Journal of Financial Regulation and Compliance

The 1998-99 banking crisis in Uganda: What was the role of the new capital requirements?
Paul Mpuga
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 Journal of Financial Regulation and Compliance
Downloaded by University of Exeter At 05:18 04 September 2016 (PT)
Journal of Financial Regulation
and Compliance, Vol. 10, No. 3,
2002, pp. 224–242
# Henry Stewart Publications,
1358–1988
Page 224
Volume 10 Number 3
The 1998–99 banking crisis in Uganda:
What was the role of the new
capital requirements?
Paul Mpuga
Received (in revised form): 18th March, 2002
Johannes Kepler University, Institute of Economics, Linz, Austria;
tel: +43 732 2457 720; fax: +43 732 2457 39; e-mail: pmpuga@hotmail.com
Paul Mpuga is a lecturer at Makerere Uni-
versity, Kampala, and is currently working
on a PhD research project, ‘Estimation of
demand for rural financial services in
Uganda’ at Johannes Kepler University,
Linz, Austria.
He obtained his Bachelor of Science
(Honours) and Master of Arts degrees in
Economics at Makerere University, Kam-
pala, in 1992 and 1996 respectively. He
has experience as a researcher in eco-
nomics and economics-related fields and
has worked for the Central Bank of
Uganda, as a researcher and the Bank of
Baroda (U) Limited, as a banking officer.
His area of specialisation is develop-
ment economics and he has a particular
interest in banking, demand analysis, rural
development and rural finance — the
working and implications of microfinance
institutions.
ABSTRACT
Up to the early 1990s, Uganda’s financial
structure was characterised by government con-
trols and instability, leading to financial repres-
sion and lack of development in the sector. The
sector was, as a consequence, dominated by
commercial banks, which are mainly concen-
trated in urban areas. Financial intermediation
was restricted to the mobilisation of short-term
savings and advancing credit to low-risk busi-
nesses with quick returns.
In 1993, The Bank of Uganda Statute and
The Financial Institutions Statute were passed
by Parliament, requiring, among other things,
commercial banks operating in Uganda to have
a minimum paid up capital of Uganda shillings
(Ushs) 500,000 (for the locally-owned banks)
and Ushs 1bn (for the foreign-owned banks).
The new capital requirements were made effec-
tive from the end of December, 1996. Between
1998 and 1999, however, four commercial
banks (three of them locally owned), were
closed because of insolvency originating from a
number of causes. It is not clear whether the
new capital requirements played a part in set-
ting off or precipitating the crisis.
The results of this study show that whereas
there was impressive improvement for the bank-
ing system as a whole, it seems that these new
guidelines had a different impact on foreign-
owned and locally-owned commercial banks.
Performance of the foreign banks remained quite
steady or even rapidly improved while the local
banks suffered massive declines in their profit-
ability and accumulated more non-performing
loans.
INTRODUCTION
Up to the early 1990s, Uganda’s financial
structure was characterised by government

controls and instability, leading to financial
repression and lack of development in the
sector. The sector was therefore dominated
by commercial banks, which are mainly
concentrated in urban areas. Financial
intermediation was restricted to mobilisa-
tion of short-term savings and advancing
credit to low-risk businesses (mainly in the
import-export trade) with quick returns.
Over the years, however, the sector has
evolved from the era of total control by
government to a more liberal one.
Whereas between the 1970s and 1980s,
successive governments made sure that the
central bank was under the full control of
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government, with virtually no regulatory
powers over the money supply in the
economy, today the central bank has full
autonomy over the formulation and imple-
mentation of monetary policy. In that
period, excessive government fiscal deficits
were met by government borrowing from
the central bank, resulting in chronic infla-
tion. The financial sector also faced distres-
sing government controls, which greatly
compromised its development. To date,
government has eased most of the controls
over the financial sector, only retaining
those necessary for prudential purposes.
Nonetheless, Uganda’s financial sector is
Table 1 Ratios of financial savings to M2 and financial savings to GDP in Uganda 1991/92–1998/993
Period Financial savings/M2
Percent
1991/92 18.9
1992/93 29.5
1993/94 27.3
1994/95 25.5
1995/96 29.2
1996/97 21.1
1997/98 32.7
1998/99 34.3
Average for the
period 29.3
Mpuga
still one of the smallest and least developed
in sub-Saharan Africa.1 The sector is very
small in terms of both value and volume of
transactions. It is equally narrow in terms
of type of transactions, there are only a
few monetary instruments — cash, and to
a limited extent, cheques and bank drafts
are used. As measured by the ratio of
financial savings to money supply (M2),
financial deepening in Uganda is still low
at an average of about 29.3 per cent.
Furthermore, the ratio of financial savings
to gross domestic product (GDP) is very
low at about 2.9 per cent (Table 1). This
compares very poorly with the average for
neighbouring Kenya of about 13 per cent
and that for the low-income countries
(excluding China and India) of about 20
per cent.2 The growth of these ratios is
equally very low. As a consequence of the
low domestic savings rate, the country
relies heavily on foreign resources and
investors for capital accumulation.
This situation can in part be explained
by the continuing decline of the formal
financial sector in the country over the
years.4 Whereas the number of commercial
bank branches in Uganda was 270 in 1970,
the total branch network in 2002 is less
than 155 branches and 45 agencies, despite
Financial savings/GDP
Change Percent Change
– 1.6 –
10.6 2.4 0.8
–2.2 2.7 0.3
–1.8 2.6 –0.1
3.7 3.1 0.5
–8.1 3.7 0.6
11.6 3.2 –0.5
1.6 4.1 0.9
2.9
Page 225
 The 1998–99 banking crisis in Uganda
the increase in the number of banks from
nine to 17. In addition, there has been a
rapid deterioration in the ratio of custo-
mers per branch from 34,000 in 1972 to
80,000 in the 1980s.5 Following the closure
of several banks and a number of Uganda
Commercial Bank (UCB) branches, the
ratio worsened to 100,000 people in 19966
and to 164,000 people per bank in 1999.7
The deterioration and instability in the
rest of the economy, including macroeco-
nomic and political instability, poor super-
vision and poor portfolio management
further exacerbated the problems of the
financial sector. In addition, there was a lot
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of government interference in the opera-
tions of the financial institutions, particu-
larly in lending because of its control of
the major banking institutions. Govern-
ment had 100 per cent ownership of the
largest commercial bank in the country,
Uganda Commercial Bank Limited
(UCBL), and minority shares in several
other private commercial banks such as
Bank of Baroda, Stanbic Bank and Bar-
clays Bank.
During the 1980s and the 1990s, the
financial sector witnessed a number of
changes and crises. Several new banks have
been established while others have been
closed. The UCBL opened several new
branches at the close of the 1980s, many of
which were later closed because of accu-
mulated losses.
FINANCIAL SECTOR REFORMS IN
UGANDA
The root cause of commercial banks’ pro-
blems lies in their desire to increase profits
by rapidly expanding their asset portfolio
(by extending loans) for which there are
no adequate provisions in the form of a
capital buffer.8 Therefore, the inadequacy
of minimum capital standards in account-
ing for the risk in banks’ asset portfolio
could be one of the major factors leading
to bank failures.
Page 226
While the primary intent of the new
banking guidelines in Uganda was to
increase bank solvency and capital ade-
quacy, no empirical study has been con-
ducted to establish this. The impact of
these new measures on the performance
and risk levels of commercial banks in
Uganda has not been empirically estab-
lished. It was expected that banks would
increase their equity financing and/or shift
their portfolio towards lower risk assets in
an effort to meet the new requirements.
The increase in equity financing implies
that the owners would demand improved
management in order to safeguard their
interests.
On the surface, the consequences of the
new standards on commercial banks in
Uganda seem to be unclear. While the for-
eign-owned banks seem to have remained
stable, the indigenous banks have experi-
enced a lot of turbulence in the wake of
the reforms. In the period 1998–1999, four
banks (International Credit Bank Ltd.,
Greenland Bank Ltd., The Co-operative
Bank Ltd. and Trust Bank Ltd.) were
closed. The first three were indigenous
banks, while only Trust Bank was foreign
owned.
Various schools of thought have
advanced a number of reasons, including
failure to meet the minimum capital
requirements, insider lending, corruption
and mismanagement as the cause(s) for the
closures. None of these, however, is based
on any scientific study or findings. This
paper tries to establish empirically the
impact of the new capital requirements on
performance and risk level of commercial
banks in Uganda and also to compare the
indigenous and foreign banks.
Importance of the financial sector in the
economy
The importance of a well-functioning
financial system in the development of a
country cannot be overemphasised. The

