Small banks in Kenya may be facing an uncertain future as the government moves forward with reforms aimed at increasing the minimum capital requirement for banks. A recent announcement by the Treasury to raise the requirement to Sh10 billion suggests imminent consolidations within the banking sector, particularly for smaller lenders.
The new regulation would force banks unable to meet the new core capital threshold to seek mergers, acquisitions, or potentially close down their operations. Core capital refers to the minimum amount of capital that a bank must maintain to comply with national regulations. Currently, the minimum core capital requirement in Kenya stands at Sh1 billion.
This requirement, enforced by the Central Bank of Kenya (CBK), is designed to ensure the financial stability and resilience of the banking sector. Core capital, also known as Tier 1 capital, includes a bank’s equity capital and disclosed reserves, which are vital for absorbing losses and protecting depositors.
During the budget reading on Thursday evening, Treasury Cabinet Secretary Njuguna Ndung’u announced plans to increase the minimum core capital for banks progressively from Sh1 billion to Sh10 billion. “This is intended to strengthen the resilience and increase the bank’s capacity to finance large scale projects while creating sufficient capital buffer to absorb and withstand shocks caused by continuous emerging risks associated with adoption of technology and innovation,” stated the CS.
This proposal mirrors a similar attempt in 2015 by former National Treasury Cabinet Secretary Henry Rotich, who proposed raising the minimum capital requirement to Sh5 billion over three years. However, the proposal was rejected by Members of Parliament who argued it would lead to market overconcentration dominated by a few large banks.
The current requirement was established in 2012, and since 2017 there have been ongoing discussions and proposals to increase the minimum core capital to bolster the banking sector further. Kenya, with 39 banks, is considered overbanked compared to its Sub-Saharan African peers, with nine banks holding 75.1 percent of the total market share.
Although Kenyan banks have maintained their capital adequacy and liquidity ratios above the CBK’s minimum requirements of 14.5 percent and 20 percent, both ratios have declined. Between 2021 and 2023, the aggregate liquidity ratio dropped by 5.50 percentage points, and the capital adequacy ratio fell by 1.30 percentage points. These declines indicate reduced liquidity in Kenya’s banking sector, according to Pan African markets research company Stears.
Financial soundness has also decreased, with non-performing loan ratios rising to 16.1 percent in April 2024. Despite having the smallest minimum capital base for banks compared to its Sub-Saharan African peers, Kenya’s domestic credit to the private sector as a percentage of Gross Domestic Product (GDP) was the second-highest at 31.5 percent in 2022.
Stears Research highlighted that increasing banks’ capital reserves could enhance their capacity to extend credit, potentially stimulating economic growth. However, larger capital buffers might also enable banks to charge higher interest rates on loans, potentially hindering borrowing and investment.
Overall, this exercise aims to increase the capital base of Kenyan banks, leading to an expansion of their asset sizes, but it also poses significant challenges for smaller banks in the industry.
