Kenyan banks find themselves in a tough spot, akin to a deer ensnared in the piercing glow of headlights. They are burdened by substantial amounts of government debt and defaulted government supplier debt. To compound matters, their ventures into foreign exchange have become a costly gamble, with a staggering 23.8 percent surge in expenses triggered by the falling Kenyan shilling..

In psychology, it is recognized that, like animals, humans tend to freeze in response to acute stress, an instinct aimed at enhancing risk assessment and decision-making abilities. However, this instinct can lead to paralysis, leaving individuals unsure of how to proceed. Kenyan lenders are facing a nearly impossible situation, stemming from years of accumulating long-dated government bonds, funding tenderpreneur Local Purchase Orders (LPOs), and following the government's lead by borrowing in dollars based on a fixed exchange rate.

Massive defaults

A sharp rise in interest rates, both globally and locally, has substantially increased the cost of doing business. However, banks are struggling to pass on this cost to consumers without triggering massive defaults, creating a catch-22 scenario.

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Equity Bank Group CEO, Dr. James Mwangi, acknowledges the challenge, stating, "Interest expense is growing much faster than interest income. Operating expenses are also growing much faster than net interest income." Despite this, the bank is maintaining customer rates at an average of 16.5 percent, a deliberate decision to cushion customers despite the sovereign risk on bonds being at 18 percent.

This approach contradicts Dr. Mwangi's ethos, as he has previously criticized such a position, considering it akin to creating opportunities for arbitrage where banks facilitate borrowers to take loans and lend to the state.

Adding to the concern for lenders is the broader economic downturn, where borrowers are defaulting and closing businesses due to costly taxation and low sales caused by inflation. The government's adoption of International Monetary Fund’s (IMF) structural adjustment policies, taxing the country into poverty while devaluing savings and borrowing recklessly, poses a significant threat to the banks, closely tied to the government's fate like Siamese twins.

Banks watch in bewilderment as government austerity measures, pending bill defaults, and currency devaluation wreaks havoc on the economy, jeopardizing their profitability. Kenya's top four local lenders experienced a surge in bad loans, with profits dipping: Equity Bank Kenya's profits declined by 19.9 percent to Kes19.3 billion, NCBA saw a 3.6 percent decline to Kes12.5 billion, and KCB Bank Kenya's profits declined by 9 percent to Kes23.9 billion.

Lazy lending

Bankers take offense when accused of practicing "lazy banking," a term suggesting a preference for hiring a single Treasury specialist to lend to the government profitably without risk, rather than investing in branch networks, staff, and sales and marketing to issue risky loans to the private sector.

However, in the past decade, driven in part by interest rate caps and the Treasury's aggressive borrowing, banks have amassed substantial government debt at the expense of the private sector. Holding such a significant amount of state debt means that when a credit ratings agency downgrades the sovereign, banks are also downgraded.

As the Central Bank of Kenya raises interest rates, many of these bonds are losing value, prompting lenders to hurriedly sell off existing bonds and competitively bid on new issues in an attempt to minimize losses. According to Eric Musau, an analyst at Standard Investment Bank, the proportion of domestic debt held by banking institutions has declined by 825 basis points, dropping from 52.83 percent to 44.5 percent over the last three years as lenders aim to reduce their mark-to-market losses.

Pending bills tragedy

The second problem is that banks not only aggressively lent to the government but also directed a substantial portion of their private sector loans to government tenderpreneurs. This debt seemed lucratively risk-free, as it was underwritten by the government, and while delays were common, the debt was consistently paid, albeit at a higher interest margin.

However, with the arrival of new political administrations at both county and national levels, there is an attempt to invalidate the nearly Kes700 billion debt. Newly elected Kenyan politicians entered office with the belief that there was money to be made in government, only to discover that the state was financially strained.

As the government runs out of debt-funded resources to misappropriate, the focus of political battles has shifted to overdue bills left by previous county and national government regimes. The National Treasury and counties are refusing to pay government suppliers, initiating audits of pending bills to render a significant number of them invalid.

Despite the Kenyan Kwanza government's campaign promise to pay suppliers promptly, upon taking office, they abandoned the plan to convert pending bills into a bond. The Treasury not only reversed the intended securitization but also established a verification committee led by former Auditor-General Edward Ouko.

