New BoU checks to cut risks on loans in foreign currency

A Bank of Uganda stand at a past finance and insurance expo in Kampala. Photo/FILE  Nation Media Group

By JOINT REPORT The EastAfrican

In Summary

• The regulator also wants banks to increase capital ratios in new rules aimed at mitigating price bubbles, particularly in the real estate sector.
• The expected end of quantitative easing by the US Federal Reserve is, however, likely to deplete liquidity levels witnessed in the international markets and increase funding costs for foreign currency-based loans.

The Bank of Uganda (BoU) is set to begin enforcing short-term borrowing limits on foreign currency loans to commercial banks, as it seeks to cushion lenders against currency fluctuations.

The regulator also wants banks to increase capital ratios in new rules aimed at mitigating price bubbles, particularly in the real estate sector.

In its latest annual supervision report, the regulator disclosed that it was concerned about the rise in foreign currency loans in the past financial year to businesses and commercial banks in the country, which have mainly been funding growth in the building and construction, manufacturing and trade sectors.

The regulator said the risk of excessive credit growth could trigger asset booms in the economy and push up property prices

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“Credit risks could be exacerbated by an expansion in banks’ foreign currency loan portfolios, particularly those directed to the real estate sector because some borrowers may be adversely affected by exchange rate movements,” Prof Emmanuel Tumusiime-Mutebile noted in the supervision report for the period ended December 2012

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Banking sector executives, said that the volatility of the Ugandan currency is among reasons businesses that have foreign currency cash flows have switched to such loans.

The loans also come at lower rates, making them more attractive not just to businesses but also banks that make money by paying interest at lower rates than they lend.

“As a subsidiary of a multinational bank, our dollar funds are sourced from the parent, which offers a stronger risk guarantee. The spreads between lending rates on shilling and dollar- based loans are fairly flexible and give clients room to adjust exposure at will,” said Patrick Mweheire, the executive director at Stanbic Bank Uganda.

He said that big firms are more comfortable borrowing at less than 13 per cent against shilling loans, and any excess margin easily prompts them to seek cheaper offshore loans.

The volume of foreign currency loans rose by 56.3 per cent to $1.2 billion, as at the end of December 2012 from $773.9 million in December 2011, with the building and construction sector receiving 25.4 per cent of the total.

Foreign currency loans to the sector more than doubled to $307.7 million as at the end of December last year from $150.9 million recorded at the end of December the previous year.

“The significant exposure to the building and construction sector is a potential source of systemic risk given the long-term nature of the loans, should the sector’s performance decline,” said BoU in the supervision report.

Rising deposits

BoU said that foreign currency loans as a ratio of foreign currency deposits increased to 87 per cent last year from 67.9 per cent the previous year, which is above the 80 per cent regulatory guideline. Funding of foreign currency loans was mainly from deposits