The financial markets in East Africa are waiting with bated breath to see what punitive action the Central Bank of Kenya intends to take on four large commercial banks that the Governor of the Central Bank, Njuguna Ndung’u, blames for exerting speculative pressures on the exchange rate.

Confronted with the recent unprecedented volatility of the Kenya shilling, Prof Ndung’u last week came out talking tough — warning the four banks of unspecified action and insisting that since the economic fundamentals were still strong, the currency was bound to stabilise in coming weeks.

Prof Ndung’u accused the four unnamed banks of “exporting” large volumes of dollars to related parties in Europe and of driving up the currency for speculative purposes.
“We will restrict them from any arbitrage using domestic currency,” he said.

The governor said an investigation into trading trends conducted by the Central Bank had revealed three things:
First, that the four banks were holding what he described as “very large overseas positions.”
Second, that the positions do not seem to reflect trading fundamentals.
Third, that the positions are largely associated with their group companies overseas.

Clearly, the governor had decided to take the battle to the banks.

Even though he did not give the names of the four banks, the governor’s strategy was to implicitly threaten to name and shame them as greedy and against the interest of the country.

Whether the strategy of taking the battle to the banks will work remains to be seen.

Interviews with dealers and financial analysts suggested that the financial community in Nairobi was still sceptical, and inclined to believe that the four large commercial banks the governor talked about had committed no sin.

“The standard practice in financial markets is that when you see a currency depreciating, you take a long-term position,” said a dealer who did not want to be named.

Financial analysts pointed out that the banks mainly buy or sell dollars on instructions from their clients.

“It is the clients who are worried about the volatility of the currency. As banks, we hardly trade on their own account,” said a dealer with an international bank.

He added: “Unless the Central Bank is able to prove that any of the banks had bought dollars way beyond core capital and in breach of the stipulated guidelines,  it will be difficult to prove impropriety.”

Asked another dealer, rhetorically: “Is it wrong to hold a long dollar position? The Central Bank will have to prove that the banks were trading way beyond the core capital,” he said, arguing that unlike the commodity markets, financial markets operate on the basis of expectations.

On the assertion by Governor Ndung’u that the banks were “exporting” dollars abroad, dealers interviewed said the governor was being merely dramatic.

“Commercial banks do not keep dollars here. If you have dollars, you keep them in New York, your pounds sterling will be in London banks, and your rands with banks in Johannesburg,” argued a treasurer with a leading bank.

He said most market players were still at a loss over the governor’s statement on dollar exports.

Still, opinion was unanimous that the decision by the Central Bank to make a public statement on the shilling’s free fall served to reassure the markets.

Of interest to the markets were the statistics the governor reeled off about the volumes of dollars held by the commercial banking system in Kenya.

He disclosed that forex holdings averaged $5.1 billion in the past six months, with the Central Bank holding $3.9 billion and commercial banks holding on average $1.2 billion.

Prof Ndung’u said Kenya’s forex holdings were much higher than the situation that prevailed during the global financial crisis in 2008.

“This shows that the impact of the current crisis is being exaggerated,” he added.

He was upbeat about Kenya’s external trade position, pointing out that the current account had improved with the declining international oil prices.

As we went to press, the markets were still gauging the likely impact of the governor’s press conference on the psychology of the market.

A day after the governor spoke, the shilling made marginal gains, trading below 90 to the dollar.

The following day, it weakened again marginally, suggesting that the currency was yet to take a permanent path to stability.

Whichever way one looks at it, the coming weeks will still present major headaches to the monetary authority in Kenya.

In theory, experts predict that the pressure on the Kenya shilling will only come down significantly as interest rates on government paper start rising, thereby attracting portfolio flows.

Indeed, interest rates in Kenya are now comparable to those in other countries, and much higher than in the Organisation for Economic Co-operation and Development countries, which are the main sources of inflows.

Unless the shilling stabilises, there is little likelihood that foreign exchange inflows will happen soon.