CMA Cracks The Whip On Directors

In an August 3rd 2022 press release riddled with punctuation and grammatical errors, the Capital Markets Authority (CMA) dropped a bomb-shell into Kenya’s very white collar board rooms. If you sit on the audit committee of an issuer of securities licensed by the CMA, you either need to track uses of funds that your company has raised from the capital markets or keep Johnny walking into deep trouble.  So what happened? Back in 2015 Chase Bank Limited sought approval from the CMA to issue a Kes 10 billion medium term note (MTN) to the public.

The first tranche of Kes 4.8 billion was issued on 22nd June 2015. Nine and a half months later, the Central Bank of Kenya placed Chase Bank under receivership on April 7th 2016. As a regulator, the CMA had to step in to take action in order to assure buyers of CMA licensed securities that someone somewhere is keeping a keen eye over issuers who have taken funds from an insider information starved public. Having found issues of preparation of false and misleading financial statements, failure to disclose material information as well as conflict of interest, the CMA issued Notice To Show Causes to 12 recipients who were members of Chase Bank’s senior management, some members of the bank’s board of directors and the reporting auditor. The press release then informs us that enforcement proceedings went ahead against 9 of the 12 recipients as 3 others chose to go to court to stop the enforcement action.

In a piece of communication that the CMA must have known would be poured over, torn apart and put together, the reader is left with some questions. From a management perspective, the group managing director, the group finance director and the bank’s chief executive officer were penalized. From a board member perspective, the chairman of the audit and risk committee and three of his committee members were penalized.  One other board member (not quoted as being a member of the audit committee) was penalized, but the press release does not indicate why he was singled out from the rest of the unpenalized board. Furthermore, as part of his penance, the chairman of the audit and risk committee is required to attend a corporate governance training for a period of not less than five days. Why he was specifically singled out as the only one who needs to be chased into the stable whose director responsibility horse has already bolted remains a mystery.

Towards the end of the press release, the CMA throws the reader an informative crumb: “After the conclusion of  the administrative hearings, the Ad Hoc Committee determined that there was lack of effective oversight on the part of the CBKL board regarding use of funds raised pursuant to issuance of MTN (sic) in 2015. The approved and published Information Memorandum (IM) dated April 22, 2015 provided that the MTN proceeds would be used for expansion of the branch network, strengthening capital base to support growth, investment into IT and product development initiatives and supporting onward lending activities. Ends”

So readers are to connect the dots on this closing statement and glean their own conclusion on what happened. After all, regulators take actions in order to send strong messages to boards and managements of licensed institutions. Nature and communication abhor a vacuum so we must fill it ourselves. Thus I’ll shoot my own interpretative shot here: Firstly, it can be assumed that funds raised in the MTN were not utilized for what they were ostensibly raised for and found their way into inappropriate uses. Secondly, the gatekeeper or the watchdog over those funds was the bank’s board and they didn’t do their job over the same time it takes from conception to birth of a human baby. Thirdly, the regulator went even more granular and said not only was it the board, but it was the audit and risk committee of the board that had the specific responsibility to keep watch. Fourthly, there’s one board member out there who was not an audit committee member but the regulator felt he should be fingered anyway. Why, we don’t know and the lesson here is therefore lost. What is now clear is why the CMA governance code requires shareholders to specifically vote for audit committee members at every annual general meeting. So that shareholders know who is keeping specific watch over the organization and to give them an express endorsement to take on that role.

This enforcement action should rightly cause a shudder to run along the unprotected backs of audit committee members. They have to oversee a company’s operations and ask the hard questions about the things that they don’t see. But it goes a little bit further than that as even board members must ask themselves if they have the right people sitting in the audit committee. Responsibility cannot be delegated because when the chips are down, everyone is in the reputational trenches.

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Twitter: @carolmusyoka

Open Data Open Innovation

[vc_row][vc_column width=”2/3″][vc_column_text]I had an interesting lunch with a Tweep the other day, an indefatigable mobile Wikipedia on technology trends both locally and globally. Our conversation turned to open data and how it can be applied in the banking industry. I have to admit I had heard of the term open data but never really paid any attention to its potentially game changing application in the financial industry. “If Kenyan banks converted their records into open data, it would lead to greater financial innovation and a better product experience for customers,” said the tech pundit. I put on my fairly ignorant and thoroughly obtuse nitpicking hat on. “Banks cannot share such sensitive data, there’s customer confidentiality to be maintained and quite frankly, such information is a key intangible asset that the bank has,” I retorted. He proved to be quite unflappable and converted my healthy skepticism into acquiescence with just one question: who said that the data provided should be given with the client name?
I was an immediate convert. If banks openly shared customer data to fintech providers, the third party would have a treasure trove of information on customer spending habits, borrowing tendencies, repayment history, saving culture and basically the whole kit and caboodle of a client’s behavior. According to the Central Bank of Kenya’s latest annual banking supervision report, for the year ending December 2015, there were about 34.6 million banking accounts in Kenya and these numbers include mobile banking accounts of the Mshwari and KCB M-pesa extraction. That is 34.6 million data sets that can clearly demonstrate spending, borrowing and savings behavior within a certain age, gender, regional demographicor business segment, which can lead to finer product targeting and pricing.
The United Kingdom (UK) is a trailblazer in this area and in January 2015, Her Majesty’s Treasury launched a “call to evidence” asking stakeholders in the financial industry on how best to deliver an open standard for application programming interfaces (APIs) in UK banking and to ask whether more open data in banking could benefit consumers.
Application programming interfaces, or APIs, allow two pieces of software to interact with each other. In banking, APIs can be used to enable financial technology (fintech) firms to make use of customers’ bank data on their behalf and with their permission in innovative and helpful ways. For instance mpesa payment platforms for businesses make use of APIs supported by Safaricom.
The aim was to produce an open API standard for UK banks to drive more competition in banking and help the UK remain at the forefront of financial technology. The report was published less than 3 short months later in March 2015.
In summary the responses from the forty respondents who included a number of banks, fintechs, the Law Society of Scotland, the Association of Accounting Technicians and the British Banking Association raised concerns around privacy of customer data and fraudulent use of that data. The need for appropriate security and vetting systems for third party providers was a key concern. The respondents did note that open data in banking would enable customers make more informed decisions on which banking products to purchase and who to bank with. An Open Banking Working Group, bringing together key stakeholders such as banks, fintechs, consumer bodies and government, was then created and an Open Banking Standard (OBS) was produced. The OBS is a guide for how banking data should be created, shared and used.The group recommended that an independent authority should be established to ensure standards and obligations between participants are upheld. The authority would govern how data is secured once shared and the security, usability, reliability and scalability of APIs. It would also vet third parties, accredit solutions and maintain a whitelist of approved firms. The UK is cautiously but steadily moving towards this standard, with the key premise being that customers will have to consent to their data being shared.
Back in the +254, we have already established ourselves as early adopters in the fintech space with the amazing innovations that have been generated by the mpesa phenomena. Moving towards open data may perhaps be the key that will unlock the risk based customer loan pricing that the interest rate capping has miserably failed to deliver. It would also provide much needed customer portability on banking services generated by product pricing sense rather than brand affinity.

[email protected]: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

Kenyans are savers not gamblers

Last week, my General Manager Domestic Affairs(aka GMDA) decided to change her bank provider. GMDA came home that evening gushing praises about how the new Bank X had told her that she could set aside Kshs 1,000 every month to save for school fees and it would be automatically deducted from her salary account. No bank had ever taken an interest in her life, or in providing her with an automated way of saving for this critical aspect of her children’s security

As GMDA was talking, a news item appeared on the television about the uptake of the M-Akiba bond. I turned up the volume, as this could potentially be an option I could provide to my the-savings-scales-have-fallen-from-my-eyes GMDA.

