New safety net for bank depositors

By James Anyanzwa

The Central Bank of Kenya (CBK) has recommended a raft of new measures aimed at deterring the recurrence of bank failures, including sudden collapse with depositors' money, which has been common in the past two decades.

CBK has proposed new regulations aimed at revamping the Deposit Protection Fund (DPF) by separating its operations from that of the bank, broadening its mandate and giving it more powers that will enable it take a more active role in resolution of problems in commercial banks.

The proposed rules are contained in a new Bill that is currently being reviewed by the Ministry of Finance.

Once enacted into law, the bill referred to as the Kenya Deposit Insurance Bill (KDIB) will convert DPF into an independent institution to be referred to as Kenya Deposit Insurance Corporation (KDIC), which will help insulate customers against effects of sudden collapse of banks such as the one witnessed in 1998 in which several banks, including Trust Bank, Reliance Bank, Prudential Bank and Bullion Bank collapsed with depositors money.

The principal objectives of KDIC will be to provide a deposit insurance scheme for customers of member institutions and to wind up the operations of any institution for which the board is appointed as a liquidator.

The management function of the new corporation will be de-linked from CBK. It will also have its own board and chairman.

Financial infrastructure

"It will be another institution that strengthens the financial infrastructure for Kenya," Prof Njuguna Ndung’u, the bank’s Governor told Financial Journal.

Ndung’u who is also the chairman of the current Deposit Protection Board says the new law will give the KDIC board powers to make rules, regulations and guidelines for the management and control of its affairs to enable it achieve its objectives as a financial safety net player.

Ndung’u says the proposed law will expand the mandate of the DPF board from the current narrow "paybox" system to a broad-based deposit insurer with powers to get more involved in problem resolution.

"Pursuant to the expanded mandate, the new entity (KDIC) shall, in collaboration with CBK, actively participate in the resolution of problematic banks to avoid collapse of institutions and liquidation," he says.

Currently, the deposit protection body is a department of the CBK whose role is limited to compensation of depositors of collapsed commercial banks and their liquidation.

The re-energising of the deposit protection arm, coupled with extra allocation of functions is seen as a major boost to central bank’s function of curator and revival of ailing institutions.

Ndung’u says the reconstitution of a separate board for KDIC will also help the banking sector by enhancing the new body’s corporate governance practices.

DPF provides deposit insurance coverage of up to Sh100,000 to each depositor of any licensed institution that carries out finance business in Kenya in cases of sudden collapse of such institutions.

According to central bank, the deposit limit of Sh100,000 fully insures 12.47 million deposit accounts, representing 93.95 per cent of the total deposit accounts as at the end of February this year.

"The primary objective of deposit insurance is to protect the "small and financially unsophisticated" depositors. The statistics confirm that the bulk of these depositors are fully protected within the threshold of Sh100,000, " says Ndung’u.

The DPF board was first established as a deposit insurance scheme following amendments to the Banking Act in 1985.

Deposit accounts

Generally, the insurance covers all types of deposit accounts including savings and current accounts, bankers’ cheques, money orders and drafts for which a protected institution is liable.

Payment is, however, restricted to one depositor per institution meaning that all the accounts of a depositor with more than one account in an institution are first consolidated before settlement because a depositor can only claim the maximum protected limit of Sh100,000.

The 1985 amendments to the Banking Act were done to expand the safety net and improve banks’ failure resolution mechanism in the wake of the banking crisis of 1983, which left several indigenous banks wallowing in acute liquidity problems.

In spite of efforts by Treasury and CBK to bail out the affected institutions, one institution was closed in December 1984 exposing the inadequacy of the safety net and failure resolution mechanisms that existed at the time.

This led to the establishment of the DPF as a deposit insurance scheme to provide cover for depositors and act as a liquidator of banks, which could not be salvaged.

The history that has informed the new changes is compelling. It started way back in 1989 when seven institutions were found to be financially distressed and drastic corrective action needed to be taken to save depositors.

A consolidation scheme that formed a new entity-Consolidated Bank of Kenya Limited was crafted to take over the assets and liabilities of the seven institutions.

The scheme, which was implemented successfully was supervised by Treasury, which also provided the seed capital for the new bank.

Despite this success, a series of other bank failures have followed with the immediate one happening in 1993 when CBK closed down Exchange Bank and a related company, Goldenberg International, a gold and jewellery firm.