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

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.

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