Kenya: Cash Crunch Erodes Net Earnings of Small Banks

Kenya's small banks have recorded a sharp decline in net earnings for the first half of the year in a marked contrast to the steep profit growth reported by their large counterparts. Analysts say the contrasting fortunes between the two tiers of lenders could lower competition in the sector, exposing customers to higher costs of financial services.

Middle East Bank, Giro, Transnational and Oriental Bank have all announced a decline in profit for the first six months of the year, which were mainly attributed to losses on sale of government bonds and an increase in their interest expenses.
Equity Bank and KCB, Kenya's top two lenders by profitability, have announced double digit growth in profits in the same reporting period.
Widening
A tight monetary stance by the Central Bank of Kenya (CBK), struggling to tame run-away inflation, has made it hard for small banks to access funds in the inter-bank market or mobilise customer deposits, pushing them to incur high financing costs.
"The big banks are perceived to have lower risk so depositors put their money in them even at a lower rate," said Robert Bunyi, chief executive of financial consulting firm Mavuno Capital.
He added that customers would be the biggest losers as the widening gap between small and big banks means reduced overall competition in the industry.
Giro Bank announced a 39 per cent decline in net profit to Sh161.5 million from Sh265 million as its "other income" category, which mainly comprises earnings from trading government securities fell by Sh279 million.
Oriental Bank reported a 30 per cent drop in net earnings to Sh118 million while Transnational Bank's net income dropped to Sh106 million from Sh145 million over a similar period.
Dim outlook
Middle East Bank, whose earnings declined by 63 per cent to Sh24.3 million, earned Sh15.6 million from "other income" this half compared to Sh100.9 million from the same line made in last year's first half.
"Last year, the banks made a killing from trading Treasury bonds, which they bought low and sold high," said Mr Ashif Kassim, a partner at RSM Ashvir.
Equity Bank and KCB, classified by CBK among Kenya's seven "big banks," announced a 57 per cent increase in earnings to Sh4.7 billion and 41 per cent growth to Sh4.1 billion respectively.
Equitorial Bank was, however, one of the small lenders that have reported their earnings so far to have defied the trend, announcing a profit of Sh30.3 million from a loss of Sh97.8 million last year.
The small banks incurred a higher cost of deposits, averaging about three per cent compared to the larger ones which paid an average one per cent interest on deposits.
KCB, for example, capitalised on cheaper customer deposits, slashing its cost of funds by half to Sh1 billion even as it grew its customer deposits by an additional Sh24 billion.
Average interest payment on deposits stood at 3.51 per cent according to CBK data.
The same scenario is replicated when competing for borrowers where the small lenders lose out to the big banks as they quote higher lending rates.
In the latest review of interest rates by banks only KCB, among the large banks, has reviewed its rates to 15 per cent while most of the small banks have increased their lending rates to an average of 16.5 per cent.
"They simply do not enjoy economies of scale. The way out for them is to build muscle through mergers or injection of capital in order to lower their costs of doing business," said Mr Bunyi.
Analysts are projecting a dim outlook for the small lenders in the second half as high inflation due to food shortages and increasing uncertainty as the country nears next year's elections weigh on economic performance.
With interest rates heading north this year, bond trading has not been as lucrative as last year.
The big banks' income from government securities is also on a downward trend, but they were able to offset the loss in revenues by cutting their spending, especially interest payment on deposits, as that of small lenders went up.The big lenders are also benefiting from profitability growth of their regional subsidiaries.
Big players
The banking sectors has been dominated by the large players with 59 per cent of the customer's deposits held by seven banks while 21 lenders ranked as small banks hold eight per cent of the Sh1.24 trillion customer deposits.
The dominance by the big players has seen them access funds from corporates and wealthy customers at a cheaper rate with small banks being forced to raise their deposit rates so as to attract depositors.