In October 2017, commercial bank interest rates – for Uganda Shilling dominated loans – recorded the lowest average since September 2010. According to statistics from Bank of Uganda (BoU), average interest rates in October 2017 dropped to below to 20% mark for the first time since 2010, to settle at 18.96%. In fact, the last average monthly interest below 20% was last recorded in June 2011, prior to the change in the BoU to set a benchmark lending rate – the Central Bank Rate (CBR) – as signal on the direction of interest rates.
The commercial bank interest rates are in part responding to the record low CBR, last set in October 2017 at 9.5%. The CBR reaching a record low at the time was a signal from Prof. Emmanuel Tumusiime-Mutebile, the BoU Governor and other members of the Monetary Policy Committee that the prospects for the economy are improving. In essence telling the banks, “Reduce rates. Boost the economy.”
In the October 2017 Monetary Policy Statement, Prof. Mutebile said, “a cautious easing of monetary policy is warranted to boost private sector credit growth and to strengthen the economic growth momentum. “
The concern has often been that interest rates are “sticky downwards.” They are slow when dropping. This has led people to argue that the CBR is not an effective tool that can lead interest rates by commercial banks to decline. But is this assertion true?
In April 2016, the MPC meeting agreed to a position that would see the CBR brought down from 17% – the highest rate since the introduction of inflationary targeting approach in 2011 – to 16%. Since then, the CBR had declined to 9.5% by October 2017. That is decline of 7.5 percentage points. Over the same period, commercial bank shilling loans dropped from 24.37% to 18.82% by end of October 2017. That is a decline of 5.55 percentage points.
That leaves a gap in the reduction of about 2 percentage points.
The bankers will argue that the CBR response by commercial banks operates in a lag nature. For instance, in October 2017, BoU announced that the CBR would fall to 9.5% from 10%. The (some) banks will announce a reduction in interest rates that will take effect in January 2018. The net effect of the CBR announcement will be in one month or two or three months. This is reflected in a notice by Stanbic Bank to customers that its Prime Lending Rate from 18% to 17.5% and that this would take effect on 1st January 2018.
So if interest rates are falling to a record low, why are we not seeing the private sector surge in loan approvals?
The BoU Monetary Policy Report does point to this “frustration.”
“Growth in Private Sector Credit (PSC) remains weak despite the protracted monetary policy easing,” the report reads. For PSC to be considered “good”, it has to be at levels above 15%.
The estimates from BoU are that PSC uptake growth was 5.8% in the quarter to August 2017. What will be interesting to watch is whether this figure will improve as the MPC makes the CBR decision on Friday, 14th December 2017. With the rate at which interest rates have been falling – by sticky standards -, people are just not borrowing. They want to borrow. The banks are just not lending “with ease” despite the “affordable loans”.
BoU points out that demand for loans – loan applications – are robust, with about Shs4.7trillion worth of requests. However, only Shs2.2trillion of loans were approved by commercial banks.
“The significant disparity between value of loan applications and approvals is in part a reflection of a raft of supply-side constraints to growth in PSC,” the report reads.
Why are banks then not lending “that much?”
Commercial banks are still playing it safe. The loan defaults are still on the high side. None-Performing Loans, as a percent of total loans, had by the quarter September 2017 reached 7.24% – a rise from the previous two quarters. It should be noted that commercial banks had only been recovering from the high NPLs that plagued the banking sector in 2016, eventually claiming a bank, Crane Bank.
The outlook is also pointing to changes in the accounting rules, IFRS 9, that come into effect on January 2018.
“The adoption of IFRS 9 will give rise to higher levels of credit impairments,” reads an article by Francois Groepe, Deputy Governor of the South African Reserve Bank.
That means banks have to watch their risk appetite, so they don’t end up making provisions from their own income. The effect of this rule will be seen, once it kicks in.
Additionally, the cost-to-income ratio of commercial banks remains high. Banks are still spending more than 80% of their income on costs. Provisions for bad debts are part of those costs. According to the BoU financial soundness indicators, specific provisions for NPLs are below 2016 levels, meaning that credit risk is reducing, hence improved loan approvals.
So, the CBR is falling. Commercial Bank lending rates have declined. Borrowing is still below expectation. Borrowers still risky.
As long as these gains are not translating into improved borrowing, then job creation, business growth and eventual economic growth will remain below expectation.
FYI: Interest rates in Uganda rarely fall below 18%. It was in 2002 to 2003 that rates were around the 17% mark. October 2003, shilling loans were 16.69%. Prior to that, it was in June 1994, when average lending rates were at 14%.