When commercial banks recorded a profit before tax of Sh85.8 billion as of June this year, it was not party time for the entire industry players.
For Jamii Bora Bank, Spire Bank, Development Bank and a host of other cash-strapped small banks, it is not just in the first half of this year that profits have eluded them.
Most of these tier three banks have been having difficulties balancing their finances for the last three years now. And things can only get worse before they can get better for these banks.
This even as things have not been rosy for the entire banking sector. As evolutionist Charles Darwin would have put it, this is a classic case of the fittest (the largest banks) blooming while the unfit (the small banks) struggle.
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Of course, for a number of these troubled small lenders, poor corporate governance and wrong investment decisions are largely to blame for their current cash problems.
Analysts have, however, cited a number of industry-wide issues, starting with the collapse of Chase Bank and the introduction of the interest rate cap in September 2016, for the small lenders’ woes.
As such, the last three years have been tough for smaller banks. Without the liberty to squeeze an extra shilling from their borrowers, mostly small and medium-sized enterprises (SMEs), and big banks refusing to do business with them, fearing another bank-run on one of the 20 or so small banks, the financial health of tier three banks has taken a serious beating.
Before the rate cap came and spoilt the cash party for banks, small lenders were the risk-takers, taking on the gamble of lending to collateral-less informal traders across the country.
These included small-scale farmers, barbers, hairdressers, mama mboga, jua kali artisans, or boda-boda operators.
A 2019 report on the impact of interest rate controls in Kenya by the International Monetary Fund (IMF) notes that the share of bank loans to micro, small and medium-sized enterprises (SMEs) — higher risk borrowers — was significantly higher for small banks.
“The overall share of banking sector loans to SMEs was about 18 per cent. However, the share for small banks (about 40 per cent) was significantly higher than that of large banks (13 per cent),” notes the report.
Mobilising the funds to lend out was even trickier. Depositors generally distrusted small, little-known banks with their money. To lure them, the small banks paid high interest on deposits compared to their medium and large peers.
They would then extend credit to the risky borrowers, those without physical collateral such as land, at an even higher price to get their pound of flesh.
Then-President Uhuru Kenyatta in September 2016 assented to the Banking (Amendment) Bill, effectively sweeping away this wiggle-room; a floor was placed on the interest rate they could pay for deposits and a ceiling on the interest return banks could charge on loans.
The collapse of three banks - Dubai Bank, Imperial Bank, and Chase Bank - earlier had already spread hysteria throughout the interbank market, with large banks refusing to lend to their smaller peers, according to bank insiders.
“The 2015 bank crisis eroded market confidence of tier two and tier three banks and as a result, there was a general deposit flight to tier one banks,” the former Family Bank boss David Thuku told The Standard in a past interview. “Generally, customers were looking at a flight to safety of their deposits,” he added.
Large banks have benefited where their small and medium peers have lost.
“Part of the growth in deposits at the eight large Kenyan banks is … driven by concerns surrounding the financial health of smaller banks,” noted rating agency Fitch in a special report on large Kenyan banks.
It added that Standard Chartered Bank of Kenya, Equity and Barclays Bank of Kenya outperformed the market in terms customer deposit growth last year, benefiting from the amnesty programme in which the Government allowed individuals with money that remained untaxed but was in offshore accounts to return it into the country without any penalty.
Only Central Bank of Kenya (CBK) continued to support smaller banks on a razor-thin strand, stepping up its overnight lending activities amidst a major snub by big lenders.
Just before the collapse of Dubai Bank and Imperial Bank in 2015, interbank deals in a trading day averaged 18,926, at some point hitting a high of 40,000.
However, the daily interbank volume would decline by a third to 13,447 in 2016. Although they rose in the following year, they have never recovered back to the 2015 levels.
The interest rate cap, according to analysts, aggravated what was already a bad situation. No wonder Fitch in its report has described smaller banks as a source of “systematic risk” in the country’s financial sector.
“These (smaller banks) are typically niche institutions with limited franchises and financial transparency. Corporate governance and access to interbank liquidity in times of stress for smaller banks in Kenya are risk factors,” said Fitch.
