How is the credit crunch in banks affecting borrowers?

Bank deposits are at their lowest point in two years on a monthly basis, and that is the money that banks depend on hand to lend out. In fact, it is the cornerstone of their business model.

In addition, data from the central bank shows that people’s borrowing is also at its lowest point in seven years.

What numbers are we talking about here?

According to recent data, the total value of deposits held by Ugandan banks decreased from Shs3.2 trillion to Shs2.65 trillion by January 2024, compared to the prior 12 months period. Bank deposits dropped by Shs300 billion in a single month, from December 2023 to January 2024.

Per Mr Corti Paul Lakuma, a senior research fellow and head of the macroeconomics department at the Economic Policy Research Centre, the decline in deposits in local banks can be attributed primarily to the populace’s financial struggles occasioned by the Covid-19 pandemic and the recent depreciation of the shilling against the dollar.

“We had a problem with foreign currency. We saw a lot of outflows of foreign currency, mainly brought by investors who sought the dollar to take advantage of the lucrative bonds in Kenya. This depreciated the shilling and also reduced the money in the banking sector as people made conversions of these currencies,” he says.

How are banks impacted by this dearth of cash?

One of the main sources of income for banks is the “spread.” Also referred to as “net interest margin,” it is the difference between the interest rate earned on loans and the interest rate paid on deposits.

Although banks normally charge interest on loans, the interest rate they pay depositors on their deposits is typically lower. The apex bank records indicate that the spread for local banks decreased to 7.9 percent in the 2022/2023 Financial Year from 10.3 percent in the 2021/2022 Financial Year, “reflecting a higher funding cost to lenders.” And yet, lending rates for shillings remained high in all major economic sectors.

This was pinned on lending rates that were higher than the recorded average of 18.6 percent for real estate, construction, mortgages, buildings, and agriculture as caution for loan defaults. But over the same time frame, the foreign currency spread increased from 2.6 to 3.3 percent.

Official data shows that banks were only lenient to businesses in the transport and communication industry, which lent them at 14 percent, manufacturing sector at 16 percent and trade at 18.1 percent interest rates. This credit tightening was due to many banks’ concerns about asset quality, which is marked by anaemic growth in lending activity and an increase in non-performing loans.

How else have banks been impacted?

Some commercial banks have even been forced to downgrade and become tier-two financial institutions as a result of the strict guidelines set by the national treasury in an effort to protect them against economic headwinds. Opportunity Bank and Guaranty Trust Bank are among those impacted; they have even had difficulty raising the Shs120 billion minimum paid-up capital, whose deadline is three months away.

The Bank of Uganda (BoU) argues that the purpose of the increased capital requirements in the banking sector is to improve the stability of the financial system, increase the ability of financial institutions to meet the expanding demands of the economy, and make the system more resilient to shocks.

Mr Lakuma says the few banks that cannot meet their minimum capital requirements have the option of consolidating so that they can improve their asset base, increase their market share, lower operational costs, and secure higher economies of scale and new customers. However, given that many of the banks in the country are owned by private shareholders with distinct interests, he is sceptical that this will occur.

“Uganda’s population is overbanked. And yet banks need to maintain their operational expenses in technology and innovations, which are highly costly, so that they remain competitive,” he says.

What of the other indicators?

Uganda’s commercial banks are experiencing an increase in non-performing loans (NPLs), even though they had begun to decline as the 2022/2023 fiscal year neared a close. The ratio of total NPLs to gross loans at the banks increased from 5.3 percent to 5.7 percent in the year that ended in June 2023, according to new data released by BoU. This was due to a 12.7 percent increase in the NPL stock that outpaced the 4.7 percent gross loans growth.

“During this period, the business environment was not good. There was a cash crunch. And the economists I talked to from the World Bank told me that the high non-performing loans in the country have been happening for the last two years, even though many industry players have realised it in the last six months,” Mr Lakuma notes.

The BoU’s 2023 annual report offers hope for the banking industry though. It notes that “supervised financial institutions continue to take measures to address credit risk, including prudent provisioning for the expected credit losses and write-off of the impaired loans. The financial institutions (credit reference bureau) regulations 2022 that were recently gazetted will enable banks to enhance credit risk management, including expanding credit information-sharing among banking institutions and other accredited credit providers.”

This is because the aggregate commercial banks’ balance sheet already shows a notable drop in loans, which when combined with declining deposits, may herald the arrival of a credit crunch, according to many of the country’s economists.

“The low bank deposits as well as loans they issue are related to high inflation, I think. We had a commodity problem. The economy is just recovering and things are broadly okay as of now. But the central bank rate (CBR), which the central bank held at 9.5 percent, I think doesn’t work for an economy like that of Uganda in terms of controlling inflation and attracting capital. If you need to attract capital, you need a CBR of a slightly higher digit or double digit,” says Mr Lakuma.

Are interest rates yet another pain point?

Yes, they are. In an attempt to strengthen their asset base, banks are currently raising interest rates that are not in line with the CBR, which they ought to do since it influences the government’s decision to regulate the amount of money in the economy.

According to official data from the BoU, the monetary tightening it made in July 2023 by reducing the CBR from 10 percent to 9.5 percent, a level that has remained constant for the past seven months, does not align with the movement average weighted lending rates that commercial banks offer to the populace.

Details show that commercial banks immediately increased their average interest rates that they charge borrowers from 17.95 percent to 18.40 percent right after the central bank had lowered the CBR. This increase began in August 2023 and continued for three months in a row. From that point on, it began to decline, reaching a low of 17.32 percent in January 2024.

What does the accessibility of credit look like?

Data from the Finance ministry already demonstrates that, from Shs21.7 trillion in December 2023 to Shs21.5 trillion in January 2024, the stock of outstanding private sector credit has fallen by 0.7 percent. This decline is primarily attributed to an increase in loan repayments, even though new credit was approved during the same time period.

    In particular, the amount of credit denominated in shillings decreased to Shs15.17 trillion in January 2024 from Shs15.27 trillion in the previous month. As did the amount of credit denominated in foreign currencies, which decreased by 0.9 percent to Shs6.38 trillion from Shs6.4 trillion during the same period, even though the weighted average lending rate for foreign currencies decreased.

    “This is partly explained by the shilling depreciation over that period,” the Finance ministry explained in the February performance of the economy report.

But increase in loan repayments by the private sector had already prompted several banks to increase the value of credit they approve for lending from Shs883.1 billion in December 2023 to Shs1.35 trillion in January 2024.

      This, the national treasury notes, was also orchestrated by the continuous improvement in economic activity and the ongoing decline in the ratio of non-performing loans to total gross loans as last year came to its close.

     But some banks have doubts about lending to businesses with lax credit standards because they are working tirelessly to cut down on NPLs and give recovery more importance. This is in addition to the supply disruptions brought on by the conflict in Gaza and Russia’s invasion of Ukraine, which have impacted importers’ ability to conduct business, the bank lending survey of the fourth quarter of 2023 conducted by Bank of Uganda on all 25 commercial banks shows.

     “Majority of the banks expect to keep their overall credit standards largely unchanged with a bias towards easing in the quarter to March 2024. Banks expect to ease credit standards for all firm sizes and loan durations on a net basis,” the survey notes.

     “Looking at the expectations for loan classifications, the majority of the banks anticipate keeping the terms and conditions unchanged for prime borrowers, average loans and riskier loans in the quarter to March 2024,” it adds.

     This, the survey shows, is orchestrated by the need to grow the client base while retaining the existing customers and the target of remaining competitive in the market.

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