CENTRAL BANK OF KENYA
Keynote Address by
PROF. NJUGUNA NDUNG’U
GOVERNOR
Nairobi Safari Club
March 27th, 2008
Distinguished Participants,
Distinguished Resource Persons,
Ladies and Gentlemen

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Keynote Address during the Official Opening of Financial Reporting Workshop – March 27 , 2008
Let me first thank Ernst and Young for the invitation to give today’s keynote
address, on the Financial Reporting Workshop for the Banking Sector. Looking at
the agenda, this meeting in the next two days will dwell on a number of important
accounting and regulatory issues. Therefore, to help set the stage for the
discussion to follow, I would like to take this opportunity to expound on the
Central Bank of Kenya’s perspective on compliance with International Financial
Reporting Standards (IFRS), and specifically at the benefits from such
compliance, the progress we have made, the link between IFRS and Basel II and
the challenges ahead.
Acceptance and use of IFRS has become virtually universal, with many countries
that hitherto operated their own national standards having phased them out for
IFRS despite the associated challenges. International flows of investment capital
and capital instruments across geographical boundaries have added a new
impetus to the adoption of international standards globally.
It is no wonder that in 1998, the Institute of Certified Public Accountants of Kenya
(ICPAK), moved from Kenya Accounting Standards in favour of International
Accounting Standards. The Central Bank as the principal regulator of banks and
non-bank financial institutions, formulates prudential guidelines that are in
harmony with IFRS in order to minimize conflict and enhance compliance with
international standards.
The Central Bank of Kenya recognises that financial reporting standards play a
crucial role in enhancing financial stability. On one hand, Reporting Standards
provide the foundation for the production of credible financial statements and
other disclosures that communicate the performance of the industry and at the
firm level.
On the other hand, disclosure of reliable information facilitates market discipline,
cultivates confidence and reduces the possibility of adverse instability. The
credibility of information allows market participants to process the right
information and make appropriate decisions, thus a good signalling mechanism.
Disclosure of information, however, should not compromise proprietary data, but
must be flexible enough to accommodate future advancement in risk

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Keynote Address during the Official Opening of Financial Reporting Workshop – March 27 , 2008
management. Such outcomes therefore, have obvious implications for the
supervisor’s ability to oversee the safety and soundness of financial institutions.
It is necessary for banks and non-bank financial institutions to prepare quality
financial statements so that shareholders and other stakeholders are wellinformed and a sound judgement on their financial status can be made by the
market. Quality and reliable information depends in turn, on the reporting
standards being applied. In this respect, IFRS ensures that financial reporting is
prepared under accepted principles that convey a true and fair view of the
financial position of an institution.
The foregoing notwithstanding, the Central Bank has made significant progress in
strengthening the supervisory approaches and risk management guidance for
banks and non-bank financial institutions. This is aimed at encouraging the banks
and non-bank financial institutions to implement sound risk management
practices at all levels and in all market segments.
It is for this reason that the Central Bank will continue to attach great importance
to risk management and reporting standards so that financial statements
produced by banks and non-bank financial institutions convey adequate
information about their risk management activities to key stakeholders, such as
shareholders, creditors, depositors and any other interested parties. It is hoped
that with adequate and timely information potential investors can make correct
judgement/assessment of this market.
The choice of Basel II as a topic for discussion during the workshop is indeed
timely. Basel II represents a crossroad, a watershed and a turning point for the
future of global supervisory practices. Basel II presents us with an opportunity to
enhance risk management systems in our banks, upgrade our supervisory
approaches and inculcate market discipline. This can only serve to enhance
financial stability. Central Bank recently issued an information memorandum to
banks and non-bank financial institutions thereby setting the stage for the
implementation of Basel II.

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Keynote Address during the Official Opening of Financial Reporting Workshop – March 27 , 2008
Unlike Basel I which focused on a single risk measure, Basel II puts more
emphasis on the banks’ own internal methodologies, supervisory review, and
market discipline. The Accord is based on three mutually reinforcing pillars that
allow banks and supervisors to evaluate properly the various risks that banks face.
All of the reinforcing pillars will contribute to safety and soundness in the
financial system.
Market discipline reinforces the incentives for the management of banking
enterprises to manage them along sound lines. It operates on the basis of
disclosures and other information available in the market and defines the reward
system for the management. Periodic and meaningful disclosures by banks
relating to their capital, risk exposures and risk management techniques enable
market participants to make an assessment of a bank's risk profile. The
information is also appropriate for supervision in that it generates advice and /or
strengthens partnership.
Enhanced, high-quality disclosures are mandated in IFRS from an accounting
perspective and in Basel II from a prudential perspective. While IFRS disclosures
focus on assessing the current financial position of an enterprise, Basel II
disclosures are more forward-looking. Given the different focus of accounting and
prudential standard setters, it is to be expected that the disclosure requirements
under the two standards differ in some respects. IFRS disclosures are made in the
financial statements by all enterprises that prepare and submit financial
statements. On the other hand, disclosures under Pillar 3 are required to be made
only by banks that are implementing Basel II. Moreover, Pillar 3 disclosures need
not necessarily be made in the financial statements.
IFRS and Basel II disclosures do, however, complement as well as supplement
each other in several ways. Both require corporates to provide information on
their capital, the risks exposed to, and how these risks are managed. Disclosures
are required to be made "through the eyes of the management". This enables the
user of information to view and assess a firm in the same way its management
would. Disclosures under both IFRS and Basel II include a good mix of
quantitative and qualitative aspects.