financial sector, including commercial
banks and other financial institutions,
mobilises savings and channels these savings
into investment by extending loans and
advances to the investing public. There-
fore, in order to promote the development
and growth of a healthy financial sector,
there is a need for guidelines and a strong
regulatory body to ensure that commercial
banks and other financial institutions are
well managed and follow the prescribed
guidelines in their day-to-day activities.
This is important because commercial
banks are able to mobilise deposits because
of the confidence the public holds in them
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and the fact that the failure of commercial
banks can cause considerable damage to the
entire economy.
In the early 1980s, a number of banks
and other financial institutions in the Orga-
nisation of Economic Co-operation and
Development (OECD) failed, destabilising
the financial systems in their respective
countries.9 The crises of the late 1990s and
early 2000s in the East Asian countries have
been attributed largely to the failure of
major banks in these countries. This has
required governments, through their cen-
tral banks, to impose stringent conditions
on commercial banks in order to protect
the interests of depositors and the econo-
mies in general. In the last two decades,
several governments, in Africa and else-
where, have been implementing a number
of reforms in their financial sectors, with
varying consequences.
Various authors have suggested a
number of explanations for the poor per-
formance and/or failure of commercial
banks, ranging from poor liquidity provi-
sions, weak management and the economic
environment to political influence. Some
commercial banks mistake central bank
lending to them as a cure for their pro-
blems — this leads to instability. Deposit
insurance schemes can also lead to the poor
performance of commercial banks where
Mpuga
both managers and customers stop worry-
ing about the possibility of bank failure
because of the perceived security from the
insurance scheme.10 This perceived security
can then lead commercial banks to reduce
their capital since the major reason for
keeping large capital no longer applies. For
example, the capital holdings of US banks
were reduced to less than half in ten years
after the introduction of the deposit insur-
ance scheme.11
The underlying institutional setting and
the economic environment in which the
banking industry operates can be critical to
the success or failure of the banks. For
example, rapid inflation or adverse terms
of trade shocks can quickly erode the capi-
tal base of a commercial bank leading to its
failure. The size of the fiscal deficit and
sudden capital outflows are some of the
other factors that can increase the probabil-
ity of a banking crisis.
As long as the institutional setting in
which they operate does not expose com-
mercial banks to risky undertakings, they
will invest in those assets that promise the
highest return and lower risk. In these cir-
cumstances, commercial banks invest in a
mix of instruments so as to maximise their
earnings without compromising their stabi-
lity.
Financial sector reforms in Uganda
Since 1987, the Ugandan government has
embarked on a wide range of reforms,
including financial sector reforms, in order
to promote sustainable economic growth.
The centrepiece for financial sector reform,
which is part of the overall Economic
Reform Programme (ERP) in Uganda,
was to rationalise operations in this sector
towards improved liquidity management
and economic progress. The reforms in the
financial sector are geared towards improv-
ing the mobilisation of savings, ensuring
efficient allocation of resources and improv-
ing the effectiveness of monetary policy.
Page 227
 The 1998–99 banking crisis in Uganda
As such, reforms in the sector have taken
the form of interest rate liberalisation,
removal of credit controls, reduction of
direct government participation in the
financial sector and strengthening of the
supervisory framework. In addition, the
exchange rate has been liberalised and for-
eign exchange bureaux legalised. The pro-
gramme has been implemented in phases to
ensure a progressive and cautious transition
from a regulated to a market-based finan-
cial system, so as to avoid huge jumps in
interest rates and instability in the financial
sector.
In the absence of short-term financial
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and money markets and with poor bank
supervision, the transition from adminis-
tered to flexible interest rates needs to
follow a very gradual process.12 A hurried
approach can easily result in a situation
where interest rates rise out of hand as
banks rush to raise their lending rates to
cover their high intermediation costs. The
consequence can be increased failure to
repay loans and instability in the financial
sector. This was clearly the case in the
Latin American countries (Chile, Argentina
and Uruguay), the Philippines, Malaysia
and Turkey in the 1980s where interest
rates were liberalised very quickly.13
Authorities in Uganda decided to take it
slowly by liberalising interest rates through
auction of T-bills, introducing the new
minimum capital requirements in a space
of about two years.
The Ugandan government embarked on
an Economic Recovery Programme (ERP)
in May, 1987 with a currency reform
under which the total money supply in the
economy was debased by a factor of 100,
as the major component of the pro-
gramme. The other components were a
conversion tax of 30 per cent imposed on
all monetary assets and the devaluation of
the Uganda shilling (Ushs) from Ushs 15
for US $1 to Ushs 60 for US $1. In April,
1992 government started the auctioning of
Page 228
Treasury bills to lay the foundation for
market-determined interest rates and as a
means of borrowing from the public, in
addition to regulating money supply in the
economy.
Government embarked on the full-scale
financial sector reforms with the imple-
mentation of the Financial Sector Reform
Programme (FSRP) in 1993, which
received financial support from the Inter-
national Development Agency (IDA). The
FSRP has been implemented to cover the
areas described below.
General policy framework
Government has taken steps to improve the
effectiveness of monetary policy and to
support more strongly the continuing sta-
bilisation and macroeconomic adjustment
programmes. Efforts have also been made
to increase deposit mobilisation and effi-
ciency of credit allocation through rationa-
lising the interest rate structure and main-
taining positive real interest rates by main-
taining low inflation rates. Further,
competition and efficiency in the banking
sector and greater private sector participa-
tion in the financial system have been
encouraged by reducing (to the minimum
for prudential control) all the existing
entry and exit barriers. Efforts have also
been made to eliminate government’s
equity participation in private banks and
moves have been made to invite private
sector participation in UCBL. All this was
meant to enhance the role of the interest
rate in optimal allocation of financial
resources.
Interest rate policy
Deregulation of interest rate controls
started early in 1992 when government
embarked on the auctioning of Treasury
bills as a basis for market-determined inter-
est rates. Between 1992 and 1993 the four-
weeks moving average of the Treasury bill
yield rate was used as a benchmark to set

