Many African banks, buoyed by the continent’s strong economic growth, have expanded impressively in the past six years. Kenya’s are no exception, their assets more than doubling between 2005 and 2010.
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But what lenders in Kenya stand out for is having broadened their reach among the country’s population so extensively. In most parts of sub-Saharan Africa, the proportions of unbanked people are still huge, lenders having grown mainly by exploiting a booming corporate sector. Even in Ghana and Senegal, two of the region’s more sophisticated economies, more than 80% of people do not have bank accounts.
In Kenya, by contrast, about 16 million people, or almost 40% of its population, are banked. This represents a dramatic rise from 2004, when there were less than 3 million account holders in the country. “Kenya has seen more success with financial inclusion than just about any other African country,” says Razia Khan, head of African research at Standard Chartered.
The banks have managed this by courting not just Kenya’s increasingly wealthy middle class, but its masses too. “Banking in Kenya used to be mostly about the upper market,” says Gideon Muriuki, chief executive of Co-operative Bank, one of Kenya’s five biggest lenders. “What we did was to go down the pyramid. It is the resulting increase in the number of customers that has really driven the growth in the banking sector.”
Until recently, banking in Africa was almost by definition expensive. Poor infrastructure meant that banks could only expand their presence in rural areas – where much of the continent’s population still lives – by building extensive, and usually very costly, branch networks.
Lenders in Kenya have overcome this problem by embracing technology and using channels other than branches to take on more customers and sell them products. This has greatly reduced their operating costs and made it attractive to tap even those only able to deposit very small amounts of money.
From mobile to branch
One of the main reasons this has happened in Kenya to a greater degree than elsewhere in Africa is because of the growth of mobile money services in the country. These were introduced in 2003 when local telecoms group Safaricom launched M-Pesa, which allows its account holders to deposit and withdraw money - via agents or ATMs of partner banks - as well as transfer it to other mobile phones.
The rise of the mobile money transfer industry in Kenya has been remarkable. M-Pesa and its rivals had just over 1 million customers in 2007, while today they have 21 million. The value of transfers in the 12 months to the end of June 2011 was Ks919bn ($10.7bn), according to the Central Bank of Kenya.
[Mobile banking] services give potential customers the first taste of a formal banking arrangement, where their money is no longer in their pockets
or under a mattress
Bankers say that mobile money services complement, rather than rival, formal banking. They claim that the former have given many Kenyans exposure to basic financial services for the first time, thus making it easier to draw them into the formal system, which offers a wider and more sophisticated range of products (including allowing customers to apply for loans via their mobiles). “These services give potential customers the first taste of a formal banking arrangement, where their money is no longer in their pockets or under a mattress,” says Richard Etemesi, chief executive of Standard Chartered in Kenya. “It is a very short step from there into a bank.”
Mr Etemesi adds that while the likes of M-Pesa and Orange Money, which is run by Telkom Kenya, might be used for small transfers of money, Kenyans prefer formal bank accounts for large sums. “Anything below Ks50,000 or even Ks100,000 would probably go through M-Pesa,” says Mr Etemesi. “Anything above that would go through the formal banking system.”
Agency banking
Another major development has been the introduction of agency banking. Kenya's central bank, as part of efforts to reduce the country's unbanked population, has for the past 18 months allowed lenders to sell their services via agents such as petrol stations, small retailers and supermarkets, rather than just through their branches.
By the end of 2011 Kenya had about 6000 agents, through which customers can place deposits, withdraw cash, pay utility bills, top up their mobile phones and make loan applications (which agents subsequently pass to a bank’s credit department). “The use of mobile phones and agents has helped us overcome the challenge of the last mile,” says James Mwangi, managing director of Equity Bank, which has 7.5 million account holders, the most of any bank in east Kenya. “We are now able to deliver financial services to villages without having to rely on bricks and mortar.”
