A number of banks in commercial business state in their
objects that they intend to add value to their shareholders by serving the
needs of the communities. The community needs can be transactional or growth intended.
The growth need requirement comes in the
form of banks’ lending to commercial interests as one investment of the
shareholder funds.
Banks support all sectors in the economy since their
clientele are engaged in the different economic sectors. Banks play an
intermediary role in spurring growth in the economy by pooling resources and
extending the same to established commercial interests for a profit to spur
growth.
In some markets Kenya being one, banking business is largely
regulated by a Central Bank but there are other businesses that deal in lending
which are unregulated. Banks soliciting deposits from the public are by law
required to obtain business licenses from the Central Bank and regularly report
to the Central Bank on their operations.
Kenya has a financial market that has grown from the commercial banking
model to adoption of innovative technology where mobile phones are not only
channels of delivery but offer access to financial services. The unregulated
market is large and no known data Is available into the size of its business.
One of the investments available (among many) to the banks
is matching the liability book they are holding. Customer deposits are
liabilities, is to lend on a sound collectible basis. The investments (Loans
among others) should earn some profit for the banks to compensate for the cost
of funds. Deposits come at a cost (handling and interest to the depositors)
The market place is competitive and in every business there
are challenges which banks call risks. For example the occurrence of an
expected or unexpected that may affect the borrower and thus risking the bank’s
capital (borrowed monies) and earnings (interest earning from the loan).
By the
bank extending credit to a customer it’s exposing itself to all the risks faced
by the borrower. It is thus imperative for the bank to evaluate all the risks
and the interrelationships to its business.
Credit risk is a wide topic in banks and a delicate one that
requires careful evaluation to determine the risk acceptance criteria. To best
underwrite quality assets in lending, it is imperative for every bank to have
in its employ competent staff who understand the loans appraisals, risk
identification and mitigation and who are effective in monitoring processes.
Sound lending calls for efficient processes in appraisal, structuring, approval
and monitoring of every extended facility.
Every credit facility has a number of risks associated with
it. The prominent risk is repayment risk, to counter this the banks take
collateral as a fall back plan in a worst case. Collaterals vary from charged
properties, joint motor vehicle ownership, Cash collaterals, Asset
hypothecation among others.
Another risk associated with lending is the
interest rate risk. This is the pricing of the loans asset. This is the return
earned from the capital extended, this is determined by the maturities and the
cost of funds. Interest income is one of the income streams for the lending
bank. High rates are unattractive to the market and even risky for a portfolio.
Pricing risk considers the cost of funds, risk profile of
the borrower and a profit margin for the business bank. Effective processes
affects the bank’s profitability and reputation thus avoiding reputation risk
and thus better positioning in the market.
Credit is extended for a long period
of time requires a thorough understanding of the credit culture, values,
beliefs and behaviour. The credit culture will determine its credit risk
management and profile.
Money being a risky stock to handle, the risk acceptance and
reward for extended credit becomes a factor to consider before lending. Fully
secured credit facilities will earn less than the unsecured facilities. The
banks have clear policy on loan process handling. This covers areas touching on
appraisal process, approval limits and process, analysis requirement,
documentation, collateral coverage, pricing, monitoring and reporting and a
general code of ethics.
Behind the scenes credit administration and monitoring is
the core to creating a credit culture that defines the credit business. Portfolio segmentation, diversification, risk
concentration, stress testing, policy administration, asset review and process
review remain technical terms for a further date review.
Another investment channel for banks is lending monies to
the Government. The Government budget in most countries goes into a deficit
that is met through going to the market to raise funds to meet budget needs.
Simple economics teach us that we should borrow for
investments and not consumption. This is premised on the fact that the
investment will spur more income generation and hence create repayment ability
and the same (should) apply to Government.
Government borrowing is done through selling government
papers short term or long term. The government papers are treated as risk free
on the assumption that the Government cannot default. The papers are sold
through the central bank at a determined rate. The administration of which is
at very minimal cost for a commercial bank.
Procedurally, banks in Kenya
investing in government papers assist in their reporting compliance. Banks with risk free assets are treated as stable. The process of selling or buying Government
papers is called open market operation and aims at controlling the volume of
monies available in the economy.
