Market News

Interest rates cap shaves Sh26bn off banks’ income

The Central Bank of Kenya (CBK) building in Nairobi. FILE PHOTO | NMG
The Central Bank of Kenya (CBK) building in Nairobi. FILE PHOTO | NMG 

Last year’s capping of interest rates has shaved Sh26.3 billion off commercial banks’ lending  income in the first six months of the year, setting the lenders up for lower profitability this year.

The 38 lenders earned Sh140 billion from interest charged on loans to customers, a 15.8 per cent drop from the Sh166.3 billion they earned in a similar period last year, according to data compiled by the Business Daily.

The rate capping law came into effect in September last year, limiting interest charges to a maximum of four percentage points above the prevailing Central Bank Rate, currently standing at 10 per cent.

Interest income plunged even as the industry’s loan book grew by 4.9 per cent to Sh2.38 trillion.

The lenders’ non-interest income grew by just 6.6 per cent or Sh4.2 billion to Sh67.8 billion, putting many of them on the path to reduced profitability.

Kenyan banks recorded an 11.2 per cent drop in net profit to Sh52 billion for the first six months of this year compared to last year, and analysts expect full year earnings to be lower than 2016.

Steep fall

Interest income for the first three quarters of this year were expected to fall steeply compared to last year when the banks were free to price the loans according to the borrowers’ risk profiles.

“Looking forward, we expect the third quarter to produce more of the same in terms of lower earnings, given that it is only the last quarter which will be like-for-like with 2016 as far as the rate cap goes,” Standard Investment Bank’s head of research Francis Mwangi said.

“Smaller banks are affected more, and this will continue due to the skewed liquidity distribution in the market and the intense competition for deposits that has emerged in the sector.”

Kenyan banks have over the years been some of the most profitable in the world, with the return on equity (RoE) for tier one lenders averaging 25 to 30 per cent between 2010 and 2015.

This has, however, dropped after the rate cap – leaving the RoE at 13.6 per cent in March from 18.2 per cent in June 2016. Tier one RoE shrunk from 34.7 per cent to 23.1 per cent in the same period.

The half-year data shows that banks resorted to cutting their cost of funds in order to stave off deeper fall in profits.

For instance, the lenders cut their interest expenses by Sh10 billion or 13.1 per cent, paying out a total of Sh67 billion compared to more than Sh80 billion in a similar period last year.

This was in spite of the law prescribing a floor rate of seven per cent on interest earning accounts (CBR minus three percentage points) – signalling that many banks moved depositor funds to the transactional category that does not earn interest. 

Government lending

Officials data also shows that the banks have directed most of their lending to the government, raising their holdings of the public debt instruments by Sh162 billion to Sh1 trillion by the end of June.

Interest earnings from these securities rose by 12 per cent or Sh5.7 billion to Sh52.4 billion as a result, a trend that is expected to persist in the medium term.

Standard Chartered Bank,#ticker:SCBK Equity Bank #ticker:EQTY and KCB #ticker:KCB remain the largest lenders to government among commercial banks, having bought Sh116.3 billion, Sh105.1 billion and Sh101.7 billion worth of government securities respectively.

This increased lending to government has starved some key sectors of credit, slowing down economic growth.

The Central Bank’s second quarter credit survey shows that more than half of banks said the rate cap had negatively affected their lending to small and medium sized businesses (SMEs), which are the main drivers of job creation and a key cog in the wheel of economic growth.

“Up to 54 per cent of the commercial banks indicated that interest rate capping negatively affected their lending to SMEs.

"Interest rate capping has compelled banks to increase their risk mitigation measures, locking out potential customers below certain risk thresholds on existing products standards,” the CBK said in the report released last week.

Overall, the annualised growth in private sector credit stood at 2.1 per cent at the end of May, the slowest growth rate in over a decade.

Political risk has also affected the issuance of new credit this year, with 55 per cent of polled banks reporting that they had tightened standards towards the General Election, fearing that unrest would affect the ability of businesses to repay loans.