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Can banks in Kenya fight the squeeze on supernormal profits in an era of capped lending rates?

By Patrick Alushula | August 30th 2016

NAIROBI: When President Uhuru Kenyatta was signing into law the Bill capping costs of borrowing money, the stock market was all ears.

Barely 24 hours later, all 11 bank stocks at the Nairobi Securities Exchange took a battering, bleeding Sh47 billion to stand in the red as investors sold their stock in a panic.

Banks have a combined market capitalisation of about Sh482 billion as at the close of last week, though this is a far cry from Kenya’s largest telecom company, Safaricom, whose market capitalisation stands at Sh793 billion.

But stock performance is far from being banks’ biggest headache. The thought of slashing interest rates at a time when non-performing loans (NPLs) are at historic highs is the elephant in banking halls.

Lenders have been asked to forget about the goose that has been laying the golden eggs – interest income from loans and advances.

Already, Co-operative Bank, whose half-year results show it made Sh21.5 billion from interest income, has slashed interest rates to 14.5 per cent for new loans. Others will surely follow.

The Chinese proverb, ‘To open a shop is easy, to keep it open is an art’ rings particularly true in these times. Business Beat takes a look at what banks may try to do to remain profitable as they navigate the turbulent path ahead of them.

Reduce risky lending, invest in Government bonds

Many banks are likely to shy away from risky borrowers and invest in more secure areas, such as Government securities, which is usually the second-largest contributor of interest income.

“Going forward, banks will not be entering into contracts of a risk above the cap on the market. The law does not oblige banks to loan,” Kenya Bankers Association (KBA) boss Habil Olaka said last week.

According to Fitch, a London-based ratings agency, South Africa recently introduced a rate cap on unsecured consumer lending, which saw some banks abandon this segment.

“Kenyan banks are more likely to become risk averse and place excess liquidity into Government bonds,” says Fitch.

If benchmarking is anything to go by, most banks had good returns from Government securities, half-year results show.

Co-op Bank more than doubled its income from Government securities to Sh16.7 billion, while Equity Bank earned Sh22.7 billion – an increase of 34 per cent. Kenya Commercial Bank got Sh5.6 billion in the first six months of the year, a 22 per cent increase.

It is unlikely that the Government will stop borrowing.

In fact, on the day the President capped interest rates, his Government advertised a Sh18.3 billion bond of 10 years, with an average yield of 15 per cent – a more attractive option for banks.

Freeze employment

The latest Central Bank of Kenya (CBK) bank supervision annual report shows lenders shed 711 jobs last year. 2015 was challenging, and saw bank profitability drop for the first time in 16 years.

With the industry still unsure about how and when the law to cap interest rates will be operationalised, hiring is likely to slow down until everything is cleared.

KBA has already said the country should not expect new jobs to be created in banks easily.

“We cannot say now that there will be job cuts. [But] probability of employment going forward may be hard,” the bankers’ lobby warned.

Banks could consolidate

The narrative that Kenya is overbanked with 42 commercial banks serving about 42 million people is likely to gain renewed attention in the coming months.

With interest income now threatened, banks may begin to seriously consider consolidation to enjoy economies of scale.

Further, for the second time, the Treasury is trying to increase the mandatory minimum capital for banks to Sh5 billion, which would be a stretch for low-tier lenders. This, coupled with reduced profitability, may trigger consolidation.

“Over the medium term, we expect to see bank mergers, acquisitions and at worst, closures, especially with Tier 3 banks and much smaller Tier 2 banks, which are already struggling to cope, with liquidity skewed towards Tier 1 banks,” Standard Investment Bank said in a research note last week.

Jared Osoro, the director of research and policy at KBA, added that market activities are already concentrated on a few players.

Fitch noted caps could force loan prices to converge, forcing lenders to compete more aggressively on products and service.

“This, it is more likely to benefit larger banks,” the ratings agency said, adding that some types of lending could prove to be unprofitable, forcing small banks to overhaul their business models.

Increase or Introduce new fees

Since the new law will require banks to pay up to 7.35 per cent interest on deposits, at prevailing rates, it will be a nightmare for banks to hold money without doing business with it.

Banks may introduce ledger fees on all accounts, as the law has not put a cap on this. While Fitch says this is a possibility as lenders look to offset deposit cots, KBA has ruled it out.

Institute of Certified Public Accountants of Kenya Chairman Fernandes Barasa said the Government should seal such loopholes.

“Parliament needs to address the issue of capping other banking charges, such as transactional costs and insurance. This might be used as a pathway to compensate for lost opportunities under the interest rates capping law,” he said.

Share resources

In a bid to lower costs, banks are likely to embrace inter-operability. This will help to bring down operational costs, which have been getting out of hand despite an increase in the adaptation of technology.

According to Gerald Nyaoma, the director of the bank supervision department at CBK, the continued rollout of innovative banking products leveraging on technology to reduce costs will help enhance efficiency.

Banks are already working on introducing an inter-participant switch. This, according to Mr Olaka, will allow money to be transferred from one bank to another at virtually no cost.

“For us, we are ready for the switch. We have prepared everything and we are just waiting for other players that may not be ready,” CfC Stanbic CEO Philip Odera told investors on the day his bank was releasing half-year results.

Banks’ full-year expenses rose by 16 per cent overall to Sh315.7 billion in December 2015.

Increase mobile lending

Despite having introduced credit reference bureaus (CRBs) to allow banks to share information about borrowers and determine their credit score, this has yet to translate to increased benefits for consumers.

With the informal sector dominant in the country, bankers have complained that they have scanty information on many borrowers, which has made it difficult to come up with appropriate loan-pricing models.

These factors are likely to see banks switch to mobile lending. Already, many lenders offer this facility. Equity Bank CEO James Mwangi told investors that in the lender’s half-year period to June 2016, 4.3 million loans were disbursed through mobile phone.

“Whatever amounts we disburse, we follow the progress every month. At 97 per cent recovery rate, we feel comfortable. It is an excellent collection, like in microfinance,” said an upbeat Mwangi.

Most banks are leveraging on telecoms’ mobile money transfer services to offer loans. Banks such as KCB and Commercial Bank of Africa have such an arrangement with Safaricom’s M-Pesa, while Equity uses its own Equitel network.

Venture into new business lines

Banks will focus on new lines of business and leverage on their reputation in the market to win customers.

“What we are going to see is banks becoming innovative in providing other services that they are not offering now,” Olaka said last week.

He, however, ruled out the possibility of lenders trying to circumvent the law by introducing additional charges to get a return on credit facilities.

According to Fitch, banks with stronger franchises and more diverse business models should be able to attract new business and, from the greater volumes, offset some of the squeeze on profitability created by capped rates.

KCB has recently tried this by using its investment wing to help distressed Chase Bank out of the woods.

Banks are also likely to get more aggressive with their investment subsidiaries.

They may get more involved in offering crucial advice, such as pricing of companies that want to issue shares or conducting due diligence on corporates, as well as other associated services.

Close some branches

Brick-and-mortar banking is becoming less popular with customers. This is good news for banks, as running physical branches increases the cost of doing business.

Last year, only 80 new branches were set up in Kenya, with 38 concentrated in Nairobi. Further, only in 19 out of 47 counties got new branches, down from 28 counties n 2014.

“The slow-down in physical bank branches expansion is partly attributed to the adoption of alternative delivery channels, such as mobile banking, Internet banking and agency banking,” said CBK in its bank supervision report.

This trend is likely to persist as the use of alternative channels for their convenience gains even more momentum. This should help banks to lower costs as their traditional source of revenue is threatened.

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