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Investors burn their fingers on rate cap gamble

By Otiato Guguyu | September 9th 2018 at 00:00:00 GMT +0300

An employee makes notes in front of an electronic stock information screen inside the Nairobi Securities Exchange Ltd. (NSE), in Nairobi, Kenya.

Investors who had put their money in listed banks’ stocks have burnt their fingers after MPs voted to retain the rate cap.

Since last week, counters in the banking sector have been falling in valuation at the Nairobi Securities Exchange (NSE) as speculators who had hoped to cash in on a rejuvenated industry, should legislators have scrapped the controversial law, sell their stocks en masse.

By Thursday’s close, Kenya Commercial Bank (KCB) was down 2.2 per cent to Sh43.50 and Equity Bank was down 1.1 per cent to Sh44.25 respectively on foreign investor selling.

As a result, the KCB closed at a seven-month low while Equity Bank was at a six-month low.

“Generally, banks have continued to experience downward pressure as investors react negatively to Parliament’s rejection of the proposed rate cap repeal as envisioned in the Finance Bill 2018,” said Standard Investment Bank in a note to investors.

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Cost management

In September 2016, there was a massive sell-off of bank counters that ripped the NSE, sending the market value of the listed banks to Sh449.44 billion at the height of the rate cap storm.

However, following a strong International Monetary Fund (IMF) push to remove the cap backed by the government through The Treasury Cabinet Secretary Henry Rotich’s Finance Bill, the lenders’ value grew to Sh743.40 billion as speculators prepared to cash in on the post-rate cap profits.

Sterling Capital, however, said valuations of banking stocks cannot plummet as much since the full effect on their financial performance was fully felt last year.

“Banks have reconfigured their business models in favour of cost-management and the growth of non-interest (non-funded income) and this has seen them improve their earnings. Take a look at the 2018 half-year results to see that the worst appears to be in the past,” said the Sterling Capital Research team in the brief.

The financial advisors and brokers say even with the rate cap in place, banks can still make a decent margin as per their calculation with spreads between 10 per cent and 12 per cent.

“If floors are removed and the ceiling is retained, we will see an interest margin of about 11 per cent-12 per cent, assuming banks will offer interest rates of between one per cent and two per cent on deposits,” Sterling Capital said.

“If the ceilings were removed, (we mentioned some form of regulation to avoid exploitative behaviour by banks) say to 16/17 per cent and the current floor is retained, we will still see a similar interest rate margin.”

Other analysts are not upbeat about the token move to remove the prescription on deposits, saying it will hurt small lenders who have been struggling to survive the current tough operating conditions.

“A repeal would have been ideal. Removing the floor will not improve the banking sector outlook. Right now, smaller banks, which are lending at sub-optimal levels, will continue struggling,” said Jibran Qureishi, Stanbic Bank regional economist for East Africa.

Deepak Dave of Riverside Capital said that removal of the floor would be to force smaller banks to fight for deposits using higher rates than their bigger peers.

“This makes it more expensive for them and squeezes cash into the priciest buckets, thus making money even more expensive,” Mr Deepak said.

Sterling Capital also conceded that the removal of the floor would have a negative impact on the ability of smaller banks to mobilise funds.

Historically, Tier II and Tier III banks have offered more attractive interest rates than the Tier 1 banks in their bid to attract customer deposits.

“Their ability to mobilise customer deposits was significantly affected by the Chase and Imperial banks being put into receivership in 2016. We observed a “flight to safety” with Tier II and Tier III bank customers moving their deposits the banks perceived to be “safer” (Tier 1 banks),” the researchers said.

While lenders predicted stronger loan growth to the private sector with rate cap removal to ride on the recent gains that have seen it touch 4.3 per cent in June, doubts are beginning to emerge.

Mr Deepak said while the demand still isn’t there for the right types of credit, private sector credit growth may remain flat once inflation is accounted for.

“We are not convinced that the removal of the floor on interest on deposits would have a significant effect on private sector credit.

“The reason being that banks have two investment alternatives: lending to the Government or lending to the private sector,” Sterling Capital said.

The current yield on a five-year government security is 11.8 per cent while that on a 10-year security is 12.6 per cent, with the maximum lending rate pegged at 13 per cent.

Reduce costs

In consideration of a comparison of the credit risk between the government and the private sector, banks will still prefer to lend to the government which is considered risk-free.

Banks will need to focus on non-funded income, cost-management, which might include a reduction in staff costs/retrenchment, and digitisation to increase operational efficiency.

They may also have to reduce operational costs and improve customer experience, concentrate on improving the performance and contribution of their regional businesses.

Mr Deepak said there is a possibility of the convenience of mobile money making up for deposit rates, meaning some evening out of the cost of money.  

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NSE Nairobi Securities Exchange Kenya Commercial Bank KCB Equity Bank Interest Rate Cap
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