Inside the world OF BANKING

There is an enigma about banks in Kenya. Various perceptions about banks have to do with high interest rates, high account charges, huge profits they make, and stringent lending rules. Recently, banks have been on the spotlight for the alleged role they played in causing inflation in the country in 2011. CAROLE KIMUTAI sought answers from Richard Etemesi, chief executive officer Standard Chartered and the current Chairman of the Kenya Bankers Association.

With less than 12 months to Kenya’s General Election, Richard Etemesi has been reflecting a lot about the country’s leadership transition under the new Constitution.

“I am looking forward to see how the new president will pick his 22 cabinet ministers. The appointments must reflect ethnic, regional and gender balance and we are about 42 tribes! Secondly, we borrowed from the US Constitution where the President comes to the office with his entire team but in Kenya, we have said Parliament approves everybody. Considering there are 47 Counties, the President could have picked someone with excellent qualifications but because he/she is not from a Member of Parliament’s County, he/her will be rejected. There is a third complication; anyone who is not happy about an appointment can go to court to challenge it!
That is the headache we have ahead.”

For Etemesi and other corporate chiefs in Africa, political risk is just among the complex risks they are required to manage every day. According to a PWC 2011 Survey on factors influencing CEO agenda in Africa, investment decisions, risk management, achieving shared priorities with government and talent management were top on the list for 201 CEOs in 10 countries in Africa interviewed.

In the survey, political instability is identified as key by 59 per cent of CEOs in Africa and 58 per cent of global CEOs who see it as potentially impacting their growth prospects over the next three years.

“Banking is about risk. We take funds and lend to people, individuals, corporate with the hope that we get the money back. We take a risk on the people we are lending to. Apart from that, most activities in the bank have a risk element. Risk management is very important for us,” explains Etemesi. For banks, credit-risk is number one on the list. It is an exposure area with a lot of processes to mitigate risks.

Does this explain why banks are averse to lending to Small Medium Enterprises (SMEs) I ask? “Most banks’ risks are based on cash-flow. When assessing the ability of an SME to pay, we look at the cash-flow. Start-ups don’t have cash-flows. It means we are taking a risk on somebody’s idea or dream and banks don’t have the capability of assessing cash-flow of start-ups.”

In Kenya, entrepreneurs often finance their business capital from savings, mortgage and other sources. After starting a venture, they are able to a get cash-flow then approach a financier like a bank, give security and get funding. “Typically in most business environments (not Kenya only), start-ups are self financed.”

Other risks for banks are operational. “They include risk of errors, fraud, theft, reputation, people risk, and strategic risk.”

In the PWC Survey, risks identified by CEOs in Africa include economic and policy threats, business operating threats and global threats. Among economic and policy threats, 77 per cent of CEOs in Africa are concerned about exchange rate volatility, followed by 74 per cent who cite uncertain or volatile economic growth. There is also concern about overregulation, inflation and government’s response to the fiscal deficit and debt burden, business operating threats like the availability of key skills, energy costs, inadequate infrastructure and an increasing tax burden, all identified by over 60 per cent of CEOs.

Views on fraud

According to Etemesi, fraud is a growing vice in Kenya. “Fraudsters are now looking for individuals within banks who are vulnerable – with financial problems, debt or living beyond their means. Fraudsters are very good in identifying people in distress.”

After identifying an insider, the fraudsters tell him/her to provide information in exchange for money. Unfortunately, the punishment for fraudsters is not heavy enough to deter them. With an outdated Penal Code, fraudsters get away with a light penalty.

“You find an offender who stole KSh 50 million being fined only KSh 1 million.”

Although Standard Chartered conducts rigorous recruitment that involves background checks, Etemesi admits that these checks are only about the individual’s past and cannot really determine the future.

“We therefore have to put checks and balances – controls on controls – that make it difficult for someone to perpetrate a fraud. However, it is all about trust in employees (99 per cent) and one per cent technology.”

Etemesi believes fraud is a societal problem. “The fundamental factor driving fraud is that we have a society that idolizes theft. The young generation grew up in an era where people stole and nothing happened to them. People stole from institutions and no action was taken, your neighbour bought a brand new car with money he/she defrauded from a state corporation and he/she is walking free. Society views such people as “smart”. You have young people who see no shame in stealing. When I was growing up, if you were called a thief it was a major issue, your family would be embarrassed, neighbours would not talk to you and you felt stigmatised. Sadly, today there is no stigma to bad behaviour!”

At Standard Chartered, staff subscribe to five values namely: creative, responsive, international, courageous and trustworthy. These values are the building blocks to the Standard Chartered culture and help employees relate with each other and the people they interact with.

“This is how corporates can influence the society, by being the change they wish to see in society.” Standard Chartered inculcates these values in employees by making them part of the annual performance appraisal.

“If you are a sales person and delivered 120 per cent on your target at the expense of the values, you get a low score. Standard Chartered staff know that their performance and living the five values are intertwined because it is also attached to remuneration and career progression.”

Banks and the ailing Shilling

In March, Kenyan banks were in the spotlight for the alleged role they played in the weakening of the Shilling. It is alleged that last year, commercial banks borrowed colossal amounts of money from the Central Bank of Kenya (CBK) and used part of it to rake in huge profits in foreign exchange market as the Shilling lost value to a low of KSh107 against the US dollar.

