The past year has been a challenging one for Kenya’s banks. As the full-year results for 2017 began to emerge, the effects of a new cap on lending interest rates become apparent, with most banks reporting reduced margins and profitability. A tighter lending environment, however, has encouraged banks to find alternative routes to revenue. Technological innovation, in particular, has received a fresh impetus as lenders reach out to prospective customers through new channels. Despite challenges posed by the interest rate framework, the sector is poised to take advantage of the relatively robust growth levels anticipated for the near term. However, more regulatory challenges remain. The introduction of the International Accounting Standards Board’s ninth International Financial Reporting Standard (IFRS 9) – a global framework outlining how institutions should classify financial assets and liabilities – will hold implications for both banks and their customers in coming years. While liquidity issues, rising non-performing loan (NPL) rates and risks associated with technology need to be addressed.
Kenya’s modern banking system began in 1886 with the opening of the National Bank of India’s branch in Mombasa. What was then the East Africa Protectorate proved fertile ground for banks servicing the international trading activity taking place along the Europe-South Africa–India axis. By 1911 the Ordinance for the Regulation of Banks Established or to be Established in the East Africa Protectorate had formalised the sector, which was made up of three lenders: National Bank of India, Standard Bank of South Africa, and the short-lived Kathiawad and Ahmedabad Banking Corporation. By 1948, 10 Kenyan towns had established their own bank branches. A number of these were owned by the UK’s Barclay’s Bank, which had entered the market in 1926.
Established in 1966, the Central Bank of Kenya (CBK) is tasked with the formulation and implementation monetary policy, currency issuance, and the provision of banking services to the government, commercial lenders and other financial institutions. The nation’s first locally owned commercial bank, the Co-operative Bank of Kenya (Co-op), opened its doors for business in 1968 and expanded the provision of financial services to the rapidly growing and previously unbanked farming community. That same year, National Bank of Kenya became the first state-owned institution in the newly independent country, and three years later it merged with Grindlays Bank to form National & Grindlays Bank – in which the government retained a 60% stake. In 1970, however, the state took full control of the firm and renamed it to Kenya Commercial Bank (KCB). That decade saw the entry of US institutions with First National Bank of Chicago, now Chase Bank, and First National City Bank, now Citibank, arriving in 1974. The financial sector was liberalised in 1991, making Kenya one of the top-three banking industries in sub-Saharan Africa and bringing a period of technological revolution. Innovations such as agency banking, mobile phone integration and credit information sharing resulted in the proportion of adults using financial services rising from 26.4% in 2006 to 66.9% in 2013.
At the end of 2017 the sector comprised three public commercial institutions; 40 private commercial banks, of which 25 are locally owned and 15 foreign owned; 73 private foreign exchange bureaux; 13 microfinance banks (MFBs); three credit reference bureaux; 19 money remittance providers; and eight representative offices, according to the CBK.
At end-2017 total net assets at commercial banks were KSh4trn ($39.2bn), up from KSh3.7trn ($36.3bn) in 2016. Local private commercial banks (excluding Charterhouse Bank, Imperial Commercial Bank and Chase Bank, which are under statutory management) made up KSh2.6trn ($25.5bn), or 64.8% of total sector assets. This was followed by foreign commercial banks with KSh1.3trn ($12.7bn), or 31.7%; and public institutions with KSh139.7bn ($1.4bn), or 3.5% of net assets.
Commercial banks are categorised into three groups using a weighted index, which takes into account a range of factors, such as net assets, capital and reserves. Accordingly, the market is made up of eight large-sized Tier-1 lenders, which account for 66% of total market assets; 11 medium-sized Tier-2 banks with a market share of 26.1%; and 21 smaller-sized Tier-3 institutions with a 7.9% share of the market.
The 15 foreign-owned commercial banks operate according to one of three models: without local incorporation, such as Bank of India and Citibank Kenya; with local incorporation and partial local ownership, including Barclays Bank of Kenya and Standard Chartered Bank Kenya; and fully foreign-owned but locally incorporated, such as United Bank for Africa Kenya and Bank of Africa. The largest bank is KCB Bank, with total assets of KSh555.6bn ($5.4bn), comprising 13.9% of the market. This is followed by Co-op Bank with KSh406.4bn ($4bn, 10.2%), Equity Bank Kenya at KSh382.8bn ($3.8bn, 9.6%), and Standard Chartered with KSh285.1bn ($2.8bn, 7.1%).
