Advertisement

Moody’s: Uganda banks stand to benefit from falling foreign currency-denominated loans

Tuesday February 19 2019
pesa

Stacks of one hundred dollar notes at the bank's headquarters in Seoul. In the past three years, the shilling-to-dollar exchange rate depreciated to Ush3,706 from Ush2,855, exposing banks’ unhedged clients to elevated default risk. PHOTO | AFP

By Allan Olingo

Uganda’s banks will benefit from moderating foreign-currency loan volumes, easing asset risk as exposure to shilling depreciation is expected to diminish, according to rating firm Moody’s.

Last year saw Ugandan banks’ foreign-currency loan volumes — predominantly in dollars — contract by one per cent, after declining two per cent the previous year.

Last week, the Bank of Uganda released statistics showing that the ratio of foreign-currency loans to total loans declined to 37.9 per cent in 2018 from 41.6 per cent in 2017 and 44.3 per cent in 2016.

According to Moody’s, although this contraction eroded revenues from this income stream, banks are increasing their local-currency lending, supporting their lending fee and interest incomes.

In 2018, local-currency loans increased by 17 per cent, suppressing the proportion of foreign currency loans to 37.9 per cent, the lowest in the past five years.

“Declining foreign-currency lending is credit positive for Uganda’s banks because it will support their asset quality and reduce negative pressure on some banks’ foreign-currency funding and capital adequacy,” said Peter Mushangwe, banking analyst at Moody’s.

Advertisement

“Declining foreign-currency lending is credit positive for Uganda’s banks, because it will support their asset quality and reduce negative pressure on some banks’ foreign-currency funding and capital adequacy,” Moody’s said in its latest note on Ugandan banks released on Monday.

Exchange rate

For Uganda, this is good news. In the past three years, the shilling-to-dollar exchange rate depreciated to Ush3,706 from Ush2,855, exposing banks’ unhedged clients to elevated default risk.

“We believe some foreign-currency loans were extended to borrowers whose revenue is in shillings, and a weaker shilling would require higher shilling cash flows for the borrowers to meet their foreign-currency loan repayments.

“The inability of such unhedged borrowers to increase prices when the shilling is weak erodes their operating margins and cash flow and diminishes their repayment capacity,” Mr Mushangwe said.

Although disclosure is limited, especially for smaller banks, foreign currency loans in 2017 contributed 43 per cent of total loans for Uganda’s largest bank, Stanbic Bank Uganda Ltd, and 47 per cent for DFCU Group, the second-largest.

Data from the BoU shows that defaults on foreign-currency loans have generally been higher than on local-currency loans, with a non-performing loan ratio of 4.6 per cent in June 2018, versus 4.3 per cent for local-currency loans, and 6.6 pre cent in June 2017 versus 5.9 per cent for local-currency loans.

Moody analysts say that fewer foreign-currency loans will also lessen foreign currency funding pressures for banks that depend on wholesale market funding to support their foreign currency assets.

Uganda’s large current account deficit, at about 5 per cent of GDP, limits prospects of strong dollar deposit formation in the system, and any substantial foreign currency lending would require banks to rely on more expensive and confidence-sensitive market funds.

Loans-to-deposits ration

For instance, as at the end of 2017, DFCU Group's proportion of foreign-currency loans to deposits was 109 per cent, creating a funding gap, while its local currency loans-to-deposits ratio was only 50 per cent.

“The ratio declined to below 100 per cent in 2018, removing the funding gap as the bank cut back on foreign-currency lending and continued the downward trend from 116 per cent in 2016.

“For Stanbic, the foreign currency loans-to-deposits ratio is lower at 76 per cent, but remains higher than the 50 per cent for the local currency portfolio,” Mr Mushangwe said.

Ugandan banks’ capital adequacy ratios are also expected to benefit from falling foreign currency loans because a weaker shilling inflates the banks’ risk weighted assets when the loans converts to a higher local-currency amount.
“We estimate that a 10 per cent depreciation of the shilling would reduce capital adequacy ratio by about 90 basis points for banks with small open positions. The shilling’s 12-month forward contract points to a weakening exchange rate of Ush3,981 per dollar. That said, Ugandan bank capital adequacy ratio will remain relatively solid.”

Advertisement