Are banks netting ‘unhealthy’ gains on loans?

Mr Moses Simiyu, an entrepreneur in Ruaka Estate on the outskirts of Nairobi has been depositing Sh10,000 diligently every month with his bank for the last 13 months with a goal of taking a loan in January next year.

The businessman wants to expand his venture and hopes the Sh450,000 loan he intends to take from the bank will help in turning his dreams into a reality.

As a condition for the loan approval, his bank requires him to save at least a third of the loan amount. Mr Simiyu’s target is Sh150,000 by December.

The desire to qualify for the bank loan clouded his judgment on whether this was the right way to go about acquiring the advance.

Little benefit

All along he was only getting 1.3 per cent for his pain. By January next year, his bank will most likely reward him with a loan priced at over 25 per cent in interest, a difference of 22.7 per cent, in what is known as spread.

He will be lucky to make enough money to repay it.

“Unless banks are controlled, they could increase the rates to levels where it becomes unreasonable for businesses or individuals to benefit from loans,” Consumers Federation of Kenya (Cofek) secretary general Stephen Mutoro, says.

It is worse when one takes a look at what banks are making by passing money around.

Commercial banks have reported Sh65.3 billion in pre-tax profit for the first nine months of the year.

Overall, the industry generated Sh175.8 billion in revenue, of which 86 per cent came from interest, fees and commissions charged to customers for borrowing and transacting and 15 per cent from lending money to the government.

Of the money the banks were lending, 75 per cent came from customer deposits. On average they were paying 1.3 per cent for money deposited while charging a minimum of 14 per cent on loans.

The banks’ interest spread averaged 12.7 per cent in the nine months to September 2011 compared to 10.15 per cent per in a similar period last year, defying CBK’s reforms to cut operating costs among commercial banks which were aimed at reviewing interest spreads.

“Reasonable margins between interest and deposits should be between four and six per cent, but the current ones cannot offer any value to small depositors,” said Mr Josephat Kinyua, vice president of Renaissance Capital, an investment firm.

The higher interests on loans combined with lower costs of loans which have seen banks report double-digit-profits in the nine month period, is now raising questions on the reasons behind the recent increase in lending rates at a time when banks are preparing for the third wave of interest rate hikes.

Huge interest

Analysts reckon that though wholesale depositors have begun receiving a significant return on their investments, banks are reaping unhealthy margins from the widening interest spreads helped by growing retail customers.

“These huge interest spreads are unhealthy and has remained a major concern for depositors. Kenya is among the countries on the continent with the highest spreads,” said Mr James Muratha, regional director for Stanbic Investments East Africa, a fund manager.

With an average annual overall inflation raging between five and six per cent over the period, customers are surely getting the short side of the stick.

“With high inflation, the value of the money also gets depleted since at the end of the year, it buys lesser goods than what it would have bought at the beginning of the year.

Making losses

Unless this happens then depositors end up making losses,” said Mr Kinyua.

According to the latest quarterly survey for the banking sector, deposits were the main source of funding for the banking sector, accounting for 75 per cent of total funding liabilities.

“The deposit base rose by 7.1 per cent from Sh1.4 trillion in June 2011 to Sh1.5 trillion in September 2011,” said the report covering the quarter ended September 30, 2011 in part.

This means that new deposits grew by Sh100 billion in the four months, five times more than what owners put into the banks.

The report reveals that shareholders only injected Sh15.5 billion more into the banking sector during the period. Banks that have already announced their earnings in the period have reported lower expenses on the deposits.

For instance, Kenya Commercial Bank, which has raised its base lending rate to 19 per cent spend Sh700 million less on its cost of funds in the nine months period.

KCB paid Sh2 billion on deposits compared to Sh2.7 billion in a similar period last year.

This came despite the bank increasing its deposits by an extra Sh59.2 billion over the past year as it reported a 43 per cent rise in net profit to Sh6.4 billion.

It earned Sh19 billion in interests, commissions and other fees.

Equity Bank made Sh13.7 billion from interest, fees and commission charged on borrowers while paying Sh1.3 billion for deposits.

Barclays Bank also benefited from cheaper deposits after it saved Sh481 million despite raking additional deposits worth Sh8.1 billion in the past year.

It earned Sh11.5 billion interest, fees and commission charged on borrowers while paying Sh433 million billion for deposits.

The dwindling returns has already attracted attention of Parliament after a legislator tabled a Bill that seeks to fix the minimum deposit rate at 70 per cent of the Central Bank Rate (CBR).

Force

The CBR currently stands at 16.5 per cent and the passing by Parliament of this law would force banks to offer a minimum interest of 11 per cent on deposits.

The Bill sponsored by Rangwe MP Martin Ogindo also seeks to prevent banks from charging borrowers more than 400 basis points or four percentage points above the CBR, which would cap the spreads at 9.5 per cent.

“Our greatest problem is that we do not have alternative sources of credit,” says Mr Mutoro.

Besides the low deposit rates, the surge in profitability is linked to increased lending by commercial banks after a contraction in net lending in 2008 and first half of 2009 due to Kenya’s weak economy.

The low deposit rate regime is set to hurt the return of high net- worth investors especially pension fund managers.