Commercial Banking in Kenya

COMMERCIAL BANKING IN KENYA

EGERTON UNIVERSITY TOWN CAMPUS

FACULTY OF COMMERCE

DEPARTMENT OF ACCOUNTING, FINANCE & MANAGEMENT SCIENCE

NAME: OCHIENG JARED OPONDO

REG NO: C12/60275/09

GROUP: A

FACULTY: COMMERCE

COURSE: BCOM 330; Financial Institutions and markets

TASK: TERM PAPER

TITLE: COMMERCIAL BANKING IN KENYA

PRESENTED TO: MRS. BOSIRE MARY

PRESENTED ON: 19TH October 2011

Researched by Opondo Jared CI2/60275/09 Page 1


ABSTRACT:

This term paper analyses the commercial banking system in Kenya. In particular it focuses on the history of commercial banks from a general perspective then narrows down to Kenya’s context. It looks at the importance of commercial banks in Kenya, the roles/functions of commercial banks. It then focuses on the regulations that govern the commercial banks. Lastly it looks at the contribution of commercial banks to Kenya’s economy.



TABLE OF CONTENTS

Abstract-------------------------------------------------------------2

Table of contents--------------------------------------------------3

Introduction--------------------------------------------------------4

The history and development of commercial banks----------5

Importance of commercial banks--------------------------------9

Roles of commercial banks--------------------------------------10

Regulations of commercial banks-------------------------------13

Contribution of commercial banks to Kenya’s economy-- - -14

Summary-----------------------------------------------------------15

References----------------------------------------------------------16



INTRODUCTION

A commercial bank is a type of financial intermediary and a type of bank. It raises funds by collecting deposits from businesses and consumers via checkable deposits, savings deposits, and time deposits. It makes loans to businesses and consumers. It also buys corporate bonds and government bonds. Its primary liabilities are deposits and primary assets are loans and bonds.

Banks work with short term funds. Their working capital consists mainly of moneys deposited by customers and withdrawable by them on demand or on short notice. If a bank lends such moneys for long periods or keeps them blocked in any other way, it will be unable to meet the demands of its depositors for withdrawal of cash, and will be forced to go into liquidation.

Banks are the main financial institutions operating in financial systems and are important as they facilitate the flow of funds between surplus units and deficit units. Banks offer a full range of financial services, both balance-sheet transactions and off-balance sheet transactions. Balance-sheet transactions are represented by assets, liabilities and shareholders’ funds while off-balance sheet transactions are contingent liabilities.

The following definitions have been advanced for commercial banks:

I. A commercial bank is a financial intermediary which collects credit from lenders in the form of deposits and lends in the form of loans. A commercial bank holds deposits for individuals and businesses in the form of checking and savings accounts and certificates of deposit of varying maturities while a commercial bank issues loans in the form of personal and business loans as well as mortgages.

II. A financial institution authorized to provide a variety of financial services, including consumer and business loans (generally short-term), checking services, credit cards and savings accounts. (Business Dictionaries Copyright c 2006, 2000, 1997, 1993, 1990 by Barron's Educational Series, Inc. )



THE HISTORY AND DEVELOPMENT OF BANKING

A: GENERAL CONTEXT

The invention of banking preceded that of coinage. Banking originated in Ancient Mesopotamia where the royal palaces and temples provided secure places for the safe-keeping of grain and other commodities. Receipts came to be used for transfers not only to the original depositors but also to third parties. Eventually private houses in Mesopotamia also got involved in these banking operations and laws regulating them were included in the code of Hammurabi.

In Egypt too the centralization of harvests in state warehouses also led to the development of a system of banking. Written orders for the withdrawal of separate lots of grain by owners whose crops had been deposited there for safety and convenience, or which had been compulsorily deposited to the credit of the king, soon became used as a more general method of payment of debts to other persons including tax gatherers, priests and traders. Even after the introduction of coinage these Egyptian grain banks served to reduce the need for precious metals which tended to be reserved for foreign purchases, particularly in connection with military activities.

B: KENYAN CONTEXT

HISTORY AND DEVELOPMENT OF COMMERCIAL BANKS IN KENYA

COLONIAL PERIOD ERA

The history of banking in Kenya dates back to the colonial period. Colonial rule brought in its wake new forms of banking. British commercial banks started operations in Kenya during the 1890s. The operations of these foreign-owned banks were characterised by high degree of concentration, branch banking, an almost exclusive concern with financing external trade and for many decades, a lack of interest in, or involvement with, the African population.



