Commercial banks hold foreign currency in two forms; as customer deposits and as reserves. According to data from the Central Bank of Kenya (CBK), commercial banks held Sh945.3 billion in foreign currency deposits at the end of January.
At the same time, the banking industry had Sh467.6 billion ($3.553 billion) as foreign exchange reserves at the end of last year.
The CBK requires commercial banks to keep a specified proportion of their total deposits at the reserve bank.
This proportion, which includes part of foreign currency deposits by customers, is termed the cash reserve ratio (CRR).
This ratio is currently set at 4.25 percent of the total of a bank’s domestic and foreign currency deposit liabilities. The cover is used to facilitate banks’ liquidity management.
How do banks earn and build foreign currency reserves?
Banks primarily earn foreign exchange through forex trading. Banks will, for instance, charge a customer when buying foreign currency, either through a commission or through the rate offered to the client which is mostly lower than the prevailing market rate, providing a profit opportunity for the buying bank.
Banks will also charge a client when selling foreign currency to earn a margin denominated in a foreign currency.
What is the difference between commercial banks’ foreign currency reserves and the CBK’s foreign reserves?
Commercial banks’ foreign currency reserves represent an obligatory cover prescribed by the banking sector regulator to cushion against potential FX liquidity shocks and are usually a percentage of foreign currency deposits held by customers.
Meanwhile, CBK foreign exchange reserves are a national asset held as a safeguard to ensure the availability of foreign exchange to meet the country’s external obligations, including imports and external debt service.
What’s the minimum banks can hold in foreign currency reserves?
The CBK requires banks to hold at least 4.25 percent of their total deposit liabilities as reserves in their vaults.
Commercial banks are currently required to maintain their CRR based on a daily average level from the 15th of the previous month to the 14th of the current month and should not fall below a CRR of three percent on either of the days.
The guidelines are, however, unclear on whether banks are expected to specifically match the reserve ratio to outstanding foreign currency deposit liabilities.
Can banks keep foreign currency reserves in excess of the CBK requirements?
Commercial banks typically keep reserves in excess of the cash reserve ratio.
For instance, banks’ foreign currency reserves as of the end of December 2022 would be above the reserve ratio requirement.
The Sh467.6 billion in reserves was equivalent to more than half of the Sh945.3 billion foreign currency deposits held in bank vaults.
Why has it been difficult to obtain dollars from banks even with the significant holding of foreign currency as both reserves and deposits?
Volatility in the local exchange rate across 2022 saw many of the foreign currency depositors hold on to hard currency with a view of making gains from a weaker local exchange rate.
Traditionally, hard currency earners, including exporters with no requirement for foreign exchange, have sold forex to banks, allowing the lenders to shift the same deposits to meet forex orders.
With volatility, however, many of these depositors, according to correspondence from banks, have opted to store away forex, cutting off a key supply for foreign exchange flows into the market and driving dollar shortages as seen in the past year.
Can banks be forced to sell foreign currency to meet demand in light of documented shortages?
The CBK would only influence the increased supply of money/foreign exchange via the cash reserve ratio where a lower requirement (lower cash reserve ratio) would prompt banks to dispense foreign currency from their forex vaults at the CBK serving to ease part of the foreign currency availability concerns.
Current provisions would, however, not allow the CBK to order banks to sell forex from deposits as the store of hard currency belongs to customers and not the banks.
