Equity Bank’s Revenue Diversification – How NFI Performed Post Interest Rate Cap

In September 2016, the Central Bank of Kenya (CBK), under the Banking (Amendment) Act 2015, capped lending rates at 4.0 percent above the Central Bank Rate (CBR) and deposit rates at 70.0 percent of the CBR.

The move came against a backdrop of low trust in the Kenyan banking sector due to the high total cost of credit and profitability in the banking sector and the failures of several banks due to poor governance.

The failure of these banks left many unable to access their deposits in these banks. This led to a negative public sentiment that necessitated regulatory action in the banking sector.

Before its introduction, SMEs and other working people had decried the high-interest rates that had locked them out of the mainstream bank credit. And while the rate cap was all for a good cause, it achieved the opposite. It negatively impacted the economy and, by extension, Kenyans.

Small businesses suffered as banks focused more on lending to corporates and the government. The cap reduced credit to the private sector, damaged growth, and weakened the effectiveness of the monetary policy.

Analysts note that SMEs were reportedly denied loans worth about 300 billion shillings ($2.97bn), about 1 percent of GDP, during the period. Furthermore, credit extension to SMEs as a percentage of total bank loans fell to 15 percent in 2019, from about 25 percent before the cap was instituted.

Banks were largely affected too. The rate cap reduced income from loans, forcing banks to diversify their revenue streams. During the regime, banks explored different avenues of revenue generation, including bancassurance, to increase non-funded income (NFI).

Most banks focused more on these alternative instruments and adopted an efficient operating model through alternative banking channels and digitization to remain profitable in the harsh operating environment.

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Take, for instance, Equity Bank; to get out of the declining non-funded income situation, it identified key growth areas to diversify its revenue stream from interest income that for long made up the lion’s share of the lender’s income.

Despite the economic challenges, the bank shifted its strategy to ensure that non-funded income, regional subsidiaries, government securities, innovation, and other initiatives help mitigate the effect of the interest capping.

Equity Bank banked on growing its NFIs – derived from bank charges, transaction fees, monthly account charges, and mobile banking, to name a few – to boost performance. The bank’s NFI in Q’3 of 2017 grew to hit 21.3 billion. However, it declined by 6.7 percent to 19.8 billion shillings in Q3’2018.

The decline in NFI was realized across all NFI segments. Fees and commissions on loans declined by 1.7 percent to 4.28 billion from 4.35 billion shillings in Q3’2017. Other fees and commission income declined by 2.7 percent to 9.4 billion, from 9.6 billion shillings in Q3’2017.

Such a decline sent many experts to argue against the interest rate cap. Many urged the government to repeal the act, true to which it listened in 2019 and scrapped it.

Banks went bank to lending to SMEs and other individuals, which saw them rise from the effects of the capping regime. Loan books grew, non-funded incomes contributed more profits, and the general banking environment improved.

Equity Bank’s NFI growth clearly exemplifies this trend since the removal of the interest cap rate. It consistently managed to register 29.8 billion shillings in 2019, which grew by 27 percent to hit 37.8 billion in 2020. This further grew by 15 percent in 2021 to reach 43.6 billion shillings.

Statistics show that Equity’s NFI by Q’3 2021 grew by 29 percent faster than the interest income from the loan book, which grew by 24.4 percent as the bank deployed deposits to a high-earning asset base other than government securities.

Nevertheless, one thing remains clear: the removal of the interest cap rate did well for banks in terms of the NFI contribution to the overall profits. In the meantime, Equity bank continues to look at where it can invest much for more revenue.

This performance is expected to improve in the medium to long term further following the expiry of the waiver on fees and commissions on loans and the loan restructuring window having closed in March 2021.