OBSCENE PROFITS

How banks rob customers to pay shareholders

Commercial banks are swimming in excessive profits in the face of a struggling economy and relentless public outcry over the high interest rates charged on credit. It is a classic example of robbing the majority poor to pay the minority rich, in this case banks’ shareholders.
 
BY EMMANUEL ROTICH and LUKE MULUNDA
 
Latest data from the Central Bank of Kenya shows lenders harvested a combined profit before tax (PBT) of Sh124.57 billion last year (2013), an a 16.89 per cent growth from the previous year’s Sh107.68 billion.
This huge profit portfolio was made from the 17.3 million customer deposits and 2.3 million loan accounts. By implication, every customer ideally contributed at least Sh6,200 to the offensive profits banks made last year.
For banks, Kenya has proved to be a relatively low risk district, with promising returns. They attribute this to improved technology, stability and communications advancement in Kenya.
But what is hardly mentioned is the narrative is that these banks are not charities. Their expansions are informed by the high returns relative to risks in new markets. In fact, Deputy President William Ruto recently accused commercial banks of exploiting Kenyans by charging them high interest rates.
“We must investigate why the interest rates are about 15 per cent when it is only three per cent in India, five per cent in Nigeria and a paltry two per cent in the United States,” said Mr Ruto.
The business community has raised alarm, arguing that the high interest rates are slugging their growth.
Indeed, a World Bank report recently said such an environment was making Kenya a less competitive foreign investment destination compared to its peers in Africa.
Efforts against
Past efforts to contain the rising interests, however, have failed. Two years ago, Parliament shot down the Finance Bill 2011 that had sought to check interest rates to a maximum of four per cent of the Central Bank Rate. And in 2001, the High Court ruled against the capping of interest rates, terming the move unconstitutional.
This followed the move by Joe Donde in September 2000 to introduce before the House a Bill seeking to control interest rates. The Central Bank of Kenya (Amendment) Bill 2000 argued that despite market liberalisation, the financial sector in Kenya had consistently maintained high interest spread.
According to Mr Donde, the objects of the bill were to harmonise the cost of lending and borrowing in the banking sector. This, he said, would ensure that the rates reflect the prevailing market conditions.
“The intention was to make the Treasury Bill, as a risk-free security, the benchmark for the interest rates in the financial industry. The imposition of this requirement meant that the spread on the interest rates would not exceed six per cent and that the Central Bank of Kenya was to ensure that banking and financial institutions adhere to this provision. As a result, the interest rates on loans will be pegged to the 91-day Treasury Bill rates,” said the Institute of Economic Affairs in a report.
Furthermore, the bill had two critical clauses: Operationalise Central Bank of Kenya Act (Cap 491) and Section 39(1) which compelled Central Bank to ensure that the maximum interest rates charged on loans by financial institutions was no more than three per cent more than the 91-day Treasury Bill rate. In operation, Mr Donde says the clause would have required all banks to align the interest rates on loans to the Treasury Bill rate plus a further three per cent.
This meant, therefore, that the Treasury Bill would be the yardstick for the determination of the interest charged on loans.
Kenyatta University Economics Lecturer Dr Emmanuel Manyasa says the lending rate would at the most be only three percentage points above the 91-day Treasury Bill rate issued by the government if the Donde Bill had seen the light of the day. “Banks would thus lose the most abused discretion to set interest rates,” said Dr Manyasa.
Analysts say such should be the case today, so that banks would benefit from economies of scale. Section 39(2) of the Bill required Central Bank to ensure that customer deposits received a return of no less than 70 per cent of the interest paid on the 91-day Treasury Bills. Just like in lending, the clause also introduced the non-market mechanism to determine the interest banks paid their customers.
Banking regulations
Proponents of the high cost of lending blame Kenya’s strict banking regulations, which require commercial banks to maintain a cash ratio of more than 10 per cent of their total deposits with the Central Bank of Kenya. The high quota, they claim, means that while the banks must pay the interest on the deposits, they only keep 90 per cent of the deposits for their operations because the Central Bank does not pay interest on the 10 per cent deposit.
“This requires banks to make up for the interest that they have to pay to depositors. The high cash ratio requirement adds to the cost of operations for bankers if they must pay interest to all depositors and reduce the revenue earning assets available to banking institutions,” said Kwame Owino of Institute of Economic Affairs.
