On Tuesday September 20, Bank of Uganda Governor Prof Emmanuel Tumusiime-Mutebile called an impromptu meeting at his office, which excluded senior management staff, to discuss interest rate caps.

The debate had spilled over into the Ugandan market after Kenya’s decision in August, to enforce ceilings on lending and deposit rates. Mutebile’s hastily called meeting came on the heels of a breakfast meeting convened earlier in the day by industry lobby, Uganda Bankers Association, which discussed various aspects of the proposal to cap interest rates in the local market.

READ: Kenya's move to cap bank rates rattles East Africa

Lately, UBA has come under pressure from politicians, civil society activists and social media platforms to curb the high lending rates levied by its members — a market segment that accounts for around 80 per cent of total assets in Uganda’s financial sector, according to the World Bank.

So far, the UBA has resisted calls to back interest rate caps, citing risks of market distortion and widespread exclusion of ordinary borrowers from the credit market, on account of unbearable lending conditions caused by potential spikes in blackmarket activity.

“We discourage the idea of capping interest rates because it could render the cost of credit more unaffordable for most people. But we are still engaging all stakeholders on this contentious issue in order to reach a reasonable compromise,” said Wilbrod Owor, UBA executive director.

About seven executives attended Prof Tumusiime-Mutebile’s meeting, including representatives from Stanbic Bank, PricewaterhouseCoopers Uganda, the East African Development Bank, Uganda Revenue Authority and the Ministry of Finance, Planning and Economic Development.

Sources told The EastAfrican that during the meeting, the governor confessed that his institution is facing enormous pressure from politicians, civil society activists and consumer groups yearning for interest rate caps, but that he felt that the Central Bank needed to reach consensus on the matter before offering sound guidance to policy makers.

ALSO READ: Uganda eases lending rate but borrowers not out of the woods yet

Prof Mutebile raised objections to interest rate caps, arguing that they could escalate distortions in the credit market, trigger blackmarket activity and deny many borrowers access to credit, according to a source who attended the meeting.

He also raised concerns about the scale of domestic government borrowing and its impact on local interest rates, pointing out that it had somehow eroded the impact of monetary policy actions.

“While the CBR is down to 14 per cent, average yields on the 91-day Treasury bill have risen to 17 per cent because of increased borrowing pressures generated by the government. This means banks and other investors are pricing their market risk by around three per cent above the policy rate, and are more likely to adopt the T-bill rate in determining their cost of funding instead of the policy rate. Therefore, an interest rate cap that is closer to the policy rate may not be effective in the market because of poor appeal to participants,” Prof Mutebile reportedly argued.

The overall size of government borrowing has risen significantly since 2011/12 on account of aid cuts, rising infrastructure spending and recent declines in tax revenues, experts say.

Total domestic borrowing stood at roughly Ush400 billion ($116.95 million) in 2011/12 but rose steadily to Ush1.1 trillion ($321.6 million) in 2015/16. Though projected domestic borrowing was slashed to Ush612 billion ($181.5 million) for 2016/17, persistent weaknesses in revenue collections could put fresh pressures on the government’s local borrowing operations.

“The government’s domestic borrowing levels must be slashed in order to minimise pressure on local lending rates. However, the quality of competition in the banking industry needs to be addressed to ensure lenders make dynamic decisions on what products to sell, interest rates to charge and which clients to sell to,” said Dr Albert Musisi, a commissioner in the Micro Economic Policy Department of the Ministry of Finance, Planning and Economic Development.

One of the public sector representatives cited high risks posed by interest rate caps against small banks that suffer relatively huge funding costs. Hence, a spike in funding costs incurred by small banks could wipe out their profit margins under an interest capping regime, he argued. This in turn could destroy small lenders and cause massive outflows of customer deposits from small players.

“Most banks in Uganda are foreign-controlled and are here to make money and not take unnecessary risks. We ought to do things that attract capital fleeing Kenya instead of discouraging it. Government needs to spend better by signing contracts with local suppliers early and paying them on time. This in turn will boost consumer demand and tax revenue growth, and eventually reduce pressure on government borrowing activities which would help bring down interest rates,” said Robert Mpuga, head of Treasury at Bank of Africa Uganda.

Lawrence Bategeka, an economist and Member of Parliament for Hoima Municipality, said: “We have 25 banks but their operations do not reflect a true market. The industry has instead turned into a cartel under UBA and cartels need to be regulated to protect consumer interests. But what works for Kenya might not work for Uganda.”