By George Mangula
The Non-performing loan (NPL) ratio for commercial banks in the country rose to 5.8 percent in June 2020 from 3.8 percent registered in June 2019, according to the June 2020 Quarterly Financial Stability Review published by Bank of Uganda (BoU).
BoU attributes the jump in NPL ratio largely to a rise in nonperforming loans (NPLs) of 73.5 percent or USh.378.5 billion over the year, with a 14.0 percent or Shs109.8 billion increase in NPLs over the quarter to June 2020, “with deterioration largely coming from the real estate, trade and commerce, and household sectors.” Similarly, BoU says, the NPL ratios for credit institutions and Microfinance Deposit-taking Institutions (MDIs) rose to 7.6 percent and 10.8 percent respectively during the same period.
Capital and profitability
According to BoU, on aggregate, all banking institutions remained adequately capitalised in the year to June 2020. The industry core capital adequacy ratio for commercial banks and credit institutions improved to 21.2 percent and 22.8 percent respectively, at the end of June 2020, well above the regulatory minimum of 10 percent.
It adds that MDIs’ aggregate core capital adequacy ratio stood at 36.6 percent, well above the statutory minimum requirements of 15 percent. The increase in capital was mainly reflective of a slowdown in loan growth and higher retained annual earnings.
Annual bank profits increase
The BoU review says annual aggregate banking sector profitability increased, though it notes that profitability declined in the six months to June 2020.
Aggregate annualised return on assets (ROA) reduced to 2.6 percent, 0.6 percent and -1.4 percent for commercial banks, credit institutions and MDIs respectively, in June 2020. BoU attributes the decline mainly to lower interest income and rising loan loss provisions.
Banks lose Shs122.8 billion in bad loans
During the same period, BoU notes, Shs122.8 billion was expensed by banks on bad loan provisions, compared to quarterly average of Shs.58.6 billion in previous four quarters. “Going forward, rising provisions are likely to erode profitability further in near term.”
Five biggest banks control 78.4 market share
“A related concern is the increased concentration of the banking sector, as the market share of the five largest banks rose to 78.4 percent of the industry profits. This has potential implications for the competitiveness and efficiency of the sector going forward.”
According to BoU, COVID-19 pandemic has heightened systemic operational risks in the banking system. First, BoU notes, the nation-wide pandemic containment measures have led to the emergence of unprecedented business continuity requirements for financial institutions.
The central bank says a key concern is the potential for the lockdown of head offices and branch locations if a COVID-19 infection occurs, thereby impacting access to financial services and the operation of payment systems. It says during the quarter ending June 2020, over half of the financial institutions’ branches were closed or had shorter operating hours. It adds the pandemic has also led to greater reliance on cashless/digital payment channels such as online banking, which has enhanced the potential for cyber-related threats.
“Nevertheless, the costs associated with managing the operational risk during this pandemic, will likely negatively affect the profitability of SFIs and could drive up access costs to consumers of financial services over the short- to medium-term.”
However, BoU says systemically important payment systems remained resilient and operated without significant disruptions during the quarter to June 2020.
Mobile money payments
The BoU report says the year to June 2020 registered significant growth in mobile money transactions, as the value of transactions grew by 19.3 percent to Shs79.8 trillion, of which Shs40.7 trillion was in the second half to June 2020. In addition, BoU says, the escrow account balances increased by 51.8 percent from Shs632.7 billion in June 2019 to Shs 960.2 billion in June 2020, with an 18.0 percent increase in the quarter ending June 2020.
The surge in mobile money transactions partly reflects measures by BOU and other stakeholders that allowed for free mobile money transactions, free wallet-tobank and bank-to-wallet transactions with mobile network operators, and no limits on frequency of transactions between March 2020 and June 2020.
According to BoU, The use of electronic banking and digital payment products also picked up further in the year to June 2020. This trend was partly driven by actions taken by financial institutions to promote the usage of cashless transactions as a measure to reduce the risk of COVID-19 transmission. Debit card, credit card, and point-of-sale (POS) transactions increased. The value of credit card payments rose by 19.7 percent and the number and value of POS transactions rose by 27.5 percent and 14.5 percent respectively.
Internet and mobile banking activity also increased for the year ended June 2020 relative to the previous year. The value of mobile and internet banking transactions increased by 157.3 percent and 52.9 percent, respectively. Active users on internet and mobile banking platforms grew notably by 36.7 percent and 46.9 percent respectively during the same period.
Resilience of the Banking System
The resilience index – which consolidates a range of macro-prudential indicators, showed that overall, commercial banks’ resilience declined significantly in the year to June 2020 due to the COVID-19 pandemic.
Nonetheless, stress tests conducted on the banking sector showed that on aggregate, most financial institutions had sufficient liquidity and capital buffers to withstand emerging shocks.
The Outlook for Financial Stability
The outlook points to challenging conditions for the banking sector going forward, mainly driven by the impact of the pandemic shock on economic activity and credit risk. BoU says Systemic risks are likely to remain elevated in the near term until economic recovery is stronger. “Empirical research has shown that nonperforming loans tend to lag economic activity by a period of 3-6 months. Relatedly, stress tests and risk modelling by BOU projects the aggregate industry NPL ratio to rise to a range of 6 – 10 percent in the near term. It is important that banks help to absorb but not amplify the shock during this period.”