The Business Laws (Amendment) Bill, 2024 (the Bill) which is currently undergoing public participation is seeking to introduce legal provisions to increase the minimum core capital requirement for Kenyan banks and mortgage finance companies from KES 250 million to KES 10 billion within the next three years. The rationale being that banks with sufficient capital can cover deposits even if loans aren’t repaid or their investments lose value, they are therefore less likely to fail. The Kenya Bankers Association has warned that this proposal will likely lead to the collapse of 24 banks.
In this article we give an overview of how Kenya’s regulatory framework and laws protect against banking crises.
Why are banks important and why is their failure heavily guarded against?
For the special role they play in an economy, banks in almost every jurisdiction including Kenya are governed under a special regime and are subjected to prudential regulation. This regime regulates the entry, continuity and exit of banks in the banking sector. Bank failure, which refers to scenario in which banks are unable to meet their obligations due to insolvency or illiquidity, can have a significant impact on a country’s economy due to a bank’s ability to serve almost every sector of an economy. What also makes banks special is their vulnerability to the loss of public confidence. The insolvency of a systemically important bank by “contagion” has the potential to disrupt non-bank financial or other sectors. As a result, the insolvency of a bank requires a different treatment than the insolvency of a company under the Companies Act (Cap 486, Laws of Kenya) or any insolvency legislation with the strategic goal of maintaining public confidence in the banking system.
Is there a difference between a banking crisis and a financial crisis?
Broadly speaking, a banking crisis occurs when the stability of the banking system is threatened and this is characterised by a run or widespread runs on deposits. The Kenya Deposit Insurance Act, 2012 (the KDI Act) defines this as a systemic risk: the possibility of a failure of one or more institutions which may cause severe disruptions in the financial system. Also, any institution that places the interest of its depositors or indeed the banking sector at risk is termed a “Problem Institution”. In countries where banks are responsible for a majority of the financial intermediation and are a primary source of funding for individuals and companies, the terms banking crisis and financial crisis are used interchangeably.
Why do banks fail?
Banks fail due to inadequate corporate governance, weak risk management or a lack of risk diversification or lending concentrations. In 1993, eleven (11) financial institutions in Kenya were placed under liquidation. In a reported case study of Charterhouse Bank (put under receivership in 2006), the practical manifestations of these causes were: A flouting KYC procedures created in line with the Proceeds of Crime and Anti-Money Laundering Act and the CBK Prudential Guidelines which require banks to report suspicious transactions to CBK; Disregarding the laws which prohibit lending in excess of 20% of the institution’s core capital to any one insider and their associates; and Disregarding conflicts of interest in the Board – The CBK Prudential Guidelines require directors, chief executive officers and the management of a bank to declare any financial interest in customers of the bank in order to reduce or eliminate conflicts of interest. It also prohibits directors, chief executive officers and management from granting any advances, loans or credit facilities which are not fully secured to any of its officers, significant shareholders or their associates. Recent bank collapse such as Dubai Bank, Imperial and Chase Bank have been reported to be as a result of fraud and insider trading.
In Kenya which entities have regulatory oversight over unstable banks?
In Kenya, the Central Bank of Kenya (“CBK”) and the Kenya Deposit Insurance Corporation (“KDIC”) have oversight of banks and other financial institutions before and during financial distress. Generally, KDIC acts in its corporate capacity by providing deposit insurance to member banks and performs certain regulatory functions. The primary laws governing bank insolvency in substance and procedure include the Banking Act (Cap 488, Laws of Kenya), the Central Bank of Kenya Act (Cap 491, Laws of Kenya) and the KDI Act.
What is CBK’s role in instances of financial distress of a financial institution?
Primarily, CBK’s role is pre-emptive of bank collapse and still limited to its regulatory or supervisory mandate. CBK has a broad mandate of regulatory inspection of financial institutions’ books accounts and records under section 32 of the Banking Act. These inspection powers are repeated under the KDI Act but are exercisable at the request or instance of the KDIC. CBK also has powers under section 32A of the Banking Act to assess moral fitness of office holders in financial institutions together with powers to disqualify them from holding posts upon unfavourable assessments. Under the Banking Act, CBK has powers to advise and give direction on the management of financial institutions where this falls foul of the law (cases of malpractice or regulatory violations) and issue corrective guidelines for implementation by the institution. Section 33A gives the CBK powers to, inter alia, restrict or prohibit dividend pay-outs; suspend or remove officers or order the institution to submit a capital restoration plan within 45 days. Also, CBK in its role as lender of last resort may intervene to provide liquidity to avert bank failure. Generally though, lender of last resort facilities are only extended to financially sound institutions as short-term loan on overnight basis and at punitive rates.
What is KDIC’s core mandate?
In Kenya, KDIC: i. acting as receiver (Section 44 (2) (b) of the KDI Act) of a failed bank, inter alia, takes over the running of the bank; ii. acting as a liquidator (section 54 of the KDI Act) determines the claims of depositors as well as liquidating a failed bank and winding up its affairs; and. iii. acting in its corporate capacity (section 5 of the KDI Act), assures that those depositor claims are satisfied.
Kenya’s formal financial system comprises about 39 commercial banks currently. Over 37 banks have failed since the eighties. In part two of our next article, we shall explore the role of Kenya Deposit Insurance Corporation in receiverships and liquidations.
If you have questions on this article, please reach out to Divinah Ongaki (dso@smc-legal.com).