When the going gets tough, the strong gets going and the weak fall aside”, this is the story line of Kenya Banking environment and dynamics.
The Banking and financial intermediation sector is encountering rough weather and serious headwinds in the last one year or so. It began with inefficient management & governance led loan impairment crisis, leading to credit losses beyond absorption capacity. This was followed by liquidity crisis when wholesale institutional depositors closed doors on most of Tier 2 & 3 Banks, who were forced to borrow at any cost to stay afloat for survival. The bolt from the blue is the cap on the lending rate at 14% when sovereign yields are elevated at 8.5-12% across 3 months to 2 years and 12-14% across 2 to 10 years, which made financial intermediation not profitable. Most of the Tier 2 & 3 Banks are forced to operate on either wafer-thin margin or negative spread with very high incremental interest cost to fund the huge gaps in the Asset-Liability mismatch of the Credit & Investment portfolio.
All combined, most of the Kenya Banks are in struggle for breath from combination of issues around Capital, Liquidity and Profitability. The P&L impact from spike in credit loss provisions and squeeze in operating margin is huge, and most need to pump in additional capital to stay above the regulatory Capital Adequacy ratio. This is the long and short of the Kenya Banking and financial intermediation environment.
The survivors of the liquidity crisis are a few Tier 1 Banks and few well performing private Banks who have the confidence of the wholesale institutional investors. Given the small size of this category of Banks who are seen as zero or low risk, it is wind-fall for them to get wholesale deposits at interest rates below sovereign yield. This segment is not impacted from the cap on the lending rate given their access and walk-in flow of time liabilities at deposit floor rate of 7%, thus giving higher net interest margin. If this is seen against steady loan impairment and credit loss provisions & write-off, the profitability of the top-tier banks could only improve.
The lazy banking comes from Banks in this segment who are credit risk-averse, who have the enviable option of deploying the 7% cost deposit in Government Bonds at rate 10-12% for 1-2 years getting good spread without deployment of risk capital. The bottom-line is that strong Banks with access to low cost wholesale deposits have no reason to worry on capital and profitability if there are no issues in the Credit portfolio. Even for those who have issues on loan impairment, there is sufficient room to manage from enhanced bandwidth from profitability and release of capital from shift of credit exposure from 100% risk weight to 0% sovereign risk weight without slippage in the top-line assets.
What about others? The group which do not have access to low cost institutional and wholesale deposits from companies and/or high net worth individuals are the worst hit, who are forced to borrow marginally below the lending rate cap or higher if the need and appetite is high. Most Banks in this category have serious problem in non-performing credit portfolio with the need to dip into P&L account for higher provisions and write-off. When the P&L is on decline, additional demand from credit loss provisions will lead to capital erosion pushing the Capital Adequacy ratio below the regulatory requirement. None from this category have the capacity to bring in additional capital to fund the P&L gap from combination of higher provisions and squeeze in net interest margin. It is a kind of Tsunami vicious circle for this category from combination of limited access to capital and liquidity against squeeze in Net profit, and would need financial engineering to declare growth in Net Profit and for stay above regulatory capital adequacy ratio. Watch out for decline in net profit and capital adequacy ratio with increase in net NPA, if not in Gross NPA against limited bandwidth to maintain higher credit loss provision.
The going is tough and those strong are few, it would be kind of extremes in this earnings season. There will be few at the top declaring very positive results, while most at the bottom in struggle for both ends meet. There will be few Banks as exception with well-run credit portfolio and product-pull access to current & savings deposits without dependency on high cost wholesale deposits.
This picture will put the Central Bank on its back-foot to come out with resolutions. Kenya in its growth phase needs a large group of strong Banks to provide leverage to private & public capital, which is already a scare commodity. It is also systemic risk to have large number of weak Banks, thereby giving limited alternate to conservative depositors. The extreme situation of lack of confidence on most Banks by the depositors and risk-aversion by lenders to most borrowers is not positive and optimistic sign on the Banking and financial intermediation system. It is time for the Government and Central Bank to provide course correction, before it turns too late!
Guest Opinion;
Mr. John Moses Harding serves as an Advisor to the Chairman and Board of Directors at State Bank of Mauritius (SBM) Holdings Ltd.
He has 27 years of banking experience having held senior roles at various International Financial Institutions including Group CEO of Liability & Treasury Management at SREI Infrastructure Finance, CEO of Infrastructure Finance Limited,
Twitter; @mosesharding
