Bank liquidity management 101

It is not long time ago when I urged the Reserve Bank of Malawi (RBM) to carry out stress tests on all local commercial banks to determine the sufficiency of their liquidity levels.

This was after realising the gravity of the liquidity squeeze as shown by the shortage of the kwacha on the local money market.

So concerned was the RBM by the cash crunch that it created a special non-collateralised lending facility called discount window accommodation (DWA) at the princely interest rate of 23.5 percent, higher than the 21 percent ruling bank rate, in an effort to recapitalise banks.

Confirming how troubled the local banks are, the financial institutions proceeded to borrow through the window at such outrageous rates.

Even now, after the expiry of the expensive DWA on July 31 2012 and despite the RBM’s warning that those wanting to continue borrowing through the window will pay the ridiculously exorbitant charge of four percentage points above the borrowing bank’s prime lending rates, banks have failed to resist.

In fact, the central bank further cautioned that it could impose additional charges if access to the repackaged lifeline is considered excessive and/or prolonged.

Guess what? This has not deterred banks. They are still going for the extended DWA. The figures I have seen from RBM are huge and demonstrate how desperate most of our banks are.

And it is scary because very soon, we will see base lending rates rising above the psychologically important 40 percent interest rate mark which will only be reached for the first time in about 10 years.

This will threaten economic recovery that is already in doubt following the (strange) decision to concurrently pursue a contractionary monetary policy and an austerity drive—and still believe that economic growth rates will improve!

Anyway, I do not know whether the central bank has carried the stress tests, but given what I heard this week, it looks like something to that effect may have happened, although not as comprehensively done as would normally be the case.

I have it on good authority that RBM last week dispatched a team of experts to Blantyre, the country’s commercial city and banking hub. The team, I am told, paid visits to banks that are in grave danger and lectured them about liquidity management.

I understand that the banks that are in more serious trouble are those that went to bed with the previous Democratic Progressive Party (DPP) administration and, at the regime’s nagging, agreed to take huge dollar-denominated loans to support importation of fuel, which was scarce at the time largely due to forex shortages.

The participating banks were supposed to make a killing, but fate would have none of the chaffy business bases that led contracting risky foreign debts. At the time they were accessing the loans, the exchange rate was K166 to the dollar.

Now, thanks to the massive devaluation and subsequent flotation by the fledgling Joyce Banda government, these banks have to settle the loans at the equivalent of K290 to the dollar (and accounting).

You can imagine how much extra kwachas these banks have to raise to repay the dollar-denominated loans (let alone raise the dollars)! After draining huge volumes of kwacha to clear the forex applications that had piled, the desperation for kwachas is not too hard to fathom; hence, the huge craving for kwachas at any cost either from the inter-bank market (assuming there are still some banks with enough kwachas to spare) or from the now greedy lender of last resort—RBM.

How did these banks get here? How can they avoid a repeat? Apparently, the RBM thinks liquidity management 101 training might do the trick. Just to quickly fill you in; liquidity management for banks simply involves putting in place what in banking parlance maybe called “self insurance” against shortfalls of cash required to meet current and forthcoming obligations.

You would think that this—estimating the scale of potential liquidity needs for a bank—is an ongoing daily activity for financial institutions.

But if RBM can think that it needs to conduct little closed door workshops for shaky banks on liquidity management, this must be a serious problem, whose enormity may only have been realised after the departure of the unsecured funding source in the name of DWA.

It is easy to see that desperation in the barrage of promotions blanketing all sorts of media channels trying to attract new deposits. In a different macroeconomic context, I would have said good luck with that.

But with dwindling real incomes and collapsing national savings, it will be interesting to see how much these attempts will result in deposit growth.

Otherwise, I would advise the struggling banks to close their eyes and start looking at ways of lengthening the maturity of their liabilities; consider issuing new capital and selling of subsidiaries and other lines of business.

You may be wondering if some banks are this neck-deep. My answer is: listen and watch, including this space.