Kenya’s status as a lower middle-income country, means that its MFBs play a key role, serving individuals and small businesses outside the remit of traditional lending institutions. The biggest MFB in 2017 by assets is Kenya Women MFB, with a 44% share of the market. This was followed by Faulu MFB with 38.4% and Rafiki MFB at 7.3%. The remaining 10% of the market is accounted for by a number of small and medium-sized players, the largest of which is SMEP MFB, which claims a market share of around 3.6%. Banks also compete, to some extent, with the more than 4000 savings and credit cooperative societies active in the country. Similar to credit unions in the US, these bodies are often the first choice for borrowers without a credit history.
Nairobi’s status as an advanced financial centre has helped some larger banks establish a successful presence in regional markets. At the outset of 2018 nine Kenyan lenders operated a total of 306 subsidiaries in the EAC, up from 297 a year earlier. Uganda was home to the highest number of branches, accounting for 102 locations, followed by Tanzania (81) and Rwanda (55). Equity Group has the most branches in the EAC, with 104 locations in five countries. Meanwhile Diamond Trust operates 70 branches in three EAC countries, and KCB group has 60 branches five EAC member states. These subsidiaries generated KSh8.79bn ($86.1m) in profits in 2017, down from the KSh8.88bn ($87m) in 2016.
The result was due to a challenging operating environment in Tanzania and Uganda. Despite this, Rwanda, Uganda and Tanzania contributed 29.44%, 19.54% and 17.88%, respectively, of all profits generated at EAC subsidiaries of local banks. Some Kenyan banking institutions have started to expand their footprint beyond the EAC. I&M Bank had a 50% stake in Bank One of Mauritius in 2017; Prime Bank had an 11.24% shareholding in Malawi’s First Merchant Bank, and a 11.46% interest in Capital Bank of Botswana; and Equity Group acquired a 79% shareholding in ProCredit Bank of the Democratic Republic of the Congo.
The banking sector has faced numerous challenges over recent years. Between 2011 and 2015 rapid economic growth and advances in financial inclusion helped the industry to expand its aggregate loan book by a compound annual growth rate (CAGR) of 16%, according to Nairobi-based AIB Capital. However, a more stringent regulatory approach since mid-2015 has resulted in the collapse of Charterhouse Bank, Imperial Commercial Bank and Chase Bank, which precipitated a decline in public confidence in the sector. Downward pressure on bank profitability was made more acute by the cap on interest rates for commercial bank loans, which was introduced in September 2016 via the Banking (Amendment) Act of 2016.
The effects of this regulatory change became apparent in 2017, with the growth of the sector’s net loans and advances standing at 5.6% for the year, against a five-year CAGR of 13.2%. The downward pressure on lending activity has had a concomitant effect on sector earnings. According to Kenya-based investment company Cytonn Investments, listed banks saw a 1% decline in earnings per share over 2017, compared to a five-year average growth of 6.7% – a phenomenon which is attributable to a compression in net margins. Meanwhile, pre-tax profits declined by 9.6% from KSh147.4bn ($1.4bn) in 2016 to KSh133.2bn ($1.3bn) in 2017, according to the CBK.
Despite these trends, however, the financial stability metrics for the sector remain robust. In addition to increased sector assets, deposits grew by 11% from KSh2.6trn ($25.5bn) to KSh2.9trn ($28.4bn) in 2017. Asset quality, as measured by the proportion of net NPLs to gross loans, stood at 5.7% – showing a modest increase over the year. Aggregate capital adequacy ratios also remained above the regulatory minimums at the outset of 2018, with the sector’s core capital to risk-weighted assets at 16.5%, down from 17% in 2016, but above the minimum of 10.5%. At the same time, the liquidity ratio stood at 43.7%, up from 40.3% in 2016, and well above the CBK minimum requirement of 20%. However, excess liquidity risks have become somewhat of a concern. “There is a fundamental difference between having excess liquidity and adequate liquidity,” Habil Olaka, CEO of the Kenya Bankers Association (KBA), told OBG. “There is excess liquidity due to the interest rate cap, and if that were to be removed, we would start to move closer to adequate levels.”
One positive effect of the new lending regulations is that, along with increased competition, they are helping to spur consolidation in the banking sector. Following three consolidatory transactions in 2016, August 2017 saw Diamond Trust Bank Kenya acquire a 100% stake in Pakistan-based Habib Bank Kenya (HBK), having gained approval for the deal from the CBK in the preceding June.
