False alarm: How banks’ predictions of doom are falling apart

Festo Chege shared a personal feeling with President Uhuru Kenyatta last August relating to his finances.

It was a relief shared by millions of other Kenyans following the enactment of interest rate regulation - which could be reversed, following sustained campaigns by lenders. “I was drowning in bank loan interests, thank you for the life jacket,” Chege posted after the Bill brought to Parliament by Kiambu legislator Jude Njomo.

“I can now make Kenya great in my own little ways,” his post that mirrored the collective relief among borrowers read further. He did not reveal who his lender was or how much he was paying in interest.

“I was under pressure to shelve the amendment. Through proxies, the commercial banks were offering millions of shillings. The lobbying was intense,” said Njomo when he sponsored the Bill last year.

Loans were priced at anywhere about 25 per cent before the regulation which handed the Central Bank of Kenya (CBK’s) Monetary Policy Committee the power to determine the base rate, which is currently at 10 per cent.

Banks were allowed a maximum margin of four per cent above the base rate. Chege’s relief is shared by millions of Kenyans to date, and even the broader fears about crisis in the banking sector may have come to pass going by the reported first quarter profits for Stanbic Bank and NIC Bank.

Interest income

Both banks reported a marginal decline in the profits for the January-March period, indicating that the earlier concerns may have been exaggerated and informed by fear of the unknown.

Profit after taxation for NIC fell by only 3.9 per cent while Stanbic reported a nine per cent decline – which was not entirely because lower interest income from loans. Analysts at the Standard Investment Bank noted that the law had worked for mid-tier banks such as NIC since it helped to ease the cost of funds.

Interest earned from government securities declined faster than profits from loans to private sector. “Our view has been interest rates control law will harmonise deposit rates in the banking industry resulting in positive gains for Tier two banks that previously paid above set minimum deposit rates,” SIB said in a research note to investors last week.

According to CBK’s Bank Supervision Annual Report 2015, the Kenyan banking sector remained stable and resilient in 2015 as evidenced by a 9.2 per cent growth in the banking sector’s balance sheet from Sh3.2 trillion in December 2014 to Sh3.5 trillion in December 2015.

Despite the banking sector stability and resilience in 2015, two non-systemic banks, Dubai Bank Ltd and Chase Bank were placed in receivership by the Central Bank of Kenya (CBK) in the second and third quarters of 2015.Despite the emerging reality, the lenders have sustained pressure on the President to consider withdrawing the legislation.

When signing the law, Kenyatta said he was aware that the it posed some threats to the economy but promised to figure out an avenue to deal with the challenges- if they would come.

In any case, the legislation widely seen as bold was meant to deal with the greed among bankers who had bluntly refused to voluntarily ease the cost of credit. CBK had on many occasions prior to the enactment of the law pleaded with the banks to ease the price of loans but the requests went unheeded.

Njoroge said afterwards that it was a welcome development, which even though was not good for business, would help inform the banks that they would never be a law unto themselves.

“Of course the rate cap will have an impact on the banks’ profits but they can still thrive without charging extortionately high interest rates,” said Njoroge. “We can’t say for sure how the interest rate cap will affect the banking sector because there is insufficient data available to us at the moment. What we can say for sure is that the average interest rates for the country has fallen. We expect the cap will weaken banks’ balance sheets to a limited extent, but not dramatically.”

Immediately after, banks took the war against the new law to the President’s door threatening that the law which would slash their profits will ravage the economy.

It is easy to look through the bankers’ argument which is also supported by economists including Central Bank of Kenya Governor Patrick Njoroge.

Among the loudest critics is the International Monetary Fund which last month slashed the economy’s outlook by nearly one per cent, basing the dull prospects on the interest rate regulation. “The interest rate controls will reduce economic growth,” IMF said in its latest report on the Kenyan economy published in April (last month).

“International experience with lending rate controls suggests that they reduce access to credit, especially for unsecured lending and for small and medium-sized enterprises, which in turn reduces GDP growth,” the report read further.

Another risk of regulating interest rates is in dollar outflows as international investors seek better returns elsewhere. The shilling would subsequently suffer and weaken, making it costlier to import commodities such as petroleum, machinery and medicines. After NIC released its financials, the Group Managing Director John Gachora cited the small decline in profits to the two factors: impact of the interest rate capping law and lower incomes from the trade of bonds in 2017. A new debate would start whether the banks were deliberately tightening access to credit to arm-twist the government to shelf the amendments on the Banking Act which regulate lending rates.

To support the line of thought, Stanbic Bank has been aggressively selling its unsecured loan product in the recent weeks to salaried employees – who are deemed to be a safer group of borrowers. Before Stanbic started reaching out, all banks turned away thousands upon thousands of prospective borrowers citing that they only wanted to invest in safe assets like lending to the government.

In turning down the applications, banks claimed that the customers were of a risk profile that could only be lent to at interest rates higher than the level prescribed by law.

Jacob Ng’etich is one of the affected customers whose application was rejected by two different banks, never mind that he has a six-figure salary and works for a blue-chip company. He intended to get the money to finance a supplier’s contract his private business had secured, and as such he lost the tender – painfully.

That could be changing fast considering that banks are sitting on large cash reserves which must be invested through lending, either to government or individuals. “The bank is consolidating its business and relooking at our strategy on the back of the interest rate capping law,” Gachora said.

“The bank remains a strong institution and has fully complied with the new law. We are re-evaluating our business in this new operating environment and we will be rolling out new products and services to ensure we continue being competitive by investing more in our digital platforms.”

Newer technologies

Several banks have announced plans to slash their workforce, citing the impact of a regulated interest rate regime. However, that might not be entirely true considering that newer technologies including online banking, SMS banking and virtual money wallets are enabling a different approach to banking.

It is common to hear young people speak how they never use their ATM cards, much less visiting their banks, to transact because they have their banks in their smart phones.

Agency banking could be the most transformational where third parties are handling the bulk of customers in offering services such as deposits, withdrawals and account opening.

Cooperative Bank, for instance, has allowed its agents to access its banking halls which eliminate almost entirely the need for tellers.

It is a trend that is catching up among most other banks, sounding a death knell for banking as a profession – especially on the front end.

What this means then is that banks will be able to offer their services at a fraction of their costs, following the major savings in staff costs and renting premises for setting up branches.

Already, several lenders have closed branches partly because it makes no economic sense to keep them open while the count of customers walking through their doors is diminishing. With lower operating costs, the lenders have a new avenue to improve their profits even in a regulated interest rate environment.

But what happens when the controls are removed? Njoroge recently said it would be “highly unlikely” that lenders will be charged the same levels of interest as before the law.

His reasoning was that the government remains the biggest borrower from banks and that his office was actively working to ensure that the borrowing from the domestic market is kept to the minimal possible.

In the recent auctions of Treasury Bills and Bonds, which the State uses to borrow, most bids have been rejected because the banks were quoting interest rates higher than it was comfortable with paying.

National Treasury expects to borrow more from the international markets and bilateral lenders than it would from the domestic markets, as a sure way of keeping interest rates down.

It is also expected that borrowing from ordinary citizens through M-Akiba- the mobile-phone based government bond, could ease pressure of seeking credit from banks and other institutional investors.

Consumers like Chege would be closely watching if the government coming in after the August 8 elections would stand with borrowers or banks – well aware of the economists’ concerns about the long-term impact of the law.