How to help distressed companies without removing the risk from lenders and borrowers
On March 31 2016, the total value of all loans in Uganda’s commercial banking industry was Shs21.7 trillion of which Shs528 billion were non-performing loans (or “bad loans”) i.e. 2.64% of the total. Under the effective oversight of Bank of Uganda, especially its director for supervision; Justine Bagyenda (known in the industry as Uganda’s Iron Lady), non-performing loans have averaged 1.7% over the last 10 years. Although there was deterioration, it was a far cry from the 17% non-performing loans in 1996.
However, in just three months, nonperforming loans jumped three-fold to Shs1.8 trillion by June 30, 2016 representing 8.4% of total loans, an unheard of thing in nearly 20 years. What has caused this sudden deterioration?
It certainly cannot be bad borrowers and reckless lenders but something troubling about our economy generally. It is thus justified to fear the situation could worsen with bad loans reaching Shs7.0 trillion (30% of total loans) by December. This fear can be contested but for policy makers it is always safe to plan for the worst even when hoping for the best.
Most commentators have denounced the proposed bailout as a scheme to line the pockets of incompetent businesspersons, reckless banks, and “regime cronies”. But let us look at the facts for some perspective.
Of the Shs528 billion in non-performing loans, Shs126 billion (24%) is a result of government not paying domestic arrears to its suppliers. Diversion of funds to speculative businesses is only Shs2.6 billion (0.49%). See Table 1. Almost 30% of these loans went to building and construction (Shs155 billion), 29% to agriculture (Shs151 billion), 24% to trade and commerce (Shs127 billion) while only 1.4% (Shs7.4 billion) went to personal household stuff. See table 3.
So Uganda is caught in a Catch-22 situation. If it intervenes to help distressed companies or over-leveraged banks, it will create the problem of moral hazard. For example, out of Shs21.7 trillion in loans, only Shs1.8 trillion is non-performing. If the problem is system-wide, how come Shs19.9 trillion of loans are still performing?
But the threefold growth in bad loans since April means that it is highly likely many good loans could go bad. Yet helping distressed companies means rewarding failure and penalising those servicing their loans. And in helping the 8.4% who are distressed, you could be encouraging many in the 91.6% who are doing well to become lax and default in anticipation of a similar bailout.
Moral hazard is a core belief among free market ideologues and a real risk in such government interventions. Moralists seeking social equity would also reject any bailout. But ideological dogmatism and moral outrage are rarely a basis for sound public policy.
I was re-watching a documentary on the 2008 financial crash in America. Secretary to the Treasury, Hank Paulsen, made the same ideological mistake in regard to Leman Brothers, a US investment bank, and refused to bail it out with only about $50 billion and let it go bankrupt. But this caused shock on the stock market leading to the near collapse of the rest of the banking sector.
Eventually, the US government had to fork out $700billion to bailout banks infected by Leman’s collapse and $800 billion as a stimulus package to recover from the ensuing recession.
If Uganda has to intervene to help distressed companies, it must be driven by the desire to avoid contagion. The failure of some of the distressed companies can lead to the failure of banks with worse consequences than the costs of a bailout.
Secondly, an economy is a circular flow of income: one person’s expenditure is another person’s income. Distressed companies must have suppliers who depend on them for business. If they go under, this may impact the ability of their suppliers to service their own loans as well.
Companies that are facing a short-term liquidity squeeze due to factors such as conflict in South Sudan, delayed payment from government, price volatility, customers who have failed to pay, low sales, termination of business contracts, breakdown of key equipment, fraud and poor management can restructure, improve themselves and pay back. Those that are uncompetitive or undisciplined will go under. That is why government should not cherry pick whom to help and whom not to. Any government committee mandated to set criteria for a bailout will become a theatre of influence peddling and corruption leading to acrimony and political contestation.
The problem facing banks right now, as stated by Uganda’s leading tycoon and owner of Crane Bank, Sudir Ruparelia, is that half of Kampala is on sale. If banks offload all collateral on the market, there will be a collapse of the real estate market. This is in large part because those in the best position to buy real estate are also the ones who are distressed. Those that are not distressed are still hedging their bets and are unlikely to put their money into brick and motor given the prevailing economic uncertainty.
I agree real estate prices in (especially) Kampala have been overpriced and there is need to let them come down to reflect actual fundamentals of the economy.
But it would be disastrous to let the housing market collapse totally. This could easily infect practically everyone because real estate is the main collateral banks use to lend. Its collapse will force banks to revalue their collateral and ask borrowers to find more security or recall the loans, a factor that will cause many more loans to go bad.
Relaxing a strict enforcement of prudential rules by the central bank means that government will not spend any taxpayer money on the bailout. It also means that neither the lenders nor the borrowers have been let off the hook – they will only have been given a short (one to two years) breather. But it has potential to help healthy companies restructure and survive while the weak ones collapse and go out of business. It will also help the central bank dissuade commercial banks from their exaggerated interest rates. The ball is in the central bank’s court.