The product is beautiful in its simplicity. Dial a number, register, place Kshs 3,000 for 3 years and earn tax -free interest twice a year. In my view, someone in Serikal is finally using data the way it’s supposed to be done: not to gather dust in shelves at the bureau of statistics but to drive behavior and economic growth. And nowhere is there more rich data than in the Financial Access Household Survey issued February 2016 by FSD Kenya working in collaboration with the Central Bank of Kenya and the Kenya National Bureau of Statistics.

The report finds that 75.3% of Kenyans are now formally included, with the giant leap being taken by women where formal inclusion leapt between 2009 and 2013 driven by the spread of mobile financial services.Formally inclusion is defined as use of banks, mobile financial services, SACCOs and microfinance institutions. Why would there be such a quantum leap in the growth of women users? I daresay that the convenience and the absolute privacy that mobile financial services provide make it a key attraction for the women. Not having to make a trip into a commercial centre to deposit or withdraw from a bank and not having a debit card or statement lying around that can generate heated arguments as to “hidden resources” is a major draw.

While the FSD report doesn’t go into the abominable aspects of betting, it does delve into it’s divine counterparty: savings. The FSD report finds that the number of Kenyans using at least one savings or deposit instrument continues to rise and at least 66.4% of the adults sampled have a savings instrument. Almost half of those adults use savings for meeting ordinary day-to-day needs, a third save for education and 40% also save for medical emergencies and burial expenses.

One more critical finding: 42.6% of business owners and 87.7% of farmers rely heavily on their savings to finance their livelihoods.

It is on the back of this data that we should critically look at the potential of M-Akiba to provide a viable savings platform. M-Akiba has the potential to pull funds sitting tied in a knot in the corner of a leso or under the cooking hearth into the formal economy especially since the FSD report finds that the top two most valued storage places for Kenyans are their mobile financial services accounts and saving in a secret place!

Meanwhile, I tried registering for M-Akiba, so that I could sell it to GMDA. After jumping through several hoops, I ended up feeling like a hamster on a wheel so I jumped off. I called the number provided online and a lovely lady called Brenda answered on the third ring, telling me the system was experience downtime. By the time of submitting this piece it wasn’t yet up. I trust that the developers of M-Akiba will make this an iterative product, tweaking it as they get more and more customer usage data to determine how and why Kenyans are using it. Just like how M-Pesa was launched as a money transfer system but ended up being a virtual repository of cash, M-Akiba might not be used for what its creators envisaged it for. Customers use your product to do a job. Time will tell what the true job of M-Akiba will be, but the ultimate winner will be the government with a new, and far less interest rate demanding investor in its securities.

Mpesa is a key economic engine

I have a little farm on the sweeping eastern Laikipia plains that has me visiting at least once a month. The singular cause of blinding migraines for the many telephone farmers is farm worker fraud. Those fellows will find a way to skim money, farm inputs or farm outputs at any given opportunity and trust me, as soon as you plug one leak they’re ten steps ahead of you preparing for the next scam. So one has to, as a telephone farmer, accept a certain level of pilferage as part of the business-as-usual operations, or opting to move and reside permanently in the farm. Irritated and exhausted by one certain input request, I set up a system that didn’t require the farm worker’s intervention. I got a trustworthy boda boda operator in Nanyuki (where trustworthy is a fairly fluid virtue) to be purchasing the input on my behalf. But I don’t send him the cash. He goes to the outlet, sends me the “Lipa Na Mpesa” till number where I pay and he takes the goods together with an electronic receipt to the farm. I specifically chose the outlet for those two reasons: they have an mpesa till number and they issue electronic receipts. I then pay him, using mpesa, for delivery of the goods and have peace of mind, knowing full well that another scheme is likely being hatched at the farm since I blocked what had been a lucrative cash cow for the workers before.

Two things that are critical to the urban telephone farmer: a local boda boda “guy” and mpesa. While I don’t have any data on the impact that boda bodas have had on the transport economy – which must be undeniably high – more data on mpesa is readily available. In the latest published Safaricom financials for the half year ended 30th September 2016, the company had 26.6 million registered customers out of which 24.8 million or 93% were mpesa customers. However, a more accurate number is yielded by looking at the 30-day active customers which registered as 23 million, with 17.6 million active mpesa customers or 76.5% of total active customers. Safaricom made more money from mpesa at Kshs 25.9 billion than it did from mobile data, which generated Kshs 13.4 billion. Mpesa revenue was equivalent to 43.3% of the voice revenue data of Kshs 45.7 billion. In simple words, mobile money is no bread and butter; it’s the cream with a cherry on top!

What were these mpesa customers doing, you ask? Well telephone farmers like me were a piddly fraction of the mpesa volumes. Three quarters of the total Kshs 25.9 billion in revenue that Safaricom received from mpesa was from what they call “bread and butter” business, which are the person-to-person transfers and withdrawals: John sends Mary a thousand shillings, who promptly goes to an agent to withdraw the same in cash and purchase food items for the house. Telephone farmers like me are to be found in what Safaricom calls “new business” which accounts for 24% of their mpesa revenue or about Kshs 6.2 billion.
New business includes customer to business (individuals paying for services using mpesa), business to customer (businesses sending money to individuals for example Kenya Tea Development Agency paying farmers their tea bonuses), Business to Business (Distributors paying a manufacturer for goods delivered) and the rapidly expanding Lipa Na Mpesa that has saved many urban dwellers the pain of having to send cash to purchase items via fundis, rogue relatives and even more rogue workers. But mpesa revenue aside, it is the sheer transaction volumes that are simply eye watering. By September 2016, mpesa had transacted Kshs 3.2 trillion. Kenya’s Gross Domestic Product or GDP, according to World Bank figures is US $ 63.4 billion or Kshs 6.34 trillion. The mpesa volumes are virtually 50% of Kenya’s GDP. However, hang on to your hat please as there is some double counting in the mpesa transaction volumes since they include deposits, withdrawals, person-to-person transfers and the business volumes. The bigger question is whether mpesa then poses a systemic risk in the event it is out of commission for whatever reason.

Firstly, mpesa is a methodology of transferring cash virtually. The actual cash sits in various mpesa trust accounts in Kenyan commercial banks. The bigger concern is not whether one’s funds are safe if mpesa goes down, it’s how to access a system that will release those funds which are sitting safely in a bank. Central Bank data from 2014 demonstrates that while mobile money volumes are extremely high at 66.5% or two thirds of the national payment system, they only account for 6.6% of the throughput value. It’s definitely a case of more bark than bite where systemic risk proponents are concerned.

But having said that, the attraction to track the mpesa movements from a tax collection perspective goes without saying. Even though the values may be low, mpesa provides an excellent opportunity for the taxman to bring in smaller businesses into the taxpayer net as each transaction has an electronic signature and trail. Designing and applying resources to create that tracking framework may perhaps be where the challenge lies.

That mpesa has changed lives goes without saying. We live in a country where one can literally take a trip from Mombasa to Malaba carrying zero cash, zero plastic card and with just her phone be able to eat, drink and seek lodging for that entire trip. The growth of the Lipa Na Mpesa payment points was 73% year on year in the half-year 2016 Safaricom financials. This means that there is rapid uptake by commercial establishments of the mpesa payment option, which quite honestly presents a better cash flow option than credit cards as there is no lag time between customer transactions and when the funds are deposited into the business account (typically 2-3 days in the case of credit cards).

Mpesa’s metamorphosis is not inclined to stop here and a banking licence may end up being required at the rate mpesa is transforming.

Imperial Audit: 42 Billion Reasons Why Directors Should Be Cautious

[vc_row][vc_column width=”2/3″][vc_column_text]A pilot was welcoming passengers to the flight shortly after take off. “Thank you for flying with us this morning. The weather is…..” He broke off his welcome with a sharp scream followed by, ”Oh my God, this is going to really hurt. It’s burning.” There was complete radio silence for a full minute before he returned. “Ladies and gentlemen I sincerely apologize for that incident, as I dropped a very hot cup of coffee on my lap. You should see the front of my trousers!” Out of the back came a worried shout from a passenger, “If you think yours are bad, you should see the back of mine.”

