Why banks made Sh197bn profit
This week I was on a two-day board retreat where we gathered away from our routine schedules to carry out the mid-term review of our current strategic plan.
During the lunch break, one of my colleagues turned to me and put me on the spot. “Could you explain this phenomenon of banks raking in phenomenal profits in the midst of a pandemic when other sectors are struggling to remain afloat, given the stringent requirements of IFRS 9, and the shocks of Russia’s invasion of Ukraine?” This is a question that has been featuring in many a discussion so I was not particularly taken by surprise.
To answer the question, first, the Russia-Ukraine crisis came to fore in February, so it had no effect on the 2021 numbers that had just been reported by banks. But to understand the “exceptional” results reported by the banks, we need to debunk the perception issue.
There is a regulatory requirement for all banks regulated by the Central Bank of Kenya to publish their year-end financial results in the newspapers by the end of the first quarter following the end of the period being reported on, therefore, by March 31, for results for the year ended December 31, 2021.
Most banks would, therefore, publish their results in the weeks before March 31, and since they are highly capitalised, the profitability would similarly be in billions of Kenya shillings, with most being reported at the same time. There is, therefore, a perception created in the minds of the readers that it is only banks reporting profits and in billions.
This perception is amplified by the Tier 1 banks as their capitalisation is significant, thereby registering sizeable profits even if their return on investment was modest. The industry’s reported profits before tax for 2021 was Sh197.6 billion compared to Sh107.3 billion in 2020 — an 84.2 percent jump. It was Sh155.3 billion in 2019.
To appreciate the “phenomenon”, let’s go back to 2019, the year, in November, when the interest rate caps were repealed by Parliament, setting the stage for banks to start on lending to entities that were hitherto locked out of the credit market. Before credit could start flowing, Covid-19 hit and most actors were thrown, at best, into survival mode.
Eyes turned to the banks as the saviours in the unfolding situation to help their customers wade the pandemic. CBK waived the stringent requirements for restructuring facilities, enabling banks to restructure repayment profiles of such facilities by allowing moratorium on principal and/or interest instalments to accord some breathing space to the entities, many of which were MSMEs, to align their loan repayment to the little cash flow trickling in.
Customer centricity was a defining feature for the banking sector. It was under pressure not to lose its own shirt as no effort was spared to save customers. This also happened to be the time when IFRS 9 reporting requirements had fully kicked in and banks, in compliance with the accounting norms, were required to enhance their provisioning for loan losses.
The major shift under IFRS 9 was that the estimated credit losses were forward looking and so booked up on onboarding ,unlike prior under IAS 39 when the estimated credit losses were based on the event of default. The provisioning for losses in 2020 was particularly elevated in view of the fact that the prospects for most borrowers looked grim. The provisions charge in 2020 was Sh110.3 billion, up from 39.5 billion in 2019.
Support to customers was maintained into 2021 as CBK retained the waivers for a 12-month period from when the pandemic was declared. When the containment measures put in place by government were relaxed and business started picking up, a good number of customers supported by the banks were on the recovery path.
Most of them for which provisions for possible losses had been taken in 2020, either did not need similar levels of provisions in 2020, while some actually had fully recovered and had their loan provisions released as they were not needed in view of the positive prospects that the accounts displayed. This explains the dramatic drop in loan loss provisions in 2021 of Sh58.8 billion, down from Sh110.3 billion in 2020.
The shift in the channels that banks provided their services to the consumers leveraging on technology to the digital platforms, also led to the good results. The inability to physically be in the place of work or the banking halls led the banks to shift to digital channels, with the attendant cost reductions which is being seen in the numbers reported for 2021. The total operating expenses for the industry dropped to Sh275.7 billion in 2021 compared to Sh317.7 billion in 2020.
It is the sum total of these movements that explains the exceptional performance reported by the banks for the year ended December 31, 2021.
Dr Olaka is the CEO of the Kenya Bankers Association