Kenya Economy: 2016/2017 Highlights of the Banking Industry
The banking industry in Kenya has had a turbulent two years in a row where business growth has been curtailed significantly and the local economy is still reeling from the effects. The industry continues to suffer decreased profits and the layoff rate has increased significantly due to unsustainable overhead cost of human resource.
We would endeavor to analyze in this write up the four key risk events that have left the banking industry limping with losses.
Closure of two major banks
Closure of Imperial and Chase bank caused skewness in the local interbank market. The reasons for closure of the banks have been largely articulated, what has been left to analyze is their impact in the financial sector.
The interbank market is a market in which banks extend loans to one another for a specified duration of time. Most interbank loans are for duration of one week or less, the majority being overnight. Such loans are made at the interbank rate which is determined by banks
The skewness resulted in some banks having excess cash while other banks having little cash. The situation could not be salvaged by the interbank lending market because banks had lost faith in one another and no one would risk giving cash to the other bank from fears that it may collapse.
The Central Bank of Kenya intervened by pumping in cash into the local market to avoid collapse of another bank. Though no other bank collapsed the impact of the closure of Imperial bank and placement of Chase bank under receivership was devastating to the economy.
Most of the impact from liquidity skewness can be observed now as banking institutions release their financial results which indicate reduced profits or outright losses.
Also Read: The Death and Resurrection of Chase Bank
De-risking by international banks
Accuity, the global financial crime compliance, payments and know your customer (KYC) solutions provider has revealed that between 2009 and 2016, correspondent banking relationships, have reduced globally by 25%.
Since global financial crisis of 2008, regulators have imposed requirements for greater transparency, established higher liquidity thresholds for banks as well as stepping up enforcement actions on institutions that violate anti-money laundering (AML) regulations.
Stringent regulations and high penalties for non-compliance has led to de-risking by major correspondent banks hence cutting out some geographical regions like Africa since the financial reward of correspondent banking does not compensate compliance penalties risks.
Kenyan banks rely on correspondent banking relationships to settle foreign transactions and allow importation of goods to the local market.
Local banks have been having difficulty in finding or retaining global correspondent banks as de-risking by international banks in Europe and US hit emerging market regions. De-risking is the process where an international bank terminates correspondent banking relationship when the threat to the bank of doing business in the high risk geographic areas outweighs the benefits of services to their client.
With AML penalties clocking as high as 10 billion dollars in 2014, doing correspondent banking in high risk geographical areas has become impractical.
Lack or loss of correspondent banks has increased international transaction costs for local banks. Many local banks have to use more than one intermediary which significantly increases transaction costs and decreases transaction efficiency.
Third tier banks have been largely affected as their risk compliance levels fall short of international standards while their portfolios do not support acquisition of advanced AML and KYC automated systems.
Local banks have to look now beyond Europe and US for correspondent banking services to retain their international customers. The East may be a good place to start especially China which seems to be unaffected by the current global correspondent banking restructuring.
Interest rate capping
President Uhuru Kenyatta signed into law the banking amendment bill which put a cap and a floor on commercial banks’ lending rates and deposit rates respectively.
The amendment has put a cap on commercial banks’ lending rates at 4% above Central Bank Rate (CBR) which is currently at 10.00%. This means that the maximum effective lending interest rate would be 14.00% for all commercial banks.
On the other hand, the amendment looks to put a floor on the deposit lending rates at 70% of the CBR. The lowest rate on deposit would be 7.00% (70% of 10.00% current CBR rate).
The banking amendment bill 2015 adversely affected ability of banks to generate future cash flows. This can be elaborated by examining the core banking business. The main objective of a bank is to leverage its capital and take deposits from individuals with surplus funds and lend the money to individual who have no funds. The other activities like transaction charges are off balance sheet activities in that they do not largely affect the cash flow of the bank.
Banks make money from the spread differential between the money deposited and the money lend by the bank. The spread differential varies from bank to bank in accordance to their corporate policies and risk threshold. Analysis of the spread differential pre and post amendment signing into law would reveal the recent slump in banking profits.
Political risk is the probability that an investment expected return would be adversely affected by political decisions, events or conditions in a given geographical area.
Investors take certain actions in anticipation of political risks to shield their investments from adverse returns and loss of capital. These actions would lead to economic downturn, upturn or stagnation depending on the level of risk anticipated.
Kenya faces economic fluctuations due to the 2017 general elections. Political risks have more impact on emerging markets like Kenya which depends on foreign direct investments (FDI) to boost local economic growth.
Political risk in Kenya may cause capital flight, low foreign investment and reinvestment which may lead to higher interest rates, higher foreign exchange rates and low economic growth in the country.
As of now, the only resilient asset in the economy is the Kenya shilling value. The shilling has been fairly stable against the US dollar but this can be attributed to the increased reserves and stringent monitoring of the markets by the regulator rather than economic factors.
The economy is shrinking as government borrowing continues to impede investors and commercial banks from lending money to the real economy. Apart from government borrowing being risk free, commercial banks cannot afford to offer better deposit rates than government borrowing rates hence any rational investor would give money to the government.
On the other hand, commercial banks have no incentive to lend money to the real economy whereas the government is offering about the same rates (loan rate capped at 14.00% while government offering about 13.555% on bond issue) with no liquidity, operational or credit risk.
The regulator may have to significantly raise the CBR to incentivize commercial banks to lend to the real economy and enable it to stop relying on government expenditure to boost economic growth.
All in all, the future looks bleak for the banking industry and the economy as a whole if the status quo remains unchanged.