Kenya’s super-size banks rake in huge profits by widening rate spreads

At KenCom House in downtown Nairobi, the race is on to build East Africa’s largest bank.

It was only in 2002 that former KCB boss Terry Davidson divided it into a “good bank and bad bank,” long before these words would be made famous by bankers in New York and London struggling to save the world from the 2008 cash crunch.

Boasting a loan book of $1.6 billion and revenues of $371 million, KCB has come a long way from its days in the corporate graveyard.

In the past five years, its loan book and revenues have grown by a compound annual rate of 27 per cent and 22 per cent, respectively.

The bank now has 203 branches — the widest distribution network in East Africa. Yet KCB became number one in Kenya by a fluke, almost after a nod by Barclays Bank, a rival several streets uptown.

Barclays was too scared to grow at a time when its UK parent company was battling a crisis that could have ended in a forced nationalisation.

To conserve capital and head off a bad loans crisis resulting from a heady expansion that saw it grow its $904 million in 2005 to over $1 billion in 2008, Barclays instead decided to shrink some $205 million in 2009.

It did not even fight hard to attract more deposits, which remained flat at $1.5 billion.

KCB, on the other hand, picked up $479 million in new deposits, which stood at $2.2 billion.

This is almost the size of I&M Bank, Kenya’s 12th largest bank by total assets.

The battle for supremacy between Barclays and KCB in the past decade has been shaped by Kenya’s shifting economic fortunes, competition from other banks, and the global financial crisis.

Local banks saw and seized the opportunity to grow, but foreign owned banks sought self-preservation.

This is a route that Equity Bank took, but with mixed results.

Five years ago, Equity was just emerging from its microfinance roots into just another fast growing mid-sized bank.

However, after selling a 25 per cent stake to a private equity fund managed by Helios for $150 million, its high capital base pushed it into the big league.

Equity’s chief executive officer, James Mwangi, responded with an aggressive push into mainstream banking, doing what every other bank was doing while still rooted in microlending.

Equity opened special divisions that served the rich; build up a treasury department and moved to a new headquarters.

Last year, Equity went way too deep into an expensive branch expansion that dented its performance in 2008 and resulted in layoffs.

As its payroll crept up from $39 million in 2008 to $5.8 million in 2009, insiders say Mr Mwangi fired some of his senior executives, instead of rethinking the branch expansion.

Closing branches months after opening them would have been a PR nightmare.

Yet with rental charges and depreciation piling $16 million on operating expenses, compared with $10 million a year earlier, it will take time for Equity to digest this expansion.

So far, with costs accounting for 63 cents for each shilling of operating income that the bank earns, the expansion has eroded the cost competitiveness that Equity enjoyed, which was second only to Standard Chartered’s among the big banks.

Even for a bad year, banks in 2009 enjoyed an easy time making money.

The easy pickings came from charging customers fees and commissions — which are also referred to as nuisance charges.

For instance, when a customers uses the banking hall, or ATMs, or foreign exchange and Treasury bond trading.

Analysts at Kestrel Capital say there was a notable increase in bond trading.

For Barclays and KCB, growth in the fees, commissions and trading income remained relatively flat.

For Barclays, this helped to stabilise revenues as its loan book shrank.

For Equity, most of its growth was powered by robust growth in this category of income.

Perhaps, the most controversial issue in the way these banks generated profits is best illustrated by the widening difference between how much they paid to borrow funds (from deposits, other banks, and shareholders) and what they eventually charged customers as lending rates.

Banks became adept at minimising their cost of funds and mismatching their loans to achieve high margins in a banking system that was awash with liquidity.

“The banks will do well as long as the government continues with the loose monetary policy,” says Johnson Nderi, a research analyst at Suntra Investment Bank.  

Equity had the highest interest yield spread of 13.8 per cent.

For instance, Equity and Barclays generated 14.96 per cent and 14.58 per cent, respectively, on their loan books, compared with the 1.17 per cent and 1.71 per cent they paid for deposits.

“It could be a result of cheaper deposits,” says Carol Musyoka, an independent financial consultant. On Barclays, her former employer, she said: “Probably it dropped off a few corporate and institutional deposits which are more expensive.”

Banks also boosted their earnings by making lesser provisions for bad loans, hoping that fewer customers will default as the economic outlook is brightening.

“This year, we expect a return of salaried and consumer lending,” said analysts at Kestrel Capital.

In this race to the top, the balance sheet of these firms, and particularly the amount and nature of capital available to these banks, will play a big role.

So far, Equity is awash with excess capital.

With a total capital of $300 million, it is holding 12 per cent excess liquidity (against a statutory minimum of 20 per cent), and 19 per cent excess capital measured against its total risk weighted assets.

This excess capital provides a good buffer against future losses, but it could also be deployed to double its lending book and deposit holdings before breaching the capital adequacy ratio.

Barclays, too, with $370 million in total capital, can double its deposits and loan book.

KCB, which has powered its growth using its retained earnings and share premium, is quickly running out of room for growth, without a recapitalisation.

The management, in its recent briefing, mentioned raising more long-term capital as a pillar to support its growth strategy.

KCB’s total capital now stands at $241 million.

Standard Chartered, with a capitalisation of $132 million, cannot afford to super-size itself to match its rivals without injecting of more capital.