Analysts call for reforms in banking sector

Kenya’s ailing sector finds itself in indeterminate state

By Bonface Otieno Kanyamwaya

The combined effects of a volatile banking sector, an austerity campaign by the National Treasury and a general economic slowdown have conspired to create a toxic brew that has darkened the economic outlook for East Africa’s largest economy.

The word in policy circles is that structural reforms are needed to salvage a fractional reserve banking system that is threatening to come off the rails.

Given that the government is the largest spender in the economy, a clear payment schedule to suppliers and contractors will help these parties reduce their likelihood of defaulting on loan obligations.

Secondly, commercial banks will need to make bigger investments in corporate governance as well as in innovation and technology that support richer credit scoring methodologies.

Lastly, the CBK will need to strengthen its internal regulatory mechanism which includes filling the vacancies in its board and equipping it with the necessary tools to act as lender of last resort.

The claim that bigger banks are necessarily more stable is not beyond impeachment. At the time of its collapse, Lehman Brothers was the fourth largest investment Bank in the United States, with 25,000 employees worldwide and US$639 billion in assets.

In the final analysis, a collective soul searching among industry stakeholders will be the secret source that will usher in a new chapter in Kenyan banking sector.

Tier 1 Bank Analysis-2015    

With Chase Bank, Dubai Bank and Imperial Bank being placed under receivership, Kenyans are now perturbed about the stability and health of the banking system. Depositors are losing confidence in the financial institutions and are concerned about the safety of their savings.

The sector recently experienced the flight-to-quality phenomenon as depositors redistribute their savings from lower tier banks to tier 1 banks to protect themselves from the risk of losing their wealth. But the multi-billion- dollar question is: Are these top tier banks stable enough to withstand a financial and economic turbulence?


There was profitability in the banking industry in 2015.  This was primarily caused by the non-performing loans and a challenging environment. With rising inflation and a depreciating currency, the Central Bank of Kenya increased the CBK rate from 10 per cent to 11.5 per cent in July 2015 in an attempt to mop up excess liquidity and tame inflation.

Interest rates were very volatile and inter bank rates soared to over 25 per cent in September 2015. With T-bill rates going over 20 per cent in 2015, banks have to offer depositors a higher interest in order to prevent a flight of depositors for a higher return. Consequently, banks hiked their lending rates in order to maintain their net interest margin.

Banks managers are assuming greater risks than normal and lending to less creditworthy borrowers in an attempt to meet their earnings targets and this has in turn led to bad debt and hence poor profitability.

Co-Operative Bank for instance recorded a 46 per cent in profits after tax; Kenya Commercial Bank (KCB) grew by 16 per cent while Commercial Bank of Africa (CBA) grew by 3 per cent.  On the other hand, Equity Bank grew by 1 per cent and Barclays Bank had no profitability growth despite a decline in bad depts.

Interest expense grew by 49 per cent for KCB, 51 per cent for Equity Bank, 68 per cent for Co-Operative Bank, 48 per cent for CBA, 46 Per cent for Barclays Bank and 13 per cent for Standard Chartered.

Profitability ratio

Equity Bank has the highest profitability ratio followed by Cooperative Bank followed by KCB. This shows that Equity Bank is efficiently using bank assets and shareholders’ equity to generate profits as evidenced by the return on average assets (RoAA) and return on average equity (RoAE) ratios. Equity Bank and Barclays Bank have the highest net interest margins of 10.5 and 10.4 per cent respectively.

CBA has the lowest net interest margin due to a heavy high cost of funds of 6.3 per cent. Standard Chartered has the lowest cost of fund at 2.9 per cent followed by Equity Bank and Barclays Bank at 3.0 per cent.

Staff costs accounts for more than 40 per cent of the total costs of the tier 1 banks. With a slow-down in earnings in growth, banks are expected to restructure in their near terms and hence a further drop in earnings is inevitable.

In economics, the law of diminishing marginal return states that as the number of employees increases, the marginal product of an additional employee will at some point be less than the marginal product of the previous employee. This goes on until further hiring reaches to a point where further hiring does not lead to an increased productivity but reduced returns.


Fundamental economic forces have led to financial innovation that has lead to increased competition in financial markets. The increase in competition has consequently diminished the cost advantage banks have had in acquiring funds and has undercut their positions in the lending market. As such, banks are forced to diversify into new activities such as bank assurance, investment banking and advisory in search for greater returns as well reinforcing other income streams such as trade finance.

In the long term, banks should not only diversify by products, but also by geography to minimise on the risk of poor return in the country in future as the banking market edges closer to saturation. To cushion themselves from macro-economic shocks, banks should not only rely on interest income, but also on fees and commission income from transactions.


With the recent development in Kenya’s financial system, restructuring are expected in the banking industry to strengthen the competitive position of banks. The regulator will adapt its policies to the new financial environment that is emerging. A constructive regulatory approach is to adopt a system of structured bank capital requirements together with early corrective action by the Central Bank of Kenya.

The Cabinet Secretary for the National Treasury’s proposal to increase the minimum core capital requirements to run a bank in Kenya from Ksh1 billion to Ksh5 billion could be a reality. This is because Kenya has more banks than South Africa and Nigeria, which have higher populations. Perhaps the time to consolidate the banking sector in Kenya has come in order to ensure long term financial stability in the financial sector.

Banks should also begin preparing themselves for the Global Basel III regulatory framework to manage risk better. Building capacity in stress testing, risk management, capital adequacy and liquidity management will be of paramount importance for the banks in Kenya in the long-term. With increase in cybercrime in Kenya, the regulator should ensure information security is robust to protect depositors from hackers.

Way forward

Going forward, banks needs to restore the confidence in the financial system. Financial institutions need to be more transparent and make disclosures to the public to foster market discipline and increase market efficiency. The regulator is expected to take early corrective measures to avert other banks being closed or placed under receivership.

Banks will also need to diversify more by products, geography and alternative income channels to cushion themselves from a volatile interest environment.

They will also have to innovative new products to add value to the industry and deploy technology which will cut costs and increase convenience and efficiency to remain competitive.