the minimum and maximum deposit and
lending rates for commercial banks. Inter-
est rates were partially liberalised in Sep-
tember, 1993 by allowing commercial
banks freedom to adjust their own interest
rates for both deposits and lending but
being guided by the monthly Treasury bill
discount rate as reference rate. In June,
1994 commercial banks were given full
autonomy to set interest rates according to
market forces.
Policies to encourage competition and
efficiency
The government was supposed to reduce
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its equity participation in banks and open
up UCBL to private participation. The
UCBL Non-Performing Assets Recovery
Trust (NPART) was set up to recover all
the non-performing loans owed to the
bank. In December, 1992 the government
offered its equity in private banks for the
sale of shares to their original owners.
The accounting and cheque clearing
system have been improved with the intro-
duction of a clearing account held by each
commercial bank at the Central Bank and
now clearing is done twice a day — at
midday and at 3.00 pm. It takes only three
days to clear cheques within the Kampala
area and efforts are in place to reduce this
further to two days and to improve the
cheque clearing system upcountry.
The legal and regulatory framework
Government has undertaken to review and
enact the financial legislation and improve
the legal and regulatory framework for
banks and other financial institutions. This
was intended to strengthen the role of the
central bank as the primary monetary and
supervisory authority and to strengthen its
research capability and, on the whole, to
give the Bank of Uganda independence.
Government was also supposed to develop
a specific restructuring programme for
UCB and the Co-operative Bank and pre-
Mpuga
pare a plan for the restructuring of the
Uganda Development Bank.
To this end the Bank of Uganda Act
was revised in 1993. The new Bank of
Uganda Statute 1993 and Financial Institu-
tions Statute 1993 give autonomy and full
authority to the Bank of Uganda in mone-
tary policy management, supervision and
control of all financial institutions in the
country.14 The objectives of the two sta-
tutes were to:
— enhance the Bank of Uganda’s power
to protect depositors’ funds held in
commercial banks
— give authority to the Bank of Uganda
to issue and enforce regulations over
commercial banks and implement key
prudential and supervisory guidelines
— set up, in line with international stan-
dards, a legal framework for Uganda’s
banking practices with respect to capital
adequacy, legal lending limits, licensing
of banks and quality of management.
These reforms have been undertaken with
the broad aim of improving the manage-
ment of monetary policy through
improved monetary policy formulation
and implementation, liquidity management
and control, development of new mone-
tary instruments and money markets, and
opening up of the financial sector to
increased private sector participation.
In 1993, the Bank of Uganda recom-
mended the adoption of new minimum
capital requirements for all commercial
banks operating in the country at the time
or new banks wishing to be licensed for
the first time. The purpose was to make
bank capital requirements sensitive to the
risk in a bank’s portfolio of assets and off-
balance sheet activities. This was in order
to avoid excessive proliferation of small
and risky banks. The minimum capital
requirements for both new and existing
banks were increased from Ushs 15m to
Page 229
 The 1998–99 banking crisis in Uganda
Ushs 500m for indigenous banks and to
Ushs 1bn for the foreign-owned banks.15
This was to be effected by the end of 1996.
Plans are now under way to increase the
minimum capital requirements of commer-
cial banks to Ushs 3bn.
Furthermore, the new standards require
that different proportions of minimum
capital be held against different categories
of assets according to perceived risks. This,
it was hoped, would help reduce banks’
incentives to lend to risky ventures that
could result in their insolvency. In addi-
tion, the new standards require that all
loans not serviced for at least six months or
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more be categorised as non-performing
assets or declared as losses to the bank.
There is concern that risk-based capital
requirements may in fact undermine the
relationship between changes in portfolio
risk and changes in required capital.16
Whereas the new capital requirements
account primarily for credit risk and coun-
try transfer risk, they do not explicitly take
into account changes in capital originating
from interest rate, foreign exchange risks
specific concentration of assets of a com-
mercial bank.
In addition, if the risk weights used do not
accurately reflect the true risk of an asset
then the banks may increase their portfolio
risk by arbitraging both between and within
risk categories. If the variance-co-variance
relationship between assets is ignored, then
the new standards may not accurately differ-
entiate between changes in asset composi-
tion that hedge portfolio risk and those that
increase portfolio risk. Again and more
important, the new capital requirements do
not limit the risk in a bank’s portfolio but
rather determine how much capital a bank
must hold, conditional upon the estimated
level of credit risk in its portfolio.
The new capital and other standards may
affect indigenous and foreign banks differ-
ently because of the rather different sets of
conditions under which they operate. Indi-
Page 230
genous banks in many less developed coun-
tries (LDCs) operate with a quasi-profit
maximising objective.17 Unlike the foreign
banks, indigenous banks, particularly the
government-sponsored banks such as the
UCBL and the former Co-operative Bank
Ltd., have a social welfare maximis- ing
objective and not a profit maximising
objective.
Right from the beginning, these banks
were established partly to fill the void in
credit left by the conservative and often
discriminating foreign banks, by providing
medium and long-term credit to pre-
viously deprived sectors and the African
population. These banks therefore adopt
risky loan portfolios, which are dominated
by mortgages to the lower and middle-
income groups and loans to small busi-
nesses. These banks also exhibit elements of
inefficient management, including poor
credit risk evaluation systems and the ten-
dency to pursue rent-seeking strategies.
Such strategies include ‘insider’ lending —
a concoction of investment schemes invol-
ving relatives, close associates/sister compa-
nies and members of the political elite.
‘False’ accounting and selective disclosure
of information and manipulation of man-
agement systems may also be used to
defraud commercial banks in Uganda.
EVIDENCE ON THE PERFORMANCE OF
COMMERCIAL BANKS IN UGANDA
AFTER INTRODUCTION OF THE NEW
CAPITAL REQUIREMENTS
Methodology and sources of data
This section presents the sources of data,
methods of data collection and data analy-
sis. The computer program, ‘Econometric
views’, was used in data analysis to exam-
ine the impact of the new capital require-
ments on indigenous and foreign banks and
the nature of the relationship between bank
risk and capital level.