The Imperial Bank forensic report is out and any bank director, actually scratch that, any director of a Kenyan company should be having severe indigestion right about now. Following its findings, the Central Bank (CBK), the Kenya Deposit Insurance Corporation (KDIC) and the bank in receivership have sued nine individuals, one deceased person’s estate and eight companies in a bid to recover Kshs 42.4 billion of the banks assets and deposits. Yes, the figure is simply eye watering by its sheer size. This civil suit represents a watershed moment for corporate governance in Kenya. With the exception of three independent non-executive directors (INEDs), the other seven individuals (including the deceased) were directors representing the eight companies that were shareholders in the bank.

While the individuals are being sued for breach of fiduciary duty – a basic tenet of corporate governance – the companies therein named are being sued as being beneficiaries of what may come to be Kenya’s single largest corporate fraud since the 19th century explorer Henry Morton Stanley stepped off a boat onto Kenyan shores.
Over the period of ten years from 2006 to 2016, the bank was found to have operated two banking systems, with the illegitimate system passing through over billions of shillings in fraudulent disbursements over that period. The non-executive directors, including the chairman, were tightly joined at the hip and had cross shareholding in various other companies some of which were property related. In view of the fact that this was starting to look like a brotherhood of veritable kleptomaniacs, the three INEDs who joined in quick succession- two who joined on 1st of July 2014 and one on 1st February 2015- may not have been on the board long enough to cotton on what was, and had been, going on for the previous nine years. But today they are jointly and severally liable for years of mismanagement. These chaps were probably pleased as punch to have made it to the board at all and may have been snookered by the fast talking CEO, whose verbosity is alleged to have steamrolled various discussions on the board audit committee which he regularly attended. Now the three INEDs have to get lumped with the other directors all of whom have been painted with a mouthful of accusations over and above breach of fiduciary duty including negligence, gross negligence, fraud and theft.

One could very well argue then, that banks owe a duty of care to their directors to provide rigorous training in both corporate governance and risk management. There are now 42.4 billion reasons why bank directors need to know what they are signing up for. Actually, I could kick it up a notch and say that the CBK should require a made-for-purpose bank director training that one must undertake before they sign off on those ‘Fit and Proper Forms’ that are required for any bank director and senior officer before appointment to the board.
Yet the CBK is not entirely blameless in this mess, as all this happened on their watch. The regulator cannot claim that it relied on audited accounts to arrive at their conclusions for renewal of licenses. There were glaring irregularities in the governance such as the Board Executive Committee undertaking the role of the Board Credit Committee (BCC) without the proper structures in place including having an INED chair the BCC as per Prudential Guidelines. There were allegedly no notices for or minutes of meetings for a BCC from as far back as 2006. Someone was asleep at the wheel over at the banking supervision unit. The lack of INEDs until February 2014 should also have raised a slap on the wrist from the regulator. But it doesn’t appear to have. The only redemption here is that the regulator eventually stepped in, and quite likely because there was a new sheriff in that town.

Whether that amount of money is feasibly recoverable is something for the courts to determine. And directors should not try and draw comfort that they can ask the companies whose board they sit on to put in indemnification provisions in the articles of association or in their appointment letters. Section 194 of the Companies Act 2015 specifically voids any provisions that a company may make to exempt directors from any liability that attaches from negligence, default, breach of duty or breach of trust. However, companies are permitted to purchase Director and Officer (D&O) Liability Insurance to provide that specific indemnity from negligence etc. But there’s a catch. The same Companies Act does not allow D&O cover to provide indemnity (i) against fines from criminal proceedings, (ii) fines from regulators for non-compliance, (iii) defense of criminal proceedings and, finally, (iv) defense of civil proceedings brought by the company itself in which judgment is given against the director.

Therefore even if the Imperial directors had D&O cover, such cover busts two out of the four prohibitions above, viz (ii) and (iv) since the company is the plaintiff in the civil suit.

What’s the moral of this sordid story? Being a director of any company is risky business. Being a director on a board full of business buddies is even murkier business, the kind that requires one to keep a set of adult diapers on hand as they undertake the flight of their lives.
[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

A Short History of Banking in Kenya

[vc_row][vc_column width=”2/3″][vc_column_text]A lobbyist on his way home from Parliament after a Parliamentary Enquiry into Trading Practices by Britain’s leading bank executives is stuck in traffic. Several of the former Bank Executives and CEO’s have agreed to return their extravagant Pensions. Noticing a police officer, he winds down his window and asks: “What’s the hold up Officer?” The policeman replies: “The Chief Executive of the U.K.’s largest Bank has become so depressed he’s stopped his motorcade and is threatening to douse himself with petrol and set himself on fire because of the shame of what he has done.”
“Myself and all the other motorcade police officers are taking up a collection because we feel sorry for him.” The lobbyist asks: “How much have you got so far?” The Officer replies: “About 40 litres, but a lot of officers are still siphoning.”

It’s not that hard to find bad banker jokes these days, they are the most vilified professionals after tax collectors. But malign them as we will, the banking industry has been a key driver of the economy through provision of working capital facilities for businesses, unsecured loans for individuals and employment for many Kenyans, not to mention a safe place to keep our funds. The attached table demonstrates the phenomenal growth that has taken place in banking in the last thirteen years.

Kes Millions Dec 2002 Dec 2015
Government Securities 100,458 658,361
Net Advances 172,169 2,091,361
Deposits 360,642 2,485,920
Shareholder Funds 50,540 538,144
Interest Income 41,495 359,493
Non Interest Income 17,367 97,317

*Source: Central Bank of Kenya Banking Supervision Report 2002 and 2015

It’s evident that there has been exponential growth in banking, all driven by Kenyans contributing to economic growth and generating more capital. Deposits have grown by a factor of almost 7 while loans have grown by a factor of 12. Look at what the Central Bank (CBK) said in 2002 while reporting about the state of the industry: “Traditionally institutions in the local market have relied on interest income on loans and government securities as their major source of income. In the last few years, there has been a shift to government securities owing to lack of borrowers due to the depressed state of the economy. In the last one-year, the Treasury bill rates have been falling dramatically, thus compelling institutions to look for alternative sources of income to meet their operational costs and report profits for their shareholders. Some of these sources, especially increased fees and commissions have placed them on a collision course with the public. In an attempt to reduce their costs, some institutions have initiated restructuring programs that include staff retrenchment and rationalisation of their branch network. These measures have met resistance from the general public and trade unions.” A few years later CBK legislated that banks required their approval before introducing new fees in a bid to reduce the collision course so identified.
The result is that as the economy took an upswing following the Kibaki administration’s fairly successful macroeconomic policies, loans ended up being an easier way to grow the bottom line. In 2002, interest income of Kes 41.5 billion (which includes interest from loans, government securities and placement of funds with other institutions) made up 70% of the banking industry’s income. In 2015, the interest income of Kes 359.5 billion made up 78.7% of the banking industry’s income. Put it another way, innovation has been the furthest thing on the minds of bankers over the last decade. With the requirement to seek approval for new fees as well as the voracious appetite for loans, lending in this country has been a no-brainer for years.
But Kenyan banks are also responsible for a fairly broad financial access, at least compared to its neighbors. The CBK Banking Supervision Report 2015 reports as much by quoting a joint study with FSD Kenya and the World Bank titled “Bank Financing of SMEs in Kenya” that was published in September 2015: “A) Involvement of Kenyan banks in the SME segment has grown between 2009 and 2013. The total SME lending portfolio in December 2013 was estimated at KSh. 332 billion representing 23.4 % of the banks’ total loan portfolio while in 2009, this figure stood at Ksh. 133 billion representing 19.5% of the total loan portfolio.
B) The preferred source of financing for a large number of SMEs is overdrafts despite the fact that banks have introduced several trade finance and asset finance products designed for the SME market. C) The share of SME lending relative to total lending by commercial banks is higher in Kenya (23.4%) compared to other major markets in Sub Saharan Africa like Nigeria (5%) and South Africa (8%). According to a study quoted in the report, this ratio is at 17% in Rwanda and 14% in Tanzania placing Kenya as the leading country among the five countries referred to in the study.”
SMEs are the cogs that move the wheels of this and many emerging market economies. They cannot survive without bank funding and the interest rate regime change is very likely to upset the status quo and roll back the gains made by Kenya in deepening financial access to this critical sector of the economy. This is largely because SME lending has typically been collateralized to mitigate the risks. A reduction in the interest rate without a reduction in the corresponding credit risk of the SME borrower, together with no improvement in the legal framework for realizing collateral from defaulted borrowers is a recipe for reduced SME lending appetite.
However as a bank CEO said to me a few days ago, “I asked my staff today: is there no other way to make money apart from loans?” and all he got were blank stares in return. The ground is shifting under the feet of banks, not only legislatively but even technologically with the entry of Fintechs in the same lending space that banks have traditionally played in. We might very well be standing on the cusp of a financial innovation wave in Kenya.
[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

