Banks to face tougher capital demands as regulator calls for stricter lending standards

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Banks will have to set aside higher levels of capital in 2017, with an additional surcharge for the three domestically systemically important banks, to protect against possible shocks, Emmanuel Tumusiime-Mutebile, the governor Bank of Uganda said on Friday.

Mr Mutebile, while speaking at the Banker’s Dinner hosted by the Uganda Banker’s Association, said the central bank is raising the minimum statutory capital adequacy ratios “in order to lock in most of the higher capital that banks currently hold,” in line with Basel III reforms and as part of an agreement reached between the central banks of the East African community.

“The minimum core capital requirement will be raised to 10% of risk-weighted assets,” Mutebile said, “and banks will also be required to hold a capital conservation buffer of 2.5% of their risk-weighted assets.” The core capital requirement is currently set at 8%, while the total capital requirement is 12%. D-SIBs will be required to set aside an additional capital buffer of 1-3.5%.

Though the changes have been in the works since 2013, they seem perfectly suited to the stormy season the banking sector has weathered in the past year or so. The governor’s speech, as well as those of the banking executives who spoke at the event, sought to reassure on the resilience of the banking sector and the need for banks to streamline their operations and apply stricter lending standards.

The governor said the central bank had to take over statutory management of Crane Bank a month ago because of “non-performing loans which had risen to more than 20% of its total loan portfolio and which left it significantly undercapitalised.” As one of the D-SIBs, Bank of Uganda intends to “resolve Crane Bank in a manner which preserves its core functions and services to its customers,” Mr Mutebile said.

“So those of our people who claim that the bank has collapsed are fools,” he added. “The bank is alive and well, if not kicking.”

Mr Mutebile also said that all other commercial banks are meeting their capital adequacy requirements and hence under no immediate danger of going Crane Bank’s way. “And therefore none of them whatsoever is anywhere near being considered as a bad bank by the central bank,” Mr Mutebile said, disputing press reports that two other banks are on the regulator’s radar.

Still, the governor conceded that the banking sector has been navigating through a perilous phase during which banks have witnessed “low asset growth, with a sharp deterioration in asset quality and with declines in returns on equity.”

The key challenge was the rise in non-performing loans “which have increased from 3.8% of total loans of commercial banks in September 2015 to 7.7% in September 2016,” Mr Mutebile said. This led to higher provisions for bad loans by the bank – Shs345 billion, which is “double the amount that was set aside in the previous 12 months” – and a fall in profits as a result. He said average after-tax returns on equity for the sector fell to 14.9% in the year to September 2016 versus 17.1% in the previous corresponding period.

The governor blamed the rise in bad loans to the increase in interest rates in 2016 – “necessitated by inflationary pressures,” oversupply in the commercial real estate sector leading to low occupancy rates and lower income for owners, the failure of government to pay suppliers and contractors, the problems in South Sudan, and misuse of loans by borrowers.

To avoid a repeat of the recent troubles and “strengthen banking sector perfomance and resilience,” Mr Mutebile said banks should strengthen “their credit management to mitigate credit risk;” restrict lending in foreign currency to companies that sell their output on the global market rather than on the domestic market to limit defaults arising from foreign exchange volatilities; and carefully evaluate the “capacity of a prospective borrower to continue servicing a loan in the event of possible shocks to their revenue streams or an increase in debt servicing costs.”

He also blamed the high lending rates on the “heavy operating costs” of banks. “Annual operating costs as a percentage of average bank assets are still as high as more than 7%, more than they were ten years ago. As a percentage of their earning assets, bank operating costs average nearly 11%.” If the banks manage to bring down these costs lending rates will follow, Mr Mutebile said.