Relatively low interests spreads in Tanzania and Rwanda are likely to slow down expansion by Kenyan banks to these markets, favouring Uganda.

According to a study by the Kenyan Bankers Association (KBA), the relatively higher difference between the interests charged on loans and paid on deposits — interest spreads — in Uganda, compared with Tanzania and Rwanda, makes the country the most attractive destination for Nairobi headquartered banks. Burundi remains the least attractive in the East Africa Community, due to a seemingly volatile economy.

The study shows that the level of inflation in targeted markets in the region is emerging as a top consideration as is labour mobility.

“The spread differential informs foreign branch decisions of commercial banks in Kenya. The above holds for Uganda, with a positive regression coefficient whereas Tanzania and Rwanda are negative,” reads the KBA report, titled The drivers of bank expansion abroad: Evidence from East Africa.

Data from the World Bank shows that in 2012, the interest spread in Kenya stood at 8.2 per cent and was 5.9 and 10.1 per cent in Tanzania and Uganda respectively. In Rwanda, the spread oscillated around 9.6 per cent.

Kenyan banks have been on an expansion spree over the past five years, opening a total of 282 branches in the region as at the end of 2012: 124 in Uganda, 70 in Tanzania, 52 in Rwanda and five in Burundi. The banks had 31 branches in South Sudan at the end of last year.

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Another KBA report released last week shows Tanzania is the largest external market for Kenyan banks, accounting for 37 per cent of their foreign assets. Kenyan lenders have 24, 14 and one per cent of their assets in Uganda, Rwanda and Burundi respectively. South Sudan is home to 14 per cent of the total assets held by Kenyan banks.

“Kenyan banks seem to prefer to expand to a country where inflation is relatively low and less likely to cause macroeconomic instability,” reads the report titled Determinants of Banks Expansion in the EAC: An Empirical Analysis of Kenyan Banks.

Kenyan banks are looking to regional markets to reduce exposure to their home country, with KCB and Equity aiming to generate about 25 per cent of their profits from the region in the next three years.

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The challenges posed by volatile macroeconomic indicators have also had an impact on the performance of Kenyan banks in the region.  For example, the contribution of Equity’s international business dropped from 12 per cent to 8 per cent of total earnings in the six months to June.

Equity Bank CEO James Mwangi blamed the suspension of donor funding in Rwanda and Uganda as well as the hostility between Sudan and South Sudan for the poor performance of the foreign units.

Last year, donors cut aid to Uganda by 80 per cent — about $180 million — over graft allegations, forcing the government to reduce spending. The central bank estimated the suspension cut the country’s economic growth by 0.7 per cent.

The suspension of oil exports by South Sudan over clashes with Sudan triggered a spike in inflation and negatively impacted on the economy. Oil generates 98 per cent of the government’s revenues.

Burundi, with one of the most volatile economies, partly due to its huge dependence on aid, a narrow tax base and limited government resources, has attracted the smallest fraction of Kenyan banks in the region.

For example, in the first five months of the year, the country’s tax collection fell by 20 per cent partly due to a fire that destroyed the country’s largest market — a key source of government revenue. The World Bank ranks the country as being “high risk of debt distresses.” This has served to make it unattractive to lenders.

The relatively lower banking penetration across the region coupled with the first mover advantage enjoyed by local banks has made it harder for Kenyan banks to grow their loan books.

“Kenyan banks operating in these markets make a bigger share of their profits from non-interest income, partly reflecting the low credit uptake in these markets,” said Kamau Kuria, a research analyst at Kestrel Capital, a Nairobi based brokerage firm.