What a dip in banks’ profits mean for economy

Compared to tourism or education which continues to suffer the brunt of Covid-19 and the resultant containment measures instituted by the government to control the spread of the pandemic, the banking sector seems to be sailing through the tides rather unscathed as evidenced by the profit margins the industry players closed their accounts with.

 Apart from banking and telecommunications, most economic sectors, including the Micro, Small and Medium enterprises continue to take a hit as the battle to contain the Covid-19 pandemic takes shape, thanks to the availability of a vaccine whose uptake remains disturbingly low.

While banks closed their accounts with some profits, although reduced, compared to the previous financial year,  the industry players say it was not all rosy.

Just like anybody else, banks were not spared by the pandemic that took its toll on livelihoods and businesses.

The profit that most banks made in a tough business environment owing to the Covid-19 pandemic, was as a result of “tight and prudent risk management.”

Compared to the 2019, the Dfcu audited financial results for the year ended December 31, 2020, indicates a drop in profit by nearly 67 per cent which the bank’s senior managers say would have been worse if they didn’t quickly tighten controls by hedging against risk.

“We cannot say we had a good time in a bad year. But we needed to put controls and measures in place to allow us prepare for the post recovery period,” Mathias Katamba, the dfcu bank chief executive officer told journalists and stakeholders while discussing the bank’s annual performance recently.  

Reality check

While still at it, commercial banks’ provisions for loan losses grew in the period ended December 2020, increasing by Shs149.1b, according to an assessment of financial results released by different commercial banks.

This was the highest growth in over years, indicating a tough period for the banking sector and borrowers, whose capacity to repay loans was clearly impacted by the pandemic.

According to data compiled from different commercial banks’ financial results, provisions for bad loans and loan losses, which is an accounting requirement, grew to a combined Shs364.7b compared to Shs215.5b in the same period in 2019.

The growth, according to different banks, was largely on account of increasing inability by borrowers to sufficiently service their loan obligations resulting from reduced economic activity and low demand.

During the period, Stanbic, which is Uganda’s largest bank by assets, reported the largest growth, compelling the bank to set aside Shs91.8b to provision for losses. This was a 110 per cent growth from Shs43.5b that the bank had put aside in the same period in 2019.

Dfcu Bank, which had earlier indicated that loan losses had impacted its profitability, saw loan provisioning increase by 107 per cent while impairment of financial assets rose by 400 per cent to reach Shs50b.

This newspaper analysis shows that this, subsequently “ate” into the bank’s profitability, which dropped by more than 67 per cent from Shs74b in December 2019 to Shs24b in 2020.

Absa set aside Shs60.7b from just Shs12.21b in 2019 while Equity reported Shs24.5b in loan provisioning compared to Shs14.3b in 2019. Centenary Bank set aside Shs43.6b during the period from Shs21.5b in 2019.

The five banks, which share the largest amount of the provisioning (Shs270.6b), reported they had more than doubled the amount they set aside in 2020 compared to the same period in 2019.

Wait a minute…

In an interview with economists and Chartered Financial Analysts (CFA), it emerged that the profitability levels that banks registered in the midst of the Covid-19 pandemic do not in any way tell the entire story.

For that, it will be wrong to assume that since  the banking industry has emerged unscathed when other players in the economy are either closing shop or scaling down operations, that the economy is on an upward trajectory.  

When asked whether the performance of the banks, leading to profits it registered as a rosy story of the economic resurgence, Ms Susan Khainza, CFA, said: “Not necessarily.”

She explains that banks get most of their income from net interest income; the difference between the interests received from lending out to the private sector and government and the cost of interest on customer deposits.

“A lot of their lending is to the government through Treasury Bills and Bonds.  The cost of interest on our customer deposits is low. If lending out to the private sector during Covid-19 was unattractive, banks increased their lending to the government, whose appetite for borrowing increased, and who offer interest rates attractive enough to make profits.”

Ms Khainza, however, foresee the banks generating more revenues if they continue to use technology to mobilise what she refers to as “cheap deposits” and taking advantage of branchless banking.  She foresees the possibility of a better year for the banks and better profits in 2021 although that, in itself, does not tell the entire story of economic resurgence. She further notes that already, banks have factored in the impact of Covid-19, while there is a semblance of recovery as things get back to normal.

