CBK predicts banks could lose Sh208.7b in bonds pricing

Central Bank Of Kenya. [Wilberforce Okwiri, Standard]

Central Bank of Kenya (CBK) predicts that Kenyan banks could potentially lose Sh208.7 billion due to interest rate increases.

However, CBK's recent stress tests reveal that the banks have sufficient capital to absorb these potential losses.

Three months ago, under the leadership of Governor Kamau Thugge, the CBK Monetary Policy Committee raised its policy lending rate to 10.50 per cent - the highest in seven years.

This decision was made in an effort to combat rising inflation and stabilise the weakened shilling, explained MPC.

As a result, banks have been increasing their lending rates and adjusting the prices of their bonds in accordance with IFRS 9 requirements.

The increased interest rates have negatively impacted the value of banks' bond portfolios, and the risk associated with interest rates remains high due to the rapid tightening of the monetary policy rate.

This has darkened the outlook for banks and investors in commercial bank stocks. According to the CBK, if average yields were to increase by 18.85 per cent and 19.89 per cent in moderate and severe scenarios respectively, banks would experience unrealised valuation or "paper losses" of Sh154.8 billion and Sh208.7 billion.

This is in contrast to the baseline estimate of Sh96.0 billion. As of June 30, 2023, banks had already reported revaluation losses of Sh102.7 billion.

An unrealised loss is a paper loss that results from holding an asset that has decreased in price, but not yet selling it.

It is important to note that the loss only becomes realised when the asset is sold at a lower price.

"If the average yields increase 18.85 per cent and 19.89 per cent, under moderate and severe scenarios, banks will record unrealised valuation losses of Sh154.8 billion under the moderate scenario and Sh208.7 billion under the severe scenario against the baseline estimates of Sh96.0 billion," says the CBK.

The CBK's interest rate stress test also assessed the resilience of banks to simultaneous shocks such as increases in non-performing loans (NPLs) and the repricing of bonds due to rising interest rates.

The results indicate that the banking sector is generally resilient to interest rate risk, even in the face of high NPLs and valuation losses on bonds held under available for sale and held for trading portfolios.

However, the CBK warns that if the current economic conditions persist, banks may face further challenges.

According to the CBK, in the combined severe scenario, 10 banks would require a total of Sh56.5 billion in additional capital to meet the minimum regulatory core capital adequacy ratio of 10.50 per cent. The bulk of this amount, Sh49.4 billion, will be required by Tier One banks.

The CBK notes that the most significant channel through which interest rate risk would impact the banks' capital is from revaluation losses arising from the repricing of government bonds held by banks.

If the policy rate (CBR) increases further, pushing average secondary market yields to 19.89 per cent under a severe scenario, a total of seven banks would need additional capital of Sh46.4 billion to meet the regulatory capital requirement of 10.50 per cent.

The CBK warns that banks would not be able to sustain their operations in the event of defaults by their largest customers.

The stress test was conducted to assess the resilience of Kenya's banking sector to interest rate shock transmitted through asset quality impairment reflected in the increase in NPLs and through valuation losses arising from the repricing of bonds.