Presentation on the Benefits of Deposit Insurance in Africa - The Kenyan Experience

1. Presentation on the Benefits of Deposit Insurance in Africa - The Kenyan Experience 2010 IADI African Regional Conference Arusha, Tanzania 29 – 30 July 2010 Presented by Rose Detho, Director, Deposit Protection Fund Board, Kenya

2. Historical Perspective of Deposit Insurance in Kenya • The concept of deposit insurance traces its origins to the Great Depression of the 1930s when numerous banks failed in USA. • Federal Deposit Insurance Corporation (“FDIC”) was formed in 1934 and it has grown to become a model institution. • The 1984 Kenyan Banking Crisis –two institutions collapsed and they were liquidated by the Official Receiver. There was no compensation paid to depositors.

3. In 1989, nine (9) financial institutions suffered liquidity strains leading to a systemic crisis. • To minimize the effect of the crisis and avert a further contagion effect and stabilize the banking sector, the Central Bank of Kenya together with the Ministry of Finance merged the nine (9) institutions into one (1) bank, the current Consolidated Bank of Kenya Limited. • DPFB participated in equity formation.

4. Establishment of Deposit Protection Fund Board • In order to restore confidence and financial stability after the first banking failure, it became necessary to establish a deposit insurance scheme in Kenya. • In 1985, amendments to the Banking Act created the Deposit Protection Fund Board (“DPFB”) as a body corporate through Section 36 of the Banking Act. Mandate • The mandate and powers of DPFB are limited and it is classified as a “narrow” or “pay-box” system. Its principle objects are: • to provide a deposit insurance scheme for customers of member institutions; • to hold, manage and apply funds levied as contributions from member institutions; and • to liquidate any member institution in respect of which it is appointed by CBK as liquidator.

5. Governance Structure • The Board of Directors is the top organ of DPFB and it comprises of: • the Governor of the Central Bank as Chairman; • the Permanent Secretary to the Treasury; and • five other members appointed by the Minister for Finance to represent the member institutions. • The Banking Act mandates the Central Bank to provide facilities and staff to manage DPFB.

6. Vision • The Vision of DPFB is to attain international standards of efficiency and best practices in deposit insurance. Mission • The Mission of DPFB is to build confidence in the Banking Sector through an effective deposit insurance scheme thereby fostering financial stability.

7. Profile of Kenyan Banking Sector * Above statistics valid as at 31.03.10

8. Profile of Kenyan Banking Sector(cont’d) • Aggressive move by Kenyan banks to downstream market through expanded branch expansion has resulted in an exponential growth of deposit accounts from this segment. • The Microfinance Act 2006 was enacted pursuant to the Government’s public policy objective on financial inclusion. • Micro finance credit only institutions are transforming into deposit taking institutions. • Faulu Kenya Deposit Taking Microfinance Ltd – licensed; • Kenya Women Finance Trust Deposit Taking Microfinance Ltd – licensed.

9. Profile of Kenyan Banking Sector(cont’d) • Most of the new deposit accounts generated through branch expansion and licensing of deposit taking microfinance institutions are within the threshold that is fully insured by DPFB and this has increased exposure compared to the growth of the Fund. • Some key facts on KWFT Deposit Taking Microfinance Ltd: • total deposit liabilities as at 30th June 2010 - Kshs.4.83 b (US$60.37 m); • 98.2% of the deposit liabilities is fully insured by the DPFB; • Asset base as at 30th June 2010 - Ksh.15.13 b (US$.188.7 m); and • ranking in peer 1 institutions in the banking industry.

10. Profile of Kenyan Banking Sector (cont’d) Note: One microfinance bank holds 4 million accounts (46%)

11. Profile of Kenyan Banking Sector (cont’d)

12. Profile of Kenyan Banking Sector (cont’d) Growth of Fund vis-à-vis Deposits and Insurance Coverage Note: One microfinance bank’s insured deposits almost equal the level of the Fund

13. Deposit Insurance Coverage (a) Membership • Membership to the Fund is mandatory for all deposit taking institutions. • Funding • The funding is ex-ante by premiums levied on member institutions. The Banking Act prescribes a maximum of 0.4% of the average of a member’s total deposit liabilities in a twelve month period. • The current annual premium is assessed at 0.15% with a minimum of Kshs.300,000.00 [US$ 3,750]. • The Act stipulates investment only in Government Securities.

