Non Performing Loans: Credit Crunch

Between 2002 and 2006, the sub-prime mortgage market started to collapse marking the beginning of the global economic crisis. During this time in the United States of America (USA), lending to the household sector was growing at a far much quicker rate than the broader economy. However, when the subprime mortgage market experienced an increase in delinquencies, there were turbulences in the subprime mortgage-backed securities market which lead to a financial crisis in October 2008 that was first encountered in the USA before it quickly spread to financial institutions in Europe.

Consequently, a recessionary economic environment was created by the financial crisis in which global trade and commodity prices such as copper and cobalt significantly declined. Thus the global financial and economic crisis had a negative impact on economies around the world through falling export demand, declining commodity prices and reductions in the availability of credit.

The Zambian financial sector did not immediately become adversely affected by the credit crunch as was reflected in the continued stability of the banking sector because Zambia’s financial sector had no exposure to toxic assets, which led to the credit crunch in most developed markets (Fundanga, 2009).

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In stark contrast with the late 1980s and early 1990s, when the sector was volatile and had many bank failures, the financial condition and performance of the banking sector between 2006 and 2008 was largely satisfactory. In a research conducted on behalf of the Overseas Development Institute (ODI), the level of non-performing loans to total gross loans and advances declined from 11.3% in 2006 to 8.

8% in 2007. It was also noted that between 2007 and 2008 total assets grew by 24.4% while the asset structure of the banks continued to be dominated by net loans and leases (Ndulo, et al., 2009). The gross non-performing loans to total gross loans ratio and net non-performing loans to total regulatory capital ratio improved from 8.8% and 9.6% in 2007 to 7.2% and 5.2% in 2008, respectively (Ndulo, et al., 2009).

Because of its limited integration into the international financial market, the banking sector was largely unaffected by the first round effects of the financial crisis which were mainly transmitted through trade. Regardless of the decline in copper and other commodity prices, the performance of the banking sector remained satisfactory up to the last quarter of 2008.

However, during the first three quarters of 2009, banks were adversely affected by the secondary effects of the crisis, through their linkage to other sectors of the economy, such as tourism, mining and agriculture, which had been affected by the crisis during 2008. The state of the financial sector during 2009 was shown in the behavior of non-performing loans (NPLs) and asset quality and capital adequacy ratios in the banking sector (Ndulo, et al., 2010).

The secondary effects of the crisis on the banking sector occurred mainly through the increase in NPLs, mainly as a consequence of the retail loans that banks extended to households during the growth period, most of which had workers in mining and its supporting industries. Prior to the crisis, most banks in Zambia had made standing agreements with the mines whereby they were to extend retail loans to mine workers. In turn the mines would deduct loan repayments from workers’ salaries as an undertaking. The occurrence of the financial crisis meant that a large number of mine workers could no longer service their loans with the banks because they lost their jobs. As a result, the banks incurred huge losses because the loans that were given out to most of the miners became non-performing.

Some banks had also a heavy concentration in retail loans going to farmers based on production and the expected selling price of their produce. Falling prices on the world market in commodities such as soya beans, cotton and cut flowers meant that farmers could not realise the expected revenue, so could not repay their loans as agreed with the banks. These loans also became non-performing. This put a strain on the credit market in the financial sector (Ndulo, et al., 2010).

In 2009, overall asset quality started to deteriorate in the banking sector. The NPLs ratio to total assets increased in the first three quarters, to about 13% in the third quarter from around 7% in the first quarter. Meanwhile, the loan loss provision to NPL ratio declined during the period, from 100% in December 2008 to 80% in January 2009 and thereafter decreasing further to about 78% in April 2009 before increasing to around 85% in September 2009 (Ndulo, et al., 2010).

Nevertheless, some banks recorded high profits because they had limited exposure to NPLs and in order to protect themselves, these banks reacted by curtailing interbank lending to banks whose profits had declined. This situation was an emergence of the first quarter of 2009 as banks developed suspicion of each other because of heightened risk levels. This resulted in the financial sector becoming illiquid and therefore a further tightening of the credit market (Ndulo, et al., 2010).

In the last decade, non-performing loans have continued to be on the rise and as of 2017, asset quality was rated fair largely on account of a decline in the sector's quality of the loan book. This was on account of elevated NPLs and the high cost of credit. The gross NPLs ratio rose to 12.0% at end-December 2017 from 9.7% at the end-December 2016 as a result of an increase in NPLs by 29.0% to K2.9 billion (BOZ, 2017).