* Q1 pretax profit down 5 pct to 6.9 bln shillings
* Kenya profit down 12 pct as rate cap bites
* Equity increases holdings in government securities (Adds details, background, quotes)
By George Obulutsa
NAIROBI, May 25 (Reuters) - Kenya's Equity Group Holdings posted a drop in first-quarter pretax profit on Thursday due to the country's cap on lending rates, and said it had lifted its holdings in government securities to try to offset the impact on interest income.
Chief Executive James Mwangi said the bank was also looking to increase its cash reserves. "Equity has chosen to trade off profitability with liquidity. Cash is king when it comes to uncertainty," he told an investor briefing.
Kenya's government capped lending rates last September at 4 percentage points above the central bank rate, saying they were too high and banks had failed to lower them repeatedly.
Equity, the country's second largest bank by assets, said first-quarter pretax profit fell 5 percent year-on-year to 6.9 billion shillings ($66.9 million).
Its loan book shrank 5 percent, and profit in Kenya was down 12 percent. Equity also operates in Tanzania, Uganda, Rwanda, South Sudan and the Democratic Republic of the Congo.
Mwangi said the bank had increased its holdings in government securities, mostly Kenyan, by 81 percent to 113 billion shillings in the quarter, because their yields were on a par with customer rates, which are capped at 14 percent.
The cap had made it difficult for lenders to calculate risk when lending to customers, especially small borrowers who are deemed more risky.
"A cautious approach in credit underwriting because of inability to price risk saw the loan book decline by 5 percent," Mwangi said.
The drop in loans was offset by a jump in income from activities such as foreign exchange trading, which rose by a billion shillings to 6.3 billion.
Non-performing loans nearly doubled to 7.1 percent of the total, Mwangi said, but remained below the industry average of 9.7 percent.
$1 = 103.2500 Kenyan shillings Reporting by George Obulutsa; Editing by Mark Potter