As Kenya became more and more part of this capitalist world economy, the banks established themselves in the colony to provide services for financing exports and imports. Three British banks dominated banking in colonial Kenya. The National Bank of India (later National and Grind lays Bank) began operations in 1896. It was followed in 1910 by the Standard bank of South Africa (later standard Bank and Standard Chartered), and shortly thereafter the national Bank of South Africa entered the field. In 1925, the latter merged with two other British banks to form Barclays Bank Dominion Colonial and overseas (later Barclays Bank).

Although their primary interest was to finance external trade, as time passed, the banks expanded their function to cover deposit banking as well. In pursuit of these ends, the banks set up branches which would enable them to most effectively serve those groups in Kenya most likely to provide commercial and deposit business. These were the immigrant Asian and European settler communities. From initial offices in Nairobi and Mombasa, the banks established branches in other parts of Kenya in 1920s and 1930s. With exception of Kisumu, all were established in centres where they could effectively serve the settler farmers (Nakuru, Eldoret, Kitale and Nyeri). This reflected the realty that from the end World War I through the middle of the 1950s, settlers provided by far the largest share of Kenya’s exports.

The three banks, on the other hand, involved themselves very little in making loans to finance agricultural or industrial development. This was particularly significant aspect of the bank’s operations in Kenya. The banks were averse to making long-term loans on any basis, and they accustomed, even in Britain, to making loans only against substantial and safe assets. For most of the colonial period, the banks did not feel that the bulk of Kenya’s population possessed such assets. For both the Africans and European settlers, for example, the major asset was land. In addition to the traditional aversion to mortgage lending in English banking circles, the three banks avoided such transactions in Kenya for additional reasons. They were hesitant because of potential problems over title to land which might be advanced as security for long-or short-term loan. The bulk of African land was held on forms of communal tenure while the great majority of settler farms and estates were held on lease (after 1915 leases were for 999 years).Researched by Opondo Jared CI2/60275/09 Page 6


In 1930, the colonial state introduced legislation which allowed for the creation of a land bank. Under terms of 1930 legislation, a Land and Agriculture Bank was established the following year. Initially provided with a capital of £240000, the amount was increased to £500000 two years later, and in 1936, a further £250000 was added. With these funds, the Land and Agriculture Bank made mortgage loans to settlers (who were famers) for periods up to 30 years at 6.5%. Meanwhile, Africans farmers were virtually excluded from its operations.

In the more prosperous time after World War II, the three commercial banks expanded their lending capacities, mostly to support commerce and industry and they also increased their number of branches opening for the first time in African districts. This was direct result of commercialisation of African Agriculture and the dramatic rise in production for export from African farms that began in the 1950s.

In the same period, new banks, all foreign-owned, began business in Kenya. A Dutch bank, Nederlandsche Handel-maatschapij, opened operations in 1951. In 1953, the Bank o India and the bank of Baroda started branches in Nairobi. These India-owned banks were followed, in 1956, by Pakistan’s habib bank. In 1958the turkey-based Ottoman Bank started business in Kenya. These banks provided greater alternatives to potential customers in Kenya, but they did not really challenge the dominance o f the ‘big three.’ By the middle of 1960, the three held 147 out of 178 branch and sub-branch banks open in the country. The only other bank to start operations in Kenya prior to 1963 was the Commercial Bank of Africa (1962), which was partially owned by interests in Tanzania.

Commercial banks operating in Kenya largely ignored the African population for most of the colonial period. The banks, on the whole, tended to see the encouragement of Africans savings and the financing of operations. In fact, for most of the colonial period, the main institution for mobilising African voluntary savings was the Post Office Savings bank, which began accepting deposits in 1910. Total savings there amounted to almost £3500000 in 1960.

Beginning in the 1950s, however, the ‘big three’ became more active in mobilising voluntary savings from African population. Total deposits in commercial banks rose from £1000000 to £10000000 in 1963. This increase



was largely the result of a great increase in the use of the banks’ savings account by the Africans. The economic changes which formed the background for this increase in the number of savings depositors include the expansion of African cash crop production and of the number of Africans employed by the state (notably through the extension of education) and private firms and the growth in the number of branch of banks.

