Top East African banks with increased exposure to government securities are staring at reduced earnings in 2025, as regional central banks cut interest rates.

These decisions by respective banking regulators are meant to stimulate private sector investments and economic growth, but could also eat into revenues earned from lending.

Global rating agency Fitch predicts that the financial performance of African banks will be impacted in countries where falling interest rates translate into lower yields on government securities, hitting banks earnings through a reduction in interest income on both government securities and customer loans.

The agency, in its latest African banks Outlook 2025 report, says African banks will likely continue to face significant challenges in 2025 including risk of sovereign debt distress, potential exchange rate volatility, regulatory interference and lower yields on sovereign securities.“Performance (of banks) will remain solid, but we expect it will drop slightly in those countries where lower interest rates will translate into lower yields on government securities. Capitalisation, funding and liquidity should remain comfortable in most markets, “the agency says in a report dated December 11, 2024.

For Kenyan banks the report says impaired loans ratio will remain high as there are no anticipation of a substantial reduction in the high pending public-sector bills while asset quality will remain sensitive to changes in Kenya’s creditworthiness due to large holdings of sovereign fixed-income securities.“Net interest margins (NIMs) will contract in 2025 as market interest rates decline. However, NIMs will remain wide, complementing large non-interest income and sound operating efficiency,” the report says.

Kenya, Uganda, Rwanda and Tanzania have avoided further rate increases in their latest monetary policy reviews to boost recovery of their economies through growth in private sector investments and increased spending by households and businesses, although the banks’ response to the interest rate signal remain low.

Kenya’s monetary policy committee, on December 5, lowered the benchmark lending rate for the third time this year by 75 basis points to 11.25 percent from 12 percent as inflationary pressures remained muted, putting overall inflation for the month of November at 2.8 percent the lowest in 17 years since 2007.

The committee, however, noted that although short-term rates on government securities had declined sharply in line with the Central bank rate (CBR), banks had not responded by lowering their rates proportionately.

Uganda’s Central Bank held in its policy rate steady at 9.75 percent for December 2024, buoyed by a strong policy bias towards lower lending rates and a stable exchange rate.

Rwanda's central bank maintained its key interest rate at 6.5 percent in November to tame inflation while the Bank of Tanzania (BoT) in October decided to maintain the bench mark lending rate at six percent for the quarter ending December 2024.

The BoT said it considered that inflation is forecast to remain low, consistent with the target of five percentThis has, for instance seen nine tier 1 banks in Kenya led by regional lenders such as KCB, Equity, Diamond Trust Bank (DTB), Co-operative Bank and I&M bank make a total of $855.73 million in interest income from their investment in government securities in the first six months of this year (2024).

Disclosures from the lenders’ unaudited financial statements show that interest income earned by these lenders from their investment in government securities increased by 17.87 percent to $855.73 million in the six months to June from $726.12 million in the same period last year.

The greatest beneficiaries included KCB group which earned $197.44 million returns from government securities during the period under review, followed by Equity group ($219.53 million), DTB ($98.6 million), Co-operative Bank ($97.67 million) and I&M Bank ($48.06 million).

According to Fitch the reduction in interest income from these investments in government securities will adversely impact the lenders’ profitability.

In July, Moody’s Investor Service downgraded the credit rating of KCB Bank Kenya, Co-operative Bank Kenya and Equity Bank Kenya largely due to their increased sovereign exposure in the form of government securities issued by a government with a weakened credit profile.“African banks will likely continue to face significant challenges in 2025 including risk of sovereign debt distress, potential exchange rate volatility, regulatory interference and lower yields on sovereign securities,” says Eric Dupont, Fitch’s Head of Africa banks.“We expect these pressures to be partially offset by renewed demand for loans in a falling interest rate environment.

Once again resilience will stem from banks solid business profiles, allowing them to generate still very high revenues and absorb credit losses.”Read: Rating agencies and Africa: Why there is bias against the continentThe European Investment Bank says the strong connection between African governments and banks have resulted in the reduction of resources available for financing private investments (crowding out) and exposing the banking sector to sovereign risks at a time of elevated concerns over sovereign debt distress.

African bank holdings of domestic sovereign debt increased sharply to 17.5 percent in 2023 from 10.3 percent in 2010, raising the potential for bank losses in the event of a debt default or restructuring.

At the same time, there is a decreasing trend in banks’ private sector lending to 38 percent in 2023 from 42 percent in 2010, posing concerns about the severity of crowding out.

African banks absorbed a sizeable share of the new issuance of domestic sovereign debt to help governments finance the widening fiscal deficits in the wake of multiple shocks – the Covid-19 pandemic, the cost-of-living crisis stemming from Russia’s invasion of Ukraine, and the global economic slowdown.

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