Why private sector credit growth has been restrained

Private sector credit growth has been subdued for several reasons.   As economic conditions weakened due to negative impact of the Covid-19 pandemic, demand for credit declined as firms cut output and households reduced consumption, decreasing their need for credit. Secondly, banks tightened lending standards in the face of greater uncertainty because some sectors of the economy remained closed longer than expected, and rising loan losses.

 In the Monetary Policy Report August 2021, the Bank of Uganda said Private Sector Credit (PSC) growth moderated despite the accommodative environment, reflecting a combination of subdued demand for and supply of credit, largely attributable to heightened uncertainty related to the Covid-19 pandemic, increased risk aversion, relatively low level of economic activity and government’s high domestic financing needs.

On a quarterly basis, annual PSC growth fell to an average of 6.8 percent in the quarter to June 2021 from 9.8 percent in the quarter to March 2021, with May 2021 registering the lowest growth rate of 5.4 percent

 In their analysis in the country report released on March 10 in Washington DC, the International Monetary Fund (IMF) said over the five years to September 2021, the ratio of commercial banks’ exposure to government debt and loans increased from 21.9 percent to 28.3 percent while the share of private sector credit to commercial banks’ total assets dropped from 47.8 percent to 40.9 percent.

 “Despite ample liquidity in the banking sector, the private sector credit remained subdued at 5.9 percent year-on-year in December 2021—mostly reflecting a rise in personal loans,” the IMF said.

 The IMF explains that although credit demand (proxied by value of loan applications) and credit supply (proxied by loan approvals) has been increasing since last June until the end of last year, both have been declining in 2021, reflecting the crowding out effect of government debt, as well as weak demand and commercial banks’ risk aversion on account of the slow and uneven economic recovery.

The IMF said asset quality risk is on the rise in view of the large share of restructured loans. NPLs rose to 6 percent of total loans in 2020, before declining to 5.3 percent in December 2021, lower than in other EAST African countries.

 Slower economic activity, particularly in the services, construction and trade sectors, explained the deterioration in asset quality, despite the credit relief measures that restructured loans in those industries.

 After peaking at 31.7 percent of total loans in June 2020, the stock of restructured loans amounted to Shs3.6 trillion as of September 2021. During the same period, provisioning increased so that they represent 46.5 percent of commercial banks’ non-performing loans (NPLs) by September 2021.

 In the Monetary policy report of February 2022, the Central Bank said commercial banks’ asset quality as measured by the ratio of NPLs to gross loans improved in the quarter to December 2021 to 5.3 per cent from 5.4 percent in the previous quarter.

 “The ratio is, however, slightly higher than the pre-Covid-19 level, which could be an indicator that the Credit Relief Measures have so far helped. Although the industry NPLs ratio is generally low, some sectors of the economy such as mining, and real estate sectors exhibited increases in the NPLs ratios,” said the central bank

 The IMF report states that the near-term aggregate risks to financial stability are elevated but manageable. Credit risks arising from non-performing loans remain the key risk to financial sector stability.

Test results indicate that most SFIs are resilient to the credit risk shock. While the aggregate core capital adequacy ratio (CAR) would decline to 19.5 percent and the aggregate NPL ratio would rise to 12.7 percent as of March 2022, nine of 25 SFIs, which account for 7.4 percent of the industry’s asset base, would be in breach of the minimum CAR requirement.

 Similarly, SFIs are little impacted by a foreign exchange shock. In this aspect, the IMF stated that given that the foreign currency denominated liabilities account for 36.2 percent of total liabilities by December 2021, Uganda’s banking sector has a relatively high exposure to currency risks.

 The IMF said Ugandan banks’ capital buffers remain strong, boosted by increased profits. They are largely driven by a consistent revenue stream from fees and an increase in interest income from government securities

27.4 percent for the year ended December 2021, which was higher than most EAC countries.

 The IMF staff said deferred bonuses and dividends—which came about from a BoU directive trying to safeguard financial stability during the Covid-19 crisis—helped boost the regulatory capital to risk-weighted assets to 23.7 percent as of end December-2021, the highest among EAC countries.

 “The authorities plan to move towards Basel III by introducing new buffers and increasing capital requirements for all financial institutions. It is estimated that 10 out of the 25 banks in Uganda would require a capital injection to meet the new capital requirements,” the IMF said.

 The IMF Mission team for Uganda, Mr Amine Mati said: “The IMF said staff supports the authorities’ commitment to proper loan classification rule and appropriate monitoring of restructured loans, particularly for the education and hospitality sector, where relief measures were extended for another year.”

By end-December 2021, the industry aggregate liquidity coverage ratio and liquid assets-to-deposit ratio stood at 252.6 percent and 48.0 percent, respectively, well above the respective minimum requirements of 100 percent and 20 percent. The ratio of liquid assets to short term liabilities and total assets increased respectively from 44.9 percent and 30.1 percent in March 2019 to 48.8 percent and 33.0 percent in December 2021.

 Customer deposits, which are the main source of funding for banks, increased by 9 percent y-o-y in June 2021, reflecting increased deposit mobilisation through agent banking and digital platforms as well as the preservation of liquidity during the pandemic.

 In his keynote address, Absa Economic Outlook and 2021 Africa Financial Markets Index on March 9, Deputy Governor Dr Michael Atingi-Ego said BoU started implementing the Basel II banking regulations for banking supervision to enhance financial and operational risks management, among others.

 “We also moved from reliance on cheque payments to advance epayment platforms and advanced the implementation of the National Payments Systems Act including the use of a Regulatory Sandbox Framework for safe testing of innovations before full deployment, and concerted efforts are underway to develop a national payment switch to aid interoperability and reduce costs of financial transactions, among others.”