The Central Bank of Kenya (CBK) recently released the 2021 Financial Stability Report which discusses developments and risks in Kenya’s economy and financial sector in the post-Covid–19 pandemic recovery phase, and details how the financial sector has remained resilient. 

The report outlines some of the policy and legal developments in 2021 that are expected to enhance financial sector stability.

The report is a result of collaboration among financial sector regulators, including the Capital Markets Authority (CMA), CBK, Insurance Regulatory Authority (IRA), Retirement Benefits Authority (RBA), and Sacco Societies Regulatory Authority (SASRA).

Below is a summary of the sector-specific findings contained in the Report.

Banking Sector

Developments

• The banks’ net assets grew by 11.4 percent in 2021 on account of faster growth in the purchase of government securities.
• The sector remained stable and resilient to the Covid-19 shock on account of strong capital and liquidity buffers, supported by monetary and financial policies in 2020.
• Credit risk remained elevated in 2021 as it was in 2020.
• The quality of assets was uneven across the entire banking sector, whereby banks in the large peer group had the lowest NPLs ratio.
• Overall, the liquidity ratio for the entire sector averaged 56.2 percent in December 2021.

Risks

Credit risk which remains elevated due to: Covid–19 pandemic whose virus mutation trajectory remains uncertain; drought shock on agriculture leading to direct and indirect impact on bank credit; tightening lending standards during electioneering period and regime change; global monetary policy tightening, with implication on domestic interest rates, exchange rate, and capital flows; and impact of Russia-Ukraine war on trade and other transactions.

Operational and governance risks are expected to rise as banks become more interconnected with sectoral and cross–border operations coupled with rapid technological innovations. There are more incidents of fraud, data privacy concerns, cyberattacks, and cybersecurity threats.

Flight to safety concerns are also emerging as banks and customers seek safe assets with positive returns and preservation of value.

Political risks associated with the 2022 General Election could impact the economy and, in turn, banks asset quality. Regime changes at national and county levels could delay payments of pending bills for supplies or works delivered, leading to an increase in NPLs for those with outstanding loans.

Sector Outlook

Overall, the banking sector outlook for 2022 is stable and resilient, underpinned by sufficient capital and liquidity buffers. This is confirmed in the latest Banking Sector Credit Risk Stress Test results conducted in May 2022.

Insurance Sector

Developments

• Overall insurance sector grew by 18.5 percent in premiums to reach Kshs 276.1 billion.
• Penetration of insurance services in the economy as measured by the ratio of insurance premium to GDP remained at 2.2 percent in 2021, the same as in 2020. The ratio is still way below the global average of 7.2 percent.
• The insurance industry asset base grew by 10.4 percent to Kshs 845.8 billion as at December 2021 from Kshs 765.9 billion in December 2020.
• The top three investment asset classes were government securities (71.7 percent), investment property (10.7 percent), and bank deposits (6.9 percent).
• The increase in profitability of the insurance sector may be due to the economy’s recovery in 2021 from the impact of Covid-19 and the adoption of digital methods in the payment of premiums and verification of insurance covers.

Risks

The insurance risk – The very nature of insurance contracts is to offer protection against loss. The insurance risk affects the combined ratio, which is a combination of claims ratio, commission ratio, and management expense ratio. The industry combined ratio was 106.2 percent as at December 2021 compared to 101.3 percent as at December 2020, indicating increased insurance risk for general insurance business.

Market risk – This is the risk of adverse fluctuations in market interest rates or asset prices resulting in overstating of assets /or understating of liabilities. Insurance companies are exposed to the risk of price movements for equities as they invest in the securities market. The sector held securities valued at Kshs 35.9 billion on the Nairobi Securities Exchange (NSE) as of December 2021, a 15.3 percent increase from 2020. 

Credit risk – Arises from the fact that a counterparty is unable to repay loans when due. The credit exposure from outstanding premiums and reinsurance recoveries increased by 5.2 percent to Kshs 40.1 billion in 2021. 

Cybersecurity threats and insurance fraud have increased. Cyber threats are evolving rapidly due to the growing digital transformation of society and the widespread use of internet-enabled devices, systems, and processes. Working away from the office (a mitigation measure against the spread of Covid-19) raised exposure to cyber risk due to limited security in home set-ups.