Although banks lobbied the IMF to exert pressure on the government, considering it a structural benchmark, Washington has not shown the same enthusiasm as it has for raising taxes. Kenya missed a crucial deadline set by the IMF for clearing pending bills, as officials delayed the benchmark due to transparency concerns and to conduct audits of the debts. Now, the banks are grappling with this collapsing debt in addition to the general rise in loan defaults caused by the economic woes induced by IMF austerity measures.

Expected bad loans

The ratio of non-performing loans (NPLs) has risen from 13.8 percent in October 2022 to 15 percent in August 2023, driven by ongoing economic downturn, inflation, and steady increase in taxes. Business’ sales have plummeted by half as manufacturers consistently raised prices for 14 months. With declining sales and increasing costs, businesses have struggled to meet their obligations, leading to a surge in defaults and asset seizures.

In a shocking move that unsettled the Nairobi Securities Exchange (NSE), Equity Bank attempted to take over two listed companies, Trans Century and East African Cables, revealing serious oversight concerns and the financial state of Kenya's largest public companies. This move clearly indicated that the challenges faced by small and private businesses were finally affecting publicly listed companies.

In recent months, Equity Bank has placed several companies under administration, including Tuskys, Kigali Business Centre, and Dickways Construction. Sumoko Down Town Enterprises and Sea Angel Petrol are also on Equity's list of troubled companies. Regional lender NCBA sought to place Multiple Hauliers under administration. Along with Co-operative Bank, NCBA attempted to pursue Kaluworks. The lender is also looking to take over Royal Swiss Bakery in collaboration with KCB and First Community banks.

KCB Bank has seized English Point Marina, Pinewood Beach Resort and Spa, and, in conjunction with Absa Kenya, sought to take over Savannah Cement. Lenders are also pursuing Hashi Energy, Mulleys Supermarkets, Invesco, Explico, and Amaco Insurance companies, indicating the challenges of a depressed economy.

Risky borrowing

As the banking business experiences diminishing income and endures mark-to-market losses, costs have also surged, especially on loans borrowed in foreign exchange. Within a year, the global interest rate, the Secured Overnight Financing Rate (SOFR), for dollar-denominated loans has risen from 1.5 percent to 5.2 percent. This implies that banks that received funding at 6-month LIBOR +5 percent are now facing a cost of funds of about 10.3 percent, not including their margins and risk premium for on-lending.

It's not just the cost of the loan that has increased; the amount of shillings needed to repay has also sharply risen due to the rapid depreciation of the Kenyan currency. The collapse of the Kenyan shilling means banks now need nearly twice as many shillings for every dollar borrowed compared to a few years ago.

Banks contend that the currency has depreciated so rapidly that many had not anticipated how severely it would decline, leading to an underestimation of the amount required to repay their dollar loans.

"The depreciation of the shilling, particularly for Kenya, has caught us off guard, and you'll see it in the numbers in many other organizations. All budgets were planned at 130; in the worst-case scenario, some people planned with 128. Today, it is touching 158, and I have no idea whether to use 158 or 160. It has become unpredictable, and with that comes challenges, particularly with the credit book on facilities denominated in dollars," said KCB Bank Group CEO Paul Russo.

Initially, banks in Kenya were making significant profits through substantial interest rate spreads when the government, under Uhuru Kenyatta, attempted to artificially support the Kenya Shilling by creating a parallel exchange rate.

The foxy forex

 

The collapse of the shilling had initially been advantageous for bankers, as they could profit from dollar shortages and the CBK’s then ill-informed policy of price controls. Banks were making significant profits through substantial interest rate spreads when the government, under Uhuru Kenyatta, attempted to artificially support the currency by creating a parallel exchange rate.

 

In contrast, the new government and the new CBK Governor allowed the shilling to devalue, citing the need to streamline the market, IMF restrictions on intervention, and a policy to absorb external shocks by boosting export productivity.

 

However, the radical policy shift under the new administration, involving spending on food importation subsidies, erratic policy decisions regarding the settlement of the Eurobond due in June next year, and an opaque multibillion-dollar oil trade deficit disguised as a Government-to-Government oil deal, has caused the shilling to fall beyond everyone's expectations.

 

While the IMF policy may have had good intentions, in practice, the pain in the midst of a recession and on the brink of an El Niño calamity may be too much for Kenya's fragile economy, which relies on importing expensive energy and crucial lifesaving medicine.

The International Monetary Fund (IMF) managing director Kristalina Georgieva. Although Kenyan banks lobbied the IMF to exert pressure on the government on clearing pending bills, Washington has not shown the same enthusiasm as it has for raising taxes.

