Two commercial banks breached a Central Bank of Kenya (CBK) insider lending limit rule last year by giving loans to internal parties in excess of their core capital.
Each bank is required to have a core capital of at least Sh1 billion, with the funds forming an institution’s permanent capital.
The law prohibits banks from issuing credit facilities that are unsecured or provided to insiders such as employees, directors, and shareholders and which cumulatively exceed the core capital.
The rule is designed to avoid insider dealings that can expose an institution to collapse, hurting depositors and other parties.
“Two commercial banks were in violation of Section 11(1) (g) of the Banking Act as they exceeded the total insider borrowing limit of 100 percent of core capital, breaching the limits placed on lending to a single borrower,” the CBK says in its newly published 2021 bank supervision report. The regulator did not name the lenders.
Though the CBK withheld their identity, they are likely to be private institutions.
The publicly traded banks have core capital far exceeding the Sh1 billion threshold and their lending to insiders represent a fraction of the permanent capital.
Lending out amounts representing the entire core capital to insiders is tantamount to withdrawing the cash that is critical in backing an institution’s risk-taking business.
Banks usually take a substantial part of deposits and lend to some customers, with some of the borrowers defaulting. To manage the risk to depositors’ funds, the institutions are required to have a core capital and other additional buffers.
Insider loans are among the multiple breaches that occurred in the banking sector last year.
The CBK in total flagged nine banks for non-compliance with various rules, compared with 13 in 2020, largely due to failure by owners to raise fresh capital in a depressed economy battered by Covid-19 shocks. Some institutions had multiple offences.
“Appropriate remedial actions were taken on the concerned institutions by the CBK in respect of the violations,” the regulator said without specifying the enforcement actions.
Eight commercial banks were in violation of Section 10 (1) of the Banking Act as they exceeded the single obligor limit of 25 percent of core capital.
A bank must not lend more than a quarter of its core capital to one borrower or related borrowers in the rule known as single obligor.
The law states that the advances, credit facilities, financial guarantees and other liabilities of the borrower and his associates shall be aggregated for the calculation of their total value and the restriction shall apply in respect of that person and his associates.
Breach of the single obligor rule was the most widespread compliance failure last year, according to the CBK report.
“Most of the violations were in respect to breach of single obligor limit, mainly due to decline in core capital in some banks that have continued to report losses,” says the CBK report.
Five commercial banks were in violation of Section 12 (C) of the Banking Act and CBK prudential guideline on prohibited business, which restricts investment in land and buildings to 20 percent of core capital.
Two commercial banks operated below the minimum core capital of Sh1 billion last year in an environment where smaller banks have struggled to attract fresh cash injections.
Five commercial banks breached the capital adequacy rule for failure to meet the statutory minimum required ratio for total capital to total risk-weighted assets of 14.5 percent.
Four banks, on the other hand, failed to meet the statutory minimum required ratio for core capital to total risk-weighted assets of 10.5 percent.
Three commercial banks exceeded the single insider borrower limit of 20 percent of core capital.
One bank was in violation of a CBK prudential guideline an institution to maintain foreign exchange exposure at not more than 10 percent of core capital.
