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It is quite encouraging that the Government has come out clearly that it is working towards fully recapitalising the central bank

Sanderson Abel

It is fundamental to have a sound, stable and healthy financial system to support the efficient allocation of resources and distribution of risks across the economy.Financial instability and its effects on the economy can be very costly because of the associated contagion or spillover effects to other parts of the economy.Financial instability may lead to a financial crisis with adverse consequences for the economy.

What is financial sector stability?

Financial sector stability can be defined in various ways:

Financial sector stability means that the financial system has the capability to allocate funds efficiently and absorb shocks as they arise, thus preventing disruption of real sector activities and the financial system.

It is a condition represented by a strong financial system capable of withstanding economic shocks, one that is able to ensure intermediary function, settlement of payments and diversification of risk.

It is a condition in which the economic mechanisms of price formation, funds allocation and risk management operate properly in support of economic growth.

A stable financial system is one in which financial intermediaries, markets and market infrastructure facilitate the smooth flow of funds between savers and investors and, by doing so, help promote growth in economic activity.

Conversely, financial instability is a material disruption to this intermediation process with potentially damaging implications for the real economy.

When financial instability occurs, it disturbs market functioning and can also impair bank balance sheets.

The result can be disruption to the financial intermediation function with resulting constraints on the availability of credit for households and businesses.

This, in turn, can lead to further reductions in aggregate demand that put additional stress on the weakened financial system. Obviously, this is not a favourable dynamic.

How can we ensure financial stability?

The central bank must be well capitalised to ensure financial stability as it can be used as the last line of defence when a crisis arises.The central bank performs a pivotal role in ensuring the smooth and efficient functioning of markets and infrastructure such as the payment system in a country and mitigating systematic risks by providing the liquidity needed to oil the wheels of the financial system.

It is quite encouraging that the Government has come out clearly that it is working towards fully recapitalising the central bank and also looking for resources to ensure that the central bank plays in the interbank market.

Financial sector stability can be enhanced by putting in place a system that ensures the financial system has in place a well-developed crisis management arrangements for handling distressed financial institutions in such a way that public confidence in the financial system will not be undermined.

Hence the concept of deposit protection is important in the country to ensure confidence and stability in the financial sector as it ensures that depositors are reimbursement in a case where any bank fails in the country.

The importance of this is that the most vulnerable members of the society and usual the financial illiterate who cannot read the market are cushioned from the effects of the bank failure.

Smooth financial intermediation is a function of the financial sector stability hence the need to ensure all factors that hinder this are resolved and done away with.

One aspect that has been working against efficient financial intermediation in the country is the non-performing loans.

The setting up of the a Special Purpose Vehicle (SPV), Zimbabwe Asset Management Company to acquire collaterised NPLs from banks and financial institutions and manage them with a view to recovering and liquidating loans in default was a commendable move of ensuring financial stability.

The SPV would buy these NPLs at a discount from the financial sector and then pursue them.

Another way to establish financial stability is to ensure defaulters in the banking system are penalised through failure to access further financing.

To accomplish this there is need for activating the National Credit Reference Bureau to provide lenders with a platform to check the indebtedness of potential borrowers thus preventing over borrowing.

One worrisome thing that has developed in the country is that the some of the citizens have become over borrowed leading to the failure to repay resources advanced to them while others have generally developed a tendency of wilfully defaulting on their obligations toward the banks, credit retail shops, and micro-finance institutions and everywhere where credit is provided.

The credit reference bureaus underpinned by a strong legal framework would go a long way in resolving this problem.

To sum up, it is imperative to have a stable financial system so that the system itself does not become a source of economic shocks but remains characterised by predictability, integrity and has sufficient controls in place to mitigate operational risks.

Sanderson Abel is an Economist. He writes in his capacity as Senior Economist for the Bankers Association of Zimbabwe. BAZ expressly invites stakeholders to give their valuable comments and feedback related to this article to him on [email protected] or on numbers 04-744686 and 0772463008.