The Story Behind Co-operative Bank’s Move on Interest Caps

Words: Emmanuel Were

If you walk into most Co-operative Bank branches, chances are that it will take you less than 10 minutes to deposit cash or a cheque into an account. The cash deposit will not be handled by an employee of the bank.

Instead, it will be an agent of the bank receiving the cash and depositing it into an account using a hand-held device similar to the point-of-sale machines used to swipe credit and debit cards in most retail outlets, like coffee houses and petrol stations.

The agents are independent of the bank as are given only a desk to work from and earn their commission. Co-op Bank does not pay their salaries, which means it makes significant savings on staff costs and related expenses.

The lender’s aggressive cost-cutting strategy and its push to go into paperless banking started in August 2014 through a transformation project dubbed ‘Soaring Eagle’. McKinsey & Company was the consulting firm that advised the bank on this strategy.

Now, two years later, Co-op Bank has pulled a fast one on other lenders by being the first to adopt a maximum lending rate of 14.5 per cent for new loans.

The bank announced last week Friday that it would comply with the Bill President Uhuru Kenyatta signed into law that caps commercial banks’ lending rates to four percentage points above the Central Bank Rate (CBR), which is currently at 10.5 per cent. The interest on deposits has also been pegged at 70 per cent of the CBR.

The CBR is the rate at which banks borrow from the Central Bank.

Why has Co-op Bank become the first to break ranks with other banks? Is it business suicide, a marketing gimmick to steal the show from its peers?

The one thing that is certain is that Co-op Bank has become more efficient at running its business by keeping a lid on its costs.

Staff costs

In the six months to June this year, the bank reported its lowest ratio of staff costs to total income since it opened its doors for business in 1968.

For every Sh100 that Co-op Bank earned in income – such as from interest on loans and fees from transactions – it spent Sh20 on staff salaries and associated costs, such as insurance and pension.

Co-op’s financials show that it previously spent as much as SH25 on staff costs for evey Sh100 it earned. Equity Bank spends only Sh18 on staff costs for every Sh100 it earns in income. This means Co-op Bank is catching up to Equity Bank in keeping costs low.

“Notably, staff costs to total income was at an all-time low of 20.1 per cent, showiing success in improved staff productivity – a key transformation strategy output,” add analysts from Standard Investment Bank in a note on Co-op’s half-year results.

And a comparison of the three largest Kenyan banks shows Co-op aggressively managed overall costs in the first six months of this year.

Coop Bank 1

For every Sh100 in income, it spent only Sh45.3 on all costs – including staff costs and rent – compared to Equity Bank, which spent Sh50.3 on costs for every Sh100 it earned in income. KCB spent Sh47 on costs for every Sh100 it earned.

These results mark the first time Co-op Bank has bested Equity Bank and KCB in managing costs.

Perhaps with the bank managing its costs better, it has the confidence to reduce the lending rate ahead of its competitors.

If a bank is able to aggressively manage its costs, which most have been doing by adopting technology like mobile banking and online platforms, then the next point of focus becomes the net interest margin.

The net interest margin reveals how efficient a bank is in earning its bread and butter of interest income, in relation to its assets, such as customer deposits.

Coop Bank 2

Equity Bank has been doing a good job of lending at a high rate and paying little interest on deposits. Its net interest margin is the fattest in the industry at 11.8 per cent, according to its half-year results released last week.

If you borrowed Sh10,000 from Equity, the bank will end up earning an average annual net interest income of Sh1,180 from your Sh10,000.

This is because the bank will lend you the Sh10, 000 at an average of 13.8 per cent, earning an income of Sh1,380. It will then pay the customer who deposited the Sh10,000 an annual interest rate of 2 per cent – or Sh200 per year.

This means the bank will earn a net interest income of Sh1,180 (Sh1,380 – Sh200) on the Sh10, 000 you borrowed from it. This translates to a net interest margin of 11.8 per cent.

First-mover advantage

Again, Co-op Bank has been catching up with Equity Bank since its net interest margin crossed into double digits at 10.2 per cent, the first time in more than six years. KCB’s net interest margin lagged behind at 9.9 per cent.

Perhaps Co-op Bank’s move to be the first to reduce interest rates is an indication that it would like the first-mover advantage to translate into it disbursing loans as its peers think about their next move.

However, it is important to note that in last week’s announcement, the lender did not comment on whether or not it would increase the deposit rate for customers.

Coop Bank 3

Again, this is where Co-op Bank has an advantage over other lenders. Because its key shareholders are Saccos and co-operatives, a move to regulate interest rates might see more people saving with Saccos and borrowing from Saccos.

It means Saccos and co-operatives could become flush with cash, which would then be channeled to Co-op Bank. And since Saccos and co-operatives have a stake in the bank, Co-op might not have to pay expensively for these deposits.

“The group appreciates the overwhelming support received from the co-operative movement, resulting in over 95 per cent market share in the co-operative business,” said Stanley Muchiri, the Co-op Bank group chairman, in the lender’s annual report last year.

And while everything seems to have fallen in place since Co-op Bank started its transformation in August 2014, perhaps only time will tell if this latest move to lower interest rates ahead of the market will extend its run of good fortune, or hurt its business.

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