The Unintended Consequences Of The Banking Amendment Act 2015

[vc_row][vc_column width=”2/3″][vc_column_text]Wednesday, August 24th 2016 will go down in history as the day Kenyans collectively chose to wet their whistles prematurely, in celebration of the Presidential assent of the Banking Bill (Amendment) 2015. But who can blame their souls that were weary from years of punitive interest rates in a regime where demand for credit by far outstripped supply?

Let me begin from the beginning. Banks take your deposits and in turn lend these out to borrowers who range from individuals borrowing unsecured loans on the back of a salary check off program, to small, medium and large businesses borrowing to finance their working capital needs or capital expenditure purchases, and who secure these facilities with a piece of property or equipment. But the Central Bank of Kenya (CBK), like any good regulator who wants to protect depositors, sets out the amount of capital that the shareholders of the bank need to maintain, in order to lend to these various types of borrowers with varied risk levels. The requirement for capital is literally to ensure that banks have “skin in the game” effectively causing banks to exercise caution in lending out customer deposits (which then become assets on the bank’s books) to entities that have demonstrated the ability to repay.

So the next time you throw a cursory glance at your bank’s financial statements, cross over to the bottom, a fairly innocuous section called “Other Disclosures” and particularly the section titled “Capital Strength”. This, good people, is where the rubber meets the road. There’s one line, usually section (f) titled Total Risk Weighted Assets. CBK requires banks to allocate capital to all the assets on their books. But different assets attract different amounts of capital. So, for instance loans to the central government via treasury bills and bonds attract a zero capital charge. The same applies to loans guaranteed by the central government as well as OECD governments. If the regular borrower, Wanjiku, also wants to give 100% cash collateral for her loan, that attracts a zero charge as well.

By the way I’m quoting from the CBK Prudential Guidelines, a document whose detail is so technical that it is recommended reading for anyone having trouble falling asleep at night. The flip side is painful: lending to anyone else – be they an individual who’s provided their Sunday best clothes as security or a corporate whose provided a prime Mombasa road property as collateral – attracts 100% capital charge. So a bank has to allocate 100% of its capital (on a weight adjusted basis) which as you know is a finite and fairly expensive resource, for your loan. It may interest you to know that mortgages which are well secured and performing only attract a 50% capital charge. Why you ask? Shelter features fairly high under Maslow’s hierarchy of needs, therefore risk of default is much lower.

Because of how much capital a bank has allocate to a loan, it’s much easier to simply place deposits in government paper. But low risk means low returns and banks have therefore taken the fairly lucrative business of lending to individuals, SMEs and corporates which are higher risk, require higher capital charges but which capital charges are resoundingly compensated by high interest returns.

However, let’s call a spade a spade. Banks in Kenya have been smug and lazy. Since demand outstrips supply, they have chosen to treat all borrowers the same. Wanjiku who has borrowed 20 loans in the last thirty years, servicing all of them well without a single default, is charged the same 19% rate as Paul, who just got his first job at a government parastatal and can use his payslip to get a check off loan to buy furniture for his new apartment. The insurance industry is willing to give Wanjiku a no-claims bonus, which is a reduction on her annual insurance policy for her car as a reward for not having any accidents in the past year. But the banking industry wants to treat Wanjiku as if her good repayment record doesn’t deserve a reward. The reduction in interest rates will force banks to do one of two things: move out of higher risk rated assets as the returns will not be commensurate with the capital charge and secondly, begin to provide much needed granularity in the way they have chosen who to lend to based on positive credit reference bureau ratings. I’ve beaten that granularity drum before, but I’m not about to get tired. Good borrowers do not warrant the high interest rates that are currently being charged to cover (lazy) banks from bad borrowers. Enough said.

In these dying column minutes let me draw your attention to one thing: the Banking (Amendment) Bill 2015 was horrendously drafted and has as many holes as my grandmother’s favorite crochet table cover. Section 33B (1) and (2) refer to a base rate set by Central Bank of Kenya. The media is using the Central Bank Rate which is a rate used by CBK to loan to banks and is NOT a base rate for lending to the public. Of course this can be cured when the CBK publishes the regulations required to operationalize the Act, by creating such a base rate which can be set wherever CBK feels is the right point including aligning it to the Kenya Bankers Reference Rate. Secondly, Section 33B (2) refers to “minimum interest rate granted to a deposit held in interest earning to at least 70% the base rate”. There seems to be a missing word there after interest earning, perhaps the drafter meant to put the word “account”. Whatever the case, the regulations will now have to prescribe what a “deposit” means for purposes of Section 33B (2). Chances are that to enable stability in the banking sector, a deposit will have to be an amount placed for a contractual period rather than just any amount in an interest bearing account (such as a savings account). The result is that banks will set up minimum amounts for which they are willing to enter into “deposit” contracts, perhaps from Kes 50 million and above to justify that high interest rate payable. Finally, if banks move to lending to GoK rather than to Wanjiku, the treasury bills and bond rates will decline dramatically and institutional investors such as pension funds will see a significant drop in their returns, meaning their pensioners will also suffer. Such are the unintended consequences of this Bill.

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Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

A Day Long and a Dollar short for Imperial Shareholders

[vc_row][vc_column width=”2/3″][vc_column_text]To understand the recent actions by Central Bank (CBK) in appointing third parties to manage Chase and Imperial Banks, a little history is required. In 1986 the Moi Government decided to get into the 20th financial century and created the Deposit Protection Fund Board (DPFB), which was only operationalized four years later in 1989. The purpose of the DPFB was twofold: To create a fund to offer protection to depositors in Kenyan banks and to take on the role of liquidator for failed banks. Between 1989 and 2012 DPFB had managed 24 banks in liquidation, the earliest being Inter Africa Credit Finance which was put under liquidation on 31st January 1993 and the latest being Daima Bank on 13th June 2005. There is no documented successful revival of any bank in those 26 years of the DPFB’s existence since the prevailing regulatory framework provided for statutory management leading to liquidation. The results speak for themselves: 24 banks in question had Kes 22 billion in deposits of which only Kes 1.5 billion were protected deposits. (Remember that the law provides insurance of up to Kes 100,000 per depositor). The DPFB in that period managed to pay out Kes 1.1bn or 74% of the protected deposits by the end of the financial year June 2012. It is noteworthy that the DPFB has an excellent record of publishing its accounts via its website since 2003, which accounts are audited by KPMG on behalf of the auditor general. The organization has been profit making from inception and by the end of FY June 2012 recorded a surplus of Kes 5.1 billion. Cash was certainly not what prevented DPFB from making 100% payment to protected depositors. One conclusion that can easily be drawn therefore is that the 26% protected depositors that weren’t paid simply didn’t make a claim for their money. Now let’s take a look at the loan recovery. In the same period the 24 banks had Kes 41.1 bn in loans outstanding, of which DPFB managed to recover Kes 6.4bn or 15.5% of the loan stock. Either DPFB was very inefficient or they quite simply couldn’t make the offending borrowers repay their (insider) loans and couldn’t find quality securities that would realize some value to extinguish those debts. My money is on the latter reason. As a result of clawing back a little in the form of loan repayments, DPFB managed to pay some depositors over and above the statutory minimum of Kes 100,000/-. Referring to this as “dividends” in their annual report, up until FY 2012 DPFB had paid only 28% or a total of Kes 5.6 bn cumulatively to depositors out of Kes 19.9 bn in unprotected deposits. In light of this less than stellar history of recovering the distressed assets and liabilities of the banking sector, the Kenya Deposit Insurance Act 2012 was enacted, which replaced the DPFB with the Kenya Deposit Insurance Corporation (KDIC).

