Determinants of Non Performing Loans in Uganda's Banking Sector (1980-2012)

Abstract

Inspite of the substantial progress made in terms of improving the efficiency, competitiveness and stability of Uganda’s financial system, a concern still remains in terms of the high numbers of NPLs (Non-Performing Loans) in banks’ balance sheets. In recent years especially 2011 to 2012, there has been an increase in NPLs, causing significant losses for banks and at the same time constraining the scope of bank credit to borrowers, moreover the main goal of every banking institution is to operate profitably in order to maintain stability and sustainable growth. This study was conducted to identify the determinants of NPLs in Uganda’s Banking sector using time series data for the period 1980 to 2012. The main objective of the study was to establish whether macroeconomic factors (real GDP growth rate, interest rate) and bank specific factors (Return on Asset, Credit growth and the Loan Loss Reserve rate) contribute to the occurrence of NPLs in Uganda’s banking sector. This study adopted the Error Correction Model and the estimated results indicated that all study variables were significant. In particular, NPLs increase with increase in the real interest rate, credit growth and Loan Loss Reserve rate, while they decline with increase in real GDP growth rate and return on asset. The study recommended the need for appropriate macroeconomic policies so as to achieve macroeconomic stability. In particular, the monetary policy should aim at that CBR rate that can enable commercial banks set moderate interest rates to their customers, control government borrowing that crowds out private lending as a result of high interest rates and use of prudential banking policies such as setting high bank capital adequacy ratios, which reduce the adverse impact of macro problems on banks. The study also recommended improving efficiency of bank management and making use of the Credit Reference Bureau.