Kenyan banks are entering a period of stronger financial performance as lower funding costs, recovering loan growth and improved asset quality continue to support their balance sheets, according to a latest assessment by Moody’s Ratings, the credit ratings division of Moody’s Corporation.
The rating agency says profitability across the banking sector remains strong despite declining asset yields in the lower interest-rate environment, with banks benefiting from a faster reduction in deposit funding costs and renewed growth in lending.
Moody’s assessment points to improving financial conditions for Kenyan lenders, although it cautions that high levels of nonperforming loans (NPLs) and significant exposure to the domestic government remain important constraints on the sector’s credit strength.
The improvement in profitability comes as interest rates decline, putting pressure on yields earned from loans and other assets. However, banks have been able to protect their margins because the cost of deposits has fallen more rapidly, supported by improved liquidity conditions.
The rating agency also expects renewed loan growth to provide an additional boost to banks’ earnings.
The recovery in lending comes after a period in which difficult economic conditions and high interest rates weighed on borrowers and contributed to deterioration in loan performance. With financing conditions improving, Moody’s expects the gradual recovery in credit growth to continue.
Loan quality improves
Moody’s says loan quality has also improved materially from previously weak levels, although Kenyan banks continue to carry relatively high NPL ratios.
The rating agency expects the improvement in asset quality to continue gradually as economic and financing conditions become more supportive. However, Kenya’s NPL ratio is expected to remain above that of most peer banking systems.
Loan quality remains one of the sector’s main relative weaknesses, particularly when Kenyan banks are compared with banking systems elsewhere in East Africa.
The persistent level of bad loans reflects the difficult operating environment that borrowers have faced in recent years, including elevated financing costs and economic pressures affecting businesses and households.
Despite the progress, Moody’s assessment indicates that banks will need continued improvement in loan performance to bring asset quality closer to levels seen in stronger regional banking systems.
Capital and liquidity provide support
The report also highlights the strength of Kenyan banks’ capital, funding and liquidity positions.
Capital accumulation, together with the gradual increase in Kenya’s minimum core capital requirement, is expected to strengthen the position of smaller banks. The higher capital requirements are likely to encourage smaller institutions to build stronger capital buffers as they adjust to the new regulatory thresholds.
For larger banks, however, Moody’s expects a modest squeeze on capital as credit growth accelerates and lenders deploy capital to support expansion and make distributions to shareholders.
Even so, the rating agency considers the sector’s capital and liquidity buffers supportive.
Kenyan banks also compare favourably with large banking systems elsewhere in Sub-Saharan Africa on funding and liquidity, providing an important buffer against financial and market shocks.
The sector’s relatively strong liquidity position is particularly significant as banks navigate an environment of changing interest rates and recovering credit demand.
Government exposure remains a constraint
Despite the improving financial indicators, Moody’s says banks’ substantial exposure to domestic government securities continues to constrain their overall credit strength.
Kenyan banks hold significant amounts of government debt, linking their credit profiles closely to the sovereign’s financial position. This means that improvements in bank profitability, capital and liquidity do not entirely remove risks arising from sovereign exposure.
The concentration in government securities has also become an important consideration as banks seek to balance lending to the private sector with investment in relatively liquid government instruments.
Moody’s says the banks’ growing regional diversification provides some additional support, but this does not fully offset the risks associated with their exposure to the domestic sovereign.
Overall, the latest assessment presents a banking sector whose financial metrics are improving on several fronts. Stronger profitability, recovering loan growth, lower loan-loss provisions and better asset quality are providing support, while capital, funding and liquidity remain important buffers.
However, high NPL ratios and substantial sovereign exposure continue to weigh on the sector’s credit profile, leaving Kenyan banks with both improved financial conditions and persistent structural vulnerabilities as they enter the next phase of growth.
