The curious case of banks growing fat as depositors fight for leftovers

Central Bank of Kenya headquarters. 

The Covid-19 pandemic has left in its wake, a dark cloud of fear with hundreds fighting for their lives and millions for their livelihoods.

Should the pandemic trigger a surge in the cost of living, with prices of consumer products going through the roof due to falling supply, the Sh3.5 trillion of depositors’ cash in banks will lose its purchasing power.

This will create an entirely different story for bankers who will come out of this crisis richer, their faces gleaming with the health of indulgence. This is when virtually everyone else, unfortunately, will be fighting penury.

Latest official data shows that Kenyan banks have grown richer, not in spite of, but because of crises, such as the current one, that tend to push up the cost of living.

Economists are still divided on whether the coronavirus pandemic will trigger a spike in prices of goods and services.

Some economists think jitters about inflation are unfounded. While the pandemic has chocked production and thus constrained supply, it has also left people jobless and without money to spend. Moreover, with curfews and restricted movements, spending has gone down.

Increase in prices of consumer products, technically known as inflation, edged up marginally to 5.62 per cent from a revised figure of 5.51 per cent in April.

However, the Central Bank of Kenya (CBK), the inflation police, does not think that there will be more money chasing fewer goods.

CBK has gone ahead to ask lenders to push more money into a cash-starved economy.

An analysis of data from The Economic Survey 2020 by the Financial Standard reveals how thrifty banks have earned more interest from borrowers while paying less to depositors and left both to be ravaged by a biting cost of living.

Whereas in the last 10 years commercial banks have been able to shield themselves from a high cost of living by revving up interest rates on loans and advances, what they have given depositors on their savings has been so thin that it has crumbled under inflationary pressure.

Banks, on the other hand, have been keen to build up a strong buffer against inflation.

For all the years between 2010 and 2019, banks triumphed against inflation, while unsuspecting depositors were vanquished.

It is a tragedy that has left so many investors poorer without knowing. Scholastica Odhiambo, an Economics lecturer at Maseno University, says that most investors only look at what they are paid - also known as nominal interest - rather than the real interest which takes care of inflation.

“The banks arbitrarily pay low-interest rate on deposits,” says Dr Odhiambo.

Experts note that most Kenyans simply deposit money in banks to obtain loans from them. “In this case, they are not aware that banks are not giving them the value for their money saved,” avers Odhiambo.

To put this in perspective, let us say you deposited Sh100,000 into one of the banks in 2014. Your wish being to withdraw the money next year, hoping to have earned some interest.

Surprisingly, even with an interest rate of 1.56 per cent that the bank gives you on the same deposits, the Sh101,560 that you get buys you fewer of the same products in 2015.

This is because the products that you bought with Sh100,000 in 2014 now go for Sh108,100.

Economists are usually at a loss with this tendency of people viewing their wealth and income in nominal terms, rather than in real terms.

The investor who keeps their money in fixed deposits or ordinary saving may not be aware of the illusion of money, says Odhiambo, instead, they wrongly believe that a shilling is worth the same as it was the previous year.

Banks have not made the same mistake.

Another expert, who did not want his identity revealed as he works for a bank and is not allowed to speak to the Press, says that banks aggregate the deposits at ever-lower rates and invest into government securities, while depositors remain unaware.

“Instead of using money market funds to aggregate and buy bills, they (depositors) keep placing money in deposits,” said the financial expert.

Between 2010 and 2019, real interest rates on deposits have been negative in six of those 10 years, meaning the depositors’ money lost its purchasing power between 2010 and 2016.

However, not even in the worst of times, have banks seen their interest rate wiped out by inflation.

If anything, in a year like 2015, when depositors were devastated by an inflation rate of 8.1 per cent, banks charged an interest rate of 18.3 per cent, leaving them with a decent real interest rate of 10.29 per cent. They gave depositors a scrawny interest of 1.56 per cent, leaving them with a -6.45 per cent in interest. 

Consequently, this has elongated interest spreads which have translated to fat paychecks for bank shareholders.

The watershed moment in the banker-eat-depositors saga came in 2015 and might have triggered the controversial move by lawmakers to put controls on interest rates on deposits and loans a year later.

It appears as if after lawmakers put a floor on the interest rate charged on deposits and a ceiling on the interest rate on loans, banks have changed their wayward ways, although some analysts say this came at the expense of lending to SMEs.

At first, before they scrapped the floor on deposits, MPs had put a law requiring banks deposit rate to be 70 per cent of the Central Bank of Kenya benchmark lending rate, known as the Central Bank Rate (CBR). For example, with the current CBR rate at seven per cent, banks were expected to give 4.9 per cent on deposits.

However, banks found a way around it by converting most of the fixed deposit accounts into non-interest earning demand deposit, or transactional accounts.

This is reflected in official figures from the CBK which shows that while demand deposits have jumped almost three times from Sh454 billion in 2010 to Sh1.25 trillion, savings deposits did not experience such a spike.

Savings deposits also rose three-fold from Sh134.8 billion in 2010 to hit a high of ShSh444.8 billion in 2015, before they started declining in 2016. By the end of 2019, savings deposits had fallen to Sh378.4 billion.

There were unconfirmed reports that only those accounts with more than Sh50 million could earn the legal rate. CBK data shows that out of 53.8 million deposit accounts by the end of 2018, only 1.4 million, 2.6 per cent, had more than Sh100,000.

For four years, banks, particularly the biggest banks, got what was effectively a government-guaranteed locked-in margin due to the rate cap.

During this period, the highest spreads were effectively flattened by the rate cap, hence making the biggest banks the best place for people to keep putting their cash.

However, even after the repeal of the caps, banks continue to give depositors a raw deal.

Take 2019, for example. Inflation increased by around 190 basis points to 5.82 per cent compared to 5.71 per cent in the previous year. Rather than raise the deposit rate to help cushion depositors against the inflationary pressure, they lowered the interest on deposits by 422 basis points. They also lowered their interest on loans and advances, but it was only by 215 basis points which means they still managed to widen the spread.

The result has been increased profitability for banks, with the profit before tax hitting Sh160 billion by the end of 2019.

During this period, every Sh100 that bank shareholders had invested earned them Sh21, compared to Sh12 that their counterparts in the US received.

A report by the International Monetary Fund (IMF) noted that at the onset of the controls, interest rate spreads - the difference between interest paid on deposits and that charged on loans - was generally on a decline, which was in line with Kenya’s peers selected from a group of 53 lower-middle-income countries.

“However, the profitability of Kenyan banks, as measured by the return on equity, remained above the 75th percentile of the lower-middle-income countries,” said the report.

Central Bank of Kenya Governor Patrick Njoroge last year told bank shareholders to expect lower returns on their investments.

"Bank shareholders should be accepting more of lower returns. Return to equity needs to come down. It has already started going down,” he said during the launch of the IMF regional outlook for Sub-Saharan Africa.