The real problem with Kenya’s banking sector

Is Kenya’s banking sector facing imminent collapse? This is the question that millions of Kenyans have been grappling with in the wake of the closure of three banks in a row since July last year.

The answer to that question is an emphatic ‘No’. A close analysis of the entire banking landscape in Kenya reveals an overall rating for the industry of “Good”. This means that overall Kenya’s banking sector remains sound.

The analysis is based on 12 parameters assessing asset quality, capital adequacy, earnings and liquidity. There are, however, areas of weakness that need to be addressed.

Over the past 10 years, Kenya’s banking sector has grown tremendously. Customer deposits have more than tripled from Sh0.57 trillion in 2006 to Sh2.6 trillion in 2015.

Meanwhile, loans and advances to customers more than quadrupled from Sh0.45 trillion in 2006 to Sh2.3 trillion in 2016.

Thanks to the strict enforcement of the central bank’s supervisory role during Micah Cheserem’s reign and the drive for financial inclusion under Njuguna Ndung’u.

But it cannot be denied that recent events have created a certain amount of doubt in the integrity of local banks.

The closure of three banks in a spate of nine months (Dubai Bank in August 2015, Imperial Bank in October 2015 and now Chase Bank) has sent jitters among millions of bank customers.

Since Patrick Njoroge took over as Central Bank of Kenya (CBK) governor on June 19, 2015, it has not been business as usual for players in Kenya’s banking sector.

Dr Njoroge has vowed to clean the sector. The annual ritual of banks sending their audited annual financial returns for vetting at the central bank has proved anything but.

The level of scrutiny that the financial statements have been subjected to this reporting season has baffled many. Sources have it that the governor has been personally scrutinising these statements.

Banks that had indicated profits in reports presented to the CBK have had those reports change to hugely reduced profits or even losses, mostly on account of enhanced provisions for bad debts.

What is ailing Kenya’s banking sector?
First of all, liquidity is not one of them. All banks met the liquidity ratio threshold as prescribed by the CBK. Because sometimes the demand for cash may be more than anticipated, banks make up for this shortfall by borrowing from each other through the interbank market.
The only problem we have with liquidity is the way it is skewed.

More than 70 per cent of the liquidity is in the hands of only a few banks (at the end of 2015 70 per cent of all quick assets was in the hands of only 10 banks in Tier I).

READ: WEHLIYE: How to restore confidence in the financial sector
When there is a confidence crisis like what Chase Bank faced, no bank was going to give them a dime, even as they watched panicked depositors withdraw their cash in droves.

When I spoke with the CEO of a major bank, accusing him and his colleagues of standing by and watching Chase Bank go through a run on deposits, he curtly asked if I would have preferred that he became the biggest fool that earned the dubious notoriety of giving Chase Bank Sh1 billion on the day it collapsed. He made his point!

Because of this crisis, the interbank market has more or less died. The worst hit are the smaller banks that are now starved of liquidity from the bigger banks.

They are not even lending to each other because they don’t know if they are going to have a run on their deposits as well.
It is worth emphasising that no bank, however big, can withstand a sustained panic withdrawal from depositors.

Indeed, the CBK could have saved Chase Bank by injecting liquidity if its wounds were not “self inflicted”. As Dr Njoroge has said, they will only support banks that adhered to ethical practices.

Chase Bank did not fit this bill because of the massive insider lending that was going on at the bank.

When Imperial Bank was placed under receivership last year, the central bank responded to the ensuing panic withdrawal and liquidity crunch by injecting liquidity through reverse REPOS. This is how it is responding to the current crisis.

The real problem with Kenya’s banking sector is asset quality. Our analysis reveals that the figures on non-performing loans (NPLs) being reported by many Kenyan banks are too good to be true, especially while lending has grown exponentially over the last 10 years.

A bank’s major assets are the loans it gives to its customers. That is why a bank has to be prudent while lending by ensuring that the borrower has the capacity to repay.

When loans go bad, it affects both the P&L and the Balance Sheet because the bank must provide for them. This is what some banks have not been doing as per the prudential guidelines provided by the CBK.

Doubled their NPLs

Since the new governor has put his foot down, gross NPLs increased by 44 per cent from Sh109 billion in 2014 to Sh159 billion in 2015. More than 10 banks doubled their NPL provisions in 2015 from 2013.

As mentioned earlier, the impact of a bad loan book is felt on the P &L, since the loss has to be provided for.
It eats into the profits of the banks, explaining why for the first time in more than 10 years, industry profits have declined by 6.8 per cent to Sh132 billion in 2015 from Sh141 billion in 2014.

It is reasonable to believe that 2016 will be an even tougher year for the banks given the CBK’s resolve to clean up the sector. We will see NPLs rising further and maybe a few more banks in trouble.

Also read: How central bank can rebuild stability in banking sector

The impact of this is that the losses will eat into the capital base of the affected banks like we have seen with Chase Bank and National Bank.
The only way for those banks to survive will be through an injection of additional capital, to merge or be acquired by other banks.

In essence, we are likely to see the banking sector consolidating, meaning we will end up with fewer but bigger banks.

But it is not the end of the road for the smaller banks that are well managed and serve a niche market. The demand for boutique banks is high because they have mastered the art of customer relationship management.

Indeed, Dr Njoroge has started us on this journey. The ride will be bumpy but we will emerge stronger and better on the other side.

However, as he performs his supervisory role, it is incumbent upon him to do everything within his powers to maintain financial stability in the market, which is the key mandate of the CBK. The emergency bailout fund will come in handy.

Mr Oloo is the CEO of Think Business Ltd, a business intelligence and strategic research firm focusing on the financial sector