As at end June 2019, commercial banks in the country accounted for 95.2 percent of the banking sector total assets of Shs31.8 trillion as the banking industry aggregate assets increased by 10.5 percent to Shs30.3 trillion from Shs 27.4 trillion in June 2018, according to the latest financial stability report for June 2019 as released by the Bank of Uganda (BOU).

According to the report released Tuesday, loans and advances, investment in government securities, balances with Bank of Uganda (BOU), and placements with non-resident banks respectively accounted for the largest proportions of the industry total assets.

Gross loans and advances increased by 11.2 percent, which was higher than the 11.0 percent increase in the year ended June 2018. As banks sought to diversify risk exposure associated with private sector credit, they increased investment in government securities more rapidly, by 14.7 percent, up from 12.2 percent growth in the year to June 2018.

As the shilling remained stable against the major foreign currencies, banks’ deposits with non-resident banks reduced by Shs439.0 billion to Shs.2, 243.3 billion, which had increased by Shs1, 017.9 billion in the year, ended June 2018; hence minimizing the banks’ assets exposure to foreign shocks, the report says.

Meanwhile, the foreign currency denominated proportion of total assets reduced from 33.1 percent to 29.4 percent over the year ended June 2019, reducing susceptibility of the balance sheet to foreign exchange rate risk, in spite of the concurrent marginal increase in proportion of foreign currency denominated liabilities to total liabilities, from 39.9 percent to 40.2 percent.

The commercial banking industry remains highly concentrated in spite of continued growth

The five largest banks out of 24 banks that comprise the commercial banking domain, accounted for 60.4 percent of the aggregate assets as at end June 2019, up from 60.3 percent in June 2018. The individual market share of the other 19 banks ranged from 0.2 percent to 5.9 percent. “Indeed, the Herfindhal-Hirschman index (HHI) also exhibited increased concentration (Chart 25). However, the trend in the HHI for assets (and loans, as a sub-category) moved in tandem with the HHI for deposits, the main funding source, suggesting matched concentration on both the assets and liabilities side of the balance sheets,” the report says.

Credit growth, risk, and sectoral allocation

According to the report, credit continued to expand, but generally remained below its historical average growth rate of 16 percent during the last ten years. However, a pickup in exposure to foreign currency denominated loans was noted which raises potential credit risk in the event of subsequent depreciation of the shilling. Over the year ended June 2019, total loans grew by 11.2 percent to USh.13.6 trillion, up from 11.0 percent growth over the year ended June 2018.

Foreign currency loans rise 6.3 percent

The report says foreign currency loans increased by 6.3 percent to the equivalent of Shs.4,949.2 billion, over the year, up from 0.5 percent growth in the year ended June 2018. Discounting foreign exchange valuation effects, foreign currency denominated loans increased by 11.6 percent over the year, significantly reversing a 7.0 percent drop over the earlier year. On the other hand, shilling loans increased at a slower rate, 14.2 percent, as compared to the 18.6 percent increase in the year ended June 2018.

However, in terms of composition, the proportion of foreign currency denominated loans to total loans reduced from 38.1 percent (June 2018) to 36.4 percent (June 2019), consequently reducing exposure of banks’ balance sheets to credit and market risk that can potentially be propagated by foreign exchange rate risk.

Credit risk reduces

BoU reports that credit risk in the banking sector reduced, with asset quality improving further. Credit risk within the banking sector eased, as measured by the two core financial soundness indicators (FSIs) – ratio of non-performing loans to gross loans and sectoral distribution of loans to total loans – as detailed below.

In addition, banks considerably provided for non-performing loans, with the ratio of specific provisions to non-performing loans closing at 49.4 percent.

Sectoral concentration of loans eased marginally

Sectoral allocation of credit remained consistent with past trends, with no extraordinary shift in the sectoral distribution of banks’ stock of loans over the year to June 2019. The three largest sectors – building, construction & real estate; trade & commerce; and personal & household – jointly accounted for 57.5 percent of banks’ gross loans and advances, down from 58.2 percent as at end June 2018. “Given that the 10-year quarterly average share of the largest three sectors in gross loans was 58.4 percent, the sectoral distribution of credit remained largely consistent with the recently observed distribution, allaying financial stability concerns of extraordinary growth or concentration in particular sectors,” the report says.

Lending to building, mortgages, construction and real estate sector, which accounted for the largest proportion (20.1 percent) of banks’ lending, increased by 11.0 percent (USh.270.5 billion), a more rapid growth compared to 8.7 percent growth in the prior year ended June 2018; with shilling denominated loans accounting for 99.4 percent of the increase. Over the year ended June 2019, credit expansion to this sector was in line with the observed improvement in property prices.

