COMMERCIAL BANKS’ INVESTMENT IN LOANS AND TREASURY BILLS AND THEIR OVERALL PROFITABILITY IN UGANDA

TABLE OF CONTENTS

DECLARATION ………………………………………………………………………………….. ii

APPROVAL …………………………………………………………………………………………. iii

DEDICATION ……………………………………………………………………………………. iv

ACKNOWLEDGEMENT…………………………………………………………………………..v

TABLE OF CONTENTS ………………………………………………………………………… vi

LIST OF TABLES ……………………………………………………………………………… ix

ABSTRACT ……………………………………………………………………………………………x

CHAPTER ONE .…………………………………………………………………………………1

INTRODUCTION …………………………………………………………………………………1

1.1 Background to the study …………………………………………………………….1

1.2 Statement of the problem …………………………………………………………..5

1.3 Purpose of the study ……………………………………………………………………6

1.4 Objectives of the study………………………………………………………………….6

1.5 Hypotheses ………………………………………………………………………………….6

1.6 Scope of the study ………………………………………………………………………..7

1.6.1 Subject scope ……………………………………………………………………………….7

1.6.2 Geographical scope ……………………………………………………………………….7

1.6.3 Time scope …………………………………………………………………………………..7

1.7 Significance of the study…………………………………………………………………..8

1.8 Conceptual framework …………………………………………………………….9

1.10 Structure of the study ……………………………………………………………….. 10

CHAPTER TWO …………………………………………………………………………….. 12

  vii

LITERATURE REVIEW …………………………………………………………………….. 12

2.0 Introduction ……………………………………………………………………………….. 12

2.1 Volume of investment in loans and profitability of commercial banks…… 12

2.2 Relationship between lending rates and the profitability of commercial banks………. 17

2.3 Relationship between investment in Treasury bills and commercial banks’

profitability ……………………………………………………………………………………. 21

2.4 Yield on TBs and commercial banks profitability………………………….. 25

2.5 Commercial banks Profitability…………………………………………………….. 26

METHODOLOGY …………………………………………………………………………. 30

4.0 Introduction …………………………………………………………………………. 30

4.1 Research design …………………………………………………………………….. 30

4.2 Population and Sample …………………………………………………………… 30

4.3 Data source and collection…………………………………………………………… 31

4.4 Measurement of variables ……………………………………………………….. 31

4.5 Empirical Estimation Model and analysis………………………………….. 32

4.6 Problems encountered during data collection………………………………. 33

CHAPTER FOUR …………………………………………………………………………….. 34

DATA PRESENTATION AND DISCUSSION OF FINDINGS ………………………. 34

4.0 Introduction ………………………………………………………………………………. 34

Table 4.2: Estimation results using ROA as the dependent variable…….. 37

4.2.1 Relationship between the volume of commercial banks’ investment in loans and their overall profitability in terms of ROA and ROE ……….. 37

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4.2.2 Relationship between commercial banks’ lending rates and their overall profitability in terms of ROA and ROE ………………………………….. 39

4.2.3 Relationship between the volume of commercial banks’ investment in TBs and their overall profitability in terms of ROA and ROE ……….. 42

4.2.4 Relationship between commercial banks’ yields from TBs and their overall profitability in terms of ROA and ROE …………………………………… 43

4.2.5 Model Prediction ……………………………………………………………………….. 43

SUMMARY, CONCLUSIONS AND RECOMMENDATIONS ………………………. 45

5.0 Introduction …………………………………………………………………………………. 45

5.1 Summary……………………………………………………………………………. 45

52. Conclusion……………………………………………………………………………46

5.3 Recommendations ………………………………………………………………. 47

5.4 Areas for further research…………………………………………………………….. 47

REFERENCES ………………………………………………………………………………….. 49

APPENDICES …………………………………………………………………………………… 56

Appendix A: Introductory letters……………………………………………………….. 56

Appendix B: Dataset ………………………………………………………………………… 58

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LIST OF TABLES

Table 4.1: Descriptive Statistics ……………………………………………………….. 35

Table 4.2: Estimation results using ROA as the dependent variable ……. 37

Table 4.3: Estimation results using ROE as the dependent variable …….. 37

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  banks  over  the  period 1998-2005.  The  study  used  a  longitudinal  research  design,  based  on  quantitative  data generated through document analysis of commercial banks’ monthly reports and returns to  Bank  of  Uganda.  Overall  Profitability  was  measured  using  two  profitability  ratios namely:  Return  on  Assets  (ROA)  and  Return  on  Equity  (ROE)  while  the  independent variables included: volume of loans, volume of TBs, lending rates and yield on TBs. 

The study found Volume of Loans and TBs having a positive correlation while Lending Rates and average yields on TBs revealed negative correlation with ROA as an element of the dependent variable. With regard to ROE, Loan Volume, Lending rates and Volume of TBs showed a positive relationship while average yields on TBs indicated a negative correlation  with  this  element  of  the  dependent  variable.  However,  in  the  two  analyses, commercial banks’ investment volume in loans was found to be the only variable that had a statistically significant influence in accounting for profitability of commercial banks in Uganda.  On  the  basis  of  the  findings,  it  was  recommended  that  commercial  Banks  in Uganda  should  aim  at  committing  themselves  to  the  implementation  of  strategies  that would  enhance  credit  creation  and  disbursement  while  ensuring  adequate  recovery mechanisms.  It was  also proposed  that additional  efforts  should be put  in educating  the clientele about the banks’ loan products and prudent borrowing practices. 

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.