COMMENT: Socio-economic impact of banks

Why policy measures that curtail the volume of bank lending to the business community must be avoided

COMMENT | LOUIS KASEKENDE | I would like to begin by explaining why I think that a socio-economic impact assessment is a very useful initiative for the bank to have taken.

Banks all around the world tend to attract a lot of public criticism, and banks in Africa are no exception. The main complaints about banks in Africa are usually two-fold. First, that they charge very high interest rates on their loans. Second, that they restrict their lending to a relatively small segment of the business community, excluding most of the small and micro-enterprises which comprise the bulk of the economy and provide the majority of employment.

While there is certainly some validity in both these arguments – one cannot dispute that lending rates are very high in real terms, for example – public debate on these issues often betrays a poor understanding of the underlying causes of these problems, many of which lie outside the banking industry itself. Furthermore, the public perception of banks often lacks a balanced appreciation of the positive contributions which they make to the economy. Unfortunately public misconceptions of economic issues can sometimes lead to poor policies, an example of which is the counterproductive ceiling on bank lending rates in Kenya.

The independent socio-economic impact assessment of Standard Chartered Bank’s operations in East Africa, prepared by the consultancy firm Steward Redqueen, addresses the second of these issues – the contribution of the bank to the economy and to social welfare, in a rigorous and comprehensive manner using an input-output methodology. It sets out to quantify the contribution which Standard Chartered Bank’s operations, principally its lending to the private sector, made to GDP and employment in Kenya, Tanzania and Uganda, in 2016. The impact arises from both the direct support which SCB’s lending provides to its borrowers and the second round effects on the borrowers’ suppliers and other indirect effects. These contributions to GDP and employment are far from being negligible.

In Uganda, SCB extended domestic credit to the private sector, through both on-shore and offshore financing, of just over $900 million in 2016, which amounts to about 3.6 percent of GDP. The socio-economic impact report estimates that SCB’s lending supported value added of 3.5 percent of GDP and almost half a million jobs. Hence each Shilling of SCB’s lending supported GDP of a similar magnitude. This might not appear very large until we recall that bank finance generally provides a borrower with funds to purchase both factor inputs and material inputs, whereas it is only the factor inputs which comprise GDP.

Therefore, the fact that there is an almost one for one relationship between SCB’s finance and the magnitude of GDP which it supports is indicative of finance being a scarce resource in Uganda and that marginal returns to capital are high, at least for the borrowers of SCB. High returns to borrowing also suggest that funds are being intermediated efficiently; i.e. channeled to those borrowers which are able to use funds most productively.

The results of the socio-economic impact assessment add to our knowledge of the economy and provide important insights into the way in which the banking industry affects the economy. For example, the report shows that value added and employment are not only generated in the businesses which directly borrow from banks, but also by the businesses which supply goods and services to the direct borrowers and through the demand generated by the spending of all those who receive wages and salaries in the businesses which benefit, directly or indirectly, from bank lending. Nearly two thirds of the impact of SCB’s operations on GDP takes the form of salaries. In terms of supporting employment, SCB’s operations in Uganda have their largest impact on the agricultural sector, which accounts for 46 percent of all of the jobs supported.

One of the salient implications of these findings for public policy is that we must be very careful to avoid implementing any measures which might curtail the volume of bank lending to the business community, as any reduction in lending could have significant negative effects on output and employment.

I would now like to address the difficult issue of the cost of, and access to, bank credit which, as I noted at the start of this address, is one of the main causes of public discontent with commercial banks in Uganda and elsewhere in Africa. The two problems – high lending rates of interest and limited access to credit – have a common cause, which is the nature of a large part of the productive base of the economy.

Uganda has what is in effect a dual economy which comprises, on one side, a modern formal sector with a relatively small number of medium and large scale enterprises and on the other side, a vast number of mostly informal small and micro-enterprises.

In general, the medium and large scale, formal sector enterprises have access to bank credit and many of them can borrow funds at interest rates which are well below average for all borrowers and in some cases even below the posted prime lending rates of banks. Many of these borrowers can also access offshore finance. The reasons why these borrowers can access credit relatively cheaply are straightforward to understand; these enterprises have established track records of profitability, are well managed and run according to strict commercial principles, they prepare detailed financial accounts and they can often provide guarantees from affiliates abroad. Hence credit risk is low and the transactions cost incurred by the bank per unit of loan value is also low.

In contrast, the informal small and micro enterprises pose very different challenges for the banks. Their revenues are volatile and their long term probability of survival is low. Most do not keep proper financial records. There is often no separation of business expenses and the personal expenses of the owner. Banks face severe informational problems in evaluating the creditworthiness of these enterprises.

Furthermore, because loan sizes are small, it is also very costly, per unit of loan value, to evaluate their loan applications and monitor their borrowing. Consequently, because of the high transaction costs and credit risks involved, it is only commercially viable for banks to serve this segment of the credit market if they charge high interest rates.

This is the principal reason why average lending rates of interest are high in Uganda. Banks in Uganda which have a large retail clientele of small scale borrowers incur much higher operating costs and must, therefore, charge higher lending rates than banks which focus on a relatively small base of large and medium scale corporate borrowers.

Is it possible for bank lending rates to be lowered without at the same time reducing the access to credit of those small scale borrowers who are the most costly for banks to serve? Certainly Yes; but this will only be possible on a sustainable basis if the costs of serving these borrowers can be reduced.

The establishment of the Credit Reference Bureau (CRB) is intended to offer banks better access to reliable information about the loan history and thus the creditworthiness of loan applicants and thereby reduce informational costs, but these costs are only a relatively small part of the overall costs which banks incur in lending to small scale borrowers, so the CRB will not, on its own, bring about a substantial reduction in the cost of credit.

In the long run, reducing intermediation costs will benefit from government’s continuous efforts in improving the business environment such as investment in infrastructure and efficacy of commercial justice system. Most importantly for banks, lowering costs will probably require employing information technology to replace traditional banking methods of delivering loans and other financial products and for assessing loan applications.

As Mr. Lamin Manjang, the CEO of SCB Kenya points out in the foreword to the socio-economic impact assessment report; SCB is investing heavily across its banking group in digital technology with the aim of enabling 80 percent of its customers’ transactions to be conducted through non branch channels. Recently, it was also reported that Standard Chartered Bank is launching its first digital only retail bank in Cote d’Ivoire; this bank will have no physical bank branches and will be a testing ground for the delivery of digital financial services. This is clearly the direction in which banking is moving worldwide.

Digitalisation has already brought about dramatic improvements in access to payments services and a reduction in the costs incurred by customers in making payments in East Africa.

The challenge for banks is to realise similar improvements and cost savings in the delivery of loan products. This will certainly be much more difficult, but if banks can do this, lower lending rates and an expansion of access to credit will become a more realisable prospect.

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Louis Kasekende (PhD) is the Deputy Governor, Bank of Uganda. He made this statement at the launch of the Standard Chartered Bank Socio-Economic Impact Report on March 21 in Kampala.