Question

QUESTION ONE
1. Elaborately discuss the financial sector regulatory structure in Kenya; clearly indicating the roles, institutions/regulators under each of the following;
a. Central bank
b. Retirement benefit authority
c. Insurance regulatory authority
d. Capital market authority
e. Micro finance institutions
f. Investment banks and stock brokers
g. Pension funds
h. Investment companies
i. Sacco Societies Regulatory Authority (SASRA) and Finance companies
2. Discuss any regulatory overlaps among the regulators discussed above.
3. Discuss the products under each of the regulators above.
4. Discuss the objectives of financial sector regulation.
5. Discuss the financial and non-financial roles played by the above financial institutions.
6. The regulatory authorities have adopted various measures to encourage business continuity in the wake of Covid -19. Discuss measures instituted by CBK and CMA.

QUESTION TWO
Discuss the various risks faced by financial institutions and clearly highlight the strategies adopted by the institutions to mitigate the risks.

Answer 1

QUESTION ONE

1.

(a) Central Bank

Foreign Exchange reserves held by the Central Bank of Kenya (CBK) are a national asset held as a safeguard to ensure availability of foreign exchange to meet the country’s external obligations, including imports and external debt service. The primary objective in the management of these reserves is therefore capital preservation.

A central bank is an independent national authority that conducts monetary policy, regulates banks, and provides financial services including economic research. Its goals are to stabilize the nation's currency, keep unemployment low, and prevent inflation.

(b) Retirement benefit authority

Retirement Benefits Authority (RBA) is a policy formulation and regulation organ in Kenya that oversees pension schemes. The organization's established under the Retirement Act, which was created to regulate and harmonize the pension scheme sector. Before the Act, the retirement benefits schemes that existed were under poor control, only governed by unreliable policies and law. With the emergence of the Retirements Benefit Act and subsequent implementation through RBA, pension schemes fell under proper regulation and started abiding by harmonized rules.

The Retirement Benefits Authority (RBA) is Kenya's regulatory body under the National Treasury established to regulate the retirement benefits industry.

(c) Insurance regulatory authority

The Insurance Regulatory Authority is a statutory government agency established under the Insurance Act (Amendment) 2006, CAP 487 of the Laws of Kenya to regulate, supervise and develop the insurance industry. It is governed by a Board of Directors which is vested with the fiduciary responsibility overseeing operations of the Authority and ensuring that they are consistent with provisions of the Insurance Act.

The Insurance Industry is regulated by the Insurance Act and its attendant Regulations. The Act provides for the Insurance Regulatory Authority (IRA) which is responsible for licensing, regulating and developing the insurance sector in Kenya.

(d) Capital market authority

The Capital Markets Authority of Kenya, also Capital Markets Authority (CMA), is an independent government financial regulatory agency responsible for supervising, licensing and monitoring the activities of market intermediaries, including the stock exchange, and the central depository and settlement system and all the other persons licensed under the Capital Markets Act of Kenya.

The capital market is market of equity and debt securities is regulated by Securities and Exchange Board of India (SEBI).

(e) Micro finance institutions

Microfinance Institutions (MFIs) provide working capital loans in short loan cycles. It is evident that the bottom poor lack business opportunities and are therefore discriminated against in accessing financial services. The credit facilities provided by microfinance institutions enable micro enterprises to borrow funds to cover various short-term financial needs, such as working capital.

CBK regulates and supervises all financial institutions, payments and settlement systems.

(f) Investment banks and stock brokers

As a corporate investment banker, it provide a range of financial services to companies, institutions and governments. You'll manage corporate, strategic and financial opportunities, including acquisitions, bonds and shares, initial public offerings (IPO), lending, mergers, privatisations. It may also advise and lead management buyouts, raise capital, provide strategic advice to clients and identify and secure new deals.

They are regulated by the Capital Markets Authority and the Nairobi Securities Exchange.

(g) Pension funds

Pension funds maintain contentment and morale of the staff. It assures them of their future financial stability, in turn, means a more healthy staff and greater productivity. Pension funds attract and keep competent employees. This is an advantage to the employer. Pension funds are there to support employees and give them a decent standard of living when commencing retirement. To maintain the same standard of living after retirement. Pension funds can provide protection and financial support to dependents in the event of a members’ death. Pension funds exist to encourage growth and investment due to state tax relief on pensions.

The Retirement Benefits Authority (RBA) is Kenya's regulatory body under the National Treasury established to regulate the retirement benefits industry.

(h) Investment companies

Investment companies only exist to invest. They make a profit by buying and selling shares, property and other assets. An investment manager decides what assets to buy in order to build a diverse, managed portfolio. When we buy shares of an investment company we make an investment that includes a share of all those assets. It’s a simple way of expanding the portfolio and spreading risk.

They are regulated by the Capital Markets Authority and the Nairobi Securities Exchange.

