Commercial banks increase interest rates

BANKING |

Commercial banks' average interest rates for shilling denominated loans rose to 19.3% in June from 18.8%, reflecting risk averseness in the banking industry.

This is despite the Central Bank maintaining the central bank rate at 7% in July.

According to data from Bank of Uganda (BoU), similarly, the average lending rate for foreign currency denominated credit also rose to 5.5% in June from 4.2% the previous month.

In July, the BoU Governor Emmanuel Tumusiime Mutebile wrote a letter to all chief executives of financial institutions to review industry lending rates.

In response, commercial banks gave the central bank a 30-day window during which individual member banks planned to review their internal positions and adjust their lending rates accordingly based on what they can accommodate.

In the letter, Mutebile threatened to invoke section 39(1) of BoU Act,2000 which mandates the bank to prescribe the minimum and maximum interest rates.

In April, the average lending rate rose from 17.7% to 18.8% despite the central bank softening its monetary policy stance in the period.

Higher interest rates increase the cost of borrowing, reduce disposable income and therefore limit growth in consumer spending.

Wilbrod Owor, executive director at Uganda Bankers Association, an umbrella body bringing together commercial banks, said: " "The expectation of a worsening loan book due to COVID-19 and a higher risk of non-performing loans in the dominant sector in spite of restructuring taking place, is putting pressure on lending rates."

While the Purchasing Managers Index (PMI) and Business Tendency Index (BTI) rose to 46.5 and 43.06 in June from 41.9 and 33.96, respectively, in May, both indices remained below the 50-mark threshold.

The Index covers the major sectors of the economy such as construction, manufacturing, wholesale trade, agriculture, and other services.

The overall BTI above 50 indicates an improving outlook and below 50 a deteriorating outlook.

Financial experts at the central bank say the main driver of lending interest rates is overhead costs. Because the banks are riddled with high overhead costs, the lending interest rates must be high enough to cover operational costs.

Overhead costs are partly dependent on the size of the bank and the type of clientele.

Because most of the lenders are small, with high operating costs and largely rely on the interest income from loans, and the majority of the borrowers are Small Medium Enterprises and households, the resulting lending interest rates are high.