Banks are just a "Cog" in a Complex Machine

It has become virtually impossible to complete a day without hearing or reading the words "bail-out" or "high- interest" rates at least a few times. Suffice to say, both words and for good reason, have generated animated debate among all echelons of Ugandan society. Being the primary interface between the public and the financial system, commercial banks have inevitably borne the brunt of the criticism and have emerged as the convenient scapegoat for the current state of the nation's financial affairs.

The simple fact that has been overlooked in this debate is that the seemingly omnipotent commercial banks in Uganda do not have absolute control over lending rates. There is an invisible hand and prevailing market interest rates are an explicit reflection of the cost of money within the economy at a given time. In Uganda's case, this is largely determined by the Bank of Uganda ("BoU") through its official rate also known as the Central Bank Rate ("CBR").

In blaming the commercial banks, we have subliminally divorced monetary policy and its urgent and critical mandate, from the prevailing high-interest rates yet the two are as intertwined as Siamese twins. You see, when BoU increases its CBR (which by the way was increased five times in 2015 from 11.0% to 17.0%) - it's making an attempt to influence overall economic activity in balance with its non-negotiable inflation target of 5%. Its mandate is very clear and it executes it flawlessly.

When demand for goods and services in Uganda exceed supply for whatever reason, could be food shortages or expensive imports and inflation is expected to rise above 5.0%, BoU moves swiftly to subdue this inflation adversary. We could think of the economy as a boda boda in motion and inflation rates as the speed by which that boda is travelling. When the boda remains static, or if we try to backpedal, we'll soon lose our balance and fall. Similarly, when the boda travels at an excessively high speed, it becomes hard to control and manoeuver through the ups and downs of the road ahead. But when the boda has a steady, controlled pace it's easy to maintain balance and create forward momentum. This is why BoU has an inflation target and enviously protects it. By adjusting CBR - which is the rate that BoU pays on reserves held by commercial banks - it's able to influence a range of lending and borrowing rates across the economy in order to either slow or accelerate economic temperature.

A reduction of interest rates makes savings less attractive and borrowing more attractive (hint increased credit growth) which stimulates spending and investment in the economy. Consumers spend more and firms borrow more to expand capacity and this virtuous cycle of economic growth and consumption keeps everything in progressive sync till the next economic shock. The ideal situation would be to keep the cycle as prolonged as possible.

Unfortunately for many Sub-Saharan Africa economies, the political election cycle has an overbearing influence on economic cycles and planning seems to be confined into these election cycles. It's worth noting that changes in the CBR also indirectly affect exchange rates, a rise in the CBR relative to external yield rates in Europe (which are close to negative) gives European investors a higher yield relative to theirs which makes Uganda shilling denominated assets more attractive. These foreign flows into primarily Government of Uganda bonds are a valuable defense of the Ugandan Shilling because these foreign investors need to convert hard currency into UGX helping to shore up the value of the local currency.

Foreign investors account for approximately 13% of all outstanding Ugandan securities or approximately ($445 million) - more than thrice what we earn from our tea exports in a year. In certain emerging markets, that number is north of 50% of outstanding government securities which has its own volatility challenges but provides a decent inflow of hard currency and a much needed cushion against depreciation. Understanding how all these seemingly discrete levers work and have knock-on effects on each other and how the central bank prioritizes certain decisions is critical to appreciating how commercial banks are a minor piece in this complex jig-saw machine.

So every time the BoU adjusts the CBR rate, commercial banks should as a matter of prudence review and adjust their prime lending rates. Stanbic Bank for example has reduced its prime lending rate by 200 basis points (2%) in the last quarter alone - a swift and comparable response to the reduction in the Bank of Uganda's CBR after their April and June Monetary Policy Committee ("MPC") meetings. The MPC is signalling a reduced threat of inflation going forward and are therefore comfortable easing their monetary stance. This hopefully sets that positive chain of events described earlier enhancing credit growth and increased consumer activity.

 It is also necessary to dispel the myth; that commercial banks relish a high interest rate environment. This is simply not true, banks don't operate in a vacuum, and they are also susceptible to the same economic cycles. Just as day follows night; high levels of non-performing loans ("NPL's") follow a high interest rate environment. The levels of NPLs in the Ugandan banking industry have grown by at least 200% over the last 18 months and are close to 7.0% of the entire industry loan book. Moreover, banks are unique in one significant way, unlike a manufacturing company that can only lose its unit cost of production (how much it cost them to make that bag of cement or sugar) banks losses crystalize on the balance sheet - what we actually lent out. It's like a cement company losing 30% of its cement plant overnight for selling cement to the wrong contractors.

Ugandans should therefore appreciate the necessity of strong and resilient banks and be thankful to an unwavering and steadfast regulator in BoU that has developed the safest and most sound banking sector in the region.

Strong banks are beneficial to the Ugandan economy primarily because; depositors can be confident that their hard-earned deposits (savings) are safe and accessible when necessary. Even the hard-core sceptic will agree that it's better to make one billion less in profit than have the adverse effects of a potential UGX 200 billion loss. This is what we do every day; manage risk. It's simply that the timing and crystalizing of our risks and losses have different cycles.

Stanbic, welcomes future reductions in the CBR and commits to moving in tandem with the BoU policy rate in the most transparent manner. While there are time lags (up to a year) before changes in interest rates affect spending, a downward revision of the CBR re-enforces where we are in the economic cycle and gets credit growth moving which is the single most important driver of our own growth. We cannot grow our business without growing access to credit and lending to the real economy. This is what has kept banking and Stanbic Bank relevant for the last century and it's not about to change. At the end of the day, banks want to lend and high interest rates make it difficult for our customers to pay back.

I encourage all of us to acknowledge the structural impediments we face and have constructive debates on finding lasting solutions to overcome them.

 
Patrick Mweheire is the Chief Executive of Stanbic Bank.

Comments and thoughts can be sent to business@newvision.co.ug