Expensive funds hurt small banks

Small banks are bleeding in silence as the sterling performance by their larger counterparts portrays a healthy industry.

Weighed down by expensive funds, most of the 22 institutions classified as small banks recorded a drop in profitability over the first six months of the year even as the entire sector registered a 30.4 per cent growth.

A situation reflective of the lopsided nature of the Kenyan banking industry.

Their small deposits base, limited capital, and small customer numbers took a heavily toll on them. While some braved the tough operating environment to post profits, others reported decline in half-year returns, with a few sinking deeper into losses.

“Mobilising deposits from this market segment is usually at much higher costs than would be the case for other banks. In a high interest regime — as was the case — the bank, therefore, will tend to feel more pinch in terms of cost of funding,” said Fina Bank head of marketing, Ms Bernadette Ngara, in an e-mail interview.

Equatorial Commercial Bank, United Bank of Africa (UBA,) and Ecobank registered losses in the period ending June this year. UBA registered a loss of Sh102 million from a loss of Sh82 million in 2011, while Ecobank posted a loss of Sh611 million from a previous loss of Sh126 million.

Similarly, Equatorial Commercial Bank sank deeper into the red, registering a loss of Sh244 million compared to the Sh30.2 million loss it recorded in 2011. Equatorial’s interest expense increased by 258.6 per cent to Sh866.3 million, up from Sh241.6 million, far exceeding its interest income that rose by 77 per cent.

Of the sampled small banks, six — Paramount Bank, Fina Bank, Bank of India, Middle East Bank, Development Bank, and Bank of Africa — registered a decline in their first half-year earnings while seven — Credit Bank, Gulf African Bank, Dubai Bank Kenya Ltd, Fidelity Commercial Bank, Habib Bank, First Community Bank, and Jamii Bora Bank — registered a rise in profits.

Data compiled by Smart Company shows that interest paid to depositors by small banks rose by an average of 279.8 per cent in the first half of this year, an indication that they were hard-hit by Central Bank’s decision to raise the market indicative rate to 18 per cent over the last three months of 2011 from a low of 6.5 per cent.

The increase resulted into rate spike, with the interbank lending rate, the rate at which banks charge each other for overnight lending, shooting up to over 30 per cent.

“Most of these banks lack the facilities and infrastructure to tap into cheaper deposits from customers. So, most of them had to make do with these expensive short-term overnight loans from other financial institutions, which explains the high expenses they paid on deposits” says Kenya Bankers Association chief executive officer Habil Olaka.

The Kenyan banking industry is dominated by six large institutions — Kenya Commercial Bank, Equity Bank, Barclays Bank, Standard Chartered Bank, Cooperative Bank, and Citibank, which controls 53 per cent of customer deposits and 62 per cent of pre-tax profit.

Medium-tier banks total 16 controlling 36 per cent of the market leaving the more than half of the industry to share the remainder9.5 per cent.

The small banks have deposits of between Sh1 billion and Sh30 billion, compared to, for instance, Kenya Commercial Bank’s customer deposits of Sh278.5 billion and Equity Bank’s customer deposits of Sh151 billion as at the end of June 2012.

Jamii Bora Bank chief executive officer, Mr Samuel Kimani, in an interview with Smart Company said the first half of 2012 was a difficult operating environment, given the high interest rates and tight liquidity situation, which made it difficult for small banks to attract deposits.

“Our balance sheet could not grow as much as we expected. The appetite for loans reduced significantly because of the high interest rates,” said Mr Kimani, adding that he expects the bank’s deposits to increase as people seek alternative investments away from government securities, whose yield has declined to single-digit levels.

Its deposits rose to Sh631 million in the first six months of this year, compared to Sh452 million in the previous period.

“We are giving between 8 per cent and 12 per cent interest to attract more bulk deposits,” Mr Kimani said. 
Although several other banks saw a decline in customer deposits, UBA saw the biggest drop, by 67 per cent, to Sh1.1 billion from Sh3.4 billion in the previous period.

Paramount Bank general manager Fred Maina said the bank’s main focus on urban based small and medium enterprises, to whom it paid high interest on their deposits, is eating into its revenues.

“We don’t really go for the small depositors because our facilities and infrastructure restrict us from doing so,” he said, adding that when interest rates went up, clients demanded high returns.

This forced the bank to increase its payout to deposits over Sh5 million to between 14 per cent and 15 per cent from between 5 per cent and 6 per cent.

“So, we found ourselves paying so much on customer deposits while the same customers kept away from borrowing,” said Mr Maina.

Last year, the Central Bank of Kenya raised its benchmark lending rate by 11 percentage points to 18 per cent to reverse spiralling inflation that reached 19.72 per cent in November and to stop the shilling, which hit a low of Sh107 against the dollar, from further weakening in value against the greenback.

The increase in the CBK benchmark rate sparked an upsurge in interest rates by commercial banks from an average of 13 per cent to an average of 25 per cent, making the cost of borrowing dear. (Read: Relief for borrowers as CBK cuts benchmark rate)

The overnight interbank rate also rose to over 30 per cent from single-digit figures, further making it expensive for banks to borrow from one another.

Due to their huge deposit base, the six big banks are the most active on the overnight lending market, giving credit to the small banks but usually at high rates.

Large depositors, such as pension funds, corporates, and individuals with huge cash reserves, also take advantage of the situation to demand higher pay for their bulk deposits.

“It is only those who had the capacity to push the costs to borrowers that were able to fair well. But, what they need to do is to engage aggressively in customer out-reach in terms of branch expansion to enable them to get more clients on their network, which may translate to more deposits,” Mr Olaka observed.