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(NEWZIMBABWE) 2004 liquidity crisis: Has the RBZ been vindicated?

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Last updated: Sat, 11 Oct 2008 05:12:25 GMT
By Victor Chimbwanda
Posted to the web: 10/10/2008 14:31:52

THE Reserve Bank of Zimbabwe (RBZ) must feel vindicated by the fact that the response of its Governor Dr. Gideon Gono to the liquidity crisis in 2004, although controversial and unpopular at the time, is being repeated by central banks and regulators across Europe and the US in the wake of the recent global financial crisis.

When the financial sector experienced a liquidity crisis as a result of irresponsible banking practices in Zimbabwe, the RBZ had some difficult decisions to make.

Every regulator knows that once confidence is lost in the financial sector owing to bank runs arising from a liquidity crisis, the entire financial sector and the economy as a whole can easily collapse.

In the past week, the US Congress has been forced to sanction a controversial US$700bn bail-out package just to ensure that confidence is restored to the markets.

Justifying a massive bailout of over £400bn for Britain’s major banks on October 8, 2008, the British Prime Minister Gordon Brown said this was not a moment for “conventional thinking”. Yes, extraordinary times call for desperate measures.

An examination of the Zimbabwe banking crisis of 2004 will show that although his decisions were controversial at the time, the Central Bank Governor acted decisively and swiftly to save the entire financial system from collapsing owing to a panic arising from a liquidity crisis experienced by several banking institutions.

This is not to say the Governor did not make mistakes. For instance, the Supreme Court observed that the initial seizure and subsequent transfer of Royal and Trust Bank assets into the Zimbabwe Allied Banking Group was irregular. In a subsequent ruling by an independent arbitrator, however, the RBZ’s decision was considered justified and inevitable.

But however unorthodox some of his actions were at the time, the Governor had to address a looming crisis that would have seen the collapse of the entire banking system. The Governor had to think “outside the box”.

In a similar way, the co-ordinated response of central banks and regulators across the globe to address the current global financial crisis has seen some of the most radical and controversial policies ever adopted to contain the crisis in order to stabilise markets.

Governor Gono’s decisions should therefore be understood in the same context.

When financial institutions such as Trust Bank and Royal Bank experienced a liquidity crisis, as has happened to many institutions in the US and in the UK such as Lehman Brothers and Northern Rock, there was a risk to the entire financial system. Although this was aggravated by the RBZ’s decision to raise the minimum capital requirements to comply with international standards (Basle II), as a matter of policy that decision was justified. It was the right thing to do if the banking sector and the entire economy were to be properly integrated into the global economy in order to have some credibility that would one day facilitate access to international capital.

It was a decision that also ensured that by embracing Basle II standards, only banks that were adequately capitalised would be allowed to operate in order to prevent misuse of depositor funds to fund illegal activities. The RBZ therefore endeavoured to ensure that global standards were being applied to guarantee proper oversight of the financial system.

The recent global financial crisis has also seen initiatives by regulators such as the FSA in the UK and the Fed in the US addressing irresponsible and improper practices by the speculative behaviour of traders and bankers in the City of London and on Wall Street. It is for this reason that institutions such as Lehman Brothers were denied a bail-out package as a way of sending a strong message that the financial system needs to be cleaned up of impropriety that has cost investors billions of dollars.

The prudent regulation of financial markets is only possible with the co-operation of the legislature as has been seen with the compromise bail-out package that was recently adopted by Congress in the US which in addition to providing a rescue scheme for troubled institutions also seeks to bring some discipline into Wall Street.

Similarly, Dr. Gono, in one of his monetary policy statements appealed to the Zimbabwean Parliament “to come up with stringent statutes that punitively fight corruption and all its shadows”.

After the RBZ’S decision to place Royal Bank and Trust Bank under curatorship was endorsed by an independent panel, the Governor assured the public that the central bank would “introduce far-reaching reforms in the banking sector, supported by a realignment and consolidation of the legislative pillars that govern the financial services industry”.

The fact that Governor Gono appealed for the legislature’s role in the RBZ’s fight to restore credibility to the financial system suggests that he was aware that it was only through proper regulatory frameworks sanctioned by Parliament that the central bank would ensure that sanity would return to the financial sector that had been plagued by illegal and improper banking practices.

It is in this context that Gono’s radical reforms should be understood. Tough choices have to be made for the sake of protecting the integrity of the markets and to prevent innocent depositors from being prejudiced by the reckless behaviour of those operating in the financial system.

The root of the current global crisis was the irresponsible lending by mortgage lenders in the US to borrowers who did not have the capacity to repay their mortgages. This created a panic in the markets for investors who had bought those loans as securities to be traded on the financial markets. Similar practices were rampant in the Zimbabwe banking sector with several indigenous banks engaging in irresponsible and insider lending that eventually led to the insolvency of such institutions because of liquidity problems.

When there is a financial crisis of the magnitude that we are witnessing today, every regulator has to make some tough decisions to prevent systemic risk from spreading. A decision as to which financial institution must be rescued or allowed to fail is not an easy one. But when a regulator has evidence that an institution is insolvent and has failed in its own attempt to rehabilitate itself as was the case with Royal Bank and Trust Bank, usually the only option is to deny it liquidity support (like what happened to Lehman Brothers which was denied a rescue package by the Fed) and focus on protecting depositor interests.

Dr. Gono chose to sanction the amalgamation of all insolvent banking institutions into a special purpose vehicle called Zimbabwe Allied Banking Group (ZABG) which offered to assume all liabilities of the illiquid banks against the transfer of their assets. Creditors had the option of accepting compensation or to have their claims converted into equity.

This strategy ensured that there was a restructuring of the banks’ debts through ZABG while their assets were preserved for the benefit of depositors and creditors. Most importantly, a large number of employees were transferred to ZABG, a move that prevented a massive loss of jobs in the financial sector.

We have recently witnessed extraordinary initiatives by HM Treasury in the UK tantamount to nationalisation of institutions such as Northern Rock and Bradford & Bingley to achieve the same objectives.

There was therefore nothing bizarre about the decisions taken by the RBZ to deal with the liquidity crisis of 2004.
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Victor Chimbwanda is a legal project consultant at the Commonwealth Faculty of Research & Advanced Legal Studies (London) and a visiting fellow in Corporate & Commercial Law at the American University of Cyprus. He can be contacted on e-mail: v.chimbwanda@yahoo.com
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Labels: FINANCIAL CRISIS, GIDEON GONO, RBZ, SANCTIONS

posted by MrK @ 10:00 AM