It has now been about two months since the President assented to the interest rate capping bill. Interestingly, interest-rate limits were eliminated in July 1991.
The amendment to the Banking Act required lenders to peg credit costs at 400 basis points above the benchmark central bank rate and compelled banks to pay interest of a minimum of 70 per cent of the CBR on deposits. This interest rate corridor essentially topped and tailed the banks. What is clear is that there are two calculations that need to be made when assessing the damage on banks’s earnings. The first is to understand how much lending was above the cap and would have to be reduced, and the second calculation was around the floor. This is not a rocket science calculation and SIB have provided research which shows:
Co-op Bank’s net interest income is expected to shrink by an estimated 24.3 per cent and will be followed by Equity Group whose interest earnings is set to fall 23.5 per cent. Barclays is projected to see a decline of 15.2 per cent in interest income, while that of StanChart is seen falling 11.6 per cent. Calculations regarding the deposit structure will also need to be factored into this to get the whole picture. Tier two and tier three banks get squeezed harder because, typically, they pay up for deposits and are now unable to recoup that deposit premium because of the cap. Tier two and tier three have been topped and tailed real good.
Equity Group CEO James Mwangi spoke of turning up the lending volume (he mentioned a figure of Sh100 billion). Joshua Oigara spoke to a sharp take-up in loans since the cap was introduced. Both are indicating the fundamental bias in favour of the big banks – they can turn up the lending volume. Others can’t.
It’s worth looking at how the share prices have performed since August 24. KCB -26.84 per cent, Barclays Bank -17.52 per cent, Equity -15.22 per cent, StanChart -11.11 per cent and Co-op Bank is -6.037 per cent. StanChart is an outlier and the only banking stock that has served up a positive return in 2016. StanChart is +15.58 per cent in 2016 on a total return basis. When you compare StanChart’s total return versus the banking index, it is even more impressive.
Credit to the private sector has been slowing sharply and last registered a +7.07 per cent expansion in July 2016 versus levels above 20 per cent July 2015. Recent moves by the CBK to steer interest rates lower were in part certainly triggered by this sharp slow-down. This is a key indicator to watch in assessing the side effects of the interest rate Act.
Another consequence is that the Act surely accelerates consolidation in the banking sector. The deposit flight to quality post, the Imperial and Dubai Bank developments coupled with the caps and floors, have surely made consolidation all but inevitable. However, merging sub-optimal balance sheets will not necessarily work. There is a requirement to infuse more equity capital.
I have been wrestling with the thought of whether the authors of the bill appreciate how much they have improved the government’s position. The net consequence of the Act (preceded by the deposit flight to quality) has created an outsize demand for the GoK (considered risk-free on the bank’s balance sheet) paper. The National Treasury finds itself in a sweet spot. Demand for GOK paper is currently off the charts as witnessed by the recent sale of Sh30 billion of 15-year infrastructure bonds. The GoK is reconfiguring its maturity profile (previously quite lumpy) very effectively.
The recovery in Kenya Airways’ share price has been entirely correlated to Michael Joseph’s quick accession to the chairman’s position at the airline. The share price has ramped +50 per cent higher over four short weeks. There is a big job to be done at the airline, which spans cancelling all fuel hedging, proper oversight over forex and Treasury and much more. Optimising the balance sheet needs someone real, credible at the head of future negotiations, and the market is betting if anyone can do what Michael can.