What big banks should learn from the recent closure of small lenders

Imperial Bank’s Upper Hill branch in Nairobi. PHOTO | FILE  

By AGGREY CHABEDA

In Summary

• There was little or no distinction between principal shareholders, directors and senior management — it was not uncommon for owners to double-up as board chairmen and managing directors.
• Some “collapsed” on their own accord and the owners walked away scot-free leaving depositors with nothing. The most infamous collapse, in the early 90s, was the closure of Post Bank Credit, a subsidiary of Post Bank.
• Good governance remains elusive in most public and several private entities. Were it not so, the media would not be replete with daily examples of unethical practice, negligence, recklessness and outright plunder of resources.

Troubled Chase Bank’s sudden closure should serve as reminder that in Kenya no institution is too big to fail, not even the so-called tier-one banks.

In the aftermath of the 2007 stock market crash, Lehman Brothers went bankrupt. US giants Merrill Lynch, AIG, Freddie Mac, Fannie Mae and UK banks HBOS, Royal Bank of Scotland, Bradford & Bingley, Fortis, Hypo and Alliance & Leicester all came within a whisker of doing so and had to be rescued.

Barclays dodged state intervention by finding new investors from the Middle East who injected much needed capital. And that is just the banks in the US and the UK.

A walk down memory lane in Kenya’s financial sector unearths past behaviour by banks that is eerily similar to what has unfolded over the past few weeks

In the 1980s Kenya witnessed an unprecedented mushrooming of banks and credit societies. The Central Bank of Kenya’s (CBK) supervision was an idea whose time had not yet come.

There was little or no distinction between principal shareholders, directors and senior management — it was not uncommon for owners to double-up as board chairmen and managing directors.

Inevitably, reckless insider lending, often unsecured, and subsequent loan defaults led to instability and failure of many banks. A few were outright fraud machines.

Post Bank credit

Some “collapsed” on their own accord and the owners walked away scot-free leaving depositors with nothing. The most infamous collapse, in the early 90s, was the closure of Post Bank Credit, a subsidiary of Post Bank. It was an open secret that this was the conduit for funds that were channelled, unsecured, to the Youth for Kanu ’92.

Its shutdown left depositors with nowhere to go. The excess money supply had an inflationary effect on the economy. Public trust in keeping money in financial institutions hit an all-time low.

Two other schemes come along in quick succession to the banking crisis, contrived by politicians and executed by Treasury and CBK mandarins — the Goldenberg scandal and Certificates of Deposits (CDs) for mopping up the excess liquidity in the market — but those are stories worthy of their own space.

Inflation spiralled as the shilling plunged from Sh30-something to the dollar to over Sh65.

By early to mid-90s newer financial institutions had emerged replacing the previous ones but largely with the same old habits.
The CBK set about trying to re-establish stability and issued a draft of measures.

Among them was a directive that credit societies could not own banks. Owners complied by turning over the pyramid but the underlying ownership and management structures remained intact.

The minimum capital requirements for a bank licence was increased — there followed some mergers, more like forced marriages. Other banks resisted or were in such a bad state that no suitors were forthcoming.

Government intervention came in the form of Consolidated Bank.
This new outfit took over the remaining “bad” banks that would otherwise struggle to get licensed. Needless to say, as in the late 80s, nobody was ever held to account and many of its former shareholders are in today’s billionaires club.

Fast-forward to the recent events and, thanks to the 2010 Constitution, the CBK has or should have autonomy and independence from interference by the executive.

Many laws have been enacted and numerous regulations put in place to minimise, or to put it in government parlance, eradicate corruption and other practices that would put bank deposits risk.

This is the reason millions of Kenyans are watching with utter shock the return of irresponsible directors and management in the industry. The question is; should it be? With all the endemic corruption and impunity exhibited around us by well-educated, well-trained, well-paid professionals in other spheres of life, I dare say that we should have seen it coming.

The CBK has come under intense scrutiny with accusations that it may have at best slept on the job or, worse, been complicit with some banks in not exposing the ills bedevilling the sector.

While we focus on how the CBK has performed its oversight role we have to accept that the job of weeding out rogue directors is a joint responsibility that extends to other regulatory bodies, the police, anti-corruption agencies, prosecutors and the Judiciary who all have to play their part.

Unquestionable integrity

Shareholders, of course, also bear a responsibility by selecting competent directors of unquestionable integrity.

The current banking crisis will result in a realignment of the industry which will ultimately improve compliance by all banks and speed up mergers and acquisitions of smaller lenders by bigger ones for longer-term industry stability — with due respect to depositors who will come out losers. But I digress.

No matter how much regulation is in place, be it by the government or private-sector self-regulation — no institution is safe from failure if those charged with the responsibility of safeguarding its assets become its main threats.

The primary blame lies with the directors — nobody else. The Imperial Bank saga comes to mind. The directors were either clueless or complicit or both and deserve punishment for it.

Good governance remains elusive in most public and several private entities. Were it not so, the media would not be replete with daily examples of unethical practice, negligence, recklessness and outright plunder of resources.

It is widely accepted that the current CBK governor espouses and lives the part of the type of director needed in the governance or management of an institution.

Shareholders, including the government which decides who governs the 200-plus public sector companies, owe the institutions they own robust mechanisms that will produce the right men and women to lead them to prosperity.

Many of these good men and women exist but few get the opportunity.