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Keynote Address during the Official Opening of Financial Reporting Workshop – March 27 , 2008
Consistent, comprehensive and comparable disclosures contribute to effective
market discipline. IFRS and Basel II disclosures try to ensure that this goal is met.
There is potential for achieving synergies in disclosures under IFRS and Basel II
by defining risk parameters in a common way, and developing common processes
and data collection methodologies. This could lead to a consistent basis for
internal reporting to the management of the enterprise and external reporting to
the supervisors or regulators and other stakeholders.
Challenges with IFRS and Basel II:
Compliance with IFRS will assist banks to comply with certain aspects of Basel II.
Both IFRS and Basel II intend to leverage on market discipline by requiring the
disclosure of certain information. Basel II encourages development of more
refined approaches to the measurement of risks and greater transparency while
IFRS strives to support broader and more sensitive recognition and disclosure of
risks.
Through financial reporting, the management of banks and non-bank financial
institutions provide their shareholders, potential investors and other stakeholders
with the past results of the business being managed and supervised. These reports
give more in-depth insight into the income statement, balance sheet and cashflow
and therefore, help the users of these reports better understand and assess the
financial performance of the business. The market participants base their
investment decisions mainly on the financial reports, thus reinforcing the
importance of providing adequate and accurate information. Although financial
reports are a crucial management tool, they at the same time provide the
management with an opportunity to explain to stakeholders the institution’s
performance, achievements and future plans.
Basel Committee on Banking Supervision recognises the importance of IFRS in
Basel Core Principle (BCP) 22 by requiring regulators to ensure that banks

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Keynote Address during the Official Opening of Financial Reporting Workshop – March 27 , 2008
maintain adequate records which are prepared in accordance with consistent
accounting policies and practices.
Compliance with IFRS and Basel II will however, pose certain challenges to banks
and non bank financial institutions. For accounting standards, the most recent
challenge is the accounting methods for sophisticated financial products, such as
bonds, in which differences in financial assets’ classifications can result in
different financial impacts. For example, held-to-maturity classification conceals
profit or loss until maturity, while trading classification charges profit or loss to
financial statements in every accounting period. The interpretation for a suitable
classification relies significantly on the intention of bank management as well as
on the judgment of external auditors.
Another practical challenge is the use of complex financial models to measure
risks in banks’ portfolio. These models are important as they provide adequate
predictive power. But there must be sufficient data, appropriate risk measurement
techniques, and a rigorous validation process for the benefits of the predictive
power of the models to be analysed. At present, the most important concern is the
lack of consistent data points over time. For example, for credit risk
measurement, a certain amount of data on default is required. Such data is
typically not readily available.
Banks may need to rethink their operations and strategies on account of the
expected greater involvement of third parties. The point here is that new
regulations allow banks to use financial models to estimate required capital and
fair values of assets and liabilities. This means that banks can take advantage of
the lower capital requirements by offering cheaper or more cost efficient products
to their customers. But these aspects in the market place are driven by the market
niche the bank is serving. The combination of market niche, requisite information
and efficiency will be the core of operating strategies in the banks.
Banks must increase their knowledge base regarding risk management techniques,
especially on risk modelling. Going forward, a good internal rating system is key
to business expansion and growth. To do so, banks can initially seek support from
external consultants to transfer the know-how on risk management. But, in the

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Keynote Address during the Official Opening of Financial Reporting Workshop – March 27 , 2008
longer term, it will be necessary for banks to train their own staff and build
expertise to work as specialists on internal rating system and risk modelling. But
we all do know that at the end of it all, these requirements and their derivative
innovations are driven more not by the regulator like CBK, but the market niche
the bank or any other firm in business is operating in. The more we understand
our market niches, the more we perform better and above all adhere to the rules of
the game. Market niches provide a drive to innovativeness.
I should now end my talk. It has been a pleasure to share with you a regulator’s
view on compliance with IFRS. I hope my remarks and observations have been
useful. We are travelling on an important and challenging path towards achieving
a robust and resilient financial system, and steady progress is being made.
Indeed, this progress is usually noticeable in times of economic vibrancy. You, as
a key stakeholder, are also an important part of this journey.
It is a great honour and privilege for me to declare the Financial Reporting
Workshop for the Banking Sector officially opened and to thank Ernst and Young
for organizing such a workshop.
Thank you very much.