Banks finally realise that rate cap is here to stay whether they like it or not


bgnzkbolil30y0qd5951f6d536acc Banks finally realise that rate cap is here to stay whether they like it or not

Banks have done a tidy job of trying to play down the number of staff they have been forced to let go, mostly to keep at bay unions officials who are not likely to take the matter lightly and probably to ensure it does not rattle their public image.

Since the law of capping interest rates came into play, screenshots of memos have been leaking to the press with the recent move by Barclays to shed off 130 employees.

Such unending moves indicate the onslaught is nowhere near its tail end. Lenders have offered to fire over 2,000 employees over the past year as they adjust to the rate capping regime. Whether the retrenchment is voluntary is another matter altogether.

“Banks have to cut the fat and the old model was indeed a fat one,” explained Rich Management Chief Executive Officer Aly Khan-Satchu.

This however shows the panic in the industry – that reacts to the new regulatory regime as double digit profit growth dips and thin margins set in.

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Loss territory

If the financial results of the first quarter of 2017 are anything to go by, the projection for the full year is unnerving. The management will have a hard time explaining to the shareholders what the future holds for them.

Lenders have on average shed up to a quarter of their revenues, compared to a similar period a year ago, with a good number of previously profitable names sliding into loss territory.

According to Central Bank of Kenya (CBK), significant slowdown in credit growth has eaten into banks’ profitability with the sector profits before tax for February standing at Sh20.4 billion, down from Sh26.3 billion posted during a similar period last year and Sh49.1 billion in 2015.

In a note to investors last week, Standard Investment Bank (SIB) took a review of the market, noting that for the second quarter under the rate cap law, net interest margins (NIM) has been shrinking by an average 1.44 percentage points between the first quarter of last year and the first three months of this year.

Equity Bank has registered the highest interest contraction of 3.14 percentage points, while Cooperative Bank’s NIM shrunk the least, cushioned by decline in the rate offered by the lender on deposits and increased lending.

Barclays Bank has maintained the highest net return from loans due to higher rates on loans and lower rates on deposits.

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When the budget speech was being prepared expectations soared on whether the Finance Bill would strike out the rate cap law, giving hope to lenders. But this was never forthcoming.

Under the lobby, Kenya Bankers Association, lenders quickly released surveys on the adverse effect of the law on the Capital Markets and the risk it posed to the economy.

Lenders were also hopping that the advice of the International Monetary Fund (IMF) would resonate well with policy makers to drop the punitive law.

President Uhuru Kenyatta in his last address to the Nation under his first-term as President raised hopes even higher with indications that the law needed review. “On the issue of access to credit for SMEs, it is unfortunate that the unintended consequence of the capping of interest rates was a slowdown in lending by our commercial banks,” the President said. “This is an issue that concerns us and is one that I will actively seek to resolve so that credit can start to flow again to the real drivers of our economy.”

When Financial Standard reached out to Treasury CS Henry Rotich then, he explained that the government was monitoring the situation with a view of taking appropriate action, including reviewing the way the capping operates.

This was just a week after CBK Governor Patrick Njoroge was quoted by The Wall Street Journal as saying that the cap on interest rates was “temporary”.

But with just months towards the elections, populism triumphed over reason, MPs said they would thwart any attempt  scrapping the law and CS Rotich kept away from making any proposals to scrap the controversial law when he tabled the Finance Bill in parliament.

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The banks will have to live with the law at least for the foreseeable future. “We do not expect major shifts in net interest margins in the second half of 2017… now that the law has not been repealed,” SIB said.

Although analysts agree that cutting down on the number of staff is the right move for any lender, especially in the digital age, they reckon that lenders have to do more on the quality of their loan books and any other costs that can be done away with to maintain profitability.

“While we are content with high capital adequacy and liquidity ratios would offer room for above book value multiples, we are mostly concerned by weak guidance offered on long-term strategic initiatives to manage non-performing loans and preserve return on equity,” SIB said.

George Bodo, the Head of Banking Research at Ecobank, said that lenders have to be efficient. “We think, as part of adjustments to the law, cost-to-income ratio should not exceed 40 per cent in order to stay positive operationally,” Mr Bodo said.

Bad debt

Managing costs has especially been made tricky with huge stock of bad debt which has to be provided for in the books.
A tenth of all loans issued by banks are not being paid and the gross bad loans now stands at a record Sh228 billion against gross loans of Sh2.3 trillion.

The only exception is Cooperative Bank whose asset quality improved in the period, from an NPL of 4.3 per cent in 2014 to 4.2 per cent.

As of last year, among the top ten lenders, I&M Bank had the lowest cost to income ratio at 48.6 per cent followed by Standard Chartered bank at 52.5 per cent, Kenya Commercial Bank (KCB) 58.1 per cent and Cooperative Bank at 58.3 per cent.

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The desired level for most lenders is below 40 per cent.

Coop Bank is one of the lenders which has impressively cut down on expenses, including staff, and digitized to improve its efficiency ratio from a high of 59 per cent in 2014 to 47.9 per cent in the first quarter of 2017.

CBA also did well, improving from a high of 55.4 per cent to 45.9 per cent. “Having undertaken a business transformation dubbed ‘Soaring Eagle’ prior to the advent of rate caps, the bank reported that 88 per cent of customer transactions have been migrated away from branches to alternative channels,” Coop Bank said in an email.

“Over 63 per cent of branch staff moved from back office to front-office sales roles, boosting productivity while cutting cost.”