Some lenders have taken to using mobile sales forces alongside agents. Barclays Kenya, the country’s second largest bank by assets, has about 1000 mobile sales officers, who mainly sell consumer loans in areas where the lender has no branches. They, like the agents, are paid based on their commissions, meaning they are usually far cheaper than salaried employees in branches. “Banks are trying to move away from the fixed-cost bases they have traditionally had to ones that are more variable,” says Adan Mohamed, head of Barclays Kenya.
The use of technology and agents has thus reduced the importance of branches. While they will still be used – and continue to be built in small numbers – they no longer have the same role as before. “The purpose of the branch has changed completely,” says Mr Mwangi. “They are now used to supervise or manage 30 agents, say, within a certain locality. They might also be used for high-value banking business and advisory services, but not transaction processing. The latter has been outsourced to the agents.”
The banks’ method of expanding by tapping Kenya’s unbanked population has proved profitable. Their returns on equity averaged 25% in 2009 and more than 30% in 2010, according to the central bank. Their returns on assets of 3.7% in 2010 made them among the highest earning lenders in Africa by that measure.
Concerns for the year ahead
Kenya’s banks will struggle to maintain such levels of profits in 2012, however. This is due to the spike in inflation and weakness of the shilling over the last nine months of 2011, which forced the central bank to raise interest rates from 6.25% to 18% between August and December. While demand for credit was still hefty for most of 2011 – loans and advances rose 37% year on year between September and October – bankers say it is already waning.
The mortgage market is very important for [Kenya Commercial Bank]. It has been one of our main growth segments in the past three years. Over that time we have been doubling our book every year
Most expect credit growth to stagnate in the first half of 2012. “That is when reality is going to dawn on people that it is not what it was before,” says Martin Oduor-Otieno, chief executive of Kenya Commercial Bank (KCB), the country’s biggest lender by assets. “In the fourth quarter of last year, things were unravelling so fast that they did not quite realise what it meant for them. Now, they are going to have to dig much further into their pockets. People looking at new investments will ask if this is really the time to do it.”
That presidential elections are looming will also deter investments and new borrowing, say bankers. Polls are likely to be held in December 2012 or in March 2013. Kenyans are largely confident the post-election violence that marred the bitterly disputed 2007 elections and led to 1200 deaths will not be repeated. But the fact a new president will be chosen – the current one, Mwai Kibaki, is on his second term and constitutionally required to step down at the end of it – and the outcome is still highly uncertain will be enough to put off many potential investors.
About 80% of bank loans in Kenya pay floating rates of interest. As such, even borrowers that took on loans when rates were low are having to make higher payments. But most analysts doubt that non-performing assets in the banking system, which had fallen to about 6% by the end of last year, will increase much. This is partly because Kenya’s gross domestic product (GDP) growth is forecast to be as much as 5% this year. And there are already signs that inflation, which reached 20% in November, has started to decline, thanks to falling fuel imports and good rains in the October to November rainy season, which boosted crop production and should reduce food prices. Many commentators predict the central bank will start to cut interest rates during the second quarter.
Moreover, since suffering from a banking crisis in the 1990s, Kenya’s lenders have proved to be good risk managers. “We will see a pick-up in non-performing loans, but not to crisis levels,” says Judd Murigi, head of east African research at investment bank African Alliance. “The banks are pretty well regulated. Credit monitoring is also much better than outside observers realise. It is well developed.”
Middle class growth
Despite an expected slowdown in the first half of this year, Kenyan banks will likely grow rapidly in the next five to 10 years. The Economist Intelligence Unit says that bank assets, which stand at $20bn today, will rise to $33bn by 2020 due to economic expansion alone. However, it estimates that further financial deepening could see the figure climb to $48bn.
The banks are optimistic that financial deepening will not slow any time soon. Thanks to the effectiveness of agency and mobile banking, Standard Chartered’s Mr Etemesi says that by 2015, between 22 million and 25 million Kenyans, roughly half the expected population by then, could be banked.
Lenders will also benefit from exploiting Kenya’s ever-growing middle class. Several are trying to build big private banking and mortgage businesses.