Genghis Capital analyst Churchill Ogutu, however, does not reckon a crisis in the small banks would bring down the entire financial sector, though he agrees “profitability and capital adequacy metrics in some of the smaller banks is an area of concern in the interest rate control environment.”
“Nonetheless, the small banks comprise around eight per cent of total banking size and thus not pose a significant systemic risk on the overall system,” said Ogutu.
Capital ratios of some of the small banks have remained low, albeit above the minimum threshold. However, four of the banks have registered below the minimum capital requirements.
Recent studies have shown that while large banks have found ways to beat the rate cap trap, small ones seem to have been caught in it. To depositors, the small banks are still prone to moral hazard in the aftermath of the 2015 banking crisis
Large banks have parked most of their deposits into Government securities, slashed staff costs by firing employees and replacing them with mobile phones even as they have relied on non-interest income, including commissions and fees to increase their margins.
This has helped lift bank profitability which took a beating a year after the rate cap came into effect in 2016 before it recovered.
The Fitch report notes that large banks have partially offset the impact of the lending rate cap by increasing volumes to prime customers.
“By contrast, smaller banks have less flexibility with client selection due to their much smaller franchise,” said the firm.
Furthermore, the smaller banks are also reliant on attracting deposits at higher interest rates and therefore the lending rate cap had a more severe impact on their profitability,” added the report.
If anything, the interest rate cap has led to the shrinking of their loan book, according to the IMF report.
Official data shows that for every Sh10 made in pre-tax profits by commercial banks in December 2017, eight went to the large lenders, including KCB, Equity Bank, Standard Chartered and Barclays Bank.
Other large, or tier one banks, that have jerked up their profitability since the rate cap was introduced include Co-operative Bank, Diamond Trust Bank, and Stanbic Bank Kenya.
The 80.78 per cent share of pre-tax profit of the large peer group in December 2016 was an increase from 78.6 per cent recorded in 2016.
However, during this period, the small peer group proportion of total pre-tax profit decreased from 2.2 per cent to negative 1.53 per cent in 2017 as eight banks made losses in 2017 compared to five in 2016.
Moreover, a year after the rate cap came into effect, the large banks’ market share increased by 0.6 percentage points to 65.98 per cent.
The combined market share of small banks declined from 8.9 per cent in December 2016 to 7.92 per cent in December 2017 in what the CBK attributed to the acquisition of two banks in the small peer group by a large and a medium peer-group bank in 2017. The eight large banks’ total deposits were nearly 10 times that of all the 21 banks combined.
This has made it possible for them to pump much of the cash safely to government securities even as they have continued to snatch customers from small banks.
Mr Ogutu noted that with CBK trying to mop up excess liquidity following increased bank deposits from the public pending the withdrawal of the old Sh1,000 banknote and payment of pending bills by both national and county governments, things will only get worse for the small banks.
“Actually, periodic intervention by the CBK in the market to mop up liquidity poses the biggest threat to the small banks in the interbank market,” he explained.
Currently, repo rates - the rate at which the central bank lends short-term money to the banks against securities - are above 91-day and 182-day Treasury-bill yields.
“And it is a no-brainer for a large bank to lend to a ‘safer’ borrower (that’s CBK) than to a small bank entity in the interbank market. This is what has propelled the interbank rate higher in recent sessions,” said Mr Ogutu.
Unable to see a bright future, some of these small banks have simply positioned themselves for sale.
“High competition in the industry, combined with an evolving regulatory framework and the adverse effect of the lending rate cap on credit growth, has spurred a wave of consolidation in recent years,” noted the Fitch report.
Some of the consolidations that have already gone through since the introduction of the rate cap include the acquisition of Giro Commercial Bank Ltd by I&M Bank Ltd; Fidelity Commercial Bank Ltd and Chase bank by SBM Bank Kenya Ltd.
Diamond Trust Bank Kenya also acquired Habib Bank Kenya. CBK has since approved the acquisition of cash-strapped National Bank by KCB.
By the end of this year, the merger between Commercial Bank of Africa (CBA) with NIC Bank will be completed, culminating into the third-largest bank in the country with total assets of Sh454 billion based on the 2018 figures.
Jamii Bora is also said to be on the shopping list of Kenyatta family’s majority-owned CBA.