Gambian banks faces interest rate risk as Tbill rates goes down

The Gambia banking industry faces financial risk as the yields on government treasury bills continues to go down throughout 2017 in addition to the Monetary Policy Committee rate cuts.

The decline of these two important rates could affect the industry interest revenue and possibly the operating profit if the banks fail to change their investment portfolio.

MPC rate influences the prime lending rate for loans while the yield on treasury bills relate to the industry concentration risk in this short-term instrument.

Reinvestment risk in Gambia banking industry

According to the reports culled from the Central Bank of the Gambia website, the banking sector holds D13 billion in Treasury bill as at December 2016.

Treasury bill investment represents over 40% of the total industry assets and now faces reinvestment risk as yield continues to decline for the instrument.

What is a reinvestment risk?

It is the risk that the proceeds from repayment of investment and interest have to be reinvested at a lower rate than the original investment rate.

In the case of the Gambian banking industry, this implies that the banks will reinvest the D13 billion investment in treasury bills at a lower rate upon maturity. For instance, in 2016, the average yield on the 182-day bill was 17% whiles the six months to June 2017 averaged at 11%.

All the treasury bill tenors have registered an average rate decline of over 6% in 2017. If we apply 6% to the industry T-bill investment portfolio, then there is a risk of about D800 million decline in interest income for 2017 subject to tenor adjustments.

What is the effect of MPC rate cuts?

Most banks in the Gambia and if not all use MPC rate as the prime lending rate for the loan and advances. The referencing of prime lending rate to the MPC rate is usually included in the facility agreement with the borrowers. It implies that most loans in the industry are technically floating rate loans.

Floating rate loans are known to face the risk of reference rate changes. If the reference rate goes down, then the lender losses while borrower benefits.

In May 2017, the Gambia MPC decided to reduce the monetary policy rate from 23 percent to 20 percent which legally required most banks to repriced the loans that refer to the MPC rate. It was further reduced to 15% in June 2017. These reductions create another financial risk called the reference rate or prime lending rate risk.

In Feb 2017, Trust Bank Ltd signal the lead and reduced their prime lending rate by 300 basis points effective 01 Mar 2017. Similarly, GTBank Gambia also announced a prime rate cut from 23% to 18% effective Jul 1^st, 2017.

These reductions will impact the banks’ loan interest income.

Many other banks are expected to follow similar direction as they have little choice due to legal or competitive reasons.

If we apply the 3% reduction to the industry loan portfolio of D3.9 billion as at December 2016, we can expect another D117 million fall in interest income.

Therefore, overall we can predict about D900 million decline in interest revenue of the Gambia banking industry in 2017.

The table below shows the sector numbers with the three of the big banks in the country.

GTBank has the highest loan to deposit ratio in the big banks while Ecobank seems more exposed to the reinvestment risk compared to the other top peers.

Although we could not obtain any of the SCB Gambia’s financials, we believe their ratios are not better than the industry top three.

Furthermore, this decline is expected to affect the Microfinance banks, insurance and individual who invests in treasury bills to manage their finances.

What brought us to this situation?

The banking sector faces the risk of profit decline due to a number of possible reasons as explained below:

1. Substantial investment in treasury bills – The industry invested heavily in the government bills. At some point, the yield on the Gambia one-year bills were 22% while the banks were paying 5-7% interest on a savings account and less than 12% on one-year fixed deposits. This effect boasted a significant net interest margin for the industry.

Furthermore, the Central Bank regulations do not allow banks to lend one or related customers more than 25% of its shareholder funds without approval of CBG. However, we do not know of any regulatory limit for investing in government securities.

2. Less investment in loan and advances – If the central government which supposed to be the highest rated borrower in the country continues to pay 22%, then there is little motive for commercial banks to invest in loans if they cheaper cost of funds.

Individuals and corporate borrowers can expose the banks to the risk of default probability compared to central government.

As at December 2016, the industry loan to deposit ratio was 21%. Which means that for every D100 deposit received, the bank only invested D20 as loans. However, the treasury bills to customer deposit ratio was 71% for the same period.

In Nigeria, the banking industry loan to deposit ratio was 80% as at Oct 2016. Although, most Nigerian banks have issued local and corporate bonds to fund their long-term loans.

It must be noted that loan and advances are 100% charge in the capital adequacy calculation and does not contribute to the liquidity ratio purpose, unlike the Treasury bills.

These two metrics are the most critical ratios for the banking industry. Capital adequacy indicates banks’ strength and resilient for unexpected loss whiles liquidity confirms the availability of cash to pay deposits.

3. Lack of long-term investment market – Even with the existence of mechanisms for government bond issuance, there is no active market for the bonds in the Gambia. We believe the government and central bank fail to develop this market. The few savvy investors and corporates all go for the treasury bills.

Furthermore, apart from Trust Bank Ltd, we do not know of any other bank in the Gambia that has a significant equity investment in another operating entity within or outside the Gambia.

Therefore, the banks have few choice of treasury bill and loan investment.

In conclusion

Although the Gambian banks are liquid and strong, they face the risk of decline in revenue due to concentration on government bills and MPC rate cut. The industry needs to diversify income sources, including more non-interest income.

There is also a need for the sector players and government to develop a long-term financial market in the Gambia. This development could include the issuance of government and corporate bonds. The long-term financial products can also support the ordinary citizens to access investment products which will help them to manage their finances.

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