Dubai Bank: Small lender whose fall has huge impact in the industry

Dubai Bank’s collapse is not good for the banking sector and the failure of any lender should not be viewed as just any other ordinary event.

Inasmuch as Dubai Bank was very small and presented very little systemic risks — at the close of the first quarter it only accounted for a paltry 0.2 per cent and 0.1 per cent of total industry risk-weighted assets and total customer deposits respectively — as at early March 2015, signs of imminent collapse were written all-over the wall.

First, with a core capital of Sh1.06 billion, the bank was too close to the regulatory threshold and had no prudential buffers.

Second, the bank’s liquidity ratio was 9.6 per cent, well below the minimum of 20 per cent, which meant that it could not cover all its short term liabilities as and when they fall due.

Thirdly, the quality of its asset book was just horrible, with a non-performing loans (NPL) ratio of 76 per cent, almost reminiscent of the 1980s.

I can’t remember seeing a bank with such humongous levels of non-performing customers in Kenya in the last one-and-a-half decades. Finally, the bank’s aggregated loans-to-deposit ratio hovered at a whopping 164 per cent, way beyond the prudentially recommended levels of 75 per cent.

Loans-to-deposit ratio is a key measure used, both internally and externally, to monitor a bank’s ability to consistently fund its asset book. Clearly Dubai Bank wasn’t able to do so and it appears to me that the bank survived on the unsecured overnight interbank cash market for its liquidity needs.

I’m alluding to this fact because I’m certain that the Central Bank of Kenya’s (CBK) swift liquidation was partly triggered by a move by most banks’ decision to suspend interbank lending to Dubai Bank thereby technically rendering it insolvent.

Of course the other reason was the fact that the bank had accumulated CBK penalties amounting to Sh5.4 million after failing to comply with the daily cash reserve ratio (CRR) requirements for a period of one month. A breach of the daily CRR threshold attracts a penalty of one per cent of a bank’s daily cash reserve requirements.

The signals aside, here’s why I think Dubai Bank’s collapse is not good for the banking sector. It will erode depositors’ confidence in the mid and smaller tier banks thereby weakening their deposit franchises.

There is nothing more important to a bank than liquidity, not even profitability. If a bank is profitable but illiquid it will collapse.

Imminent collapse

Therefore, if a bank’s liquidity generation structures and capabilities are weakened it will struggle to survive, and by survival I mean being able to fund its core activities at the right cost.

Consequently, banks in the same tier as Dubai Bank will have an uphill task in renovating the trust between them and their depositors.

Additionally, Dubai Bank’s collapse, to a moderate extent, will also weaken the public’s confidence in the regulatory pre-emptive capacity; basically, with all the signals of an imminent collapse written all over, could it have been prevented before it occurred?

This event also corroborates Treasury Cabinet Secretary Henry Rotich’s view that commercial banks’ minimum balance sheet strength should be raised, ostensibly to weed out non-competitive balance sheets from the market.

Otherwise, I can mention four or five more banks that will require very close regulatory monitoring.