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Liquidity Risk Management by Zimbabwean Commercial Banks

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Liquidity Risk Management by Zimbabwean Commercial Banks LIQUIDITY RISK MANAGEMENT BY ZIMBABWEAN COMMERCIAL BANKS By LAURINE CHIKOKO Thesis Submitted in Fulfilment of the Requirements for the Degree PHILOSOPHIAE DOCTOR COMMERCII (ECONOMICS) IN THE FACULTY OF BUSINESS AND ECONOMIC SCIENCES OF THE NELSON MANDELA METROPOLITAN UNIVERSITY SUPERVISOR: PROFESSOR P. LE ROUX December 2012 DECLARATION I, Laurine Chikoko, hereby declare that LIQUIDITY RISK MANAGEMENT BY ZIMBABWEAN COMMERCIAL BANKS is my own original work. All the sources used or quoted have been indicated and acknowledged by means of complete references. It has not previously been submitted for assessment or completion of any postgraduate qualification to another University or for another qualification. Laurine Chikoko LIQUIDITY RISK MANAGEMENT BY ZIMBABWEAN COMMERCIAL BANKS ii ABSTRACT Macroeconomic and financial market developments in Zimbabwe since 2000 have led to an increase in many banks‟ overall exposure to liquidity risk. The thesis highlights the importance of understanding and building comprehensive liquidity frameworks as defenses against liquidity stress. This study explores liquidity and liquidity risk management practices as well as the linkages and factors that affected different types of liquidity in the Zimbabwean banking sector during the Zimbabwean dollar and multiple currency eras. The research sought to present a comprehensive analysis of Zimbabwean commercial banks‟ liquidity risk management in challenging operating environments. Two periods were selected: January 2000 to December 2008 (the Zimbabwean dollar era) and March 2009 to June 2011 (the multiple currency era). Explanatory and survey research designs were used. The study applied econometric modeling using panel regression analysis to identify the major determinants of liquidity risk for 15 commercial banks in Zimbabwe. The financing gap ratio was used as the proxy for liquidity risk. The first investigation was on liquidity risk determinants in the Zimbabwean dollar era. The econometric investigations revealed that an increase in capital adequacy reduced liquidity risk and that there was a positive relationship between size and bank illiquidity. Liquidity risk was also explained by spreads. Inflation was positively related to liquidity risk and was a significant explanatory variable. Non-performing loans were not significant in explaining commercial banks‟ illiquidity, which is contrary to expectations. The second investigation was on commercial banks‟ liquidity risk determinants in the multiple currency era by using panel monthly data. The results showed that capital adequacy had a significant negative relationship with liquidity risk. The size of the bank was significant and positively related to bank illiquidity. Unlike in the Zimbabwean dollar era, spreads were negatively related to bank liquidity risk. Again, non-performing loans were a significant explanatory variable. The reserve requirements ratio and inflation also influenced bank illiquidity in the multiple currency regime. In both investigations, LIQUIDITY RISK MANAGEMENT BY ZIMBABWEAN COMMERCIAL BANKS iii robustness tests for the main findings were done with an alternative dependent variable to the financing gap ratio. To complement the econometric analysis, a survey was conducted using questionnaires and interviews for the same 15 commercial banks. Empirical analysis in this research showed that during the 2000-2008 era; (i) no liquidity risk management guidelines were issued by the Reserve Bank of Zimbabwe until 2007. Banks relied on internal efforts in managing liquidity risk (ii) Liquidity was managed daily by treasury (iii) The operating environment was challenging with high inflation rates, which led to high demand for cash withdrawals by depositors (iv) Locally owned banks were more exposed to liquidity risk as compared to the foreign owned banks (v) Major sources of funds were new deposits, retention of maturities, shareholders, interbank borrowings, offshore lines of credit and also banks relied on the Reserve Bank of Zimbabwe as the lender of last resort (vi) Financial markets were active and banks offered a wide range of products (vii) To manage liquidity from depositors, banks relied on cash reserves, calculating and analysing the withdrawal patterns. When faced with cash shortages, banks relied on the daily limits set by the Reserve Bank of Zimbabwe (viii) Banks were lending but when the challenges deepened, they lent less in advances and increased investment in government securities. (ix) Inflation had major effects on liquidity risk management as it affected demand deposit tenors, fixed term products, corporate sector deposit mobilisation, cost of funds and investment portfolios (x) The regulatory environment was not favourable with RBZ policy measures designed to arrest inflation having negative repercussions on banks` liquidity management (xi) Banks had no liquidity crisis management frameworks. During the multiple currency exchange rate system (i) Commercial banks had problems in sourcing funds. They were mainly funded by transitory deposits with little coming in from treasury activities, interbank activities and offshore lines of credit. There was no lender of last resort function by the Reserve Bank of Zimbabwe. (ii) Some banks were still struggling to raise the minimum capital requirements (iii) Commercial banks offered narrow product ranges to clients (iv) To manage liquidity demand from clients, banks LIQUIDITY RISK MANAGEMENT BY ZIMBABWEAN COMMERCIAL BANKS iv relied on the cash reserve ratio, and calculated the patterns of withdrawal, while some banks communicated with corporate clients on withdrawal schedules. (v) Zimbabwe commercial banks resumed the lending activity after dollarisation. Locally owned banks were aggressive, while foreign owned banks took a passive stance. There were problems with non-performing loans, especially from corporate clients, which exposed many banks to liquidity risk. (vi) Liquidity risk management in Zimbabwe was still guided by the Reserve Bank of Zimbabwe Risk Management Guideline BSD-04, 2007. All banks had liquidity risk management policies and procedure manuals but some banks were not adhering to them. Banks also had liquidity risk limits in place but some violated them. Furthermore, some banks were not conducting stress tests. Although all banks had contingency plans in place, none were testing them. Specifically, the research study highlighted the potential sources of liquidity risk in the Zimbabwean dollar and multiple currency periods. Based on the results, the study recommends survival strategies for banks in managing liquidity risk in such environments. It proposes a comprehensive liquidity management framework that clearly identifies, measures and control liquidity risk consistent with bank-specific and the country‟s macroeconomic developments. The envisaged framework would assist banks in dealing with illiquidity in a manner that would be less disruptive and that could render any future crisis less painful. Of importance is the recommendation that the central bank might not need to be too strict or too relaxed, but be moderate in ensuring an enabling regulatory environment. This would help banks to manage liquidity risk and at the same time protect depositors in any challenging operating environment. In both the studied time periods, there were transitory deposits. Generally there is need to inculcate a savings culture in Zimbabwe. LIQUIDITY RISK MANAGEMENT BY ZIMBABWEAN COMMERCIAL BANKS v DEDICATION I dedicate this thesis to my sons Kudzai Ryan Joseph and Tinashe Michael Chikoko. LIQUIDITY RISK MANAGEMENT BY ZIMBABWEAN COMMERCIAL BANKS vi ACKNOWLEDGEMENTS First of all I am grateful to God Almighty, who makes a way where there is no way. Glory is to God. I am indebted to my PhD promoter, Professor Pierre Le Roux for his sustained guidance and supervision. His suggestions and improvements guided me to come up with the best analyses and research results. My sincere gratitude goes to Professor Francis Bismans and Stein Masunda for their assistance on some technical issues of panel regression analysis. I am also indebted to Nebson Mupunga, the Principal Economist in the Economics Division of the Reserve Bank of Zimbabwe, Dr Zachary Tambudzai, Dr Victor Gumbo, Njabulo Nkomazana and Gift Mugano for peer reviewing the thesis. Nyaradzo Dhliwayo may God reward you for all your support. Deanne Collins and Dr T.D. Javangwe, thank you for editing my work. Furthermore, I extend my deepest gratitude to the Nelson Mandela Metropolitan University for sponsoring my studies. I am also thankful to the Midlands State University for all the support they gave me during my studies. To Professor Ngwabi Bhebhe, I express my profound gratitude for your indefatigable spirit in consistently providing an enabling environment and resources for research. In addition, I wish to thank the Midlands State University Librarian, Mrs N Macheka for her untirirng dedication to the maintenance of high standards in the Library. Mum, you are the reason I have made it this far. You are the best thing that has ever happenned to me. My late father, what you saw in me has come alive. Kudzai Chikoko, my late husband your dream has come true, may your soul rest in eternal peace. All my family members, brothers and sisters thank you for your cherished support. To all my friends, your words of encouragement will forever be cherished. To my precious children: Kudzai, thank you for your smiles and gentleness. I love you. Tinashe, my bundle of joy and energy. Thank
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