On March 31 2016, the total value of all loans in Uganda’s commercial banking industry was Shs21.7 trillion of which Shs528 billion were non-performing loans (or “bad loans”) i.e. 2.64% of the total. Under the effective oversight of Bank of Uganda, especially its director for supervision; Justine Bagyenda (known in the industry as Uganda’s Iron Lady), non-performing loans have averaged 1.7% over the last 10 years. Although there was deterioration, it was a far cry from the 17% non-performing loans in 1996.
However, in just three months, nonperforming loans jumped three-fold to Shs1.8 trillion by June 30, 2016 representing 8.4% of total loans, an unheard of thing in nearly 20 years. What has caused this sudden deterioration?
It certainly cannot be bad borrowers and reckless lenders but something troubling about our economy generally. It is thus justified to fear the situation could worsen with bad loans reaching Shs7.0 trillion (30% of total loans) by December. This fear can be contested but for policy makers it is always safe to plan for the worst even when hoping for the best.
Most commentators have denounced the proposed bailout as a scheme to line the pockets of incompetent businesspersons, reckless banks, and “regime cronies”. But let us look at the facts for some perspective.
How to help distressed companies without removing the risk from lenders and borrowers
Of the Shs528 billion in non-performing loans, Shs126 billion (24%) is a result of government not paying domestic arrears to its suppliers. Diversion of funds to speculative businesses is only Shs2.6 billion (0.49%). See Table 1. Almost 30% of these loans went to building and construction (Shs155 billion), 29% to agriculture (Shs151 billion), 24% to trade and commerce (Shs127 billion) while only 1.4% (Shs7.4 billion) went to personal household stuff. See table 3.
So Uganda is caught in a Catch-22 situation. If it intervenes to help distressed companies or over-leveraged banks, it will create the problem of moral hazard. For example, out of Shs21.7 trillion in loans, only Shs1.8 trillion is non-performing. If the problem is system-wide, how come Shs19.9 trillion of loans are still performing?
But the threefold growth in bad loans since April means that it is highly likely many good loans could go bad. Yet helping distressed companies means rewarding failure and penalising those servicing their loans. And in helping the 8.4% who are distressed, you could be encouraging many in the 91.6% who are doing well to become lax and default in anticipation of a similar bailout.
Moral hazard is a core belief among free market ideologues and a real risk in such government interventions. Moralists seeking social equity would also reject any bailout. But ideological dogmatism and moral outrage are rarely a basis for sound public policy.
I was re-watching a documentary on the 2008 financial crash in America. Secretary to the Treasury, Hank Paulsen, made the same ideological mistake in regard to Leman Brothers, a US investment bank, and refused to bail it out with only about $50 billion and let it go bankrupt. But this caused shock on the stock market leading to the near collapse of the rest of the banking sector.
Eventually, the US government had to fork out $700billion to bailout banks infected by Leman’s collapse and $800 billion as a stimulus package to recover from the ensuing recession.