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Why large banks beat tier-two lenders in profitability race – Business Daily

The Central bank of Kenya, Nairobi on Wednesday, December 30, 2020. PHOTO | DENNIS ONSONGO | NMG
Large banks are widening the profitability gap between them and their tier two and three counterparts, leveraging on their wider reach and cheaper cost of funds to extract a higher return on assets.
The tier-one lenders significantly extended the gap in earnings in 2021 as they made a better recovery from the Covid-19-led slowdown of 2020 compared to the other tiers, nearly doubling their gross earnings in the process.
The nine banks that make up the top tier are Equity, KCB, Co-operative Bank, NCBA, Standard Chartered Bank Kenya, Absa Bank Kenya, Stanbic, DTB, and I&M.
Together, they grew their pre-tax profit by 84 percent or Sh78 billion to Sh170.6 billion last year, while the eight tier two lenders grew theirs by 38 percent or Sh6.5 billion to Sh23.58 billion.
Tier three lenders, which number 22, raised their pre-tax profits by 39 percent or Sh970 million to Sh3.48 billion.
The Kenya Bankers Association (KBA) attributed the higher return on assets and equity of tier one banks to their advantage in market share in both deposits and assets—particularly cheaper deposits.
The nine tier one banks account for 75.3 percent of both assets and deposits of the industry by the end of last year, data from the Central Bank of Kenya (CBK) shows.
“Across bank sizes, profitability (measured by Return on Assets and Return on Equity) was highest among tier one banks in 2021; an observation that supports the view that larger operations allow banks to exploit economies of scale, thereby enhancing their profitability. Further, efficient banks – that is, those with lower cost-to-income ratios – have a higher RoA and RoE than less efficient banks” said KBA in its 2022 State of the Banking Industry report that was released last month.
Return on Equity (RoE) is a measure of a bank’s ability to generate profits using shareholder funds, giving investors a measure of how much they are getting from every shilling of retained capital.
Return on Assets (RoA) is a measure of a lender’s capacity to make profits from the total resources it controls, including borrowed funds.
For tier one lenders, RoA stood at 3.79 percent last year, compared to 1.83 percent for tier twos and 1.53 for tier threes, indicating that they were able to extract a higher return from their assets, which are mainly in form of customer loans and lending to the government.
In terms of value to their shareholders, tier one average RoE stood at 25.6 percent on average in 2021, marginally ahead of tier two RoE of 25.5 percent, while tier three lenders trailed significantly at 4.83 percent.
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