Njuguna Ndung'u: Bank regulation reforms in Africa: enhancing bank
competition and intermediation efficiency
Keynote address by Prof Njuguna Ndung'u, Governor of the Central Bank of Kenya, at the
12th Seminar by African Economic Research Consortium, Mombasa, 22 March 2010.
* * *
Prof. William Lyakurwa, Executive Director, African Economic Research Consortium;
Senior Policymakers here present;
Distinguished Guests;
Ladies and Gentlemen;
I am delighted to be with all of you here in Mombasa and to speak on Bank Regulatory
But before I make
Reforms in Africa: Enhancing Bank Competition and Intermediation.
my remarks, let me take this opportunity to thank the African Economic Research
Consortium (AERC) for their invitation to give the keynote address at this seminar. This is
indeed a timely topic as we continue to assess the effects of the global financial crisis and
find long term solutions to mitigate and prevent recurrence. I am informed that approximately
70 senior policymakers from over 20 countries in Sub-Saharan Africa (SSA) are in
attendance. This signals the importance of this seminar and the policy spin-offs it will
generate.
At the outset, Ladies and Gentlemen, I would like to recognize the important role that AERC
has played in strengthening local capacity for managing economies within Sub Saharan
Africa. The Consortium has contributed to advanced policy research and graduate training in
economics. Most institutions of policy in Sub-Saharan Africa today are led by AERC alumni.
I am happy to be part of this group myself.
Ladies and Gentlemen; this seminar is taking place at a time when countries in Africa are
taking stock of the second and third round effects of the global financial crisis. You will agree
with me that the crisis which initially hit African countries with stronger financial linkages to
international capital markets; significant trade relations with the Western world and rich
natural resource countries set the stage for challenging times in policy making and
implementation.
Africa's prospects in the post-crisis period are contingent on the behaviour of policymakers.
Indeed, there is need for better regulation that can readily identify emerging vulnerabilities;
properly price risks; and strengthen incentives for prudent behaviour. It is tempting after the
crisis to call for more regulation - but we should emphasize better regulation. Second, we
should emphasize building strong institutions. Globally, the remedial actions taken by
governments to deal with the crisis have borne fruit and the green shoots of recovery are
beginning to sprout.
For us here in Kenya, we remain committed to fostering a stable market-based financial
system as mandated by law. An efficient financial system collects and collates deposits from
micro-savers and channels them to investors. This is the intermediation process. This
process allows economic agents to evaluate the risks and prices in the market and align their
investment portfolio and investment gestation.
The Kenyan case is both interesting as well as a policy strategy. It reflects a case of
segmented markets. But the cost of credit and interest rates spread remains high. The
spread is a major challenge in the banking sector because it acts as an impediment to
expansion of credit and development of financial intermediation and signals inefficiency in
the sector.
The challenge for a policymaker is to develop a financial sector that answers to the
challenges of the economy. In order to address market inefficiencies, the Central Bank and
other stakeholders have undertaken significant reforms for the banking sector. These
reforms include the operationalisation of the credit reference bureaus, payment systems
improvements, opening of new currency centres, automation of trading system for treasury
bonds, and the activation of horizontal repos. I will spend the next few minutes to highlight
these initiatives.
Operationalisation of credit referencing mechanism: The Banking (Credit Reference
Bureau) Regulations were operationalised on 2nd February 2009. This will facilitate the
sharing of credit information by institutions licensed under the Banking Act. This link will allow
the industry to build information capital that is critical in the credit market. It will also enhance
access to credit by SMEs and individuals that have been constrained by lack of physical
collateral. Further, the Banking Sector will be able to address the problem of non-performing
loans at the origination point as credit history of applicants will be taken into account during
the credit appraisal process.
Licensing of deposit taking microfinance institutions: The Microfinance Act was
operationalised effective May 2008. Currently, one institution has been licensed and eight
applications for license are being processed. With the unique business models of
microfinance institutions mainly targeted at the lower end of the market, bringing them under
the purview of the Central Bank will not only give them a legal basis in dealing with
depositors but will also boost access to formal financial services by the populace. Deposit
Taking Microfinance Institutions are free to be community-based or nationwide.
The national payments system sits at the centre of the financial system. It is imperative
that payments systems are secure and efficient. The Central Bank continues with its
initiatives to modernize the national payments system. Accordingly, from 1 October 2009,
value capping was effected with all payments above Kshs.1 million being made through the
Real Time Gross Settlement System (RTGS). This initiative enhanced the security and
efficiency of high value payments.
The celebrated MPESA falls under this category of reforms. As we have seen this market
unfolding, MPESA account holders have soared to 9 million, total transactions surpassed
Ksh.48 billion a month (or averaging Ksh.1.6 billion a day) and agents increased to 17,000 in
the last 3 years.
Ladies and Gentlemen; on the monetary policy front, the CBK has observed that despite
signalling efforts by the Monetary Policy Committee to bring down the rates of interest by
lowering the Central Bank Rate (CBR), banks have not responded accordingly. Further, the
failure of the banking system to extend the maturity of their loan products is a consequence
of the characteristic nature of their deposits which are largely short term, but also their
assessment and pricing of risk. To support economic development, there is need for the
development of banking products that support long term lending. These development
banking products will play a significant role in influencing a downward trend in commercial
banks lending rates. The Central Bank will therefore explore how development banking
products can be introduced into the market to enhance the monetary policy transmission
mechanism and lengthen the maturity profile of commercial bank term loans.
Developments in the bond market: The Central Bank has successfully raised funds for
infrastructure development for the Government through infrastructure bonds. These
infrastructure bonds have not only facilitated financing of the Government's infrastructure
program but also set the pace for the issuance of similar bonds by corporate entities such as
KENGEN and Safaricom. This, coupled with automated trading in the Nairobi Stock
Exchange will be important for a vibrant bond market. In addition, to deepen and widen the
bond market, the Central Bank implemented the following measures:

