The building that houses the Central Bank of Kenya (CBK) is a cold fortress. It could be this isolation, why the staff of the CBK think they are revered that the rest. But they are slowly becoming relics, ill equipped to regulate the banking industry of the modern age.
Three Kenyan banks have collapsed in quick succession. Yet, the CBK thinks the solution is prescriptive guidelines, which are mostly tick the boxes.
There is need to engineer the regulatory frame, and adopt more forward looking regulatory approaches. One of these include periodic stress tests.
A stress test is performing a series of simulations under hypothetical adverse stress scenarios in order to assess how a financial institution would be affected under each scenario.
For instance, what would be the impact in cases of increase of non performing loans, cyber attacks, or changes in micro and macro economic variables.
It is a type of forward-looking analysis which can help the CBK and and individual banks to identify problems which may not be revealed by just analysis of historical data.
The problem with mechanical repetition of the same inspection programs year after year, which CBK promotes, is it promotes a tendency to focus more and more on minor flaws while failing to address more fundamental issues.
In such a case, banks are forced to allocate resources to address trivial irregularities. Such a supervisory regime, majorly based on checklists, hinder creativity and innovation.
International Financial Reporting Standard 9, a new accounting standards that came in force at the beginning of this year, promote stress testing initiatives by requiring banks to make a forward-looking estimation of future losses (expected credit loss).
Further, the Basel Committee on Banking Supervision has been reviewing the relationship between the amount of expected losses under the capital adequacy. This will inform issues of loan loss write-offs and necessary provisioning.
Only dynamic supervision can create a financial stability necessary to promote market vigor, which should be the ultimate goal of regulation.
To ensure stability of banking, CBK should encourage them to undertake regulator stress testing in determining variables as matter of compliance.