HIGH BANK PROFITS vs ECONOMIC GROWTH
The recent news that commercial banks in Kenya have achieved a record pre-tax profit of KES 262 billion raises questions about the relationship between bank profits and economic performance. This paradox seems counterintuitive given the challenges faced by the broader economy, including slow growth, high unemployment rates, and increased business closures.
Understanding Bank Profits Amid Economic Challenges
- High Lending Rates:
Banks have benefited from high lending rates, which increase their interest income on loans. This is particularly significant in environments where central banks maintain higher interest rates to control inflation or stabilize currencies.
- Income from Government Securities:
Banks also earn substantial income from investing in government securities such as bonds and treasury bills. These investments provide stable returns with lower risk compared to lending to private businesses.
- Diversified Income Streams:
Many banks have diversified their revenue streams beyond traditional lending activities, including fees for services like transaction processing and investment products. This diversification helps mitigate risks associated with loan defaults.
- Operational Efficiency Improvements:
Some banks have implemented cost-saving measures through digital transformation and operational efficiency improvements, which can enhance profitability even during economic downturns.
The Paradox: High Bank Profits vs. Economic Performance
Inverse Relationship Concerns: While it might seem counterintuitive for banks to report high profits during economic slowdowns, this can occur due to factors like increased reliance on government securities or higher interest margins.
Risk Management Practices: Banks often tighten credit standards during economic downturns to reduce exposure to non-performing loans (NPLs), which can protect profitability but may exacerbate economic challenges by limiting access to credit for businesses.
Economic Indicators: Despite bank profits rising due to specific financial strategies or market conditions, broader economic indicators such as GDP growth rate or unemployment levels may not directly correlate with these profits.
The apparent paradox of rising bank profits amidst a struggling economy stems from strategic financial management practices within the banking sector rather than an inverse relationship between bank performance and overall economic health. However, this situation highlights potential systemic issues where financial institutions might prioritize stability over supporting vulnerable sectors of the economy. So it’s a still a partial indicative factor that an economy is struggling and more people are sustaining their business through increased borrowings rather than from their profits/reserves.