Issuance of benchmark bonds: The Bank together with Market Leaders Forum
adopted 2, 5, 10, 15 and 20 year maturities as benchmark bonds. This move has not
only firmed up the yield curve, but has improved pricing, reflected through improved
secondary market trading.
 This has increased trading activities in the
Reopening of benchmark bonds:
secondary market.
 The vibrant bond market has led to a
The shape and position of the yield:
downward shift in the Yield Curve with an upward gentle slope reflecting stability.
This has created reliable pricing benchmark for corporates, many of who raised
required capital via issuance of corporate bonds in 2009/10. It is also a useful tool in
pricing credit facilities as it signals the direction of interest rates.
You will recall that the Central Bank of Kenya, the Nairobi Stock Exchange and the Capital
Markets Authority collaborated in the automation of trading of Treasury Bonds through the
NSE. The main objective of this initiative was to make bonds trading secure, efficient and to
create a vibrant market. The expected improvement in market activity will also improve
market liquidity and encourage more investors to participate in the bond market.
Operationalisation of the horizontal repos: We have introduced the Interbank Master
Repurchase Agreement otherwise known as the Horizontal repo which is aimed at
deepening the capital and money markets and enhancing the intermediation process. I am
happy to note that the horizontal repo as a tool of redistributing liquidity in the market has
also provided a useful barometer on the status of liquidity in the banking sector. The
horizontal repo is an additional facility for commercial banks to use alongside the vertical
repo which is an instrument between commercial banks and CBK.
The changing market dynamics in the Kenyan Banking Sector has
Other initiatives:
necessitated the Central Bank to reinvent itself and become proactive in detecting
opportunities and threats to financial sector stability. With a view to not only enhance
intermediation and competitiveness of the banking sector but also to increase efficiency and
access, the Central Bank has been in the forefront in encouraging various financial services
providers e.g.

mobile phone money transfer providers such as M-PESA and ZAP

SACCOs and Agency Banking models

Shariah compliant banking products - we have seen the introduction of two
Shariah compliant banks and growing interest in a number of institutions seeking to
offer Shariah compliant products.
Ladies and Gentlemen; we have now started to realize the dividends of the reforms we
have undertaken in the financial sector. Kenya now has a healthy, sound and strong banking
system. The size of the banking system has been enhanced both in terms of deposits
mobilised, credit growth and competition. Specifically:

Deposit accounts have increased from 2.6 million (end 2005) to 8.4 million (end
2009) and deposits have doubled from Ksh.545 billion (US$7.2 billion) to
Ksh.1,065 billion (US$14 billion) in the same period.

Lowering barriers to entry - via removal of minimum balances has supported
financial reach.

Banks have taken their services to the customers due to increasing competition and
improvements in the delivery channels. Banks are opening and re-opening branches
in areas with none or few branches.
Efficiency is achieved when there are strong institutions with requisite capacity to satisfy
market needs while complying with statutory and prudential requirements.
Ladies and Gentlemen: One of the main challenges of monetary policy has been the
presence of currency outside banks. In March 2008, it was Ksh.9 billion above the Central
Bank target. However, in March 2010 it was Ksh.4.9 billion below CBK target as a result of
banks increased coverage of rural and low income areas.
Ladies and Gentlemen; Financial sector reforms are far from being accomplished. Given
the changing dynamics of the economy and its growing complexities, the financial industry
has to remain responsive and supportive of the broader economic ambitions and agenda. All
the major players and stakeholders in the banking system will have to strive for continuity,
broadening and deepening of reforms; build and sustain the already implemented reforms
and fill the remaining gaps. The growing competition along with increasingly diversified
services both across the regions and sectors, as well as improved access to customer-base
on the back of progressive reliance on technology, are the harbingers of the changing and
efficient intermediation role of banks in the days ahead.
The Central Bank is committed to reforms in the banking industry towards enhanced
competitiveness. In line with this, the Central Bank has earmarked amendments to the
Banking Act and Microfinance Act going forward. The amendments to the Banking Act and
Microfinance Act are expected to further enhance efficiency and competitiveness of our
financial sector. CBK in collaboration with the Government and the market players will
enhance its efforts in addressing other structural rigidities that contribute to market
inefficiencies to take stock of developments as well as other emerging constraints.
Before I conclude, Ladies and Gentlemen, let me once again take this opportunity to
reiterate the critical role of the financial sector in Africa's economic development. This
potential can only be realized when African policymakers implement reforms to remove
binding constraints in the sector. I am sure that in this gathering we have the capacity to
identify those constraints to unleash Africa's potential.
Finally, I do hope that you will find time in your busy schedules to enjoy our world renown
beaches. I wish you fruitful deliberations.
Thank you!