IMF published its staff report and selected issues report under the 2018 Article IV consultation with Kenya. Directors commended the authorities for progress made in strengthening the banking supervision framework and encouraged continued efforts in this area. They saw merit in further measures to develop the bank resolution framework and risk-based anti-money laundering and combating financing of terrorism (AML/CFT) supervisory tools.
The staff report highlights that the interest rate controls have reduced bank profitability. The impact of interest rate controls on the performance of banking sector has largely fallen on smaller banks and does not pose a systemic risk at this time; however, with the system in aggregate remaining sound, the interest rate controls pose risks to financial stability if maintained for much longer. Non-performing loans (NPLs) have continued to increase and liquidity support by the Central Bank of Kenya (CBK) to banks remains relatively high. NPLs increased to 12.4% in April 2018, from 9.6% a year earlier. Banks and corporates appear relatively resilient to shocks in the corporate sector. Stress tests suggest that Kenya’s large non-financial corporations, which have enjoyed strong growth and profitability in recent years, are resilient to shocks and Kenya’s banks are resilient to corporate sector shocks. Even under extreme shock scenarios, banks would experience an increase in NPLs but would not experience a severe deterioration of capital levels
The report further notes the authorities continue to strengthen the banking supervision framework. Capital and liquidity positions of commercial banks and micro finance institutions have been improving. Specialized on-site inspections of banks’ ICT systems are being implemented, in addition to the IFRS 9 standards (although IFRS 9 will be phased in over a five-year period). CBK also recently issued a guidance note to banks on cyber security. Staff encourages CBK to continue to implement remedial plans for banks that are not compliant with capital and liquidity ratios, including requiring banks to present credible restructuring plans to restore prudential ratios in a time-bound manner. Additionally, the report mentions that the authorities are also making progress with AML/CFT reforms. Kenya’s financial supervisors are working to develop risk-based AML/CFT supervisory tools and to enhance the operations and procedures of Kenya’s financial intelligence unit, which should help to strengthen anti-corruption efforts. While reporting entities are being encouraged to undertake risk assessments for AML/CFT, Kenya has not yet conducted a national risk assessment, which would help to better understand AML/CFT risks.
The selected issues report states that a deteriorating environment for corporates in Kenya would have a negative impact on the banking sector. A number of assumptions are made to assess the potential impact of stress test scenarios on the banking sector. Under a specific set of assumptions, the size of NPLs and that of losses/needed capital injection are calculated. Based on end-2016 figures, NPLs would increase to 12.3% in the baseline scenario, 12.9% in the adverse scenario, and 13.3% in the extreme scenario. Assuming a 100% risk-weighting on these items, the capital adequacy ratios would decrease, but remain healthy at 18.1% in all three scenarios. The exercise suggests that bank capital is adequate to withstand these shocks. The report highlights that the different stress test scenarios conducted for large corporates find that corporate resilience is solid and able to withstand the estimated shocks. In line with these findings, the banking sector also shows capacity to absorb these shocks. Under the adverse and extreme scenarios, the banking sector would experience an increase in NPLs, but would not see a severe deterioration of its level of capital.
Keywords: Middle East and Africa, Kenya, Banking, NPLs, AML/CFT, IFRS 9, Stress Testing, Financial Stability, Article IV, IMF
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