By contrast commercial banks did little to expand credit facilities to African enterprise during the same period. Even when the big three’ decided to, In the late 1950s, to offer longer term loans for development, this did little to meet the credit needs of Africans since the minimum amounts of such loans exceeded that sought by potential borrowers.

Until independence, moreover, the land and Agriculture Bank continued to provide credit exclusively to European famers. Provision of credit to majority of Kenya’s population would become, therefore, a major concern of Kenya’s independent government in developing its policies towards the banking institutions it inherited.

POST INDEPENDENCE ERA

After independence, the number of commercial banks operating in Kenya increases as both local and foreign owned banks entered the scene. In 1968, the government established the Co-operative Bank of Kenya to provide specialised banking services for the members of the growing co-operative movement. In the same year the National bank of Kenya wholly owned by Kenya was established. By the end of the 1980s, it had become Kenya’s fourth largest commercial bank with branches in the largest cities. In 1974, moreover, two American banks, the first National Bank of Chicago and the first National City Bank of New York, were established.

In 1971, significant changes took place in the structure and operations of National and Grinlays bank following agreement with the government, its commercial banking operations came under the control of the newly created Kenya commercial Bank. The government assumed 60% ownership of the Kenya Commercial Bank, and it remained the largest of the country’s commercial banks in terms of deposits and number of branches. The merchant



banking operations of National and Grindlays were taken up by a new bank, Grindlays bank international (Kenya limited). The Kenya government owned 40% of the latter bank. While Barclays and Standard Chartered remained under foreign private ownership, both undertook the sale of shares to the public in the 1980s, thus broadening to some degree, their Kenya ownership.

The number of commercial banks by 1980 consisted of 24 full fledged commercial banks with more than 400 branches, branches, agencies and commercial banking units.

To date the list of commercial banks include; African Banking Corporation, African Development Bank, Akiba Bank, Bank of Baroda, Bank of India, Bank of Oman, Bank of Tokyo, Bankers Trust, Banque Indosuez, Barclays Bank of Kenya, Biashara Bank of Kenya, CFC Bank, , Finance Bank, Commercial Bank of Africa, Continental Bank of Kenya, Cooperative Bank of Kenya, Development Bank, Diamond Trust Bank, East African Development Bank, Euro Bank, First American Bank of Kenya, Habib Bank, Industrial Development Bank, Kenya Commercial Bank , Kenya Post Office Savings Bank, Kestrel Capital East Africa, Korea Exchange Bank, K - Rep Bank , Mashreqbank, Middle East Bank, National Bank of Kenya, Panafrican Bank, Prudential Bank, Riverbank Estate, Stanbic Bank, Standard Chartered Bank ,Trade Bank, Trust Bank, Victoria Commercial Bank, Equity Bank , Family bank.

IMPORTANCE OF COMMERCIAL BANKS

The banks play very important role for the economic development of the country. The importance can be examined as under:1. Increase in saving: The people deposit their savings into the banks and the bank pays reasonable profit on these savings.

2. Increase in investment: The money which is collected by the bank is lent to businessman and industrialist. The increase in the investment increases the level of employment.3. Increase in employment: The banks advance loan to the investors. As a


http://www.kcb.co.ke/

http://www.standardchartered.com/ke/

http://www.standardchartered.com/ke/

http://www.k-repbank.com/


result; the industrial units are setup in different parts of the country. Hence the level of employment is increased.

4. Transfer of Money: When the people want to transfer their money from one place to another place, they get traveller cheque and the bank draft from the bank.5. Loan to Govt.: When the govt. needs funds to complete the public works programs, the banks provide loans to it.

6. Capital formation: the process of the capital formation is completed with the financial of commercial banks. So banks increase capital formation.7. Balanced development: when the banks provide loans to the less developed areas, the chances of progress and development are increased in the areas.8. Saving in metals e.g. gold, when the payments are made through currency notes and credit instruments, the precious metals are saved.

Banks are back bone for the economic development of any country. A planned banking system is indispensable for economic growth and development of the country.

