Brace Yourself for Economic Slowdown as Chase Bank Reopens
Chase bank will reopen on 27th April 2016 under KCB as the manager appointed by Kenya Deposit Insurance Corporation (KDIC). Reopening of Chase bank news was well received in the financial markets as it may ease liquidity constraints that have plagued the local market.
Chase bank was placed under receivership on 7th April 2016 after experiencing internal corporate governance issues. Though the bank will reopen this Wednesday, impact of the receivership may last for several months in the local economy.
To understand the expected effects, we have to analyze current liquidity status of the Kenyan banking sector and how it will affect the overall performance of the economy. Liquidity can be termed as the ability of an institution to meet its current obligations as they fall due. Liquidity has been tight in the banking system since Chase bank was placed under receivership. Central Bank of Kenya introduced a liquidity support frame work on 11th April 2016 to boost market liquidity and ease anxiety in the financial sector.
The liquidity framework support did little to ease liquidity constraints since the regulator used the same financial tools to manage market liquidity. Market liquidity remained highly skewed as few banks had extremely high liquidity while other banks had extremely low liquidity. The liquidity skewness can be observed from the Repo, Reverse Repo and interbank market transactions. The reverse repo market is a market where commercial banks can borrow money from the Central bank whenever they have a shortage of cash while the repo market is a market where banks can park excess funds with Central Bank. Interest rates in both markets are determined competitively by the participants.
Central Bank of Kenya (CBK) offered 33 billion shillings in the reverse repo and 50 billion shillings in the repo market over the last two weeks. Market uptake was 18 billion shillings in the reverse repo and 50 billion in the repo market. The average rate in the reverse repo market was about 5.5% whereas in the repo market it was about 12.5%.
Looking at the above data, participation in the repo market was higher than in the reverse repo market. CBK injected a total of 18 billion shillings and mopped up a total of 50 billion shillings in the local market. This indicates that there is sufficient liquidity in the market but it is extremely skewed. Some commercial banks would prefer to lend to the Central bank at an average rate of 5.5% while other banks are borrowing from the Central Bank at 12.5%. The regulator clearly makes an arbitrage profit of 7% (12.5% less 5.5%) from borrowing and lending of commercial banks activities on its window.
The arbitrage opportunity can be explained by the inactivity in the interbank market. The interbank money market is a market where banks extend loans to one another for a specified term. Average number of transactions decreased from 30 transactions a day to 7 transactions a day after Chase bank was put under receivership. The volume transacted also decreased significantly from over 20 billion shillings per day to under 10 billion shillings per day. The graphs below depict the visual decline of the volume and number of transactions in the interbank market.
The blue line indicates date when Chase bank was put under receivership. We can note that the volume traded significantly declined after the receivership.
The black line indicates receivership of Chase bank. The number of transactions fell from over 20 transactions to under 10 transactions per day.
You must be wondering how all this would affect the economy. Let me quell your curiosity by explaining how tight liquidity affects the general economy. Tighter liquidity means that banks would lend less money to the economy. The local economy is debt driven because businesses require loans from banks to expand. With banks giving minimal loans due to high liquidity risk in the interbank market, businesses would expand at a slower pace hence the general economy would also expand slowly.
Liquidity constraints would also reduce money supply in the general economy. This means that individuals would have less money to spend. Less spending would lead to decreased consumption and production. All this would cumulate to slower growth in the economy.
Hope that the market confidence returns is the only light at the end of the tunnel for the economy. Chase bank may reopen and get back to business quicker than market expectations hence the markets may reverse and start to boom. Political risk would now be the only impediment to the growth of the local economy as we near general elections.
Also Read: Kenya Unemployment Reality Check