Effective Financial Intermediation: Key to Zambia’s Sustainable Growth

Jan 31, 2011
The Zambian economy has continued to recover from the effects of the global economic crisis. In 2010, real GDP is estimated to have grown by 7.1 percent from 6.4 percent in 2009, far exceeding the target of 5 percent for 2010. This was largely driven by the continued strength of the agricultural, mining, and construction sectors, and a rebound in the tourism sector. However, Zambia, like many other sub-Saharan countries, has been grappling with the problem of low domestic savings needed to enhance economic growth and development. Excessive reliance on foreign savings to finance investment is highly unsustainable as evidenced by the decline in Zambia’s foreign private investment inflows to about 7.2% of GDP in 2009 from 16.7% of GDP in 2007, due to the global financial crisis.

Over the long term, greater reliance on domestic resources is critical if Zambia, like other African countries, is to develop more resilient economies. Domestic savings and investment in Zambia, and many other African economies, are low. Investment has thus been financed mainly through foreign savings. One of the reasons for this has obviously been low income levels and a narrow tax base. Another important constraint has been that of low financial intermediation.
However, the potential of savings in rural areas is high and, if captured, could help redress the situation.
The issue of high lending rates has become topical in Zambia. After the liberalisation of the economy in 1991, the Government moved away from financial repression by abandoning the administrative controls on interest rates. This means that lending rates are determined by the forces of demand and supply in the credit market, overcoming the inefficiencies that resulted from financial repression. An important effect of this repression in the credit market was that it limited the supply of credit while at the same time increasing demand when the rates were set below the market equilibrium level. This partly led to credit rationing and thus limited the ability of financial intermediaries to effectively use their roles to contribute to economic growth and development.
In a liberalised financial market environment, the Central Bank contributes to the reduction in lending rates by reducing inflation. The Government also contributes by implementing prudent fiscal policy, thus limiting the crowding out of the private sector by the Government. This should reduce the cost of lending to the private sector.
A key factor that commercial banks take into consideration in determining lending rates is the risk of default arising from the poor credit culture in the economy in general. To help
resolve the problem, the Bank of Zambia, through the financial sector development plan, has facilitated the establishment of a credit reference bureau which collects information on borrowers that is
used by credit providers. It is hoped that this will lead to a fall in default rates and thus increase intermediation.
The response of commercial banks to the factors outlined above has been slow. Therefore, another avenue taken by the Central Bank to achieve lower rates is the stimulation of competition in the financial system. In this regard, the number of commercial banks registered in Zambia has increased from 13 in 2002 to 18 at end 2010. It is envisaged that as competition in the banking sector increases, banks will be more innovative in attracting savings from the unbanked public, especially in rural areas, and making their operations more cost effective. This will lead to competitive pricing of banking products and services and enhance financial intermediation.
For its part, the Zambian Government has tried to address the problem of low financial intermediation through the implementation of a financial sector development plan. With 67 percent of the population having no access to financial services, effective financial intermediation is inhibited. There are a number of factors that can be attributed to this, including high transaction costs associated with opening bank accounts and low outreach by existing financial institutions, especially in rural areas. As there are very few banks outside urban areas, most people in rural areas have limited access to finance.
In 2011, the Bank of Zambia aims at further reducing inflation to lower levels. The decline in inflation and Government securities yield rates should, in the coming periods, contribute to a decline in banks’ lending rates and thus stimulate borrowing by the private sector. These efforts are expected to be complemented by efforts aimed at enhancing financial inclusion, including financial literacy and improving the supply and outreach of innovative banking and financial services. These efforts will go a long way in improving financial intermediation, which will in turn contribute to sustainable growth in Zambia.

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