Opinion & Analysis

Kenya banking sector is in poor health

Customers in a Banking hall. FILE PHOTO | NMG
Customers in a Banking hall. FILE PHOTO | NMG 

With the 44 commercial banks having published their Q2 accounts for this year as required by prudential guidelines, it is an opportune time to look at the figures more closely, plot the trends and try to assess what the numbers reveal in terms of both the health of this critical sector and the broader macro economy.

As we all know, the banking system is a reliable barometer for tracking the strengths and weaknesses of the economy. So, what does one see after poring through the statistics?

First, there is an almost complete evaporation of liquidity especially in smaller segments of the banking sector. The number of banks clinging on their licences through emergency injections of liquidity from the Central Bank of Kenya (CBK) have increased from what we saw in quarter one.

The number of banks operating below regulatory minimum requirements, are overdependent on inter-bank funding and have borrowed heavily from the CBK’s Lender of Last Resort Facility are increasing. A sizeable number of banks are forever running to the CBK window for emergency liquidity as they are unable to raise funds from the money market in the normal way.

Secondly, a very high number of small banks are operating below minimum capital requirements and are muddling through with elevated non-performing loan levels that are eroding their capital bases and gradually driving some of them towards insolvency.

Thirdly, we are now seeing a trend where banks are facing major challenges in terms of ability to operate the legacy model of accepting deposits from the public and lending them to businesses at a profit.

When you look at the numbers closely, you will find that nearly ten banks cannot continue operating on the legacy business models because the cost structures are misaligned with revenues. They are not making money from intermediation.

When you look at the statistics on cost income ratios, the inescapable conclusion is that the reason many of our banks are still in business is because they have resorted to the easy option of trading in government paper. They are not banks-anymore. They have become traders.

Clearly, the operating environment for the banking sector is slowly deteriorating by the month. Key statistics such as the percentage of non -performing loans to capital, earnings, revenue growth, cost to income ratio and return on capital, point to depressing times for large swathes of our banking sector.

But is the interest rates cap regime responsible for the deteriorating business environment for the banking sector? Methinks the decline in the business environment for the banking sector predates the rate-capping law. The trends in decline in loan growth that so dominates policy discussion today started long before Kiambu MP Jude Njomo came to town with his rate-capping law
The slow take up of credit we are seeing today is also the trend in Tanzania and Uganda.

It is most likely a reflection of stressed private sector balance sheets in the economy. However, the rate-capping law, has without a doubt- exacerbated the situation. We are witnessing the consequences of the folly of imposing interest rate caps in an environment of high non-performing loans in the banking sector.

Did we really expect the rate-capping regime to work in the context of widespread financial distress among small banks? I am not arguing against the need to keep lending spreads low.

If we want to protect consumers from greedy banks, why can’t we think about a consumer protection law for the financial sector, complete with thresholds on the category of small borrowers that can enjoy the protection.

The truth of the matter is that the rate-capping law as practised in Kenya only protects interests of politically-connected borrowers with hundreds of millions in loans from state-controlled banks that they have poured into speculative investments. High lending spreads are bad for the economy. But the economy will also be healthier when you have many profitable and efficient banks.

Our banks are operating under a regime where prices of inputs are controlled at 70 per cent of the Central Bank Rate while output prices are capped at four per cent above the CBR. Lending spreads, the difference between lending and borrowing rates, are capped at seven per cent. Before the rate-capping law was introduced, the greedy banks enjoyed lending spreads that were always in double digits.

We must all accept the bitter truth that the banking sector is not in very good health.