Ukraine War – The recent Russia-Ukrainian conflict is set to have an impact, as seen from the already substantial change in the energy market, for example, the increase in fuel prices. As a result, the conflict is a risk to the insurance market, given increased commodity prices, which will impact the cost of insurance across the board. The conflict is also expected to have an adverse impact on the marine cargo class of business and on companies that have exposure to Russian or Ukrainian companies.

Political Risk – This being an election year, political risk is an emerging risk to the insurance industry due to the possibility of riots and/or civil unrest, which could disrupt business. Companies could choose to scale down operations as a mitigation to the risk. Investment returns for the industry are also expected to be subdued during the electioneering period.

Climate Change Risk – Climate change such as severe drought or floods will likely lead to higher claim pay-outs from insurers underwriting those risks and will reduce underwriting performance. As mitigation, affected insurers should reprice their portfolios to factor in long-term exposure to climate changes.

Sector Outlook

The sector outlook remains positive in terms of growth, stability, and resilience. The IRA has enhanced surveillance and taken measures to address existing challenges to improve the sector’s performance.

Capital Markets

Developments

• The NSE performance was resilient to the Covid-19 pandemic as investors deployed hedging strategies to mitigate market risk in 2021.
• Foreign investors remained on the sell side in 2021, albeit with a gradual recovery. However, rising global interest rates following monetary policy tightening in advanced countries to stem inflation have reversed the gains on the purchase side.
• The capital market recorded positive developments in the corporate bond market segment in 2021.

Risks

Technology-related risks have increased due to the adoption of digital platforms, innovations, and automation of processes. The CMA continues to admit eligible applicants into the Regulatory sandbox to allow testing of these innovations at a limited scale before their roll-out at commercial scale.

As measured by equities turnover ratio, liquidity risk remains high, with just 5.9 percent in 2021 against 6.4 percent in 2020, and way below the peak of 10.2 percent liquidity ratio recorded in 2015.

Sector Outlook

Overall, the sector continues to face elevated risk and volatility in 2022 on account of the Russia-Ukraine war and its related risks, rising global interest rates following monetary policy tightening in advanced economies to stem inflation, domestic macroeconomic risks, and the August 2022 general elections.

Pensions Sector

Developments

• The economic recovery and improved equities market performance positively impacted the pensions sector. Total assets grew by 10.6 percent, to Kshs 1,547.43 billion in December 2021, from Kshs 1,398.96 billion in December 2020.
• Despite the overall growth in pension assets, the penetration of pension among the working population is still low at about 21 percent.

Risks

Inadequate cover – The pension sector cannot provide adequate cover to millions of Kenyans in retirement to enable them to afford a decent lifestyle. As a result, most Kenyans above the age of 60 are dependants.

Inadequacy of benefits – Some reasons for the inadequacy of benefits include low contributions, short contribution period, and leakages due to early withdrawals.

Longevity risk remains a challenge because of rising life expectancy after retirement exposes retirees to the danger of outliving their retirement savings.

Sector Outlook

RBA continues to implement a risk-based supervision framework with enforcement measures for schemes that have a high-risk profile. In addition, RBA continues to strengthen the regulatory framework to forestall any risks that may affect the sector.

Sacco Sector

Developments

• Savings and Credit Cooperatives (Sacco) Societies recovered in 2021 following the reopening of the economy. Total assets recorded 4 percent annual growth, to Kshs 700.3 billion in 2021, mainly driven by gross loans.
• The sector had mixed performance of Financial Soundness Indicators (FSIs) as of December 2021.

Risks

Rapid adoption of digital financial solutions such as mobile and internet banking has introduced cyber security risks and fraud, leading to loss of funds in some SACCOs.

SACCOs are increasingly being exposed to environmental risks such as climate change.

SASRA did not renew licences of four (4) deposit taking SACCOs due to failure to meet the minimum regulatory ratios and loss of business.

SACCOs face compliance risks emanating from current and new legislation, which directly affect their business operations. These include tax laws, unclaimed financial assets, data protection, and anti-money laundering, among others, that negatively affect their operations.

Conclusion

Kenya’s financial sector is projected to remain stable and resilient to Covid–19 pandemic and other emerging risks in 2022. However, the Russia-Ukraine war, rising global interest rates following monetary policy tightening to stem inflation in advanced countries, capital outflows from emerging and developing economies, domestic vulnerabilities to macroeconomic conditions, and spillovers from the August 9, 2022, general elections are likely to work against quick recovery of the financial sector.