Written by James Makau
November 18, 2008: A growing appetite for domestic borrowing in government has ended the era of cheap credit for consumers culminating into a gradual but steady business model shift in the banking sector.A silent shift in how Kenyan banks are making money — from private sector lending in favour of government — has been going on in the past year, tightening credit lines across the economy.For the banking industry, this change of business model is not only proving profitable but also acting as a shield from the turbulence that has come to characterise the financial markets as the global economy slides into a recession.The pace of increase in Government borrowing has pushed up interest rates, delivering a handy boon for the banking sector. This appetite for borrowing by the government is expected to rise even further as the economy slows down in tandem with global trends and company profits decline, leaving the taxman with less revenue.The situation is not helped by the fact that the government is in the middle of a fiscal year in which it planned for one of the biggest budget deficits in the country’s history. In the past nine months, interest rates on government paper have, for example, moved from an average of seven per cent in January to 8.5 per cent at the end of last week.Coming at a time when lending to individuals and companies had become less profitable and far more risky, the pull of this improvement in rates has been irresistible to the banking sector.And although lending to the private sector still accounts for the largest proportion of total lending by banks, there has been a steady rise in the volume of lending to government in the past six months.
Consumer lending In recent months, this shift in business model has seen banks back peddle on aggressive marketing of consumer loans that characterized the sector in the past four years.And as the Government faces increased pressure to meet its expanded Cabinet requirements and pressing infrastructure spend, higher yields offered through the Treasury Bills and bonds are now in vogue.“The credit risk profile has changed significantly for banks and at the margin new lending decisions have to be made carefully against the ability to pay,” says Mr Robert Bunyi, a financial advisor at Mavuno Capital. He reckons that with a tightening of credit criteria, it is only natural for banks to park excess funds into government paper. While the Kenyan banking sector has somewhat successfully managed to steer clear off the headwinds in the global financial markets, local pressure arising from January’s post election turmoil still haunts lenders.A steep rise in the cost of living over the past 10 months has had the banking sector on toes, as concerns over borrowers’ ability to meet debt obligations build up.
Banks have been pulling back from consumer lending to government paperFaced with increased energy and utility bills as well as rising food prices, Kenyan borrowers have been hard pressed between servicing loans taken and meeting their consumption needs.To cushion against possible loan defaults, banks have marked up their provisions for loan losses, an indicator of lower risk appetite within their ranks. While in some banks the increase of loan loss provisioning has been in tandem with the increase in loans and advances to customers, this higher provisioning has come against a backdrop of slower lending in others.Barclays Bank Kenya has for instance raised its loan loss provision from Sh808 million in June to Sh1.18 billion in September, while Standard Chartered Bank raised its provisioning from Sh148 million to Sh290 million. KCB Bank reviewed its provision for bad debts upwards by 19.5 per cent to Sh1.1 billion while Equity Bank raised its bad debt provisioning by 18.6 per cent to Sh543 million.While KCB and Equity Bank witnessed a rise in loans and advances to customers, both Barclays Bank and Standard Chartered have registered slight declines in loans and advances to customers in the third quarter of the year.
Back to the 90s?Central Bank data shows that the interest rate margin — gap between deposit and lending rates — has halved from 20 per cent to 10 per cent in the last six years subdued by the steady drop in lending margins.Lending rates have dropped from between 25-30 per cent to between 14 and 20 per cent, while deposit margins have risen marginally from an average of four per cent to five per cent as competition for deposits hots up. The drop in the net interest margins has posed the highest risk to earnings for an industry that has posted record profits for five consecutive years.Declining lending margins had been worsened by the bleak outlook on the rate of return on government paper, which previously was the industry’s cash cow. By mid last year, Treasury bill rates had dropped from a high of 15 per cent in 2004 to 6.2 per cent as at last Thursday’s auction. The drop in the interest rates is a result of excess cash in the money market.Over the last three years, the net interest margin has been reducing following the steady decline of lending rates driven by intense competition in the loans market among industry players.Banks have been making money by taking short term deposits at low rates and lending them for longer periods, and at higher rates, to companies and households.As a result, the net interest margin had been steep and the lending business easy.“I think the days of cheap and easy credit will come back, probably in 2010 as the economy stabilises,” says Mr Bunyi.Banking sector analysts say that in the long term the nominal cost of credit should fall as inflation declines.Interest rates should also decline if we as a country finally figure out a stable political architecture that is conducive to private enterprise.“With sustained inflationary pressure in the short term, investors will continue to demand relatively higher yields,” said Mr Edward Gitahi, senior investment manager at AIG Investments. “From a strategic standpoint, players in the banking sector need to be aware of the need to have scale because it enables one to sell a diversified range of financial services, absorb loan losses and address numerous market niches. Also I believe banks have to figure out solutions that would be of interest to small and medium businesses the segments that will see the fastest growth in the medium term,” he said.