Small borrowers pay the highest price for loans in Kenyan market

High risk profile and heavy operational costs have widened interest rate spreads in the lowest segment of the lending market, leaving small borrowers with the highest loan burden, a new banking sector survey has shown.

The survey by audit firm RSM Ashvir shows that the interest rate spreads — the difference between the rate charged on loans and what banks pay depositors — stood at an average of 11 per cent last year, making Kenya one of the most expensive markets to borrow in East Africa. 

The profitability of most banks is linked to money they make from lending operations and where the spread is a key determinant of revenue.

Official statistics show that the wide interest rate spreads were key drivers of the 16.1 per cent profits growth that the lenders posted last year.

Commercial banks returned Sh89.5 billion in profit before tax in 2011 compared Sh77.1 billion that the industry realised in 2010.

Profitability of commercial banks and the interest rates they charge has been the subject of intense public debate since late last year causing parliamentarians to seek legal controls on the cost of money.

On Wednesday, RSM Ashvir said its survey had found that Jamii Bora has the widest interest rate spread of 38.9 per cent, followed by
K-Rep at 20.8 per cent, Imperial Bank (20.5 per cent), Family Bank (16.5 per cent), UBA (15.9 per cent) and Equity Bank (15.7 per cent).

“These banks mainly lend in smaller amounts that demand higher margins to finance the high cost of maintaining the accounts,” said Ashif Kassam, a managing partner at RSM Ashvir.

Jamii Bora disputed the figures, saying the audit firm had failed to consider that it sold off some of its bad loans last year as it moved to improve its loans portfolio.

“Last year, we sold our bad loans of about Sh300 million and wrote back suspended interest, which makes our interest income look big,” said the bank’s CEO, Samuel Kimani.

The survey found that banks with a large customer base in the corporate and trade finance markets have significantly lower spreads of up to 4.5 per cent at Development Bank.

Spreads were also significantly low at Citi Bank (6.6 per cent), Bank of Africa (6.5 per cent), Oriental (6.5 per cent) and Middle East (5.7 per cent).

Kenya Bankers Association (KBA) said the higher spreads charged by microfinance banks are linked to the level of risk in the market segment.

“This has more to do with the product than the size of the borrower,” said Habil Olaka, the KBA chief executive.

Mr Olaka said unsecured products attract higher charges because they are riskier unlike the ones that are backed by collateral.

But RSM Ashvir said that at an average of 11 per cent, the interest spreads are high considering that the default risk has dropped steadily in recent years with non-performing loans dropping to 4.5 per cent – below the global benchmark of five per cent.

“The acceptable spread in Kenya should be between 7.5 per cent and 10 per cent so overall banks are enjoying high spreads that are reflected in the industry’s high return on capital at 34.6 per cent,” said Mr Kassam.

The audit firm said it had settled on 7.5 per cent by factoring Kenya’s high inflation rate and credit risk and comparing that with the global standard interest spread of five per cent.

Critics have argued that the fact that banks with small spreads made profits enforces demands for lower interest rates which stand at more than 28 per cent with some lenders.

“The problem is not that banks cannot operate with lower spreads but become  rigid – meaning they can’t respond to market changes and will exclude some borrowers,” said Mr Olaka.

Kenyan parliamentarians have proposed that the lending rates be capped at four per cent above the Central Bank Rate (CBR) and deposits rates fixed at not lower than 70 per cent of the CBR.

READ: MPs ride on tax law to tame commercial banks

Parliamentarians have put up a spirited fight over interest rates, terming banking sector profits as abnormal, standing at more than four folds the GDP growth rate.

In the last financial year, Barclays Bank posted the largest return to shareholders at 61 per cent, followed by Standard Chartered at 49.1 per cent.

KBA acknowledges that this level of return on capital is high but argues that the right figure to use is the risk adjusted return which factors in the unique operational challenges that the lenders face.

RSM Ashvir said it used the published annual results to calculate the interest spreads.

Mr Kassam said the firm had divided interest on advances by average performing advances to get the average yield on advances and to arrive at the average interest on deposits.

Mr Kimani of Jamii Bora said that the bank is currently lending at between 18 and 24 per cent and paying depositors at the rate of between two to three per cent.

“For large deposits we pay higher. I have just come from taking Sh1 million at 15 per cent and I can tell you that our spread is at half the 38 per cent they are stating,” he added.

K-Rep managing director Albert Ruturi held that it had a micro-finance arm whose clients risk profiles are high.

“If you look at our micro-finance business then you should compare us with Kenya Women and the others because micro-finance business is labour intensive and associated costs high,” said Mr Ruturi. 

gngigi@ke.nationmedia.com