14. Deposit Insurance Coverage(cont’d) • Hedging against interest rates fluctuation is done by adopting an investment-portfolio mix policy as follows: • 70% invested in long term bonds/securities and infrastructure bonds; and • 30% invested in short term securities. • DPFB has the power to borrow up to a maximum of Kshs.0.5 billion (US$6.25 m) from the Central Bank.

15. Deposit Insurance Coverage(cont’d) (c) Coverage • DPFB provides deposit insurance coverage of up to Kshs.100,000.00 [US$1,250] to each depositor for all types of deposit accounts. • Interbank money market accounts are excluded from coverage. • 31st March 2010:- 8,179,113 deposit accounts (92.35%) were fully covered. • The insured amount was determined at the inception of the Fund. Although it is higher than the Per Capita Income of Kshs.35,350 (US$.442), the Board is considering a review in the near future.

16. Deposit Insurance Coverage(cont’d) Coverage Indicators as at 31.03.10 * Recommended level – 40% ** Recommended level – 80%

17. Deposit Insurance Coverage(cont’d) (d) Deposit Pay-off • Litmus test for DPFB came in 1993 when it was appointed as liquidator for the first group of six (6) institutions that failed between January and April of that year. Turn-around-time for payment was about six (6) months. • Turn-around-time reduced to one month. Aim for a single digit turn-around-time, with an immediate target of fourteen (14) days. • Twenty four (24) member institutions failed in 1993 – 2005 and _ 51,299 depositor accounts out of 124,415 (i.e. 41.2%) have been fully paid. • Any outstanding balance of protected deposits that remain unpaid is due to failure to file claims by some protected depositors.

18. Deposit Insurance Coverage(cont’d) • A law was passed to limit the filing of claims by depositors to two years from the date the liquidator makes a declaration to pay protected deposits. • The rapid expansion of the branch network to the downstream markets by banks and the onset of coverage of the deposit taking microfinance institutions has significantly increased DPFB’s exposure. • Mitigation measures for the risk: • strengthened banking supervision and stringent regulations; • the core capital level increased gradually from a minimum of Kshs.250 million (US$.3.125m) to Kshs.1 billion (US$.12.5m) ; • new supervisory and prudential regulations since 2006 by the Central Bank; and • Market discipline enhanced through a sound disclosure regime. • No Kenyan financial institution was directly affected by the global financial crisis and the last bank failure was in 2005.

19. DPFB as a Liquidator • Section 35 of the Banking Act provides that the Central Bank may appoint DPFB to be the Liquidator of an insolvent institution. • DPFB has acted as Liquidator of twenty four (24) member institutions that failed between 1993 and 2005. • Once an institution has sufficient funds, and having reimbursed the Fund on the subrogated claims, the Liquidator declares a dividend payment to depositors and other creditors. • Creditors are ranked for payment starting with preferred creditors, (e.g. DPFB subrogated debt, Government taxes, salary arrears due to former staff), secured creditors and finally unsecured creditors and depositors.

20. DPFB as a Liquidator (cont’d) • In three (3) institutions, all creditors have been paid in full and DPFB will consider paying surplus funds to shareholders. • Details of payment of liquidation dividends since 1993 are as follows: • Amount paid to large depositors and sundry creditors - Kshs.4.38 billion (US$.54.75 million); • Amount owed to large depositors and sundry creditors as at liquidation date - Kshs.23.31 billion (US$.291.37m); • 8,657 out of 16,675 accounts (51.9%) of large depositors and sundry creditors accounts have been paid.

