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Sizing up health of local lenders

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Bank of Uganda offices in Kampala.

Today, if someone walks into a bank for a loan, they will almost definitely be faced with either excessive interest rates or tight borrowing terms. Even if a borrower has a good credit history, banks might still hesitate to approve their loan request. The reason? The banks themselves are facing financial difficulties.

Bank of Uganda (BoU) statistics show that the value of loan applications from supervised financial institutions amounted to Shs5.68 trillion in the quarter to March 2024, but the loans that borrowers managed to get approved for were only around Shs4 trillion. 

Put simply, many banks are having operational difficulties. And there are signs. Some have had to lower their status from being top-tier banks to a lower tier, and a few have even closed down like Afriland, which exited after two years of operations in the country. 

We understand that some others who have survived without substantial cash reserves have sought solace in their parent companies for inter-company loans or cash allotment.

Capitalisation

BoU announced on June 18 that Mercantile Credit Bank was winding up and liquidating due to inadequate corporate governance and a failure to recapitalise its minimal capital requirements. Minimal capital requirements in banking are rules that say how much money a bank must have on hand kept by the central bank. 

At the peak of the pandemic, banks experienced such a lending frenzy that they were forced to borrow money from the central bank in order to make up for liquidity shortages, sometimes to the point where their cash reserves were depleted. 

The central bank data indicates that they borrowed Shs330b from it during the quarter that concluded in January 2022 through the Standard Lending Facility. This was a special package that BoU developed in order to provide a safe haven for banks that experience funding shortages, of which the pandemic ensured there were many.

While this data does not identify which bank received what, information from March 2021 indicates that three unnamed banks had borrowed Shs155 billion to meet their immediate liquidity needs.

Other initiatives included the Covid-19 Liquidity Assistance Programme, which attempted to address issues brought on by the pandemic such as a surge in non-performing loans that slumped many operators’ profits, and the Emergency Liquidity Assistance.

A few other banks made the decision to engage in interbank lending, and, as a result, the interest rate on those transactions increased to 6.9 percent at the time, marginally higher than the 6.5 percent central bank rate (CBR) during that period. But this CBR has been raised by the apex bank since then to 10 percent in an effort to cool inflation.

Banks downgrade

As multiple commercial banks navigated through these turbulent times, the Treasury tightened their capital injection regulations in June 2023 in an effort to protect them from unanticipated global shocks. Minimum capital requirements for commercial banks shot up from Shs25b to Shs150b. 

As the capital requirements began to bite, some banks downgraded operations. Guaranty Trust Bank Uganda Ltd is one example. In June 2023, as the regulations were taking effect, it downgraded from commercial bank status to credit institution status. 

The bank was placed in the same basket as Opportunity Bank and ABC Capital Bank (U) Limited, whose downgrade was approved by the central bank in March 2024, allowing the trio to downgrade between April and June of this year.

BoU stated in a public notice that the three-month transition period would enable these commercial banks to arrange suitably for the phase-out of products and procedures that need a Tier 1 license, guarantee a seamless service transition for their clients, and minimise any impact on the stability of the financial sector.

Tier 1 banks are like the top teams in the league. They have the most money, the best resources, and can handle big financial transactions. They offer a wide range of services and are generally very stable.

Tier 2 banks are like the middle-tier teams. They still play well and offer many services, but they don’t have as much money or resources as the top teams. They might focus on more specific or smaller-scale services.

The three banks that downgraded had requested the central bank for this prior to this action because they thought they might not be able to meet the necessary capital increase. The central bank anticipated this would happen and was able to keep it under control by mandating all local banks raise their capital buffers from Shs25b to Shs120b by June 2023 and Shs150b by June 30, 2024. This allowed the bank to slightly raise this cash after a certain period of time in tranches.

In fact, according to data from the International Monetary Fund (IMF), by September 2023, 18 of the 25 supervised commercial banks had accumulated the new paid-up capital requirements, which at the time was Shs120b. That amount increased to Shs150b by June 30, 2024 as earlier planned by the central bank. 

The remaining seven, or at least 5.1 percent of the assets in the banking sector, had either applied for a downgrade or were still in need of capital infusions, according to documents included in the IMF’s Uganda Fifth Review under the Extended Facility Arrangement and Request for Modification of Performance Criteria.

Rules of engagement 

The capital of credit institutions, also known as tier-2 financial institutions, rose from Shs1b to Shs25b. The revisions also raised the minimum capital requirements for microfinance deposit-taking institutions from Shs500m, which was first introduced in 2003, to Shs10b. 