The inside man

 

On a rare occasion, we had the opportunity to hear KCB Group Board Chairman, Dr Joseph Kinyua, weigh in on the matter. Dr. Kinyua was Kenya’s longest-serving civil servant, leaving government after 44 years, during which he rose to the position of Head of Public Service.

 

A close ally of former President Kenyatta, who tapped him from the National Treasury, where he served as a Principal Secretary, to the State House, Dr. Kinyua, unlike most officials from the previous administration, transitioned to the KCB Group as board chairman. This transition underscores the value of his counsel even under President William Ruto’s government.

 

A highly regarded economist with experience at both the Treasury and the CBK, shaping policies across four presidencies, Dr. Kinyua is also associated with the IMF, having served as an economist for the multilateral lender between 1985 and 1990.

 

Despite his alignment with the textbook economic logic of the structural policies of his former employer, he expressed dismay at how things are unfolding. He acknowledged the importance of stable and predictable currency movement, citing that extreme strength or weakness could adversely impact export businesses.

 

“What is important is to ensure the movement is one which is stable and predictable. It is not that when the currency is too strong, it is not also good. It becomes a factor that discourages export business. So we normally do in our financial programming have a framework within which you ensure you maintain the rate to move along a corridor that will not destabilize economic business,” he stated.

 

Expressing concern about the current volatility, Dr. Kinyua emphasized the need for gradual, predictable movements to facilitate planning without causing disruptions.

 

Retail investors at the bourse hit

 

For many institutional and foreign investors, the signs on the Nairobi Securities Exchange have all been red, leading them to reduce their exposure and exit. For example, KCB Group, which is largely owned by institutional investors, witnessed its share price plummet from a high of Kes43 to a low of Kes15 after the institution sold 0.08 percent of its holdings, while foreigners dumped 0.51 percent of their shares.

 

Local investors, whose modest pensions are tied to the fortunes of the banks, have experienced a 50 percent decline in the value of their years of savings, as KCB Group's market capitalization shrunk from Kes133.2 billion to just Kes67.0 billion within a year.

 

The small investors who still see value in the bank are the main reason the bank's share is slowly recovering. The share price is currently rising to Kes20 only through investors increasing their holdings by 0.59 percent. When KCB shareholders gathered for the release of the third-quarter results, the retirees' anxiety was focused less on the overall performance of the bank and more on the value of their shareholding, which had halved in just one year.

 

Catherine Emali, a shareholder, expressed concern, stating that over the last couple of months, they have been anxious, making calls to understand how a seemingly profitable bank like KCB could experience such a steep fall in share price. "We have had troubled minds in the last two months, not being able to sleep because of the share price declining each day, and as we know, KCB is one of the strong counters in the NSE. So our worry was, what is happening, what is the rumor, and we keep ringing each other to get the news," Ms. Emali said.

"We have had troubled minds in the last two months, not being able to sleep because of the share price" KCB Group shareholder Catherine Emali.

The currency of candor

 

The bank's CEO, Mr. Russo, mentioned that he had received several calls from shareholders inquiring about the lender's surge in defaults, decline in profitability, lack of dividends, and its proximity to the government after KCB Group participated in the Hustler Fund, issued Letters of Credit for the Government-to-Government (G-to-G) oil imports, and collaborated with the Kenya National Trading Corporation (KNTC) for the importation of food commodities and edible oil.

 

Paul Russo opted for candor to alleviate investor concerns, acknowledging that his statements might make some people uncomfortable in their frankness. Candor, a trait that temporarily cost OpenAI CEO Sam Altman his job, is a rare quality in authority and is thus highly valued.

 

According to Mr. Russo, the market unfairly punished KCB Group when, in the first half of the year, the bank took a significant hit by anticipating defaults and setting aside substantial provisions that affected profitability. He noted that other lenders were now experiencing similar hits, with rivals reporting declines in profitability and making substantial provisions in the third quarter.

 

He clarified that shareholder funds had actually grown from Kes187 billion last year to Kes218.8 billion, making KCB the largest lender, as the bank became the first to accumulate over Kes2 trillion in assets. Mr. Russo addressed accusations of the bank being too close to the government stating that 96 percent of KCB loans were issued to the private sector, with only 4 percent going to the government.

