New regulation to hit bankers’ single largest source of income

Interest income from loans and advances, which is the largest source of revenue for banks, is set to take a major hit with the signing of the interest rate capping Bill on Wednesday.

Central Bank of Kenya (CBK) sector data for 2015 shows the interest earned from the products amounted to Sh272.11 billion for the banking sector, accounting for 60 per cent of the total Sh448.03 billion income made by the lenders during the year.

The three largest banks in Kenya—KCB Group, Equity Bank and Co-operative Bank— have reported in their 2016 half year results ratios of  interest income to total income of 78.1, 71 and 78.7 per cent respectively.

Banks are lending at an average rate of 18.2 per cent, which should come down by at least 3.7 percentage points to 14.5 per cent due to the new law; or even less than that if they were to continue to offer lower than average lending rates for large corporate and high-net worth clients.

The minimum deposit rate that has been prescribed for interest earning accounts will also increase the interest expenses of banks, which stood at Sh111.08 billion last year, representing 35.2 per cent of total expenses of Sh315.7 billion


In an analysis of six large banks—CFC Stanbic, Co-operative, DTB, Equity, KCB and NIC Bank— analysts at UK investment bank Exotix Partners Ronak Gadhia and Alan Cameron say banks’ 2017 net interest margin could shrink on average by 200 basis points to 5.6 per cent as a result of the new cap.

“The largest impact will be on the likes of Co-operative, Equity and KCB due to their high exposure to local currency retail loans, which typically have the highest lending rates,” say the Exotix analysts.

“The impact on banks’ deposit costs will depend on their underlying deposit split between current, saving and term deposits. In this regard, we note that banks with relatively high corporate loans tend to source a higher proportion of their deposits from long-term and savings accounts.”

Banks may therefore be forced to cut other costs to accommodate the narrower margins, which could spell the continuation of staff reduction efforts that have been seen in some of the larger lenders in the past three years.

An increase in the risk-free lending to government is also on the cards once the lenders are unable to add onto their customer loans the risk premium that has been the cause of personal loans going as high as 24-25 per cent in interest.

The surge in money offered to government could eventually bring down the rates on offer on treasuries, thus reducing as well the interest earnings from this line of lending for banks.

According to Exotix, the return on equity for banks is also likely to go down, although being far higher than the average for the region, the banks should still remain attractive in the long run for investors looking to share in the profitability of the sector.