Big bank profits in the third quarter were below average

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Big bank profits in the third quarter were below average


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Summary

  • Three quarters of the pre-tax profit was not really “earned” but came from write-backs of depreciations noted in 2020.
  • If it is true that the worst of the pandemic has passed for their borrowers, then why aren’t the loan books increasing?

The eight largest banks doubled their net profits year-on-year in the third quarter of 2021 to reach 28 billion shillings, the second consecutive quarter that net profits increased. Upon closer examination, however, these profits do not appear to be as robust.

Three quarters of the pre-tax income was not really “earned” but came from write-backs of depreciations noted in 2020, the result of accounting maneuvers. Generally speaking, for banks, the concept of impairment of financial assets refers to the amount by which the carrying amount of an asset exceeds its recoverable amount.

Essentially, every loan given to a client is meant to be self-financing and generate profits. If a loan, due to macroeconomic factors, has not been able to self-finance and generate profit, then its carrying amount exceeds the recoverable amount and this difference should be reflected in the income statements through ‘loss of value.

As performance improves and the recoverable amount begins to increase, impairment losses are reversed. This is a purely accounting maneuver, which was the case for the eight big banks. However, the other 31 banks painted the opposite picture and did not publish any prior write-downs; and therefore declared a status quo performance during the quarter.

One wonders what type of economic scenarios are modeling the big banks over the next two years, given the continued advance of the Covid-19 pandemic on the national economy and the looming electoral cycle. But it’s a pretty questionable crystal ball.

In any case, it increasingly appears that Covid-19 has been around for some time.

Nonetheless, if it is true that the worst of the pandemic has passed for their borrowers, then why aren’t the loan books increasing? By the end of September 2021, credit to the private sector had grown by a meager 7.4% in annual terms. Instead, the build-up of public debt, which currently pays up to around 13%, continues.

By the end of the quarter, the ratio of government debt to total assets of the big banks rose to one-third, the highest since I started keeping records. On the flip side, the ratio of customer loans to total assets fell to 51%, the lowest since I started counting.

This change in allocation also results in high liquidity ratios. The sector’s average liquidity ratios rose to 60% (from 57% at the end of the second quarter) while for the big banks they stood at 55%. Thus, they do not increase loan portfolios, but they do signal that the risk environment has improved. A classic dichotomy there.

As I said in my previous article, banks have deployed excess capital to ensure less capital intensive banking activities and they must return some of the excess capital to shareholders in the form of dividends (or even buyouts).

Buying government debt with a capital adequacy ratio (CAR) of 18% is an inefficient use of capital (because buying government securities does not require any allocation of capital). In addition, for the fourth year in a row, banks will not cover their cost of capital in 2021.

With an annualized return on equity holding steady at 15% in September against a cost of equity of around 18%, economic returns on bank capital are still expected to be negative in 2021.

For example, Equity Bank #ticker: EQTY, the region’s largest balance sheet, saw its capital adequacy ratio stabilize at 20% between 2015 and 2020, while the average return on equity fell to 16. % versus 24% during the same period.

KCB #ticker: KCB, the nation’s largest balance sheet, also saw its average return on equity decline from 24.2% in 2015 to 14% in 2020 while, at the same time, its capital adequacy increased from 16.9% to 21.6% in the same period. You should have bypassed the banks.

Bodo is a banking analyst

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