If financial institutions are to minimize risks associated with bad debts, they will have to be more involved in the running of the economy through buying shares in businesses, an Economist at African Development Bank (AFDB) has advised.
This will give banks a chance to monitor closely their clients hence minimizing losses arising from poor management of businesses that in turn make it difficult for them to pay back.
In an exclusive interview with Business Times, Leonard Rugwabiza, an economist at AFDB noted that the practice would facilitate banks to extend credit in particular long term loans to the private sector.
“I do not think the banks are in a serious problem now. Some of the banks have become prudent with loans. But I guess in one year or six months they will start thinking – we are back to normal so we can give credit/ begin to lend, because now they are afraid to lend,” Rugwabiza said.
He also pointed out that the liquidity crisis experienced by commercial banks at the beginning of the year has now been solved by the Central Bank’s decision to restore liquidity in banks by allowing financial institutions to access government’s long term deposits.
However despite the initiative, recently the Central Bank revealed that outstanding credit to the private sector has not yet picked up as most banks are not utilizing the facility.
The funds were made available to facilitate commercial banks to extend finance to businesses that deal in mortgages, leasing, commercial trucks and general investments.
The economist noted that strong recovery of the economy from external shocks of the global crisis will require ensuring that credit to the economy starts to flow.
“There is a limit as to what government can do - the only thing is that it should become interesting for them(banks ) to lend long term finance,” he said, arguing that banks will only use the facility if there benefiting more from extending long term loans than in the short term.
The economist however observed that banks can minimize risks associated with credit, if they become more involved in activities of their clients.
“This is something that they never do here – some of this long term lending is done in taking shares in companies,” he said, proposing that banks should go ahead to take up leadership (board members) in businesses.
“If its (bank) on the board of the company it means that you have got somebody to monitor the development of the company. If you are giving money to a cement plant because they want to expand, you will have to make sure that every decision made by the board of company is in the interest of the bank,” he said, added.
Rugwabiza also mentioned that more involvement of banks is critical for development of the capital market and also reduces risks linked to capital market investment.
“Banks can take quite important shares and be on the board at least –it’s another way to ensure that if they do a consortium- it ensure that resources invested are well managed. This will definitely have an impact on the capital market.,” he said.