The Central Bank of Kenya (CBK) has reported that UBA Kenya breached capital requirements, failing to meet the 8% minimum core capital-to-deposit ratio due to ongoing losses. In a report highlighting regulatory breaches among Kenyan banks, the CBK noted that UBA Kenya’s core capital-to-deposit ratio dropped significantly from 29.46% in 2022 to 7.92% in 2023, despite efforts to reduce its losses. Sources with direct knowledge of the matter disclosed that the CBK imposed fines on the bank, though UBA, in an official release, stated it was unaware of any penalties.

UBA’s Struggle to Meet Regulatory Standards

UBA Kenya, part of the pan-African United Bank for Africa Group headquartered in Nigeria, has faced challenges in maintaining required capital adequacy levels. The bank’s financial struggles are partly attributed to high operational costs and reduced lending income in a competitive and challenging economic environment. While UBA managed to narrow its pre-tax loss to $2.6 million (KES 344 million) in 2023 from $3.3 million (KES 437 million) in the previous year, it still falls short of the regulatory benchmarks set by the CBK.

Capital adequacy ratios, such as the core capital-to-deposit ratio, are critical for ensuring banks have a cushion to absorb potential losses, protecting depositors and maintaining stability in the banking sector. With UBA Kenya’s ratio below the minimum requirement, the CBK’s decision to issue fines underscores its commitment to enforcing regulations designed to safeguard the financial system.

Regulatory Breaches Among Kenyan Banks

UBA Kenya is one of twelve banks flagged by the CBK for failing to meet various regulatory standards, reflecting a broader trend of financial strain among Kenyan banks. Other banks cited include Housing Finance, a specialized mortgage lender, and Development Bank of Kenya, a state-owned institution, both of which also failed to meet the required core capital-to-deposit ratio. According to the CBK, several banks reported capital erosion attributed to ongoing operational losses, currency depreciation, and a challenging macroeconomic environment.

The CBK mandates that all Kenyan commercial banks maintain a minimum:

• Core capital to risk-weighted assets ratio of 10.5%.
• Total capital to risk-weighted assets ratio of 14.5%.
• Core capital to deposits ratio of 8%.

Non-compliance with these requirements suggests potential vulnerabilities within these banks that could impact the broader financial system. The CBK highlighted that breaches primarily involve the “single obligor limit” due to the depreciation of the Kenyan shilling against the US dollar, which has increased banks’ liabilities in foreign currency. Additionally, the financial losses many banks face are affecting their core capital levels, heightening risks of further non-compliance.

Impact of Depreciating Kenyan Shilling and Economic Challenges

The depreciation of the Kenyan shilling has exacerbated financial pressures on Kenyan banks, making it more expensive for banks to service foreign currency-denominated obligations. Over the past year, the shilling has depreciated against the US dollar, driven by high import bills, fluctuating global commodity prices, and reduced foreign exchange inflows, which have intensified inflationary pressures in Kenya. As a result, banks with substantial foreign liabilities face increased costs, impacting their capital adequacy ratios and liquidity levels.

This currency depreciation affects the broader economy by increasing inflation, as imported goods become more expensive. High inflation has led to rising interest rates, which while aimed at controlling inflation, have also made borrowing more expensive for businesses and consumers, slowing economic growth and reducing banks’ profit margins. In this environment, banks face the dual challenges of increased regulatory scrutiny and deteriorating financial performance, as they navigate a volatile economic landscape.

Spotlight on Capital-Deficient Banks: Spire and Consolidated Bank

Among the banks unable to meet regulatory standards, Spire Bank and Consolidated Bank stand out for their prolonged capital deficiencies. Spire Bank, which was acquired by Equity Group in 2023, continues to struggle with meeting the core capital requirement of $7.7 million (KES 1 billion). Despite the acquisition aimed at stabilizing the bank’s finances, Spire Bank has not yet been able to meet the 10.5% core capital-to-risk-weighted assets ratio mandated by the CBK.

