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Understanding liquidity in Ugandan banks

Act 1, Scene 1.

Let us assume that you went to a bank ATM looking to withdraw some money. Assume your you have a withdrawal limit per day of Shs2m. Now that is the exact amount you would like to withdraw. However, when you get to the ATM, the machine indicates you can only withdraw Shs1m. Your bank balance is about Shs6m. This scenario is sometimes an indicator that the bank does not have enough “cash” to move around in order to meet its obligations (liabilities) like ensuring customers can make withdrawals.

That scenario is sometimes referred to as the lack of liquidity. In essence, the bank cannot meet depositor obligations. When you deposit money in a bank it plays different functions. It can be lent out (in cash) or it can be used to cover some very short-term need. However, the bank is supposed to ensure that should you want your money, you would be able to make a withdrawal, seamlessly.

So how exactly do you tell whether a bank is “liquid” or not? Well, the first warning shot should be your inability to access your own money. That would mean the bank has spent the cash and has no cash to offer you. Your money on the account at that moment is inaccessible because there is no cash in the bank system. That is a simple way.

Act 1, Scene 2

Now let’s move to the more technical way. The numbers. Every bank publishes its financial results. In those results, the tendency is to jump to profitability and revenue. That is only half the story. There are other indicators that may show you how healthy a bank is in terms of meeting its day-to-day obligations.

Some of the aspects to look can be the Cash and Balances with the Bank of Uganda. All commercial banks are required to have cash and balances with the regulator.

Another indicator would be the investment in government securities. This is money that your bank has lent to the government. Government securities can be traded in order to generate cash to meet some short-term obligations. In 2017, lending to the private sector was sluggish because commercial banks were stocking up on government securities.

Additionally, BoU provides for commercial banks to access funds through what they call the Lombard Window. This where BoU acts as a lender of last resort. In times of liquidity challenges, a bank may use government securities as collateral to access cash to meet some of its obligations.

It obviously is important for a bank to have a good loan book where borrowers are paying back money with interest on a monthly basis. This ensures the bank has cash at hand. When borrowers are not meeting monthly obligations, then meeting daily cash calls by depositors can be challenging. That explains why commercial banks would rather stock up on customer deposits and reduce lending when the risk is considered high.

“Liquidity risk is the risk that we either do not have sufficient financial resources  available  to  meet  our  obligations  as  they  fall  due, or  can  only  access  these  financial  resources  at  excessive  cost.  It is  our  policy  to  maintain  adequate  liquidity  at  all  times  and  for  all  currencies, and hence to be in a position to meet obligations as they fall due. We manage liquidity risk both on a short-term and structural basis. In the short term, our focus is on ensuring that the cash flow demands can be met where required.” – This is a statement you will see in most commercial bank annual reports.

That is why some of the banks can access long-term funds to lend in the long-term instead of relying on short-term deposits. In the balance sheet, this can be viewed as borrowed funds or funding sources.

Act 1, Scene 3

So, just how is Uganda’s banking sector doing in terms of liquidity?

And indeed, according to BoU, the sector is above the requirement

“Banks held liquidity buffers well above the minimum requirement in 2017. The ratio of liquid assets to total deposits increased from 42.5 percent as at end of 2016 to 54.6 percent as at end of 2017, well above the regulatory minimum of 20.0 percent. Commercial banks held USh.9.9 trillion in liquid assets at the end of December 2017, and this was 18.6 percent more than the level held at end of 2016. With the increase in funding noted above, banks’ liquid assets increased as the banks opted for more investment Government of Uganda and BOU securities, which increased by USh.2,175.0 billion, while only increasing their lending to the private sector by a meagre USh.168.4 billion,” the BoU supervision report for 2017 reads.

Act 1, Scene 4

So, if a bank shareholder makes the decision to exit a bank does that affect the “liquidity”. Not quite. Let’s use the example of dfcu that has been in the news lately for facing liquidity issues + shareholder exiting. The exit of CDC from dfcu has been gradual. CDC used to control over 60% of the bank 20 years ago. The shareholding has over the years been shrinking and it reached 9.9% as at December 2017. CDC wants to exit further and all it has to do is agree on a price with new buyers that would want to take up the shareholding. This does not affect liquidity. The majority shareholder in the bank, Arise BV injected $50m capital in the bank when they acquired Crane Bank. If Arise had hinted at exiting, then we would begin questioning the status of the bank. For now, they have expressed their interest to keep with dfcu. That means dfcu can also access some long-term financing from Arise. Arise has about $700m worth of assets under management.

 

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