2014 to $4.02 million for the quarter ended 31 March 2015. The deterioration in aggregate net profit was largely attributed to loan impairment charges, which increased from $12.31 million as at 31 March 2014 to $40.18 million as at 31 March 2015.
The question is therefore, which factors have contributed to the decline in credit growth and to what extent can this be explained by the increase in the level of NPLs?
OBJECTIVES OF THE STUDY
The main purpose of this study is to examine the impact of non-performing loans on bank lending by commercial banks in Zimbabwe during the period 2010 to 2014.
The study will pursue the following specific objectives:
‘ To determine the extent to which NPLs affect growth in loans;
‘ To examine the causality between NPL and Bank lending;
‘ To establish other determinants of bank lending
RESEARCH QUESTIONS

The study will seek to answer the following questions:

‘ What has been the impact of the high level of NPLs on lending by banks?
‘ What is the direction of causality?

HYPOTHESIS

The hypotheses tested in this study are:

H0: The level of NPLs has no statistically significant impact on loan growth in Zimbabwe
H1: The level of NPLs has a significant impact on loan growth in Zimbabwe

SIGNFICANCE OF THE STUDY

The research seeks to focus on the impact of NPLs on banks’ lending in Zimbabwe under the multi-currency period. The NPLs, apart from being a source of concern for financial stability have led to a decrease in credit growth and fall in economic activity. Since the incurrence of bad loans is part of the normal bank business it is important that regulatory authorities can establish threshold for bad loans above which action should be taken.

A number of studies have been done on the causes of high NPLs in Zimbabwe (Mabvure T et al, 2012, Chikoko L et al, 2012). However, literature to examine the impact of NPLs on lending is limited. This study therefore seeks to contribute to this study by assessing the extent to which the high levels of NPLs have constrained the growth of credit in Zimbabwe under the multi-currency system.

ORGANISATION OF THE PAPER
The study seeks to evaluate how NPLs impact on the lending behavior of commercial banks in Zimbabwe. The rest of the study will be organized into section 2 focusing on how the behavior of bank lending is affected the growth of NPLs, section 3 reviews the empirical literature, the methodology is discussed in section 4 and discussion of findings dealt with in section 5. Section 6 concludes the study.

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