The Central Bank of Kenya (CBK) has put forward a new guideline to strengthen commercial banks without having to raise capitalisation to the Sh5 billion proposed by the National Treasury in the latest Budget.
While the CBK does not propose a particular capital figure, the guideline implies banks that do not have enough free cash to cover the risks will have to ask shareholders to inject new money.
Currently, the law requires banks to only keep at least Sh1 billion in core capital, but the Treasury secretary has proposed to raise this to Sh5 billion, arguing that it is intended to make local financial institutions stronger to the point of being able to expand in the continent and withstand adverse business climate.
The CBK guideline note on international capital adequacy assessment process (ICAAP) has been put out for comment by banks and other stakeholders in the next 30 days.
“All institutions are required to develop an ICAAP policy that ensures that overall internal capital levels are adequate and consistent with their strategies, business plans, risk profiles and operating environments on a going concern basis,” the CBK said in a statement.
The proposal to introduce ICAAP also comes at a time the regulator is gearing up to conduct stress tests on the institutions. The guideline says banks should formulate their capital adequacy strategies in line with the results of the stress tests, which also come after collapse of three banks in the nine months to April.
The banking industry will be joining the insurance sector which has already decided to keep capital based on risks rather than just meeting the minimum levels.
Banks have been given a free rein to determine how they will conduct the risk assessment and determine the capital that is adequate for them.
“[The] CBK recognises that there is no single correct approach to conducting the ICAAP. As such, the focus of CBK is on providing high level guidance rather than prescriptive criteria on ICAAP methodologies or techniques that should be employed. Institutions should design their ICAAP to cater for their individual needs and circumstances,” said the CBK.
However, the regulator will evaluate the extent to which each bank has kept its ICAAP reasonable once it is completed and submitted. The CBK may require a bank to take certain actions on capital and risk management on the basis of its ICAAP.
“Based on these reviews, the Central Bank may require any bank to, among other things, take action to improve its capital and risk management processes if it is not satisfied with an institution’s ICAAP,” said the CBK.
Each bank is supposed to evaluate market, credit and operational risks in determining the capital it should keep.
Other risks outlined in the guideline are exposures to groups of connected borrowers or those in the same economic sector or geographic region. Interest rate risk — arising from potential changes in the price of money — must also be considered as is reputational risk whereby profits can decline should customers or shareholders take a negative view of an institution. The institutions will have up to March of every year to submit the ICAAP, taking account of the previous financial year ending December 31.
“On an annual basis, banks shall, not later than the end of March, submit to the CBK their ICAAP report as at 31st December of the previous year…The report is transmitted to the CBK along with the relevant board resolutions and senior management reports containing their comments on the ICAAP,” said the guideline.