As regional integration projects go, the East African Community (EAC), consisting of Kenya, Tanzania, Rwanda, Burundi, Uganda and South Sudan, has been a standout success. Since its formation in 2000, the bloc has been quick to pursue economic integration through the ratification of protocols for, among other things, a customs union, a common market and a common currency.
According to the US think tank the Brookings Institution, these efforts and others have seen the EAC emerge as the world’s second fastest growing economic community behind the Association of South-east Asian Nations, while per capita incomes for the region have risen above the rest of sub-Saharan Africa in recent years.
Kenya spreads its wings
Off the back of this integration, cross-border banking models have come to the fore as lenders from the EAC’s largest economy, Kenya, have leveraged this co-operation to expand into regional markets. Today, a total of 11 Kenyan banks have operations across the region, with their most significant presence in Uganda and Tanzania. Kenyan banks with the largest regional footprints include Kenya Commercial Bank, present in six markets, Equity Bank in five markets, and Diamond Trust Bank in four markets.
“The expansion of Kenyan banks across the east Africa region has largely arisen from greater trade and co-operation occurring within the EAC. As more corporates from Kenya have started doing business across borders, the banks have followed. In addition, some banks wanted to diversify their operations by entering new markets,” says Christos Theofilou, assistant vice-president and analyst at ratings agency Moody’s.
Adding to these factors is the considerable success enjoyed by Kenyan banks in both mobile and agency banking. Given their relative sophistication in the east African context, Kenyan lenders have been able to capitalise on these innovations to replicate the success of schemes such as mobile wallets and payments throughout the region. These innovations have provided them with a competitive edge in neighbouring markets.
In executing this expansion Kenyan lenders have typically injected equity into target banks that share similar business propositions. For instance, Equity Bank’s acquisition of Uganda Microfinance Limited in 2008, the lender’s first move towards regional expansion, meant that natural synergies emerged from both banks’ focus on financial inclusion. As such, this type of growth has in some ways strengthened a number of regional banking markets.
“Since Kenyan lenders have pursued mergers as opposed to establishing greenfield operations, it means they have strengthened EAC banking sectors rather than fragmenting them. The Kenyan banks with regional operations now have more than 300 branch outlets, including [those in] South Sudan,” says Professor Njuguna Ndung’u, the former governor of Kenya’s central bank.
Supervisory strength
Nevertheless, as the trend towards cross-border banking in the EAC has gathered pace, it has raised new questions around the strength of the supervisory structures overseeing this growth. As noted by the International Monetary Fund (IMF) in its February 2015 survey of pan-African Banks, the rise of banking entities with cross-border activities increases the chance of transmitting macro-financial risks.
Similarly, the IMF notes that supervisory capacity is typically under-resourced and constrained across most of Africa, meaning that the inclusion of cross-border oversight mechanisms may be challenging. Yet, the Central Bank of Kenya has adopted a number of innovative initiatives to monitor the cross-border operations of Kenyan lenders.
“Kenya was the first regulator in the region to establish supervisory colleges for specific banks with exposure to a number of regional markets. This has brought together regulators from jurisdictions in which Kenyan banks have expanded to provide a better oversight of lenders with cross-border activities,” says Mr Ndung’u.
Kenya has now established these supervisory colleges to cover the activities of most of its domestic banks with a regional footprint. And while this is an encouraging step in the right direction, there is still some way to go before these colleges offer sufficient rigour to monitor for a full range of potential weaknesses. This partly comes down to their collegiate nature; they are only as strong as the input provided by other regulators from the region.
“Overall, things are moving in the right direction. But until all supervisors are able to improve their internal oversight mechanisms and reach a more or less equal level of regulatory development, there will be challenges in cross-border supervision. For now, the Kenyan authorities are doing what they can,” says Mr Theofilou.
Challenging environment
The strength of the regulatory bodies in partner countries matters. In particular, the operating environment in some EAC jurisdictions, notably South Sudan, is highly challenging. Having effective supervisors in place to monitor the risks to cross-border banks is therefore crucial.
As the presence of Kenyan lenders in South Sudan has grown, so too have the risks. By March 2016, the devaluation of the South Sudanese pound (SSP) had seen Kenyan lenders sustain sizeable foreign exchange losses, equivalent to about $127m, according to reports from Business Daily Africa.
“There is an elevated country risk in some of these regional markets. An example is South Sudan and its volatile operating environment. In addition, Kenyan banks’ franchises in these markets are relatively immature and less entrenched, asset quality is typically weaker, and they would be more vulnerable to a sudden shock. The banks are trying to counter this by holding more capital and liquidity in these operations,” says Mr Theofilou.
Nevertheless, efforts are under way to strengthen the regional regulatory environment. The IMF, through its Africa Regional Technical Assistance Centres (Afritac), is working in partnership with recipient countries to enhance technical assistance and develop capacity building when it comes to financial sector regulation and supervision.
Among other things, this includes assisting countries with their on-site and off-site supervision activities, as well as implementing consolidated supervision for banking groups and mixed financial conglomerates. At present, Kenya, Rwanda, Tanzania and Uganda are member countries of the Afritac East programme.
Well buffered?
Looking ahead, efforts to build up regulatory capacity in the region are likely to grow in importance as cross-border banking operations begin to grow in size and importance. Similarly, the ongoing drive to improve co-ordination between regulatory agencies will be of equal consequence. Achieving positive reforms and developments will not be easy, while the risks will remain relatively elevated until such changes are implemented.
Nevertheless, Kenya’s banks are well capitalised with an aggregate core Tier 1 ratio of 15.5% as of September 2015, according to Moody’s. This puts them in a good position to weather any significant shocks in the near term, as does increasing scrutiny at home.
“[For Kenyan banks], weaknesses in cross-border supervision, a frequent restructuring of non-performing loans and fairly low loan-loss provisioning – by emerging market standards – remain a concern, although these issues are under increasing regulatory scrutiny,” says Mr Theofilou.
Worth the risk
But the benefits of Kenyan banks expanding across the region are commensurate with the risks to financial stability. As the IMF notes, host countries tend to benefit from these cross-border investments through access to new technologies and services, increased competition in the financial services space and the diversification of financing sources.
These points are particularly true for Kenyan lenders, given their introduction of new banking models in some markets. Accordingly, most observers believe that positive implications can be drawn for financial inclusion, as well as innovation, in the EAC at large as Kenyan banks expand their footprint.
Meanwhile, the march towards greater regional integration continues. With a full monetary union scheduled for 2023, further challenges and opportunities will emerge for east Africa’s banking landscape.
This includes the set up of an East African Monetary Institute to act as a precursor to a region-wide central bank. In addition, plans to introduce a single financial services regulator for the EAC – the East Africa Financial Services Commission – are being pursued, although the timing remains unclear.
