Banks set to lose benefits of lending rate cap repeal
Lewis Njoka @LewisNjoka
Benefits Kenyan banks are currently enjoying from the repeal of the rate caps will be reversed by the coronavirus pandemic shocks with the economy projected to grow at one per cent.
Fitch Ratings, a global rating agency, said operating environment pressures will result in weaker asset quality and profitability metrics in 2020, with capitalisation, funding and liquidity less affected.
“Risks are tilted to the downside again. The coronavirus pandemic will reverse the benefits to banks from the repeal of the interest rate cap in terms of lending growth, asset quality and earnings,” said Vincent Martin, an analyst at the agency.
A report by Fitch shows that loan books expanded in the first half of 2020, mostly to the corporate sector, but declined after April due to Covid-19 related lockdown.
This mirrors a similar phenomenon between 2016 and 2019 where private sector credit contracted 1.2 per cent in real terms on average compared to a 9.6 per cent growth in 2015 before rate cap was adopted.
The repeal of the lending rate caps in November 2019, gave banks the leeway to price risk appropriately. This, however, will be reversed by coronavirus shocks.
Rate caps were introduced in 2016 to curb high lending rates but brought about unintended consequences such as banks shying from giving loans to segments considered riskier such as small and medium enterprises (SMEs).
Commercial banks instead favoured government securities resulting in restricted private sector credit growth and a sharp decline in bank margins.
In the report, Fitch noted that there has been heightened asset quality risk within the sector with the non-performing loans (NPLs) ratio jumping from 12 per cent as at the end of 2019 to 13.6 per cent as of August this year.
“But given the extent of the disruption to businesses and households, we forecast the NPL ratio closer to 15 per cent by end of 2020, with pressures arising from particularly affected segments, such as trade, personal lending and manufacturing,” reads the report.
Relief measures
However, banks’ own debt relief measures, including loan repayment holidays, will prevent a faster rise in NPLs this year, according to the agency.
The Covid-19 pandemic is also expected to put pressure on bank earnings as witnessed in the first half of the financial year.
Bank profitability, according to Fitch, declined sharply in the first half of the year due to reduced earnings, policy rate cuts, lower client activity and increasing loan impairment charges.
“Looking into the next 12 to 18 months, our view is that Kenyan banks will respond to the current challenges posed by the weakening operating environment in Kenya and regionally by adopting prudent growth strategies,” it reads.
As a result, the report adds, the agency expects private-sector credit to grow by a tepid one per cent to two per cent in 2020, (2019: 1.8 per cent), considered to be significantly below the sector’s potential.
Fitch Ratings forecasts Kenya’s gross domestic product (GDP) growth to slow to one per cent in 2020, the lowest since 2008, as the slowdown in global trade hits key economic drivers, such as exports, tourism and agribusiness.
Luckily, the banks have a stable funding, funded primarily from customer deposits, and are sufficiently liquid.
Additionally the sectors funding is largely in local currency, which limits the risks associated with reliance on foreign currency funding common in other Sub-Saharan Africa markets.
