Banks will need Sh70 billion in new capital rules

Opinion and Analysis

 

 

Traders said the shilling could come under pressure next week when the government releases funds and importers demand dollars for end-month trade. Photo/FILE 

 

By George Bodo

In Summary

• A new stipulation in the guidelines is the requirement that banks hold a capital conservation buffer of 2.5 per cent over and above the existing minimum ratios to enable them withstand unforeseen periods of stress.

It seems more Kenyan banks will be in the market soon for additional capital. It all began with Diamond Trust Bank, whose cash call from shareholders opened on June 30. The bank is looking to raise Sh3.6 billion to meet both its regulatory and business needs.

 

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• Banks will need Sh70 billion in new capital rules

Joining the fray is NIC Bank. The lender said in June that it will seek additional capital through a corporate bond and a rights issue within the course of 2014.

Back-of-the-envelope calculations suggests that it could be looking for an amount between Sh2 billion to Sh3 billion.

But this could just be the tip of the iceberg since the 33 non-listed banks could also be involved in some form of capital raising.

But why are banks busy looking for additional capital? This is, for most part, regulatory driven.

First, the Central Bank of Kenya published new risk management guidelines requiring banks, with effect from January 2014, to hold capital charge for market and operational risks, which in effect increases their risky assets and hence the need for more capital.

Market risks are those generally associated with investments in instruments that are affected by daily movements in interest rates, such as government bonds (and are as such marked-to-market periodically).

Operational risks, in a strict sense, refer to risks associated with people, processes and systems. Previously, banks have been calculating the amount of capital they need to hold using credit risks only.

Secondly, a new set of prudential guidelines were issued, and this is where it gets a little tricky.

A new stipulation in the guidelines is the requirement that banks hold a capital conservation buffer of 2.5 per cent over and above the existing minimum ratios to enable them withstand unforeseen periods of stress.

This brings the minimum total capital to risk weighted assets requirements (commonly referred to as the capital adequacy ratio) to 14.5 per cent and takes effect in January 2015.

If this rule was to be brought forward and effected in the beginning of 2014, then four banks would not meet the requirement.

Actually, as per the Basel guidelines, this capital conservation buffer rule was meant to be applied to banks considered to be systemically important, or the so-called “too big to fail banks” (Basel SIFI Guidelines).

Ratio fell sharply

However, based on the above two guidelines from CBK, conservative estimates suggest that banks will need upto Sh70 billion to meet the new capital rules.

Already, the industry capital adequacy ratio fell sharply at the close of the first quarter to 15.7 per cent, from 18 per cent at the close of 2013.

R

Listed banks remain the hardest hit, with their aggregate capital adequacy ratio declining to 15 per cent at the close of the first quarter compared to 20.7 per cent at the close of 2013.

But these new capital requirements can only mean investors in bank stocks should expect reduced dividend payouts (and declining dividend yields), especially in 2015, as banks opt for prudent earnings retention policies.

Indeed, investors have been bearish on banks; in fact, the average price index of bank stocks at the Nairobi Securities Exchange returned a performance of 16 per cent in the first half of 2014, compared to a return of 31 per cent in a similar half of 2013.

So, as banks begin reporting the second quarter performance results, investors should watch out for capital adequacy levels and determine if there will be need for additional capital.