CBK moves to shield shilling with new forex trading rules

The Central Bank of Kenya has introduced new forex trading rules that could cut by up to half commercial bank earnings from the lucrative line of business.

All forex transactions would have to be backed by commercial activity when the guidelines come into force.

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The move is aimed at eliminating trading on currency volatility — commonly known as margin trading.

“To the greatest extent possible, all foreign exchange transactions should be supported by the underlying commercial activity,” the guidelines say.

This means that forex dealers will, for instance, be discouraged from trading in currency unless such a deal is backed by an order from an oil importer.

Ordinarily, currency trading among banks involves taking a position in the market that is seldom backed by an underlying commercial activity but is driven by interpretation of market information and its possible impact on the currency of interest.

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Forex trading has become a critical earnings driver for commercial banks and grew by 55.6 per cent last year to account for Sh19.3 billion of the industry’s total income compared to Sh12.4 billion in 2010.

The quest for control of this key revenue stream has sparked a vicious talent war for currency trading experts among banks and positioned some lenders as dominant players in the forex market.

The Kenya Bankers Association said it understood where Central Bank was coming from, citing the depreciation of the shilling last year, but said it was going to seek clarification on the meaning of commercial activity as its blanket application could hurt trading.

“The CBK may be seeking comfort that forex trading is not being abused,” said Habil Olaka, the chief executive of KBA.

“As long as one is able to show that there is no abuse and measures have been taken to cover any loopholes the regulator should listen because blanketing the whole issue would hurt trading.”

Mr Olaka said that in the event of a blanket ban on trading not backed by commercial activity, the challenge will be in determining what constitutes commercial activity because bank transactions ordinarily includes hedging and balancing of the books to meet regulatory requirements which may arguably pass as commercial activity.

Currency traders, who spoke on condition of anonymity to avoid antagonising the regulator, opposed the guidelines, saying that the rules would hurt earnings and force them to load higher margins on clients to cover for lost business.

“Taking a view in the market is not a crime; every market is based on a view.

They may be trying to protect the shilling but putting a ring fence around it won’t help because it will still be traded against other assets,” said one trader.

Analysts said placing big margins on customer trades would only add volatility to the Kenyan currency.

However, one trader supported the regulator’s move saying it is meant to scrutinise proprietary trades to ensure banks are protected.

Use of words such as “to the greatest extent possible” in the regulations means that the CBK is leaving room for banks to play the role of market making by trading the currency among themselves to ensure liquidity.

“It brings more scrutiny to proprietary trading which is necessary to avoid recklessness,” said the source even as he agreed that additional layers of scrutiny would affect the volume of transactions, and if not checked, hurt market liquidity.

The new guidelines, which will come into force in January, also bar dealers from conducting two consecutive trades with the potential of moving the market.

“Market manipulation practices include insider dealing and deliberate attempts to interfere with the market’s free and fair operations, including carrying out two or more concurrent or succeeding foreign exchange deals or transactions that have or are likely to have the effect of altering or maintaining the ruling exchange rate with the intention of influencing the decision of others to either participate in a deal or otherwise,” the guidelines say.

The real import of this rule is, for instance, that a bank cannot serve two big clients seeking to trade huge volumes of currency.

Such trades usually give the dealers leverage to demand better deals than the market rate.

Market data shows that traders such as oil importers make orders of up to $35 million forcing traders to push the market for attractive rates to secure the transaction.

“As long as we stay committed to the workings of a liberalised economy, the CBK should let fundamental supply and demand forces to guide the market,” said another trader.

Action will also be taken against any dealer who makes a false impression of active trading to move the market or carries out fictitious forex deals that influence the currency position.

Exchange rate turbulence at the end of last year has seen the Central Bank introduce measures to curb speculative trading that governor Njuguna Ndung’u said was responsible for the depreciation of the shilling to an all-time low of Sh107 to the dollar in October.

The list of measures the CBK has introduced includes the capping of the amount of foreign currency banks can hold at 10 per cent of their core capital from the current 20 per cent.

This had the effect of cutting by half the amount of cash available to traders for forex dealing, ultimately denying them idle funds for speculative trading.
The regulator has also extended the period international banks can lend to their local subsidiaries to a minimum of one month to ensure that the funds credited to local operations is not used for short term speculation.

The weakening of the shilling against major world currencies at the end of last year was seen as partly responsible for the steep rise in the cost of living during the same period.

The decline made CBK the subject of a parliamentary investigation.

Apart from monetary policy action, the stability of the shilling is seen to depend on fiscal measures relating to the unfavourable balance of payment position that has continued to rise, driven by the rising fuel bill and importation of heavy machinery for infrastructural development.

The middle class’ rising demand for luxury goods has also raised the imbalance requiring policies that discourage it and boost demand for local products.

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