KDIC-with-power-foam was created to make whites whiter and colors brighter. This piece of legislation gave the new institution far more operational discretion and a solution driven approach to managing failed banks than its predecessor. KDIC was now motivated to breathe life into failed banks rather than play the lugubrious mortician role of its predecessor. Through Section 53 of the Act, KDIC is given a tight timeframe – 12 months to be precise with a window to extend for a further 6 months- to either cure the bank of the matters that caused it to go under receivership or put the bank in liquidation. Twenty six years of experience had also led the former DPFB team to realize that perhaps the solution to keeping a bank open is to outsource receivership to a third party (with the necessary operational capacity) who would be nimbler in putting the structures in place to begin assessing loan viability and recovery thereof in order to pay suffering depositors and creditors. We have a different perspective now on how to manage failed banks, a perspective that allows for industry experts to step in and help KDIC execute its mandate. A perspective that allows for employees to continue working, borrowers to continue paying and depositors to receive funds over and above the historical statutory minimum.

The aim to maintain a going concern would be an unprecedented win for CBK as it would stabilize jittery depositors, calm foreign investors who were now having doubts about the wisdom of investing in Kenya and allow legitimate borrowers to continue utilizing much needed working capital facilities that were the lifeblood of their businesses. The first trial of the KDIC’s going concern experiment was with the appointment of KCB in April 2016 under S. 44 (2)(b) (iii) of the KDI Act that essentially allows KDIC to appoint a third party to manage the assets, liabilities and affairs of the institution. That KCB has a fully-fledged debt recoveries department that can land on errant borrowers like a ton of bricks is without question. This is business as usual for them. It is only through the active management of the loan book that depositors and creditors will get paid, and, hopefully a going concern is maintained. More importantly, the credit risk team at KCB should also be able to actively manage the performing loan book with a view to ensuring that businesses are not starved of the loan facilities that are needed to keep their businesses afloat. Providing mirror loan facilities on KCB’s own books provides an obvious solution to legitimate and well performing businesses. Operational capacity and deep industry experience is what third parties appointed by the KDIC under S. 44 (2) (b) of the Act bring to the table. But it’s a day long and a dollar short for the shareholders of Imperial Bank when energetically stating righteous indignation at CBK’s actions to appoint third parties to help recover the bank’s assets. Those energies should have been better placed keeping a tighter lid on the co-shareholder who led them down the rabbit hole of fraud in the first place.

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Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

Chasing The Truth In Parliament

[vc_row][vc_column width=”2/3″][vc_column_text]Last week, an unlikely source in the form of a Parliamentary Committee helped to unseal the tightly held lips of the Chase Bank’s board of directors. The directors had been summoned to assist the Committee to understand the challenges that faced the Bank, resulting in the same being placed under receivership by the Central Bank of Kenya. This was an opportunity for the board to give its side of a controversial story, a tale that has as many versions as there are heads to the Greek mythical hydra. The story caught my attention for one reason only: The directors called the auditors professionally ignorant. Actually let me quote the exact statement here: “The Musharakah Agreements for each of the SPVs clearly show Chase Bank’s 99% interest in the Musharakah assets. Deloitte’s insistence on treating this as a normal loan or advance can only be labelled as professional ignorance at best.” Part of the dispute between the auditors, Deloitte in this case, and the board of directors has been on the treatment of a series of real estate transactions either as internal loans to a key shareholder (according to the auditor) or as Musharakah assets (Islamic financing terms according to the directors). So I pored over the submissions made by the directors in their vigorous defence of these assets.
Banking is premised on the fact that there are depositors who want a safe place to put their money, and there are borrowers who require to borrow funds for consumption. The bank is simply an intermediary. In the case of Islamic banking, the institution applies Sharia compliant procedures in the booking of those deposits and loans. The key point here is: there must be a customer. Period. Finito. Whether it is mainstream or Islamic banking there must be an individual or an entity who is the customer. But the directors state thus in their parliamentary submissions:
“Subsequently, Deloitte rejected the Musharakah Agreements and Deloitte insisted that the Musharakah properties be charged to the bank, thus effectively classifying the SPVs as Loans and Advances rather than Islamic investments as documented. These loans would then become technical insider loans, as the shares in the SPVs were held by the two directors, albeit held in trust for the Bank. Chase Bank’s Management emphasised to Deloitte that treatment of the Musharakah assets as Loans and Advances would be in contravention of not only the principles of Islamic banking (and therefore a breach of trust with Islamic depositors), but also of Section 12(c) of the Banking Act and
would incorrectly treat these as an insider loan. It was evident that Deloitte were simply not interested in appreciating the nature and substance of the Musharakah Assets or the principles of Islamic banking.”

I scratched my head and read the report twice over. At no point did the directors say who the ultimate customer was. I mean, a bank doesn’t wake up and decide to give a loan out to a customer, whether Islamic or otherwise. Why was there no attempt to say that this was an unfair treatment of a yet-to-be-named customer who had borrowed from the bank in good (Islamic) faith? That the assets were bought in the name of the SPV is not in doubt. That the SPV has two Chase directors as the shareholders is not in doubt. But where the shareholders were holding the shares “in trust” for the bank is where it starts to get “grab-a-bag-of-popcorn” interesting. The directors fail to mention if a “deed of trust” was provided to the auditors as evidence of that understanding between Chase Bank on the one hand and the SPV shareholders on the other. I mean, one doesn’t assume trust falls off the back of the Kisumu express train, it must be documented somewhere, right? The directors beat their Islamic financing drum further by dragging in the regulator into their drama: “On 26th July 2012, Chase bank wrote to the Director of Bank Supervision at CBK requesting CBK to revise the Central Bank Prudential Guideline on Publication of Financial Statements and Other Disclosures to accommodate Islamic products and
specifically:
(i) the Islamic Banking Income received to be reflected separately in the Profit and Loss
Account;
(ii) The Islamic Banking Expenses also to be reflected separately in the Profit and Loss
Account;
(iii) The Islamic Banking investments or Financing Activities as a separate Asset line in the
Balance Sheet;
(iv) The Islamic Deposits or Liabilities as a separate Liability item in the balance Sheet; and
(v) A separate Off Balance Sheet line item for Islamic banking.
The CBK has not objected, in the absence of any changes to the Prudential Guidelines, to the classification and treatment in any of its reports to the Bank.”

I have to admit, that this submission by the directors stumped me. If you wrote to the regulator and asked to be reporting Islamic Banking products separately, and the regulator did not object, then why do your 2014 and 2015 financial accounts not reflect the same? I zoomed across to the only fully-fledged Islamic Banks in Kenya, Gulf African Bank and First Community Bank (FCB) websites to see how their Islamic assets are recorded. Their professionally competent auditors in the name of KPMG and PriceWaterhouseCoopers (PWC) respectively reported loans as “financing activities (net)” exactly as Chase had requested the CBK to do in (iii) above. (It’s noteworthy that PWC audited the FCB accounts in 2014 but the 2015 published accounts are silent on who their auditors were) If Chase directors had knowledge as far back as July 2012 on how “Musharakah Assets” should be recorded on the balance sheet why wait until June 2016, or four years later, to call their auditors professionally ignorant? And why are the Islamic depositor funds not separately recorded yet the directors have vigorously highlighted the potential breach of trust for the Islamic depositors if Musharakah Assets are treated as loans and advances?

