Rakesh GuptaBy Rakesh Gupta N. R.

As the country reels under an apparent slowdown, experts, academics, policy makers and politicians are providing several explanations to pinpoint the underlying reasons. From these explanations, a range of possible recommendations emerge for a rejuvenation of the economy to (re)witness the growth miracle and poverty reduction (56.4 percent in 1992 to 19.7 percent in 2012/13) experienced in the 1990s and early 2000s. The banking sector is a key player to facilitate this objective. However, they are making headlines for wrong reasons. The sector that is stealing the infamous limelight of the economic downturn is banking sector. The banking sector largely claims that the economy is to blame for the sector’s anaemic performance off late. In this article, we try to understand these dynamics.


Banking sector is crucial to provide credit for productive and consumption purposes to the private sector and the population. Financial liberalisation reforms in the 1990s ushered in a new era to formalization of the banking sector. These reforms lowered barriers to entry as witnessed by the increased number of commercial banks willing to do business in Uganda, alongside banking market rebalancing and restructuring (privatizations, spin-offs, mergers, and even some exits of inefficient players) up until recently which is a natural course for any industry throughout its lifecycle.

Graph 1

The duel of economy and banking sector: who stirred the commotion?
Commercial banks’ lending to the private sector is on a downward trend. The banking sector grew considerably and consistently despite low coverage due to the large informal economy. There was also growing formal sector facilitated by banking sector expansion which is a laudable achievement. Our trend analysis starting 1990 confirm the same. However, we notice from figure 1, a reversal of fortunes for the banking sector around 2010 and not just the last year as many may believe. The news emerging from the banking sector may be the falling out of an overdue stressed functioning of the whole sector. From the above figure, we also notice that between January 2015 and September 2016, the average growth in private sector credit from commercial banks was 0.65 percent. We also observe that commercial banks’ lending has been increasing throughout, but the lending growth is on a clear downward slope starting 2007 and even negative over several months which was uncommon in the 1990s and 2000s. This is a first result to take note of troubles for the banking sector.

Graph 2

Similar downward trend is observed in the overall economy. GDP growth displays a downward trend starting around 2010. This is confirmed around the same time inventories data – which are stocks of goods held by firms to meet temporary or unexpected fluctuations in production or sales, and “work in progress” – are piling up around the same time.

Graph 3

Banking sector health is on a decline in the recent past. The crucial indicator that directly reflects the health of banking sector is the non-performing loans (NPL) to total gross loans ratio. This ratio has been continuously rising from the lows of 1.6 percent around 2010 to 8.31 percent for the latest April 2016 estimate which is the highest in the entire history of Ugandan banking sector history. This has a direct adverse impact on the return on equity (ROE) – which is the return earned on all the capital invested in the bank – can be observed to be a mirror image to NPL-to-loans ratio across time. In 2015/16 ROE of the total banking industry stood at 13.78 percent which is lower than any T-bills of shortest maturity period which is suggestive of liquidation of all commercial banks in Uganda and to invest them in T-bills (14.22 percent as of November 2, 2016) of the central bank, Bank of Uganda (BOU).


The drag on ROE is brought in by the capital requirements spike in the recent years which is rather a reactionary and kneejerk reflex of the BoU to contain the scare of commercial banks failure. These requirements are multiple times the recommendation as per BASEL-III. We believe, BOU monitoring capabilities have been sharp and well monitored, hence capital requirements may be reduced for the sector to be profitable again.


In conclusion, a closer and detailed scrutiny of the NPLs’ sector and industry specific stress factors is a prerequisite before policy recommendations and banking industry interventions are implemented to target and have a better impact of fiscal, monetary and financial regulation toolkit. Higher interest rates and large interest rate spread could be brought down promoting financial inclusion and attracting more deposits. A wild card here would be to use the current “interest-free” mobile money to contribute to the deposit pool of formal commercial banks, and in-turn linking mobile money industry to complement efforts of formal financial inclusion of population. Most importantly, again, understanding NPLs piece-by-piece (more details be made public) is required before tagging the entire economy or the entire banking sector as defunct and regroup efforts in a targeted fashion to restart the economy with a healthy banking sector.

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