Kenya’s banking sector was a crisis waiting to happen, say analysts

Fears of structural weaknesses in Kenyan lenders resurface as third bank is placed under receivership in less than six months. TEA GRAPHIC 

By ALLAN OLINGO and JAMES ANYANZWA

In Summary

• While analysts say another round of bank failures is not on the cards, they have been warning banks since 2012 to stop understating loan provisions and to increase their capitalisation.
• This means the regulator, the Central Bank, was until last year turning a blind eye to the practice, which has now come back to haunt the financial sector.
• CBK governor Patrick Njoroge has admitted that the banks previously were competing with each other on who would declare the highest profits at the expense of factual book reporting.

Fears of structural weaknesses in Kenyan banks have resurfaced following the placing of a third bank under receiver management in less than six months, with analysts pointing to weak supervision and outright fraud by directors.

The Central Bank of Kenya put Chase Bank under receivership on Wednesday after a run on deposits of $80 million caused by the restatement of the company’s accounts for 2015 to reflect the actual bad debt and insider lending position; and the exit of the bank chairman and group managing director.

READ: Senior managers at Kenya's Chase Bank step aside

Speculation is rife on which other lenders could be in the crosshairs of the regulator. Already National Bank has been forced to restate its bad debt position and provisioning, and to send home five top managers over the wanting disclosures. Orders for their arrest were issued on Friday.

READ: How non-performing loans reversed NBK’s performance

ALSO READ: Troubled National Bank of Kenya requires $130m in capital to survive ruin

The situation is similar to the speculation that prevailed during the major bank failures caused by systemic weaknesses in 1988, 1993 and 1998 that claimed more than 50 financial institutions. A running thread in the failures of what came to be known as “political banks” was unsecured lending to directors, politicians and their associated companies; a factor in the closures of Dubai Bank, Imperial Bank and now Chase Bank.

While analysts say another round of bank failures is not on the cards, they have been warning banks since 2012 to stop understating loan provisions and to increase their capitalisation. This means the regulator, the Central Bank, was until last year turning a blind eye to the practice, which has now come back to haunt the financial sector.

One analyst — Citi — warned way back in 2012 that exaggeration of bank profits posed potential risks to the operating performances of the Kenyan banks.
This year, Renaissance Capital and BPI Capital have raised similar concerns.

READ: Kenya banks record 38pc profit growth, but are they padding the figures?

Red flags

Kato Mukuru, the head of equity research at Exotix Investment Bank said Kenyan banks demonstrated strong performances in 2012, with the banking stocks following the robust operating performance of the industry, which continues to defy the challenging macro-economic and social backdrop.

“As banks ultimately tend to reflect the macro, we think it is time for the market to pay attention to the risks,” Mr Mukuru warned.

Citi also estimated that the six largest banks may be under provisioned by $208 million, with all of them also overstating their profits.

“We are concerned by the relatively slow growth of balance sheet provisions when compared with credit growth. This has resulted in current balance sheet provisions being too low, in our opinion,” Mr Mukuru warned.

On NPL, Citi warned that substandard and doubtful renegotiated loans were being reclassified as normal even when past principal and interest was not fully repaid. This was against the prudential guidelines of the Central Bank.

Four years later and both Chase Bank and National Bank are forced to correctly state their loan loss provisions, sending them into losses.

This has sent jitters through the Kenyan banking sector, which has already recorded a steady rise in gross NPLs, from 5.7 per cent in 2014 to 6.8 per cent currently.

Early this year, both Renaissance Capital and BPI Capital, raised similar concerns about the real health of the country banks.

Adesoji Solanke, an analyst at Renaissance Capital attributed their concern to the impact of the devaluation in South Sudan.

“We are cautiously optimistic about the outlook for the Kenyan banks especially on the impact of the sharp devaluation of the South Sudanese pound,” Mr Solanke said.

However, the placement under receivership of three banks, and the current challenges facing National Bank, have raised questions on the quality of supervision that Kenya’s Central Bank’s employed until Dr Patrick Njoroge took over from Prof Njuguna Ndung’u in July last year.

Best regulated

Neighbouring Uganda, which has witnessed several banks collapse, tightened its banking regulations and now has the best regulated banking sector in the region, according to a recent report by the Global Economic Index.

READ: Lessons for CBK from the Bank of Uganda

Dr Njoroge has admitted that the banks previously were competing with each other on who would declare the highest profits at the expense of factual book reporting.

“This is a habit that we are clamping down on. We are now insisting on factual reporting of the financials in order to reflect the banks true picture,” Dr Njoroge said.

Late last year (2015), the International Monetary Fund called for close monitoring of Kenyan banks to ensure that their regional expansion plans do no compromise their soundness.

In its latest review of the country’s economic situation, IMF said though the risks from the global financial and economic conditions have lessened and financial indicators have remained favourable, there is a need to be more cautious, with the focus on closely monitoring the health of the banking system and adapting banking supervision to growing regionalisation.

READ: Kenyan banks exposed to bad loans danger: IMF

However, in February, Global ratings agency Moody’s gave Kenyan lenders a clean bill of financial health, just after Imperial Bank and Dubai Bank went under receivership. The study, which assessed the overall stability of Kenya’s 42 banks, says most lenders have promising growth prospects, although it pointed out that their asset quality faces risks stemming from structural weaknesses, rapid loan growth and rising interest rates.

“Despite a backdrop of global emerging market volatility, we expect Kenya’s banks to maintain solid capital and liquidity buffers over the next 12-18 months,” said Christos Theofilou, Moody’s associate vice president.

Mr Theofilou said that Kenyan banks’ resilience comes from continual improvements to the regulatory and supervisory environment, as well as its predominantly deposit-funded liability structure and strong profitability, but the new regime at Central Bank has in a way proved the agency wrong with the recent revelations of under provision for NPLs.