Kenyan banks are set for consolidation to meet a deadline to boost minimum core capital and cut costs in a lower interest rate environment.
Although banks are on course for good profit growth this year as evinced by first-half results, senior industry executives say the sharp falls in Kenyan interest rates this year have put pressure on bank margins.
Two small lenders, Equatorial Commercial Bank and Southern Credit Bank have already completed a merger this year, citing the need to enlarge their branch network and balance sheet.
“We expect mergers and acquisitions in the sector to continue being driven by market demands and the need for scale to exploit these opportunities,” central bank Governor Njuguna Ndung’u told Reuters.
“In addition, this allows them to enlarge and serve their market niches,” he said.
In 2008, then Finance Minister Amos Kimunya proposed to raise the minimum core capital for banks to 1 billion shillings from 250 million shillings, giving 2012 as the deadline for all banks to comply.
The local implications of enhanced capital rules abroad following the global financial crisis may also encourage mergers and acquisitions in the sector, analysts said.
Lenders in Kenya have already met the set capital thresholds under the new Basel III rules, but a scramble for opportunities in a more competitive landscape may prompt the regulator to keep a more watchful eye over the institutions.
“Increased competition and capital adequacy requirements under Basel III are likely to be the key drivers behind sector consolidation,” said Francis Mwangi, a banks analyst at African Alliance.
Good liquidity and conservative lending practices — lenders have increasingly been putting their money cash into relatively risk-free government securities over the past five years — might also attract foreign investors.
The liquidity ratio for the sector at the end of last month was 46.3 percent against a statutory minimum of 20 percent.
Total capital to total risk-weighted assets was 20.6 percent, while the statutory minimum is 12 percent.
MANY COMMERCIAL BANKS
Eric Munywoki, a researcher at Dyer and Blair Investment Bank, said sharp falls in the yield curve this year and policymakers’ actions supported the consolidation case.
Yields have dropped by more than 300 basis points across the curve this year in tandem with a sustained easing cycle.
The rates at which banks lend have also been falling, though too slowly in the eyes of the central bank, which sees credit growth as a key driver of economic recovery.
“We have so many commercial banks, and for them to survive after the central bank lowered its lending rate expecting them to replicate the same (cut rates), they will have to merge,” said Munywoki.
While small institutions might merge or find a home in the arms of a bigger rival, foreign banks might find rich pickings in National Bank as the state divests from the ninth largest lender by assets.
National, which completed a turnaround this year after heavy losses in the late 1990s and early 2000s, is focusing on lending to small and medium-sized businesses, vital to many economies in sub-Saharan Africa. The sale of the stake has been delayed by shareholder disagreements over the process.
“Banks have delivered high absolute and juiced returns, and, like the rest of Africa, I am sure the Kenyan banking sector is popping above the international radar,” says Aly Khan Satchu, an independent analyst in Nairobi.
Shares in the banking sector are up 60 percent on a market cap weighted basis so far this year, outperforming the all-share index NASI, which is up 37.4 percent in the same period.
Renaissance Capital said the four listed institutions they track offered growth in terms of earnings, estimating 2010 gross profit growth at 42 percent.
RenCap tracks Cooperative, Barclays Bank of Kenya, Equity and Kenya commercial Bank.
The central bank said profit before tax at the end of August had already reached 98 percent of 2009 year profits.
KCB, the largest bank in Kenya by assets, has attracted interest in the second half after a rights issue induced a fall in its shares. Analysts said its shares now offered a discount on the bank’s valuation.
One investment banker said private equity group Helios’s acquisition of a 24.99 percent stake in Equity Bank for $178.7 million in 2007 is a pointer to more foreign appetite. Equity is usually the most traded bank stock on the Nairobi bourse and its shares have gained 81.2 percent so far this year.
He said there was also more general interest in Africa from foreign multinationals.
Foreign investors who do look at opportunities in the sector will be reassured that analysts do not anticipate significant risks to the banking system.
“I do not see severe risks facing the sector as long as economic growth and activity maintain the same pace. This improved activity means reduced instances of non-performing loans and increased consumer spending,” said Renaldo D’souza, a Genghis Capital analyst.