The acquisition brought HBK’s presence in Kenya to an end, after more than 60 years of operations in the country. Looking to market entrants, in September 2017 the CBK granted permission to France’s Société Générale to open a representative office in Nairobi. The group has been present in Africa for over a century, and presently maintains operations in 19 countries across the continent. Last year also saw a significant market exit, with the June 2017 decision of the CBK to cancel the licence of Central Bank of India (CBI) – which had operated a representative office in the country since 2013. The move followed the CBI’s decision to close all its representative offices in global markets. This may come as positive news to some players, who have argued that Kenya is overbanked. While mergers can be useful, it is important to be cautious, since two undercapitalised banks do not necessarily result in one capitalised bank post-merger, some have warned.
Mortgage lending is another area where the new lending framework has the potential to bring positive results. According to the CBK, almost all banks in Kenya offer mortgage products to their staff and customers, and the interest rate caps immediately made them a more attractive funding option, with the average interest rate for mortgages falling to 13.57% in 2017, compared to 18.7% in 2015.
The growth in home loans can be seen in the value of outstanding mortgage loan assets, which increased to KSh223.2bn ($2.19bn) by the end of 2017, up from KSh219.9bn ($2.15bn) at the end of 2016 and KSh203.3bn ($2bn) at end-2015. Traditionally, the mortgage market has been dominated by variable interest rate lending, but the interest rate caps have modestly shifted the market towards fixed rate instruments. In 2015 nearly 90% of mortgages were issued on a variable rate basis, up from 62% in 2016 and 78.4% in 2017.
Challenges to the market’s growth also remain. The level of NPLs in the mortgages segment reached 12.2% in 2017, compared to 10% in 2016, a figure which raises questions regarding the sustainability of growth in the home lending arena. This increase is in line with the trajectory of NPL rates of the sector in general, which increased from 9.3% to 12.3% over the same period.
The CBK’s annual survey of licensed banks also revealed a range of other obstacles to growth. The results published in 2018 showed that banks thought that high costs of housing units and land for construction were the single biggest barriers to mortgage uptake. This was closely followed by high incidental costs, such as legal and valuation fees, and the stamp duty. Other barriers included difficulties with property registration and titling, access to long-term finance, low levels of income and stringent land laws. Among the suggestions to address such issues were increasing the availability of cheap long-term funds, extending the provision of basic infrastructure services to developers, reducing the stamp duty for first-time buyers and expanding low-cost housing developments.
As the market’s regulator, the CBK has gained a reputation as a prudential overseer of banking activity. Over recent years it has sought to raise the financial soundness metrics of the industry by improving transparency and data collection, boosting bank resilience and innovation, and enhancing governance and accountability. In terms of regulatory changes, the interest rate cap and its effects continue to dominate the public conversation through most of 2018. However, a second regulatory challenge is rapidly emerging. Introduced in 2018, the IFRS 9 protocol is part of the worldwide response to the global financial crisis of 2007-08, but its full implementation is likely to prove problematic for some lenders.
As a result of Kenya’s adoption of IFSR 9, its banks have been compelled to fundamentally adjust the way they address credit risk. Most significantly, banks now have to recognise credit risk at the beginning and during a loan’s entire credit life cycle, rather than at the point of default. Banks must also take into account varieties of credit which were previously ignored in risk assessments, such as credit and overdraft limits, letters of credit, performance and financial guarantees. For customers, the biggest change applies to the way their commitments will be analysed under the new system, with a new protocol of cross-product default, meaning that, rather than being assessed in isolation, a customer’s personal, credit card, mortgage and other commitments will be considered together. A default on any facility will result in banks impairing the other products held by the customer.
The capping of interest rates in 2016 formed part of a wider CBK effort to increase financial inclusion in Kenya. Recent years have seen significant progress in this regard, with the proportion of the adult population with access to financial services rising from 27% in 2006 to 75.3% in 2016, according to the CBK. Nevertheless, nearly a quarter of the population still does not have access to any formal financial services, particularly in the northern regions. This phenomenon was noted by Patrick Njoroge, governor of the CBK, at the KBA annual conference, held in September 2017. Njoroge outlined the CBK’s vision of an more customer-centric banking sector, where “products, channels and indeed pricing must be informed by customers’ needs, preferences and affordability”.
Risk-based credit pricing is also a strategic priority for the regulator, a development which will require the cooperation of banks, credit bureaux and other stakeholders in the development of credit scoring systems that will allow lenders to reward borrowers with strong credit. Increased transparency in interest rates, fees and charges also remains a key CBK issue. In June 2017 the regulator joined forces with the KBA to launch a cost-of-credit website to better inform consumers about a number of commonly used banking products.
