Last week Bank of Uganda communicated that the process of banks raising their minimum capitalization by the end of the year was going well.
Under the Financial Act 2022 commercial banks are supposed
to raise their minimum paid up capital to sh120b by the end of 2022, but
preferably by the end of last month. The previous minimum requirement was sh25b. By
the end of the next year the banks should have bumped up this number further to
sh150b.
"The idea behind the steep increase is recognition that it was long overdue, going by the duration between the last increments, but intended to enable banks become more resilient, able to absorb bigger shocks, ensure the stability of the sector and improve the ability for banks to do more for their clients...
In all three respects we have come a long way but still have
a long way to go.
In 1998 and 1999 when we had a spate of bank closures, the law
provided that minimum capital requirement to set up a bank was sh500,000 for a
local bank and one billion shillings for a foreign bank. The good old days!
It should not come as a surprise that of the four banks that
collapsed in the late 1990s three of them were local. If these banks had stayed
on the straight and narrow, who knows we would have more, big privately owned
local banks today.
Most of the bank closures were due to failures due to insider
lending. The owners of the bank were lending themselves and cronies money,
which they neglecting to repay the loans. Essentially the Ugandan depositor was
financing these ladies and gentlemen for free. And they may have got away with
it if they had not got too greedy and compromise the banks’ balance sheets irredeemably.
As a result of those bank collapses the central bank in 2004
raised the minimum paid up capital requirement to sh4b and raised this figure
again in 2010 to sh25b. This in addition to limits on how much one shareholder
can own of a bank and how much banks can lend to one client have meant that the
sector has been spared the upheavals of the late 1990s.
"It was inevitable that bank capitalization was going to rise eventually but imagine if one had set up their bank with sh500,000, about $500 in 1993 when the law was passed, and built up the banks’ equity with retained earnings, it would not have been a stretch to meet the subsequent capitalisation increases. That’s the problem we are always wiser in hindsight...
But when you hollowing out the bank at every turn, it will
take a small crisis and the whole operation comes falling like a pack of cards.
Hence the need for the bank owners to put in more of their money to cover reasonable
losses without jeopardizing the bank.
Covering the downside is always a good idea but to my mind
what this increase in capitalisation will do is force banks to be more
innovative and even aggressive in their provision of services. As it is now the
biggest bank’s profits far outstripped their paid up capital last year, which
means their respective owners were literally laughing all the way to the bank,
forgive the pun.
Private investors should get an adequate for their money,
but if the society in which their business operates benefit proportionately that’s
a guaranteed win-win situation.
Used to these juicy returns bank owners in London or
Johannesburg or Nairobi or New Delhi if they commit more of their funds will
expect comparable returns, say six times more to much the increase in their
contribution to the business. Bank managers will have to find ways to increase
markets share, provide more products to their clients and even seriously
consider lowering lending rates to meet the new targets. Doing all this legally
and safely.
For example, unsecured lending really took off after the 2004 increase
in minimum capital to sh4b from the earlier one billion shillings. Previously
banks were content to insist you provide collateral for any lending. AS it is
salary loans are now a major component of any banks revenues and the fastest
growing revenue stream in the industry.
It will also means banks can finance bigger projects locally
rather than syndicate them abroad. This may see banks paying more in taxes as
they keep more of the profits from such transactions.
Of course there are those who will jump up and down and complain that increased capitalization effectively shuts out local banks. Well if previous experience is anything to go by maybe that is a good thing. But it is also not true there are no local banks – Housing Finance Bank and Post Bank are there and holding their won.
But also it an indictment on our business community, that if
they feel so strongly about having a local bank, why don’t they come together raise
the required sh120b and meet other requirements and have their own thing.
Oh, but they did that in the past with Greenland Bank,
unfortunately it went under in 1999. Insider lending again the main culprit. A case
of once bitten twice shy?
