Why banks need Sh76bn under new capital rules

New capital ratios will force eight listed banks to collectively increase shareholder capital by Sh76 billion so as to maintain the loan book expansion headroom afforded by the current rules, an investment bank says.

Standard Investment Bank (SIB) notes the listed banks can only grow their loan book by an average 61 per cent under the new capital ratios coming to effect in December, compared to 111 per cent under the current regime.

The new capital regime introduces a capital buffer which will push the minimum ratio of core capital to total deposits up from the current eight per cent to 10.5 per cent. The ratio of total capital to credit advances will go up to 14.5 per cent from 12 per cent.

New requirements mean banks will now make less for every shilling now invested as more resources are diver to meeting Central Bank of Kenya (CBK) ratios.

“To deliver the same growth in risk-weighted assets under new capital adequacy requirement rules, eight of the reviewed banks would have to increase their tier1 capital by a total Sh76.2 billion,” said the investment bank in a report on the country’s banking sector.

It further notes bank returns on equity are likely to be impacted by the higher capital requirements cutting it by an estimated 1.5 percentage points.

To protect the returns on shareholders’ funds, banks have the option to increase lending rates but this is not likely to happen given the pressure to lower interest rates.

Lower return on equity could make banking counters less attractive to investors. Banking sector has been attractive due to its market-beating returns that have recorded rapid growth year on year.

Last year, the industry’s average return on equity was 29.2 per cent with profits before tax of Sh125 billion.

Other analysts concur with the report saying banks’ other options are to diversify their income streams and cut operational costs so as to maintain the returns.

“Given possible reduction in lending rates, hence squeeze in net interest margins, for them to retain the same growth level in earnings, either more capital need to be raised or to look for additional non-funded sources of income so as to maintain same return to shareholders,” said Vimal Parmar, head of research at Burbidge Capital.

The higher capital levels are meant to ensure the industry has financial muscle to absorb shocks in the market such as bad loans.

The Treasury has made public calls for banks to reduce interest rates so as to fuel economic growth through cheap finances.

Some of the banks are already undertaking fund raising. NIC has called its shareholders to an extra ordinary general meeting to approve issuing of a corporate bond and make a rights issue.

READ: NIC mulls raising capital to meet new statutory ratios

SIB estimates that NIC needs Sh5 billion in order to be compliant and keep growing its loan book at the same rate. Diamond Trust Bank is currently raising Sh3.6 billion by selling more than 22 million new shares to its existing stakeholders at a discount price of Sh165 each. I&M is expected to raise Sh3 billion through a corporate bond approved last year.

National Bank of Kenya has received shareholders’ approval to raise Sh10 billion through a rights issue while Housing Finance has also received approval to issue a Sh20 billion corporate bond.

Banks’ lending ability is tied to their capital levels with CBK requiring them to have total capital that is at least an eighth of their weighted risky assets.

Credit facilities issued by banks are referred to as the risky assets but each is weighed differently according to how risky they are perceived. Loans are considered the most risky compared to short-term products trade financing.

SIB notes that banks have been holding high capital ratios compared to the minimum requirements indicating that they needed the headroom to facilitate business growth.