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.

Is Uganda Capable of Defeating the Resource Curse?

Political and economic dysfunction known as “resource curse” has triggered odd responses among countries that have discovered oil recently. The economic suffering of countries in rich in natural resources contradicts the basic laws of economics that would predict that the more natural resources the country has, the more the economic advantages and opportunities. The literature for example is beset by illustrations of how oil-rich Nigeria has misused a quarter trillion dollars of oil revenues and country is deeply indebted.  Venezuela, which was the richest country in the world in oil deposits, is struggling economically with two thirds of the population in living in poverty.  Indeed, the current Venezuela crisis and stories of how the country with the world’s largest oil reserves cannot afford to feed its people are reminiscent of the economic and political challenges that have befallen a host of oil rich countries. Therefore, the possibility of a resource curse overshadows the optimistic view that would surround any oil or mineral discovery. 

However, researchers have recently come to believe that the resource curse is no longer a possible threat given that there are many measures capable of overcoming it arising from past experiences. The researchers make reference to countries like Norway and Bostwana, among others who have managed their oil very well for the benefit of their population. Whereas this optimistic view has its merits, the prevalence and spontaneous incidences of the initial conditions in Uganda that resemble those of the countries that have mismanaged oil in Africa is worrying. Any average upright Ugandan, who follows the current economic and political trends, will agree with me that the current political and economic landscape raises many concerns. Like Kehlog Albran once quoted, “I have seen the future and it is very much like the present, only longer”, the current state of affairs and conditions before oil production starts raises questions about whether the country will be capable of avoiding the resource curse. The points of contention relate to the prevailing political challenges related to declining democracy, the weak political institutions, corruption permissiveness, high levels of unemployment, inequalities and poverty, and the people’s huge expectations about oil. 

It should be noted that available evidence across the many oil rich countries shows that the most fundamental problems that have led to the resource curse are politically oriented. The claim that oil-impedes-democracy is both valid and statistically robust in the empirical literature. The windfall oil revenue in most developing countries becomes a disincentive to the political leadership to share power; and the availability of oil revenue offers the leaders leverage to buy political legitimacy and repress opposition.  Democracy and the rule of law diminish to almost zero and the control over natural resource wealth replaces reason, justice and fairness. The resources that were seen as a nation’s endowment become exclusive to the current government and the people close to it.  This fuels resentment, resistance and conflicts by those excluded resulting into civil obedience, protests and wars as has been the case in Nigeria, Venezuela and Democratic Republic of Congo.  Therefore, in a country where the current regime has been in power for over three decades; and with significant traces of declining democratic space, rule of law and repression of opposition, one has to fear what will happen when oil windfalls start dropping.  I have fear that the current political regime will not be able to manage the temptations that come with oil windfalls. The bitter truth is that oil revenues will destabilize the remaining nascent democratic institutions and amplification of autocratic ones.  Remember, it is not only oil and gas revenue we are taking about, the prospects of other mineral rents/revenue is huge.  

The institutions that should provide the oversight and management of oil revenues and minerals in general have many inherent problems. It is frustrating to hear that Uganda has the best policies in place but the problem is implementation.  As the President of Equatorial Guinea Teodoro Obiang Mbasogo said while addressing the Oil and Gas Convention and Regional Logistics Expo 2017 in Uganda should cause worry about oil revenues management. He cautioned Ugandans that “Oil is like honey, it attracts both well-meaning bees and evil ones”. Therefore, one wonders how the institutions tasked with managing oil will be run in a country where most of the bees are not well-meaning. The greediness of Ugandans about oil revenue has been already demonstrated by investigations into the famous presidential hand shake. The investigations revealed that even celebrated “holy and trusted leaders”-the well-meaning bees change into evil bees in the face of oil money. Therefore, in a country where the “evil bees” outnumber the good ones, there is high probability that people who will be entrusted with managing our oil revenues do not have Ugandan interests at heart.

Nonetheless, the pre-oil socio-economic conditions that have influenced the oil problems in other countries are apparent in Uganda. For example, before oil production in Venezuela in the 1970s, high unemployment, income inequality and poor public services characterized Venezuela’s economy. Despite the favorable oil prices at the time, it became extremely difficult for Venezuela government to use the oil revenue to solve its socio-economic problems. In Uganda, the gap between the rich and poor is widening, unemployment is skyrocketing and public service delivery is poor and inadequate.  Where the majority of the population is poor, inadequate jobs, no stable incomes and poor social services, there is widespread dependency on the government as source of hope. It is not surprising that Ugandans have huge expectations about oil. The question therefore is; how will the current government manage these expectations bearing mind the declining oil prices and the socio-economic inequalities of income, poverty, ethnic tensions, and unemployment?

In conclusion, the resource curse is a conditional one and therefore the battle to avoid it is not an easy one if the prevailing political, socio-economic conditions are favourable. This is the situation Uganda finds itself in before oil production and mineral exploitation.   Just knowing that the problem existed in other countries and borrowing a few benchmarks it is not enough to avoid the curse. Already, the 2017 Resource Governance Index released in June shows that Uganda is among countries that are struggling to adequately govern their oil, gas and mining sectors. Therefore, country  need to conduct a thorough diagnosis of the mineral sector, dissecting current pre-oil conditions in their totality and avoid the mistakes others did in managing mineral revenues.  The starting point should be to start regarding our natural resources as national endowment. This definitely will facilitate deeper scrutiny of other oil rich countries, both those who failed and those that have survived the resource curse.