For instance, the report says, the Residential Property Price Index (RPPI) indicates that property prices in the Greater Kampala Metropolitan Area generally increased by 2.5 percent over the year ended June 2019. In terms of currency composition, the proportion of foreign currency denominated loans to building, mortgages, construction and real estate reduced further from 50.2 percent to 45.2 percent over the year ended June 2019, partly a consequence of the macro-prudential policy intervention that set a ceiling for the loan to value ratio (LTV).

While the loans extended for land purchase account for a mere 0.6 percent of gross banks’ loans, the macro-prudential policy, of a 70 percent cap on LTV for foreign currency denominated lending for land purchase, has been effective. The proportion of foreign currency denominated loans in total loans for land purchase has reduced to 18.7 percent as at end June 2019, from 43.0 percent as at end of April 2016 – prior to the policy coming into effect.

Trade and commerce sector, which accounted for 20.1 percent of gross loans, grew at 10.7 percent, a slower pace relative to 12.5 percent growth registered in FY2017/18. Similarly, growth in personal and household loans slowed to just 7.7 percent, slower than the 13.8 percent rise in FY2017/18.

Analysis of the sectoral distribution of foreign currency lending shows that the major tradable sectors – manufacturing, trade and commerce – accounted for 43.8 percent of the industry foreign currency loans, up from 39.3 percent share as at end of June 2018; with the largest proportion of the increase in foreign currency lending associated with these sectors.

Conversely, the share of the building, mortgages, construction and real estate sector in foreign currency lending dropped from 26.5 percent to 24.9 percent over the same period. Also consistent with prudential regulation, the stock of foreign currency denominated loans to households reduced by 4.3 percent, and accounted for only 2.7 percent of the gross lending to households.

Stories Continues after ad

The banking sector in the EAC region registered strong growth as at end March 2019 where total assets for commercial banks had grown by 9.7 percent to US$70.6 billion, compared to an increase of 5.4 percent in the year to March 2018, according to the Bank of Uganda Financial Stability Report for June 2019 which quotes EAC Monetary Affairs Committee as the source of the data.

The report released on Tuesday attributes the growth in assets to improved macroeconomic performance and accommodative monetary policy in the region.

The regional banking sector was profitable on the whole, owing mostly to increased lending activity. The average return-on-assets ratio rose from 2.1 percent to 2.5 percent between March 2018 and March 2019.

In addition to boosting profit buffers, the sector remained well capitalised during this period, supported by robust Macroprudential regulation and supervision. As at end March 2019, the average core capital adequacy ratio for the region stood at 18.6 percent, which is well above the regulatory minimum requirement of 10 percent.

Credit growth improves

Credit growth improved across the region, mainly on account of eased supply-side constraints and increased aggregate demand. On average, credit to the private sector grew by 11.3 percent in the year to March 2019, compared to 6.2 percent in the previous year.

Credit risk, as measured by the ratio of non-performing loans to gross loans (NPL ratio), was moderate in the region during the period under review. Changes in the sector’s asset quality were mainly attributable to delayed government payments to suppliers and inadequate credit underwriting.

NPLs decline

The average NPL ratio for the region reduced from 10.3 percent in March 2018 to 8.6 percent in March 2019. However, Kenya’s banking system registered a significant rise in credit risk as the NPL ratio increased from 11.8 percent to 12.8 percent, despite the low interest rate environment and recovery in lending activity.

Credit risk, as measured by the ratio of non-performing loans to gross loans (NPL ratio), was moderate in the region during the period under review.

Changes in the sector’s asset quality were mainly attributable to delayed government payments to suppliers and inadequate credit underwriting. The average NPL ratio for the region reduced from 10.3 percent in March 2018 to 8.6 percent in March 2019.

However, Kenya’s banking system registered a significant rise in credit risk as the NPL ratio increased from 11.8 percent to 12.8 percent, despite the low interest rate environment and recovery in lending activity.

Stories Continues after ad

East African countries are progressively improving their policy frameworks governing trade, but governments need to do more to improve the business environment as a whole, according to the second edition of the African Union Commission’s (AUC) economic report produced in collaboration with the Organisation for Economic Co-operation and Development (OECD) Development Centre.

Governments in the region are adopting a series of pro-trade reforms to reduce barriers to trade and improve the overall trade environment. In 2019, at the time of writing, most countries in the region had outperformed the sub-Saharan Africa average for trading across borders, says Africa’s Development Dynamics (AfDD) 2019 report released Tuesday.

However, while some countries like Mauritius, Rwanda and Kenya outperform others in the Ease of Doing Business rankings overall, more countries in the region require additional work to improve the overall business climate. “Complex and burdensome business procedures in many countries undermine efforts to promote business linkages, cross-border firm networks and regional value chains,” the report says.

