Uganda is planning to raise the official protection cover for cash depositors from Ush3 million ($805) to Ush10 million ($2,682) in a fundamental move that promises a huge relief to citizens holding fat account balances in times of a bank collapse.
But this could raise contribution costs for financial institutions in an industry haunted by previous bank failures.
Deposit protection cover is the maximum amount of money provided by the government for compensation of depositors who hold cash in closed banks or other “dead” financial institutions.
The current Ush3 million ($805) deposit protection ceiling was introduced in the early 1990s under the repealed Financial Institutions Statute of 1993.
But significant growth registered in customer numbers, deposits and service providers within the financial sector since 2004 and movements in macroeconomic indicators such as inflation have rendered it obsolete.
The new reform proposal is in the final drafting stage, with officials at the Deposit Protection Fund (DPF) making final touches on the blueprint before submitting it to the Fund’s board for discussion and approval.
Though previously a department of the Central Bank, the Deposit Protection Fund of Uganda was recently transformed into a separate institution headed by a chief executive responsible for managing assets meant to be utilised for compensation of depositors belonging to closed banks, credit institutions and micro deposit taking institutions (MDIs) regulated by the Bank of Uganda.
As as of June 2018, there were 33 contributing financial institutions enlisted with the DPF, comprising 24 commercial banks, four credit institutions and five MDIs.
The expansion of the deposit protection cover will cut losses for some big depositors affected by future bank closures.
Under the existing rules a depositor with a bank balance of say Ush5 million ($1,341) would only get Ush3 million ($805) while those holding account balances below Ush3 million would be fully compensated.
However, the enhanced deposit protection cover poses a bigger financial burden for local lenders, especially small players with modest balance sheets.
Currently, regulated financial institutions are required to contribute 0.2 per cent of the value of annual deposits to the DPF; a fee that might be raised to support a higher deposit protection cover.
Under these rules, Bank of Baroda Uganda for example, would remit Ush2.6 billion ($697,419) to the DPF against total customer deposits valued at Ush1.3 trillion ($348.7 million) as at the end of December 2018.
But industry players seem unsure of an alternative contribution rate for the deposit protection fund in light of the new proposal.
“The increase in our deposit protection cover is meant to assist us resolve future cases of small, failed banks with toxic assets that are hard to sell off to other commercial banks.
“Such situations require the Central Bank to absorb all the assets in question and pay off all the affected depositors some of whom may have huge bank balances.
“This adjustment will enable us compensate more depositors with large bank balances, said Kenneth Egesa, the director for financial stability at Uganda’s Central Bank, which oversees activities of the Deposit Protection Fund.
He added: “The change in our deposit protection cover will be contained in amendments to the BoU Act of 1991 and we expect those amendments to be approved by Parliament before the end of year.”
Raising the deposit protection cover could draw more scrutiny towards the DPF’s asset base which is lower than deposits accumulated by contributing institutions.
Whereas total assets held by the DPF grew to Ush583 billion ($156 million) by the end of June 2018, from Ush500 billion ($134 million) as at the end of June 2017, total deposits held by the banking sector rose to Ush20 trillion ($5.4 billion) from Ush17.7 trillion ($4.75 billion) over the same period, the Fund’s Annual Report for 2017/18 notes.
The total number of deposit accounts rose from nine million to 10.9 million at the end of 2017/18. Around 97 per cent of depositor accounts hold balances below or equal to the Ush3 million ($805) ceiling. But only 9.4 per cent of the total value of deposits held by the financial sector is sufficiently insured by the DPF.
Under the proposed deposit insurance structure, annual premium costs incurred by a medium sized bank will rise from around Ush1.2 billion ($321,886) per year to Ush2.4 billion ($643,771).
“This expense is fairly high for most banks and some may be forced to pass on the extra costs to clients in the form of deposit fees and loan interest charges,” said Simon Peter Kavuma, the chief finance officer at Citibank Uganda Ltd.
Phillip Sendawula, the chief financial officer at Exim Bank Uganda said that while the changes would benefit customers, banks would incur higher operational costs.
“Depositors are still protected because of generally few bank closures. However, political risk remains the biggest factor facing Uganda’s financial sector compared with core performance indicators registered by sector players every year,” he said.