Consolidated Bank, another state-owned institution, has also faced difficulties in meeting regulatory capital requirements. The government of Kenya has periodically injected capital into Consolidated Bank to bolster its financial standing, but the institution has continued to struggle with high levels of non-performing loans (NPLs) and limited profitability. Both Spire and Consolidated exemplify the challenges faced by smaller banks in adapting to stringent regulatory standards amid a difficult economic environment.

CBK’s Upcoming Capital Requirement Hike

In a bid to strengthen the resilience of Kenya’s banking sector, the CBK is preparing to raise the minimum capital requirement for commercial banks tenfold, from the current $7.7 million (KES 1 billion) to $77.8 million (KES 10 billion). This significant increase, announced in June, aims to bolster the sector’s resilience against risks including economic shocks, currency volatility, and rising cyber fraud. However, this move is expected to place considerable pressure on smaller banks, which may struggle to meet the new threshold.

The CBK’s rationale for the capital hike is to create a more robust banking sector that can better absorb shocks and withstand periods of economic instability. For small and mid-sized banks, the new capital requirement could lead to increased mergers and acquisitions, as some institutions may seek to consolidate their resources to comply with the new rules. This trend aligns with the CBK’s broader agenda to reduce the number of small banks in the country, promoting a more consolidated and stable financial sector.

Rising Cybersecurity Risks in Kenya’s Banking Sector

The CBK’s capital increase initiative is also motivated by growing concerns over cybersecurity risks. Kenya’s financial institutions have been increasingly targeted by cyber-attacks, with hackers exploiting weaknesses in banks’ digital infrastructure to commit fraud. In response, the CBK has emphasized the need for enhanced cybersecurity measures, particularly as digital banking and mobile money platforms gain popularity among Kenyan consumers.

The risk of cyber fraud has become a significant factor in the banking sector’s regulatory framework, as a failure to secure customer data can result in substantial financial losses and reputational damage. By increasing the capital requirements, the CBK aims to ensure that banks have sufficient financial resources to invest in advanced cybersecurity systems and protect their customers from cyber-related threats.

Economic Implications of Banking Sector Challenges

Kenya’s banking sector challenges are reflective of broader economic concerns that affect the nation’s growth prospects. High inflation, currency depreciation, and regulatory pressures are all converging to create an environment in which banks face reduced profitability and increased capital strain. For the Kenyan economy, the challenges in the banking sector may reduce the availability of credit, impacting small businesses and consumers who rely on accessible financing for growth and daily expenditures.

Moreover, the tightening of capital regulations is likely to affect lending rates, as banks may become more selective in their lending practices to maintain compliance with capital adequacy ratios. This tightening of credit could have a dampening effect on Kenya’s economic recovery, particularly as the country seeks to rebound from the economic impacts of the COVID-19 pandemic and ongoing global economic uncertainties.

The Road Ahead: Strategic Implications for Kenyan Banks

As the CBK implements more stringent regulatory standards, banks will need to adapt by adopting risk management strategies, improving operational efficiency, and exploring options for capital augmentation. This may include pursuing mergers, seeking external investors, or focusing on niche markets where they have a competitive advantage. UBA Kenya, for example, may look to its parent company, UBA Group, for additional capital support or explore strategies to improve its profitability in the Kenyan market.

The CBK’s regulatory approach reflects a commitment to building a resilient and transparent banking sector, one that can withstand local and global economic pressures. For investors, these changes may offer reassurance that Kenya’s financial system is adapting to global standards, which could, in turn, attract more foreign investment.

Conclusion: Strengthening Kenya’s Banking Sector for Future Resilience

The CBK’s recent actions to enforce capital adequacy rules and prepare for a significant capital requirement hike signal a proactive stance on safeguarding Kenya’s financial stability. While UBA Kenya and other banks work to meet the regulatory thresholds, the challenges they face highlight the need for a resilient banking sector that can withstand economic pressures and ensure stability for depositors and investors alike.

As Kenya’s banking industry evolves, the CBK’s regulatory changes underscore the importance of a strong capital base, effective risk management, and cybersecurity in maintaining confidence and stability in the financial system. With a commitment to these principles, Kenya’s banking sector can navigate the challenges posed by a volatile economic environment and position itself for sustainable growth in the future.

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Photo source: Google

By: Montel Kamau

Serrari Financial Analyst

1st November, 2024