The Chase Bank saga is a case study of corporate governance failure, weak internal controls, questions on the auditors’ scope and depth of review and a passionate to almost rabid love for the brand by its most loyal customers. But on the back of all of that are innocent depositors who must always remain in the minds of all bank directors whose oversight role gets heavier with each passing day.

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

Banking Crisis in Kenya

[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.
[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

Driving on borrowed funds

[vc_row][vc_column width=”2/3″][vc_column_text]Mutua stops John in BuruBuru and asks for the quickest way to Westlands.
John asks, “Are you on foot or in the car?”
Mutua says, “In the car.”
John says, “That’s the quickest way.”

In case you missed it, there is an obscenely symbiotic relationship between the growth of credit supply in Kenya and the now ubiquitous traffic jams that are spreading beyond this cities of Nairobi and Mombasa. Rather than rehash what I have written before, I pulled out some data from the Economic Survey 2015 that was put together by the Kenya National Bureau of Statistics so as to get a verified position of my thesis. First let me give credit where it’s due. The 2015 Economic Survey, all 334 pages, is a treasure trove of statistical information on all aspects of the Kenyan economy. It is a very useful tool for looking at historical information about education, health, banking, government and many other sectors as well being able to extrapolate trends if you’re so inclined. Well, the data on vehicle importation was eye-popping to say the least. In the last four years, the annual importation of motor vehicles has grown from Kshs 62.8 billion in 2011 to Kshs 101.7 billion in 2014, a 62% growth in value terms. I know what you’re thinking, as you roll your eyes at this number: it must be the confounded boda bodas that are driving this growth.

Actually it’s not. In 2011, there were 140,215 motorcycle registrations, which was actually the highest in the last four years. By 2014, there were 111,124 motorcycle registrations or a 20% drop. Conversely, lorries and trucks grew from 5,247 in 2011 to 10,681 in 2014, a growth of 103%. Now, I find that quite interesting. What are these lorries hauling? Is this growth in any way related to long distance transportation of goods across East Africa or is it related to the SGR construction where countless Chinese trucks criss cross Mombasa Road moving building materials? I did note that many of them did not bear Kenyan registration plates when I last drove past an SGR construction site so my point might actually be moot (since the KNBS numbers describe actual vehicle registrations) and the growth in truck importations could directly be linked to long distance transportation or phenomenal growth in the building construction industry. But I digress, as I wanted to demonstrate vehicular traffic of the jaw-dropping fame that has now consumed us as a country. In the same period, saloon car registrations grew from 11,026 in 2011 to 15,902 in 2014. That sounds low doesn’t it? 44% growth in 4 years? Well you just wait for the kicker. Registration of station wagons grew from 31,199 to 53,542 or 71% growth in the same four-year period! These are your Proboxes, Toyota Wishes, Nissan Wingroads, Subaru Imprezas, and all manner of station wagons that, together with saloon cars, have transformed our roads into the collective sludge of traffic non-movement. What is financing this phenomenal growth in vehicular traffic? The Kenyan banking industry is.

So I pulled up a fairly decent report issued quarterly by the Central Bank of Kenya. The report, titled “Developments in the Kenyan Banking Sector” provides information on sectoral distribution of loans in the banking industry. Using the quarter one 2012 and quarter one 2015 reports, the not-so-surprising revelation is that lending to the personal/household sector (which is where unsecured consumer lending is recorded) is the single largest borrowing segment in the entire Kenyan banking industry. Let me say that again: loans to individual Kenyans are higher than loans to any other singular sector of the economy. (If I handed in this piece on time, my copy editor would have been able to insert an illustrative table, but time doesn’t allow for this insertion, unfortunately). By December 2011, the banking industry had lent out 318.8 billion to the retail sector, which was 27% of the Kshs 1.1 trillion gross loans and advances. Four years later, the banking industry had lent out 518.2 billion to the same retail sector out of the Kshs 1.97 trillion gross loans and advances. So even as the growth in loans and advances has almost doubled in four years, lending to the personal sector has steadily maintained its rate at just a quarter of total bank lending. The bulk of these loans are personal, unsecured loans that are taken to purchase motor vehicles.
I called up an old friend, who heads up the Risk Department in a Tier One bank here in Kenya. He confirmed my numbers that personal consumer lending at his bank makes up about 55% of the total bank loan book. He dropped another bombshell as a parting shot. He had just returned from a credit conference in South Africa where a consultant had made a presentation on the state of credit in many African economies. In South Africa particularly, the rate of borrowing in most households was at 75%. In Kenya, the research had it at 68%. While the banking industry (and to a lesser but noteworthy extent, the Savings and Credit Cooperative Society industry) have democratized access to credit in this country, a key unintended consequence has been to democratize access to vehicle ownership for Kenyans. What we see on our roads daily will not go away. And for those whose hopes had risen with the increase of excise duty on the smaller capacity vehicles as was done in the last budget, you need to peg your hopes down a notch. Increased taxation will not stop vehicle buyers from purchasing cars; it will only increase the size of loans being requested by consumers. For as long as the banking industry is willing to continue growing its personal unsecured lending segment, there will be more cars on our roads that can only mean even more mind numbing traffic and idiotic over lappers. It might actually be faster to walk to Westlands from BuruBuru than to drive in the next five years!

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

Bankers are business people too

[vc_row][vc_column width=”2/3″][vc_column_text]A distraught investor called his financial advisor. “Is my money really all gone?”
He wailed. “No, no,” the advisor answered calmly. “It’s just with somebody else!”
I need to disabuse some readers of the notion that banks are charitable institutions. The amount of energy spent chanting dirges about how “banks are out to fleece us” or the more recent, “banks want to finish Kenyans with interest rates” is energy better spent understanding that a bank is a business like the neighborhood kiosk, providing a service of convenience. The less than palatable solution to the purveyors of negative energy is this: put your spare cash under your mattress and go borrow your financial needs from the knee-cap breaking shylock two streets down the road from your house. Enough said: if you’re mildly irritated at my incendiary introduction, let’s keep rocking and rolling as I explain why you need to get over yourself.

The months of September and October 2015 were difficult ones for the Government of Kenya. Cash flows got mismanaged as more money was being paid out than was being received and they had to come to the domestic market to borrow funds to meet their obligations. Bank treasurers as well as savvy institutional investors smelt blood in the water. They had already done a quick back of the envelope calculation on the use of the proceeds from the now infamous Eurobond and figured out that the government had come up short when there were multiple domestic as well as international obligations to be paid. These things really don’t require a rocket scientist, after all, housewives have been calculating and balancing kitchen budgets for years. Word soon spread that the government needed money, and banks as well as institutional investors were happy to step up to the plate. But remember that banks place your deposits in two places: in loans to businesses and individuals or in loans to government via treasury bills and bonds.

Two things will always happen when the government suddenly becomes exceedingly thirsty for cash and dips its beak into the private sector. Firstly, the arbitrage sharks that are always looking for an opportunity will strike. If an individual or corporate with a good credit history at their bank can borrow at 12% as was the case with some, then they will borrow and take the money to the government via the T-bill auction that was giving rates above 22%. That 10% spread is easy money. So easy that the bank’s initial reaction will be to raise interest rates to reduce the arbitrage opportunities that it is providing to some of its clients. Which then leads to the next question, why should the bank be the only one allowed to make money from government borrowing? Well, the fact is, everyone who was flush with cash and spotted the opportunity jumped into the high interest rate bandwagon. Large depositors demanded that the banks give them double digit interest rates or they would withdraw their funds and open CDS accounts at the Central Bank themselves in order to buy government paper. I know an individual who got 19% on his large deposit at a multinational bank in September this year. Now if you recall, I did say that banks fund their loans from customer deposits. When a large number of deposits start to re-price, the obvious impact will largely be on the future loan book that will be funded from the re-priced deposits. There is also an impact on the existing loan book because a bank is constantly trying to manage the profitable bridge between interest received (from loans) and interest paid (on deposits). The net interest income will obviously be impacted from the re-priced deposits. And banks are accountable to shareholders you know, the owners of the business who are demanding a return on their heavily regulated capital.

