Bank of Uganda

In 2007/08, the bursting of the U.S. housing bubble caused the values of securities tied to U.S. real estate pricing to plummet, impacting negatively on financial institutions and markets globally.  The crisis played a significant role in the failure of key businesses, declines in consumer wealth estimated in trillions of US dollars, and a downturn in economic activity leading to the 2008–2012 global recession and the European sovereign-debt crisis. 

The importance of a strong banking sector to a country’s economic growth and development is well established in literature. In Uganda, the banking sector which accounts for 80% of the financial sector faced a crisis in the 1990s when several indigenous commercial banks were declared insolvent, taken over by the central bank and eventually sold or liquidated. These included Uganda Cooperative Bank, Greenland Bank, International Credit Bank, Teefe Bank and Gold Trust Bank. 

The banking sector is now healthy, recording strong profits in 2012, in part because of high interest margins. Banks’ profits after tax stood at Ushs.370 billion over a nine months period stretching from July 2012 to March 2013 relative to Ushs.430 billion registered in March 2012. Overall, the total assets of commercial banks grew by 9.7 percent from Ushs14.4 trillion in June 2012 to Ushs.15.8 trillion in March 2013.The banks’ capital position remained very strong, with the core capital for the banking system as a whole standing at 18.8 percent of risk weighted assets in December 2012.

At the beginning of March 2013, the statutory increase in the minimum paid up capital of banks from Ushs 10 billion to Ushs 25 billion took effect, with all 24 banks in operation now in compliance. Core capital which is the primary form of capital grew by 16.0 percent from Ushs.1.87 trillion in June 2012 to Ushs.2.17 trillion at the end of March 2013.

There was also an increase in the liquid assets to deposit ratios of the banking sector from 37.6 percent in the March 2012 to 42.7 percent in March 2013. Credit to the private sector grew by 6.0 percent from Shs.7.19 trillion in June 2012 to Ushs.7.62 trillion by end March 2013, reversing the stagnation experienced during the period September 2011 to June 2012.  However, a slight decline in the stock of loans and advances was registered between December 2012 and March 2013 mainly due to the closure of the lands registry which impeded the banks’ ability to verify land titles which are used as collateral for commercial bank lending. Worth noting is the limited competition in the banking sector.

The bulk of the UGX 430 Billion net profits made by banks was shared as follows; Standard chartered (130 billion), Stanbic (130 billion), Crane bank (80 billion), and the rest of the 21 banks account for UGX 90bn.

The banking sector remains an effective transmission conduit of monetary Policy. In particular in 2011, the economy faced high inflation levels hitting 30.5% in November. To curb inflation, the BOU aggressively tightened monetary policy by raising the CBR. The CBR was increased from 13 percent in July 2011, when it was first introduced, to 23 percent in October, and remained constant until February 2012. The increase in the CBR was quickly passed on to interbank rates and other market interest rates. The average interbank rate increased from 10 percent in June 2011 to 27 percent in December 2011. Commercial banks’ lending interest rates increased from 21 percent to 27 percent; and yields on treasury bills and bonds also increased. Consequently annual headline inflation has since subsided to single digit figures at 3.6% in May 2013 and the CBR rate currently stands at 11%.

However, according to World bank and IMF estimates, Uganda’s average private sector credit as a percentage of GDP for the period 2009 to 2012 at 13.9% is among the lowest by East African countries; Kenya (34.4%),Tanzania (19%), Rwanda (13.1%) and Burundi at 15.3%.

It is worth noting is that commercial banks private sector credit growth declined in 2011/12 to 14.6% of GDP from 16.6% in the previous financial year.  Nearly all new credit over the last 2 years has been extended in foreign currency, and is posed to increase in the next few months since commercial banks are slow at lending in Local currency.

Linkages with the agriculture sector which employs over 66% of population is still weak. Private sector Credit is largely skewed to construction, trade and salaried loans. The building and construction sector constituted the largest share of total credit, dominating at 23.3 percent. The share of the trade and commerce sector to total lending, which in the previous year constituted the largest share at 21.5 percent, increased slightly to 21.7 percent. Personal and household loans constitute 21.1%, manufacturing at 8.9% and  agriculture at 6.4%. 

There are about 5 million accounts. This is equivalent to a 14% commercial bank penetration rate given the current population of 35 million. Access to commercial banks by Ugandans per 1000 adults remained low (168) for the period 2008-2012. Other East African countries such as Kenya and Rwanda stand at 523 and 215 respectively.

The drastic growth of Mobile money to over 11million accounts with a total transaction value exceeding 20% percent of GDP (bigger than the size of proposed budget for FY 2013/14 ) poses a negative risk to  the banks’ potential profit growth as well as a compliment for increased financial access. The outstanding challenge is how financial transactions on the mobile money platform can be integrated into the banking sector.

The Financial Year 2011/12 was a difficult year for Uganda, facing the worst inflation in two decades and consequently slower growth at 3.4%. This in turn inflicted downturn risks on households and corporate entities. The commercial loss expense provisions in the wake of high interest rates have since increased and the data from Bank of Uganda shows that commercial Banks’s expense provisions grew by 260% from UGX 77.9 bn (US$ 31.6M) in December 2011 to UGX 205.9Bn (US$ 82M) in December 2012. Also the non-performing loans share of the total lending stood at 4.5% in December 2012 which is twice the amount the previous years.

Despite the central bank reducing the CBR to 11%, the decrease has not been met with a proportionate cut in credit rates as banks only adjusted lending rates marginally downwards to an average of 24%. Hovering uncertainty, high alternative sources coupled with slow adjustment of credit risk continue to forestall deeper cuts of credit rates by lenders.

The total size of the formal financial sector (see table below) as measured by conventional indicators, (such as the ratio of deposit bank assets and the assets of nonbank financial institutions to GDP, the ratio of private credit from formal financial institutions to GDP, the number of bank branches scaled by population, or the fraction of adults with accounts at formal financial institutions) the formal financial system is relatively small in Uganda. This is consistent with financial intermediation being a costly activity in the country. To the extent that monetary policy actions affect only the share of the economy that is served by the formal financial sector, the small size of that sector limits the reach of monetary policy, thus reducing its impact on the economy. Also to note is that costly intermediation likely implies a sharply rising marginal cost of intermediation as banks try to serve smaller and more opaque borrowers, so even for the share of the economy that is served by the formal financial sector, central bank actions may have weak effects on the supply of bank lending. 

The banking industry remains solid with high capital and profit levels but penetration rate remains low. There is need for commercial banks with high non-performing loans to ensure that lending standards remain high and that loan quality does not deteriorate further. The growth in foreign denominated credit poses an indirect credit risk. The growth in banking volumes due to cross border transactions will require vigilance by both banks and central banks. Private sector credit to GDP at 14.6% remains lowers than the EAC macro-economic convergence criteria of the 30%.  The banking sector linkage with the agriculture sector is still weak.  The passing of the anti-money laundering legislation will come in handy in mitigating the misuse of the banking sector to launder proceeds.  Agency banking, Islamic banking and liberalization of the pension sector should boost the banking sector. The transition requires BoU vigilance.

By Enock Nyorekwa Twinoburyo
The author is an Economist.