Sources of data and methods of
collection
Data are collected on each of the variables
in the model from the monthly and quar-
terly reports (the BS100) of commercial
banks to the Bank of Uganda. Data are
also collected from the Bank of Uganda
Quarterly and Annual reports. Data for the
period June, 1993 to December, 1999 have
been collected and analysed. Data on the
following variables were collected: depos-
its, assets, advances, non-performing
advances, liquid assets, paid-up capital, core
capital and total capital. Other information
collected included provision for bad loans,
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risk-weighted assets and net profits.
The rest of this section presents a discus-
sion of the general performance of com-
mercial banks from June, 1993 to June,
1999 as a group and then a breakdown of
the performance of foreign-owned and
local commercial banks. In the discussion
on the general performance of banks,
descriptive statistics, including totals,
averages and standard deviations, for a
number of variables for all banks as a
group are considered.
The model
The method employed is based on earlier
works conducted in the USA18 and the
Eastern Caribbean Central Bank area.19 To
model the simultaneous relationship
between bank capital, portfolio risk and
the risk-based capital standards, the two-
stage least squares (2SLS) approach is
employed. The 2SLS procedure recognises
the endogeneity of both bank capital and
risk levels in a simultaneous equation fra-
mework and, unlike the ordinary least
squares estimation, it provides consistent
estimates of the parameters.20
A partial adjustment framework is
employed to show that observed changes
in bank capital and risk levels are decom-
posed into two components, a discretion-
ary change and factors exogenous to banks
Mpuga
such as changes in income or loan values.
The framework allows for technical and
institutional rigidities and inertia, which
may occur during the period after the reg-
ulatory change. The model is developed as
follows:
DCAPjt = DdCAPjt + Ejt (1)
DRISKjt = DdRISKjt + St (2)
Where, DCAPjt, and DRISKjt are the
observed changes in capital and risk levels
for bank j in period t. DdCAPjt and
DdRISKjt represent the discretionary
adjustments in capital and risk. Ejt and Sjt
are the exogenously determined factors
affecting a bank’s capital and risk level. In
any period, however, banks may not be
able to adjust their capital and risk levels
instantaneously, therefore a partial adjust-
ment framework is employed to the discre-
tionary changes in capital and risk such
that:
DdCAPjt = a(CAP*jt – CAPjt–1) (3)
DdRISKjt = b(RISK*jt – RISKjt–1) (4)
Where, CAP*jt and RISK*jt are bank j’s
target capital and risk level respectively. In
the partial adjustments framework, the dis-
cretionary changes in capital and risk are
proportional to the difference between
target level and actual level in the initial
period, t-1. Substituting equations (3) and
(4) into (1) and (2), gives
DCAPjt=a(CAP*jt – CAPjt–1)+Ejt (5)
DRISKjt = b(RISK*jt – RISKjt–1)+Sjt
(6)
Equations (5) and (6) indicate that changes
in capital and risk in period t are a function
of the target capital and risk levels plus
exogenous factors. The target levels of
Page 231
 The 1998–99 banking crisis in Uganda
capital and risk are dependent on observa-
ble variables such as changes in regulatory
capital requirements, level of non-perform-
ing loans, total bank assets, return on assets
and the level of bank liabilities. The model,
which explains changes in capital and risk,
leads to two simultaneous equations:
DCAPjt = d0 + d1LogSIZEjt +
d2LOANSjt +d3DRISKjt + d4INCjt
+d5DEPjt + d6CAPjt–1 + d7DPROVjt
+d8D1 + mjt (7)
DRISKjt = l0+ l1LOANSjt
+ l2ACAPjt + l3DEPjt + l4RISKjt
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+ l5PROVjt + l6BANK + njt (8)
Where changes in risk (DRISKjt) and capi-
tal (DCAPjt) are included to recognise the
possible simultaneous relationship between
changes in capital and changes in risk. The
rest of the terms are defined as follows:
— LogSIZE = the natural logarithm of
the bank’s total assets. This is important
because of its relationship to bank
ownership characteristics and access to
equity capital. Bank access to equity
capital may reflect the relative impor-
tance of bankruptcy cost avoidance or
managerial risk aversion
— LOANS = the ratio of loans to assets.
This is important because of its rela-
tionship to diversification and the
nature of the investment opportunity
set. It measures the impact of loans in
the asset portfolio on capital and risk
— INC = the return on assets in the last
period, which is used as a proxy for
profitability in the period. It captures
both endogenous and exogenous influ-
ences on profitability
— DEP = deposit to asset ratio. This is
used to measure the impact of changes
in deposits on capital and risk
— RISK = the composite measure of
asset portfolio risk. This is defined as
Page 232
the ratio of risk weighted assets to total
assets. It is based on the risk-based
capital standards and it reflects the risk
inherent in the composition of the asset
portfolio
— DPROV = change in the ratio of the
specific provisions for loan losses to
total loans in the period of reforms. It
is included to determine the impact of
the new provision guidelines on bank
capital risk levels
— BANK is a dummy for the category of
the bank, 1 representing locally-owned
banks and 0 the foreign-owned banks
— mjt and njt are disturbance terms.
General commercial bank performance
The descriptive statistics show impressive
performance of commercial banks in
Uganda when treated as a group. The vari-
ables on total assets, deposits and advances
show that the commercial banking sector
in Uganda has experienced steady growth.
For example, total industry assets, total
deposits and total advance grew from
about Ushs 500bn, Ushs 200bn, and Ushs
100bn to around Ushs 1,300bn, Ushs
1,000bn and Ushs 400bn respectively. The
total of non-performing assets for the
industry as a whole remained fairly stable
ranging between Ushs 50bn and Ushs
l70bn. There seems to be no break in the
period December, 1996 when the new
capital requirements became effective,
therefore the new capital requirements
seem to have had little impact on the
growth of major commercial bank vari-
ables for the industry as a whole.
Considering the net profits and total
capital for the industry as a whole, the
impact of the new capital requirements
seem to have been positive. For the period
from June, 1993 to March, 1997 net profits
for the entire industry were negative and
from September, 1994 to June, 1996 total
capital was negative. The situation changed
after this period, however, and both net

