An interbank liquidity crunch pushed banks to borrow a record Sh40 billion from the Central Bank of Kenya (CBK) in six months to December last year.
A CBK report shows that advances to commercial banks rose from Sh71.8 billion in June last year to a record high of Sh111.7 billion by end of December.
The interbank market for foreign currency has been muted, with analysts blaming it on fresh market restrictions by the central bank, which has been keen to curb speculation in the foreign exchange market.
The interbank liquidity crunch partly triggered a biting dollar shortage, with the CBK forced to intervene to stabilise the market.
“Advances to commercial banks partly resulted from open market operations that remained active during the period,” said the CBK in its Quarterly Economic Outlook for the period between October and December 2022
Open market operations are conducted by the CBK to either increase or reduce money in the financial system.
Through the open market operations, achieved through the repurchase agreements of Treasury Bills and Bonds, the CBK provides temporary liquidity by temporarily holding a security on behalf of the commercial bank for cash with an agreement to buy it back in the future at a pre-determined price.
Advances to commercial banks consist largely of repurchase arrangements and emergency loans from the banking regulator for banks facing a temporary cash crunch.
“I would say they [the advances by CBK to commercial banks] are understandable given the interbank crunch and dollar shortage,” said Deepak Dave, the founder of Riverside Capital.
“Worth commenting that such rises normally mean the market was misbalanced temporarily, which often leads to a knock-on effect in the FX [foreign exchange] market.”
Without the intervention of the CBK, Mr Deepak said, things would have been worse for the foreign exchange market.
Because the CBK is a lender of last resort, banks have to first get such short-term cash from other banks in what is known as the interbank market.
Last month, following a directive by President William Ruto to the CBK to revive the largely dormant forex interbank market, the regulator came up with a foreign exchange code to infuse discipline in the trading of hard currencies.
The foreign exchange code, among others, prohibits banks from engaging in trading practices, quoting prices or making transactions with the intention of manipulating price movements or disrupting the functioning of the market.
Some experts have attributed the increase in liquidity support to banks starting in the second half of last year to a jump in non-performing loans (NPLs), with a lot of them forced to dip into their profits to provide for possible defaults.
An analysis of the nine top banks’ balance sheets in the year ended December 2022 shows loan-loss provision costs grew by nearly a quarter to Sh75 billion from Sh60.1 billion in 2021.
Starting in June last year, the availability of cash in the financial sector reduced, with the total liquidity ratio dropping from a high of 58 percent in July 2021 to 50.8 percent in December last year, according to CBK data.
Total liquidity ratio— a measure of the ability of a company to pay off its short-term liabilities—dropped further to 50.7 percent in January this year.
“Liquidity has been quite tight over the past year. If I focus on Q3 and 4 thereabout, liquidity was centred on T-Bills as well as lending to the private sector, hence the rise in private sector credit,” said a research analyst with one of the investment banks who also asked not to be named in the story.
The increase in the overnight lending by the financial regulator surged in the third quarter of last year when Kenya was in the middle of elections, which forced investors to adopt a wait-and-see approach.
Besides the election jitters, the economy was also buffeted by a myriad of shocks, including sky-high inflation in the wake of Russia's war with Ukraine and the worst drought in 40 years that hit the dominant agriculture sector.
A hike in interest rates by central banks in advanced economies — which triggered a massive capital flight from emerging and frontier economies — also resulted in tight liquidity in the global financial markets.
The advances to commercial banks captured in the CBK’s report do not give a breakdown of the composition of these assets.
However, an analysis of the CBK's previous financial statements shows that repurchase agreements of Treasury bills and bonds and liquidity support framework constitute over 86 percent of the regulator’s advances to commercial banks.
By June 2022, the emergency loans from the CBK to banks—consisting of repurchase arrangements and liquidity support framework—stood at a record high of Sh78.9 billion, and surpassed another record of Sh66.4 billion, the CBK’s financial statements disclosed.
The growth was mainly due to increased injection to banks through repurchase arrangements, with Repo Treasury bills and bonds increasing to Sh27.8 billion in June last year from Sh10.96 billion in the same month in 2021.
However, the outstanding balance under the liquidity support framework dropped to Sh51 billion in the year to June last year from Sh55.5 billion in a similar period a year earlier, signalling reduced financial stress in the period.
The liquidity support framework, also known as the lender of last resort (LOLR), was introduced in April 2016 following the placement of Chase Bank under receivership due to its inability to meet its financial obligations.
Two other banks, Imperial Bank and Dubai Bank, collapsed earlier, triggering panic withdrawals from small banks.
There has been little disclosure on banks that have tapped from the liquidity support framework.
However, in 2021, the Co-operative Bank of Kenya revealed that the CBK handed Kingdom Bank, formerly Jamii Bora Bank, a Sh20.96 billion emergency cash lifeline in the previous year to rescue the small lender from a liquidity crunch and fading customer confidence.
Co-operative Bank of Kenya—which acquired a 90 percent stake in Jamii Bora Bank for Sh1 billion in August 2020 and renamed it Kingdom Bank — revealed the CBK loan facility that saved the small lender from an imminent collapse.
