Growing sovereign debt, an interest rate cap and the emergence of new technology firms are just a few of many trends impacting the Kenyan trade finance landscape. GTR gathered some of the country’s leading trade financiers and insurers to talk about how their business is changing and what awaits them in the year ahead.
Michael Gichure, cluster head, trade sales, Kenya and EAC, Ecobank Kenya
George Kiluva, head of trade finance, Commercial Bank of Africa
John Lentaigne, chief underwriting officer, African Trade Insurance Agency (ATI)
Daniel Lukah, general manager, trade finance, Equity Bank
Patrick Makau, executive principal and head of trade and trade products, Kenya and East Africa, Standard Chartered
Mary Mulili, general manager, business development, Bank of Africa
Bramuel Mwalo, director of Africa business, Kountable
Dennis Nyakundi, head of trade finance, SBM Bank Kenya
Sanne Wass, senior reporter, GTR (chair)
GTR: Kenya’s current public debt stands at around KSh5tn, or 57% of the country’s GDP. How is the rising sovereign debt impacting trade finance in Kenya and the way you service your clients?
Lentaigne: As an investment guarantee agency, one of the main things we do is insure sovereign debt obligations, so we naturally actively monitor government debt levels. I think everybody is quite concerned at the general elevation of debt across East Africa and indeed Sub-Saharan Africa as a whole. Coupled with rising dollar interest rates, there is certainly a potential for an emerging market shock.
Having said that, we do think that in the East African region at least, most of the sovereign debt levels are at manageable levels and thus, provided that borrowing is productive – focused on infrastructure and investment – ATI has continued to support sovereign borrowings.
One observation I would make related to sovereign borrowing, and governments themselves frequently aren’t aware of this, is that investment insurance underpins most major investments and debt going into countries in East Africa. Sovereign borrowings, particularly if they are bilateral or syndicated loans, are often insured, both with institutions like ATI and private investment insurers. The problem with this is that high sovereign borrowings – particularly in the loan market – therefore have the effect of crowding out appetite and capacity for other projects that also require investment insurance, such as sub-sovereign and private sector risk.
Gichure: I think debt is good, to the extent that it is benefitting the economy. It is all justified in the sense that we are putting these funds into good use in terms of the sectors where the money is being deployed. And trade finance bankers have seen the government funnelling investments into our key sectors: manufacturing, energy and infrastructure.
If you look at the knock-on effect on the ecosystem around infrastructure, for instance, business is booming for construction companies. The same goes for manufacturing: many manufacturing companies would have to support that development or project, which is hugely capital intensive but also has an impact on employment. So you could say that the multiplier effect overrides the short-term impact it creates on the spend.
You occasionally hear the government saying it is trying to sort out some of those medium to long-term debts, and those commitments are huge. Some of it is covered by arranging other debts to tick the box and being able to remain afloat and meet their recurrent expenditures. But in the grand scheme of things, it supports trade finance in the sense that we are able to support the value chain in the manufacturing, energy and power sectors. The completion of the Samburu wind power project is an example of a project that has had a big impact on the economy and the overall growth of trade finance.
Lukah: Debt is good to the extent that it drives the growth of GDP, but over and above just having debt, we have got to make the repayments. Being a very heavily imports-based country, there is big pressure on our dollar liquidity, which is having an impact on some of our products. My experience currently is that sometimes we are not able to competitively quote, because our dollar is very expensive.
The opportunity for us here is not necessarily to make debt appear bad, but the debt must help us grow our export market and generate more foreign currency. If we are not able to generate money to make the repayments, if we can’t take effective advantage of that infrastructural growth, it could give us a lot of pain in the long run.
Mulili: What we’ve seen is that government expenditure has gone towards contract financing, which would fall within the trade finance space. We have seen a bit of delay on government payments, with the turnaround time for certain projects lengthening. Some of the entities that have come to us bankers have said they are not willing to take that risk, because they have seen tendencies of delayed payment.
Mwalo: Our business is directly impacted by the daily operations in terms of procurement by governments. I agree with everyone in the room that debt is good, but when you look at how it was used, we can’t confidently say that it was applied productively. Those are some of the concerns that people are having towards debt.
We set up Kountable in 2017, in an election year. And in that year, we were able to fund close to US$20mn-worth of procurements within a period of about four months, and 80% of it was government. From that year, most of the deals delayed, and they were paid after around 280 days. There was a period between April and August 2018 where every payment was stopped, and that shock was felt. But that has improved. Right now, our payment is around 110 days, 150 days for specific companies. So I’ve seen a bit of a change in terms of how quickly government is able to pay.
