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Commercial Banks’ Investment In Loans And Treasury Bills And Their Overall Profitability In Uganda
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Thus, the conventional wisdom in the Ugandan banking industry is that investment in TBs is an alternative source of risk free income. TBs are a short-term monetary policy instrument used by BOU to control liquidity in the economy. However, it is also a risk free asset for investors, attracting commercial banks to use it as an alternate investment to loans. As at December 2003, the volume of commercial banks investment in TBs stood at Shs 886 billion, exceeding the volume of loans for the same period, which stood at Shs 847 billion (BOU (Annual Supervision Reports, December 2003).
The Yield on a TB is a function of the interest rate, amount invested and its maturity period. The interest rate on TBs and hence the Yield is volatile. For example, BOU uses bi-monthly auctions to sell TBs. A Reference rate is computed for each Auction as a moving average rate for the last three consecutive auctions, based on the 91- Day TB. The average TB reference rate was 7.72% during the Financial Year (FY) 1998/99, sharply rose to 19.28% in FY 1999/00, dropped to 5.33% in FY 2001/02 and hiked to 18.58% in FY 2002/03 (BOU Annual Report, 2002/2003). On the other hand, the yield from traditional lending activities is a function of the lending rate and the amount loaned. The weighted average lending rate of commercial banks for the five year period between FY 1998/99 and 2002/03 varied within a range of 22.96% as the highest in FY 1998/99 and 17.57% as the lowest in FY 2001/02 (BOU Annual Report, 2002/2003). The lending rate is thus stable compared to the interest rates on TBs.
The overall profitability of an investment is established using return on investment ratios, which gives an indication of a business firm’s efficiency of operation (Van Horne, 1980). Profitability ratios include the Return on Assets (ROA) and return on Equity (ROE). ROA compares net profits after taxes to total assets; while ROE compares net profits after taxes to the Net Worth of the firm. ROA and ROE for the commercial banking industry has been fluctuating over the years. For example, the industry’s ROA was 4.21% in the year 2000, but had declined to 2.7% by 2002. ROE stood at 45.10% in 2000, rose to 50.85% in 2001, fell to 24.4% in 2002 and in 2004, had risen to 37.4%. (BOU Annual Supervision report, 2004).
1.2 Statement of the problem
Commercial banks in Uganda are increasingly investing in TBs as an alternate asset to loans. Volume of investment in TBs grew by 417% over the period 1995 - 1999, compared to growth of 40% in loans over the same period, and in 2002 and 2003, the volume of TBs exceeded that of loans. Conversely, the average TB reference rate was 7.72% during the Financial Year (FY) 1998/99 and sharply rose to 19.28% in FY 1999/00; while the weighted average lending rate of commercial banks for the five year period between FY 1998/99 and 2002/03 varied within a range of 22.96% as the highest in FY 1998/99 and 17.57% as the lowest in FY 2001/02.
Although commercial banks have relatively increased their investment in TBs as an alternate investment to their traditional business of extending loans, there is absence of systematic understanding of how this is associated with the overall profitability of the banks as measured in terms of ROA and ROE. This study therefore set out to analyze the extent to which commercial bank’s volume of investment in loans and associated lending rates and volume of investment in TBs and associated yields influences the overall profitability of commercial banks in Uganda
1.3 Purpose of the study
The study sought to establish the relationship between volume of investment in loans and associated lending rates and volume of investment in TBs and associated yields on the overall profitability of commercial banks as measured in terms of ROA and ROE.
1.4 Objectives of the study
i. To establish the relationship between the volume of commercial banks’ investment in loans and their overall profitability in terms of ROA and ROE
ii. To establish the relationship between commercial banks’ lending rates and their overall profitability in terms of ROA and ROE iii. To establish the relationship between the volume of commercial banks’ investment in TBs and their overall profitability in terms of ROA and ROE
iv. To establish the relationship between commercial banks’ yields from TBs and their overall profitability in terms of ROA and ROE
1.5 Hypotheses
1. The volume of investment in loans affects the overall profitability of commercial banks in terms of ROA and ROE
2. Lending rates impinge on the overall profitability Commercial banks in terms of ROA and ROE
3. Volume of investment in TBs influences the overall profitability of commercial banks in terms of ROA and ROE
4. The yield from TB investments has an effect on the overall profitability of commercial banks in terms of ROA and ROE
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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---
