CBK should embrace a tighter liquidity measurement system
The Central Bank of Kenya building in Nairobi. PHOTO | FILE
What you need to know:
Usually, rumours touching on a financial institution’s (in) solvency are never pleasant because they could trigger a run on the institution at the very instance.
A run can quickly evaporate its liquidity. And the rest becomes history. But here’s the bad news: there are just not enough measures that can insulate a bank from a rumour-triggered run.
Over the past week, rumours have swirled on social media about financial ill-health of some banks.
Although they still remained unverifiable even at the time of my writing, they were triggered by various circumstances.
Some of the affected banks have had to come out strongly to reassure customers that everything is normal.
After all, banking is all about confidence. Usually, rumours touching on a financial institution’s (in) solvency are never pleasant because they could trigger a run on the institution at the very instance.
A run can quickly evaporate its liquidity. And the rest becomes history. But here’s the bad news: there are just not enough measures that can insulate a bank from a rumour-triggered run.
However, fully aware of that fact, I still think the current liquidity measurement regime needs some overhaul. It does not inspire confidence. At the moment, banks in Kenya measure their liquidity positions by discounting current liquid assets against current liabilities.
The regulator, in turn, has set the minimum ratio at 20 per cent to be met at all times. With such a framework, no bank, in my view, can withstand a severe liquidity stress, and we saw it with Chase Bank early this year.
Here’s why I say so: liquid assets are divided into two categories: one, encumbered assets — which can never be liquidated on demand. And, if you do liquidate them, you will have to take a haircut. For instance, government securities are encumbered because a bank will never be able to liquidate its portfolio of securities on demand. And the haircut would come through a process referred to as rediscounting.
The same principle applies to corporate bonds. In fact, for a corporate bond, unless the issuer’s cash-flow position significantly improves and decides to redeem its debts, you may never be able to redeem it. However, there’s the secondary market for such papers.
Well, the current set up of the secondary market, to me, has its own negative dynamics that may not enable a distressed institution access liquidity at the shortest notice possible.
Two, unencumbered assets—which can be liquidated on demand and the bank doesn’t need to take a haircut. They include such items as cash in the bank’s vault and clearing accounts at the central bank, nostro accounts and overnight placements in the money markets.
For me, these are the only assets that qualify to be christened as liquid. I have a problem with the inclusion of encumbered assets into the bucket of liquid assets. It does not paint the true liquidity picture of a bank.
LCR framework
Consequently, I am urging the Central Bank of Kenya (CBK) to consider introducing the liquidity coverage ratio (LCR) framework.
The framework is a harmonised global liquidity standard advocated by the Basel Committee on Banking Supervision.
This is a group of international banking authorities that works to strengthen the regulation, supervision and practices of banks globally. One of their main roles is to issue supervisory frameworks to regulators worldwide on various aspects of supervision. They do this by issuing documents containing guidelines.
The LCR framework was part of the guidelines issued in a document named the Third Basel Accord (or commonly referred to as Basel III). The LCR framework took effect on January 1, 2015.
While regulators retain the full discretion on when to adopt such guidelines, I think CBK should consider adopting them, especially after the events of 2015. It is a better liquidity measurement regime and could help inspire confidence in as far as a bank’s short-term resilience to liquidity shocks is concerned.
And its workings are very simple: what the regulator is always looking out for is a bank’s ability to cover for its liabilities as they fall due — on a 30-day basis. Actually, it is intended to promote resilience to potential liquidity disruptions over a thirty-day horizon.
And a bank needs to demonstrate that it has adequate central bank eligible unencumbered liquidity assets for coverage purposes. The coverage ratio should be 100 per cent at all times. This, to me, is the only way I can put my fears to rest when a bank comes out to reassure me.
