Kenyan banks continue to post huge profit margins despite the prevailing high interest rate regime,this leaves one to wonder how do Kenyan banks make their money? Banks basically make money by lending money at rates higher than the cost of the money they lend. More specifically, banks collect interest on loans and interest payments from the debt securities they own, and pay interest on deposits, CDs, and short-term borrowings. The difference is known as the “spread,” or the net interest income, and when that net interest income is divided by the bank’s earning assets, it is known as the net interest margin. Below are the major sources of income for Kenyan banks:
1. Interest Rate Spread.
The difference between the interest charged on loans and interest on savings. most banks give 3% on deposits in savings account and 10% on term deposits and call deposits whilst charging as high as 21% on loans advanced to borrowers.This leads to interest differential of approximately 18%.
Interest income(interest on loan) by far exceeds interest expenses(interest paid on deposits). Equity bank had interest income of kes 18.3B in 2011 against an interest expense of 2.8B thus Net interest income of 15.5B and 11.0B in 2012 according to their financial reports, similarly KCB had interest income of 27.9B in 2011 against interest expense of 4.6B. Banks profit from the difference between the interest rate paid to depositors and the interest rate banks receive from loan repayments. Once a depositor deposits money at the bank, the bank then turns around and lends the money to clients for mortgage, personal, auto or business loans. This process is how money is created into the financial system which expands the monetary base. If a bank offers 3% interest on deposits and charges an average of 21% on loans, it keeps the difference as profit. However, banks do not lend out all the money they have or receive because it is dictated by a central bank on how much banks needed to keep as reserves.The CRR.
2. Forex Interest.
Banks also make a sizable income from the currency exchange. Kenyan banks make very huge income from the difference at which they buy and sell foreign currencies. Some banks set very high margins as high as Kes 10 per dollar! For example by selling a dollar at kes 85 and buying same dollar at kes 74. The bank makes a clean kes 11 per dollar, this is a non funded income. Look at a scenario where an exporter has been paid in dollars say $1,000,000 through telegraphic transfer yet he holds a Kenya shillings account, the bank will convert this dollars into shillings to credit the customer say at kes 74 per dollar thus 74,000,000. If an importer wants to make payment in dollars say of $1,000,000 this importer will have to provide kes 85,000,000 to the bank in exchange of $1m thus the bank would have made a clean 11 mio Kenya shillings from this deal i.e they bought a million dollars at kes 74 per dollar and sold a million dollars at kes 85 per dollar.
3. Investment Income
The Nairobi Securities Exchange bond market has been very active, this is partly attributed to the increased investment in bonds by Kenyan banks.
Banks prefer investing in bonds due to the security bonds provide to depositors money and the surety of income. Both government and corporate bonds. These banks aren’t relying so heavily on the retail banking sector for revenue and profits creation, they have diversified broadly in various investment vehicles, Banks have invested Billions in Treasury bills and Bonds.
4. Money markets and other dealings
The money market is a financial market that provides investors access to short term debt instruments, which include treasury bills, certificates of deposit (CDs), banker’s acceptances, commercial papers and repo agreements. These instruments are usually issued by financial institutions, especially Banks. Money markets are used for raising of short term finance, sometimes for loans that are expected to be paid back as early as overnight. Banks lend huge amount of shillings to each other through the inter-bank money market lending, This is where a bank lends money to another payable overnight. Big banks lend out constantly to small banks to boost their liquidity positions. Banks further lend this borrowed funds to their clients at a higher rate thus making some margin on it. There has also been an increased trade in Repos (Repurchase orders). Repos are collateral-backed lending to banks. According to the Business Daily, CBK reported a Sh521 million interest income from banks that used the short term window, commonly referred to as overnight lending, and Sh1.4 billion from inverse repurchase orders. Sh19.8 billion was borrowed in 2011 from CBK by banks.
5. Cost cutting
Reduced branch expansion, most banks have reduced their expansion especially the domestic ones, choosing to improve the functionality and capacity of the existing branches. Freeze on employments- Comparative to 2010/2011 financial year the banking industry has had lower recruitment drive. It has not been rosy either to the decision makers in this industry(Senior Managers and Directors) having to contend with Lower bonuses.
Some banks have gone too far by cutting their advertising and marketing expenses, CSR by banks in kenya is almost unheard of!
The truth is banking is a business that aims to makes profits for shareholders