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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
viii
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
ix
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.
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