Kenya’s interest rate cuts to affect banks' lending margins

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International ratings agency Moody’s said that Kenya’s low interest rate will affect most Kenyan banks’ lending portfolios.

This follows after the Central Bank of Kenya (CBK) cut the Kenya Banks’ Reference Interest Rate (KBRR) from 9.13 to 8.54 per cent. The credit negative move will drag on the profitability of Kenyan banks albeit from a high base.

Moody’s says that the rate will have an immediate effect on the portion of floating-rate bank loans that charge the KBRR, which totalled 732 billion Kenyan shillings as of December 2014, around 38 per cent of total loans and advances.

“These loans will be re-priced, reducing banks’ interest rate spreads, since banks’ cost of funding, which is not linked to the KBRR, will likely remain broadly stable” said the agency in a statement.

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Introduced in June 2014 by the CBK, the KBRR is a means to enhance the supply of private sector credit in Kenya by facilitating a transparent credit pricing framework. 

“Banks are allowed to charge a premium over the KBRR based on factors such as the cost of doing business and the borrower’s credit quality, and a lower reference rate is likely to affect Kenyan banks to varying degrees,” continued the statement.

Corporate-oriented such as NIC Bank Ltd and CFC Stanbic Bank are likely to be the hardest hit as corporate loans and deposits are highly competitive and price sensitive. They also typically charge a tight premium over the KBRR.

“For these banks, we expect a rapid and sharp decline in net interest margins.”

Moody’s added that retail-oriented banks however such as Co-operative Bank of Kenya, Equity Bank and Barclays Bank of Kenya Ltd, have greater leeway to delay their response and make lower adjustments to pricing by charging higher premiums. Their profitability is therefore less likely to be affected.

“The main driver for the interest rate cut is a drop in government borrowing rates, to which the KBRR is directly linked. The two-month weighted average 91-day Treasury bill rate, a component used to price the KBRR, has dropped to around 8.6 per cent as of January 2015 from 9.8 per cent as of July 2014,” the agency noted.

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However, Moody’s believes that the Kenyan banks’ profitability will remain strong despite declining margins.

“According to the CBK, Kenyan banks’ return on assets was 4.7 per cent in 2013, with net interest margin on earning assets at ten per cent, which compares favourably with global emerging market peers,” Moody’s added.

“In addition, a gradual reduction in lending rates, in addition to a lower cost of living given declining oil prices, will support borrowers’ loan repayment capacity, easing loan-loss provisioning needs.”

Also, most Kenyan banks have responded to declining margins by improving efficiency and growin their regional operations, while profitability has weakened sector wide, it should remain in line with global emerging market peers.

“Longer term, any further reduction in interest rates and in the cost of credit in Kenya should help create new business opportunities for banks. Expanding financial services in the country should be further supported by reduced public sector borrowing following the Eurobond issuance, which will free up banking sector resources to be deployed to the private sector.”