Will record low CBR bring down bank interest rates?

KAMPALA. Sticky downwards is a phrase often used to describe price movements proving to be resistant to reducing.
That describes the movement of interest rates in reaction to the Central Bank Rate (CBR).
This is the sentiment of Mr Gideon Badagawa, the executive director Private Sector Foundation Uganda (PSFU), who told Daily Monitor that the “CBR reduction has not been commensurate with commercial bank interest rates.”
In the last one year, Bank of Uganda (BoU) has eased the CBR by 7 percentage points, whereas commercial bank interest rates have on average dropped by 4.71 percentage points.
BoU notes that this reduction in commercial bank lending rates is “marginally lower than” the CBR reduction. In essence, the banks are slowly responding.
Interest rates, on average are at 20.52 per cent – a spread of about 10 per cent from the current CBR.
On Monday, the Monetary Policy Committee (MPC) sitting at BoU set the benchmark lending rate at its lowest level ever of 10 per cent.
Known as the Central Bank Rate (CBR), the rate cut was done with aim of triggering economic activity, at a time the economy is in slowdown mode.
“With domestic inflationary pressures remaining subdued and given the continued weak growth prospects, the BoU judges that continued easing of monetary policy is appropriate.
“This will be consistent with achieving the core inflation target of 5 per cent over the medium -term and will also support the recovery of real output in the economy,” Mr Emmanuel Tumusiime-Mutebile, the BoU Governor, said in the Monetary Policy Statement (MPS) issued on Monday.
In order to revive the economy, BoU wants the private sector to be able to borrow money from commercial banks.
Easing the lending rates facilitates that but only when commercial bank lending rates also fall to historical lows.
Often, the bankers have stated that the CBR is a signal rate and doesn’t automatically translate into lowering of lending rates to its level.
“There will always be a spread between the CBR and commercial bank interest rates. The cost of money due to high operating costs continues to exist for commercial bank interest rates to be closer to the CBR. What we are going to see is a reduction in the same margin of 1 percentage in terms of interest rates,” said Mr Stephen Kaboyo, the managing partner at Alpha Capital Partners.
The indicator for improved lending is the measurement of Private Sector Credit (PSC) uptake.
Even as interest rates have been falling, quarterly growth in credit uptake as at April 2017 was 6.5 per cent, lower than the 9.5 per cent in the quarter to April 2016.
“Demand for credit (loan applications) remains robust while supply (loan approvals) remains subdued,” reads the Monetary Policy Report for June 2017.
Adding: “PSC may continue to be constrained given that commercial banks continue to tighten credit standards.
Moreover, low credit to the manufacturing, business services, and mortgage which are the main drivers of growth continue to decline.”
The banks are still exercising caution, even when their interest rates have reduced. This caution is being driven by loan defaults that have reduced but the projection is that they are likely to go up again.
Estimates indicate that loan defaults, Non-performing Loans (NPLs) as a percentage of total loans in March 2017 had declined to 6.3 per cent from 10.5 per cent in December 2016.
According to the MPS report, the banking sector “could see further increase in NPLs because there are higher loans in the watchful category.” The banks are also constrained because the returns on government securities have also been declining. This has often been a safe haven for commercial banks as they stay away from risky borrowers. For instance, a 2 year bond of Shs102.2b in April 2016 had a return of 15.4 percent.
In May 2017, a two-year treasury bond of Shs104b had a rate of 14.6 percent.
However, the changes have not been significant enough to take bring banks back to the private sector.
Kampala City Traders Association chairperson Evaristo Kayondo said: “Bank of Uganda has been reducing its rate for a year now but interest rates remain high. Businesses can’t be borrowing at a rate of 20 percent and expect to survive. For the last one year banks have taken over properties of business because of these high rates. We don’t expect a lot to change.”

CBR movement
How the Central Bank Rate has changed over time.
July 2011 - 13 per cent
Decemmber 2011 - 23 per cent
June 2012 - 20 per cent
December 2012 - 12 per cent
June 2013 - 11 per cent
June 2014 - 11 per cent
Decemebr 2014 - 11 per cent
June 2015 - 15 per cent
December 2015 - 17 per cent
June 2016 -15 per cent
December 2016 -12 per cent
June 2017 - 10 per cent

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