BANK OF UGANDA
Remarks by
Prof. Emmanuel Tumusiime-Mutebile,
Governor, Bank of Uganda
Uganda Bankers' Association
Annual Bankers' Conference
July 19, 2017
The Keynote Speaker, Prof. Njuguna-Ndugu, Emeritus
Governor of the Central Bank of Kenya,
The Chief Executives and Senior Staff of Banks Present,
The Senior Management of the Uganda Institute of
Banking and Financial Services,
Distinguished guests,
Ladies and gentlemen.
Good morning to you all.
Let me begin by commending the Uganda Bankers'
Association for organising this inaugural Annual
Bankers' Conference. We have a very busy schedule of
sessions on a variety of important topics to look
forward to today. In my brief remarks I would like to
outline what I believe are some of the key challenges
for the Ugandan banking industry in the years ahead.
As will become clear, these challenges are in some
respects interrelated, as progress in one area will make
it easier to make progress in others.
A major challenge for the banking industry; one which
is of the greatest importance for the rest of the
economy, is how to strengthen bank lending to the
private sector.
Bank lending expanded rapidly in the first decade of
this century; in real terms the stock of credit expanded
four-fold between 2001 and 2011, and this enabled
many new borrowers to access credit.
But since 2011 credit growth has slowed and over the
last two years, there has been virtually no growth in
real terms (after adjusting for inflation).
The main reasons for the stagnation of bank lending lie
on the supply side of the credit market. Over the last
five years, since the first half of 2012, loan demand, as
proxied by the value of loan applications received by
banks, has grown robustly, by about 17 per cent per
annum in real terms, but the value of loans actually
approved by banks has grown much more slowly.
Consequently, whereas in the first half of 2012, banks
approved loans in value amounting to 70 per cent of
the total loan applications that they received, that
figure had fallen to 51 per cent in the first four months
of 2017.
It is clear that, against a background of rising non-
performing loans and difficulties in realising the value
of loan collateral in property markets, banks have
become much more wary about the creditworthiness of
loan applicants and as a result have become more
reluctant to extend credit to them.
Unfortunately, the pool of prime borrowers - mainly
large, well established companies - is small in Uganda.
Hence if they are to expand their loan portfolios in a
financially sustainable manner, banks will have to
bring into the credit market more small and medium
sized enterprises (SMEs).
To do this, banks will need to strengthen their
capacities for identifying and evaluating potential new
loan customers and ensuring that the characteristics of
the loan products on offer are suitable for the types of
business undertaken by their customers, especially in
aligning loan repayments with the future stream of
business revenues. Given that an expansion of banks'
loan portfolios will almost inevitably involve banks
being exposed to greater credit risk, it is essential that
this is accompanied by a strengthening of banks' risk
management strategies.
The ability of borrowers to service their loans and,
therefore, their creditworthiness, is not independent of
the interest rates charged on these loans. The higher are
lending rates of interest, the larger is the burden placed
on the borrower to service his or her loans.
Ceteris paribus, lower interest rates would, therefore,
contribute to enhancing the capacities of borrowers to
service their loans out of their business revenue and
thereby help to alleviate credit risk. Reducing lending
interest rates in a financially sustainable manner is the
second major challenge facing the banking industry.
Unfortunately, high lending rates of interest are
primarily the result of the high cost structure of
banking in Uganda, and lending rates will not fall in a
sustainable manner until banks have been able to bring
down their operating costs.
The average annual operating costs of Ugandan banks,
as percentage of their income earning assets, is
currently around 11 per cent, which is very high by
international standards.
Large branch networks and the high cost of staff are
major contributors to the high operating costs of banks.
When the interest costs of deposits and provisions for
bad debts are added to operating costs, banks' annual
costs as a per cent of their income earning assets rises
to almost 18 per cent, which obviously constrains the
extent to which average lending rates can fall.
Hence, the third challenge facing the Ugandan banking
industry is how to reduce its high operating costs,
without compromising service delivery or customers'
access to services.
The structural factors, which underlie the high bank
lending rates point to the inevitable consequences of
any attempt to force banks to reduce their lending rates
by legislation, as has happened in Kenya.
If lending rates were capped by legislation at levels
below the real cost of lending, taking into account
operating costs, provisions, and the costs of funds,
banks would make losses on their loan portfolios.
They would respond by curtailing their lending to
those borrowers to whom lending involves the highest
costs, in the form of high transaction costs for loan
evaluation and monitoring, and/or because of higher
credit risk premiums. The banks might also attempt to
recover some of their losses by increasing the fees and
charges levied on their customers.
If lending rates were capped, the borrowers who
would suffer the most, in terms of losing access to
credit, would be SMEs. This is because SMEs are both
more risky and involve higher transaction costs for the
banks as a share of the amount that they borrow than
prime borrowers.
Given these costs, banks can only extend credit to
SMEs in a commercially viable manner if they are free
to set lending rates at levels, which can cover the
expected costs of lending, including the default risk.
Instead of lending to SMEs, capping lending rates
would encourage the banks to concentrate their
reduced loan portfolios on their prime borrowers,
which already benefit from the lowest lending rates in
the economy.
Thus capping lending rates would be highly
counterproductive in that it would damage the SME
sector by constraining its ability to obtain working
capital and finance for investment to expand capacity.
As the SME sector is crucial for the future growth of the
economy and the creation of employment, capping
lending rates would constitute an act of economic self-
harm.
We already have the salutary experience of the 1970s
and 1980s to teach us how damaging the control of
interest rates can be. In that period, the banking sector
shrank dramatically because many types of banking
business, including lending to the private sector, were
not financially viable. Uganda cannot afford to repeat
the mistakes of the past; mistakes, which proved so
ruinous to our economy.
I cannot stress strongly enough that it will only be
possible to reduce bank lending rates in a financially
sustainable manner if banks can lower their operating
costs.
Bringing down operating costs will almost certainly
entail greater use of innovative technologies, including
IT, to deliver banking services.
A major shift towards digital, or electronic banking is
already underway worldwide, as we will be discussing
in the session on the digital financial revolution later
this morning.
The adoption of mobile and online banking, together
with smart ATMs, will help banks reduce their costs,
although unfortunately that will also mean lower
employment in the banking industry.
As they adopt electronic banking technologies, key
challenges for banks will be to ensure that these new
technologies can deliver the same quality of, and access
to, services for their customers as the more traditional
technologies and that the risks entailed in electronic
banking are fully understood and can be managed
effectively.
In particular, banks must ensure that their electronic
systems can be safeguarded against cyber-attacks, both
to protect the integrity of individual customer's
accounts and to prevent threats to the financial safety
of the bank itself.
The adoption of electronic banking has implications for
bank regulation and supervision, which in Uganda has
traditionally focussed on banks' management of credit
risk.
In future, operational risks arising from electronic
banking are likely to become of greater significance as
potential threats to the financial soundness of banks
and their ability to command the confidence of their
customers. Bank regulators need to strengthen their
capacities for monitoring the security of banks' IT
systems.
To conclude, I believe that the future of the banking
industry in Uganda is bright. In terms of productivity,
the adoption of international best practises and its use
of modern technology, banking is one of the leading
industries in Uganda.
Banking also operates in a macroeconomic and
prudential regulatory environment, which provides
scope for investment and innovation while, at the same
time, safeguarding the interests of depositors and the
safety and soundness of the financial system.
Consequently I am confident that banks will be able to
meet successfully the challenges that they face, and in
doing so, continue to contribute to the development of
the Ugandan economy.
Finally I would like to wish you all the best for the rest
of this conference.
Thank you for listening to me.