A final point to the business of banking: contrary to popular belief, it is not all champagne and roses when banks have to consider raising interest rates. The credit risk director will typically sit through that Assets and Liabilities Committee -ALCO meeting (assuming he’s invited) with a furrowed brow and a sinking feeling in the pit of his stomach. Why, you ask? The credit director knows very well about the elasticity of the borrower’s pockets. There is only so much stretching a borrower can do before he decides to throw in the towel and default on a bank loan that is causing more grief and sleepless nights than a private developer’s illegal boundary walls coming down. A borrower has typically submitted cash flow projections to his banks demonstrating that he can comfortably make the principal plus interest repayments over the lifetime of the loan. A minor rate increase will cause some level of digestive discomfort. A major rate increase will cause cardiac level discomfort. Which is why banks ask individual borrowers for their pay-slips and information about other borrowings so that they can tell what the “debt service coverage ratio” is for the individual borrower. How much of her disposable income is going towards servicing loans? The rule of thumb is that it should not be beyond 30% of one’s net income which allows one to pay rent, buy food and basically live decently rather than skating on the edge of financial despair. The same applies for business loans, as there is an ideal leverage ratio for businesses that are in the manufacturing or in the service industries (manufacturing businesses are permitted higher leverage ratios due to their propensity to use loans for purchasing capital equipment).

Therefore it’s not an easy ALCO decision to raise interest rates as the bank will be balancing a need to maintain the net interest spread while managing the increased risk of borrower default. Since the escalated government borrowing had cooled down in November, the banks last week could thus start to yield to the Central Bank Governor’s exhortations to stop loan interest rate increases. Total relief in sight for distraught borrowers!

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]

Banks and Corruption make for strange bedfellows

[vc_row][vc_column width=”2/3″][vc_column_text]On April 13th this year, I opined quite loudly about the role being played by the banking sector in Kenya’s institutionalized corruption culture. In case you missed it, my observations were as follows:

“Picture this scene: Mr X has been banking at Bank Y for the last 10 years. His account turnover is about an average of Kshs 250,000 on a monthly basis. The account suddenly begins receiving deposits and withdrawals ranging from Kshs 20 to 100 million, which moves his average monthly turnover to about Kshs 50 million. The Anti Money Laundering officer, usually a skinny, bespectacled recent university graduate, flags these movements to his boss the Compliance Manager. The Compliance Manager flags it to his boss, the Risk Director. The Risk Director walks over to the Retail Director and shows him the transactions as he’s a smart chap who doesn’t want to put anything in writing, just yet. The Retail Director, who is royally chuffed that his liability targets are constantly met since his team’s successful senior civil servant recruitment drive last year, rubbishes the report and dares the Risk Director to take it higher, “Weeeh, even the Managing Director knows we have these accounts, can’t you see how they are helping our deposits to grow?”

Well, in my typical smug armchair analyst fashion, I have been unequivocally vindicated. Far be it for me to say I told you so, but the Sunday Nation on July 5th reported some interesting court findings. An article titled “Suspended city official deposited Sh 1 bn in two years” written by Andrew Teyie caught my eye. In it tells the story of an extremely industrious public servant who allegedly deposited close to a billion shillings in nine accounts spread in five local banks within two years. This information is sourced from documents tabled in court by his accusers, the Ethics and Anti-Corruption Commission (EACC). First off, I have to doff my hat to the industrious public servant for mitigating concentration risk by opening accounts at five different banks. Baba attended risk assessment 101 and passed with flying colors. It is never advisable to put your eggs in one basket, spreading them to three is wise and to five is brilliant. It also helps to reduce the risk that in case one of the five banks cottons on to what you are up to and reports you, there are four other banks to keep fooling.

According to the court documents, industrious public servant had declared his income at Shs 831,840 (although it doesn’t quite say to whom the declaration was made) yet deposits were being made on at least twice weekly ranging from Sh 1 million to Shs 13 million. Yet the banks are required to have established Anti-Money Laundering (AML) processes to capture abnormal transactions. An abnormal transaction would be anything that goes against the norm for the type of activity a customer has been registered as undertaking. So for example a salaried customer would be expected to have a one major credit into the account, followed by a slew of debits as he withdraws his salary in dribs and drabs over the course of the month. If the salaried customer has multiple credits, especially those that significantly exceed his stated salary, this would typically raise a flag.

A way around this, for the experienced money launderers, is to open a hotel, restaurant or casino. All these businesses deal with cash such that an inordinately high number of deposits would hardly raise anything other than a bored eyebrow over at the compliance team in the bank who never quite get off their cushy behinds and go look at the actual customer turnover within these joints.

Now it is highly likely that an enthusiastic compliance officer raised the flag, drew compliance manager’s attention who drew risk director’s attention who cast a baleful glance at retail director before heroically blowing the whistle to the Central Bank team who then ran pell-mell in the direction of Integrity Centre with the file in hand to knock the sky and our expectations open with the news of this chap’s accounts. Somehow I don’t think you believe that, which is quite funny because neither do I. Truth of the matter is that industrious public servant is one of the small fish that can be pan fried in the rather tepid fight against corruption and he laid himself wide open by not covering his standard gauge tracks when banking his proceeds. He relied, quite safely, on his banks that did not report the suspicious transactions to the regulator. He also unwittingly relied on a regulator that was snored quietly on the sidelines as these AML breaches happened, and continue to happen, on their watch.

A couple of paradoxes that arise from this case are noteworthy. First off, that the Kenya Revenue Authority appeared and decided swoop in for the tax evasion kill is nothing short of comedic. How do you tax corruption proceeds of a public servant? A public servant in many cases is only taking what are public funds hence it beggars belief that one can tax what one has already collected as tax and has been misappropriated by public officials. Is that not taxing the tax that’s been taxed? The second paradox is the sand that is being thrown in the public’s eyes. Industrious public servant is a tiny little goldfish in an enormous fish tank. The EACC has demonstrated publicly that they can get historical data on the banking activities of public servants. So why isn’t the Central Bank’s supervision unit being used to assiduously partner with EACC to hunt down these nefarious characters? EACC knows where all the corruption proceeds are. Our Central Bank knows (or can exercise a tiny bit of supervision to find) where all the corruption proceeds are. You and I are foolish pawns who lap up the piddling little stories of corruption arrests. Meanwhile the big fish don’t do their banking in Kenya: it’s too pedestrian.

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Confluence of Political and Economic Risks

I recently dined with a European diplomat who asked the ubiquitous question that foreign residents in this country like to do: “What do you think will happen at the next Kenyan elections?” Before I tell you what I answered, I have to state categorically and most unequivocally that I am neither a political analyst nor commentator. I do, however, occasionally comment on the confluence of politics and economics as often happens invariably. That confluence is particularly necessary in the banking industry, where I spent many happy years, when analyzing credit risk of a customer for a term loan of not less than five years.

Within the duration of that loan such a customer is bound to cross the Kenyan election cycle. Depending on the nature of the customer’s business, the company is likely to have difficulties in loan repayments due to cash flow constraints occasioned by poor sales, deplorable debt collections or, heaven forbid, destruction of the company premises therefore impacting on the ability to produce the goods and services that are being procured. My answer to the diplomat saw him imperceptibly swallow and he leaned forward in interest.

“There will be bloodshed in 2017 as the historical patterns demonstrate it.”

“What do you mean?” he whispered.

“In banking, we look at historical behavior as a strong barometer of what future behavior is likely to portend. To understand our history of political violence, you have to start in 1992 when the first multi party elections were held,” I began. “In that year, you had an incumbent who was running against a very strong and credible opposition. That was when Kenya endured the first of several bloody episodes of tribal clashes.” I went on. “In 1997, the same incumbent was running for his second and last term as president. He had the benefit of the state machinery behind him, as well as a fragmented opposition. This time, the political waters were muddied in the coast region, where the pre-election clashes were largely centered. The coastal tourism economy very nearly collapsed and the hotel industry underwent massive bankruptcies.”

