Why CBK may not let Chase Bank Follow The Imperial and Dubai Bank route
The Kenyan financial sector has been experiencing turmoil since mid last year due to various internal and external factors. For those who have been in the dark, let me bring you up to speed on the current status of the financial sector.
Kenyan interest rates hit a four year high of over 20% late last year in both short term and long term debt due to shift in global market expectations. The situation was not helped by liquidation of Imperial and Dubai bank which added liquidity constraints in the already strained local market.
Liquidity can be defined as the ability of a financial institution to meet its current obligations when they fall due. Banks don’t always hold as much money as they have collected in deposits and savings from clients hence they have to borrow in the interbank market to cover for large withdrawals by clients.
The interbank market is a market in which banks extend loans to one another for a specified duration of time. Most interbank loans are for duration of one week or less, the majority being overnight. Such loans are made at the interbank rate which is determined by banks.
Closure of Imperial and Dubai bank caused skewness in the local interbank market. The reasons for closure of the banks have been largely articulated, what has been left is their impact in the financial sector.
The skewness resulted in some banks having excess cash while other banks having little cash. The situation could not be salvaged by the interbank lending market because banks had lost faith in one another and no one would risk giving cash to the other bank from fears that it may collapse.
The Central Bank of Kenya intervened by pumping in cash into the local market to avoid collapse of another bank. Though no other bank collapsed, the impact of the closure of Imperial and Dubai banks was devastating to the economy.
Most of the impact from interest rate increase and liquidity skewness can be observed now as banking institutions release their last year financial results which indicate reduced profits or outright losses like in the case of National and Chase banks.
The reduced profits or losses can be traced back to increased interest rates and liquidity tightening in the local market which caused a chain effect affecting the general economy. Since the government was taking expensive money in government debt (over 20% interest), investors demanded higher return from their deposits and savings to match the risk free rate of over 20% offered by the government. In turn, banking institutions increased the rate on loans (some banks increased loan rates up to 30%) to compensate for overhead costs and risk premium associated with a borrower.
The increase in loan rates resulted in increase in loan defaulters, reduced business growth and tight money supply in the general economy. Most of you may have experienced the slowdown in Kenyan economic performance late last year and early this year especially those who are in business.
Banks had to adjust their provisioning for bad loans in anticipation for more defaulters hence booking less profits or losses at end of year.
Now that you are up to speed, lets answer the big question “Will Chase Bank collapse?” .I will start by stating that booking a loss for a bank is not an unusual event. The issue arises when the bank cannot be able to meet its obligations when they fall due. This can only happen when there is a bank run (a bank run is a situation where every client wants to withdraw his/her cash from the bank) or the banks’ loses wipes out its capital.
Since Chase Bank is not facing any fraudulent allegations like Imperial Bank, the losses may be covered by the regulator asking the shareholders to inject more capital into the bank. The regulator had given Dubai bank the same option some time back though it did not work out as the shareholders refused to increase the core capital. This case may not arise with Chase bank considering Dubai bank had other underlying issues.
The other supporting argument is that the market is already spooked by the closure of two banks in less than a year period. The regulator cannot afford the loss of another banking institution which may completely erode confidence in the Kenyan financial sector. The facts must be beyond reasonable doubt for the regulator to take such a move.
With that I rest my case that Chase Bank is here to stay and that the recent events are only bumps in its financial prosperity as an SME banking power house.