Commercial banks had borrowed a cumulative Sh90.4 billion from each other using their government securities as collateral between the start of the year and July 4, pointing to liquidity challenges for some lenders despite muted growth in lending to customers.
Liquidity distribution in the banking sector has in recent years been skewed in favour of large lenders, partly reflecting their ability to gather cheaper deposits at scale, and the lingering effect of the flight to safety by customers of small banks were spooked by the collapse of three smaller lenders in 2015 and 2016.
Small banks also faced difficulties accessing the interbank market for emergency liquidity needs due to perceived higher risk of default in the wake of the three lenders’ collapsing, leading to increased dependence on liquidity support from the Central Bank of Kenya (CBK).
The revival of the horizontal repo market (as the collateralised interbank borrowing is known) in 2022, supported further by the introduction of the digital bond trading platform DhowCSD, opened a new channel for the banks to access emergency funding.
CBK data shows that by July 4, the outstanding amount in horizontal repos stood at Sh3.6 billion, which was borrowed at an annualised interest rate of 9.75 percent, reflecting the short maturity cycle of the facility.
As a liquidity support facility for banks, the horizontal repo supports other windows such as the CBK’s reverse repos and the discount window.
Banks also offer liquidity support to each other through the interbank or overnight market, which unlike the horizontal repos does not require collateral.
The horizontal repo facility was introduced in September 2008, but utilisation remained low, eventually falling into dormancy in 2014.
This was largely due to the inability of the lenders to transfer the ownership of the collateral —Treasury bills and bonds— from borrowers, making it hard for creditors to recover their funds in case of default.
The revival of the market in 2022 was also supported by a change of rules allowing the borrower to continue enjoying the coupon payments for the pledged securities —the lender is supposed to pass back that coupon to the borrower.
At the same time, the CBK has been mopping up excess cash from banks, showing that the liquidity in the sector remains skewed.
In the first half of the year, the CBK mopped up a cumulative Sh3.78 trillion in liquidity from banks through repos.
This marked a turnaround following last year’s aggressive liquidity injections worth Sh5.6 trillion to commercial banks through reverse repos, while mop ups stood at zero.
Repos entail a sale of government securities held by the CBK to banks on a short term basis, thus reducing the level of deposits the lenders hold with the regulator and cutting their ability to make new loans.
Reverse repos work the other way, injecting liquidity into the banking sector by allowing banks to borrow from the CBK using their holdings of bonds as collateral.
Traders said that in addition to banks holding excess liquidity due to reduced lending, the CBK has also contributed to the growing shilling pile because of its dollar buying activities in the market since June 2024 –effectively injecting shillings into the banking system in exchange for hard currency.