“Well what do you make of the peaceful election in December 2002?” the diplomat asked. “Doesn’t that destroy the pattern of electoral violence?”

“Actually, therein lies the pattern,” I responded. “Every time an incumbent is stepping down, there has been a peaceful transition in Kenya. It happened in 2002 and in 2013. But whenever there’s been an incumbent fighting to maintain the status quo, there has been bloodshed; ergo 1992, 1997 and 2007. The 2017 elections are a status quo event. The pattern will be the same.” My lunch partner mulled over this for a few minutes and promptly changed the subject.

In 2008, a few banks took advantage of the politically instigated clashes in the beginning months of the year to blame the growth in non-performing loans. Some of this was not entirely true and was a slick way of reporting previously suppressed bad loans. But you’d think that the regulator would have cottoned on to the games being played. It didn’t. It is not difficult to see why, when you look at the kind of pedestrian analysis the banking supervision department at the Central Bank of Kenya (CBK) undertakes. In the recently released 2014 Bank Supervision Annual Report, the Central Bank dedicates the monumental amount of three sentences to analyze the 2014 asset quality of the entire banking industry. I will pick two of the three sentences as an illustration:

“ The lag effects of high interest regime in 2012/2013 and subdued economic activities witnessed in the period ended December 2014 impacted negatively on the quality of loans and advances. As a result, non performing loans (NPLs) increased by 32.4% to Kshs 108.3 billion in December 2014 from Kshs 81.8 billion in December 2013.”

When your non-performing asset book increases by a third, it requires a fair amount of explaining beyond the vanilla high interest rates and subdued economic activities reasoning. There should be a fairly robust amount of granularity around the specific industries driving the poor performance of loans. It is an open secret that the central government endured inordinate cash flow challenges in 2014 that impacted key suppliers of services, particularly in the construction industry. This would invariably have a knock on effect to the suppliers of construction companies such as cement, cable and ballast for example. But this is what should be of concern as we hurtle towards an election cycle in the next two years. The retail loan book across the banking industry is the single largest loan segment with 3.6 million accounts grossing Kshs 516 billion and accounting for 26.6% of total loans in the market. This is ahead of trade at Kshs 375 billion (19.3% of total loans) and manufacturing at Kshs 237 billion or 12.2% of total loans. Retail loans, codified by the CBK as personal/household loans, are consumer loans and in this market represent the largely salary check off loans that pepper many banks’ unsecured loan offers. It’s highly likely that the bulk of these loans are used to purchase consumer items such as cars, furniture and electronics rather than investment in income generating activities. A political event such as post election violence, followed by an economic downturn caused by reduction in productive capacity of Kenyan companies will lead to retrenchments. You can also never underestimate the capacity of cheeky borrowers to take advantage of politically volatile environments to stop repaying loans due to destruction of work places and such like sob stories. I saw it happen in 2008.

A notable risk therefore sits in the banking industry come 2017: any delays in government payments (partly occasioned by tax collection difficulties on the part of Kenya Revenue Authority) together with probable election related violence will negatively impact bank loan books. Don’t be surprised if you find difficulty getting an answer on your loan application that year. Your bank is just not that into you in an election year.

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Twitter: @carolmusyoka

Our Banks Are Laundering Corruption Proceeds

A man walked into a Swiss bank and whispered to the manager “I want to open a bank account with 2 million dollars.” The Swiss manager answered, “You can say it louder, after all, in our bank poverty is not a crime.”

As the sun set on the month of March 2015, there was cause for much reflection by the various civil servants who found themselves on the “List of Shame” that read like a who’s who in Kenya’s enterprising and highly lucrative public service. I can only imagine how many folks in the civil service girdled their loins in preparation for battle as they poured over the list with bleary eyes that were bloodshot with the previous night’s spiritual indulgence, fervent in the hope that their names didn’t appear.

Well, there were no public gasps of shock or righteous indignation; Kenyans have truly become immune to lists of shame. As a Nigerian friend recently told me, it only makes news in Nigeria when a public official has stolen over $100 million – Kshs 91 billion . Anything beneath that is deemed verily normal. However, there seemed be a lot of skepticism as to what the definition of “stepping aside” truly meant and whether it would conform to the Kenyan precedent of lying low like an envelope for three to four months followed by a quiet slinking back into office under the cover of media darkness.

Good people, we are talking about hundreds, nay, billions of shillings that have been corruptly acquired. This is not an amount that can fit into your Little Red suit pocket, or tied into the corner knot of Mama Mboga’s khanga. These funds have to be moving within and around the Kenyan banking sector. Yes, the banking sector that has remained grossly silent and unapologetically mum about the billions in liability windfalls that have dropped miraculously from the sky. Picture this scene: Mr X has been banking at Bank Y for the last 10 years. His account turnover is about an average of Kshs 250,000 on a monthly basis. The account suddenly begins receiving deposits and withdrawals ranging from Kshs 20 to 100 million, which moves his average monthly turnover to about Kshs 50 million. The Anti Money Laundering officer, usually a skinny, bespectacled recent university graduate, flags these movements to his boss the Compliance Manager. The Compliance Manager flags it to his boss, the Risk Director. The Risk Director walks over to the Retail Director and shows him the transactions as he’s a smart chap who doesn’t want to put anything in writing, just yet. The Retail Director, who is royally chuffed that his liability targets are constantly met since his team’s successful senior civil servant recruitment drive last year, rubbishes the report and dares the Risk Director to take it higher, “Weeeh, even the Managing Director knows we have these accounts, can’t you see how they are helping our deposits to grow?” The Retail Director has been considering opening a branch for High Net Worth Individuals on the 10th floor of a new building in Westlands with a dedicated high speed lift from the basement, primarily to enable senior civil servants come and go easily without being noticed.

This scene is quite likely replicated across some of Kenya’s banks today that have “flexible” anti-money laundering (AML) rules and ill defined Know Your Customer (KYC) policies. Because if you Know Your Customer as per the Central Bank of Kenya guidelines, you should know your customer’s source of funds and be in a position to flag suspicious inordinate account activity on a real time basis; technically. The Central Bank inspectors who come round every so often, should also be able to pick up on this activity since they have access to the exception reports on account turnovers; technically. But does this happen? Let’s take a look at how developed markets penalize offending banks. In July 2013, Europe’s largest bank HSBC was accused of failing to monitor more than $670 billion in wire transfers and more than $9.4 billion in purchases of US dollars from HSBC Mexico, American prosecutors said. The bank was criminally charged with failing to maintain an effective anti-money laundering program, failing to conduct due diligence amongst other charges. Bloomberg Business reported that court filings by the US government indicated that lack of proper controls allowed the Sinaloa drug cartel in Mexico and the Norte del Valle cartel in Colombia to move more than $881 million through HSBC’s American unit from 2006 to 2010. HSBC was fined over $1.8 billion in penalties as a result.

Along more familiar bank territory, Standard Chartered agreed to pay $300 million to New York’s top banking regulator for failing to improve its money laundering controls, reported the BBC in August 2014. The Bank was also banned from accepting new dollar clearing accounts without the state’s approval. The penalty arose from a clear lack of learning as the bank had its AML problems identified in 2012 which had still not been fixed by 2014. The 2012 problems had led to the bank being penalized $340 million for allegedly hiding $250 billion worth of transactions with the highly sanctioned country of Iran. The banking regulator required that an independent monitor be installed at the bank and the monitor discovered that Standard Chartered had failed to detect a large number of potentially high-risk transactions.

At the risk of sounding judgmental, it’s quite likely that the banks in Kenya operating under international jurisdictions are applying their KYC and AML screws very tightly on what are termed as Politically Exposed Persons (PEPs) for no other reason than to avoid international notoriety of “chicken-gate” proportions. Actually, the corruption proceeds are more likely to be found in some of our local banks, mingling merrily amongst the hard earned proceeds of sweat generating wananchi.

Poor senior civil servants don’t exist in Kenya. They bank alongside the wealthy, productive citizens of this beloved country. Our banking industry knows them quite well.

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Twitter: @carolmusyoka