OREANDA-NEWS. The consolidation that will inevitably follow increased capital requirements from end-2018 will benefit Kenyan banks' credit profiles because it would strengthen their franchises, says Fitch Ratings. The highly fragmented sector is unable to service the financing needs of some major infrastructure projects. Capital requirements will rise fivefold to KES5bn (about USD50m).

Forty-three commercial banks operate in Kenya, a country of 44 million people, compared with Nigeria's 22 for around 180 million inhabitants and South Africa's 19 for 55 million. In addition, concentration is fairly high, with the country's top eight banks holding about 60% of the market. Foreign-owned banks are prominent among the largest institutions, but even these tend to be small by international standards.

Roughly half of Kenyan banks have less than KES5bn of equity and will need to strengthen capital. We believe mergers and acquisitions will be the preferred route for consolidation as market leaders, such as Kenya Commercial Bank and Equity Bank, seek to further boost their franchises. Raising substantial new capital in the country's equity markets may prove more difficult. We expect foreign investors' appetite for emerging-market risk to reduce once interest rates begin to rise in the US. The small size of some of the banks will also be an obstacle to attracting new investors.

Kenya's banks have healthy profitability, reporting a return on average assets of around 3%. But the fairly short timeframe for meeting new capital requirements means we think they are unlikely to rely on retained earnings alone to boost capital.

The leading banks have reasonable financial metrics despite the operating environment. Prudential Tier 1 capital ratios reported by the sector are around 18%, providing a reasonable buffer to absorb unexpected credit losses. Impaired loans represent around 6% of total sector loans, around 55% reserved, but Kenya's volatile economic and financial trends can force banks to make sharp increases in loan loss provisions during times of heightened stress.