profits and total capital became positive.
This is an indicator that the new capital
requirements and the tightening of the
bank regulations had a positive impact on
the banking industry in Uganda as a
whole. The failure of individual banks
seems to have been rooted more in internal
problems than the introduction of the new
capital and regulatory requirements.
In fact, after the closure of three insol-
vent banks in the 1998-99 financial year,
the sector seems to have become much
stronger. This is realised in terms of the
significant increase in both total deposits
and total assets of the entire banking
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system after the crisis. For example, total
bank deposits increased from Ushs 669.9bn
in December, 1998 to Ushs 1,004bn in
March, 2000, an increase of 33.3 per cent
while total bank assets increased by 23.4
per cent from Ushs 1,160bn to Ushs
1,515bn.
Commercial bank performance by
category
Whereas the foreign-owned commercial
banks registered substantial increments in
their capital, deposits, assets and net profits,
the local banks seem to have suffered mas-
sive stagnation or very little improvement.
The total capital for foreign banks as a
group steadily increased throughout the
period while that for local banks remained
negative for much of the period. Total
capital for the local banks was positive
after 1996 but again fell into negative
during 1999. Total deposits for the foreign
banks, which stood at about Ushs 65.8bn
in June, 1993 were increasing throughout
the period to about Ushs 660bn by Decem-
ber, 1999. On the other hand, total deposits
for local banks increased at a much lower
pace from about Ushs 151bn in June, 1993
to about Ushs 352bn by the end of Decem-
ber, 1999. Total assets for foreign banks
increased from about Ushs 136bn in June,
1993 to about Ushs 838bn by the end of
Mpuga
1999. On the other hand, the total assets
for local banks increased from around Ushs
336bn in June, 1993 to a high of Ushs
600bn in December, 1998, but this had
declined to about Ushs 444bn by Decem-
ber, 1999. A graphical presentation of bank
performance is included in Appendix 1,
Figures 1–10.
Whereas the foreign-owned banks
posted positive net profits for much of the
period, the profitability measure for the
local banks remained largely negative, with
very little improvement after 1997. Foreign
banks had much more advances than the
local banks, and in both cases they were
increasing for most of the whole period.
The local banks, however, experienced a
decline in total advances after 1999, possi-
bly because of the closure of some of the
problem banks, most of which were local.
In terms of non-performing assets, the local
banks had much more non-performing
assets than the foreign banks for the whole
period. This situation could have resulted
in the exposure of the local commercial
banks to risk and vulnerability that may
have led to their failure in 1999.
The correlation coefficients between risk-
weighted assets, deposits, core capital, total
capital and advances are largely negative
for local banks as opposed to the positive
correlations for the foreign-owned banks
(Table 2). This is a sign that the state of the
locally-owned commercial banks was not
healthy. For example, the negative correla-
tion between net profits and advances sug-
gests that while advances were on the
increase, net profits were declining and
therefore wiping out the capital of this sec-
tion of the industry.
Regression results
The regression results support the hypoth-
esis that the change in the capital require-
ments affected the locally-owned
commercial banks differently to the foreign-
owned banks. The variable BANK is signif-
Page 233
 The 1998–99 banking crisis in Uganda

