How increasing interest rates set banks for profit windfall


The Central Bank of Kenya in Nairobi. FILE PHOTO | NMG

Commercial banks are set to gain from the rising interest rate environment as returns from both government securities and private sector lending continue to increase.

Yields from government securities are, for instance, expected to continue growing from the pass-through of a higher Central Bank Rate, deficit financing by the exchequer and investor expectations on the direction of interest rates.

The expectations for higher interest rates have driven yields on short-dated interest rates upwards culminating in an inversion where returns on short-term papers such as Treasury bills are greater than long-dated bonds.

Commercial bank lending rates have meanwhile soared to multi-year highs, pushed in part by competition from government paper and the implementation of risk-based credit pricing.

The average commercial bank lending rate for instance rose to a 65-month high of 13.5 percent in July according to data from the Central Bank of Kenya (CBK).

Combined, the rising yields are expected to drive up banks' interest income for the year to December 2023, setting up lenders for another period of record profitability.

Analysts expect the higher lending margins presented by the rising interest rates to spur growth in loan underwriting by banks.

“We expect the banking sector to report a comparatively faster loan book growth than in 2022 following implementation of risk-based lending which when combined with rising interest rates results in higher lending margins,” analysts at Sterling Capital noted.

The analysts expect private sector lending to nevertheless ease slightly, averaging between 10 and 12 percent for the year as high yields on government securities offer banks an attractive alternative to private sector lending.

An unprecedented increase in non-performing loans (NPLs) in the banking sector and a further spike in returns from government securities could, however, set the private sector credit growth trajectory lower.

Banking sector NPLs have, however, been tipped to track growth in the loan book, resulting in a largely unchanged outcome in asset quality.

Additional data from the CBK shows banking sector profitability rose marginally to Sh120.2 billion in six months to the end of June from Sh119.7 billion a year earlier.

Gross loans over the same period meanwhile expanded by 13.9 percent to Sh3.98 trillion from Sh3.49 trillion previously.

During the first half of 2023, banking sector liquidity slumped to 49.7 percent from 52.5 percent pointing in part to increased lending.

Asset quality in the sector has been largely unchanged with the NPLs ratio having fallen to 14.5 percent in June from 14.9 percent in May.

Manufacturing, transport and communication, trade and consumer durables sectors have led in the demand for credit over the opening half of the year.

The number of loan applications and approvals has remained strong, reflecting resilience in economic activity.

Private sector credit growth eased to 12.1 percent in July from 12.2 percent in June and 13.2 percent in May. Nevertheless, the growth has remained in double digits since March 2022.

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