ROLES/ FUNCTIONS OF COMMERCIAL BANKS

The commercial banks perform a number of vital functions. The functions of a commercial bank can be broadly classified into the followings: (1) Accepting Deposits: -The bank collects deposits from the public. The deposits can be of different types – such as: Savings Deposits: This type of deposits encourages saving habit among the public. The rate of interest is low. At present it is about 5% p.a. Withdrawals of deposits are allowed subject to certain restrictions. This account is suitable to salary and wage earners. This account can be opened in single name or in joint names.



Fixed Deposits: Lump sum amount is deposited at one time for a specific period. Higher rate of interest is paid, which varies with the period of deposits. Withdrawals are not allowed before the expiry of the period.

Current Deposits: This type of account is operated by businessmen. Withdrawals are freely allowed. No interest is paid. In fact, there are services charges. The account holders can get the benefit of overdraft facility.

Recurring Deposits: -This type of account is operated by salaried persons and petty traders. A certain sum of money is periodically deposited into the bank. Withdrawals are permitted only after the expiry of certain period. A higher rate of interest is paid.

(2) Granting Advances: - The bank advances loans to the business community and other members of the public. The rate charged is higher than what it pays on deposits. The difference in the interest rates (lending rate and the deposit rate) is its profit. The bank loans are: Overdraft: This type of advances is given to current account holders. No separate account is maintained. All entries are made in the current account. A certain amount is sanctioned as overdraft which can be withdrawn within a certain period of time, say three months or so. Interest is charged on actual amount withdrawn. An overdraft facility is granted against a collateral security. It is sanctioned to businessman and firms.

Cash Credit: The client is allowed cash credit upto a specific limit fixed in advances. It can be given to current account holders as well as to others who do not have an account with the bank.



Separate cash credit account is maintained. Interest is charged on the amount withdrawn. The advances are given for a longer period and a larger amount of loan is sanctioned than that of overdraft. The cash credit is given against the security of tangible assets and/or guarantees.

Loans: Lump sum amounts are given. It is normally for short term, say a period of one year or medium term, say a period of five years. Repayment of money can be in the form of instalments spread over a period of time or in a lump sum amount. The loans are granted to meet long term working capital needs. Interest is charged on the actual amount sanctioned, whether withdrawn or not. The rate of interest depends upon the amount of loan and period of loan. Loans are normally secured against tangible assets of the company.

Discounting of Bills : The banks can advance money by discounting or by purchasing bills of exchange both domestic and foreign bills. The bank pays the bill amount to the drawer or the beneficiary of the bill by deducting usual discount charges. On maturity, the bill is presented to the drawee or acceptor of the bill and the amount is collected.

(3) Agency Functions: -

The commercial bank acts as an agent of its customers. The commercial bank performs a number of agencies Functions, which includes:

Transfer of Funds: -The commercial bank transfer funds from one branch to another or from one place to another. Collection of Cheques: -The commercial bank collects the money of the Cheques through clearing section of its customers. The commercial bank also collects money of the bills of exchange. Periodic Payments: -On standing instructions of the client, the bank makes periodic payments in respect of electricity bills, rent, etc.



REGULATIONS OF COMMERCIAL BANKS

Regulations of commercial banks refer to the laid down rules under which the commercial banks operate. These regulations are clearly set out in the banking act chapter 488 of 1st November 1989 and revised recently in 2009.

1. Minimum reserves: The Central Bank may prescribe the minimum ratios which shall be maintained by banking institutions as between their core capital and total capital on the one hand and their assets (including their total loans and advances) and off balance sheet items on the other. This minimum holding of liquid assets is determined by the central bank from time to time. Section 19 (b) states that this minimum liquid assets or balances are held at central bank.

2. Accounts and audits: The financial year of every banking institution shall be the period of twelve months ending on the 31st December in each year (section 20A). All entries in any books and all accounts kept by an institution shall be recorded and kept in the English language, using the system of numerals employed in Government accounts. Every institution shall exhibit throughout the year in a conspicuous position in every office and branch in Kenya a copy of its last audited balance sheet and last audited profit and loss statements (which shall be in conformity with the minimum financial disclosure requirements prescribed from time to time by the Central Bank and shall include a copy of the auditor’s report) together with the full and correct names of all persons who are officers of the institution in Kenya, and shall, within three months of the end of each financial year, cause a copy of the balance sheet and last audited profit and loss statements for that financial year to be published in a national newspaper. An institution shall, not later than three months after the end of its financial year, submit to the Central Bank an audited balance sheet, showing its assets and liabilities in Kenya, and an audited profit and loss account covering its activities in Kenya together with a copy of the auditor’s report, in the prescribed form.



