While effort has been taken to address the Non-Performing Loans challenge which is explaining bank closures, very minimal effort has been made to reduce the interest rates even after reduction in Central Bank Rate. Gideon Badagawa shares what government can do to bring down this burden on borrowers
The takeover of Crane Bank management by Bank of Uganda (BoU) is normal regulatory practice but we need to bother ourselves more with the reasons for this. Possibly, every one of us can draw lessons to improve our practices whether you are a lender, borrower or regulator. BoU has put it that capital inadequacy due to Non-Performing Loans (NPLs) was partly to blame for the mess at Crane Bank.
Generally, the stock of NPLs has almost doubled in a period of barely a year on account of low aggregate demand, government arrears and in some cases mismanagement of loan resources by borrowers. Every bank should have a role in loan performance, especially where we are dealing with a very nascent borrowing public.
Past bank closures have been blamed on these reasons in addition to insider lending. The banking sector is generally strong given the good performance witnessed as recently as June 2016 for those that published mid-year results and December 2015 for those that publish annually. Those results underline the strength of the financial sector and bank customers need not panic into bank runs.
The takeover of Crane Bank, however, provides one more case study in the on-going debate on cost of credit. The BoU has addressed itself to the NPLs challenge and insider lending and today, opinion is crystallising to confirm that NPLs are more dangerous to the banking sector than lowering interest rates. The BoU stress tests reported in its Annual Supervision Report of December 2015 that no bank would require additional capital even if net interest income reduced by 50 per cent. However, the report affirms that 17 banks would require additional capital of at least Shs595b if the largest three loan customers for each bank defaulted. This is revealing. Besides even an increase of NPLs by 100 per cent, that is from 5.3 per cent to 10.6 per cent would only affect four banks.
Many factors are blamed for the NPLs with high cost of credit being one of them. While effort has been taken to address the NPL challenge which is largely explaining bank closures, such as financial literacy training, strengthening of the financial institutions’ laws, government plans to reduce domestic borrowing, clearance of domestic arrears, no effort has been made to directly reduce the interest rates even after reduction in Central Bank Rate.
Uganda’s interest rates are hovering around 23 per cent, the highest within East African Community (EAC). The second highest is around 15.8 per cent while the lowest is 14.5 per cent! The question is whether Uganda’s private sector can compete with its regional peers or surrender into a supermarket for regional and global producers. If that happens, shall the NPL situation be improved or weakened further? If it weakens, do we see more banks falling in the Crane Bank line? Are we likely to see more closures because businesses cannot pay up?
Here are key questions that should be asked by the bankers:
1. Who is borrowing and for what purpose? Government and the Central Bank should always task banks to take interest in this.
2. Why are they not paying up if they utilise their loans well? Is it that markets are not paying up as quickly as they should?
3. Are we lending to insiders?
Ugandans must save and not wait to borrow to invest. The current environment shows that this may not be sustainable for both the lender and borrowers.
what are the options?
Other areas of consideration include the following:
Capitalisation of Uganda Development Bank
Productive sectors that will help bring down inflation, not only need low cost credit but also long-term financing. Uganda Development Bank is such a bank that can fund agriculture, manufacturing, mining, education, health and similar sectors. Capitalisation of about $500 million (Shs1.7 trillion) is required. This is about 8 per cent of Uganda’s annual budget which is an achievable target especially if allocations are staggered over say three years. Government needs to take serious steps on this.
Financial sector reforms
The sector has evolved over time with new services and providers including SACCOs, Microfinance Institutions and Mobile Money. Besides, the sector is dominated by a few and benefits of competition are not trickling down to the rest of the economy as had been expected. The structure appears to miss a credible organ in charge of consumer protection. In the current structure, consumer protection is fused with regulation and conflict may arise between maintaining healthy financial services providers and fair practices that protect consumers. Developed economies have regulators, financial sector players and consumer protection agencies within the sector. Uganda should also move towards this.
Reduction of the Crowding out effect
The responsibility to fund government continues to rest on a few taxpayers; forcing government to borrow from the domestic financial sector. This crowds out the private sector and keeps the interests rates high for the private sector and government as well. Effort must be made to grow the number of tax payers as well as the value they contribute. This calls for both a healthy economy and an effective tax administration. A healthy economy will result from increased reallocation of government revenue from consumptive activities to investments in productive sectors, curbing corruption and red tape, timely implementation of policy directives as well as donor-funded projects. Therefore, we should honour our tax obligations and implement projects and programmes.
When all is done, the need to take over banks would be for other reasons besides improved confidence in the sector will spur savings needed for investments into the economy.
The writer is the executive director of Private Sector Foundation Uganda.