EPRC in the news
As the country reels under an apparent slowdown, experts, academics, policymakers 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 per cent in 1992 to 19.7 per cent in 2012/13) experienced in the 1990s and early 2000s.
The banking sector is a key player to facilitate this objective. However, banks are making headlines for wrong reasons. The banking sector largely claims that the economy is to blame for its anaemic performance of late. In this article, we try to understand these dynamics.
The banking sector is crucial in providing 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.
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 confirms the same. However, there was a reversal of fortunes for the banking sector around 2010 and not just the last year as many may believe. Between January 2015 and September 2016, the average growth in private sector credit from commercial banks was 0.65 per cent.
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.
Similar downward trend is observed in the overall economy. GDP growth displays a downward trend starting around 2010. Banking sector health has been on a decline in the recent past. The crucial indicator that directly reflects the health of the banking sector is the non-performing loans (NPLs) to total gross loans ratio.
This ratio has been continuously rising from the lows of 1.6 per cent around 2010 to 8.31 per cent for the latest April 2016 estimate which is the highest in the entire history of Ugandan banking sector.
This has a direct adverse impact on the return on equity (ROE) – money earned on all capital invested in the bank – and 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 per cent, which is lower than any treasury bills of shortest maturity period. This is suggestive of liquidation of all commercial banks in Uganda and to invest them in treasury bills (14.22 percent as of November 2, 2016) of the central bank.
The drag on ROE is brought in by the capital requirements spike in the recent years, which is 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 the Basel committee on banking supervision reforms III. We believe BoU’s monitoring capabilities have been sharp, 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, link mobile money industry to complement efforts of formal financial inclusion.
Most importantly, again, understanding NPLs piece-by-piece (more details being made public) is required before tagging the entire economy or the entire banking sector as defunct.
The author is a fellow with the Economic Policy Research Centre, Makerere University.