Risks posed by KCB, Equity expansion


Equity Bank branch on Muindi Mbingu Street in Nairobi. FILE PHOTO | DENNIS ONSONGO | NMG

Both KCB Group and Equity Group Holdings have ramped up their pan-African ambitions, with the DRC being the latest addition to both banks’ geographical footprint.

Equity Group has a presence in six countries while KCB Group now operates in seven countries and they both have disclosed plans to expand further beyond current coverage.

Both banks have also employed the subsidiarisation approach where subsidiaries are fully owned and maintain individual balance sheets.

While the expansion agenda not only elevates their regional profiles, it also invites systemic risks in their home markets.

Specifically, Kenya, being the home market for both banks, held a third of customer deposits and a quarter of total assets at the close of 2022.

And apart from holding domestic credit and market risks, their balance sheets also carry additional cross-border risks, namely (i) sovereign-since they hold domestic debts in those cross-border subsidiaries; (ii) political risks-since the cross-border subsidiaries operate in countries with varying political dynamics; and (iii) foreign currency risks-since they report in home currency.

And because of intra-group linkages, if a subsidiary in one part of its presence faces difficulty, the transmission into markets with systemic importance can be quite quick.

For instance, if Equity’s operations in the DRC run into an existential threat (such as a run on deposits), the transmission into its other affiliates can be quite quick. The same applies to KCB Group.

They present significant systemic risks to domestic financial stability, largely due to their large balance sheets, regional presence and interconnectedness.

Essentially, they are too big to fail. Consequently, these two banks need to be declared as domestically systemically important banks (D-SIBs) by the Central Bank of Kenya (CBK), the home regulator.

Such a declaration fits well with the risk-based regulatory approach where ‘the bank that takes more risk should have more capital’.

By being declared as D-SIBs, they will be asked to put in place higher loss absorbency capabilities, by way of fortifying their balance sheets through higher capital adequacy and liquidity coverage ratios.

Additionally, they will be subject to robust stress testing and more frequent on-site supervision.

Specifically, the D-SIBs should be asked to set aside a much higher loss absorbency (HLA) by way of an additional capital surcharge of a percentage to their respective minimum required capital adequacy levels, which should be met with shareholder funds through the Common Equity Tier 1 (CET1) capital.

Further, the following regulatory impositions should be put in place: (i) higher liquidity coverage requirements that are subject to change from time to time; (ii) quarterly stress testing on capital and liquidity; (iii) they must develop specific annual recovery plan; and (iv) make quarterly disclosures of their financial condition and risk management activities as may be prescribed by CBK.

Another concern revolves around the fact that these banks consolidate their operations under non-operating holding companies (HoldCos).

And due to the lack of robust supervisory oversight of holding companies, disclosures on intra-group exposures, especially cross-border transactions, in itself pose a risk.

This is probably exacerbated by the fact that cross-border resolution mechanisms aren’t robust enough. Consequently, this calls for a regular convention of supervisory college meetings for supervisors across the seven markets in which the two banking groups operate.

In 2021, the Central Bank of Kenya convened a meeting of supervisors in which the two banking groups operates.

It also conducted an assessment of the legal and regulatory frameworks and supervisory practices in the seven jurisdictions.

For the East African Community members, there was convergence. However, there is a need to continually monitor the other non-converging jurisdictions.

Additionally, as the two banking groups expand beyond the EAC region, the CBK will have to expand its working arrangements with the host regulators, specifically focusing on host country assessments.

There is also the inability of the regulators to administer fit-and-proper assessments on shareholders (and directors) at the Holdco level, again due to a lack of robust supervisory oversight of holding companies.

The writer is a thought leader.