Central Bank tightens rules to avoid bad debt but it could hurt clients

The Central Bank of Kenya building in Nairobi on June 2, 2014. FILE PHOTO | SALATON NJAU |  NATION MEDIA GROUP

In Summary

• Diamond Trust Bank rights issue was oversubscribed fourfold, attracting applications worth Sh15.9 billion against the Sh3.6 billion that it was seeking in the recapitalization plan.

By RAMENYA GIBENDI
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This year witnessed banks resorting to various recapitalisation mechanisms as the deadline for compliance with new Central Bank of Kenya requirements on capital rations drew closer.

CBK requires all lenders to maintain higher capital adequacy levels with effect from January 2015 in a move aimed at ensuring the lenders are able to withstand market shocks — such as bad loans.

The new requirement has resulted in most banks raising capital through rights issues, private placement, reserves and subordinated loans that also qualify as tier II capital.

The new rules require all lenders to maintain a minimum core capital to risk-weighted assets ratio — a measure of a bank’s financial strength based on what shareholders have put in — of 10.50 per cent, up from the current eight per cent.

The banks are also required to maintain a total capital to risk-weighted assets ratio — a measure of a bank’s financial strength based on total capital including items such as goodwill and revaluation — of 14.50 per cent, up from the current 12 per cent.

Central Bank of Kenya (CBK) recognises long-term loans as Tier II capital, which then gives lenders headroom to take more deposits and, therefore, generate more loans, which is the core business of any bank.

The push to have banks increase their capital buffer has engrossed central bankers globally in the past few years following the 2007-2009 financial crisis that took a hit on lenders.

Under the Basel III rules, a set of guidelines meant to strengthen banks’ capital adequacy ratios being implemented globally, banks are expected to raise their capital thresholds.

Banks in Kenya had a two-year grace period to comply with the new ratios and Kenya Bankers Association, the lender’s umbrella body, has previously said it would not be seeking an extension to the grace period.

Latest figures from the banking regulator indicate that banks turned to their shareholders as one of the means to comply with the CBK requirements on capital rations with shareholder funds in the industry growing by 19.8 per cent.

Shareholder funds grew to Sh479.6 billion in August 2014 up from Sh400.3 billion over a similar period last year underlining intense activity by banks to withhold a portion of shareholder earnings. 

Analysts have however pointed out that the new capital requirement may have adverse negative effect on lender’s returns on equity going forward.

In a note to investors in August, Standard Investment Bank noted that lender’s returns on equity are likely to be impacted through cutting it by an estimated 1.5 percentage.

According to them, banks could now end up making less for every shilling invested as more resources are diverted to meeting Central Bank of Kenya (CBK) ratios.

SIB noted that banks have the option of increasing interest rates as a means to protecting a decline in return on equity but the option is remote considering the concerted efforts in the country to reduce interest rates on loans.

Standard Investment Bank estimated that eight listed banks need at least Sh76 billion to fund their current financial performance ahead of the new rules.

Kenya Commercial Bank had the highest requirement at Sh15.9 billion with NIC bank at Sh5 billion being the least, according to SIB’s estimates then.

Already NIC has managed to raise Sh5 billion from a recent bond issue after exercising a Sh2 billion green-shoe option-a mechanism built into a bond issue allowing the absorption of extra funds in case of an oversubscription.

Diamond Trust Bank rights issue was oversubscribed fourfold, attracting applications worth Sh15.9 billion against the Sh3.6 billion that it was seeking in the recapitalization plan.

National Bank of Kenya received shareholder approval for a Sh13 billion rights. The proceeds from the cash call are meant to help the lender offset some of its long-standing debts.