GTR: How do you tackle government delays in paying suppliers?
Nyakundi: It does affect the way we do business. There are a couple of things that we as financial institutions try and do to balance it out. One is to decide how much risk we want to take on government. The other is to get partnerships, for example with Kountable and ATI and other credit insurance companies, to cover ourselves.
The other thing is that now, we as banks are asking the customers to put in some flesh, some contribution, so that instead of taking 100% exposure, we would take probably 60%. The situation has forced banks to come up with new structures, new solutions, because if you can’t do business with government then there is no business at all. It’s about finding a smart way of doing the business but also managing the risk.
Mwalo: Being informed and connected is the most effective way of protecting your interests in this kind of business. It has benefited us to build relationships in order to acquire information and intelligence on the politics and payment dynamics around these deals. We have built relationships with the people who write the local purchase orders and who have the information. One of the reasons we have done so is that Kountable takes almost 100% of the risk when we don’t take collateral and we don’t take any form of security directly linked to the deal. That means the contract needs to pay for itself and pay us the margins that we require. We cannot do that if we don’t have visibility on the payer-end.
Rule number one, there are some entities you don’t touch, and we need to know them. There are no two ways around it: you need to know which entities you can’t fund. Once that is done, then you go down into the details of the deal, how much you are willing to take in which sector and in which ministries. We have over the past year known that healthcare is one of the best bets. The delays are not that bad. So we can do a large number of deals with the Kenyan Medical Supply Agency. Corporates pay better. Currently we are building our database to record the performance of these ministries, for our own use. Probably later on it can be open-source for other people to utilise it.
Makau: It also depends on the type of project, and where the actual repayment is coming from. You talk about the payer being the government, but behind the government is the actual repayment, whether it is multilaterally funded, whether it is government-to-government or whether it is just simple government budgetary allocation. In our experience, in trade finance, the devil is in the detail. If you don’t get the detail right, then you are in for big problems. It may be a World Bank project, but it can have multiple criteria that must be met before payment is done.
Lentaigne: It is interesting listening to Bramuel, because with invoice discounting, you are one of the first to feel the pain, if there are problems. There is no doubt that the payment risk for suppliers and contractors to government is one of the toughest areas to be in. Governments always service their international obligations first, whereas contractors are frequently paid last. In trade finance, particularly for those contractors selling into regional government or sub-sovereigns, this is where late payments tend to be felt.
Unfortunately with this line of business there’s also a higher propensity for corruption and fraud. There are unfortunately serious delays in paying suppliers in some of the East African regional countries. And of course, when you’ve got a combination of high government borrowing at the sovereign level that is insured, and then late payments and even potential fraud issues at the sub-sovereign level, your risk mitigation solutions and partners dry up – because risk mitigation partners such as ATI are not a magic silver bullet. At the end of the day, if we think a risk is unsustainable, we are not going to insure it. One consequence of this is that in some of the regional economies, and I’m not pointing fingers at Kenya here, late payments to suppliers and contractors are having a spill-over effect and becoming a drag on growth in the real economy.
GTR: Let’s move on to talk about Kenya’s interest rate cap, because this seems to be something that is really impacting everyone around this table. The cap was introduced in September 2016 and was aimed at helping small businesses access capital at affordable rates. How is it going with reaching this aim?
Gichure: The interest rate cap is an interesting phenomenon. It came around the time we had the general election, the agenda for which may have reached its intended result, which was to show people that the government would be able to control the cost of credit. And to a big extent I would say, yes, they managed to move the interest rate from an average of around 25% to around 13-14%. The expected broader impact was that more people would be able to access credit which would create a spiral effect on the economy, and that people would develop SMEs. But I talk to SMEs, and it has been a painful two years, and right now, at the central bank and the parliament, it is just a matter of time before we see revisions on that interest rate capping.
It came with some unexpected consequences. One of which was that most banks then pointed to risk-free investments, where you pool all the private lending from SMEs to lending to a few blue-chip companies and multinational corporations, to then just investing. All our interest income was then coming from government, in short-term treasury bills and bonds. You would see the impact, where there was an oversupply of lending to government, inasmuch as government has come out and said it didn’t want to crowd out, but that was the impact it created. You would then deal with a lot of people, especially SMEs and local corporates, who are struggling and have felt the brunt of the impact of the interest rate capping.
Nyakundi: The interest cap might benefit the few who are getting financing from the banks and financial institutions, because now the pricing becomes better for them thanks to the competition within the banks, but it is just a few.
