Exploring interest rate spreads and bank profitability in Uganda

Following Uganda’s financial reforms and liberalisation in the early 1990s, the banking system was characterised by high-interest rates, wide intermediation spreads, and substantial bank profitability. Over the last seven years (since mid-2011), the average lending rate in Uganda has exceeded 20%, while implicit deposit rates have averaged 13% over the same period. Compared to regional peers, Uganda’s lending rates are high in both real and nominal terms with a significantly higher interest rate spreads. This project seeks to explore and analyse the performance and cost structures of Uganda’s banking sector, with the aim of better understanding the determinants of persistently high-interest rate spreads in the sector.

High real interest rates and spreads may reflect a number of factors, including:

  • Lack of competition in the banking sector.
  • A high rate of non-performing loans (NPLs), so that the high spread is necessary to compensate for loan losses.
  • High operational costs (e.g. of branch networks).
  • High benchmark risk-free lending rate, against which bank lending rates are calibrated.
  • Regulations relating to bank lending rates (e.g. linking the prime lending rate to policy rates).
  • Other regulatory requirements, such as reserve and liquid asset ratios.

This study will investigate the drivers of high bank lending rates in Uganda using several different approaches. It will include a detailed comparison of interest rates (deposit and lending rates), spreads, bank profitability, operational cost ratios, NPLs and regulatory requirements in Uganda and elsewhere.

This project is extremely relevant for government policy.  High-interest rate spreads in the sector reflect either inefficiencies in the financial intermediation role played by the banking sector or an uncompetitive market structure. Both would stall economic growth by limiting private sector access to credit. The recent slowdown in Uganda’s economic growth has been associated with weak private sector credit growth, which has fallen from double digits levels of over 20% in 2011 to only 6.2% in December 2017.  Against this backdrop, understanding the specific cause(s) of high bank lending rates and spreads will be crucial in aiding the Bank of Uganda and the Government tailor an appropriate policy response to revive private sector credit growth and address inefficiencies in the banking sector.

Outputs