Property lending is still small. There are only about 18,000 mortgages in the country. But the number is rising quickly because of buoyant property markets in cities such as Nairobi, the capital, and Mombasa. Some banks are now willing to provide mortgages with 100% loan-to-value ratios. Those of more than 50% were rare until recently. “The mortgage market is very important for us,” says KCB’s Mr Oduor-Otieno. “It has been one of our main growth segments in the past three years. Over that time we have been doubling our book every year.”
Bankers are largely confident that mortgage borrowers will be able to cope with high interest rates, especially if they start to fall by the middle of 2012.
Corporate banking
There will also be plenty of corporate banking opportunities. Many of these will come in the tourism, telecoms and infrastructure industries, which the government sees as crucial to Kenya’s development.
Another sector likely to experience credit growth is agriculture. It makes up less than 6% of banks’ portfolios, but that figure should increase substantially as production methods improve and irrigation is used more widely, making farmers less beholden to rainfall patterns. “The agricultural sector makes up almost a quarter of Kenya’s GDP,” says Barclays’ Mr Mohamed. “So it is very significant. But it is fragmented and could be organised much better. Once it is and once the vagaries of the weather are not such a big factor, banks will look to do much more business with it.”
Many Kenyan banks are looking to exploit the country’s position as east Africa’s economic powerhouse to expand regionally. Several of the bigger locally owned ones – including KCB and Equity Bank – already operate in Tanzania, Uganda, Rwanda and South Sudan. Even some of Kenya’s mid-market banks, such as Prime Bank, which holds a large stake in First Merchant Bank, one of Malawi’s biggest lenders, are large enough to grow abroad. “Kenyan banks have big balance sheets and they are able to export their expertise into the wider region,” says Co-operative Bank’s Mr Muriuki.
Forget consolidation
Kenya’s banking system is very competitive. It has 43 commercial lenders, which analysts say is plenty for an economy of only $32bn. But such is the potential for them to expand at home and abroad over the next decade that few expect much consolidation to take place.
Most of the big lenders, thanks to very low funding costs, enjoy high net interest margins of roughly 10%. But even smaller banks have hefty interest spreads. Bharat Jani, head of Prime Bank, says his firm’s are about 7%. And he believes that, despite the competition, he should be able to grow his asset base by 20% annually over the next five years.
Banks are worried about a proposal before parliament to cap interest rates and set a floor for deposit rates. If passed, this would limit them to charging 400 basis points above the central bank’s main interest rate (which still stood at 18% at the end of January) for their loans. Bankers say this is nonsensical, citing that in November the government was forced to pay a 22.8% coupon on a two-year local bond.
“When the government is borrowing at 23%, how can the banking sector be expected to give money to the private sector at 22%?” asks Mr Jani. “There is no way the banking sector will be as efficient or vibrant, or contribute to the economy as much, if there is an interest rate regime.”
Bankers believe the proposal, which the finance ministry and central bank oppose, has been tabled partly because elections are due soon and it would likely be popular among many Kenyans, some of whom have expressed their discontent at banks’ high profits in recent years. “We moved away from controls a long time ago,” says Mr Oduor-Otieno. “It would be suicidal to go back. We understand where it is coming from. We understand that interest rates are very high at the moment. But that is a reflection of the macroeconomic environment. It is not driven by the commercial banks.”
Bright future
Nonetheless, Kenyan banks are confident they will flourish over the next several years. They have already proved themselves adept – perhaps more so than those in any other sub-Saharan African country – at using technology and innovative delivery channels to tap the unbanked market.
Moreover, Kenya’s expected strong economic expansion in the medium term will mean they should be able to boost their incomes from their existing customers, both corporate and retail, substantially. The government has set a target for the country to reach middle-income status by 2030, which would require growth rates of more than 5% being sustained until then. Many analysts believe that is feasible. “To the extent that this vision is realised, the banking sector will enjoy very strong growth in the next two decades,” says Mr Mohamed.
