KCB Group CEO Paul Russo has just one rallying call to his team: ‘Go find cheap deposits’. He wants them to thrive at what has been one of the toughest tasks for his team and indeed the banking sector this year.
Banks have watched as the number of customers opting to invest directly in government paper rise, forcing them to increase returns on deposits to levels last seen 26 years ago in an attempt to stop the flight to Treasury bills and bonds.
However, this decision by banks to increase deposit rates to a 26-year high of 11.59 percent on average by September this year has come at a high cost to lenders in the form of increased interest expenses.
Kenya’s top nine banks paid customers Sh306.24 billion in interest on deposits in the nine months ended September, marking a 26.1 percent growth or Sh63.4 billion from Sh242.85 billion in the preceding similar period.
The increase in interest expenses came despite the stock of deposits dropping to Sh5.679 trillion at the end of September from Sh6 trillion nine months earlier.
While part of the decline in deposits had to do with the 17.4 percent appreciation of the shilling, which reduced the value of dollar-denominated deposits in local currency terms, Central Bank of Kenya (CBK) Governor Kamau Thugge reckons that customers were diverting some of their deposits into government paper.
“Because T-bill rates have been attractive to depositors, there has been movement of some deposits from banks to T-bills. And for them (banks) to attract deposits, they had to raise the interest rates they gave on deposits and that rate is the cost of funding which they passed on to customers in terms of higher lending rates,” said Dr Thugge during the recent post monetary policy media briefing.
Banks believe that the digital platform, called Dhow Central Securities Depository (DhowCSD), which was launched on September 11 last year to buy government paper, has everything to do with their increased cost of funds.
The platform has disrupted their access to cheap deposits by providing a window for individuals and firms to easily purchase government paper, even via their smartphones.
This is the first calendar year that investors have enjoyed the convenience of automated purchase of government paper on gadgets such as smartphones, marking a departure from the previous practice where they had to physically visit CBK offices and file a slew of paperwork for approval.
However, the platform has rattled commercial banks, which have warned of risks including the loss of fixed deposits and their intermediation role in the financial system.
Big headache
Mr Russo says that while depositors deserve a decent return, they should be aware that without cheap deposits, banks will struggle to cut lending rates.
His biggest headache going forward is finding cheap deposits, even if it means turning more to development finance institutions. But he is not alone. He says bank CEOs have have met several times this year to discuss how to cut lending rates when deposits are high.
“I think at the end of the day, every depositor needs to go where there is a return, and a better return for that matter. So we have to appreciate that,” says Mr Russo.
“We want to bring down the cost of credit but certain elements and parameters are standing in the way. If we are going to be borrowing money at 15-16 percent…Yes, we are taking some deposits at that rate, what do we need to do? My push for my team is to go get cheaper liquidity.”
CBK summons
The challenges of finding an answer to this question has seen banks drag their feet in cutting lending rates this year, even with several summons from CBK, which started cutting the central bank rate (CBR) in August.
This year, CBK has lowered the rate by 1.75 basis points to 11.25 percent from the 12-year high of 13 percent, which lasted between February 6 and August 5.
The standoff has seen the pace of growth in private sector credit fall to a 22-year low of 0.4 percent in September as borrowers flocked to Saccos where rates are not tied to the CBR and are therefore generally lower.
Lenders argue that they had already locked in deposits at a very high rate. Kenya Bankers Association (KBA) chairman and NCBA Group managing director John Gachora, said earlier this month that lending rate cuts will be gradual as higher cost deposits mature and are replaced by lower cost deposits.
“As the business of banking involves mobilising deposits and extending loans from the pool of deposits, we will continue to progressively reduce the loan interest rates balancing against the prolonged high cost of customers’ deposits that were locked in during a period of higher interest rates before the CBK initiated interest rate cuts,” said Mr Gachora.
Hailed by the CBK as a “simple, secure and efficient” system for investing in government securities via mobile phones and the online portal, DhowCSD is now seen by banks as a tool for customers to have their cake and eat it too, and flock to banks asking for the same cake.
The number of central securities depository (CSD) accounts stood at just 41,125 when DhowCSD went live, but by the middle of this year it had more than doubled, with no sign of slowing down.
The number of accounts had reached 83,259 by mid-year, with individuals—many who ordinarily used to keep their money in banks with little or no return— making up 79 percent of the investor base.
Banks have been reluctant to increase lending in an environment where loan defaults have been rising on the back of general economic hardships, with defaults hitting Sh669.5 billion in September or 16.5 percent of the Sh4.064 trillion loan book.
Mr Russo says banks may have to navigate the new year by turning more to development finance institutions for loans as “alternative sources with better pricing,” if borrowers such as small and medium-sized enterprises are to enjoy cheaper credit.
“If private sector lending continues to go the direction it is going, we are concerned. There is absolutely no reason for trying to run a bank and credit to the private sector is shrinking. It should concern you as a CEO. But you are also an agent, you are working on behalf of depositors,” said Mr Russo.
Banks are hoping for some respite as the rates on short-term papers continue to come down, promising to touch single digits.
Yields on 91-day, 182-day and 364-day Treasury bills averaged 10.03 percent, 10 percent and 11.76 percent respectively in the auction held for the week ended December 15. The same papers fetched 15.98 percent, 15.97 percent and 16.1 percent in the first auction of the year in January.
