High cost of loans sets banks on path to profit record

Commercial banks posted Sh111.5 billion profit in the 11 months to November 2013 surpassing the full-year performance for 2012, according to the Central Bank of Kenya (CBK) data.

The lenders made a total pre-tax profit of Sh107.7 billion in 2012 and 2013’s harsh operating environment associated with the General Election was expected to depress the overall performance.

Banking sector analysts said the industry’s performance is linked to the huge interest spreads they continue to enjoy in the marketplace. The lenders have more recently been able to retire expensive deposits while growing their loan books in a market of high interest rates.

“In 2013 the banks managed to expand their lending activities without significant increase in the cost of deposits, leaving them with large interest margins,” said Francis Mwangi, who heads the research arm of Standard Investment Bank.

Though 2013 started with a low uptake of loans, the lenders appear to have turned the tide in October and November, disbursing a total of Sh70 billion in new lending that pushed the total loan book to Sh1.59 trillion.

Deposits grew at a slower pace, attracting only Sh10 billion in new funds during the same period and pushing total savings to Sh1.92 trillion.

The huge growth in the banks’ loan book came in the wake of the CBK’s decision to increase cash flow in the economy through a reduction of interest rates.

READ: Bank profits surge to record Sh108bn on expensive loans

The CBK data shows that Kenya’s six largest banks had saved more than Sh10 billion from the reduction in interest expenses by the end of September 2013, pointing to a slowdown of the aggressive deposit mobilisation activities earlier in the year.

The profit performance cements the banking sector’s position as the most profitable sector in Kenya, a reality that is also expected to see the recent drive to bring down interest rates led by Deputy President William Ruto intensify.

Though news of increasing profitability of banks is music to shareholders’ ears, it has recently come under heavy criticism that the success is coming at the expense of other segments of the economy that continue to pay a high price for capital.

Finance secretary Henry Rotich — responding to Mr Ruto’s quest to reduce the cost of lending in the economy — recently asked the Competition Authority of Kenya to investigate the banking sector’s operating environment.

“Of critical concern to the government relating to competition is the level of interest rates which may be slowing the investment pace in various sectors of our economy. I welcome the authority’s initiatives towards reviewing competition in the banking sector,” Mr Rotich said in his communication to the competition authority.

Commercial banks have over time insisted that the high interest rates they charge are linked to the high cost of lending and high risk levels in the Kenyan economy.

But it has become clear that the high interest margins enjoyed, especially by the six largest bank, remain the key driver of the industry’s profitability.

That reality was confirmed by a recent World Bank study of Kenya’s lending market which found that the greatest proportion of the wide interest margins (48 per cent) goes to bank profits — higher than what is absorbed by operational costs.

The CBK data shows that the gap between the interest rates that large banks charge their borrowers and what they pay depositors stands 12 per cent.

READ: Large banks squeeze more profits out of customers than small lenders

KCB, Equity, Barclays, Co-op, Standard Chartered and CFC Stanbic are officially classified as belonging to the large banks segment of the industry.

The six, who are all listed on the Nairobi Securities Exchange, took home 65 per cent of the industry’s profits in 2012. Small and medium-sized lenders operated average margins of 9.9 per cent.

Average lending rates stood at 16.32 per cent last September while the average fixed deposit rate stood at 6.45 per cent.

Most savers are, however, being paid an average of two per cent interest rate for money deposited in the current and savings accounts.

The CBK has said that it is persuading the lenders to review their pricing of debt which is the only option available to the regulator in a liberalised market.

Parliament has in the past made attempts to regulate interest rates but government interventions have ensured that the lenders are left to self-regulate.

Low interest rates paid to depositors has been blamed for the lack of enthusiasm for savings by the Kenyan public.

“The banks need to go back to growing deposits and that may impact their interest margins as they would have to beat the current government securities returns (at over 10 per cent),” said Mr Mwangi.

The ratio of loans to deposits went up to 83 per cent indicating that the banks had little headroom of continuing to lend without facing liquidity challenges.

The recent growth in lending was, however, accompanied by an increase in defaults as the gross non-performing loans rose to Sh81.4 billion from Sh79.7 billion at the end of September.

Defaults in the industry have been on the rise since 2010 when the CBK initiated a high interest rate regime to prop the shilling and rein rising cost of goods.

The defaults as a ratio of the total loan book however dropped to 5.1 per cent from 5.2 per cent in September, being the first time that the ratio was dropping since 2010.

“When you look at profitability without looking at increase in investment then you miss the whole picture. You have to look at how much the capital base has grown,” said Kenya Bankers Association chief executive Habil Olaka.

Banks have been involved in capital raising activities in the recent past in line with new prudential guidelines introduced by the CBK.