Credit risk remains high as local banks see 7.1 percent profit growth

KAMPALA-Risks for commercial bank lending in the country remain elevated due to slow credit growth, lingering concerns over asset quality, and high write-offs as banks clean up their loan book of COVID-19 impaired loans, states the Bank of Uganda [BoU] latest Quarterly Financial Stability Review, June 2022.

Further BoU notes that credit growth remained slow during the review quarter, as BoU Supervised Financial Institutions [SFIs]’s risk aversion to lending persisted due to uncertainty over the pace and path of economic growth and the creditworthiness of borrowers.

While the commercial banks’ gross loans grew by 4.1 percent to Shs 18.6 trillion in June 2022, from Shs 17.9trn in March 2022, BoU says the increase was largely reflective of net capitalised interest on loans that fell due but remained unpaid.

Similarly, credit institutions [Cis] and microfinance deposit-taking institutions [MDIs]’ loans increased by 1.3 percent and 1.1 percent to Shs 257.8 billion and Shs 420.6bln respectively over the quarter ended June 2022, notes BoU.

Asset quality remains a concern

Banks’ aggregate non-performing loans [NPLs] ratio reduced to 5.4 percent from 5.9 percent over the quarter under review, largely due to the ongoing COVID-19 Credit Relief Measures.

However, BoU warns NPLs could increase in the near term due to the slowdown in economic growth coupled with rising lending rates.

BoU attributes the reduction in the banks’ NPLs partly to write-offs of bad loans, amounting to Shs 103.2bln during the quarter to June 2022 compared to Shs 69.6bln in March 2022.

However, the BoU report says the banks’ recoveries on previously written-off loans increased from Shs to Shs 67.3bln during the quarter ended June 2022, from Shs 29.0bln during the quarter ended March 2022.

CRM programme

BoU notes Credit Relief Measures [CRM] for the education and hospitality sectors, which started on October 1, 2021, shall expire on September 30, 2022. “With the gradual recovery in activity in the education and hospitality sectors, demand for the targeted credit relief has reduced, and only Shs 6.7bln in credit relief was extended to the two sectors during the quarter ended June 2022, compared to Shs 10.9bln for the prior quarter,” says BoU.

The total stock of loans that remains under the CRM program reduced to Shs 2.2trn by end-June 2022 (from a peak of Shs 5.2trn in September 2020, adds BoU

However, asset quality of loans still under CRM remains a concern, though the value of past due CRM loans reduced to Shs 978.2bln over the quarter ended June 2022, from over Shs 1trn  over the quarter ended March 2022, reducing the ratio of past due restructured loans to gross loans from 5.7 percent to 5.1 percent.

“Notably though, this ratio has persisted for over one year and portends permanent impairment due to the impact of the pandemic, suggestive of a further increase in NPLs in future. Regarding the ability of banks to absorb related losses, solvency stress tests by BOU indicate that most SFIs are resilient to further deterioration of the past due CRM loans.”

Funding and liquidity conditions

BoU notes the banks’ retail deposits, which form a stable source of funding and constitute 84.2 percent of total liabilities, grew by 5.2 percent to 31.1trn in June 2022 from Shs 29.5trn in March 2022.

“On aggregate, banks still hold strong liquidity buffers, sustaining their resilience to potential liquidity shocks. However, the liquidity coverage ratio [LCR], which measures the ability of banks to withstand a 30-day liquidity stress period, decreased from 301.7 percent to 184.5 percent over the quarter ended June 2022, but remained well above the 100.0 percent minimum requirement.”

The aggregate ratio of liquid assets to deposits [liquidity ratio] also decreased to 46.5 percent from 49.6 percent, although all banks met the regulatory minimum of 20.0 percent.

Going forward

BoU says the key risks to liquidity and funding include the further tightening of funding conditions, with rising interest rates and increased foreign capital outflows, as the necessary tightening of monetary policy continues.

Furthermore, the potential rise in NPLs could compound liquidity pressures if loan repayments reduce. “While all banks remained compliant with the minimum regulatory liquidity requirements, the trend suggests that prolonged monetary policy tightening could adversely test the resilience of some banks.”

Profitability and capital adequacy aggregate

According to BoU, the banking sector profitability improved for the quarter ended June 2022 as their aggregate net profit after tax [NPAT] increased by 7.1 percent to Shs 330bln in the quarter ended June 2022 from Shs 308bln in the quarter ended March 2022, mainly attributed to a 4.7 percent increase in interest income.

Bad debts

Provisions for bad debts during the quarter under review amounted to Shs 72.3bln in June 2022, a reduction of 37.7 percent compared to the prior quarter.

The MDIs registered an aggregate NPAT of Shs 14.3bln for the quarter ended June 2022, from Shs 11.9bln in the prior quarter. In contrast, the NPAT for credit institutions [Cis] declined further to a loss of Shs 2.2bln in the quarter ended June 2022 from a loss of Shs 771.3mln in the quarter ended March 2022, largely attributed to an increase in provisions for bad debts.

Policy Stance and Outlook for Financial Stability

Overall, BoU says the banking sector remains resilient to potential risk, supported by strong capital and liquidity buffers, and BOU prudential policy measures. “However, during the quarter ended June 2022, systemic risks to the banking sector started to pick up due to spill-over effects from external risk factors, including the slowdown in global economic growth, rising inflationary pressures, and tightening financing conditions.”

Performance of banks hinged on domestic and global macroeconomic conditions

Going forward, the banking sector’s performance will depend on the trend in domestic and global macroeconomic conditions, as these directly impact households’ and businesses’ income. “Furthermore, the tightening monetary policy in advanced economies could induce further reversal of foreign capital flows from developing countries such as Uganda, which would likely lead to an increase in banking institutions’ funding, liquidity, and market risks.”

Digital Channels and Operational Risk

The use of digital payment systems continued to grow strongly, both for mobile money service providers and in SFIs, says BoU, adding, “The demand for digital payment services was mainly driven by a favourable policy environment, evolving consumer behavior/needs, and recovery in economic activity.”

The value of internet and mobile banking fund transfers rose significantly by 98.9 percent and 164.5 percent respectively in the year to June 2022, compared to the prior year. The value of mobile money transactions rose considerably by 37.6 percent to Shs 155.99trn in the same period.

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