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Why your bank could be closed by the regulator

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Motorists drive past the building that housed Global Trust Bank in Kampala. Bank of Uganda recently withdrew the bank’s operating licence. Photo by Abubaker Lubowa 

By ISMAIL MUSA LADU

Posted  Tuesday, August 19   2014 at  01:00

In Summary

Past bank closures. In the last 10 years only two banks have been closed by the Central Bank, the National Bank of Commerce and Global Trust Bank.

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Financial industry players and the regulator would want to quickly forget the closure of Global Trust Bank whose impact, according to consumer activists, could impair the confidence of the population in financial institutions.
Recently, Global Trust Bank’s licence was withdrawn by the Central Bank on the grounds that the commercial bank is no longer a commercially viable institution.
In response, the bank’s shareholders described the regulator’s action as an ‘unfortunate’ incident, implying the closure of the bank was unwarranted.
In an e-mail interview exchange with the executive director research, Bank of Uganda, Mr Adam Mugume, it emerged that the Central Bank can prevail upon any financial institutions at any time if it believes the financial institution is going off the mark.

Requirements
He said: “The law requires a financial institution, at all times, to maintain a core capital of not less than 8 per cent and a total capital of not less than 12 per cent of the total risk adjusted assets plus risk adjusted off balance sheet items.”
This means the banks must always maintain a minimum capital requirement of Shs25 billion. This is mainly done to protect the consumers’ interests. At the same time, the bank must not be overwhelmed by risks.

Why Bank of Uganda closes a bank
In his view, the Central Bank may, at any time, revoke a licence of a financial institution if it is satisfied that the financial institution at any time is significantly undercapitalised or has in the view of the Central Bank contravened the Financial Institutions Act, (FIA) 2004 or any other financial law persistently.
“The closed banks usually fail to comply with instructions or directions given by the Central Bank as stipulated in the FIA to remedy managerial or financial deficiencies. Most banks that have been closed violate mainly the above regulatory requirements,” Dr Mugume said.
Where a financial institution is significantly undercapitalised, the Central Bank may enter into an agreement with the board of directors of the financial institution requiring it (the financial institution) to rectify its significant undercapitalisation within 90 days, and to restore capital adequacy within 180 days, or within such shorter periods as the Central Bank shall order.
“If after this period the financial institution has failed to raise its capital to the levels necessary to rectify its significant undercapitalisation; or before the end of the period the financial position of the institution continues to deteriorate, the Central Bank, without having to wait for the expiry of that period, closes the financial institution and places it under receivership,” Dr Mugume explains.
Where the closure of the financial institution would pose a systemic risk to the stability of the financial system, Dr Mugume says the Central Bank takes the financial institution into statutory management in accordance with FIA.

Signs of struggling bank
Bank of Uganda says a struggling bank is one that makes losses persistently and the losses have diminished its capital, meaning it is struggling to keep afloat. Here, the bank owners are required to inject in more capital to keep the bank functioning. The persistent losses often arise because of poor management.

Fate of customers
According to Mr Mugume, customers are taken care of under what he described as ‘deposit protection.’
“It is a bank deposit guarantee scheme aimed at protecting depositors against loss of their deposits or part of their deposits in the event of failure of a bank or other deposit-taking institution in which they hold funds,”
“This is provided by making the deposits available to depositors up to a guaranteed coverage amount prescribed by the law. The main role of deposit protection in a financial system is therefore to provide cover that safeguards depositors against losses they would otherwise incur if a bank or deposit-taking institution closes.”
The rationale for establishing the Deposit Protection Fund is for protection of depositors from the risk of losing their deposits from bank failures; and enhancing public confidence in the banking sector in particular and the financial sector in general.
Also, Uganda maintains a formal deposit insurance fund administered by the Central Bank. Section 108 of the FIA 2004, and Section 80 of the Microfinance Deposit-taking Institutions 2003 (MDI Act 2003) mandate the Bank of Uganda to establish, manage and control the Deposit Protection Fund. FIA 2004 also empowers the minister of Finance from time to time, to fix the size of the fund sufficient to protect the interests of depositors.
The DPF is thus currently administered by the Supervision Function of the Bank of Uganda. Proposals to establish a Deposit Protection Corporation to assume the role of administering the DPF are some of the proposed amendments to the Financial Institutions Act 2004 which were forwarded to Parliament.
The Ugandan Deposit Protection Fund started operations in 1997. It provides coverage to all banks and credit institutions and is mandatory. It charges a flat premium rate of 0.2 percent of the deposit liabilities of the financial institution in its previous financial year and it insures up to Shs5, 000,000 accounts.

Assessment of the financial industry
In 2013 and the current year, the financial system profitability has declined slightly largely due to the slackening of the economic activity and the global financial turbulence.
Indeed, this is reflected in the rise of the ratio of non-performing loans which is currently at about 6 percent from about 2 percent in 2011.
Due to the rise in the non-performing loans, the overall rate of growth for bank lending declined, almost halving from 11.6 percent in December 2012 to 6.6 percent in December 2013. But this has since recovered to about 12 percent as of June 2014.
But banks are likely to face challenges from the reduction in credit growth and a decline in credit quality, which may dampen returns on equity.

PRECAUTIONS FOR CUSTOMERS

Ugandan Banks are well capitalised and liquid and the BoU ensures that the customers are not inconvenienced in anyway by weak banks. That is why bank closure has been minimal in the last 10 years. However, the customers should also endeavour to follow financial news and follow the way their bankers manage the banks.
At the same time, the Central Bank also advises that you should keep your money in more than one bank in an attempt to reduce chances of losing money with a collapsing bank.
However, no customer has lost money because of a bank closure in the last 10 years, according to Mr Mugume.

iladu@ug.nationmedia.com