By James Anyanzwa

The Central Bank’s increased surveillance of commercial banks seems to be wreaking havoc on its money market reform programme.

The primary casualty includes the regulator’s market for short-term funds popularly known as horizontal repurchase agreements (Repos). This market was established to provide an opportunity for commercial banks to borrow from each other using Government securities (Treasury Bills and bonds) as security to meet daily obligations at the clearing house.

However, the credit facility, which is barely two years old, is staggering in turbulent waters owing to deteriorating interest from banks.

Investigations by Financial Journal revealed some banks have shunned the market, while others reduced their participation partly due to fears of exposing their daily cash-flow positions to the regulator.

The facility, which was launched in September 2008, is viewed as a mere gimmick by the regulator crafted to delve into the banks’ financial health.

Certainly, banks reservations are prompted by the fact that borrowing from the Central Bank’s own market gives the regulator a golden chance to scrutinise their financial position.

The matter has not been made any better by the exorbitant cost of funds, prolonged credit acquisition procedures and structural rigidities, which have formed additional roadblocks to this market.

"Borrowing from the horizontal Repo market is very expensive and involves a lot of formalities. If a bank borrows from this market, Central Bank may conclude the institution is in trouble," a highly placed industry source told the Financial Journal last week.

"The inter-bank market is informal and transactions between banks are conducted in very short periods of time without additional requirements such as security."

Under the horizontal Repos arrangement a bank (borrower) offers either a Treasury bond or bill as security for an overnight loan, by selling the security to another bank (lender) with promise of buying it back after an agreed term.

The security will be moved into a designated Repo account in CBK’s central depository register, and will not be available for trade by either the entity transferring (seller) or the beneficiary of the transfer (buyer).

According to the CBK’s statistics, horizontal Repo rates are fixed at 2.8 per cent, which compares unfavourably with the inter-bank market rates of 1.2 per cent.

Lack of information

In May, only six horizontal Repo transactions valued at Sh642.5 million were transacted at an average price of 3.4 per cent each.

Efforts by Financial Journal to obtain comments from the Central Bank proved futile, as officials didn’t respond to our e-mailed questionnaire by the time of going to press.

But previously, banking regulator attributed the dismal usage of inter-bank Repo market to lack of information about the facility with regard to its legal and technological framework and mode of evaluating interest earnings.

Owing to its low uptake, CBK announced plans to broaden the horizontal Repos beyond commercial banks to other institutions such as fund managers, pension funds and insurance companies.

CBK established the horizontal Repo market to give banks a new platform for borrowing to offset daily requirements at the clearinghouse.

The facility was also expected to facilitate money supply between banks.

But banks seemingly recoiled from the credit window, preferring instead the inter-bank market where transactions are carried out informally (friendly terms) and much faster, without need for security.

By July last year only a single transaction had been successfully effected between two banks. CBK hopes that the credit window, and will boost liquidity distribution and deepen the bond market.

CBK, in conjunction with market stakeholders, is working on a number of initiatives to build a competitive bond market that will support the country’s development agenda under Vision 2030.

The initiative includes maximizing horizontal Repos to deepen and promote investor education to increase market confidence and investors.

CBK has also implemented a number of measures, including introduction of benchmark bonds and re-opening of these benchmark bonds to create liquidity and facilitate trading.

A robust financial market cushions the economy against external shocks, in addition to mobilising critical resources for public and private sectors for long-term financing.

Enormous potential

The success of the Government’s infrastructure bond and other corporate bonds demonstrates enormous potential of the fixed income market.

Last year, the Government raised Sh54.7 billion through bonds issues, which were all oversubscribed.

The secondary bond market was relatively buoyant with total bond turnover during the year (2009) standing at Sh95 billion compared to Sh67 billion in 2008 and Sh85 billion in 2007.

The relatively higher returns available from fixed income securities partly reduced the appetite for equity investments by domestic investors.

However, rates on short-term government securities have plummeted significantly in the last few weeks.

Last week, interest rates on the 91-day Treasury bill continued with their declining trend with the cut-off rate dropping by 83 basis points to 1.8 per cent from 2.6 per cent the previous week.

CBK offered 91-day Treasury bills worth Sh4 billion, but the total number of bids received amounted to Sh 9.2 billion, representing a 231 per cent subscription rate.

Similarly, the cut-off interest rate on the 182-day Treasury bill dropped to 1.8 per cent from 2.45 per cent after CBK received bids worth Sh11.85 billion, a 198 per cent subscription rate for Sh6 billion offered.

Last month, the Government offered the first 25-year Treasury bond for a total amount of up to Sh 7.5 billion. The issue received bids worth Sh 27.1 Billion or 360.96 per cent subscription. -