How central bank can infuse stability in the financial sector

The Central Bank of Kenya is partly to blame for the woes currently bedevilling a number of lenders. PHOTO | FILE 

By MARUBU MUNYAKA

My article on interest rates published in the Business Daily of Monday April 4, 2016 looked at the state of the country’s economy as a result of the ongoing monetary intervention by the Central Bank of Kenya (CBK) in an effort to maintain monetary stability.

In it, I argued that the high interest rates will kill business in this country as banks continue to retain huge spreads - the difference between loans and deposit interest rates - as they compete to report high profits.

CBK, as the financial sector regulator, should shoulder part of the blame for the failures in the banking system due to its market intervention in a quest to stabilise the shilling and tame inflation without looking at the negative implication of this policy intervention instrument, particularly when held for a long time.

I repeat that the government should do what retired President Kibaki’s regime did –borrow foreign exchange reserves via loans and grants from development partners to enhance liquidity in the market, stabilise the shilling and reduce inflation in the economy.

Such a measure does not impose punitive and negative implications to the banking sector.

The Central Bank and the Treasury have refused to adopt the two-prong approach in dealing with the shilling instability and inflation resulting in the troubles the banking sector is finding itself in today.

High returns by commercial banks and high growth in reported profits occasioned by high interest margins and other costs, are what is killing borrowers resulting in business failures.

Their failure impacts negatively on the performance of banks as their bad debts must be provided for in the profit and loss accounts.

Competition to make higher profits in order also to meet the prescribed minimum capital, which has been projected to rise from Sh1 billion to Sh5 billion, is the other cause of the troubled banking sector.

If the government had maintained the exchange rate at Sh60 to the dollar, there would not have been any need for the revision of the minimum capital to Sh5 billion.

The cutthroat competition forces banks to take on very high risk loans, which are not properly structured, leading to huge provisions in bad and doubtful debts, which is the reason behind the troubles both the National Bank of Kenya and Chase Bank, among others, are grappling with.

The other problem is that most of the regulators and auditors as well as commercial banks in this country either do not understand, appreciate or both the concept of structured finance as practised in the global market place.

As a result, when a regulator or an auditor comes across such a transaction, the natural thing for him is to recommend a full (100 per cent) provision for bad and doubtful debt.

This wrong application of the Basle Accords on Capital Ratios and Provisions for Bad and Doubtful Debts is what is destabilising the banking industry among others.

So, the natural decision model by the regulator is that banks must provide for 100 per cent bad and doubtful debts if no tangible collateral is used to secure loans.