Co-operative Bank of Kenya (COOP) announced last week but one that they were hiring global consulting firm, McKinsey & Company, for advice on improving operational efficiency. Investors took notice. Cooperative bank's shares have risen by over 10% in the last two weeks, from KES 19.35 as the close of markets on September 18th, 2014 to KES 21.50 as at 12.30 pm today. Ryan Hoover an investment analyst with Africa Capital Group explains why.

What is causing the excitement among investors? How much scope does Cooperative Bank (COOP) — Kenya’s fifth-largest bank in terms of market capitalization — have to streamline its operations? And how might such restructuring impact the profits?

First, it’s important to note that COOP isn’t the only Kenyan bank to call in McKinsey. Last August, Equity Bank (EQTY) also revealed that it had asked McKinsey to advise it on strategy. Moreover, in 2011, KCB Bank Group (KCB) brought them in to assist with a restructuring that eventually slashed the bank’s management payroll by 42%.

To get a sense of what they might be able to do for COOP, let’s take a look at how well Kenyan banks presently manage the cost of doing business.

The chart below shows each Kenyan bank’s cost-to-income ratio over the first six months of 2014. We calculate the cost-to-income ratio by dividing total operating expenses by total operating income.

Kenya’s Most Efficient Listed Banks

COOP bank keeps less than 42 shillings as pre-tax income for every 100 shillings it generates in the form of net interest income and fees. Meanwhile I&M Holdings (IMH) keeps nearly 61 shillings for each 100 shillings of operating income.

If COOP could cut its cost-to-income ratio to 50% (a level that would make it fifth in the list above), it would result in a 20.1% boost to pre-tax profit.

But how realistic is it to expect such a reduction in expenses?

Salary Costs at Kenyan Banks

For most banks, the biggest cost of doing business (apart from interest expense) is staff compensation. Thus, this is what McKinsey will likely try to slash first.

 

As you can see, COOP’s wage bill isn’t as large as that of National Bank of Kenya (NBK), but it’s not exactly slim either. The leanest banks on the list reap more than five shillings of operating income for every one shilling they pay out in the form of salaries. COOP gets just four shillings.

If McKinsey can help COOP bring staff costs down to 20% of operating income, downsizing alone could boost pre-tax earnings by nearly 12%.

This will doubtless mean hardship for some of Cooperative Bank of Kenya’s 4,177 employees, but it will also give the bank more flexibility to lower its lending rates, putting growth capital within reach of more Kenyan households and businesses.

Later this October, Kenyan banks will start releasing their third quarter results. It is expected that investor increase in the banking sector on the NSE will increase in anticipation of these results. As at 11.00 am today, banks  constituted three of the top five most traded shares. Other multinational non-listed banks such as Ecobank are looking to increase their presence in Kenya. The increased competition in the sector should make the above case of Co-operative bank, a worthy investment consideration.

Part of the article is sourced from investinginafrica.net, you can read the full article here