Banks in Uganda play a critical role in economic growth through the credit transmission mechanism. By lending to the real sectors of the economy, banks support job creation, innovation and the long term growth prospects of the Ugandan economy. Bank lending to the private sector has been expanding over the years, growing at an average of 15% over the last four years. Growth in lending to the private sector has partly been boosted by the fact that banks have a wide national foot print giving them access to cheap deposits. Quite commendably, banks have been able to lend out more, while maintaining a high quality loan book owing to improvements in risk management and credit appraisal.
Trends in Private Sector Credit (Ush, Billion, 2006-2015)
Source: Bank of Uganda
Being the traditional source of financing for the real economy in Uganda, banks can lend more through mobilization of more deposits and injecting more capital into their operations to meet regulatory requirements on capital adequacy. Mobilization of more deposits is a costly affair involving brick and mortar expenses. Moreover, as a regulatory requirement, Banks are required to raise more total capital as their loan book expands owing to requirements pertaining to total capital and risk weighted assets. At the current total capital to risk weighted assets ratio of 12%, for every shs 100 of credit created, shareholders need to inject Shs 12, which could strain shareholders. Therein lies a challenge that can be addressed adequately through securitization of risk weighted assets.
Securitization is a structured finance technique that involves the pooling of assets and subsequent sale in the capital markets of the claims on the cash flows backed by this pool.Investors buying these claims are entitled to payments of principal and interest on the underlying pooled assets. Through this process, illiquid financial assets such as mortgages and loans are bundled together and converted into liquid marketable securities, funded by and tradable in the capital markets.
How Securitization Works
Securitization is achieved by pooling a number of assets by a bank, typically the originator of the loan. The ultimate objective is to transform a portfolio of loans originated by a financial intermediary into a publicly issued debt security. The resultant security is not only tradable, transferable and liquid, but also ring-fenced and isolated from the originator. To get to this point, a large number of loans need to be granted by the lender to different borrowers. The resulting portfolio needs to be large enough to reach a minimum critical size for the securitization to be economically viable. The originator then transfers the loans to a bankruptcy-remote special purpose vehicle, created for the limited purpose of acquiring the underlying loans and issuing securities on the claims on the portfolio (principal and interest payments). The issued securities are then purchased by capital market investors such as institutional investors,asset managers and pension funds. The holders of ABS receive principal and interest payments based on the cash flows from the portfolio of loans. The originator will very often be the servicer of the transaction, collecting payments and tracking performance of the underlying pools.
Benefits of Securitization to the Banking Sector
Banks stand to make numerous gains from the securitization of their loans. Particularly, by securitizing loans, banks can expand lending by releasing capital in existing assets with resorting to shareholders for more capital or mobilization of more deposits. By transferring assets to a special purpose vehicle and moving them from their balance sheets,Banks can have more leeway to lend and still remain within regulatory parameters as more capital is freed up for lending due to a decline in risk weighted assets. Thus growth in lending happens without injection of more capital.
Banks can also transfer the arising credit risk from their loan assets to the capital markets. The transfer of credit risk to entities better placed to manage it reduces the likelihood of banks becoming credit constrained. Securitization facilitates the transformation of illiquid assets pools into marketable securities, originators can easily transfer into cash through the capital markets. Bank issuance of asset backed securities can aid in building up of a track record and recognition. Securitization provides banks an opportunity to boost their profiles in the capital markets as well as gain visibility from the process.
Asset Back Regulations
The Capital Markets Authority in a bid to diversify sources of funding for businesses and widen the product offering for investors passed the Capital Markets (Asset Backed Securities)2012 regulations. The regulations apply to the issue, offer and listing of Asset Backed Securities in Uganda. They specifically focus on: parties to securitization, legal structure of Asset Backed Securities, issuance, credit enhancement, continuing disclosure and periodic reporting.
Securitization remains a foreign concept this side of the Sahara. The East African Community has yet to witness any securitization transaction as a means of increasing funding to businesses and offering investors additional investment instruments. With an appropriate legal-regulatory framework and an insatiable demand for credit by the private sector in Uganda, the banking sector in Uganda can trail blaze regionally by adopting this innovative financing technique.
By Dickson Ssembuya
Senior Research and Market Development Officer
Capital Markets Authority
Disclaimer:The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of the Capital Markets Authority
 Risk Weighted Assets are used to determine the minimum amount of capital that must be held by banks and other institutions to reduce the risk of insolvency. The current Bank of Uganda Total Capital to Risk weighted Assets ratio is 12% while the industry had a ratio of23.4% as at the end of December 2015.