Why I smell a rat in newly proposed banking law

Central Bank of Kenya building in Nairobi

Bank managers are responsible for maximising shareholders’ wealth. They, however, operate in a volatile environment and regulating interest rates as implied in the Draft Financial Markets Conduct Bill 2018 could pose a major threat to the stability of the country’s financial markets.

Bank managers focus on deposits and advances, with the interest rate being the link between the two because they pay interest on the former and charge interest on the latter.

Therefore, the core variable that requires utmost monitoring by a bank manager is the interest rate.

But the Financial Markets Conduct Authority (FMCA) through the draft Bill - just like the capping of interest rate - proposes to take away the right and responsibilities of bank executives to manage interest rates.

Dampen flow

In other words, the manager will be in charge of a product whose price is determined by a State agency. This might dampen the flow of funds to the market.

In addition, to earn good returns for owners, bank managers must augment efficient operation of the financial system which is required to support economic growth.

Banks must help in channeling funds to productive businesses. They also provide critical transaction services, including cheque clearing, wire transfer services and cash dispensing machines (ATMs). Failure in such systems would adversely impact the economy while inconveniencing the masses.

A good example is the untold suffering that comes with a glitch in Safaricom’s M-Pesa service.

By putting their money in the bank, customers indirectly instruct bank managers to decide on their behalf whom to lend to and to ensure that the money is repaid in time.

From this, banks are delegated monitors that effectively lower borrowing and lending costs.

Any slight malfunction of the banking sytem can lead to untold losses, which is why the institutions are heavily regulated.

The argument against regulating banks, however, is that any requirement that could interfere with their efficient running would be just as costly and should not be tolerated.

This is why the draft Bill by the National Treasury is likely to destabilise rather than steady the financial markets.

Through the proposed law, banks will see their compliance costs increase substantially. This is because they will be reporting to both the Central Bank of Kenya (CBK) and the proposed Financial Markets Conduct Authority.

Informed market players are aware that this twin accountability will cause role confusion between the new authority and CBK as well as the Capital Markets Authority (CMA).

The additional compliance costs will impact returns for shareholders. Treasury is not clear on how the proposed law, if passed, will benefit banks. It might in the long run reduce their value.

Financial implications that will come with non-compliance also cannot be gainsaid.

In the late 1970s, I happened to work for CBK. The terms were good then and I am sure the same remains today.

The reason why the staff of such insitutions is paid well is to ward off corruption. In addition, CBK spends substantial amounts of money on staff development. 

The point is that it is costly setting up and running a surveillance unit for any organisation, including one of CBK’s calibre.

In terms of managing interest rates, the proposed law takes away that role from CBK as well as from the market forces.

It is possible that the bad boys of the banking industry are not comfortable with the current regime at CBK and are behind the Bill. This could be because they would find it easier to deal with the proposed authority than CBK.

Up to the task

Despite the well documented problems in the banking sector, CBK is very much up to the task of fulfilling its surveillance role.

No other State agency should duplicate what the regulators, including CMA, are supposed to do.

This duplication will mean that banks pay fees to CBK and to this new authority, thus reducing profits to the bank and the wealth of the shareholders. The debate should be how to make CBK more independent.

It is possible that CBK and the proposed authority will have conflicting ideas about setting interest rates.

This is why it is advisable to allow the market to dictate interest rates. Should the Bill be passed into law, maintaining discipline in the banking industry might also become a problem.

The writer teaches at the University of Nairobi