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Small banks bear brunt of rate cap in second quarter

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Banking Tier III banks in Kenya reported near flat earnings in the second quarter of the financial year hit by interest rate ceiling law among other factors. FILE PHOTO | NMG

Commercial banks have just published their second quarter results for the period ended June 30, 2017. How did they fare?

Well, they delivered flat earnings on a quarter-on-quarter basis, perhaps a pointer to the fact that banks were largely not keen on booking new risks during the period.

But the most interesting story was told by the small-sized Tier III banks—19 of them (including the latest entry Dubai Islamic Bank) at the close of the quarter.

The story is that they reported a net loss of Sh284 million during the quarter—the first loss position in FY2017. They did report a loss of Sh220 million in the last quarter of 2016.

Before that, they hadn’t reported a loss for a while. For the two occasions they have booked a loss, three factors have been at play.

First, they are still unable to adjust to the current risk-pricing cap regime (the Banking (Amendment) Act, 2016)—and this continues to shred their income statements.

In the just-concluded second quarter, Tier III names shed Sh1 billion in loan book annuity income, primarily because they didn’t book new risks to the extent that their loan books shrank by Sh33 billion quarter-on-quarter.

Secondly, steep loan non-performance continues to be a thorn in their balance sheets. By the end of the second quarter, close to 20 per cent of their loans were non-performing and this had negative ripple effects on their financials: the proportion of revenues impaired by loan loss provisions doubled quarter-on-quarter to 16 per cent (or the equivalent of Sh700 million).

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Usually, when an asset becomes non-performing, a bank has to appropriate funded revenues generated in the period when such an asset is reclassified towards establishing a loan loss provisions pool.

For the Tier III names, they had to top up their loan loss provisions pot to the extent of 16 per cent of second quarter revenues. The industry level for the quarter was equally elevated, but at around 11 per cent.

Thirdly, these guys continually have serious balance sheet funding constraints. During the quarter, they spent slightly over half of their funded revenues to compensate their funders—which is mostly fraught with the expensive purchased funds.

Previously, they could compensate for any marginal rise in funding costs by simply repricing loan books upwards. But with risk pricing caps, they no longer have that luxury. 

Finally, they are simply not efficient. Indeed, the proportion of revenues appropriated towards overheads (famously referred to as cost-to-income ratio), surged to 108 per cent, from 85 per cent in the first quarter.

This means they spent Sh1.80 out of every shilling in net revenues generated as overheads. This was in stark contrast to industry trend, where banks generally spent 57 cents out of every shilling in net revenues generated. 

Essentially, they bled money in the second quarter. These array of negative business dynamics, as evidenced by second quarter financial performance, reinforces the fact that the long-term viability of a number of Tier III players could be in doubt especially if the current risk-pricing cap regime drags on for two more years and they fail to respond. And survival will depend on a robust response to the negative dynamics.