Table 2 Correlation coefficients between major variables by bank category

Bank = 1: Foreign-owned, obs 248 Bank = 2: Local, obs = 240

rwa dep cc np adv tc npa rwa dep cc np adv tc npa

rwa 1.00 1.00
dep 0.86 1.00 0.77 1.00
cc 0.78 0.79 1.00 –0.80 –0.59 1.00
np 0.73 0.75 0.78 1.00 –0.75 –0.51 0.86 1.00
adv 0.91 0.95 0.81 0.75 1.00 0.91 0.83 –0.86 –0.74 1.00
tc 0.82 0.80 0.95 0.79 0.83 1.00 –0.60 –0.46 0.93 0.74 –0.75 1.00
npa 0.40 0.40 0.36 0.28 0.47 0.44 1.00 0.88 0.79 –0.93 –0.80 0.94 –0.81 1.00

rwa = risk-weighted assets, dep = deposits, cc = core capital, np = net profits, adv = advances, tc = total capital,
npa = non-performing assets
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icant at the 5 per cent level and is negative,
implying that being locally owned affected
the changes in capital ratio negatively. This
is true in the regression without a constant.
In the regression with a constant, the vari-
able BANK is not significant.
Other weaknesses in the local commer-
cial banks came from the rapid expansion
and extension of loans, the coefficients of
which are significant in the regression of
change in capital ratios against the log
of loans, profits, deposits and bank cate-

Table 3 Regression results: change in bank capital, with a constant

Variable Coefficient Std. Error t-Statistic Prob.

C –0.949531 0.290016 –3.274068 0.0011

LOGSIZE 0.130826 0.060018 2.179770 0.0298
LOGLOANS –0.224121 0.060540 –3.702048 0.0002
DRISK 0.045076 0.022724 1.983623 0.0479
INC –0.143318 0.196313 –0.730048 0.4657
LOGDEP –0.358498 0.096687 –3.707829 0.0002
CAP 0.466384 0.232692 2.004301 0.0456
DPROV 0.000218 0.000933 0.233844 0.8152
BANK –0.069580 0.062061 –1.121153 0.2628
R-squared 0.280437 Mean dependent var 0.047767
Adjusted R-squared 0.268419 S.D. dependent var 0.767878
S.E. of regression 0.656785 Sum squared resid 206.6248
F-statistic 23.33520 Durbin-Watson stat 2.710230
Prob (F-statistic) 0.000000

Dependent Variable: DCAP

Method: Two-Stage Least Squares
Sample (adjusted): 1,488
Included observations: 488 after adjusting endpoints
Instrument list: LOGSIZE LOGLOANS DRISK INC LOGDEP CAP DPROV BANK

Page 234
 Mpuga

Table 4 Regression results: change in capital, without a constant

Variable Coefficient Std. Error t-Statistic Prob.

LOGSIZE –0.058209 0.016555 –3.516186 0.0005

LOGLOANS –0.199607 0.060680 –3.289502 0.0011
DRISK 0.027852 0.060680 1.247342 0.2129
INC 0.233304 0.160683 1.451949 0.1472
LOGDEP –0.324375 0.097092 –3.340914 0.0009
CAP 0.850932 0.202897 4.193909 0.0000
DPROV 0.000114 0.000942 0.120676 0.9040
BANK –0.133705 0.059483 –2.247791 0.0250
R-squared 0.264334 Mean dependent var 0.047767
Adjusted R-squared 0.253605 S.D. dependent var 0.767878
S.E. of regression 0.663402 Sum squared resid 211.2489
Downloaded by University of Exeter At 05:18 04 September 2016 (PT)

F-statistic 24.63853 Durbin-Watson stat 2.789866

Prob (F-statistic) 0.000000

Dependent Variable: DCAP

Method: Two-Stage Least Squares
Sample (adjusted): 1,488
Included observations: 488 after adjusting endpoints
Instrument list: LOGSIZE LOGLOANS DRISK INC LOGDEP CAP DPROV BANK

Table 4 Regression results: commercial bank exposure to risk, with a consent

Variable Coefficient Std. Error t-Statistic Prob.

C –0.596804 0.085148 –7.008992 0.0000

LOANS –0.605448 0.294808 –2.053704 0.0405
DCAP1 1.04E-06 2.61E-06 0.397675 0.6910
DEP 0.349294 0.167701 2.082835 0.0378
RISK 0.936240 0.053144 17.61690 0.0000
DPROV –0.000237 0.001514 –0.156369 0.8758
BANK –0.140676 0.097634 –1.440849 0.1503
R-squared 0.463016 Mean dependent var 0.042402
Adjusted R-squared 0.456318 S.D. dependent var 1.449894
S.E. of regression 1.069076 Sum squared resid 549.7464
F-statistic 69.12405 Durbin-Watson stat 1.864724
Prob (F-statistic) 0.000000

Dependent Variable: DRISK

Method: Two-Stage Least Squares
Sample (adjusted): 1,488
Included observations: 488 after adjusting endpoints
Instrument list: LOANS DCAP1 DEP RISK DPROV BANK

Page 235
 The 1998–99 banking crisis in Uganda

Table 6 Regression results: commercial bank exposure to risk, without a constant

Variable Coefficient Std. Error t-Statistic Prob.

