A lot of water has flown under the bridge in regard to the best approaches we can take to transform the Ugandan economy. The journey for transformation of any economy must be buttressed by a robust means of financing economic activities based on low cost of doing business.
I recently researched on the “Impact of the Central Bank Monetary Policy on Commercial Bank Competitiveness in Uganda”. My research results indicated that the greatest hindrance to business activity in Uganda is inadequate financial penetration both in terms of financial products as well as gross financial illiteracy. These two are exacerbated by inappropriate financial infrastructure such as lack of electricity in most rural areas, which have all combined to make financial institutions a preserve of a few urban centres.
Indeed, we continue to have a low banked population (8.3 per cent) with majority of the people (68 per cent) operating a subsistence economy. This is where we need to salute the new innovations such as mobile telephone banking that has greatly enhanced financial transactions. Because of a low banked population with narrow financial products, amidst high operational costs, commercial banks have resorted to charging very high interest rates. These are levied on a population that is not adequately financially literate, hence, very high non-performing loans from banks.
Now, it is extremely gratifying that Uganda government has embraced Islamic banking. This will bring a new dimension in the financial sector in Uganda. Islamic banking is premised on principles of financial sector operations with the following characteristics:
• There is no interest charged on loan recipients.
• The bank from where one borrows, instead of charging interest rate, gets involved in implementation of the project for which the loan has been acquired.
• Business risk is, therefore, shared between the bank and loan recipients.
These principles are advantageous because one of the critical impediments to financial deepening in Uganda is the high interest rate. Imagine securing a loan at an interest rate of 28 per cent per annum. In 2010-2012, some commercial banks charged interest rates in the range of 30-32 per cent.
Ironically, these are the lowest rates given that some MFIs charge 4 per cent per month, implying an interest rate of approximately 48 per cent per annum. Worse still, many people use money lenders purportedly because of the ease with which money lenders operate. As a result, many people have ignored the exorbitant interest rates from money lenders and still use the source as it is very convenient.
Islamic banking will go a long way to increase access to investment finance, avoid the high interest rates from both formal commercial banks and other non-banking sources of finance.
The loans will be interest free and the concerned bank will get involved in the running of economic activities for which such loans have been acquired. If there is profit from economic activities implemented by the loan recipient, the bank will partake of the dividends. However, if there are loses, then, the bank will also accordingly suffer together with the client.
This approach presents a new dimension in risk management in the financial sector. Apart from making it much easier for one to access financial capital, Islamic banking will instill competition in the banking industry which will greatly enhance the quality of financial services.
The principle of ‘joint implementation of economic activities’ turns the bank from which money has been borrowed from a sleeping partner to an active shareholder in the business that has been financed by the loan. It is hoped that this new approach will greatly enhance potential entrepreneurs’ access to financial capital, hence contribute significantly to economic growth and transformation. However, three things shall be necessary for successful implementation of Islamic banking in Uganda:
1. Improved corporate governance: This shall be critical for successful implementation of projects. The requirements are openness in conducting business activities and disclosure in regard to business performance.
2. Good financial records: In Uganda, this is a major weakness. Many business activities are conducted without proper documentation. If there are no clear records, how will one tell whether the business is making profits or losses?
3. High level of integrity: Integrity is a fundamental ingredient for doing business. This goes with trust. In the event that there is a breakage in trust, it will be difficult to rebuild it. If a house developed a crack during construction, it will be difficult to have such cracks rectified unless tackled right from the foundation.
As has been said before, once you break the trust, you have broken all. As the old adage asserts, “There will be no second chance of making your first impression.” We salute the Uganda government for embracing Islamic banking and we should all give it the support it deserves.
Mr Nuwagaba is a consultant on economic transformation. firstname.lastname@example.org