Central banks also influence the interest rate by setting a
minimum rate at which the banks can borrow from the central bank for onward
trading with their customers. This however does not influence the rate at which
the bank will advance credit to its customers in the various sectors in the
economy. The central banks however lack the tools to enforce the rates to a
desired level. Theirs is just a policy rate. In kenya it’s the central bank
rate.
Government papers should not offer better returns so as to
allow the banks concentrate on lending to the economy where growth and
employment is generated. Fiscal discipline and integrity needs to be maintained
in Government so that the monies spent can have a larger distribution and
impact back to the economy. Anything that affects the value of Government
spending only worsens the economy and hence the ultimate value of the spent
resources.
Kenya Credit market pricing
The Kenyan market has seen rates vary depending on products
and lenders. Informal lenders are reported to charge as high as 100% per annum
while commercial banks have had their rates lower than that. Historically the
interest rates in the country have remained unpredictable and unregulated.
The last few years have however seen attempts to control the
interest rates.
In year 2000, a banking amendment act was passed by parliament
and assented to by the president to become law. The act sought to cap bank
lending rates at 4% above the prevailing Treasury Bill rate and as the law
required then it had an effective date.
By the time the bill was assented to by the president the effective date
had lapsed and that meant the banks had to re-write their loan contracts and
review the interest rates for the same.
The bankers contested that and the high court held that the
bill was unconstitutional in the sense that it was operating in
retrospect. That essentially killed the
bill.
In 2007 the in-duplum rule was passed and affirmed by courts
that a defaulted loan earnings are capped at a 100%. Essentially the interest
and fees charged should not exceed the principal amount. The limit of interest
to be recovered of a defaulted loan was capped. However this was no panacea to
high interest rates since most of the loan accounts are short term loans with
most borrowers being business entities with regular need for working capital.
In 2014 Kenya bankers reference rate KBRR was introduced to
further make disclosures on the cost of lending. KBRR requires the bank to add a premium “K” and
disclose the same. The lending rate thus is KBRR+K where K will contain the
cost of funds, risk profile margin, administrative cost and the profit margin.
Of key importance is the understanding of the consumer
behavior in regards to income generation and expenditure. Kenya has poverty
levels of almost 50% of the population. We define the poor as the persons
living below a dollar a day though that has been revised to those living below
a dollar a day. Unemployment rate is at 45% thus compounding the already not so
good outlook.
Surveys place the basic needs as a priority to the
population. Food, clothing, education, healthcare and security are priority
needs to the general population. These are the areas that the population spends
monies on and hence have no savings. The absence of a good education system, a
frail healthcare system and food production cost on the increase the
mobilization of savings by banks from the populace has remained unpromising.
The country is a net importer, our industrial output is low
and hence no tangible employment is happening in the economy. Our Agriculture
is facing stiff competition from the trade partners and our production costs
are on the rise. This coupled with the lack of value addition for our farm
produce is exposing our little resources at the consumption level. The general
population has little to save.
General cost of funds (Deposits) as at June 2016 placed the
average cost of funds at 7%. The average earning for Government papers at 10%
and average lending rate at 18%. There is however a general increase in default
rate and the non-performing loan portfolio is on the increase. Regulated banks
provide reserves which are passed as expenses for loans which become
delinquent. Thus the general performance
for of loans has a direct impact on the earnings of the lending institutions.
At a public level, we are running at deficit every year. Our
recurrent expenditures have increased exponentially, our discipline in handling
our public resources is wanting and thus we are not getting value for the
constrained resources we have. The Government is bridging these gaps by
domestic borrowing. The cost of Government borrowing in the long term papers
has averaged 12%-14% in 2016.
The recent introduction of a banking amendment law capping
the bank’s lending rates at 4% above the Central Bank Rate presents a complex
scenario. It makes the cost of borrowing
predictable and it brings relief to the borrower who was paying higher
premiums. However there is a flip to this.
Banking, being the players actively participating in
government papers is both a risk taking and profit making business. Bank
investments should return earnings commensurate with their risks. The timing is
tricky with the country going into an elections year. Already banks have
started shoring up their investments in Government papers in the reported results
for the first half of 2016. And this year alone the government would be looking
for funds to cover an almost 20% deficit.
A day after capping the commercial
rates at 14.5% the Government traded a paper at 15%. Where will you put your
monies profitably?
Kahugu Muiruri
September 2, 2016
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