Submitted by Kevin Gikonyo,
Former Banker,financial market consultant and a contributor to Nairobi business Monthly.
Harry Markowitz a renowned scholar corralled a theory in 1952, otherwise known as the Management Portfolio Theory (MPT). His empirical literature emphasized on diversification of risk and has been used in many settings, albeit most doers of MTP have never read it, simply because it was anchored on sheer logic. An example, if you happen to be an Olympian in a javelin contest, chances of making to the medal bracket are more when you make many attempts, of course “un-Yego-nically” stating.
Many businesses that have become industrial giants have made a mark and survived from periodic income shocks due to the fact that they diversified their income streams. The likes of Samsung, LG, and Apple to mention a few embraced this concept to the core and it has given them colossal returns. Locally, a classic reference resonates well, when we analyse Safaricom’s market dominance as a mobile service company, in the early year 2000 where Kencell, now Airtel, opted to concentrate on the high-end market thereby limiting its income stream to a chosen few. Safaricom chose to diversify and tap as many customers as possible through agents, per second billing and the now M-PESA money minting “technobank” mobile service and the rest is history.
The Kenyan Banking industry is no exception to these pace setting concept of diversification. The more customers, the more returns to shareholders. Equity Bank the 2nd largest bank in Africa after CBA Kenya, by customer base of close to 9million, used the same theory to dominate more than a decade ago and has recently posted a 10.1 Billion KES half year net profit ending July 2016, representing an 18% increase in profit compared to a similar period last year. Equity bank commonly referred to as a “Poor man’s” bank pitted KCB by March 2016 as the most profitable bank in the region. KCB held the mantle for several years as the most profitable, largest customer based bank and has slowly over the years been overtaken by Equity bank and now only retains as the biggest bank by asses base in the region. The latter will certainly be reversed soon to Equity’s bank favour, owing to the newest acquisition in DRCongo of ProCredit bank’s 79% share in September last year and propagation of Equitel mobile service.
While the concept has been used almost to a “near-perfect” by Equity bank, there is one bumpy aspect that seems to elude most players in the industry and has been subject to heated debates around interest on loans. This debate has been going on for years and has only maintained undertones and periodically resurfaced at eminence of economic contractions over the years. This year has been one of the toughest for businesses and for the first time in Equity bank’s history their loan portfolio shrunk by 6 Billion KES to 269 Billion, while that of KCB almost flattened to 347.3 Billion since December last year at 345.9 Billion.
Ms Waitherero of Standard Investment Bank (SIB) was quoted saying the shrink could be attributed to bank’s increase in choosing the quality of loans by lending to only those with good credit ratings. A keen look into the interest rates around the world, Kenya’s average of 18.3% at the moment ranks as one of the highest and the relation is somehow inversely related to developmental status of a country. With the most developed nations like USA, Switzerland, UK and Japan having the least interest rates on loans of nearly 2% p.a on average.
An unforgettable look into the past in 1993 commercial banks in Kenya chocked its customers with high interest rates that skyrocketed to 35% bringing most businesses to their knees. Auctioneers became a busy lot at the time and made a kill out of the misery of poor Kenyans who defaulted on loans. They defiled years of hard sweat for family business empires and companies without regard and the major exodus to SACCOs happened during this period. Some of the affected persons have never looked back ever since, from their once lenders and now “nemesis”. SACCO’s in Kenya have for the longest time charged 1% interest on loan per month and have enjoyed a growing lending book with limited records to show exact figures due to the closed membership status that does not mandate them to make public their balance sheet results. Their Non-Performing-Loans (NPLs) are always low, since most members access loans against their deposits or group guarantors as collateral.
Equity bank redefined the loan space by commercial banks nearly a decade later by offering loans for as low as 13% p.a giving to almost anyone who opened an account without the much stringent collateral requirements. As long as one could prove their capital venture is able to guarantee a steady income, they were eligible for a loan. However, that is slowly changing and in quiet quarters the initial loyal members of the once vibrant Equity Building Society (EBS) are feeling the bank is slowly taking shape of the other “Richman’s” banks.
The journey to clamor for reduced interest rates on loan by Kenyans has always faded disgracefully and blame for the status quo was placed on the movers and shakers of the economy that often had patrons in political circles or those in power were owners or big shareholders of the same institutions thus creating a conflict of interest. A case in history is the famous “Donde Bill” (Named after Hon Joe Donde, 1997 elected Gem constituency MP).In September 2000; he published a bill that sought to cap interest rates on loans and was unanimously passed by parliament and later on vetoed by President Daniel Arap Moi on grounds that it subverted the ideology of liberalisation. President Moi then had interest with Trans National Bank creating a same script different cast 16years on. A second attempt was tried in 2015 August by another Gem MP, Hon Jakoyo Midiwo and that of Sirisia MP Hon John Waluke.The former’s proposal was declined on technical grounds that any amendment to a finance bill must have been debated by stakeholders before approval by the budget committee and subsequent tabling to parliament, under rule 114 of the finance bill.Hon Mutava Musyimi’s led budget committee deliberated on Waluke’s proposal and was later on urged to withdraw the proposal under grounds that Bank’s would regulate themselves amid a raft of measures to ensure they keep the interest rates to their bare minimum. That was short lived when at the end of last year commercial banks threw the economy into an interest spin again of close to 30%p.a on personal loans. Hon Midiwo had sought to cap interest rates at 3% above the CBR while that of Hon Waluke sought to cap it at 5% above CBR.
