Banking Crisis in Kenya

April 11, 2016

[vc_row][vc_column width=”2/3″][vc_column_text]The Kenyan banking sector is in turmoil with vicious rumours swirling about the health of many banks and discerning where the truth is sandwiched between various shades of grey is remarkably difficult. It would be remiss to discuss a few banks without looking at the whole industry to begin with, and the macroeconomic environment that they are operating in that has led to the current state of dire illness in some banks. Mariana is a businesswoman. Since 2011, she has been running a small security guarding company, providing guards to small businesses. In 2014, she was encouraged to grow her business using the preferential supplier incentives that the government was providing for women and youth. She bid and successfully won a tender to supply guarding services for a government ministry that had multiple installations that required security. All of a sudden she had to recruit two hundred new guards and purchase uniforms and boots for them. She approached her bank and showed them the government contract against which they provided an overdraft facility for her, using her retired parent’s house as security. In the beginning, the cash was good, Mariana was paid on time and she was able to pay salaries and slowly start reducing the overdraft. But in 2015, her invoices to the Ministry started taking three to four months to be paid, and she increasingly turned to the ballooning overdraft facility to pay her guards’ monthly salaries. Within 3 months she had reached her limit on the facility and the bank was reluctant to increase it. She was desperately in trouble: hundreds of salaries to pay, an overdraft facility to reduce and her parents’ house in jeopardy. Mariana is not alone. This story is replicated hundreds of times at both national and county government level. Small business owners who have provided goods and services to national and county governments but experienced the sharp cash crunch that occurred in 2014 and 2015 which meant that their payments were significantly delayed. Some of these businesses had been responsible, cash was received and ploughed back into the business’s working capital cycle to pay for the goods and purchase more. Some of these businesses were irresponsible, and buoyed by the huge payments in their accounts for the first time in their lives, diverted some cash into non income generating assets like cars and land. Whatever the case, many businesses had used commercial bank loans to fund the sudden expansion caused by a large buyer of their goods and services. The slowdown in government spending has hit these businesses hard, and invariably impacted their ability to repay their loans. This is very apparent in the growth of the non-performing loan book amongst the banks as well as the reduced profitability of most of the banks judging from the 2015 end year financials.

Now let’s take a step back and look at the role of the regulator. That the government had slowed down its spending has not been a secret. The role of a banking regulator is to constantly monitor the financial and operational health of the banks under its watch. Basic economics: a slow down in money supply will cause the economy to contract and for businesses to start exhibiting financial stress. A basic prudent requirement therefore is for a central bank to require their licensees to undertake stress testing of their loan books for a number of reasons, key of which is to determine if the banks are making adequate provisions for the deteriorating loans as well as to establish how much of their loan book is exposed to the key economic metric that is causing the stress, in this case reduced government spending. In so doing, the regulator quickly establishes exactly what percentage of the banking industry’s assets are likely to be of a diminishing quality, what impact that will have on the respective banks’ balance sheets and whether discussions regarding additional capital injection need to be had with bank managements.

Do we have rogue banks? The recent events point to the fact that we do. The existential crisis that is emerging is that the regulator’s banking supervision unit is not on top of its oversight game. But it’s not only the regulator on the spot here. The audit committees of some of these banks have clearly not been holding their internal auditors to account. The internal auditors, who, together with the credit risk teams, are supposed to be regularly reviewing the credit quality of their loan books and have a duty to raise the flag on non-performing loans, or insider loans that do not have the appropriate documentation and requisite securities against which banks have recourse in the event of default. Some clever institutions know exactly how to manipulate the bank system so as not to reflect the poor servicing of bad loans at month end. They also know how to suppress non-performing loans by keeping them as overdrafts whose deteriorating quality is difficult to discern, as there are no monthly amortization repayments that would indicate non-serviceability. Section 769 of the new Companies Act 2015 requires shareholders of quoted companies to appoint members of the audit committee. The mischief that this is supposed to cure is to ensure that the shareholders take ownership of who is providing appropriate governance over the books of the company. Shareholders must ensure that the audit committee members are not only financially literate individuals, but, in the case of quoted banks, at least one should have some commercial banking operational experience and therefore know how to identify where dead bodies are being buried. The Central Bank prudential guidelines require bank audit committees to be chaired by independent non-executive directors. What is becoming crystal clear is that the oversight capacity of these audit committees is seriously wanting as there seems to be a lack of knowledge on how internal systems can be manipulated to hide bad loans. Nobody is blameless in this crisis at both regulator and board director level.
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Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

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Carol Musyoka Consulting Limited,
A5 Argwings Court,
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P.O Box 6471-00200
Nairobi, Kenya.
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Email: [email protected]

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