ANB-BIA SUPPLEMENT

ISSUE/EDITION Nr 369 - 01/06/1999

CONTENTS | ANB-BIA HOMEPAGE | WEEKLY NEWS

Kenya

How to save the Banking industry

by James Pod, Kenya, April 1999

THEME = FINANCE

INTRODUCTION

There is a contagious crisis in the banking industry in Kenya
which could have far wider and deeper economic and social implications
than the uprooting of corruption

By October 1998, 35 commercial banks had gone into liquidation since 1984. Then there was the near-death of the National Bank of Kenya. It is now also public knowledge that the Kenya Commercial Bank is not safe either. All these are an indication of disappearing public deposits representing a loss of confidence in the country's banking system.

Domestic savings in Kenya over the years have amounted to over 70% of growth fixed capital formation. The big question in Kenya today is, whether the government can now create an environment whereby people are encouraged to save. A modern economy requires conscious deliberation, tough discipline and a belief in hard work on the part of the citizens. Are any of these factors to be found in today's Kenya? Also, it has been shown that the moment the government interferes with the private sector, it unleashes a recipe for disaster. And when the government tries to control the country's financial institutions, it is a recipe for a collapse in the financial sector.

How should the financial sector be made successful?

The government must maintain:

• An appropriate legal framework, well established property rights and an efficient judicial system. This is important in the enforcement of contracts. There should be contractual obligations to pay back loans borrowed and the legal system should ensure just that.
• A financial safety-net to avert liquidity crisis. This would help ride over temporary shocks in the financial sector which are normal in day-to-day operations.
• An adequate regulatory and monitoring framework to prevent collusion and excessive risk-taking. The Central Bank of Kenya here is the main agency and has been empowered by law to achieve this.
• Fiscal adjustment to prevent budget over-runs and domestic debts, which reduce available credit for private sector operations and affect the interest rate structure. This has been critical in the last three years.
• An enabling environment to encourage the growth of a potentially successful borrowing class - the investors. It should discourage those dependant on handouts and who do not respect the banking regulations. This is the origin of the current banking crisis.

Safeguards eroded

In the crisis, some or all of the above safeguards have been eroded. The government is seen to have let down the monetary system. One of the functions of the financial system is to receive savings from micro-savers and channel these to investors. In return, the financial sectors screen potential borrowers in terms of their credit worthiness and risks involved in lending to them. This is the financial intermediation process.

If this process is short-circuited by politicians and the government, it fails as an intermediation process. This shakes the pillars of the monetary system, on which the economy hinges as a conduit of economic activity.

In government-owned banks, or where the government has influence or has interfered with this process, the screening role of the financial sector is replaced by political patronage and loans become handouts. There has been a belief that the government will one day bail out these banks. But the destination of these funds have been to individuals (consumption) or parastatals, (like the Kenya Oil Corporation and the National Cereals Board), which are essentially unproductive, or to failed productive activities, causing wealth destruction.

Facts about the current banking crisis

• Most of the non-performing loans have gone to politicians and well connected individuals. Thus they are not dependent on their credit rating.
• These loans were borrowed but the intention was not to pay them back. They were considered as handouts. That is why no sufficient collateral exists in the majority of the cases.
• Most of these non-performing loans are not new. The auditor-general (corporations) must have known about them. The private auditing companies must have known about them all long.

The Central Bank must have known about them too, but looked the other way. It failed in its functions. What happened to the disclosure requirement of non-performing loans? Why does the Central Bank of Kenya disclose the list of loan defaulters only in the midst of crises? One wonders whether it is the Bank's way of throwing in the towel, saying that it cannot handle the situation because of the powerful nature of these loan defaulters.

Directors of these banks knew about these problems and failed to stop them or seek solutions or were dealing with a very powerful clique of people who do not respect the market rules and laws. Under the circumstances, they have no business running banks in the first place. Appointing advisers for them when they have already failed, comes too late and achieves nothing.

• The Capital Market Authority has knowledge of companies or banks performance before they are allowed to float shares. For example, the Capital Market Authority (CMA) declared the National Bank, not so long ago, a good institution for investment. The CMA misled the public and the National Social Security Fund (NSSF) bought equities in this bank. This has crippled the NSSF so that it can no longer be a major player in the money market and pillar for long-term loans and bonds. This builds into a large conspiracy theory, which has taken advantage of the asymmetric information in the system.

Some feasible solutions

• The government should keep out of the financial sector. The sector will develop only if professionalism is respected. The government at the moment lacks credibility, foresight, and discipline to participate in this sector.
• The CBK should not selectively apply the regulations and surveillance on the financial sector. The collapse of a bank or a financial institution has an enormous effect on the economy and other banks. Large number of Kenyans are driven into poverty, especially small depositors, who support the growth of the sector.
• There is need to set up a financial sector with safeguards, create confidence with creditors, and lessen the spread of contagious effects to other banks.
• The government should not use public money to bail out crisis-ridden banks. In particular, government revenue should not be used at all. These are tax payers' funds.
• Solve the domestic debt problem. The current banking crisis has a bearing on this. Debt reduction has so far not been done properly. The CBK is bringing interest rates down by rejecting Treasury Bills offers at a time when the financial sector is excessively liquid. This has squeezed profit margins of some banks and exposed their internal non-performing loans problem.

When properly done, reducing Kenya's domestic debt will revitalise production and reward the people who work hard in this country. At the moment, the government has betrayed Kenyans by rewarding the lazy!

END

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