Promote Stress Testing to Prevent Collapse of Kenyan Banks

 

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Periodic Stress testing by banks can enhance their stability

The building that houses the Central Bank of Kenya (CBK) is a cold fortress. It could be this isolation, why the staff of the CBK think they are revered that the rest. But they are slowly becoming relics, ill equipped to regulate the banking industry of the modern age.

Three Kenyan banks have collapsed in quick succession. Yet, the CBK thinks the solution is prescriptive guidelines, which are mostly tick the boxes.

There is need to engineer the regulatory frame, and adopt more forward looking regulatory approaches. One of these include periodic stress tests.

A stress test is performing a series of simulations under hypothetical adverse stress scenarios in order to assess how a financial institution would be affected under each scenario.

For instance, what would be the impact in cases of increase of non performing loans, cyber attacks, or changes in micro and macro economic variables.

It is a type of forward-looking analysis which can help the CBK and and individual banks to identify problems which may not be revealed by just analysis of historical data.

The problem with mechanical repetition of the same inspection programs year after year, which CBK promotes, is it promotes a tendency to focus more and more on minor flaws while failing to address more fundamental issues.

In such a case, banks are forced to allocate resources to address trivial irregularities. Such a supervisory regime, majorly based on checklists, hinder creativity and innovation.

International Financial Reporting Standard 9, a new accounting standards that came in force at the beginning of this year, promote stress testing initiatives by requiring banks to make a forward-looking estimation of future losses (expected credit loss).

Further, the Basel Committee on Banking Supervision has been reviewing the relationship between the amount of expected losses under the capital adequacy. This will inform issues of loan loss write-offs and necessary provisioning.

Only dynamic supervision can create a financial stability necessary to promote market vigor, which should be the ultimate goal of regulation.

To ensure stability of banking, CBK should encourage them to undertake regulator stress testing in determining variables as matter of compliance.

Kenya has banned Front Running

 

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Front Running Cycle: Photo, Courtesy

The Capital Markets Act (Amendment) Bill, 2018 has been tabled before parliament. The Bill seeks to amend the Capital Markets Act to criminalize an act known as front running. There is a background to this legislative proposal.

The Central Bank of Kenyan and the Capital Markets Authority have one thing in common. They both hate Fred Mweni, a former chief executive of a stock brokerage firm and bond markets expert.

Mr Mweni is the Kenyan version of the wolf of wall street. He made (or ruined) his name by manipulating the trade of Treasury Bonds and other fixed income securities, to a huge fortune, and almost killed the fixed income segment of the capital markets.

The issue is Mweni, being a stockbroker, also acted as “an insider trader” of treasury securities. He would use that information he gathered as a stock broker to make a buy or sell for himself, an exercise known as front running.

Apart from front running, he thrived in playing the sale-buy-backs games, where he would sell treasury bonds from backs with the promise of a future buy back. He would manipulate markets in this, and it is reported that his fraudulent trading ways earned him over Sh100 million.

There is a legal position. A stockbroker is required to declare if they have a vested interest in a security before dealing with it. When a stockbroker trade without such declaration, it amounts to conflict of interest and disadvantages other traders. It can ruin the market confidence.

For instance, when the Nairobi Securities Exchange was going public through an initial public offering, stockbrokers were required to issue disclaimers to declare that they had an interest. Before the demutualisation of the NSE, the stock brokers were owners of the bourse.

The CMA decided to take a regulatory action against Mr Mueni front running ways. The investigations have dragged in for a while, but to a dead head. There is nothing the regulators could do, despite front running ruining the confidence of the market, as there is a legal lacuna. The law is not clear, as they may say.

That has necessitated the amendment before parliament. It enables aggrieved investors to sue the market intermediaries for damages. It gives more teeth to the regulators. It makes front running an offence.

The wording of the amendment is as follows-

“Any person in a market intermediary who has insider information on client orders with a price differential or is aware of such orders and effects an own account transaction in the securities concerned or in any related investments directly or through any other person, to take advantage of the price differential before the client order is executed commits an offence.”

Fred Mweni and other wolfs of the bond markets and front runners, their days are numbered.