How a government default on TBs could hit banks hard

How a government default on TBs could hit banks hard

By Simbarashe Zishiri, HARARE, October 24 (The Source) – Zimbabwe’s financial sector could come under great strain if government defaults on honouring maturing treasury bills, with local banks facing undercapitalisation and the economy facing a recession.

Statistics from the central bank show that the amount of TBs held by different institutions in the market, largely banks, increased by 20,25 percent from $2,079 billion held as at December 31, 2016 to $2,5 billion as at June 30. Of the total TBs held in the market as at June 30, $843,2 million (representing 33,7 percent) were issued to finance government expenditure.



The Parliamentary Budget Office last week flagged the possibility of a default, warning that government was ‘creating more fictitious money’ through excessive issuance of TBs. The consequences for the local banks will be dire.

A sample of balance sheets from different banks as at June 30, shows that for most banks,
TB holdings are greater than bank’s core capital (tier 1) which is used to measure the capital adequacy of a bank.

Tier 1 capital measures the bank’s financial strength from a regulator’s point of view — the
money that a bank has stored to keep it functioning through all the risky transactions such as trading or investing and lending.

The sample includes CBZ which has a core capital of $139,5 million and TB holdings worth
$814,5 million on its balance sheet, implying that the amount of government paper the bank holds is 5,8 times its core capital.

CABS also has a core capital of $104,95 million and holds TBs worth $131,57 million
on its balance sheet, implying that the amount of government paper the bank
holds is 1,3 times its core capital.

Additionally, Ecobank which has a core capital of $101,8 million, holds TBs worth $90,7 million on its balance sheet, implying that the amount of government paper the bank holds is 0,9 times its core capital.

FBC Bank Limited which has a core capital of $56,1 million, holds TBs worth $76,6 million on its balance sheet as at June 30, implying that the amount of government paper the bank holds is 1,4 times its core capital. The bank reported that it holds 4 percent of total TBs issued.

State owned bank POSB’s balance sheet as at June30, shows that its core capital stood at
$44,9 million while the bank held TBs worth $55,5 million on its balance sheet, implying that the amount of government paper the bank holds is 1,2 times its core capital.

The above sample shows the extent to which banks are exposed to government paper, giving
rise to fear that if the state fails to honour its obligations banks will lose their core capital which is supposed to cushion them from the risky transactions they perform, such as trading or investing and lending.

TB holdings are considered risky because they expose the bank to one client, the government, and in this case where we have more banks holding onto government paper the risk becomes greater with sector wide implications.

Bankers I spoke to say that a default by government will see the paper being heavily discounted and will also have a negative impact on the capitalisation of banks, especially for those banks which have been recapitalised using TBs ,such as POSB and Agribank.

Their credit risk would have increased and their capital position will come under pressure.

Given the amount of government paper held by banks, this could cause cash flow problems for most banks in the country.



Additionally, cash flow problems will put a constraint on the depositor’s ability to access funds and banks on the other hand, will find it very difficult to make payments on their own obligations.

The scenario of a default may look farfetched because the government will continue to create money through the real time gross settlement (RTGS) mechanism, but the fact that the Parliamentary Budget Office is bringing up the issue means it is a distinct possibility.

However, economists are of the view that government will continue to create phony money through RTGS in order to meet its obligations on maturing TBs.

For banks, treasury bills are better than the NPLs that banks were sitting on, because a default by government is better than a default by a company since the government will always
be there tomorrow and one can still have a claim, unlike a company which might cease to exist.