 

Read also: Subsidiaries drive Equity profit up 5 percent to Sh36.2 billion

 

Facing East Africa and cutting to the bone

 

He emphasized that KCB treated the state at arm's length in transactions involving the Hustler Fund, the G-to-G oil deal, and KNTC to avoid exposure to potential losses. Despite allegations, Mr. Russo clarified that KCB had no exposure to the Hustler Fund and made Kes58 million by purely facilitating the fully funded government project.

 

Regarding KNTC, he assured that the team was working to eliminate exposure by the end of the year, settling the letters of credit. In the G-to-G deal, where the bank guaranteed $3.37 billion or 85 percent of imports, the oil served as collateral. Furthermore, KCB Group's coverage of the oil import trade increased from 42 percent to 85 percent, and the bank expanded its banking services for oil retail outlets of the oil marketers.

 

Mr. Russo, in his candor, earned investor confidence at a high price. He outlined that the East Africa project could be the new goldmine to replace Kenya’s declining fortunes. All Kenyan bankers have projected how East Africa subsidiaries have grown in the bottom line, amplified more by shrinking Kenyan numbers than regional growth.

 

“As I stand here this evening, I need to express that my mindset has been rejuvenated. So, come the AGM, I hope, my good CEO, you will deliver a positive message as you have promised,” said Catherine Emali.

 

The question remains whether this momentum can be sustained when the major stakes are in the Democratic Republic of Congo (DRC), a country where seven million people have recently been displaced amid another surge in violence around Northern Kivu ahead of a hotly contested Presidential election on December 20.

 

Read also: How Absa Bank is empowering Kenyans through digital savings

 

Wiser depositors

 

Locally, banks have turned to cutting down their costs through radical restructuring, including reductions in expenditure on photocopy paper. The lenders have implemented staff voluntary exit programmes, and an insider mentioned that banks are heavily relying on disciplinary measures to reduce staff numbers. “I received a show-cause letter, and when I went to HR, there were so many of us; it's like they are targeting a specific number,” said a clerk at a local bank to Maudhui House.

 

Banks are also turning to low-income Kenyans for savings, hoping to secure cheaper deposits to reduce their cost of money. Currently, banks are offering higher deposit rates and conducting publicity marketing, including cash prizes, in the hope of attracting deposits.

 

NCBA Bank, under the Twende Mbele media blitz, has initiated a three-month deposit mobilization campaign called "Deposit & Delight," offering cash rewards to savers. This initiative provides Kenyan customers with the opportunity to win up to Kes1 million for deposits as low as Kes5,000.

 

Elsewhere, Absa Bank Kenya is promising to reward savers with a 9 percent interest rate, with monthly payouts making the investment relatively liquid. On its part, Standard Chartered Bank Kenya has launched a Kes15 million campaign aimed at rewarding new account holders who transfer their salary accounts to the bank, titled "Switch your Salo. Bank Better," while KCB Group is running the 'For People For Better campaign.'

 

However, with digital banking, competition from unit trusts, and awareness of government interest rates, it remains to be seen whether prizes or higher rates of return will attract more depositors.

 

The exceptions

 

The lenders who have managed to avoid this predicament are primarily foreign banks, including Absa Bank, Stanbic Bank, and Standard Chartered Bank, whose credit lines are not dependent on expensive commercial dollars. "Some of the banks were borrowing at Libor when it was 0.5 percent, but the SOFR is now above 5 percent, and they have not been able to pass it on to consumers. Those that had less exposure to Tier II capital, like Absa, Stanbic, and Standard Chartered, actually did well," explained Mr. Musau.

Absa Bank's local unit reported a 9.9 percent growth in net profit to Kes11.1 billion, StanChart grew its local unit earnings to Kes9.4 billion, while Stanbic added Kes2.3 billion more to its local unit earnings. Local lender Co-operative Bank also avoided the challenges and reported Kes16.4 billion under Co-op Bank Kenya at the cost of slowing deposits. I&M Bank posted a slight increase in profits to Kes5.7 billion, with the bank stating that they had hedged their borrowings.

 

“The cost of funds has shot up with the current market conditions where the government is competing for deposits, and banks must reprice to maintain their liquidity. We have hedged our borrowings and are in control of our finance costs,” said I&M Group Chief Financial Officer Amit Budhev Bank.

 

Mentoria Economics Chief Economist Ken Gichinga also mentions that all banks are hoping that the biggest push to this crisis, the rise of the US Federal Reserve Bank rate, will finally start reversing in the middle of next year. Without this reversal, no amount of strategy can steer them away from the path of the speeding headlights.

 

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