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Citi says rate caps to hit small banks hardest

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Small lenders have traditionally offered relatively higher interest rates to attract deposits. PHOTO/FILE

Summary

  • Regulation of rates is expected to hurt small banks the most since they lack the economies of scale of their larger peers to work with the thinned margins.

The capping of interest rates could force small Kenyan banks out of business to the advantage of big lenders, researchers at Citibank have predicted.

The Banking (Amendment) Act 2016, which came into force on September 14, sets the maximum lending rate at four percentage points above the Central Bank Rate (CBR).

The law also sets minimum returns payable by banks on customer deposits at 70 per cent of the CBR.

This has thinned margins for banks, with small lenders taking the biggest hit in their business model.

Small banks, which rely heavily on wholesale deposits, had been paying interest of more than 10 per cent to cash-rich firms and high net worth individuals.

The cash was then lent to borrowers at rates of up to 18 per cent or higher, leaving them with a significant spread to cover their cost of funds and book a profit.

Regulation of rates is therefore expected to hurt small banks the most since they lack the economies of scale of their larger peers to work with the thinned margins.

Besides lending, big banks earn billions of shillings from transaction charges on millions of customers giving them a diversified income base.

“Assuming that the top five to 10 banks, in a country with over 40, are the best placed to drive this sort of strategy, one would expect that many of the smaller banks could potentially be forced out of business,” reads the Citi report.

Seven large banks, including KCB, Equity, and Co-op Bank, had a combined market share of 58.2 per cent last year when 21 institutions classified as small lenders had a market share of 9.24 per cent.

Citibank says consolidation of Kenya’s banking industry is likely to be the biggest impact of interest rates regulation, with small lenders teaming up or being acquired by their larger rivals.

READ: CBK study urges small banks' merger to pool lending funds

The anticipated mergers and acquisitions could also be driven by the moratorium on licensing of new commercial banks, making takeovers the only option for new entrants into the local banking sector.

Small lenders, which have less than 200,000 customers, have traditionally offered relatively higher interest rates to attract deposits from cash-rich firms and individuals.

Regulation of interest rates, which currently places the maximum lending rate at 14 per cent and deposit rate at a minimum of seven of seven per cent, has brought down margins to seven per cent from the previous range of between 10 per cent and 15 per cent.

Margins for small lenders is expected to be compressed further from incurring relatively higher cost of funds in the context of failure of Dubai Bank, Imperial Bank and Chase Bank that saw a significant flight to perceived safety that benefited the big banks.

Citibank says large lenders are better positioned to lend more and raise their transaction charges as a strategy to offset the thinned margins.

“In this environment what we would probably expect to see is that the larger, more dynamic banks will have to compete more aggressively in volume terms to offset any loss in spread earnings,” reads part of the report.

“Moreover, they would also benefit in this case from being able to add small additional, non-interest charges to lending facilities.”