The skewed distribution of liquidity that has hit small lenders can be resolved by reviving the platform for banks to lend to each other using government security holdings as collateral, money market experts say.
Mortgaging of treasuries and allowing sale in case of default will make smaller banks relatively risk-free, a de-risking that is very important given the jitters from recent collapse peers.
This type of lending, technically known as horizontal repo, has hardly been used by Kenyan lenders who instead rely on the overnight or interbank market to satisfy short-term cash demand, as well as the vertical repo that sees banks borrow from the Central Bank of Kenya (CBK) using securities as collateral.
Eleven fund managers, economists and treasury dealers surveyed by HTM Capital say while the CBK has been active in trying to redistribute liquidity in the market, this role is distorted by the regulator’s role as the fiscal agent, which sometimes calls for withdrawal of liquidity at the same time.
“The break-down of market driven liquidity distribution via the interbank is mainly not working because of counter-party risk concerns. Until when market players are confident to lend to each other, the CBK’s intervention in restoring the market mechanism is limited,” says HTM in the report.
“The market can develop the horizontal Repo market for banks to freely share liquidity…a medium term objective to restore a market-driven mechanism is to address the structural issue of a segmented interbank market.”
The liquidity in the market has traditionally been skewed in favour of the large lenders. In recent months they have been reluctant to lend to smaller counterparts following the collapse of three banks in 2015 and 2016 and the introduction of a rate cap which has hit smaller lenders’ margins.
This lack of access to the interbank market is also forcing the smaller lenders to take up other types of expensive credit, which hurts profitability.
The horizontal repo market was launched in 2008 and was meant to encourage banks lend more to each other to rebalance the liquidity in the sector.
In the past, experts have called for reform of the horizontal market to allow the lending bank to sell the security in case of a default by the borrower.
Currently banks use Treasury bills and bonds as security for horizontal repos but are not allowed to sell on default.