CBK flags risk in banks’ high State debt exposure

The Central Bank of Kenya building in Nairobi. FILE PHOTO | NMG 

By PATRICK ALUSHULA
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Summary

• Investment in government securities by lenders rose 19 percent last year.
• As at December last year, government bonds accounted for 20.1 percent of total liquidity of the banking industry, 24.36 percent of total assets held by banks and 16 percent of total income.
• The CBK warning comes at a time the government is pursuing fiscal consolidation to help it live within its means owing to high level of borrowing and underperformance of tax revenue.

Commercial banks face heightened sovereign and liquidity risks, the regulator has warned, citing rising exposure to government bonds in a capped interest rate regime.

Central Bank of Kenya (CBK) says while parking money in Treasury bonds may signal a flight to safety by banks to control loan defaults, a reduction in debt appetite by government may exert downward pressure on interest rates and hurt banks.

“High exposure to government bonds by banks poses both sovereign and liquidity risks--- Any shock to interest rates or rapid implementation of fiscal consolidation would negatively affect banks,” the CBK cautions in the latest financial sector stability report.

As at December last year, government bonds accounted for 20.1 percent of total liquidity of the banking industry, 24.36 percent of total assets held by banks and 16 percent of total income.

The CBK warning comes at a time the government is pursuing fiscal consolidation to help it live within its means owing to high level of borrowing and underperformance of tax revenue.

Acting National Treasury Cabinet Secretary Ukur Yatani has sent out a memo seeking budget cuts on travel, entertainment, training, publicity, office rent and car fuel. These items cost taxpayers Sh46.6 billion in the year to June 2019, up 54.2 percent from Sh30.2 billion in the previous financial year

While the average liquidity ratio for banks was at 48.6 percent in December last year, it drops to 28.5 percent when government bonds are excluded, showing the significance of State paper to banks’ liquidity.

The caution comes when yields on government paper have been declining since the fourth quarter of 2016 when rate cap took effect triggering banks to turn to short-term government paper. Treasury bonds were subscribed at 76.22 percent last year compared to the rate of 122.36 percent in 2017.

“The undersubscription in 2018 may be explained by lower coupon rates offered on bonds to reduce cost of debt in line with the debt management strategy,” said CBK.

Investment in government securities rose by 19.03 percent compared with just 3.07 percent growth in loans and advances in 2018 as most banks diverted their funds from lending to the private sector.

This helped banks to book 16 percent growth in interest on government paper from Sh102.8 billion to Sh119.2 billion last year.