Bank of Uganda should ease capital requirements for banks

Monday May 18 2020

 

By Simon Mutungi

Following the 2008 global financial crisis, many banks collapsed worldwide, while others had to plough through public funds in the form of government bailouts in order to survive.

To avert a consequent repeat of this episode, the Bank of International Settlements (BIS), a global standard setting body for central banks, under the auspices of the Basel Committee on Bank Supervision (BCBS), amended its standards with the passing of the Basel III Accords.

These increased the capital and liquidity requirements that banks are mandated to hold as buffers against shocks in times of crisis.

In 2009, Uganda became part of this risk management framework and the Bank of Uganda (BoU) subsequently implemented Basel III by requiring banks to hold a minimum Shs25b in the capital.
This was done with the passing of the Financial Institutions (Revision of Minimum Capital Requirements) Instrument No43 of 2010 in accordance with Section 26(5) of the Financial Institutions Act 2004.
Later on, perhaps to restore public confidence in the banking sector after the Crane Bank debacle, the BoU, in December 2016, would further raise the minimum statutory capital adequacy ratios to 10 per cent (up from eight per cent) of the risk-weighted assets of the bank on top of holding a capital conservation buffer of 2.5 per cent of their risk weighted assets.

An additional capital surcharge of 1 to 3.5 per cent was charged on the big banks considered as Domestically Systemic Important Banks, which currently include Stanbic, Standard Chartered and dfcu, with strong capital buffers ensuring sound banking and indeed the BoU June 2018 Financial Stability Report showed that the banking sector remained well capitalised and that banks had adequate liquid assets.
This stability buffer is, however, not only meant to help banks weather a stormy crisis, but also encourage them to help their struggling customers in tough times such as these caused by the Covid-19 pandemic.

According to the latest BoU monetary policy, the Covid-19 pandemic has led to a severe contraction in economic activity due to a combination of global supply chain disruptions, travel restrictions, measures to limit contact between persons, and the sudden decline in demand.
The lockdown is likely going to force many firms out of business, as well as employees out of work.

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To help stimulate growth in the economy, the government must support the banking sector since it is a central player in economic growth and a conduit through which finances are distributed.

To keep credit flowing to counter the economic havoc caused by the pandemic, I propose the dropping of the minimum capital requirements and compulsory reserve funds for these banks.

Although well intentioned, the capital requirements eat into the banks’ capital available for loans disbursement. For instance, in 2015, Stanbic Bank had to pay out 30 per cent of its earnings in these regulatory capital requirements.

This means banks are currently sitting on giant stockpiles of cash and other safe assets as required by law. By softening this requirement, the BoU will effectively be freeing up money that can then be loaned out to the populace that is in dire need of it.

A rough and conservative estimate would indicate at least Shs650 billion in liquidity being freed up if Uganda’s 26 Tier 1 commercial banks are allowed to relax these capital requirements. However, the BoU does not have to reduce the requirements to zero per cent.

A gradual relaxation could work as was seen in South Africa when the authorities dropped the minimum capital requirements and compulsory reserve funds for lenders, reducing the liquidity coverage ratio to 80 per cent from 100 per cent.

The UK, Europe and the United States of America too, have softened these requirements for their banks. These are committee members of the BCBS that set the Basel III capital requirement rules, but they have chosen to adjust accordingly in light of the Covid-19 pandemic’s economic shocks.

When international bodies set standards, we tend to follow them hook, line and sinker without adjusting to our circumstances and even when the standard setters themselves deviate from the very rules.

The suspension of the capital requirements should only serve as a temporary relief and the BoU should commit to reinstate the requirements when the dust settles.

The freed-up liquidity should primarily target loans to household consumers and small-and medium-sized businesses. They are not to be used by banks to distribute earnings in the form of dividends and BoU should reserve the right to prohibit any payouts.

BoU has already issued a directive suspending any bonus and dividend payments in a bid to reserve capital. The BoU has also undertaken to provide exceptional liquidity support to any bank.

Another aspect in which BoU can enable banks to help the struggling businesses and consumers is to further reduce the interest rates by cutting the Central Bank Rate to eight per cent.

This would motivate banks to lower their lending rates averaging 20 per cent so as to enable businesses to apply for new loans or pay existing ones. South Africa has this year already cut its interest rates thrice to 4.25 per cent, whereas the Federal Reserve in the USA dipped to 0 per cent.

In conclusion, despite the need to pump liquidity into the economy, banks should be cautious not to make subprime loans as an increase in non-performing loans will cripple the banking sector and possibly turn into a full-blown economic crisis.

Mr Mutungi is a PhD fellow at Yale University
@shakamara on Twitter

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