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September 24, 2018

Fewer large lenders are not a panacea to bank failures

The Central Bank of Kenya. Photo/Monicah Mwangi
The Central Bank of Kenya. Photo/Monicah Mwangi

There is a raging debate on whether the country has too many banks, and how far this has contributed to the recent failure of lower-tier banks. The failures have resulted in market confidence shifting in favour of large banks. With the support of the liquidity programme introduced by Central Bank, calm will eventually return to the market. There is, however, the possibility the market will experience consolidation, resulting in fewer banks, but it is critical that this is market-led rather than regulation-driven.

A look at the development of the local banking industry shows the number of banks has actually reduced over time. In 2000, the industry had 60 licensed institutions comprising 49 commercial banks, five non-bank institutions, two mortgage companies, and four building societies. Today, the sector has 50 banking institutions comprising 40 licensed banks, a mortgage company, and nine microfinance banks. This excludes the three banks that were recently placed under receivership.

There are a variety of views on what is the optimal number of banks in an economy, and because country circumstances differ, there is no global best practice. However, having a few large banks instead of the current profile with many banks across a size spectrum, may not be the solution to bank failures that we are experiencing today – it also has its own risks.

One, it is important there are many players in the market in order to spur competition. The larger the number of banks, the higher the level of competition, and the lower the likelihood of monopolistic tendencies that may result in higher interest rates.

Two, small banks serve specific niche markets that may not be served by large banks. Their size gives them the flexibility to quickly adapt to customer needs and changing market conditions. For instance, what makes Chase Bank an attractive buy is the fact it had mastered the SME market.

Three, in order to survive, smaller banks seek new ways to address customer needs, making them key drivers of innovation, and even industry transformation. Equity Bank is a good example. In 2000, Equity Bank was among the four building societies, operating as Equity Building Society. Banking was then reserved for the elite, with minimum balances and a myriad of other requirements intimidating to most ordinary citizens. Equity Bank welcomed anybody who had an identity card to walk in and open an account. Today, it is rated among the six top-tier banks. It transformed local banking as we know it today.

Finally, it is widely acknowledged that large banks were at the centre of the recent global financial crisis. Large 'too-big-to-fail' banks, on average, are more organisationally complex, create more systemic risk to the market, and are a contingent liability to Central Bank and taxpayers.

 

Karen Kandie is a financial & risk consultant and a PhD candidate in finance.

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