A report by Kenya’s Parliament House Committee that investigated the weakening of the shilling against major world currencies says banks had borrowed a total of KSh 600 billion. According to media reports, the House Committee believed key banks manipulated money markets by hoarding and speculating on billions in foreign currency to cause an artificial shortage, apparently after borrowing, heavily and cheaply from CBK and investing in government securities as well.

“Three commercial banks, namely CFC Stanbic Bank, Standard Chartered Bank and Citibank were reported to have had increased foreign exchange trading activity and (CBK) wrote to them,” according to the report.

Etemesi in his capacity as the chair of KBA, sought to set the record straight. He says banks are required to maintain a Cash Reserve Ratio (the minimum amount of cash a bank has to maintain) which at the moment is about 10 per cent and kept at CBK in form of Treasury Bills and Bonds.

“That is the maximum a bank can borrow. So when the MPs said we borrowed KSh 600 billion, no bank has that kind of deposits and anyway it is only for one day! What the MPs did is take all the borrowings that the banks made on various days last year and added them together to make the KSh 600 billion figure.”

What was the borrowing all about? On a daily basis banks receive and give money. At the end of the day, banks total up all the money they have to pay out (cheques written to other banks) and money coming in (deposits from other banks). The cheque payments are done is a Clearing House owned by the KBA.

“Any bank that goes to the clearing has money that they are going to pay out (cheques drawn on them and deposited in other banks) and cheques drawn on other banks that belong to them. If you go to the Clearing House, you could pay out more than you are receiving and sometimes you may receive more than you are paying. If the later is happening then you are okay because you have more deposits. But if you are paying out more than you are receiving, then you have a deficit. When you have a deficit, the Clearing House rule says you must square down the deficit that day. You cannot have a deficit outstanding for more than that day,” explains Etemesi.

Banks have three ways of dealing with the deficit. First option is liquidating investments like the Treasury Bonds and Bills. Second alternative is borrowing from another bank that had more deposits on that day – known as interbank borrowing. The amount lent is paid the next day. The third option is the CBK Discount Window.

“This is a lender of last resort and you have to prove that you tried to liquidate all your assets and went to the interbank option but no one was willing to lend you money. The CBK then lends you money at a rate and you secure the money with your stock of Treasury Bonds Bills. It is very expensive to borrow into the Discount Window. It is not the preferred option and banks would rather borrow from each other or liquidate their assets. The risk that drives banks to borrow from the Discount Window is called Settlement Risk. Last year, banks on average borrowed from each other KSh 12 billion. This is all about managing liquidity to ensure that as a bank, you are
always square,” explains Etemesi.

According to the House Committee Report, the interbank rate was steady at between 1.1 and 1.2 per cent for most of 2010 as the CBK Discount Rate stood at between six and 6.7 per cent for the same period. In June 2011, the interbank rate rose to 6.2 per cent and by June 17, CBK and inter-bank rates were the same at 6.25 per cent. By July 1, it was cheaper for banks to borrow from CBK’s Discount Window than from commercial banks. For example, on July 22, it cost banks an average of eight per cent interest rates to borrow from other commercial banks, and an average of 6.25 per cent to borrow from CBK.

Bank interest rates

Etemesi says interest rates are driven primarily by CBK’s desire to contain inflation. “The CBK has a number of tools to contain inflation which is what happened last year when the price of goods and the Shilling went up. To contain inflation, CBK increased interest rates to reduce borrowing.”

Etemesi adds that the interest rate is a variance between interest paid on loans and what deposits earn known as the spread.

“If you look at a bank’s tariff, you will see interest paid on a fixed deposit account is two to three per cent. Then you look at the maximum interest charge which is 25 per cent. You can assume banks make 23 per cent which is not true because you have taken the highest and lowest denominator. Not all deposits are savings accounts, it’s a whole mix of savings accounts, current accounts, fixed deposits (big amounts – demand a higher interest rate), market deposits (deposits from other financial institutions demand high interest rates). Typically, a bank will have a mix. You will have a current account where you pay no interest, a savings account where you pay small interest (two to five per cent), term deposits (six to 12 per cent) market deposits (similar to Government deposits).

A bank takes the average costs of funds – average deposits and average lending to determine the spread. Before the Shilling went up, the average spread was 10 per cent.”

Etemesi says nobody has recommended a Spread that banks should have. From the interest percentage, 2.6 per cent goes to the government in form of taxes and the rest caters for expenses such as operating costs.

“Profit to shareholders is about 2.1 to 2.6 per cent. The profit margin is actually not 10 per cent but on average two per cent.” Over the last 10 years bank Spreads have been falling. In 2002, the Spread was 20 per cent. Before interest rates went up in November 2011, the Spread had dropped to 9.4 per cent. “If we didn’t have inflation, the Spread would probably be at seven per cent.”

On bank profits, Etemesi says people should first look at the amount of capital banks employ. The Kenya Commercial Bank has KSh 45 billion worth of capital, Equity Bank KSh 20 billion, Barclays KSh six billion – this is the amount shareholders have put in. The capital supports infrastructure, deposits in the CBK etc.

“The capital deployed is huge. Total capital in the banking sector is KSh 260 billion. The return on capital for banks is between 20 to 26 per cent. A percentage of a large number (capital) is a large number (return). Banks make a return based on their capital.”