 But that does not mean that banks role in resurgence of the economy should be under estimated.

“Banks have a critical role in revitalising the economy, the most important, being the multiplier effect.  Banks have the ability to lend out more money than the actual amount of their deposits.  In essence the banks “create” money by lending out more than the cash held in savings in the bank,” says the Chartered Financial Analyst.

“Bank of Uganda influences this through regulation of the amounts of money banks must hold in reserves to meet the withdrawal demands of their customers. The Central Bank also influences the amount of money in circulation by buying and selling government bonds to the banks,” she says.

 “For example, buying bonds from banks increases the amount of cash the bank has in reserves, increasing its ability to lend more to the private sector.  The Central Bank uses its policy rate to influence long-term and short-term interest rates that the banks lend out to the private sector as banks increase or reduce their base rates in line with the increase or decrease of the Central Bank Rate.  The creation of money, the amount of money in circulation and the interest rates that banks lend at have a critical role to play in the economy.”

In another interview with the Makerere School of Economics lecturer, Dr Fred Muhumuza, the options that have been extended to the banks to restructure the loans is a good move for the bank just as the auction that was extended to them by the central bank.  That he says does not mean the economy is booming or will get better any time soon.

Following the impact of Covid-19, the country’s GDP growth that was hovering at between three to four per cent contracted to 1.4 per cent over the last 13 months. Although the economy is estimated to rebound to 5 per cent GDP growth by the end of 2021, the pace of recovery will depend on how fast business activity picks up and the effectiveness of the measures put in place, including the uptake of the vaccine by the population.

Not yet out of the woods

Industry analysts like Dr Muhumuza believe that the banks’ performance does not only sum up the performance of the economy but is also a tell-tale sign of what is ahead. So, brace for a subdued economy. 

Already, the trajectory for some banks net loans and advances to customers is steadily growing. However this can only pay off if the pandemic is contained and all the economic sectors are opened up sooner rather than later or else the list of defaulters could only go higher as the economy contends with proper effects of the pandemic.

Economic Policy Research Centre research fellow Corti Paul Lakuma says despite business activities gradually getting back to the pre-Covid-19 levels, uncertainty is still rife particularly relating to risks involving the mutation of the coronavirus. This is not good news to the economy.

Mr Lakuma says to avoid a second phase of economic slump on the account of the pandemic, there is need to first contain the pandemic and open up the economic sectors to reduce the effect of the pandemic’s inertia on the economy. This is further reechoed by economic sector players who all remain optimistic about a faster recovery of the local economy on account of a successful national vaccine roll out programme and continued resilience of the business community.

“If vaccination is anything near a quarter of the population, the economy will be able to reopen substantially. However, vaccine uptake has been marred by lack of confidence and logistical challenges,” he said. 

A new report by the Economic Policy Research Centre (EPRC) titled: Disruptions from Elections and Covid-19 pandemic affect Businesses Environment” indicates that businesses are more pessimistic about the near term developments than they were in last quarter. 

Generally, the report shows that deterioration in business conditions is expected to relapse most from the anticipated unfavourable business environment, business optimism, high input cost and limited business expansion heightened by the anticipated political election cycle.

Lower business confidence is expected in the services and the manufacturing sectors. In  particular,  the  service  sector  will  suffer  more  than  manufacturing  while  the  agricultural  sector  is expected to have relatively modest improvements.

Perceptions about doing business in Uganda in the current quarter (October-December 2020) declined drastically compared to the previous quarter (July-September 2020). The negative sentiment in the business environment was primarily driven by the unfavourable business perceptions across all sectors, reflecting heightened risk in anticipation of the general elections. Just like in the last quarter (July-September 2020), some business constraints persisted.

 In  this  regard,  inadequate  credit  access,  insufficient demand, exchange rate volatility, unfavourable tax policy and  electricity  unavailability  were  critical  binding  constraints  to  business competitiveness in the current quarter.