On the other hand, financial analysts say the high lending rates have been due to the lengthy and costly litigation which may last up to three years to complete. This means even if loan payments have been defaulted on, it takes quite a long period of time to get the loan and interest amount back.
“Increased defaults have also contributed to the high interest rates though this is being curbed slowly by the setting up of credit reference bureaus,” said Charity Chelimo, a credit officer in a local bank.
Central Bank of Kenya Governor Njuguna Ndung’u says the launch of credit reference bureaus in July 2010 has proved to be important in the operations of financial institutions. “The number of credit reports requested by institutions stood at 2,596,600 in March 2013 up from 2,321,766 reports in December 2012, representing an increase of 11.8 per cent,” said Prof Ndung’u.
Over the same period, the number of reports requested by customers increased from 28,733 to 35,172. “The introduction of the credit information sharing mechanism has further strengthened credit appraisal standards. Banks have now incorporated credit reference reports in the credit risk appraisal. It is also expected that credit referencing will go a long way in inculcating credit discipline in borrowers,” he said.
Credit risks
The huge growth in earnings by banks was, however, accompanied by an increase in credit risk, which saw the level of non-performing loans grow by 30.91 per cent to Sh80.59 billion from Sh61.56 billion in the previous year. This shows that borrowers are struggling to pay back either because the rates are too high (which could highly likely be the case) or the economy is not growing fast enough to create revenues to service loans.
The banks’ total income grew 1.53 per cent to Sh357.9 billion from Sh352.52 billion, while total expenses fell 4.7 per cent to Sh233.32 billion from Sh244.84 billion in a similar period. The banking market is controlled by a few big players, which dictate the pace in the industry and pocket much of the wealth skimmed from banking service consumers though high interest rates and other service charges like ATMs, ledger fees and counter withdrawals.
In 2012, for instance, six big banks amassed billions of shillings in profits and controlled over half of the total market share. These banks raked in a total of Sh70.67 billion, accounting for 65.5 per cent of the total profits made by the entire banking industry.
This compares adversely with a paltry Sh2.15 billion (two per cent) in profit made by 22 small banks and Sh35.06 billion (32.5 per cent) made by 15 mid-sized banks. The six big banks also controlled Sh880 billion worth of customer deposits compared with Sh656 billion and Sh171 billion for the medium and small sized banks respectively.
Last year the banking industry s’ total income grew 1.53 percent to Sh357.9 billion from Sh352.52 billion, while total expenses fell 4.71 per cent to Sh233.32 billion from Sh244.84 billion in a similar period.
Interest rates
Concerns over high interest rates have seen the government announce stringent measures to streamline operations of the banking sector.  These include monitoring how banks calculate their interest rates and reviewing the cartel-like behaviour in the industry, which is blamed for the rise in interest rates.
The interest rates spread – the difference between deposit and lending rates – which currently stands at 10.49 per cent, is amongst the highest on the continent and acts as a disincentive to save and borrow from commercial banks. Currently, banks are offering loans at rates of 17.06 per cent against the deposit rates of 6.57 per cent.
The high interest rate environment has made it difficult for the government to attain double-digit economic growth and excluded many Kenyans from meaningful economic activities.
Previous attempts to control interest rates in the market hit a brick wall after a move to amend the Finance Bill 2011 to introduce a clause to cap rates was defeated on the floor of the August house. The debate on increased regulation of interest rates started in 2011 when rates by commercial banks went to a historical high of 30 per cent.
According to Central Bank’s prudential guidelines (2013), a loan is declared as non-performing when the principal or interest is due and unpaid for 90 days or more or when interest payments for 90 days or more have been re-financed or rolled-over into a new loan.  Central bank monetary policy committee (MPC) has frequently cut the bank’s prime lending rate – known as the Central Bank Rate, or CBR – to spur household and business spending, but majority of banks ignore the signals, citing high cost of funds and the overall cost of doing business.
This trend is expected to hold, given that CBK has been unable to tame high interest rates through its benchmark rate reviews.

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