In the meantime, banks are reacting to the imposition of interest rate caps in a number of ways. Enhanced efficiency has become a strategic priority across the sector, and some of the routes to it are already well established.
A move towards the increased use of banking agents has been gathering momentum since the concept was introduced to the market in 2010. In 2017 the value of banking transactions undertaken through agents rose by 46.4% from KSh734.2bn ($7.2bn) in 2016 to KSh1.1trn ($10.8bn), according to the CBK. By December 2017 there were 61,290 banking agents serving commercial banks and 2191 agents serving MFBs, representing a 14% and 6% increase on 2016, respectively. The number of banking transactions undertaken by agents grew by 34.1% over the year, from 104.2m to 139.8m, with deposits and cash withdrawals accounting for the bulk of activity, followed by balance enquiries, the distribution of social benefits, and bill payment. Equity Bank, Co-op and KCB account for almost 90% of approved commercial banking agents, while more than 94% of MFB agents came from Kenya Women Finance MFB. However, as other institutions seek new efficiencies and market visibility, this dominance is likely to diminish.
Bancassurance is another alternative revenue channel for lenders looking to retain profitability levels in the face of shrinking margins. Banks have been partnering with insurers to sell insurance products since the regulator first made provision for bancassurance in 2004. The practice is generally carried out according to one of three models: insurance companies using their own staff to sell products in bank branches; banks using their own employees to sell insurance, usually from a dedicated desk within the branch; and banks joining with brokers to sell insurance and service existing contracts on a profit-sharing basis.
While the channel remains relatively underdeveloped, the potential benefits for financial institutions seeking to grow their non-funded incomes, as well as insurance companies attempting to broaden their customer base, suggest bancassurance will play an important role in the industry’s future growth.
Perhaps the most promising alternative channel, however, is mobile money. For the past decade, this arena has been dominated by telecoms players, which have revolutionised the way in which most Kenyan’s transfer funds. M-Pesa, launched by Vodafone’s Safaricom in 2007, is now used by 30m users in 10 countries, and has expanded from a simple text-based money transfer system to a platform for loans and savings, as well as salary disbursement, bill payment and health care provision. Other platforms have been developed by telecoms providers, such as Airtel and Telkom, helping to establish Kenya as a major global player in mobile money innovation.
To date, the banking industry has sought to capitalise on this development by establishing partnerships in the telecoms industry. KCB and Commercial Bank of Africa have joined forces with Safaricom to establish KCB M-Pesa and M-Shwari, respectively. The paperless banking services offered through M-Pesa allow customers to open and operate bank accounts, receive instant micro-loans of up to KSh100 ($0.98) and save for a fixed period of time at the new deposit rates established by the CBK. Equity Bank, meanwhile, has established its own service, Equitel, through which customers are able to carry out transactions via a third party contracted by the lender.
For many in the industry, the efficient exploitation of the mobile channel is dependent on banks seizing the opportunity to expand into this arena, and a development last year suggests that this effort has begun. In early 2017 the KBA began a phased rollout of PesaLink, a new bank-to-bank money transfer platform, which is expected to reduce the cost of transactions and alter the way in which consumers interact with their banks. The new service allows account holders to make real-time payments between banks without having to go through intermediaries. The technology for PesaLink is provided by Integrated Payment Services, a subsidiary of the KBA, which is expected to open up its platform for other innovations. In the meantime, the mobile arena continues to evolve. Wallet-to-wallet interoperability went live in April 2018 allowing customers of different mobile money platforms to transfer money to each other. Digitalisation is also allowing banks to reach out to more customers with increased efficiency.
However, the rapidly expanding digitisation of banking services has opened the sector to cyberattacks. To address this challenge, the CBK issued a “Guidance Note on Cybersecurity” in 2017. The report outlined regulatory standards to industry participants on the assessment and mitigation of cyberthreats, including governance requirements; calls for regular assessment, testing and training; as well as the notification of the CBK within 24 hours of a cyberbreach.
While a number of challenges faced the banking sector in 2017, solid fundamentals point to continued positive performance. Increases in net assets and deposits, consolidation, as well as the continued streamlining and digitisation of bank services contributed to sector resilience. Still, the CBK is aware of risks and is taking steps to counteract challenges. In addition, future industry performance should supported by the country’s robust economy, with the World Bank estimating that GDP would expand by 5.5% in 2018, compared to 4.8% in 2017 – a growth projection that bodes well for the financial industry.
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