Lending rates cut may see banks shift focus to non-interest income

The banking industry is likely to shift its focus to non-interest income to mitigate a revenue decline resulting from a drop in lending rates.

A report released on Friday by Sterling Capital further says commercial banks could retire expensive fixed deposits held mostly by corporates in order to reduce interest expenses.

Following the January 14 reduction of the Kenya Bankers Reference Rate (KBRR) to 8.54 per cent from 9.13 per cent, commercial banks that are highly dependent on lending to business for their income are set to experience reduced interest income, says Kenya’s Sector Outlook 2015.

AT THE FOREFRONT

“To curb this, we should anticipate commercial banks to increase their focus on non-funded income, with agency banking being at the forefront. We also are likely to see most banks retiring expensive fixed deposits in a bid to cut back on interest expenses,” the report says.

The Central Bank of Kenya (CBK) and the Kenya Bankers Association (KBA) introduced the KBRR in July 2014 as a reference rate for banks to use in pricing their loans.

This was expected to bring transparency to the loans market and increase competition, leading to a decline in lending rates.

The annual percentage rate (APR), which calculates the total cost of credit in order to bring transparency to the loans market, was introduced alongside the KBRR.

The APR constitutes the bank interest rate based on the KBRR, in addition to the premium. Other costs like legal fees, insurance, valuation and government levies are factored in.

Analysts have predicted that the gradual decline in lending rates would see the earnings of banks whose portfolios are not well diversified but which are highly reliant on lending, decline going forward.

According to January 19 report by ratings agency Moody’s, corporate-oriented banks like NIC and CFC Stanbic could be the hardest hit because “corporate loans and deposits are highly competitive and price sensitive, and banks typically charge a very tight premium over the KBRR. For these banks, we expect a rapid and sharp decline in net interest margins”.

Conversely, retail-focused banks like Co-operative, Equity, Kenya Commercial Bank (KCB) and Barclays have greater latitude to delay their response and make lower adjustments to pricing by charging higher premiums.

“Their profitability is, therefore, likely to be less affected,” Moody’s investor report says.

Banks like KCB, Equity and Co-operative, for instance, generate 40 per cent of their non-interest income, therefore they are not lopsidedly reliant on interest income. Much of the non-funded income is accrued from agency banking and forex trading.

CFC Stanbic, on the other hand, generates 50 per cent of its proceeds from non-interest income, which is primarily derived from forex trading.

“We expect the mentioned banks to continue recording similar growth numbers as the historical growth recorded,” Parshv Shah, an analyst at Afrika Investment Bank, notes.

The sector is, however, expected to grow strongly on the back of improved credit uptake in sectors like construction, mining and housing. The relatively lower KBRR is also expected to attract more lending.

By the third quarter of 2014, banking sector loans and advances stood at Sh1.9 trillion. Deposits were at Sh2.15 trillion.

Widening of distribution networks away from brick and mortar to agency banking and through technology like mobile phones has helped boost deposits and diversify revenue streams.

GROWTH IN LOAN AND DEPOSITS

This is in addition to regional expansion by a number of local banks, a phenomenon that has seen growth in loans and deposits. 

“Product development through partnerships with retail supermarkets, telecom providers and the bancassurance model has also pushed the growth of non-funded income. We expect this to develop further with the rise of cashless payment systems across the country,” Sterling Capital analysts say.

In a highly competitive environment, local banks have resorted to a raft of cost cutting measures, including laying off workers they deem redundant, deploying technology and use of agencies in deposit mobilisation and in making a number of transactions in a bid to maintain their growth momentum.

They are also increasingly targeting new clients in the retail and small and medium enterprise (SME) market to sustain momentum on loan growth.