Engage banks before capping interest rates

What you need to know:

  • The issue: Interest rates.
  • Our view: Under the current situation, low interest rates in consort with the right policies can work to achieve the same result.

The Governor Bank of Uganda (BoU), in a no-holds-barred letter to the chief executives of commercial banks, threatens to cap interest rates if financial institutions do not cut lending rates.
In response to the deadly Covid-19 pandemic, BoU has cut Central Bank Rate (CBR) to an all-time low of seven per cent between April and June. Under normal circumstances, a reduction in CBR would translate into cheap credit needed to buttress limping businesses and households.

BoU expected banks to reciprocate its gesture, but they remained defiant. Some reduced but the markdown was insignificant. In fact, the average lending rate increased from 17 per cent to 18 per cent. The pandemic has forced people to spend less and higher borrowing costs made matters worse. The demand for goods and services has dropped and killed impetus for investment and job creation.

However, threats to cap interest rates under Article Section 39(1) of BoU Act, 2000, will only make matters worse. The way out is for the regulator to meet banks and chart a way forward. The banks are reluctant to reduce interest rates because they do not want to lend money to people who are struggling to survive.
The banks are stuck with nonperforming loans (NPLs). The stock of NPLs increased by 14.9 per cent in March 2020 to Shs782.6b. This has worsened the industry aggregate NPL ratio from 4.7 per cent to 5.4 per cent. Credit growth is also likely to remain subdued until the pandemic is contained globally. This will affect their income and profitability.

Besides, BoU had already warned the banks that prolonged slowdown in economic activity could depress residential property prices and invariably lower collateral valuations, with adverse implications for credit risk. In its Financial Stability Review for the quarter ended March 31, BoU indicated that lending to the private sector slowed down over the quarter ended March, with gross loans and advances increasing by 0.2 per cent, to Shs14.5 trillion, slower than the 4.6 per cent increase over the prior quarter.

As the economic fallout spreads, banks find themselves trapped but in these difficult times, they must show empathy to their clients. Economic activity is facing unprecedented decline due to Covid-19 lockdown. The lockdown has contained the spread of the virus, but made matters worse. Businesses as well as households with outstanding loan obligations are restless, lost in thought and on tenterhooks.
We are asking the banks to be considerate. We are all in this together. Since BoU is under obligation to protect the economy, a roundtable discussion makes a lot of sense. Even though higher interest rates can be a disinflationary instrument and at the same boost the banks’ income and profitability, our view is that under the current situation, low interest rates in consort with the right policies can work to achieve the same result.