REVEALED! Why Interest Rates Will Stay High

By Taddewo Senyonyi

The media has lately been awash with bailout stories of struggling tycoons and businesses.

Although there are a number of factors behind ailing tycoons and businesses, high interest rates charged by commercial banks is one of the top reasons struggling tycoons and experts blame for collapsing businesses.

As a result of high interest rates and a wobbly economy characterized by exchange rate depreciation (the Uganda Shilling lost 27% of its value last year), low exports and generally slowed business activity-partly due to election fever, a number of businesses found it hard to pay back the loans.

Consequently, the banking sector registered an increase in Non-Performing Loans (NPLs) rise in 2015, thus affecting their profitability.

Total banking industry NPLs increased to Shs649.4bn in 2015, up from Shs397.7bn in 2014.

This represents 63.3% increase. Crane Bank and Standard Chartered Bank (StanChart) were the worst hit, with Crane Bank recording Shs142.3bn in NPLs in 2015, up from Shs19.36bn in 2014, while StanChart recorded Shs113.9bn in NPLs in 2015, down from Shs119.50bn in 2014.

Consequently, Crane Bank, one of the biggest banks in Uganda, recorded a loss of Shs3.1bn, down from Shs50.6bn profit in 2014; while StanChart saw its profits diminish to Shs28.3bn in 2015, down from Shs114.49bn in 2014.

In fact, majority banks are grappling with NPLs, a development that has resulted into liquidity tightening which could badly affect credit to the private sector.

Why Interest Rates Remain High

However, the business community should brace for hard times as all indications point that interest rates will remain high for some time.

Public perception is that when the Bank of Uganda (BoU) cuts the Central Bank Rate (CBR), a benchmark lending rate for commercial banks, interest rates charged by commercial banks should also come down.

However, on many occasions, commercial banks have not followed suit; interest rates have annoyingly remained high. For example, although the CBR has stayed at 16% for a long time before reducing to 15% in June 2016 and 14% on Monday August08, 2016, average lending rates for commercial banks stand at 24.48% as of May 2016.

During the BoU Golden Jubilee celebrations last week, President Yoweri Museveni wondered why banks were charging high interest rates yet they are regulated! But the BoU Governor Prof. Emmanuel Tumusiime-Mutebile has in the past reiterated that he will not force banks to lower rates.

“….I have no legal basis to force the hands of banks on the charges, it’s a matter for them and their clients,” said a flamboyant Mutebile said a few years ago when traders were protesting high interest rates.

But why are banks charging high interest rates? Are they happy to charge high interest rates and choke on NPLs? Are there chances of interest rates coming down soon? What is being done to lower interest rates?

According to Fabian Kasi, the Chairman of Uganda Bankers Association (UBA), interest rates remain high due to a number of factors including but not limited to the cost of funding, operation costs and default risks.

He explains that the cost of funding is usually determined by the costs of various sources of funds that banks use.

These include the interest paid to ordinary depositors (usually about 4%, fixed deposits which are usually up to Treasury Bill (TB) rate of about 17%, funding from funding agencies e.g. Africa Development bank or European Investment bank, which usually peg their funding on the TB rates.

“When all these costs are weighted, the bank will get a resultant cost of funding.

There has been an observation that even when the Central Bank Rate is lowered, banks take time to adjust their rates.

We need to note that banks do not borrow from the Central Bank alone, after all the Central Bank is a lender of last resort.

Even the funds lent by the Central Bank are short-term mainly for liquidity management,” Kasi said in an exclusive interview with Red Pepper.

The BoU agrees with Kasi’s argument. In an earlier interview with this reporter, Christine Alupo, the Director of Communications at BoU noted that the BoU is not the primary source of funds for commercial banks.

“The BoU is a lender of last resort for commercial banks and not their primary source of liquidity.

However, in implementation of monetary policy decisions (CBR), the BoU provides or withdraws liquidity from the interbank through issuance of repurchase agreements (repos) and reverse-repos whenever the market conditions necessitate as such,” Alupo said.

According to BoU, other sources of funds for commercial banks include administered funds from development partners like International Finance Corporation (IFC) and Propaco, placements from parent banks, borrowings mainly from external sources, interbank borrowings, nostro accounts, deposits from no-resident and shareholder funds.

“Financial sector is liberalized; banks set interest rates including those on deposits based on their assessment of current and prospective macroeconomic and business environment,” Alupo said.

Kasi, who is also the Managing Director at Centenary Bank explains that due to low savings rate in Uganda, the cost of funding tends to be higher than in those countries such as Kenya where the savings rates are higher.

“We also need to consider the relationship of the CBR, which is usually a signal of where the Central Bank would like interest rate to be.

It should be noted that since most banks if not all don’t use Central bank funds for the funding of loans, the CBR may have little impact on the cost of funding for the banks,” Kasi says.

This means interest rates may not come down soon despite persistent cries from the business community. He adds that banks operational costs, which are usually determined by inflation, availability and access to services such as electricity, fuel, labour also affect interest rates.

“When the costs of such inputs go up, the costs of delivery of credit goes up and therefore the pricing of those loans,” Kasi says.

He adds: “When many loans become bad and therefore have to be provided for, it reflects the costs associated with default which has to be reflected in the pricing.

Currently, the banking industry is facing challenges of default, NPA (Non-Performing Assets) rate standing at about 7%, which is high.”

Outstanding total commercial banks’ lending to the private sector has remained almost stagnant for the last one year.

According to the BoU, as of May 2016, commercial banks’ lending to the private sector stood at Shs10.8tn. this is not far from the Shs10.1tn commercial banks had lent to the private sector in May 2015.

Any hope?

Kasi says for interest rates to come down sustainably, the above factors have to be reversed; there’s need for reduced cost of funding, increased savings (especially for long term purposes) among Ugandans and reduction in operational costs.

“If we get more clients borrowing and paying back in time, then default risk would reduce,” he says. Asked about what needs to be done to help Uganda’s economy, Kasi said there is need for increased effective demand for goods and services.

“Effective demand means that people have money to buy what they need. Money will be got through increased production and paying for what has been produced.

We read that there are some vendors who sold services to Government and they have not yet been paid; they should be paid so as to get cash flows to buy their needs and also be in position to pay for the loans they contracted from banks.

There are traders who sold items to customers in Southern Sudan, but have not been paid; we should explore ways through our Government as to how best to address this issue,” Kasi observes.

He explains that as interest rates start to come down, “we should see more lending to the private sector, as long as Government does not crowd the private sector out by over borrowing domestically.”

He adds that as private sector credit increase, investments and production will increase, resulting into more employment and earning by the public.

“This will increase demand in the economy and revamp it eventually. Production focus should be in sectors where we have comparative advantage, which also has the potential to increase exports and therefore foreign earnings,” he explains.

Bailout

Asked about his view on proposed bailout of struggling tycoons, Kasi said: “If it is to happen, it should be thoroughly thought out with clear criteria as to which enterprise to support, safeguards for recovery of whatever support will have been given, so that at the end of the day, we attain a win-win situation for the enterprise owners, and tax payers.”