Demand for foreign currency loans (FCY) in Uganda’s banking sector has steeply grown over the past six years with total FCY loans, as a percentage of total loans, rising from 25 percent in 2008 to 44 percent last December. FCY borrowings are seen as a hedge against interest rate risks in an environment where the Uganda shilling borrowing rates remain significantly elevated. According to an Ecobank research note released mid-April, FCY lending rates have generally remained very stable over the past six years (and especially since Q1 2006), unlike the volatility witnessed in the shilling lending rates over the same period.
Shilling borrowing rates tend to edge up as election related spending dries up liquidity. ‘For instance, in the run-up to the 2011 elections, which were held in February, both the overnight interbank lending rates and 91-day treasury bill yields rose up steeply, a trend that persisted and peaked in January 2012, almost a year after the elections. In 2014, commercial banks’ weighted shilling lending rates averaged at 22 percent while FCY lending rates averaged at 9.4 percent. This compared favourably with 2013 figures, which averaged at 23.2 percent and 9.7 percent respectively. And with official campaign period set to begin in November 2015, local currency lending rates could start edging up as early as September as election related spending picks up,’ explained an Ecobank analyst.
The manufacturing sector has the highest composition of FCY loans, at 74 percent of total loans, followed closely by the agricultural and services sectors at 53 percent and 48 percent of total loans respectively. The key businesses driving the strong FCY borrowing demand in the manufacturing sector are fast-moving consumer goods manufacturers, which account for a third of total lending to the manufacturing sector. In the agricultural sector, the demand is coming from food processors and marketers. Within the services sector, demand is being driven by trade, telecommunications (telcos), property developers, commercial and residential mortgages.
With the anticipated high interest rate environment expected to prolong after the general elections, businesses, especially those with existing borrowing relationship and some notable level of FCY receivables, are expected to convert their current shilling obligations into FCY. Additionally, businesses are also expected to meet new borrowing requirements through FCY borrowings. ‘Consequently, we see the ratio of FCY loans, as percentage of total loans, rising to 50% from the current 44 percent,’ the analyst said.
To manage FX risks, banks often require that any request for FCY obligations should be matched with equivalent FCY inflows, meaning that obligors need to show evidence of FCY earnings (dollar-to-dollar matching). ‘The steep rise in FCY loans over the past six years has meant that, obligors, especially the high quality names, have had to ask for their goods and services to be paid in FCY (especially USD), or at least be linked to prevailing USD exchange rates. For instance, commercial and high end rentals in Kampala, the political and commercial capital, are increasing being quoted in USD. And with the expected rise in demand for FCY loans in 2015, we see increased dollarization across key sectors of the economy,’ the analyst explained.
Despite the fact that FCY loans-to-deposit (LDR) ratio is yet to breach the Bank of Uganda’s ceiling of 80 percent, there is are visible FCY funding constraints. First, there is a clear overall balance sheet mismatch to the extent that the ratio of FCY assets to FCY liabilities is still close to 100 percent. Second, the ratio of FCY deposits to total deposits is trailing the ratio of FCY loans to total loans (36 percent versus 42 percent in 2014). Customer deposits remain the main source of balance sheet funding, comprising 80 percent of total liabilities, on average terms. Additionally, exposure to non-resident banking institutions (in the form of FX borrowings) remains very limited and currently accounts for only 2 percent of total liabilities.
This effectively implies that banks are funding their FCY asset book locally. But with Uganda’s economy’s foreign exchange earning capacity increasingly weakening, as evidenced by the depreciation trend of the Uganda shilling against major global currencies over the past six months, banks, especially the local names, may have to consider long term funding from development financial institutions (DFIs).
However, despite the visible funding constraints, banks are seemingly able to deal with the resultant re-pricing and refinancing risks as net interest margins (NIMs) remain stable. This remains non-reflective of the generally thin-margin nature of FCY loans. Additionally, it is an indication of a general price insensitivity of FCY obligors, since, it seems, banks are able to pass-on any volatilities in the funding market. Analysts therefore expect lending rates in Uganda’s banking sector to follow the previous upward pre-election and post-election trends. To hedge against any crystallisation in interest rate risks, they expect demand for FCY lending (especially USD loans) to grow strongly in 2015 with the ratio of FCY loans, as percentage of total loans, rising to 50 percent from the current 44 percent.