LOANS –1.066545 0.297664 –3.583049 0.0004

DCAPRAT1 0.188243 0.073193 2.571882 0.0104
DEP 0.291493 0.184471 1.580153 0.1147
RISK 0.876900 0.054693 16.03302 0.0000
DPROV –0.000315 0.001577 –0.199810 0.8417
BANK –0.437819 0.089729 –4.879349 0.0000
R-squared 0.415961 Mean dependent var 0.042402
Adjusted R-squared 0.409903 S.D. dependent var 1.449894
S.E. of regression 1.113776 Sum squared resid 597.9200
F-statistic 68.65752 Durbin-Watson stat 1.700383
Prob (F-statistic) 0.000000
Downloaded by University of Exeter At 05:18 04 September 2016 (PT)

Dependent Variable: DRISK

Method: Two-Stage Least Squares
Sample (adjusted): 1,488
Included observations: 488 after adjusting endpoints
Instrument list: LOANS DCAPRAT1 DEP RISK DPROV BANK

gory (local or foreign). The variable CONCLUSIONS

LOGLOANS is negative and significant at
the 1 per cent level. The R-sq of the
regression is 28 per cent when run with a
constant and 26 per cent when the model is
run without a constant.
The results of exposure to risk also seem
to support the hypothesis that the locally-
owned banks’ level of risk increased in the
wake of the new capital requirements.
When the model is run without a constant,
the BANK variable is significant at the 1
per cent level and is negative. The variable
is not, however, significant when a con-
stant is introduced into the model. Again,
loans are found to affect the level of risk-
weighted assets negatively. The variable
LOANS is significant at the 5 per cent
level in both models, but it has the wrong
sign. Since the dependent variable RISK is
defined as the ratio of risk-weighted assets
to total assets the expected sign of the vari-
able LOANS should be positive, ie more
loans would expose the bank to higher
risk.
The results of this study indicate that, on
the whole, the new capital requirements
for commercial banks had a positive
impact on their performance in terms of
accumulation of deposits, assets and
growth in advances, liquid assets, paid-up
capital, core capital and total capital and
net profits. This is true when the commer-
cial banks are looked at as a group. The
story, however, is different when local and
foreign banks are examined separately,
with the local banks exhibiting a tendency
to poor performance (Appendix 1). From
the regression analysis, it is clear that the
hypothesis that the new capital require-
ments affected the commercial banks differ-
ently cannot be rejected. The locally
owned-banks are seen to have suffered
more in terms of reductions in capital and
increased risk as compared to the foreign-
owned banks.
The banking sector in general is still
weak in respect to overall earnings and the
quality of assets in the sector,21 requiring

Page 236

even tighter monitoring to protect deposi-
tors against bank failures. The profitability
of the banking industry, as measured using
net profits, is still very low. Though the
trend in the value of non-performing assets
of the entire banking system seems to be
going downwards, its proportion of total
deposits, at about 12.8 per cent in March,
2000, is still too high. The situation is
much worse for indigenous banks as a
group as opposed to foreign-owned banks.
In terms of non-performing assets, the local
banks had many more non-performing
assets than the foreign banks for the whole
period.
Downloaded by University of Exeter At 05:18 04 September 2016 (PT)
The explanation for the realised differ-
ences in performance between the foreign-
owned and the local banks could lie in the
management ability of the foreign-owned
banks. Therefore, any moves to raise the
capital requirements for commercial banks
need to be supplemented with strong man-
agement and supervisory inputs, particu-
larly for the locally-owned banks.
REFERENCES
(1) Ddumba-Ssentamu, J. (1999) ‘Institutions
and rural development in Uganda’, in
Kayizzi-Mugerwa, S. (ed.) ‘The African
economy: Policy, institutions and the
future’, Routledge Publishers Ltd.,
London.
(2) World Bank (1999) ‘World Development
Report 1999/2000’, Oxford University
Press, Inc., New York.
(3) Source: Republic of Uganda (2000)
‘Background to the Budget 1999/2000’,
Uganda Printing and Publishing
Corporation, Entebbe.
(4) Other factors that may explain the lack
of financial sector development in
Uganda include: low incomes; poor
infrastructure; financial sector controls;
macroeconomic and political instability.
Mpuga
(5) Ddumba-Ssentamu (1999) op. cit.
(6) Obwona, M. and Musinguzi, P. (1998)
‘Savings mobilisation and credit conduits:
Formal and informal financial sector
linkages’, Economic Policy Research
Centre, Research Series No. 5.
(7) Ddumba-Ssentamu (1999) op. cit.
(8) Mitchell, A. E. W. (1998) ‘The impact of
risk-based capital requirements on the
indigenous banks of Eastern Caribbean
central bank area’, Savings and Develop-
ment Quarterly Review, Vol. 22, No. 2.
(9) Ibid.
(10) Selgin, C. (1995) ‘Bank self-regulation:
Comment on Bordo and Schwartz’, Cato
Journal, Vol. 14, No. 3.
(11) Kaufmann, G. G. (1991) ‘Lender of last
resort in contemporary perspective’,
Journal of Financial Services Research, Vol.
5, No. 2, pp. 95-110.
(12) Popiel, A. P. (1994) ‘Financial systems in
Sub-Saharan Africa: A comparative
study’, World Bank Discussion Papers,
Africa Technical Department Series,
IBRD/The World Bank.
(13) Villanueva, D. and Mirakhor, A. (1990)
‘Strategies for financial reforms’, IMF
Staff Papers, Vol. 37, No. 3, pp. 509–536.
(14) Kasakende, A. L. and Atingi-Ego, M.
(1995) ‘Financial liberalisation and its
implications for the domestic financial
system: The case of Uganda’, a research
proposal presented at AERC Workshop,
Nairobi, Kenya.
(15) Republic of Uganda (1993) ‘Financial
Institutions Statute, 1993’, The Uganda
Gazette, Vol. 86, No. 21.
(16) Mitchell (1998) op. cit.
(17) Ibid.
(18) Shrieves, R. E. and Dahl, D. (1992) ‘The
relationship between risk and capital in
commercial banks’, Journal of Banking and
Finance, Vol. 16, pp. 439–457.
(19) Mitchell (1998) op. cit.
(20) Ibid.
(21) Republic of Uganda (2000) op. cit.
Page 237
 The 1998–99 banking crisis in Uganda

