The Central Bank of Kenya (CBK) building in Nairobi, (inset) new CBK Governor Kamau Thugge.
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How CBK has evolved since independence, its achievements and future
The Central Bank of Kenya is a public institution established under Article 231 of the Constitution of Kenya, 2010. It is responsible for formulating monetary policy to achieve and maintain price stability and also issues currency.
Throughout the colonial period up to independence, the East African Currency Board (EACB) played the key role of currency issuance in the entire East African states comprising Kenya, Uganda and Tanganyika.
When Kenya gained independence from its colonial master in December 1963, the EACB assumed central banking functions, including lending to the government and lending to commercial banks.
The Central Bank of Kenya was established by an Act of Parliament of March 24, 1966, and opened its doors to the public on September 14 at Herufi House. Soon after commencing operations, it issued the first Kenyan currency notes in denominations of 5, 10, 20, 50 and 100 shillings. The first coins that the CBK circulated were in denominations of 5ct, 10ct, 25ct, 50ct and Sh1 back in 1967.
The first Governor of the Central Bank was Dr Leon Baranski who was seconded to the newly independent state by the International Monetary Fund and the World Bank. During his one-year tenure at the helm, he oversaw the operationalisation of the CBK act as the top Bank assumed responsibility for monetary policy and management of the country’s external assets to nurture the nascent banking sector.
Dr Baranski was succeeded by Duncan Ndegwa – the first African and longest-serving Governor of the CBK, who served for four terms and retired in December 1982. Mr Ndegwa is credited with transforming the country’s monetary and fiscal systems from the East Africa Board to the Central Bank of Kenya.
Other Kenyans who have served as Governors of the CBK include Philip Ndegwa (1982-1988), Eric Kotut (1988-1993), Micah Cheserem (1993-2001), Nahashon Nyaga (2001-2003), Dr Andrew Mullei (2003-2007), Prof Njuguna Ndungu (2007-2015) and Dr Patrick Njoroge (2015-2023).
President William Ruto nominated Dr Kamau Thugge to hold the reins of the apex bank.
The former IMF senior economist and Johns Hopkins University graduate becomes the tenth CBK governor.
Former CBK governor Philip Ndegwa.
In the 57 years of its existence, the bank has achieved important milestones and experienced many challenges in the execution of its mandate. It has also undergone major transformations due to the legal and regulatory framework, which has continued to evolve in tandem with changing domestic and global dynamics.
The introduction of a crawling peg to replace the fixed exchange rate was an important policy shift by the CBK in the year 1982.
A crawling peg is a monetary regime that allows a national currency to fluctuate within a specific band.
Exchange rate
From independence to 1974, the exchange rate of the shilling was pegged to the dollar. Between 1974 and 1982, the exchange rate experienced a series of devaluations that led to the adoption of a crawling peg to stabilise the volatile shilling.
The crawling peg regime lasted eight years to 1990 when the government moved to a dual exchange rate up to the year 1993 when the exchange rate was fully liberalised.
The current exchange rate system is a free float determined in the market by the forces of demand and supply.
The Central Bank of Kenya participates in the forex market when it needs to stem volatility emanating from exogenous shocks like in the prevailing circumstances where the shilling has sharply deteriorated against the greenback to historic lows.
The amendment of the Banking Act (chapter 488) to introduce a deposit insurance scheme in the year 1985 was an important move to safeguard customer deposits in banking institutions. The Deposit Protection Fund Board (DPFB), which was later renamed to the Kenya Deposit Insurance Corporation (KDIC) under the Kenya Deposit Insurance Act, 2012 provides incentives for sound risk management and promotes stability of the financial system by protecting depositors against loss in case of a bank failure.
Former CBK governor Eric Kotut
KDIC instils confidence into depositors to keep their savings in the banking systems, hence enhancing liquidity and boosting lending.
To facilitate the exchange and settlement of payment instruments such as direct debit instructions, cheques, and Electronic Funds Transfer (EFT) between commercial banks, the Central Bank of Kenya, in the year 1997, through a partnership with Kenya Bankers Association (KBA) established the Automated Clearing House. Following an upgrade of the ACH technology in March this year, banks will now offer faster clearing services with cheques which took up to three days to mature previously set to clear within one day.
To mitigate against risk and safeguard the banking sector, the Central Bank of Kenya in the year 2005, issued the Risk Management Guidelines outlining the minimum coverage and elements of a comprehensive risk management programme.
In accordance with the Basel Core Principles for Effective Banking Supervision, Risk Management Processes require banks and banking groups to have comprehensive risk management processes to identify, evaluate, monitor and control or mitigate all material risks and to assess their overall capital adequacy in relation to their risk profile.
Former CBK governor Micah Cheserem.
Significant risks faced by banking institutions are market, operational and credit risks. A survey by the CBK in 2011, showed that robust risk management helped 90 per cent of Kenyan banks to cut financial losses.
One of the biggest innovations in the banking industry was the introduction of M-Pesa in the year 2007. It disrupted the traditional banking system, capturing the previously unbanked market and allowing businesses to be run from a mobile phone.
The introduction of M-Pesa has greatly facilitated access to banking services.
The Communications Commission of Kenya reported in September 2021 that there were 29.1 million M-Pesa users, making up 63% of the population. The research showed that Kenyans used M-Pesa to transact business valued at Sh5.1 trillion in the three months ended September 2021.
