Long-term deposits deny banks room to cut lending rates

Commercial banks are tied with expensive long-term deposits and bonds, making it difficult for them to cut lending rates further.

In 2008 and last year, some big banks signed long-term fixed deposits at about 10 per cent and raised billions through corporate bonds at between 11 and 12 per cent when the economy was gripped with tight liquidity.

The country was at the time facing a scarcity of deposits, prompting banks to pay higher rates of about 10 per cent for up to a decade as they sought funds for onward lending.

But with a build-up of cash and scarcity of investment opportunities, deposits rates are now falling as the short-term government debt market gets saturated, leaving investors with loads of cash to bank.

For instance, the rates for wholesale deposits have dropped to between six and seven per cent in 2010.

The cut in deposit rate has been even deeper in the small savers segment where the rate of return is at below 1.5 per cent from about two per cent last year.

But for banks that had gone heavy in search of long term fixed deposits in 2008 and 2009, they have been left with expensive money since they cannot change terms of the contracts midway.

“There are those who are still paying the higher rates of last year on their deposits,” said Mr Shamaz Savani, the managing director of ABC Bank

“Normally once you sign an agreement for a fixed deposit for a year or more, you have to stick to it, even if interest rates come down in between.”

Most banks — save for KCB and Citibank — have lowered their base lending rates by between one and 1.5 per cent, a move that analysts attribute to the expensive whole sale deposits that account for about 40 per cent of the country’s lending book.

Central Bank of Kenya (CBK) Governor Njuguna Ndung’u has been pushing banks to cut their lending further in line with the fall in Treasury bills and bonds.

The 91-day Treasury-bill has dropped from 7.3 per cent to 1.72 per cent over the past year while the long dated bond has dropped from an average of 12 per cent to nine per cent.

This means that banks that raised money from the capital markets for onward lending are holding expensive money.

For instance, CfC Stanbic raised Sh2.4 billion last year through a corporate bond that they will pay a 12.5 per cent return annually for seven years.

The implication of this is that banks are likely to reduce their focus on the expensive route of raising working capital through the corporate bond or commercial paper markets.

No bank has recently indicated its intention to raise money through a corporate bond.

Both types of instruments are priced such that they offer a premium on corresponding Treasury instruments, indicating that banks would have to offer higher rates to obtain money from investors.

Even preference shares in some institutions have raised the cost of money for them and even increased the risks despite the overall high growth of the sector.

Bridge mismatch

A major reason for banks to raise new long-term funds that inevitably turn out to be more expensive is that they need to reduce the mismatch between assets and liabilities in the sense that deposits are mostly short term but the growth areas such as mortgages require long-term financing.

“The banking sector in Kenya is faced more and more with increasing asset-liability mismatches as the earning assets mix gets more long term in nature, while the deposit and savings character remains the same,” said an analytical report by Faida Investment Bank.

The report noted that some banks are locally tapping the domestic markets to raise currency through fixed-income instruments to bridge the mismatch.

“Where this has been successful, the cost of funds has been much higher, three or four times, than ordinary retail deposit funding costs,” says Faida.