James Obuku imports goods from China for retail purposes. At the height of the depreciation of the Shilling, Obuku took out a loan at an interest rate of 28 per cent which kept on fluctuating because it was not a fixed rate loan. As such, he paid through the nose.
If Obuku attempts to borrow again today, he says he will be given credit at an interest rate of 25 per cent which is still high. With the current (Central bank rate) CBR at 14 per cent, this implies that the commercial banks will be getting a profit of 11 per cent. According to Bank of Uganda (BoU) statistics, the interest rates charged by commercial banks have averaged at 21.3 per cent since the start of the millennium and about 21.7 per cent since July 2011.
Some experts have blamed this on BoU, saying tightening the CBR – the regulators tool for macroeconomic management – amounts to further increases in the cost of credit. But its easing is not followed by a corresponding reduction in lending rates.
Kenya recently signed into law a legislation that imposes limits on bank lending and deposit rates, challenging the regulator’s conduct of monetary policy in a free market environment.
Back here, Ugandan financial sector players think capping interest rates is counterproductive while the civil society and pockets of the business community are pushing for Uganda to go the Kenya way.
Before the 1990s, Uganda’s economy, just like many other economies in the region, was controlled. Almost all economic indicators including prices, interest rates, exchange rates were controlled by government.
Dr Ezra Suruma, the former finance minister and Chancellor Makerere University, in an interview with Prosper magazine says back in the 70s and 80s, the interest rates were set by the Minister of Finance during the budget speech reading. This rate would then be used throughout the year until the next budget reading.
However, he says the controlled regime did not deliver much. “It is not right to say that controlled interest rates worked in the 70s and 80s because the economy that we inherited in 80s was completely broken down. There was no economy. …We had controlled rates announced by the government but we did not have an economy at that time,” Dr Suruma notes.
He says everybody wanted to borrow at that time because of very high inflation. “Whatever you borrowed, you would pay back cheaper money later and could always multiply your money very quickly through trading and the opportunities for speculation.”
“It would not be correct to say it worked because hardly anybody was investing. The activity going on then was trade. It will be very hard to point out any hard investment at that times based on borrowing,” he says.
Dr Suruma adds: “We looked at that situation and decided that it would be better to liberalise and when we did, the rates went high because inflation was still high.”
In 1993 when Dr Suruma joined the Uganda Commercial Bank (now Stanbic Bank), some loans were being given out on an interest rate of 53 per cent. This was exorbitant so the then government worked hard to bring them down to a more reasonable level mainly by bringing down inflation.
“But at some point, they seem to have become stuck; we thought that the difference between the rate of inflation and lending rate would be a few interest rate points. So if inflation was 5 per cent, one would expect the highest rate to be 10 per cent which would double the inflation rate. Normally, it should be like 8 per cent. But that never happened,” he explains.
Banking sector not competitive
Dr Suruma says one of the reasons for the high interest rates was that the banking sector was not competitive. “Initially, we were not allowing new banks to come into the sector because it had become unstable. One of the reasons given for the rates being high was that the competition was not as high,” he says, adding: “When there is limited competition, you may even have what they call a cartel in which major banks decide what the rates should be.
For instance in the 90’s, Uganda had one large bank -Uganda Commercial Bank, which held about 47 per cent of the total deposits for the whole country. This made it a huge player in setting the market trend.
One of the reasons the World Bank pushed for the privatisation of the bank was to reduce its dominance in the financial sector.
Mr Lawrence Bategeka, a senior research fellow, says one of the assumptions of a free market is that there must be many players. However, in Uganda, “There are only 25 banks which have developed Cartel like behaviour,” he says.
He says one of the things they want to look at is the extent of genuine competition in that sector. Is there really competition? Are there a few big banks coming together and determining what the rate should be rather than competition determining the basis? The ideal is what we call ‘perfect’ competition where you have a large number of lenders and borrowers such that the market is determined by forces of supply and demand.
Mr Fred Muhumuza, an economist and researcher, says in between control and free market is regulation. “Every time you liberalise and you don’t strengthen regulation, the markets go mad because markets are self-interest driving and interests are so many in the market. Even in the banking industry, there are those that want to eat up the small ones,” he says.
Mr Muhumuza says what we miss out in Uganda is the strong regulatory frame work and competition authority which should check the behaviours of the market. He says capping interest rates alone is not enough to solve the interest rate problem.
Mr George Lipimile, the chief executive officer of the COMESA Competition Commission (CCC), says a competition law is there to protect the process of competition.
“It is meant to punish large companies on account of their size and commercial success. The idea behind these laws is that in every market, there should be vigorous competition forcing firms to continually strive to improve their goods and services and to offer them on favourable terms.
However, according to Bank of Uganda experts, competition in the Ugandan banking industry has increased in the last 10 years with now 25 commercial banks, five microfinance deposit taking institutions and four credit institutions operating in the country. The market share of the three largest banks has since reduced, much of this competition takes place through expansion of branch networks – the number of bank branches has increased from 141 in 2006 to 691 today.
“By efforts to mobilise deposits by offering attractive time deposit rates, both of which raise the costs of doing business for the banks and increase rapidly if banks extend their branch networks outside of the main cities; costs which must be passed onto borrowers in form of high lending rates,” Dr Thomas Bwire, an economist at Bank of Uganda (BoU) says.
Interest rate spread
Interest rate spread — the difference between the lending rate banks charge borrowers and the deposit rate offered to savers, is one way of finding out how efficient banks are. But to understand why lending rates are so high, one ought to look at the causes of high interest rate spreads.
“The largest single contributor to interest rate spreads in Uganda is bank overhead costs, which are high because of the structural features of the economy and the banking system,” Dr Bwire shares.
Mr Ramathan Ggoobi, an economics lecturer from Makerere University Business School, says the central bank should exercise its regulatory powers to check the high overhead costs incurred by the commercial banks that in turn transfer the burden to the borrower through increased interest rates. He also says banks offer a saving rate of three per cent yet our inflation is almost 5 per cent, a disincentive to savers.
“When you ask the central bank to regulate, they say its policy reversal. It is good that we should liberalise but let us not deregulate like this,” Mr Ggoobi says.
Mr Louis Kasekende, BoU’s deputy governor also down played the possibility of BoU proposing any legislation to cap lending rates like Kenya did last week. In the 1960s, there were fixed interest rates by the central banks for different loans and saving products.
“Our assessment then is that it did not serve us well. If you look at the financial system of the 1980s, it actually contracted. We moved away from fixed interest rates to market-determined interest rates and our experience with these rates has been very good since 1993,” he said. “Any move away from market-determined interest rates would be a policy reversal and you do not just give away something that has been serving you well in terms of the financial sector,” Mr Kasekende said.
Comparison with the region
Kenya, which is relatively advanced economy in East Africa, has a CBR currently at 10.5 per cent, the maximum interest rate stands at 14.5 per cent.
Other free markets globally have strong regulations to restrain banks as such guarding against increase in interest rates. Free markets, from the United States to Britain to China, sometimes need the steady restraining hand of regulation on the hand brake.
Uganda’s economy in pre-colonial times
Economy. Before the 1990s, Uganda’s economy, just like many other economies in the region, was controlled. Almost all economic indicators including prices, interest rates, exchange rates were controlled by government.
Capping rates in free market economy. Kenya recently signed into law a legislation that imposes limits on bank lending and deposit rates, challenging the regulator’s conduct of monetary policy in a free market environment.