Banking Profits in Tough Times: An Economist’s Insight into Uganda's Financial Landscape
The recent report that Uganda's largest banks are making substantial profits amid widespread economic difficulties raises important questions about the dynamics of financial institutions in developing countries. This scenario is not unique to Uganda, but a phenomenon seen in many low-income countries where large banks thrive even as the wider population struggles with economic hardship. This article examines the reasons for this trend and draws parallels from other regions to provide a comprehensive understanding of the economic forces at play.
The profitability paradox in Uganda
In 2023, several of Uganda’s major banks, including Stanbic Uganda Holdings Ltd, Centenary Bank and ABSA, reported double-digit profit growth. This was in stark contrast to the difficulties faced by smaller banks, some of which were forced to divest or downgrade due to regulatory changes that increased capital requirements. The profitability of these large banks, despite the general economic turmoil characterized by high inflation and geopolitical tensions, highlights the paradox that financial institutions are thriving while the population is struggling with economic challenges.
The rise in profits is largely due to the central bank's response to inflation, which has increased interest rates. Higher interest rates allow banks to increase the cost of borrowing, which has a direct impact on their interest income. Stanbic Uganda Holdings Ltd, for example, recorded a 15.2% increase in profits, primarily due to loans and advances. Centenary Bank's profit also grew due to interest on marketable securities, loans and advances.
The role of government bonds in bank profitability
Another factor contributing to the profitability of Ugandan banks is the high level of government borrowing from commercial banks. Governments often borrow from domestic banks to finance budget deficits, which has become a notable trend in Uganda. This borrowing is considered a safe and profitable investment for the banks as it offers attractive returns with minimal risk compared to loans to private companies.
However, this practice has wider implications. When banks prioritize lending to the government over the private sector, it leads to a crowding out effect that reduces the availability of credit to private companies and individuals. This can stunt private sector growth as businesses face higher borrowing costs and limited access to the funds needed to expand and operate. In Uganda, this dynamic has contributed to high interest rates that make it difficult for private businesses, especially small and medium enterprises, to obtain affordable credit.
The broader picture: examples from other countries
Uganda’s experience is mirrored in other developing countries, where banks often report robust profits in the midst of economic difficulties. In Kenya, for example, the banking sector has also made significant profits despite widespread economic difficulties among the population. In 2022, Kenyan banks reported record profits despite a sharp rise in inflation and the cost of living. The ability of these banks to maintain high profit margins despite adverse economic conditions can be attributed to several factors:
Interest rate hikes: Just like in Uganda, central banks in other countries often increase interest rates to curb inflation. While this move serves to stabilize the economy, it directly benefits the banks as they raise their lending rates, thereby increasing their profit margins. In Nigeria, for example, large banks such as Guaranty Trust Bank and Zenith Bank have historically made high profits during periods of high inflation and high interest rates.
Diversified income streams: Banks in Uganda and elsewhere have diversified income streams, including fees, commissions and trading income, which are less sensitive to economic conditions affecting the average citizen. ABSA Uganda, for example, reported a 42% growth in transaction and trading income, showing that banks are not solely dependent on lending.
Economies of scale and market dominance: Large banks often benefit from economies of scale that smaller banks cannot achieve. They have better access to capital, better risk management and can offer a wider range of services. This dominance allows them to maintain their profitability even when market conditions are generally unfavorable.
Regulatory environment: Regulatory changes, such as the increase in capital requirements in Uganda, often affect smaller banks disproportionately. Larger banks with their considerable capital reserves can cope with these changes more easily, further consolidate their market position and continue to generate profits.
Impact of public debt on the economy as a whole
While bank profitability can be seen as a sign of a resilient financial sector, it does not necessarily translate into wider economic benefits, particularly in a context where access to financial services remains limited for many people. High borrowing costs due to increased interest rates and significant government debt can stifle economic growth by making access to credit more expensive for businesses and individuals. This exacerbates income inequality, as the wealth generated in the banking sector is not passed on to the wider population.
In addition, the pursuit of profit maximization can sometimes lead banks into practices that are not necessarily in line with economic stability in general. The recent loss of Equity Bank, for example, attributed in part to fraudulent activities related to unsecured loans, underscores the risks associated with aggressive growth strategies.
Going forward: Balancing profitability and Economic Inclusion
To address the disconnect between bank profitability and the economic hardship of the broader population, policymakers and regulators must strike a balance. This includes creating a regulatory environment that not only supports bank stability and profitability, but also promotes financial inclusion and accessibility.
Countries such as Rwanda have made progress in this area by focusing on mobile banking and digital financial services to reach the unbanked population to ensure that the benefits of a strong banking sector are more widespread. Uganda could take similar steps to improve financial inclusion and ensure that the success of the banking sector translates into tangible benefits for the wider economy.
To mitigate the negative impact of government borrowing on lending to the private sector, several measures can be considered:
Diversification of government funding sources: Governments can explore alternative sources of funding, such as issuing bonds in the international markets, seeking concessional loans from multilateral institutions, or utilizing public-private partnerships. By diversifying funding sources, the pressure on domestic commercial banks can be reduced, making more credit available for the private sector.
Develop capital markets: Strengthening capital markets can provide businesses with alternative ways of raising capital, e.g. through shares or corporate bonds. This would reduce dependence on bank loans and allow the private sector to invest even when government debt is high.
Regulatory intervention: Central banks can play a crucial role in managing the balance between government and private sector borrowing. This can include setting limits on the proportion of bank assets that can be invested in government securities or creating incentives for banks to lend to the private sector through targeted lending programs or guarantees.
Improving fiscal discipline: Ultimately, sound fiscal management is needed to reduce the need for excessive government borrowing. This includes improving tax collection, cutting unnecessary spending and ensuring that public funds are used efficiently. By maintaining fiscal discipline, governments can reduce their reliance on domestic borrowing, allowing more funds to flow into the private sector.
Conclusion
The profitability of Uganda’s largest banks amid widespread economic difficulties reflects a broader trend seen in many developing countries. While large banks benefit from higher interest rates, diversified income streams and economies of scale, the challenge remains to ensure that this profitability contributes to broader economic growth and stability. To achieve this balance, the impact of government borrowing on lending to the private sector must be addressed. By learning from global examples and taking targeted action, countries like Uganda can work towards a more balanced economic environment in which the success of banks goes hand in hand with the well-being of citizens.