(i) Sacco Societies Regulatory Authority (SASRA) and Finance companies

The Sacco Societies Regulatory Authority (SASRA) is a semi-autonomous Government Agency under the Ministry of Industrialization and Enterprise Development. The establishment of SASRA, which falls within the Government of Kenya’s reform process in the financial sector, has the objectives of protecting the interests of Sacco members, ensuring that there is confidence in the public towards the Sacco sector and spurring Kenya’s economic growth through mobilization of domestic savings. SASRA is charged with the role of regulating, licensing and supervising deposit taking Sacco Societies in Kenya. SASRA is mandated to regulate, license and supervise deposit taking Sacco Societies in Kenya. In pursuit of its mandate, the Authority will partner with county governments to ensure that there is economic growth in Kenya.
The Sacco Societies Regulatory Authority (SASRA) is the regulatory body charged with regulating deposit‑taking Sacco Societies (Savings and Credit Cooperatives Societies) in Kenya. Its mandate allows it to regulate and supervise licence and levy contributions in all Sacco Societies in Kenya in accordance with the Sacco Societies Act of 2008.

3. Discuss the products under each of the regulators above.

• The Federal Deposit Insurance Corporation (FDIC) was created by the Glass-Steagall Act of 1933 to provide insurance on deposits to guarantee the safety of funds kept by depositors at banks. Its mandate is to protect up to $250,000 per depositor. The catalyst for creating the FDIC was the run on banks during the Great Depression of the 1920s. FDIC insurance does not cover products such as mutual funds, annuities, life insurance policies, stocks, or bonds. The contents of safe-deposit boxes are also not included in FDIC coverage.
• The Commodity Futures Trading Commission (CFTC) was created in 1974 as an independent authority to regulate commodity futures and options and other related derivatives markets and to provide for competitive and efficient market trading. It also seeks to protect participants from market manipulation, investigates abusive trading practices and fraud, and maintains fluid processes for clearing.

• The Office of the Comptroller of the Currency (OCC) was established in 1863 by the National Currency Act. Its main purpose is to supervise, regulate and provide charters to banks operating in the U.S. to ensure the soundness of the overall banking system. This supervision enables banks to compete and provide efficient banking and financial services. The OCC is an independent bureau within the Department of Treasury. Its mission statement verifies it is to "ensure that national banks and federal savings associations operate in a safe and sound manner, provide fair access to financial services, treat customers fairly, and comply with applicable laws and regulations."

4. Discuss the objectives of financial sector regulation.

The key elements of such regulations are consumer protection, taxpayer protection, and financial and macroeconomic stability. Financial regulations, however, are mandatory in the sense that they are essential in preventing financial crises and hence have certain aims and objectives. The newly established banking regulations aim to provide a resolution mechanism that could provide for a recovery of financial institutions without using taxpayer money.

The second objective of the financial regulations is to protect retail and small investors and depositors. Since transparency brings an overall benefit to the market, ultimately contributing to financial stability, another important objective of financial regulations is to ensure transparency of markets and institutions. Financial remunerations had no limits or regulation before the financial crisis.

Another important objective of financial regulation is thus to implement a risk adjusted remuneration system for financial institutions. Since avoidance of the contamination of risks that would threaten the deposit base and consumer confidence is necessary, financial regulations also aim to protect deposits from trading.

5. Discuss the financial and non-financial roles played by the above financial institutions.

Financial Roles played by the financial institutions

• Savings function: Bonds stocks and other financial claims produced and sold in financial markets by financial institutions provide a profitable, relatively low risk outlet for the public's savings. By acquiring these financial assets, households may choose to forego consumption today to increase their consumption opportunities in the future. This flow through financial markets into investments allows the economy to increase the production while increasing productivity, increasing the worlds standard of living.
• Wealth: The sum of the value of all assets we hold at any point in time. the combined value of homes, automobiles, clothing and hundreds or thousands of other assets we have managed to accumulate and hold up to the present day.
• Fianancial wealth: The portion of wealth held by society in the form of stocks, bonds, and other financial assets, created by the system of financial institutions and markets.
• Wealth holdings: Stored purchasing power that will be used in the future periods as income to finance purchases of goods and services to increase societies standard of living.

Non-financial Roles played by the financial institutions

Non bank financial institution (NBFI) is a financial institution that does not have a full banking license and cannot accept deposits from the public. However, NBFIs do facilitate alternative financial services, such as investment (both collective and individual), risk pooling, financial consulting, brokering, money transmission, and check cashing. NBFIs are a source of consumer credit (along with licensed banks). Examples of nonbank financial institutions include insurance firms, venture capitalists, currency exchanges, some microloan organizations, and pawn shops. These non-bank financial institutions provide services that are not necessarily suited to banks, serve as competition to banks, and specialize in sectors or groups.

Life insurance companies insure against economic loss of the insured’s premature death. The insured will pay a fixed sum as an insurance premium every term. Because the probability of death increases with age while premiums remain constant, the insured overpays in the earlier stages and underpays in the later years. The overpayment in the early years of the agreement is the cash value of the insurance policy.