July 27th 2016 Kiambu town MP Hon Jude Njomo proposed a bill to cap interest rate yet again at 400 basis points above CBR (Central Bank Rate) currently at 10.5%.In addition, the bill proposed that banks give an interest on deposit of not less than 70% of the CBR, meaning banks will be forced to operate on a certain bracket margin based on CBR. The bill was unanimously passed on 28th July in a bid to reintroduce capping of interest rates on loans. CBR is usually determined periodically by a Monetary Policy Committee (MPC) within the central bank, chaired by the central bank governor. MPC usually factors the country’s inflation, major currencies foreign exchange position, monetary and fiscal analysis and global economic effects on Kenya in order to establish the value of CBR.
”Interest rates in Kenya are weird and an outright daylight thuggery by banks and capping should have been done 60years ago. We are trying to regulate interest rates, to the interest of our own people who have been exploited for long. If the president does not sign the bill into law we will take him to court. He should choose whether to safeguard the interest of Kenyans or that of a business man” said Awendo MP, Hon Jared Opiyo with obvious inference to President Kenyatta’s family and close allies the Ndegwa family who have interest in CBA and NIC bank respectively. Amid immense public and political pressure against that of his personal interest and those of the commercial banks, President Uhuru assented to the bill on 24th of August 2016 to the relief of most Kenyans who frenzied on social media upon assenting of the bill. “This is the third time that the National assembly is attempting to reduce interest rates to affordable levels. In the previous instances, dialogue and promises of change prevailed and banks avoided the introduction of these caps. In those instances banks failed to live up to their promise and interest rates have continued to increase along with spreads between deposits and lending rates” said President Uhuru in a well-crafted public statement that also sought to give the downside of capping interest but assured that his administration will closely monitor the volatility of the monetary effects of the law .Hon Rotich the Treasury CS had dashed Kenyan’s hopes where he had earlier in the week given a public statement saying ”It is time for banks to start making a decent income from lowering interest rates, although capping rates is the second best solution. Kenyans should be a little patient to allow government tackle the external factors that make the rates become high”. He promised in a public address to introduce a financial services authority bill that will ensure consumers are not exploited by financial service institutions.
The financial service in Kenya is second to none in Africa, according to Brookings Financial and Digital Inclusion report that evaluates access to and use of affordable financial services. Brookings institution, a U.S based non-profit making organisation in Washington DC does global research on economic, education and governance in domestic and foreign policy development. Most Kenyans feel the banks are making super profits and their only rush is to grow super profits to compete amongst themselves. A snippet data for last year shows a combined pre-tax profits for banks at a staggering 134 Billion KES in the 12 months through December and if this year half results are anything to go by, these figures could be in excess of 160Billion by end of the year. At the height of all these accolades Kenyans still believe that commercial banks are a preserve of the working, middle and top income earners in the country. They rarely support start-ups and kill the dreams of many young Kenyans even before they leave their beds of innovation and entrepreneurship. Most banks before you access any loan you have to provide 6months statement, valuable collateral or show proof of a steady employment income. The bigger share of the mass is left to the whims of government fronted corrupt loans schemes like Uwezo fund or SACCOs and “shylocks” where the later usually charges very high interest rates of up to 100% p.a or 10% per month.
I strongly believe the current debate is an advertent cry of accessibility to loans and not of high interest rates. The credit access bar has gone to another level with growing information sharing by the credit reference bureaus whose ones adverse listing leads to an outright lockout from mainstream lenders into the dungeons of hungry waiting “shylocks”. The argument to reduce interest rates is as divergent as the proponent’s and opponent’s personal attributes, more like the chicken and the egg analogy wanting to ascertain which one came first.
Commercial Bank of Africa the largest bank in Africa by customer base has a unique partnership with Safaricom’s M-shwari platform. It registered the greatest jump in its loan book by close to 305% from 7Billion to 23Billion over the same
period last year. Accessibility of these loans over the mobile phone is amazingly fast at 7.5% p.m. Yes you might have missed it! Mathematically it translates to a 90% interest rate per year. Surprisingly this is indifferent to customer’s decisions and they would rather rush to get these loans from the comfort of their homes and less stringent requirements. This would essentially mean loans offered by CBA through M-shwari platform are the most expensive formalised loans in the industry at 90%p.a. and are not encompassed in the new law which only targets mainstream banking.
