With the enhancement of capital requirements for banks and the recent enactment of the Banking (Amendment) Act 2015 capping interest on loans and stipulating a minimum return on customers’ deposits, the banking sector is bracing itself for huge challenges ahead. Recently, the central Bank of Kenya denied Consolidated Bank of Kenya an operating license for failing to meet the new capital requirements. As a consequence, the Governor of Central Bank of Kenya has been quoted several times saying that the merger of small banks is inevitable. With only a population of 40 million, Kenya has 44 banks. This is compared to Nigeria with a population of 170M with only 19 banks. As matter of fact, Kenya has more banks than established economies like the UK. With all these statutory amendments, we posit that it is necessary for small banks to merge so as to reap from the economies of scale.
Currently, the banks listed on the Nairobi Securities Exchange (NSE) have begun to feel the heat of the new law as investors dump the stock due to fears of decreased earnings. The banking stocks on NSE saw all of them lose a combined Sh47 billion in market value when the Bill was implemented.
The capping of rates has effectively reduced the spread or mark up for banks. This is due to the fact that the model that they have relied on to make the profits has been curtailed. Banks basically make a profit from taking deposits from customers at very low rates and thereafter advancing these deposits as loans expensively. Majority of the banks rely on interest income, very few banks depend on non-interest income which is derived from areas such as fees and commissions, foreign exchange trading and dividend. They will now be forced to become a bit creative in the way they do business in order to survive. One way to do this is to merge so as to reduce the cost operations.
In Kenya the economy is said to be overbanked and this may lead to a situation where banks fight for profit and market share. This could cause distress to the economy should some banks fail. With the new law in place we might see mergers and acquisition of banks taking place. There are many banks and not all can sustain themselves with the decrease of interest rates. The aim of Banks is to make profit and if merging is what it will take for them to improve in their financial performance and withstand future shocks then it will be inevitable.
The banking industry has also witnessed increased private equity investment, with several funding deals and acquisitions. The ground for more deals is ripe, given that several banks have come under liquidity pressure owing to huge withdraws of money by depositors. Though the Central Bank usually opt that mergers and acquisitions should be natural and not forced, adding that with the current developments, there was a lot of pressure on banks to come together.
Local mobile money transfer services like M-pesa and Airtel money have brought in a lot of competition to banks. Since their introduction, many people are finding it easier to save and transfer money through these mobile money transfer services as opposed to banks.
There is also competition from financial technology companies. Financial technology (FinTech) companies are usually start-up companies based on using software to provide financial services. The increasing popularity of FinTech companies is disrupting the way traditional banking has been done. This creates a big challenge for traditional banks because they are not able to adjust quickly to the changes – not just in technology, but also in operations, culture, and other facets of the industry.