Increase in bad loans to weaken Uganda banks’ earnings

Ugandan banks’ bad loans doubled to Ush345 billion ($94 million) at the end of September compared with the same period last year.

Non-performing loans (NPLs) hit a new high of 8.3 per cent in August compared with the previous record high of 7.2 per cent posted in mid 2009. This has complicated matters for several banks faced with a rising burden of shoring up their balance sheets against increased default rates among borrowers.

Under banking supervision rules, the increase in loan default levels requires lenders to maximise their bad loan provisions in order to protect their liquidity ratios and preserve depositors’ money. In addition, default expenses are incurred every month against bad loans on account of missed loan repayments.

Total industry NPLs stood at 7.5 per cent in December 2015 according to Bank of Uganda data.

Industry sources cited the agricultural and construction sectors as the biggest contributors to rising NPL ratios while the trade and commerce, manufacturing sectors posted lower default rates by close of September, which is attributed to significant disbursements of overdrafts and lower credit risk exposure.

Comprehensive data on the distribution of NPLs across all sectors during this period was not available by press time.

Whereas the value of NPLs dropped by six per cent between July and September, it is unlikely to reverse industry earnings as the year ends.

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An increase in credit default costs incurred on NPLs directly leads to a rise in operating expenses. This in turn, reduces profits earned by commercial banks, experts say.

High loan default rates and a slowdown in credit growth have eroded returns on equity in recent months, signalling weak earnings for lenders this year. Average after tax returns on equity registered by the industry fell to 14.9 per cent in the 12-month period, which ended in September compared with 17.1 per cent posted in September 2015, BoU data showed.

Though many banks have sought to reduce their operating costs and raise efficiency levels through aggressive marketing of digital transaction channels that include mobile phone and online banking tools, the gains expected from these initiatives might take longer to materialise due to slow uptake.

READ: Digital banking provides alternative revenue for Kenyan lenders

However, local banks could realise reasonable cost savings from the closure of poorly performing branches and fewer new branches opened this year.

Despite a record surge in NPLs this year, banking executives believe interest incomes could post strong returns, which could offset an increase in loan default costs. This optimism is backed by fairly high lending rates in the market during the first three quarters of this year, which saw banks widen their interest margins to meet steep funding costs.

However, recent easing of the monetary policy by the central bank have apparently reversed this trend, with many banks moving to reduce their prime lending rates following slight reductions in the Central Bank Rate (CBR). The CBR was slashed by one per cent to 13 per cent in October this year, a decision largely informed by a need to boost economic activity and credit growth.

“The squeeze on bank profitability would have been much worse were it not for banks widening their net interest margins. The high interest rates for the most part of the past 12 months helped banks to recoup some of the losses they suffered as a result of bad debts,” said Emmanuel Tumusiime-Mutebile, BoU Governor, while addressing a Bankers’ forum last month.

The weighted average lending rate stood at 24.1 per cent in the five months ending August, BoU statistics showed.