Response to Recent Media Reports on Commercial Banks Borrowing From Central Bank of Kenya Overnight Discount Window Facility

It has come to the attention of the Kenya Bankers Association that certain sections of the media have carried reports on the Commercial Banks borrowing from the Central Bank of Kenya through the Overnight Discount Window Facility and to which we wish to make some clarifications as follows:

Highlights

1. The CBK Overnight Discount Window is a last resort facility for providing overnight liquidity to stable banks with temporary liquidity shortfall, which is in line with Central Bank operations world over.

2. Commercial Banks borrowing from the CBK Discount Window averaged Kshs. 4.4 billion per day in 2011.

3. The total core capital of CBK is only Kshs. 5.0 billion and therefore lending Kshs. 600 billion is beyond the capacity of CBK’s balance sheet

4. The total core capital of all commercial banks in Kenya is Kshs. 259 billion, and so borrowing Kshs. 600 billion would mean that all banks in Kenya are insolvent

5. CBK Overnight Discount Window is for overnight borrowing only, and it is incorrect to add up a succession of overnight loans paid off the next day and show them as outstanding.

6. Commercial Banks in Kenya conduct their business within the guidelines set by the Central Bank of Kenya.

1. Rationale for the CBK Overnight Discount Window

• Section 36 of the Central Bank of Kenya (CBK) Act provides for a facility whereby the Central Bank can grant loans or advances to banks, secured by Government securities. The CBK Overnight Discount Window is a facility of last resort and is a means of providing overnight liquidity to stable banks that have a temporary shortage of cash. The facility is necessary as circumstances can arise when even fundamentally sound banks cannot raise liquidity on short notice. This facility plays a significant role in ensuring banking sector stability by offering overnight liquidity as a last resort.

• Liquidity shortfalls in commercial banks can arise out of large and unanticipated payments of taxes, dividends, some depositors calling for deposits without prior adequate notice or generally liquidity tightness occasioned by tight monetary policy stance that may not be fully covered by the traditional sources of liquidity.

• As a requirement, banks must explore all the available markets for liquidity before coming to the CBK Overnight Discount Window. These include the interbank market, Horizontal Repos, rediscount of Government securities at CBK, and sale of foreign exchange holdings. When these sources cannot fully cover the shortfalls, banks are legally allowed access to the CBK Overnight Discount Window to ensure that their maturing obligations, most of which are for clearing the market, are fully financed. This serves to protect the credibility of the banking system as a custodian of deposits and an appropriate avenue for financial intermediation.

• Given that the CBK Overnight Discount Window is a facility of last resort, access to funds through the facility is designed to be less attractive through a high penalty interest rate and restrictive guidelines. The higher interest rate and restrictions are meant to send a strong message to banks that funds from CBK can only be accessed under extreme liquidity shortfall conditions.

2. Facts on the Operations of the CBK Overnight Discount Window

• The CBK Overnight Discount Window constitutes only a small proportion of the total borrowings by commercial banks through the interbank market. Specifically, commercial banks borrowing through the CBK Overnight Discount Window averaged only Kshs 4.4 billion per day in 2011 compared to an average of Kshs 12 billion per day for borrowing through the interbank market.

• Since borrowing through the CBK Overnight Discount Window is for overnight only, it is incorrect to add up a succession of overnight loans that were paid off the next day and claim that these were still outstanding loans. In addition, given that the total core capital of CBK is only Kshs 5.0 billion lending 600 billion is beyond the capacity of CBK’s balance sheet. Secondly, the total core capital of all commercial banks in Kenya is Kshs 259 billion, and so, borrowing Kshs 600 billion would mean that all banks in Kenya are insolvent. The claim therefore that CBK lent Kshs 600 billion to banks through the Overnight Discount Window facility is without foundation and is grossly misleading.

• While the CBK Overnight Discount Window is an important tool for central banks dealing with liquidity problems that may threaten financial stability, commercial banks are often reluctant to borrow from it not only because this source of liquidity tends to be expensive but also because of the “stigma” that is associated with Discount Window borrowing. This is because banks fear that the regulator, other banks, or investors would read a negative signal about a bank’s health if that bank is discovered to be a regular borrower at the Discount Window. The assertion therefore that banks frequent the Discount Window to borrow at a free cost is against this principle.

• The CBK publishes the total amount of borrowing from the Discount Window on a weekly basis, but not the information on individual lending. However, the CBK Overnight Discount Window rate is published on the CBK website on a daily basis.

• Since the CBK Overnight Discount Window is an overnight facility, banks cannot borrow funds through the facility and invest in longer term assets due to the maturity mismatch as they must repay the funds the next day. Existing guidelines prohibit use of funds borrowed through the facility for on-lending to other commercial banks or investing in Government securities or foreign exchange trading. In this regard, the nature of operation of the CBK Overnight Discount Window does not provide an opportunity for foreign exchange speculation.

• Access to the CBK Window by commercial banks did not start in 2011. Even during regimes of easing monetary policy stance, there would still be banks accessing funds through the CBK window due to occasional yet unanticipated liquidity shortfalls. As expected, the demand for funds by banks during tight monetary policy regimes is higher.

• There is no linkage between the increased activity at the CBK Window between June and October 2011 and investment in Government securities and foreign exchange trading due to a mismatch in the maturity structure given that borrowing through the CBK Window is for overnight only.

• Following the adoption of a tight monetary policy stance in March 2011, interest rates in the interbank market rose rapidly prompting banks to resort to the CBK Overnight Discount Window as they adjusted their portfolio to meet their daily liquidity requirements. Activity at the CBK Overnight Discount Window also reflected increased cost of funds as most depositors moved to divest their deposits from banks to invest in Government securities which were attracting higher yields.

• The persistent inflationary pressures in 2011 also undermined the mobilization of savings which is the main source of funds for banks. Consequently, banks started liquidating their assets including their holdings of Government securities. The stock of Treasury bills and bonds decreased from Kshs 425.1 billion in March 2011 to Kshs 363.3 billion in September 2011 and further to Kshs 346.5 billion in December 2011. Notably, many banks incurred heavy losses through rediscounting of their holding of Government securities in their bid maintain liquid positions.

• The rise in the interest rates on Government securities in 2011 following tightening of monetary policy also attracted short term capital inflows as investors sought to take advantage of the higher yields. This explains the build-up of foreign assets of banks during the period.

The Kenya Bankers Association members conduct their business within the Guidelines set by the Central Bank of Kenya.

HABIL OLAKA
CHIEF EXECUTIVE OFFICER