21. Vision 2030 and DPFB • Kenya Vision 2030 is the country’s new development blueprint covering the period 2008 to 2030. • It aims to transform Kenya into a newly industrialising middle-income country providing a high quality of life to its citizens by the year 2030”. • Vision for financial services: • to create a vibrant and globally competitive financial sector in Kenya that will create jobs and also promote high level savings to finance Kenya’s overall investment needs; • savings rates projected to rise from 17% to 30% of GDP in about a decade; • bank deposits projected to rise from 44% to 80% of GDP; and • Cost of borrowed capital projected to fall. • DPFB to provide a safe environment to drive savings.

22. Vision 2030 and DPFB (cont’d) • DPFB as a player in the new credit information sharing initiative through Credit Reference Bureaus (“CRB’s”) launched on 13th July 2010 to usher in improved lending environment and enhance credit access. • Vision 2030 aspires for a country firmly interconnected through a network of roads, railways, ports, airports, water and sanitation facilities, and telecommunications. • DPFB’s investment portfolio in the Infrastructure Bonds stands at Ksh.4.5 billion (US$56.25 million) comprised of 8 and 12-year bonds. • DPFB is to invest about Ksh.2 billion (US$5 million) in an upcoming 25-year infrastructure bond.

23. Vision 2030 and DPFB (cont’d) • DPFB is expected to play its rightful role in realization of Vision 2030 by providing an enabling environment and a safety net for members of the public to channel their savings in the banking system with confidence: • to promote financial inclusion/savings; • betterment of quality of life; • grow investments; • promote job and wealth creation; and • spur overall economic development.

24. Challenges facing DPFB • Mandate: DPFB’s mandate is a narrow pay box system thus it cannot deal with problem banks resolutions. • Governance: five Board members are drawn from the banking sector and this presents a conflict of interest. • Independence and Autonomy: As provided under the current law, the Central Bank provides staff and facilities and therefore management is under the Central Bank. • Investment limitations: The law restricts investments of the Fund to Kenyan Government Treasury Bills or Bonds only. The short term Treasury Bills interest rate has in the recent past fallen below 2% p.a., which is lower than the inflation rate and as a result the Fund is receiving a negative rate of return on any funds invested in Treasury Bills.

25. Challenges facing DPFB (cont’d) • Public Awareness: there is a low level of public awareness of activities of DPFB, which has resulted in low uptake of protected deposits and dividends once such payments are declared • Poor records: Most failed institutions have been found to have poor records management and this has hampered the debt recovery exercise by DPFB. • Protracted Litigation: the judicial system in Kenya is severely clogged resulting in extremely prolonged litigation that can take up to ten years to conclude. • Insider lending: results in massive loss of depositors’ funds. • Cross-Border Issues: these include, different laws that require harmonization; arbitrage; and absence of deposit insurance in some host countries.

26. Way Forward: As DPFB evolves in its role a financial safety net player, some key Legislative changes are necessary. Key among them are: • Amendments to the Banking Act have been proposed in the Finance Bill 2010 to provide: • for DPFB to hold unrealizable securities taken over from institutions in liquidation in order to facilitate immediate winding up of those institutions; and • to empower DPFB to receive payments after the winding up of a failed institution. • Proposals submitted to the Ministry of Finance for amendment of the law which are still under consideration are:

27. for an amendment to the Law of Limitations Act (Cap 22) to safeguard the interests of an institution in liquidation on adverse possession claims on properties offered to an institution as security; and • to establish a special court/tribunal to deal with cases for institutions in liquidation in order to fast track the litigation process. • DPFB to increase awareness of its activities by embarking on a viable public awareness campaign and rebranding. • Keep abreast with the National Payments Systems Bill currently awaiting debate in parliament and which will address many gaps brought about by recent innovations in the services offered by the industry such as e-banking, mobile banking and agency banking.

28. The Deposit Insurance Bill that is pending publication by the Attorney General and subsequent debate and enactment by Parliament, once passed, will: • transition DPFB into a fully autonomous body known as the Kenya Deposit Insurance Corporation (“KDIC”); • alter the corporate governance structure from the present form in DPFB to one that reduces possible conflicts of interest; • grant KDIC a broader mandate for deposit insurance in line with international best practices; • align the structure and operations of KDIC to international standards; and • address the issue of funding with additional fall back sources to include the Consolidated Fund.

29. THE END THANK YOU