3. Information and reporting requirements: The Central Bank may require any banking institution and their agencies to furnish to it, at such time and in such manner as it may direct, such information as the Central Bank may reasonably require for the proper discharge of its functions of maintaining supervision and surveillance of the affairs of banking institutions under this Act.

4. Inspection and control of institutions: The Central Bank may, at any time and from time to time, and shall, if so directed by the Minister, cause an inspection to be made by any person authorized by it, in writing, of any banking institution and its agencies and of their books, accounts and records (section 32(1)).

5. Deposit protection fund: section 36 establishes a body corporate to be known as the Deposit Protection Fund Board. The Board shall consist of: the Governor of the Central Bank who shall be the chairman; the Permanent Secretary to the Treasury; and five members appointed by the Minister in consultation with the Central Bank to represent the interests of institutions. The principal object of the Board shall be to provide a deposit insurance scheme for customers of member institutions and liquidate and wind up the operations of any institution in respect of which the Board is appointed as a liquidator in accordance with this Act or any other written law.

6. Restrictions on the increase of bank charges: No institution shall increase its rate of banking or other charges except with the prior approval of the Minister for finance and the central bank of Kenya.

CONTRIBUTIONS OF COMMERCIAL BANKS TO KENYA’S ECONOMY

Commercial banks play an important and active role in the economic development of a country like Kenya.. If the banking system in a country is effective, efficient and disciplined it brings about a rapid growth in the various sectors of the economy. The following is the significance of commercial banks in the economic development of a country.



1. Banks promote capital formation: Commercial banks accept deposits from individuals and businesses, these deposits are then made available to the businesses which make use of them for productive purposes in the country. The banks are, therefore, not only the store houses of the country’s wealth, but also provide financial resources necessary for economic development.

2. Investment in new enterprises: Businessmen normally hesitate to invest their money in risky enterprises. The commercial banks generally provide short and medium term loans to entrepreneurs to invest in new enterprises and adopt new methods of production. The provision of timely credit increases the productive capacity of the economy.

3. Promotion of trade and industry: With the growth of commercial banking, there is vast expansion in trade and industry. The use of bank draft, check, bill of exchange, credit cards and letters of credit etc has revolutionized both national and international trade.

4. Development of agriculture: The commercial banks particularly in developing countries are now providing credit for development of agriculture and small scale industries in rural areas. The provision of credit to agriculture sector has greatly helped in raising agriculture productivity and income of the farmers.

5. Balanced development of different regions: The commercial banks play an important role in achieving balanced development in different regions of the country. They help in transferring surplus capital from developed regions to the less developed regions. The traders, industrialists etc of less developed regions are able to get adequate capital for meeting their business needs. This in turn increases investment, trade and production in the economy.

6. Influencing economic activity: The banks can also influence the economic activity of the country through its influence on

a. Availability of credit

b. The rate of interest

7. If the commercial banks are able to increase the amount of money in circulation through credit creation or by lowering the rate of interest, it directly affects economic development. A low rate of interest can



encourage investment. The credit creation activity can raise aggregate demand which leads to more production in the economy.

8. Monetization of the economy: The commercial banks by opening branches in the rural and backward areas are reducing the exchange of goods through barter. The use of money has greatly increased the volume of production of goods. The non monetized sector (barter economy) is now being converted into monetized sector with the help of commercial banks.

SUMMARY

In conclusion, the development of commercial banks to the current ranks is a significant achievement in the economic history of Kenya. the commercial banks play a pivotal role in the economic advancement of Kenya, and we can say without fear of contradiction that is the force behind the recent witnessed widespread investment activities in the country. The importance, therefore of commercial banks to the economic development of a country cannot cannot be overemphasised.

REFERNCES

1. An economic History of Kenya (W.R. Ochieng, R.M. Maxon © 1992)

2. A History of Money (©Glyn Davies)

3. "Commercial Banks." 123HelpMe.com. 01 Oct 2011 <http://www.123HelpMe.com/view.asp?id=164261>.

4. Banking act of 1968 and revised in 2009 chapter 488

5. http://www.slideshare.net/Mustafaseady/role-of-commercial-banks-in-the-economic-development-of-a-country.


Documents

Commercial Banking in Kenya