Ratio Magazine :: The Inside Track to East Africa’s Economies - Kenya: Faida Investment Bank on Kenya’s Banking Sector: Ready for Take Off

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Kenya: Faida Investment Bank on Kenya’s Banking Sector: Ready for Take Off

Friday, 03 October 2008

Ratio Magazine showcases research from Faida Investment Bank’s Head of Research, David Mataen, who analyses the prospects for Kenya’s banking sector.

Despite the political violence at the beginning of the years, Kenya’s banking system remained stable through June 2008. The overall performance of the banking sector was rated ‘strong’, an improvement from the ‘satisfactory’ rating attained during the same period in 2007. The banking sector total assets stood at KES978bn by December 2007, while total liabilities were KES845bn. Combined sector core capital increased tremendously from KES99bn in 2006 to KES188bn on the back of sector-wide earnings retentions, a couple of rights issues and a massive private equity injection into Equity Bank.

Sector-wide revenues look encouraging: All traditional revenue sources have trended upwards in the five year between 2003 an 2007. However, interest income continued to top all other revenue sources despite unflagging interest margins contraction. Not only has interest income grown immensely as a source of net revenues for the sector, but the margin between it and fee income has continued to widen each year. This has been the effect of a sudden return to basics by commercial banks, incidentally not just in this country, but globally. Banks realised that capital markets and their derivatives cousins are a fickle, less dependable source of life, and have since all gone back to embrace their roots as deposits takers and interest rates arbitragers.

Fees income has, however, also grown as banks charged a fee for loans origination and processing. Foreign exchange revenues have generally grown only gradually, often imperceptibly, for the whole sector, with some exemptions; mostly those that were only beginning to get into it or stood favorably on the traffic paths of the tremendous inflows of foreign exchange that have inundated Kenya’s economy in the recent past.

A quick look at the expense profile of the sector reveals a very telling story: While direct operating expenses have grown generally in line and often below the rate of growth of the underlying businesses, general administrative expenses have continued to take up close to 40% of the total spend of banks in the economy for all of the past five years. This fact is borne out by the blistering pace of expansion, growth, modernisation and strategy overhaul all players in the sector have been going through. Expenditures in opening new branches, an increasing number of ATMs, setting up more modern and scalable core banking systems platforms, rolling out newer channels through points of sale (POS) networks, establishing card businesses, and establishing subsidiaries within the region (for some) bear the bulging bill of other administrative expenses for the sector. In short, the Kenya banking scene has been dressing up for growth, scale and modernisation.

Sector-wide operating margins have widened since 2005 as the curves of net operating income and total expenses diverged away from each other. These positive margins expansions were achieved despite substantial capital expenditure and investments in new branches, off-the-shelf IT systems and human resources. The sectors’ return on each unit of investment has been improving, making it a hugely attractive destination for new capital.

Total deposits grew by a whopping 21% to stand at KES723bn in December 2007, from KES595bn in 2006. Earning assets, i.e. loans and advances, grew a little faster than deposit liabilities at 28% to top KES542bns in December 2007, from KES469bn in 2006. Net new lending was KES72bns in the year.

Provisioning for bad and doubtful debt is a direct operating cost for the business of a bank. As a measure of sector operational efficiency, loans loss provisioning, and the total stock of provisions held are vital for the determination of the ultimate sector-wide operating margins. The sector-wide provisions portfolio was at its highest in 2005/2006, and in 2007 it came down to 2003 levels, despite a much larger and wider asset base in the entire sector. Yearly loan loss provisions charges have dropped gently and steadily over the course of the past five years.

The sector asset quality has improved enormously over the recent past. Measures to clean up lending books have borne positive results: The net non-performing portfolio stood at 18.5bn in December 2007, down from KES23.6bn in 2006. And despite the surge in lending, loan loss provisions to 5.6bn in 2007 against KES7.7bn in 2006. In fact, a pleasant phenomenon occurred in 2007, when there was convergence between total non-performing loans and total provisions held by the sector. The implication of this is that the sector generally has no uncovered exposures to possible loss from loan assets, i.e. that for all other probable deterioration in asset quality, the sector is holding full and realisable security.

Each and every balance sheet item has increased consistently and incrementally in every year of the last five years. Total sector assets have exactly doubled since 2003. So have shareholders’ funds. Ambitious drives to extend banking services to hitherto unbanked sections of the economy, and generation of innovative deposit products, resulted in very successful deposits mobilisation and retention in the sector over the last five years. Shareholder funds have been boosted in part by net new capital additions from issues of securities through public rights issues or private placement; and accumulated retained earnings.

Where deposit liabilities have grown by 88% within the period, net loans grew by 117%, indication that the sector has both squeezed out slack and had some solid write backs from the non-performing portfolio. Investment in government securities, though growing, has certainly not increased at the pace of loans and advances to customers. This is a very welcome confirmation that the sector has fully turned to supporting the productive sectors of the economy, on which the economy depends for value creation and thus growth.

Sector profitability has continued to improve over the past five years. In fact, out of 44 banks, in 2007 only one bank reported losses. Overall sector profitability grew by 19% between 2006 and 2007, to stand at KES42bn – levels never before seen in the Kenya’s financial sector. Return on capital employed has equally improved incrementally from average 12% in 2003 to above 20% in 2007.

The Kenya Banking sector is densely populated with 45 commercial banks (in addition to two mortgage finance companies, and 105 forex bureaux), but at the same time highly concentrated with eight banks of the 45 banks literally controlling 70% of the sector by all aspects. Barclays, KCB, Standard Chartered, CfC/Stanbic and Co-op Bank, in that order, are the top five banks in the country according to key criteria.

David Mataen is the Head of Research at Faida Investment Bank (FIB). For more information, contact David on This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

For David's investment recommendations read:
Kenya: Faida Investment Bank Recommendation: Kenya Commercial Bank
Kenya: Faida Investment Bank Recommendation: Barclays Bank Limited
Kenya: Faida Investment Bank Recommendation: Equity Bank Limited

Disclaimer: The information contained herein is obtained from sources that to the best of our knowledge are reliable. As such, neither Faida Investment Bank nor Ratio Magazine/Africa Business Insight are responsible or liable for any factual errors arising thereof. Any opinions expressed herein are ours and may change anytime at no notice.

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