For many of the local banks, this meant raising large sums of money from their parent companies, finding new investors for others, issuing bonus shares on the stock market, as was the case for Bank of Baroda, or experiencing downgrades or liquidation like Mercantile.

Sunday Monitor has established that some of these financial institutions protested to Parliament about these requirements, but their complaints were unanswered. Their argument was that those with large capital would continue to make good profits even if they lent at lower market rates, which would make it difficult for smaller banks to operate efficiently in the same market when they charged market rates.

But many economists counter-argued that if the nation’s macroeconomic conditions experienced another downturn, small banks would report negligible profits or even losses, if they didn’t have this capital to help them remain firm in case a drastic shock struck them. 

Mr Denis Kizito, the Capital Markets Authority’s director of supervision, told Sunday Monitor that he doesn’t believe this capital that BoU requested from banks was too high for them because if it was so, they would have sought refuge from the country’s capital markets.

“We didn’t see these banks coming to the capital markets asking for this cash. Most of them sourced it organically,” he said, adding that it was only Bank of Baroda that did so.

Mr Kizito further offered that banks should not be concerned that this capital will be increased anytime soon because history has shown that it takes time for central banks to raise minimum capital requirements.

“This time it was demanding. There are already concerns in the market about a superficial economy. Uganda lacks an independent statistical office. The Uganda Bureau of Statistics is purely a government entity,” he said, adding, “The market worries that there is a likelihood that it would provide the Bank of Uganda with cooked figures. And I believe the central bank sensed something was wrong in the economy and required banks to increase their capital buffers so that they became safer.” 

Scorecard

During the first three months of 2024, the combined amount of loans that lenders gave out, including that of credit unions, and micro deposit-taking institutions was still the same at Shs21.5 trillion, BoU data shows. This was contracted across all sectors except households and real estate.

These financial institutions increased their income ratios during that time, but that did not prevent them from testing the murky waters of the economy. The non-performing ratio for commercial banks had remained relatively low, but rose to 5.1 percent in March 2024 from 4.7 percent in December 2023. 

BoU worries in its Financial Stability Risk Assessment Report released on May 13 that: “non-performing loans could rise if full effect of sustained high rates passes through to borrowers [but] BoU continues to engage [these financial institutions] to enforce prudent credit risk management and adequate capital planning to minimise losses.”

In the first three months of 2024, the total amount of deposits held by BoU’s licensed credit institutions had increased by 3.4 percent to Shs34.8 trillion. Their growth rate slowed this year, BoU figures show, because they grew by 1.3 percent in December last year and just by 0.4 percent in March this year.

 But overall, their net profits grew by 15.9 percent to Shs1.5 trillion during the same time, fuelled by a 13.8 percent rise in interest incomes.

Only non-banking financial institutions were unable to maintain a sharp increase in profits after their profitability dropped as a result of high personnel and deposit costs.

Defying odds?

The central bank observes that the economy and the banking sector are remaining resilient amid domestic and global challenges. Part of it is because the country’s quarterly gross domestic product increased by 5.5 percent in December 2023 from 5.3 percent in September 2023 “primarily due to the industry and services sectors.” And part of it is that the headline inflation or how expensive life is getting, reduced to 3.3 percent in March 2024 from 3.4 percent in February 2024, but higher than 2.6 percent in December 2023.

“Stress tests show that supervised financial institutions are adequately capitalised to absorb potential shocks, [but] rising funding and credit costs may reduce their profit margins and hinder their ability to build capital in the short-term,” BoU says.

The primary source of concern for the apex bank is the funding issues these banks are facing, as evidenced by data indicating slowed government borrowing, that moderated at 30 percent in the first quarter of 2024 and that, when comparing data covering the last eight years to March, private sector credit is seriously declining, primarily due to elevated borrowing costs.

The annual credit flows to the private sector to March 2024 increased by 6.7 percent, compared to an official target of 13 percent.

Due to elevated interest rates, as mentioned by the BoU, the private sector has started fetching loans overseas, especially when it comes to loans for trade and real estate, as Mr Lazarus Mugabi, a board member of the Association of Real Estate Agents Uganda, told this reporter last year. As a result, the government has languished in the domestic banking borrowing space directly through bonds and indirectly through initiatives like the Parish Development Model.

But President Museveni is making a move in this regard. During his June State-of-the-Nation Address, he said he has already instructed the finance minister to cap the interest rates that money lenders charge on their loans because they are “extortionate”.