On the investments side, the banks explored other frontier for survival so as to continue playing the numbers game. The focus was to either to loan more or play it safe and cut on loaning risky ventures. According to CBK data, banks credit to the private sector has remained at all-time low of four per cent since August last year when the law capping rate was introduced, the lowest in over a decade when the country was undergoing post poll chaos.

Mr Bodo thinks lenders should not shy away from the market but instead ensure they get good borrowers. “Because lending business is no longer margin-driven, they need to volumise business through a product-focused approach to lending. This is why strategies like cross-selling now matters a lot,” Bodo said.

“Additionally, price is no longer a competitive factor and lending is now a battle of the good customer. Banks now have to either look for these customers out there or create them.”

Increasing lending

While Equity bank has cut lending to riskier segment as a result, Coop Bank has done the opposite.

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It has increased lending by 15 per cent from Sh214 billion in the first quarter of 2016 to Sh246 billion to March this year over concerns that cutting back lending will hurt customers, which will in turn hurt the bank in the long-term. “Equity Bank stands out as the only bank having adopted a balance de-risking strategy by cutting its loan assets allocation,” SIB said in the note last week.

Stanchart also announced that they are targeting SME with up to Sh12 billion up for grabs for lending this year, a shift from peers shying away from the private sector. “Stanchart have a blue chip SME book and are probably able to make a very calculated risk adjusted intervention. Others might not have the same blue-chip SME Customer Base. Again StanChart like KCB is signaling strength,” Satchu said.

For Coop Bank, the over 5,000 saccos with assets worth more than Sh800 billion offers them potential for quality loans since their sacco business account for 54 per cent of the lender’s entire loan book, alongside mortgages that are backed by assets.

Other lenders have opted for loans to State although as a result of flooding that space, they have pushed down the rate of return on the Treasury bills and Treasury bonds which are trading at record lows.

This overwhelming interest has enabled the government to get cheaper credit with the 91-day bill trading at record lows of 8.4 per cent from high of 22 per cent in the late 2015, while the half-year and full year Treasury bills trading at an average of 10 per cent each.

Although inflation that was at 11.7 in May is above the T-Bill rates, Mr Satchu said it is mainly a food phenomena that will not affect the real value of lenders returns. “If you strip out food inflation basket – Inflation might well now be negative. Therefore, Government bonds offer value especially if borrowing increases after polls,” he said.

He added that especially for Tier 1 Banks perspective such as Barlcays, KCB, Equity, longer duration bonds look good value.
The cost of the money to be invested has also created another avenue for differentiation.

KCB recently jolted the market after it offered 8.5 per cent for a goal savings account instead of the seven per cent prescribed by law. “Yes I noticed that. I think KCB is signaling strength and calculating that they pay a concession to take capture the imagination and what tends to be sticky money,” observed Satchu.

“We still remain in a Darwinian moment when the fittest of Tier Ones and Twos will survive. By appreciating a positioning for the Future the Winners will win big.”

Deposit rates

Across the industry however, lenders who were getting money at rates higher than 10 per cent used the laws recommendation of a floor on deposit rates of 70 per cent of the Central Bank Rate to cut their expenses.

According to SIB, the average rates on deposits contracted 0.9 percentage points year on year in the first quarter of 2017.

“As expected, on cost of funds, Tier 2 banks have benefited the most from the introduction of interest rates controls – the spread between highest and lowest rates on deposits has contracted from 4.18 percentage points to 3.40 percentage points in the first quarter of 2017,” SIB said. The lenders also changed interest-earning deposit accounts into transaction accounts to shield themselves from the deposit rate imposed by the Banking Amendment law.

A review by SIB on the supply of money showed that the value of interest-earning accounts contracted by Sh176.23 billion to Sh1.017 trillion in the wake of the new law, levels last seen in 2014.

Mr Bodo explained KCBs strategy as a bid to get funding a longer period and the move by smaller lender to stick to funds from transactional accounts as their source of funding as the way to go. “To survive, banks need to do two things: first, they need to significantly reduce re-pricing sensitivities by match-fund their asset books. This means building more sticky liabilities,” he said.

“Second, at the same time, they need to keep balance sheet funding costs as low as possible-which implies building more low-cost stick current account funds.

This is especially to Tier 2 and Tier 3 banks who have a penchant for expensive purchased funds.”

Banks must also look outside the box of lending. There are immense opportunity to diversify non into interest incomes.

Forays into bancassurance, leasing, capital markets is becoming popular with Barclays Africa set to acquire a controlling stake in Kenya’s First Assurance for Sh2.9 billion while Equity, has an underwriting subsidiary named Equity Insurance Agency Ltd.

Kenya Commercial Bank has KCB Insurance Agency while NIC Bank has NIC Insurance Agents.

The must also up their game in the financial technology space as channel strategy and make products like the mobile lending competitive to their financial technology (FinTech) counterparts.

Mobile money

Tala, Branch, Saida and Mombo Mobile, which issue short-term loans via mobile money and have been dispensing billions competing fervently with regulated lenders like CBA’s M-Shwari, M-Coop Cash, KCB-M-Pesa and Equitel.

“Those Lenders who appreciate we are at an inflexion point and that they need to fundamentally re-engineer their business Models will do best and FINTechs of course who are not carrying a legacy on their backs,” Mr Satchu said.

The high cost of running brick and mortar branches at a time of mobile-disruption, coupled with regulatory flexibility that has allowed non-bank channels to serve as bank agents has left most financial institutions in dilemma – over   how to optimise physical outlets while bringing down costs.

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