How and Why Kenyan Banks Are Consistently Making Profits

The banking industry is the cornerstone of the global economy, playing a pivotal role in facilitating financial transactions, supporting economic growth, and providing a range of financial services.

In Kenya, most banks reported their year to September earnings. All the banks reported generally positive growth numbers. Why is this the case?

Before we discuss Kenya banks and their strong profits, it is important to understand the intricacies of the banking business.  

Let’s start by discussing the core functions of banks. At a minimum, banks serve three primary functions:

Demystifying banking – Functions of banks

1. Deposit-Taking: Banks provide a safe place for individuals and businesses to deposit their money. These deposits form the foundation for various banking activities.
2. Lending: Banks lend money to individuals, businesses, and governments, promoting economic activities such as home purchases, business expansions, and infrastructure development.
3. Facilitating Payments: Banks enable the transfer of funds domestically and internationally through various channels like wire transfers, checks, and electronic transactions.

How Banks Make Money

Banks generate revenue through diverse channels:

1. Interest Income: One of the main revenue sources for banks is the interest earned on loans provided to borrowers and the interest paid on deposits. There are markets where this makes up the larger share of a bank’s profit.
2. Fees and Commissions: Banks charge fees for various services, including account maintenance, transactions, and advisory services. This is often called non-funded income and, in some markets, makes up the largest share or bank revenue.
3. Trading and Investments Banks engage in financial markets, trading securities, and making investments to earn profits.

Also Read: Bank Announces Revised Interest Rates Effective December

In order to attract customers, banks will generally come in three forms. It’s good to note that over the years, banks have called all three forms into divisions in order to maximize revenues.

1. Retail Banks: Retail banks generally serve individual customers and small businesses. They offer these customers services like savings, checking accounts, loans, and mortgages.
2. Commercial Banks: Commercial banks focus on providing services to businesses, including loans for working capital and expansion.
3. Investment Banks: These types would primarily be involved in capital markets, assisting businesses with raising funds through stocks and bonds.

In Kenya, all banks are considered commercial banks. Most the banks in Kenya have formed divisions within the many that serve their diverse clients. The divisions are: Corporate, Retail, Investment, Bancassurance, and Islamic.

Before we discuss why banks in Kenya do very well, we need to appreciate that banks operate within a highly regulated environment that helps ensure stability and protect customers. Regulatory bodies set standards for capital adequacy, risk management, and disclosure.

But even amidst this very highly regulated environment, take note that in the first half of the year, Kenyan banks registered a combined net profit increase of 26% compared to the same period in 2022.

Also consider that loans and advances grew by 11% in the first of half of this year, with improved asset quality – what is often called non-performing loans (NPL).

Performance of Kenyan Banks

Here are addition key metrics that highlight the performance of Kenyan banks in 2023:

Profit before tax: Ksh 143.5 billion (USD 1.3 billion)

Return on equity (ROE): 20.5%

Cost-to-income ratio: 48.4%

Non-performing loans (NPLs): 5.2%

The sector is also well-capitalized, with a capital adequacy ratio of 17.2%, which is above the CBK’s minimum requirement of 14.5%.

Also Read: CBK Raises Base Lending Rate to 9.5%

So – what are some of the reasons that allow Kenyan banks to consistently make profits?

Why Banks are Making Profit

Consider the following:

1. Stable Economic Growth: For a last couple of years, Kenya has experienced relatively stable economic growth, providing a conducive environment for banks to thrive. A growing economy typically leads to increased demand for banking services, loans, and financial products.
2. Robust Banking Sector: The Kenyan banking sector is characterized by competition and innovation. Banks continually diversify their services, adopt technology, and explore new revenue streams, contributing to sustained profitability.
3. Interest Income: A significant portion of a bank’s revenue comes from interest earned on loans and advances. In Kenya interest rates are considered quite high currently around 13% compared to 3-5% in more mature economies. This demand for credit, whether for personal loans, mortgages, or business financing, contributes to interest income and overall profitability.
4. Financial Inclusion Initiatives: Kenya has been a pioneer in mobile banking and financial inclusion, with services like M-Pesa. These initiatives have expanded the reach of banking services, bringing more people into the formal financial system and creating additional revenue streams for banks.
5. Government Securities: Banks often invest in government securities, providing a secure avenue for generating income. The stability of the Kenyan government contributes to the attractiveness of these investments.
6. Diverse Revenue Streams: Kenyan banks diversify their revenue sources, including fees from various services, foreign exchange transactions, and income from non-interest activities. This diversity helps mitigate risks and ensures a steady income flow. For example, banks will charge you for account opening and maintenance, bank statement request, late payment and other transaction fees.
7. Low operating costs: Kenyan banks have relatively low operating costs, which helps to boost their profits. This is due in part to the fact that Kenyan banks have a large number of branches, agency outlets and ATMs, which allows them to spread their fixed costs over a large customer base.
8. Regulatory Environment: The Central Bank of Kenya regulates the banking sector prudently, ensuring financial stability. Stringent regulations and oversight contribute to maintaining the health of banks, fostering investor confidence.
9. Entrepreneurial Activity: Kenya has a vibrant entrepreneurial ecosystem, with many small and medium-sized enterprises (SMEs). Banks play a crucial role in supporting these businesses through loans and financial services, contributing to economic growth and their own profitability.
10. Population Growth: Kenya’s growing population creates a larger customer base for banks. As more people enter the workforce and require financial services, banks can expand their client base and offer a broader range of products.

It’s important to note that while profitability is a positive indicator, and Kenyan banks are keen on driving up profits, they must also manage risks effectively and ensure responsible lending practices to maintain the long-term sustainability of the banking sector.