The effect of macro economic variables on performance of Uganda’s banking sector (2008 Q3 – 2018 Q1)

Abstract

Back in the 1930s, a fall in stock prices led to a drop in worldwide GDP, thereby highlighting the relationship between the macro-economy and the financial sector. Particularly for banking sectors, literature (for example Qinhua and Meiling, 2014) often concludes that Macroeconomic policy is crucial for the development of a sound banking system. While it is evident that past research has been carried out to assess the impact of macroeconomic factors on bank profitability in various parts of the world, research that aims to explore the effect of macroeconomic dynamics on bank profitability in East Africa, Uganda in particular, is limited. Based on this back ground, the study employed ordinary least squares method (OLS) to assess the effect of macroeconomic variables namely; gross domestic product, inflation rate, real effective exchange rate, lending rate and the 91-day Treasury bill rate, on performance (proxied by return on equity) of Uganda’s banking sector. The study covered a time period from September, 2008 to March, 2018. Overall, the study findings from the multiple linear regression specified that GDP, real effective exchange rate and 91-day treasury bill rate had a negative effect on bank profitability while inflation rate and the lending rate positively influenced profitability within Uganda’s banking sector between September, 2008 and March, 2018. Evidently though, only the effects of GDP and inflation rate were found to be significant at 5 percent, while lending rate was significant at 10 percent. The main recommendation from the study is the need for commercial banks to put in place measures that can ably help them forecast the inflation rate so that they can benefit from a higher inflation rate and increase their profitability.