Announcements Criteria Research

GCR places a positive trend on the Kenyan Financial Institutions Sector Risk Score, upon removal of interest rate caps.

Johannesburg, 30th October 2019 – GCR Ratings (“GCR”) has placed the Kenyan financial institutions’ sector risk score on a positive trend, upon the recent Parliamentary Committee decision to repeal the interest rate capping law.

A positive change in the sector risk score could lead to ratings improvements for Kenyan exposed financial institutions and potentially other entities that are exposed to the Kenyan financial institutions sector risk score, either through their own sector risk scores or via the sovereign hurdle.

Rationale

In our opinion, the 2016 law, which limited the amount financial institutions could charge of loans to 4% above the Central Bank rate, lowered monetary policy flexibility, increased government holdings by banks (which increases the risk of financial repression), restrained profitability and dampened credit growth. The effect on the banking system was particularly visible on the lower tiers of the domestic banking sector, where banks are struggling with higher cost of funds and sometimes reliance on the Central Bank of Kenya for liquidity.

We believe that the removal of the caps will not automatically lead to a significant increase in sector-wide lending growth or profitability, however it should have a positive impact on interest margins and internal capital generation by the 2020YE. This alone could drastically improve the business case for mid and lower tier financial institutions, over the longer run. However, , we expect to wait until mid-2020 before we improve the sector risk score. This will allow for early signs of improvement by the banks, and also additional time to judge whether the fiscal position of the Kenyan government, the risks posed by FX lending and FX liquidity management, and asset quality, act as counter-weights to these improvements.

Kenyan Financial Institutions Sector Risk score: ‘3.5’

The Kenyan financial institutions sector risk score of ‘3.5’ balances the good economic growth and diversification with an increasingly strained government fiscal position and weak sector-wide asset quality, with non-performing loans of around 12% at December 31st, 2018. Positively, the foreign currency exposures (around 20%-25%) are moderate for the region, however we increasingly believe the Kenyan Shilling to be vulnerable to a reversal in remittances or USD flight out of the continent. We also consider the sector to be somewhat overbanked and strongly competitive, with tier one and international banks generally more profitable and having stronger asset quality. We believe that consolidation will be a recurrent theme across the sector going forward. Regulation is broadly in line with the regional average, although we see some weaknesses in the regulation of FX risks, the protracted resolution of failed banks and protection of the credit hierarchy during bank failures. We consider the funding for the top end of the market to be stable, dominated by retail and corporate deposits. However, institutional investor concentrations and Central Bank funding can permeate the funding of second and third tiers of the sector.

The GCR Financial Institutions Sector Risk Assessment

The Financial Institutions Sector Risk Score, assessed on a scale between 0-15, is important in a number of ways. Firstly, as a key factor in the operating environment component score. The core of the GCR Ratings Framework is based on GCR’s opinion that an entity’s operating environment largely frames its creditworthiness. As a result, the operating environment analysis anchors the underlying risk score for the GCR ratings methodology. Financial institutions are especially vulnerable to these factors. GCR combines elements of the country risk and sectoral risk analysis, blended across countries for entities operating across multiple jurisdictions, to anchor a financial institution to its current operating conditions. Furthermore, the operating environment (the country risk score combined with the financial sector risk score) creates the floor from which government support can be provided for banks and the hurdle which may cap risk scores for entities significantly exposed to one jurisdiction. For more details on any of the above, please read the related criteria and research listed above.

GCR will periodically publish updated “Financial Institutions Sector Risk Scores”, which will supersede previous publications. The publication titled “GCR Financial Institutions Sector Risk Scores, 30 October 2019”, available at https://gcrratings.com/risk-scores/, supersedes the article published on 23 July 2019, and contains the updated assessment on the Kenyan Financial Institutions Sector.

Analytical contacts

Primary analyst

Matthew Pirnie

Sector Head: Financial Institutions

Johannesburg, South Africa

matthewP@GCRratings.com

+27 11 784 1771

Related criteria and research

Criteria for the GCR Ratings Framework, May 2019

Criteria for Rating Financial Institutions, May 2019

GCR Country Risk Scores: 23rd July 2019



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