The International Monetary Fund (IMF) recently sent a team to re-examine Uganda’s financial system. How did they rate it after decades of civil war, mismanagement, and the 1998/1999 banking crisis?
The Financial Sector Assessment Program (FSAP) staff report concludes that Uganda’s financial system is fundamentally stable, though there is room for improvement. The system is small and underdeveloped, dominated by commercial banking. There is little consumer banking, especially outside urban centres – despite the majority of Ugandans living in rural areas. There are few nonbank institutions and financial intermediaries, and those that do exist are fairly ineffective. Reform and development of the regulatory framework, including banking supervision and anti-money laundering legislation, is still needed. Heavy reliance on foreign donor flows is a potential risk to stability; it also contributes to excess liquidity which discourages interbank lending and further development of financial markets. The lack of creditworthy domestic borrowers means that a very high proportion of assets are held abroad in loans to foreign banks.
- The closure of four troubled banks in 1998/1999 and the privatisation of Uganda Commercial Bank Limited (UCBL) has left the banking system consolidated and more resilient than before; some new competitive forces are tentatively identified.
- Loans and deposits are both highly concentrated: the top five borrowers hold 40 per cent of all loans and the top five depositors account for 21 per cent of all deposits; there is intense competition for this top tier of customers.
- Four foreign banks now dominate the sector, accounting for around three quarters of all assets, loans and deposits, with three medium-sized and eight very small banks making up the rest.
- These smaller banks pose no threat to macroeconomic stability but their frequent violations of prudential requirements impose a burden on supervisors.
- High interest rates (receipts were up to 42 per cent on treasury bills in 2002) and a substantial reduction in non-performing loans (NPLs) due to tighter loan restrictions have kept the banking sector highly profitable.
- Payment systems are antiquated and need modernising for efficiency and security: cash transactions are the norm, and the only other option is paper cheques, which are processed manually (and slowly); clear ‘failure to settle’ rules have only recently been introduced and acted upon.
Financial sector reforms are improving the investment climate, though development is hindered by a dependence on agricultural exports and donor flows, and concerns over ongoing political instability.
- Adherence to international standards on transparency is high, though in payment systems it could be improved. In areas such as the Basel Core Principles for Effective Banking Supervision it is generally good, but needs work on internal risk management systems.
- There is some vulnerability to interest rate shocks; recent reductions in the level of dollarization have reduced vulnerability to exchange rate appreciation.
- The National Social Security Fund (NSSF) needs urgent reform. Contributors have seen negative returns in real terms, and its considerable assets are concentrated in real estate and short-term deposits rather than being used for long-term development goals.
- Microfinance schemes are numerous and some are now reaching commercially viability, suggesting that the government should now pull out of direct microfinance lending. However, lending overall still does not meet the needs of the rural borrowers who constitute the bulk of the country’s economy.