APPENDIX 1: DIAGRAMMATIC REPRESENTATION OF COMMERCIAL BANK

PERFORMANCE IN UGANDA, 1993–1999

Figure 1 Total deposits (dep), assets (ass), advances (adv) and net profits (np) for all commercial
banks in Uganda, 1993–1999

160,000

140,000

120,000

100,000
Ushs million

80,000

60,000

40,000
Downloaded by University of Exeter At 05:18 04 September 2016 (PT)

20,000

0
93:q2
93:q3
93:q4
94:q1
94:q2
94:q3
94:q4
95:q1
95:q2
95:q3
95:q4
96:q1
96:q2
96:q3
96:q4
97:q1
97:q2
97:q3
97:q4
98:q1
98:q2
98:q3
98:q4
99:q1
99:q2
99:q3
99:q4
-20,000

-40,000
Period

dep ass adv np

Figure 2 Total deposits, assets, advances and net profits for local commercial banks, June, 1993–
September, 1999

80,000

60,000

40,000
Ush s m illion

20,000

0
93:q2

93:q4

94:q2

94:q4

95:q2

95:q4

96:q2

96:q4

97:q2

97:q4

98:q2

98:q4

99:q2

99:q4

-20,000

-40,000
Period

dep ass adv np

Page 238
 Mpuga

Figure 3 Total deposits, assets, advances and net profits for foreign commercial banks, June, 1993–
September, 1999

80,000

70,000

60,000
Ushs million

50,000

40,000

30,000

20,000

10,000
Downloaded by University of Exeter At 05:18 04 September 2016 (PT)

0
93:q2

93:q4

94:q2

94:q4

95:q2

95:q4

96:q2

96:q4

97:q2

97:q4

98:q3

99:q1

99:q3
Period

dep ass adv np

Figure 4 Total capital (tc), core capital (cc) and risk-weighted assets (rwa) for all commercial banks,
June, 1993–September, 1999

100,000

80,000

60,000
Ush m illion

40,000

20,000

0
93:q2
93:q3
93:q4
94:q1
94:q2
94:q3
94:q4
95:q1
95:q2
95:q3
95:q4
96:q1
96:q2
96:q3
96:q4
97:q1
97:q2
97:q3
97:q4
98:q1
98:q2
98:q3
98:q4
99:q1
99:q2
99:q3
99:q4

-20,000

-40,000
Period

tc cc rwa

Page 239
 The 1998–99 banking crisis in Uganda

Figure 5 Total capital, core capital and risk-weighted assets for local commercial banks, June,
1993–September, 1999

50,000

40,000

30,000
Ushs million

20,000

10,000

0
93:q2

93:q4

94:q2

94:q4

95:q2

95:q4

96:q2

96:q4

97:q2

97:q4

98:q2

98:q4

99:q2

99:q4
Downloaded by University of Exeter At 05:18 04 September 2016 (PT)

-10,000

-20,000
Period

tc cc rwa

Figure 6 Total capital, core capital and risk-weighted assets for foreign commercial banks, June,
1993–September, 1999

60,000

50,000

40,000
Ushs million

30,000

20,000

10,000

0
93:q2

93:q4

94:q2

94:q4

95:q2

95:q4

96:q2

96:q4

97:q2

97:q4

98:q3

99:q1

99:q3

Period

tc cc rwa

Page 240
 Mpuga

Figure 7 Total commercial deposits (dep) and assets (ass) by category, 1993–1999 (in Ushs million). 1 represents foreign
banks and 2 represents local banks. Note that for the foreign-owned banks, there was a steep rise in both deposits and
assets, with some decline in the second quarter of 1995, while the increase in deposits and assets for the local banks
was more gradual.

80,000

70,000

60,000
Ushs million

50,000

40,000

30,000

20,000
Downloaded by University of Exeter At 05:18 04 September 2016 (PT)

10,000

1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 2

Period/bank cat egory

dep ass

Figure 8 Total commercial bank advances (adv) and non-performing assets (npa) by category, 1993–1999 (in Ushs
million). 1 represents foreign banks and 2 represents local banks. Note the steady increase in advances and slow rise
in non-performing assets for the foreign banks while the local banks experienced a gradual increase advances followed
almost closely by an increase in non-performing assets.

35,000

30,000

25,000
Ushs million

20,000

15,000

10,000

5,000

1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 2

Period/bank cat egory

adv npa

Page 241
 The 1998–99 banking crisis in Uganda

Figure 9 Commercial bank net profits (np) and total capita (tc) by category, 1993–1999 (in Ushs million). 1 represents
foreign banks and 2 represents local banks.

10,000

5,000

-
Ushs million

(5,000) 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 2

(10,000)
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(15,000)

(20,000)

Period/bank cat egory

np tc

Figure 10 Commercial bank risk-weighted assets (rwa) and paid up capital (pc) by category, 1993–1999 (in Ushs million).
1 represents foreign banks and 2 represents local banks.

60,000

50,000

40,000
Ushs million

30,000

20,000

10,000

1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 2

Period/bank cat egory

rwa pc

Page 242
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