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Commercial Banks’ Investment In Loans And Treasury Bills And Their Overall Profitability In Uganda
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CHAPTER ONE
INTRODUCTION
1.1 Background to the study
Due to the crucial roles that banks hold in the financial sector, this research evaluates the profitability of the commercial banks in Uganda. The performance evaluation of commercial banks is especially important today because of the fierce competition and globalisation of world economies. Evaluation of banks’ performance is important for: depositors, shareholders, investors, bank managers and regulators. In a competitive financial market, bank performance provides signals to depositors and investors with regard to whether to invest or withdraw funds from the bank (Abdus & Kabir 2000).
Similarly, it flashes direction to bank managers whether to improve its deposit service or loan service or both, to improve its performance. For that reason, identifying the key success factors of commercial banks enables the design of policies that may improve the profitability of the banking industry (Buyinza, 2010).
The importance of bank profitability can be appraised at the micro and macro levels of the economy. At the micro level, profit is the essential prerequisite of a competitive banking institution and the cheapest source of funds. Indeed, without profits, any firm cannot attract outside capital (Gitman, 2007). Thus, profits play a key role in persuading depositors to supply their funds on advantageous terms. By reducing the probability of financial trouble, impressive profits figures also help reassure a bank’s other stakeholders, viz: investors, borrowers, managers, employees, external product and service suppliers, and regulators (Anyanwaokoro, 1996). It is not merely a result, but also a necessity for successful banking in a period of growing competition in financial markets. Hence, the basic aim of a bank’s management is to achieve a profit, as the essential requirement for conducting any business (Bobakova, 2003).
In Uganda, after a long period of economic, financial management and political instability, in 1987 the government adopted a rehabilitation and recovery programme to rebuild the economy and restore macroeconomic stability under the auspices of the International Monetary Fund, the World Bank and the donor community at large. Financial sector reforms in Uganda were implemented as part of the stabilisation and beginning in 1990, a number of reforms were implemented in the financial sector in order to achieve the main goals of increased efficiency and financial deepening. During this period however, developments in the financial system were disappointing and in view of this, Nanyonjo (2001) argues that bank restructuring did not yield the expected results. According to her, despite some improvement, the quality of commercial bank assets remained weak during the post reform period. By the end of June 1997, about 30 percent of all commercial bank loans in Uganda were non-performing. This not only reflected weak management and procedures, but also poor credit discipline. In addition, profitability of several banks deteriorated during the same period which Nanyonjo (2001) attributes to the presence of non-performing loans in bank portfolio. This indicator showed some worrisome signs, and hinted a progressive deterioration of bank soundness. As a result, several banks indeed experienced solvency and liquidity problems and were closed down during the 1998/1999 financial year. Therefore, although the Government of Uganda through the Central Bank has often sought for permanent measures that would enhance the profitability and stability of banks operating
in the Uganda’s banking industry, if the historical antecedents of financial sector reforms are anything to go by; they have not completely succeeded in achieving this feat. Against this backdrop, the broad aim of this study was to identify, on the basis of empirical evidence, significant determinants of bank profitability in Uganda. However, its scope was delimited to volume of investment loans and treasury bills, lending rates and yield on treasury bills as determinants of bank profitability.
As postulated by intermediation theories, Loans are the traditional business of commercial banks. However, in the case of Uganda’s banking industry, the experiences of the last two decades appear to have negatively impacted on this role. In the 1980s and 1990s, the industry was riddled with high levels of Non Performing Assets (NPA). The ratio of NPA to total loans fluctuated between 26% and 39% between 1995 and 1999 (Bank of Uganda (BOU) Annual Supervision Report, 1999). As a result, many banks re-designed their investment portfolio. They turned to other safer alternative investments than lending, such as the Treasury Bills (TBs). As a result, commercial banks investment in TBs grew by 417% between 1995 and 1999 (BOU Annual Supervision Report, 1999), compared to growth in loans of 40% for the same period. Financial sector reforms and aggressive loan recovery efforts resulted into substantial reduction of the NPAs from 7.2% in 2003 to 2.2% in 2004 (BOU Annual Supervision Report, 2004). Nonetheless, commercial banks’ balance sheets reflect a strong preference for liquid and low-risk assets, which has implications for their soundness and overall profitability (Tumusiime- Mutebile, 2005).
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ABSRACT - [ Total Page(s): 1 ]ABSTRACT Investigating the determinants of profitability of commercial banks has been one of the more popular topics among researchers in banking studies. Hence, to contribute to the existing knowledge, this study sought to analyze the extent to which investment in loans and treasury bills influence the overall profitability of commercial banks in Uganda, using a data set comprising 95 observations for 15 commercial ba ... Continue reading---