The SMEs the interest cap was supposed to help are actually slowly being pushed out of mainstream banking. They are going to financial intermediaries, micro-finance institutions, who are not managed by this interest rate cap, which then means that those intermediaries charge higher interest rates than the banks. So you have basically wiped off the margin for these SMEs. They are just doing business to keep their name going, but not really to grow.
Mulili: In the banking space, you have seen a lot of innovation and digitisation. With the interest capping, people are innovating. Why would a bank have a team of 100 people handling SMEs? Platforms have been deployed to process such small loans on a predetermined credit scoring model. We have also seen partnerships, where banks have partnered with telcos and firms that would ideally serve those SMEs but who don’t want to take the risk directly.
Makau: I would just like to back what others say: banks play a key role in economic development in Kenya and in East Africa in general. We are here to take calculated risks. But the environment does not provide an opportunity to calculate the risk and then price for that risk effectively. The net effect is that the individuals, corporates and SMEs are not getting financing as envisioned.
I couldn’t agree more with Mary. In my opinion, the spirit of the interest rate cap was good. Was the way it was implemented the most optimal measure? That is an open debate. But we are where we are. So what do we do? We innovate. We reduce our brick and mortar presence and go digital. The greatest place innovation has come through is working with financial intermediaries who are not affected by that interest rate cap, with telcos who offer bank-related services, with fintechs and with the likes of Kountable. We are complaining about opportunities to deal with SMEs working with government, but Bramuel is saying that in Kountable’s first year, it had US$20mn of exposure to government. That used to be my US$20mn; now it is with him. The net effect of that innovation is a huge channel of energy in the financial space that we were too comfortable to look into, which is having a generally positive effect on the overall economy.
Granted, not everyone is benefiting from that. Bramuel is capped on his appetite, there are not enough Kountables to fill that void; but there are people who are getting a benefit. Now the banks and other intermediaries, government programmes and risk distribution partners need to find a way to channel the rest of that populace to get them to some positive growth.
Lukah: I just want to throw a spanner into the works, because although I totally agree with my colleagues, I want to take a long-term view. As far as banking is concerned, the excitement we are having about innovation is to me very short term. If you take Kountable, it has a limitation to how far it can go. If you look at the innovation of telcos, really, they are not financing development and investment; they are financing consumers.
The SMEs are still starved of credit, so we are not really developing. What has really happened in the market is that we have locked out liquidity to government borrowing and chased our customers to a few firms like Kountable, or thrown them to the hyenas of microfinancing and Shylocks – who don’t even have the capacity anyway. But ultimately, since the majority cannot get proper credit, we are looking at stagnation. Meanwhile, the same government that has introduced this cap still has a very high appetite of consuming, and that is why we are still sending a lot of money there.
The fact is that this country is going to stagnate, which will bring us back to square one. We won’t even be able to pay these debts, because we are not going to generate anything. What are we talking about with innovation? Have we grown the economy? The answer is no.
Mwalo: I will speak from an SME perspective, because we really have to think like SMEs to be able to serve SMEs. With or without the interest rate cap, I think we are blaming the wrong ‘person’. I’m looking at it this way: Kenya’s political economics is built on numbers. Do you want to win an election? Numbers. Do you want to please people? Numbers. So the quality of investment, projects and what we are putting our money into is something that we all need to start paying attention to.
In the list of top 100 SMEs this year, we have had a few additions, but for the last three years they have been the same companies, with a slight improvement on turnover. Why is that the case? You can easily assume it’s their access to credit which directly affects their bottom line. They cannot scale otherwise. If a financial institution says they are innovating for SMEs, then they should show a product that has impacted this bottom line.
Makau: Innovation is not only about providing new products. It’s about new methods, new techniques, new ideas. The wheel has been invented, so the struggle is to find new ideas in how to finance corporates to import goods or to provide working capital. For trade finance, it is either payables or receivables, whatever you want to call it, it fits into that.
Does it mean it was not innovation because the banks were forced into it? I don’t think so. I’ll give two examples. One is credit decision-making across the spectrum. Today, we are able to use algorithms in different areas of the bank to make credit decisions. One thing I like about what Kountable does is what Bramuel said: that it’s very important to build data points and databases. The relationships you are building are not only for relationships’ sake, but they give you insight into operational processes, design processes, and then the data that can lead somewhere. So one thing we are doing differently is credit decision-making.
