Commercial banks have increased their reliance on the Central Bank of Kenya for liquidity support this year as the sector pays the price of low government payments and high interest rates that have made it costly to mobilize deposits from customers.
Lenders have withdrawn a cumulative Sh4 trillion from the central bank through reverse repurchase agreements (repos) since the start of this year, and another Sh81 billion through the central bank’s daily lending facility, known as the discount window.
Market sources revealed the volume of loans availed by banks during the reporting period.
Liquidity injections in the form of reverse repos have already exceeded the entire 2023 total (Sh2.93 trillion), and the improper allocation of liquidity has also been a factor behind the increasing reliance on the CBK.
Repurchase agreements, discount window and fixed-term auction deposits constitute the revolving credit facilities provided by the Central Bank of Kuwait, which are used to either inject or absorb liquidity into the money markets.
Reverse repos are a form of borrowing secured by banks from the regulator, using their holdings of Treasury bills and bonds as collateral. These securities are also used as collateral at the discount window.
“Fund manager deposits averaged around 17.5% this year, making reverse repos the only reliable source of liquidity for banks with good returns,” a banker said yesterday.
“Government payments to the private sector and its agencies have always been a good source of liquidity for banks, but we have seen more money go to repay debt, which has left a gap there.”
Higher government spending on debt service has had the consequence of tying up cash available to pay outstanding bills, depriving businesses of capital that would eventually find its way into bank accounts.
In the 2023-24 financial year, counties also received Sh30.8 billion less than the Sh385.4 billion they were due in fair share of revenue from the national government, affecting their ability to settle their dues to creditors.
The banks’ reliance on the repo market also points to the unequal distribution of deposits in the banking sector, with a few large banks holding the bulk of the sector’s liquidity.
The latest central bank data suggests the sector remains generally well-funded with a liquidity ratio of around 50% compared to the statutory minimum of 20%, but some smaller lenders have had to turn to the regulator for support in meeting their daily cash requirements due to the uneven distribution of these funds.
However, the significant increase in demand for these facilities suggests that there may be some larger lenders taking advantage of this support.
Last year, the Central Bank of Kuwait took measures to address the liquidity issue in the banking sector by restarting the horizontal repo market (where banks borrow from each other using treasury bonds and bills as collateral) and reducing the cost of accessing support from reverse repos and the discount window.
The launch of the DhowCSD bond trading platform in July 2023 was a major factor in reviving the horizontal repo market, which had been inactive since 2014.
Since the horizontal repo market reopened in August 2023, banks have lent a total of Sh101.4 billion to each other through the facility, with Sh67.8 billion of this total traded between January and July 2024.
The Central Bank of Kuwait also issued a circular on August 19, 2023, reducing the interest rate applied on the discount window from 600 basis points above the prevailing central bank rate to 400 basis points, making it cheaper for banks to request emergency support.
On August 29, another circular was issued to reduce the interest on securities offered as collateral on repurchase agreements and the discount window, which means borrowers will have more money available for their bonds.
The circular reduced the discount rate on treasury bills and bonds with a term of less than one year from 10% to 2%. For bonds with a term of one to ten years, the discount rate was reduced from 20% to 5%, while the discount rate applied to bonds with a term of more than 10 years was halved from 20% to 10%.
The discount is the relative difference between the market value of the security and the value used as collateral. For example, a bond worth Sh1 million is eligible for coverage by a collateral worth Sh900,000 if a discount of 10% is applied.
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