Contractual savings institutions (also called institutional investors) provide the opportunity for individuals to invest in collective investment vehicles in a fiduciary rather than a principle role. Collective investment vehicles invest the pooled resources of the individuals and firms into numerous equity, debt, and derivatives promises. The individual, however, holds equity in the CIV itself rather what the CIV invests in specifically. The two most popular examples of contractual savings institutions are mutual funds and private pension plans.

6. The regulatory authorities have adopted various measures to encourage business continuity in the wake of Covid -19. Discuss measures instituted by CBK and CMA.

The Central Bank of Kenya (CBK) is a public institution established under Article 231 of the Constitution of Kenya, 2010. The Bank is responsible for formulating monetary policy to achieve and maintain price stability and issuing currency.

The Central Bank’s mandate is discharged through six core functions:-

• Banking Services: The Central Bank provides banking services to government ministries, departments and agencies, semi-autonomous government institutions and county governments.
• Financial Markets: To implement monetary policy decisions, the Central Bank employs financial tools at its disposal to foster liquidity in the financial market and manage growth of credit in the economy. The Bank manages the country’s foreign exchange reserves and intervenes to mitigate unforeseen disruptions in order to ensure stability in the foreign exchange market. Further, the Bank discharges its agency role to the National Treasury as it manages the Government’s domestic borrowing.
• Bank Supervision: The Central Bank provides legal and regulatory framework and issues prudential guidelines to govern the operations of financial institutions under its mandate. It also licenses and undertakes surveillance of the financial institutions to ensure compliance with laws and regulations.
• Payment and Settlement Systems: Safe and efficient payment and settlement systems is a key component of an effective and efficient financial sector. The Bank formulates and implements such policies as best promote the establishment, regulation and supervision of efficient and effective payment, clearing and settlement systems that promotes social and economic activities.
• Currency Services: The Central Bank is responsible for the design, production and distribution of the Kenya currency. The Bank ensures that there is adequate supply of clean currency to support social-economic activities.
• Monetary Policy: The Central Bank collects and analyses economic and financial data and undertakes research in micro- and macro-economic activities to inform the formulation of monetary policy geared towards achieving and maintaining stability in the general level of prices.

The CBK and the other government entitites were quick to react in the wake of the downturn. In a successful run to avoid bank turn, the government announced that it would guarantee all deposits of any size in all banks in the immediate aftermath of the crisis.

QUESTION TWO

The major risks faced by banks and related financial institutions include credit risks, interest rate risks, market risk, and operating and liquidity risks. The other risks include residual, dilution, settlement, compliance, concentration, country, foreign exchange, strategic, and reputational risks. The major tools of a risk management system used by banks are stress testing and asset and liability management. The different forms of interest rate risk are gap or mismatch risk, basis risk, embedded-option risk, yield curve risk, price risk reinvestment risk, and others.

Strategies adopted by the institutions to mitigate the risks:

1. Document the rationale for loan upgrades. Linda Keith CPA, whose firm trains business lenders in credit analysis, says bankers should be careful to document the thinking behind their judgment that a loan should be upgraded for purposes of the Allowance for loan and lease losses (ALLL). “It’s important to eliminate regulator guesswork,” she says. It’s also important, she says, for financial institutions to verify that guidelines for analyzing a potential upgrade are “clear, clearly communicated to, and consistently followed.” Keith will help lead a presentation on deciding and defending upgraded loans for the ALLL at the Dec. 5-6 summit.

2. Don’t be afraid to uncover vulnerabilities. RMPI Consulting partner Jay Gallo, who will discuss “Integrating Risk Appetite, Stress Testing and Capital Planning,” says stress testing is positive in that it enables financial institutions to gauge their potential vulnerability to exceptional but plausible adverse events. “Stress testing should assess and quantify your institution’s vulnerabilities under multiple unfavorable scenarios,” he says. “Once the potential downside is understood, you can take steps to reduce or mitigate those risks, or you can ensure you have sufficient capital to manage those risks.”

3. Develop a successful stress testing framework with three “knows.” Jack Gregory and Dave Keever, senior stress testing and credit experts for Crowe Horwath, say financial institutions looking to prepare and manage stress test forecasts need to know three key things:

• The institution’s portfolio.

• The scenarios and their impact on the bank’s capital and liquidity.

• The forecasts including what they show and why.

4. Set deadlines. To make the year-end ALLL as efficient as possible, it is best to get as much work done as possible prior to year end, says Mike Lubansky, director of consulting services at Sageworks. To do that, financial institutions should set hard deadlines for:

• Risk-rating changes.

• Charge-offs.

• Updating the core system to reflect the risk-rating changes.

• Determining the loans that need to be reviewed for impairment (FAS 114/ ASC 310).

• Updating the data on the impairment analyses (appraisal values and selling costs, or cash flows).