An analysis by the World Bank found that since M-Pesa was launched in 2007, it has contributed 2 per cent to Kenya’s GDP. The study further showed that M-Pesa creates 185,000 employees in Kenya.
Non-Performing Loans
Before 2006, the Kenyan banking and credit sector lacked a system to gauge the credit worthiness of a borrower and as such banks suffered high Non-Performing Loans (NPLs), averaging 18.9 and eating into their profitability due to higher provisioning.
Former CBK governor Nahashon Nyaga.
To cure the NPL headache, the Banking and Finance Act of December 2006 allowed the establishment and operation of Credit Reference Bureaus (CRBs) for the purpose of collecting and disseminating borrower information among financial institutions. To achieve more on the establishment of the CRBs and develop a sustainable information sharing framework, the Banking CRB regulations 2008 were adopted to guide the sharing of credit information among lenders.
In July 2010, the Credit Information Sharing Framework was rolled out, allowing the banking sector to share credit information from their borrowers to a licensed credit reference bureau.
Credit information sharing has been key in flagging borrowers with a poor repayment history, hence helping banks to appraise their loan applications accordingly.
Former CBK governor Andrew Mullei.
Following the financial crisis of 2007 to 2009, stringent regulatory measures, such as higher capital requirements became more pronounced as a move towards making the banking industry stable, more competitive and resilient in the face of economic headwinds. Towards that end, the international regulatory reform package referred to as Basel III developed by the Basel Committee on Banking Supervision (BCBS), recommended tighter capital requirements with the minimum capital ratio doubled.
In full compliance with the Basel standards, the CBK proposed to raise the minimum capital requirements from Sh250 million in 2008 to Sh1 billion by December 2012. The CBK had envisioned that the increase in minimum core capital requirement would motivate smaller banks to merge or seek other forms of consolidation.
Former CBK governor Njuguna Ndung'u.
It was envisaged that the resulting banks from the mergers would attain higher levels of efficiency due to economies of scale and enhanced capacity thereby be able to compete with their large peers on an equal footing. However, the consolidation activities undertaken between 2008 and 2022 reduced the number of commercial banks slightly from 45 to 38 as at 2023, meaning the increase in core capital did not achieve its intended purpose.
One big challenge that the CBK has encountered in executing its mandate is political interference. On January 25, 2019, gunmen associated with the Somali-based Al-Shabaab terrorist organisation viciously attacked the DusitD2 Hotel complex in downtown Nairobi, killing at least 21 people and injuring scores of others in a siege that lasted for hours.
Later, a bank manager of tier 1 bank was arraigned in court for facilitating the financing of the DusitD2 hotel attack via huge M-Pesa transactions.
The manager was charged with failure to report unusual and suspicious activity regarding proceeds of crime and anti-money laundering, aiding and abetting the commission of a terrorist act, and failure to report a large transaction amounting to Sh34.7 million.
The utmost gravity of the horrifying crime committed at DusitD2 and many others highlight the need for banking institutions to comply with internationally recognised anti-money laundering laws and regulations in order to mitigate the adverse effects of criminal economic activity and promote the sanctity and stability of the local banking sector.
Enactment of Proceeds of Crime and Anti-Money Laundering, 2009, (POCAMLA), and enactment of several legislations in the subsequent years, including one that requires banks to report transactions that meet the $10,000 (Sh1.45million) threshold was Kenya’s first major step in aligning to the global anti-money laundering (AML) and financial crime standards.
However, legislators have been vociferous in their opposition to the AML regulations, reprimanding the immediate former CBK governor Dr Patrick Njoroge for implementing the laws in the country, citing invasion of customers’ privacy and inconvenience due to the paperwork involved.
Interest rate capping, which became law on September 14, 2016, was another piece of legislation encroaching on CBK’s mandate. The reintroduction of interest capping, which was abolished in 1991, clearly infringed on the independence of the CBK and complicated the conduct of monetary policy, hence producing perverse outcomes.
Immediate former Central Bank of Kenya Governor Patrick Njoroge.
There was also a marked reduction in financial intermediation as commercial banks shunned small borrowers, exemplified by the significant increase in average loan size arising from declining loan accounts.
Commercial banks
Additionally, rationing out Micro, Small and Medium Enterprises (MSMEs) from the credit market by commercial banks is estimated to have lowered economic growth in 2017 by 0.4 percentage points negatively impacting job creation. In view of the foregoing, both the Parliament and the executive must desist from interfering with the CBK’s mandate as enshrined in the constitution.
In the future, the CBK needs to rethink the supervision of emerging market participants, like FinTechs with their disruptive business models. The CBK should consider engaging FinTechs early in their life cycles to gain knowledge of their platforms and guide them toward compliant and sustainable growth by providing useful advice and support.
Secondly, the CBK is considering rolling out digital currencies. Nevertheless, the apex bank must examine the probable effect of digital currencies on interest rates, exchange rates, and asset prices and the impact of the design of digital currency on the banking sector.
Crucially, the CBK must endeavour to influence climate policy through its monetary policy. By incorporating climate in financial risk assessments and incentivising green finance, the CBK can help mitigate environmental risk, hence ensuring stability and sustainability of the banking system.
The writer is a banking and finance expert. [email protected]
