BODO: Fast growth takes Equity closer to regulatory limit

Opinion and Analysis

A K-Rep Bank branch on Kenyatta Avenue in Nairobi. The investment firm Centum has announced its intention to raise its stake in the bottom-tier bank. PHOTO | SALATON NJAU  

By George Bodo

In Summary

• Equity Bank needs to raise funds or retain profits to be safe as CBK rules come to effect next year.

Equity Bank released its second quarter results this week with the lender saying it had earned Sh1.02 a share for the three-month period ended June 30, compared to Sh1.05 in the first quarter period ended March 31.

The results reflected a slight two per cent quarter-on-quarter drop. But they also showed the bank will need to significantly recapitalise its balance sheet.

 

Equity Bank has grown so fast since going public in August 2006. In fact, between 2006 and 2013, the bank’s total risk assets grew from just Sh16 billion to Sh187 billion, translating to an average growth rate of 44 percent per year.

This is higher than the average industry growth rate of 22 per cent per annum over the same eight-year period. The problem is this kind of growth level eats into capital, primarily because banks have to maintain a certain level of capital adequacy.

Starting January 2015, all banks will be required hold a capital conservation buffer of 2.5 per cent over and above the existing minimum ratios to enable them withstand future unforeseen periods of stress.

This will bring the minimum regulatory capital adequacy ratio to 14.5 per cent. The bank’s second quarter results showed that it is just 2.5 percentage points above this new rule; and for a bank the size of Equity, which holds significant system risks, this is a real close shave.

In fact, from a regulatory perspective, any of the tier one banks should not be allowed to get this close because of the regulatory perception that they are generally systemically important to the banking system.

With these high levels of risk taking over the last eight years, Equity has effectively overheated and it is the first time, since 2006, that its capital adequacy ratio has fallen below 20 per cent; and if the bank’s risk appetite continues to grow at the current quantum, then its capital adequacy could be below the regulatory minimum by as much as 300 basis points by the end of 2015, that is, if it doesn’t raise more capital.

Already, on a year-to-date basis, the bank’s risk assets have grown by a massive 45 per cent compared to industry growth rate of 25 per cent; and this surge has been partly fuelled by the fact that, as part of the new regulatory risk management guidelines, the bank is now compelled to classify market and operational related risks as part of its risk portfolio.

However, on a global scale, the bank has two choices: to slow down on its risk appetite, or bring forward its capital raising plans while maintaining current growth momentum.

The bank, while releasing its second quarter results, disclosed cash call plans over the next two years, but it may have to bring forward this recapitalisation plan.

And given its sheer size and systemic risks it poses, the bank, at any given time, needs a 10 percentage points buffer over and above the regulatory minimum (which translates to roughly 24 per cent).

To achieve this level, it will need to raise capital in the region of Sh12-15 billion; and in addition to selling new shares to investors (rights issue), the bank also still has the choice of increasing its profit retention levels or going for additional Tier 2 capital (or even both).