The second thing we are doing differently is looking for new ways to get a credit risk uplift. And not only traditional land and buildings, but to find a different methodology, whether that’s from a legal perspective, from a risk participation perspective, from the perspective of a multilateral that wants to focus on supply chain finance, or from a distributor finance perspective. In order to take that risk that we have not been allowed to take, we are finding different ways of calculating our risk and taking risk where we can. But there is still a lot to be done.
Lukah: If you make a comparison with the IT space in this country, why is innovation so vibrant in that sector? You cannot talk so seriously about innovation when your hands are tied by regulation to the extent that the regulator is literally at your desk in the bank. You have to find ways for the regulator to support that innovation. Think of the number of times that our teams are making reports, and on the number of questions we have to answer. Banking within the local market has now become investigative and compliance will be the next biggest role for bankers, taking them away from financial banking.
Kiluva: We are under strict regulation. We’ve got the new accounting standard, the IFRS 9, where banks have to write away anticipated profits at the onset and hope to wind back.
Gichure: I think the interest cap was a good thing that happened. Banks were almost sleeping. We were then awakened to
innovation, cost containment and different ways of working. One inevitable outcome is consolidation. We were bound to become fewer, leaner and more efficient, which is a good thing and has a good knock-on effect on the general industry.
The only downside with all this innovation is that if we allow it to continue in the manner that it has gone, with things like the use of social lenders being able to extend loans, we are bound for another crisis. There are clients who are borrowing year-round from one bank to pay off another, and it’s a house of cards. Fintech is good, but we need some form of regulation.
Kiluva: On the subject of the spiral or debt accumulation, what happens after the public has accumulated debt from social lenders that can no longer be sustained? Businesses will collapse from over borrowing. No business will generate returns at finance costs of 84% annually.
Makau: If somebody is doing social lending, that is different. There are people who are doing very good things with algorithms, where they check with the national registry, with M-Pesa, with the criminal records database, with your credit balance at the bank. Now, isn’t that what we have been challenging banks to do; to go beyond brick and mortar? We are going to datapoints that mean something: are you a valid, registered business or individual? We are going to use data.
Other intermediaries who are amongst us; that is exactly what they are doing. If there is somebody trading on Facebook likes and Twitter retweets, all the best to them. But what we have been asking and challenging ourselves to do is to look at what is there and use that data in a relevant manner. If Safaricom knows that I am on top of my M-Pesa and where they can find me, where I work, they can take that risk on me. I hear you: the risks are there, but we are at the cusp of the innovation revolution now. Do we maintain the 300-year-old letter of credit only, or do we find the right way to innovate?
GTR: Finally, what opportunities and challenges do to you see for the year ahead?
Lentaigne: I would like to focus on some of the opportunities, because we have talked about some of the tougher challenges we face in the region. For instance, it’s important to remember that East Africa – and Africa as a whole – continues to move against the global protectionist trend, and there are huge opportunities arising from the reductions in trade barriers.
In East Africa, you have got some of the fastest-growing economies in the world. We are seeing increased economic diversification and there is strong innovation here. Whether it is services in Kenya or tourism in Rwanda, regional economies are diversifying, and it is easier to trade across borders than it has ever been. East Africa is not overly reliant on oil, and that is a big plus. Yes, there are challenges: sovereign debt levels, interest rate caps, economic nationalism to a degree and the difficulties of getting prompt payment in the sub-sovereign sector, but fundamentally we remain, at least for the next 12 months, very positive when looking at the East African economic climate.
Gichure: I have a ray of optimism. It’s really the way that we have seen our governments coming in with manifestos, having clear priorities on what they want to tackle. You know where the government is likely to spend your money. One thing is having that manifesto priority, another is to have the goodwill and showing the effort towards implementation. In an area like healthcare, where the banking industry has not been very awakened in terms of lending to that sector, we are now gradually beginning to support some of those healthcare tickets. This is one area of opportunity that I can feel would portend a key milestone for the banking fraternity.
Kiluva: I am very bullish on investment in healthcare and manufacturing, and confident these two are working. Over the last three months, I’ve been to five forums where government and manufacturers have sat on opposite sides, and the engagements have been pleasant. There is goodwill in government.
Chinese business is an opportunity. There is a lot of scepticism and suspicion, but we need to sober up and take advantage of this opportunity. They’ve shown us new ways of doing things. Without them, we’d still be doing our infrastructure the same old way.
Nyakundi: My colleagues have given a positive outlook and I am also very optimistic. We will have a good 2019 in terms of government implementation of various projects, the big four agenda, and it will realise the opportunity for us to play in that space.