Behind the inexorable decline of banks’ profitability

• Return of Equity almost flat between 2015 and 2020
• Profitability of big banks declined from 57.6% in 2008 to 17.5% in 2020

Banks make profits through various charges such as service fees, commissions for transactions and earnings from the net interest margin.

While Botswana’s banking sector has grown tremendously over the years, with total assets of commercial banks growing from P45.9 billion in 2008 to P107.7 billion in 2021, on the other hand, the industry has seen its profitability take a nosedive. These are the points raised by Econsult in its analysis of the banking industry in its economic review for the second quarter of the year. The think tank has observed that the sector’s profitability has declined extremely since the 2008 Global Financial Crisis (GFC).

Profitability has reportedly fell from 51.6 percent during the GFC to 16.1 percent in 2020. The decrease is attributable to the fall in bank profits (interest income and other incomes), in part due to a general decline in interest rates, coupled with higher expenses as banks had to make provisions for bad debts,” says Econsult in its report compiled by Sethunya Kegakgametse and Kitso Mokhurutshi. Return of Equity – a key component used to measure profitability either before or after tax – is said to have been almost flat between 2015 and 2020 when measured after tax.

“This is consistent with the level of credit growth during the period, which has been subdued, perhaps reflecting a lack of profitable lending opportunities combined with concerns about credit risk,” the two wrote. The report also states that in the previous years, banks’ profits and earnings were on a downward trend and it was important for banks to be cautious to meet prudential capital adequacy requirements and contribute to financial stability. Another factor attributed to a decrease in bank profitability over the years is the fall in profitability of the big banks.

It has been observed that larger banks recorded low returns after the financial crisis while smaller banks posted higher returns after the same period. For the four big commercial banks (FNBB, Absa, Stanbic and Standard Chartered), profitability declined from 57.6 percent in 2008 to 17.5 percent in 2020. Among those considered big banks, Standard Chartered is reported to have struggled the most with deteriorating profitability. “Its profitability declined from 88.6 percent in 2008 to 26.6 percent in 2014, and fell further to 4.6 percent in 2015, and recorded a loss in 2017 due higher operating expenses.”

The bank was, however, able to bounce back in the years that followed, with profitability of 4.7 percent in 2020. Even though those that fall in the smaller category are reported to be less profitable, profitability has nevertheless increased marginally between 2008 and 2020, from 8.1 percent to 10.7 percent. “This suggests that economies of scale may not be the only factor driving profitability,” says the Econsult report. “Smaller banks can still be profitable if they can secure a niche in the industry.”

It further highlights that it appears smaller banks have been doing well in attracting customer deposits. This is because during the same period, customer deposits for the smaller banks increased at a faster rate than customer deposits for the larger banks. Still in the same period, customer deposits from smaller banks grew at an average of 16.8 percent, whereas for the bigger banks, customer deposits grew at an average of 5.5 percent, this was between 2008 and 2020.