Small banks might opt for foreign debt as liquidity tightens

What you need to know:

Dyer & Blair analysts say recent crisis in banking sector has hit tier II lenders’ cash positions.
The sector was recently rocked by the collapse of Dubai Bank, Chase Bank and Imperial Bank.
Reports of large depositors having millions held up in the collapsed banks has pushed the market to redirect funds to large banks.

The lopsided distribution of banking sector liquidity in favour of large banks is likely to push tier II lenders to seek short-term foreign financing to balance their cash positions, potentially exposing them to foreign currency risks.

A sector analysis note by Dyer & Blair Investment Bank said movement by depositors to large lenders in the wake of bank collapses has skewed the liquidity balance further.

It notes although the capital positions of mid-tier lenders remain comfortable, a few may have problems with their liquidity requirements.

The Central Bank of Kenya (CBK) is on record saying that 80 per cent of the sector’s liquidity is concentrated in seven banks, leaving small and medium sized lenders facing chronically tight liquidity.

The sector was recently rocked by the collapse of Dubai Bank, Chase Bank and Imperial Bank, with the result being that the lenders with access to massive liquidity became more careful over who to lend in the overnight window.

Reports of large depositors having millions held up in the collapsed banks has pushed the market to redirect funds to large banks.

“Flight to safety by institutional and high-net worth investors as opposed to yield-chasing will skew liquidity in favour of tier one banks. Given the volatility of the interbank lending market and the skewedness of liquidity control in favour of tier one banks, we expect tier two lenders to shy away from the interbank market in favour of short-term foreign borrowing…resulting in more foreign currency exposure,” says Dyer & Blair analyst Kasee Mbao in the report.

However, the lenders with foreign parent ownership can leverage on the owners for short-term financing, he said.

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

Foreign debt becomes cheaper than domestic borrowing when institutions are charged a rate pegged on the six- month Libor rate (US dollar), which is currently at 1.25 per cent.

Should a lender opt to issue a domestic bond, the risk factor is likely to see them charged a premium on the prevailing government bond rates, which have ranged between 12 and 14 per cent in recent issues.

The interbank lending rate is currently at 5.6 per cent, having risen from 3.1 per cent over the past one month.

For the listed tier-two lenders, raising funds from the stock exchange could prove tricky due to the current bear market, which has seen a majority of bank stocks make double-digit percentage drops in share price in the past one year.

“We are of the opinion that, given the current market prices, rights issues would be ill-advised for tier-two lenders,” said Mr Mbao.

The new interest-rate capping law is also a factor for mid- and small-tier banks, some of which are expected to merge to remain viable.

Current multiples also mean that these lenders are attractive to strategic investors looking to get into the Kenyan banking space.