It says regional integration is a contentious political process to manage and should be deployed tactfully to promote an environment conducive to transforming the economy’s productive structure. “Regional integration exposes businesses to outside influences, opportunities and competition. This can trigger resistance or hesitation among certain stakeholders that fear economic disruption.”

It adds that regional integration initiatives also carry enormous potential for economic and social benefits to ordinary citizens and domestic private sector operators alike. I t says: “A tactful approach with carefully selected initiatives should be deployed as opposed to a wholesale push for larger and more competitive markets.”

Regional integration can create larger markets, increase economies of scale and reduce transaction costs for the region, although this does not seem to take place yet. There is little evidence to suggest that integration in the major East African regional economic communities (RECs; i.e. the Common Market for Eastern and Southern Africa [COMESA] and the EAC) have led to increases in intra-regional trade.

Ten years after its launch, intra-regional imports in the EAC as a share of GDP were lower than prior to its launch. COMESA has fared only slightly. Lack of trade complementarity among member states, overlapping membership and a general decrease in exports’ share of GDP go some way to explain this situation. Consequently, efforts by RECs to promote East Africa’s productive transformation have been largely ineffective, partly due to a poor implementation of regional programmes.

Individual countries’ overlapping membership in RECs further complicates national trade regimes and prevents deeper integration into one group. A tripartite free trade agreement in goods, negotiated between COMESA, the EAC and the Southern African Development Community in June 2015, provided an opportunity to partially rectify this. However, the experience overall has been a disconnect between regional and national objectives for growth and, by extension, a prioritisation by member states of their own interests over those of the region. These factors combined prevent countries from fully benefiting from the regional integration process.

Promoting greater levels of trade facilitation over integration could increase the number of regional value chains (RVCs). Reducing regional transaction and trade costs is critical to supporting RVC integration since goods cross regional borders multiple times.

It is estimated that reducing time to trade by 1% increases the level of foreign value added by 0.18% after two years. Regional projects, such as the Single Customs Territory, which focus on reducing the cost and time for trading across borders, could allow RVCs to play a greater role in East Africa’s productive transformation. Through implementation of the SCT project, transportation costs on the Northern Corridor between Kigali and Mombasa were reduced from USD 5 000 per 20-foot container at the beginning of 2013 to almost USD 3 000 in 2019.

Investments in transformation capabilities are needed to unlock trade’s growth potential

Exports’ share of GDP is decreasing for East Africa, as much of the region’s growth is concentrated in non-tradeable sectors. While exports’ shares of GDP vary across countries, they tend to be above 40% for upper-middle-income countries globally. The East African average was just 14% in 2017, down from 19% in 2000. This low and declining share can partly be attributed to the fact that much of the region’s growth comes from the non-tradable construction, real estate and retail sectors.

The island countries of Madagascar, Mauritius and Seychelles all have relatively higher trade shares. Rwanda stands out for its exceptional rate of sustained export growth since 2000, averaging 17% per year, while its share of exports as a percentage of GDP increased from 6% to 18%. However, even with this level of growth, Rwanda’s share of exports in the national income remains below the average for countries with comparable income levels (around 25%).

The region constitutes of services-exporting economies

 Services accounted for 57% of exports from East Africa in 2017 and have remained above 50% for the past decade. Major export sectors for services in the region include tourism, transport, ICT and finance. Services exports have grown 6% on average for the past year, largely in line with the average growth for total exports.

While services have greatly contributed to growth in East Africa’s exports, relying solely on service-driven export growth has its downsides. Firstly, some services tend to require high-skilled labour, which calls for a long-term investment in human capital. Secondly, though services are often traded, they tend to be less tradeable than goods and raw materials. Ultimately, there is no obvious or easy way to rapidly improve productivity in services.

Exports from agriculture and mineral sectors are growing strongly. The shares of exports from agriculture and minerals have increased over time, accounting for 26% and 6%, respectively, in 2017. The positive growth in agriculture is a result of investments to improve productivity in key agricultural export commodities by countries such as Ethiopia, Kenya and Rwanda. As countries push for growth in agriculture exports, markets outside East Africa are becoming increasingly important. Mineral exports also are largely destined for markets outside the region.

The share of the region’s manufacturing export products has fallen, from 20% a decade ago to 12% in 2017. Manufacturing export performance has been particularly disappointing given the efforts that East African countries have put into growing their industrial base.

Increasing the size of manufacturing exports is a critical component for the region’s productive transformation, due to a higher productivity and large employment potential. However, at the current pace, the region will not be able to rely on manufacturing-led export growth to absorb new entrants into the labour force.

The report sheds light on the state of productive transformation in 14 East African countries: Comoros, Djibouti, Eritrea, Ethiopia, Kenya, Madagascar, Mauritius, Rwanda, Seychelles, Somalia, South Sudan, Sudan, Tanzania and Uganda.

Stories Continues after ad