It is also true that interest rates are inversely related to a lender’s income, proportionate to the quality of loans and a function to accessibility of loans. A recent example of Family bank’s Six months results to June 30th 2016.The lender whose interest was the lowest at 14.8%-Source Central Bank Interest Rate Report grew its interest income by 34% to 6Billion,but declined its profits by 40% to 711.5 million compared to a similar period last year. These profit margins were eaten away by increased Non-Performing Loans (NPLs) that grew eightfold to make the provision for bad debts hit 299.3million thereby increasing its operating expenses by 30% to 3.8Billion.Hence the less your interest rate the more interest income and in order to sustain the proportional benefits then banks need to innovate and develop policies that will increase the quality of loans.
With 43 Banks ,12 Deposit taking Micro-finance,30 Credit only Micro-finance,199 SACCOs,5 Mobile money operators and 3 Credit reference agencies, Kenya is well placed to enhance a more robust financial inclusion above the current 75% one of the highest ratings in the world and the 1st in Africa. To the contrary there has been too much inefficiency, too much money idling in capital, that it created a” Devil’s” workshop in finding ways to use it including insider lending. These have since seized with the new “sheriff” in town CBK Governor Njoroge who is operating in full swing sending bank executives into panic mode in order to meet the previously ignored regulatory requirements. Some allege Mr Njoroge has gone-slow on his aggression because the expose on Bank’s anomalies were enormous and periodic surveillance was a compromise away from the public glare to avoid capital flight. Insider lending in family owned banks, unnecessary system upgrades and unregulated provisions for bad debt were used to hide the true position of most banks. Most shocking was the use of parallel systems in NBK that led to massive siphoning of funds even by junior staff according to Wanjiru who feared use of her names for fear of victimisation. She was among the staff who noticed the anomaly way before the interdiction of its executives. This practise made the unaccounted for insider lending at Imperial and Chase bank look like Child’s play and of course the government will always come to its rescue at the expense of taxpayer’s money.
Bank’s shareholder and owners have often placed high targets to the executives to increase profits by as much as 20% every year placing a huge burden to increase billions and sometimes without ethos. One of the tier one Bank’s CEO was tasked to increase profit volumes by more than 25% a year albeit that it was still making super billion profits .The low hanging fruit was to drastically increase ledger fees by more than 200% while issuing a short notice to customers who had no option but to swallow the bitter pill. These figures would amount to millions of dollars a year and a part-in-the back end of year bonuses would allow these executives to lavishly buy beach houses along the Mombasa coast on cash transactions basis at the expense of customers and overly strained junior employees. Most junior employees work more than 10hours a day to the ignorance of unions and banks association that play to the pipers tune. This pressure is so real that it has degenerated to drastic measure to reduce wage cost in order to increase profits by giving early retirements to youthful staff even those under 35 years of age rightly earning huge salaries under undue coercion.
With the new law, time is ticking fast and in two weeks after gazetting the new law will take effect. Unfortunately those who had taken loans before the Presidential assent will still pay with previous rates since no law applies retrospectively. Customers can however borrow a fresh loan under the new rates to offset the previous loans .Banks need to adjust into new frontiers of ensuring ultimate efficiency on capital and utmost generation of income. Tier 2 and below have to employ techniques of diversification faster than their tier one counterparts. These forms of diversification could be employed through myriad ways by;
- Geographical coverage: Where technology can be used to bring a closer access to banks services and use of national agent in order to increase their ease of access to service.
- Sources of Income: Where banks will need to engage in more few sources of income like banc assurance and investment banking.
- Product and Services: Where the types of loans will need to be broaden to include intellectual property or innovations funding
- Economic Sector: Where a move from the conventional industry players will be beneficial and a specialisation on such sectors could lead to loyalty since there will exist an indifferent cost on loans.
- Sources of Capital: Where use of corporate bonds and other cheap instruments of capital will ensure banks are be able to sustain reduced loan interest margins.
The tier one banks will have an easier ride ahead since they will be able fund other sources of revenue. The smaller banks would result to reduce the risk on loans hence stifle access to loans and engage in more government securities that are other less risky or otherwise adapt a “hustlers” mentality to issue small loans to many Kenyans. Mergers, acquisitions and take-overs may be inevitable to some banks as interbank lending may soon become a high cost to maintain in order to meet their daily liquidity ratios. Kenya is still considered overbanked and bigger economies in Africa like Nigeria have fewer banks supporting their financial system.
The Eureka moment for Kenyan commercial banks lies in making sure loans are accessible as much as possible to as many people as they can following Markowitz theory of diversification. These techniques have so far been perfected by “shylocks” who enjoy massive returns from already locked out non-capitalised populace. Commercial banks need stringent policies to enhance borrower’s accountability, recovery and collection techniques to avoid a growing book of defaulters and allow increased loan assets. It is better to loan 10 people with 100,000 each than one person with 1million in order to reduce the cost of NPLs. It is working with CBA, Equity and KCB banks already. The biggest gain will be the corporates, SMEs and salaried Kenyans who will be able to access loans easily and cheaply as competition amongst banks to offer quality loans takes shape. Those away from these brackets may find it hard to access loans in the interim and an economic ripple effect maybe their mid-term benefit.