Why Are Uganda's Lending Rates So High? Unlocking the Secrets Behind the Banks' Profits

Friends,

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As you may have followed, President Museveni has directed his Minister to scrutinize the reasons behind the persistently high lending rates in Uganda. This has prompted a conversation on the same topic, which I have been following closely.

In this letter, I will break down a few things about what is behind the high lending rates and what the banks are not telling us.

Interest Rate Margin

Uganda boasts one of the highest interest rate margins in the region and ranks among the top 25 globally, a position shared only with a handful of countries experiencing hyperinflation like Turkey, Brazil and the likes.

Interest rate margin is the difference between the interest income that banks generate from your deposits (Money you and I are keeping on our savings accounts) and the interest rates they impose on loans to private sector.

Ugandan commercial banks who majorly rely on our deposits for Capital/liability employ our deposits, for which they compensate us with a mere average interest rate of 2% (Apart from Fixed deposit accounts, you will be lucky to get an average 2% rate on your savings account in Uganda, that is sometimes also gets eaten away by Monthly account maintenance charges), to issue loans at staggering rates exceeding 20% to the critical sectors and to individuals.

This results in a massive margin of over 18%. One would naturally assume that these banks, benefiting from affordable deposits, would reciprocate by lowering their lending rates or offering higher interest rates on deposits. Regrettably, this is not the reality in our country.

Since January 2023, the average interest rate on loans has persisted at 20%, while the average rate on deposits lingers around 2%. This discrepancy prompts us to question the wisdom of maintaining substantial deposits in banks if we are not reaping the benefits of favorable lending rates.

Comparatively, in Kenya, our neighboring nation, the interest rate margin is averaging 9.3%. Their weighted average commercial bank rate fluctuates between 13%-15% while interest income given on the savings account is around 2.5%. creating a margin of around 9.3%, what explanation does Uganda have for maintaining such a significant interest rate margin?

Risk-Free Rate

As many of you may have observed in online discussions, the focal point revolves around the risk-free rate, which represents the interest banks earn by lending to the government through Treasury bonds and bills. While this rate is not static, it warrants closer examination.

The 364-day Treasury bill currently stands at an average rate of 12%, in stark contrast to 1-year loans, which carry an interest rate averaging 20%. What justifies the substantial 8% risk premium for individuals borrowing for a year or less? To unravel this, we must scrutinize this on a period-by-period basis.

RFR Interest rate Comparison between Uganda and Kenya

Consider the loan duration versus the Risk-Free Treasury bill and Treasury Bond rates.

The annual rate on a 182-day Treasury bill stands at approximately 12%, which represents the risk-free rate for loans lasting 6 months or less. Astonishingly, invoice financing, which is one of the most expensive lending methods, carries an interest rate of close 23% for the same duration from most banks. What drives this exorbitantly high rate, with a premium of almost 11%?

The majority of borrowers commit to loans with an average term of 5 years. The 5-year Treasury bond offers a risk-free rate of 14.125%, yet commercial banks in Uganda charge as much as 23% for secured loans of the same duration.

It's essential to factor in the loan period when discussing the risk-free rate vs the lending rate to ensure an apples-to-apples comparison.

A 1-year loan should be evaluated against a 1-year Treasury bill, eliminating the risk premium for long-term borrowers. Unfortunately, Ugandan commercial banks have overlooked this principle in their pursuit of profit maximization.

In Kenya, our immediate neighbor, the interest rate margin averages 9.3%, with an average weighted commercial bank rate ranging between 13%-15%. However, their risk-free rate for bonds averages 17% per annum for both 2-year and 5-year Treasury Bonds. Friends, as you can see, the Average weighted Interest rate on borrowing in Kenya is lower than the Government Treasury bond rates.

Or, from the table above, Kenya's Treasury bonds currently yield higher interest rates than Uganda's, yet loans in Uganda remain more expensive than those in Kenya.

While Treasury bonds undoubtedly play a pivotal role in determining the ultimate lending rate and provide the baseline for the risk-free rate, this should not justify Uganda's current exorbitant lending rates.

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