Kenya: Banks Reaping From High Interest Rates, But This Trend Has No Long-Term Future

Nairobi — The biggest controversy with regard to the banking sector over the past few years has been that of the interest rates.

The current high and rising interest is a challenge. Commercial banks have been lending at the upper end of the interest rate spread despite the lowering of the CBK base rate between 2008 and early this year.

President Kibaki, Finance minister Uhuru Kenyatta, and Central Bank of Kenya governor Njuguna Ndung'u have tried to persuade commercial banks to lower lending rates with little success.High overheads have been cited as the root cause of the problem. While this may be true, it could also be that we have too many commercial banks.

Although the increased number of banks would normally be expected to induce competition, the 43 banks currently operating in the country are too many for a small economy such as ours. Countries with bigger economies and higher population have far fewer banks.

The increase in the number of banks has led to competition in the clamour for deposits from few sources, resulting in high cost of funds in the form of paying high rates to big depositors, contrary to the norm that competition brings down prices.

Kenya's banking system could do better with fewer banks. Some banks are small, yet they have to invest heavily in their own switch, open up many branches, and roll out products for just a few customers, making their cost per customer high.

This is eventually passed on to the client. If we had fewer banks spread over the same number of customers, the cost would reduce, translating into lower lending rates.

The decision by the Central Bank to increase the minimum core capital of banks from Sh250 million to Sh1 billion was the opportune time to slash the number of banks.

However, we seem to have missed the chance because CBK either gave the banks too much time or most banks were already meeting the new requirement.

If the time to meet the requirement was shortened or a core capital higher than Sh1 billion set, some banks would have been compelled to either merge or be taken over by bigger banks.

The quest to post high profits is also responsible for high banking and lending rates. The assertion that credit risk and/or overhead cost is to blame for the high cost of lending is, therefore, only partially true.

According to a recent World Bank report, the interest rate spread in Kenya has remained relatively steady and hovered between 10-12 per cent for the past few years.

Overheads and profit margins have kept the spread high, contributing 4.22 and 3.19 per cent respectively.

Profit margin contributes around 33 per cent of this spread, compared to provisioning for bad and doubtful debt loans, which accounts for only around 15 per cent of the spread.

Although urgent attention is needed to bring sanity and fairness to the system, there is little the authorities can do to force banks to lend at reasonable rates.

If commercial banks have not responded to CBK's reduction of the base rate by lowering their own lending rate, policy makers stand little chance of persuading banks not to raise their lending rates now that the base rate is headed north. Kenyan businesses and households can only hope that the moral conscience of commercial banks can trigger a favourable response to calls to reduce interest rates.

The commercial banks owe it to themselves and to the nation to lower the cost of borrowing. The current state of affairs is not tenable.

Commercial banks must realise that excessive interest charges increase the risk of huge loan losses and financial instability in the medium-term, which creates a necessity for them to moderate short-term profit expectations.

They must see provision of affordable credit as being in their own interest. They need the economy as much as the economy needs them. In fact, it is not possible to talk about long-term stability of the banking sector without a strong and prosperous economy.

One of the major sources of funds that keep banks going is interest payments from the private sector. A weak private sector is a serious threat to financial stability and will not be in the long-term interest of the banking sector.