Kenyan banks and stockbrokers are set for a tough start of 2013 as the money and capital markets regulators push through new rules which could hurt earnings.

The Central Bank of Kenya has set January 1, 2013 as the effective date for the revised Prudential Guidelines and Risk Management Guidelines, which will require commercial banks to notify borrowers on any changes in interest rates and other charges at least one month before adjusting the cost of loans. Such a notice will also carry disclosures on the total cost of loans.

The CBK aims to quell growing concerns by borrowers over arbitrary adjustments of lending rates and hidden costs, said the regulations released on Monday.

The regulator is also seeking to limit banks’ forex trading by insisting every forex transaction be supported by a commercial undertaking.

As the commercial banks consider the implications of the new rules, the Capital Markets Authority (CMA) and the CBK are also finalising guidelines which will transform the way bond trading is done in the country, for a possible rollout early next year.

Stockbrokers who had opposed the bond plan — which will see the rollout of a hybrid bond trading system — have softened their stance, allowing the regulators to implement the changes.

Under the planned bonds system, large commercial banks, insurance firms and fund managers will be allowed to bypass the Nairobi Stock Exchange (NSE) and its brokers to trade their bonds directly.

The CMA and CBK are pushing for the establishment of an over-the-counter (OTC) market for bonds and Treasury bills, in addition to the existing NSE system, to boost bond turnover and deepen the market.

The OTC is a negotiated market between two parties where participants in the bond market trade debt instruments directly without going through brokers and dealers.

CMA acting chief executive Paul Muthaura said the platform is expected to go live in the first quarter of 2013. “We are changing the way the bond market operates, both to reduce the cost of trading as well as improve liquidity in the market,” said Mr Muthaura in an interview.

He said they are also “looking at the sell-buy back rules to see how we can strengthen them to deepen the bond market.”

The changes are likely to hit banks that have been making billions of dollars through bond trading.

An investigation by The EastAfrican last month brought to light how banks moved their bonds portfolios in a bid to hide losses occasioned by the steep jump in interest rates. The investigation revealed that banks, in the wake of a huge rise in interest rates, had been moving their bond holding from held-for-trading to hold-to-maturity to avoid losses.

When interest rates rose sharply in 2011, the commercial banks, which were holding billions of shillings in bonds in the held-for-trading basket, should have declared their reduced value in their profit and loss accounts.

But, instead, they circumvented this by using the “sell-buy back” tool — where a bank sells its bond and later buys it back. They turned to other banks and highly-liquid institutions, such as parastatals, to sell the bonds at the rates at which they had bought them in 2010, with the promise to buy them back later at slightly lower rates as an incentive for the other parties to take up the bonds.

Although bankers say the proposed changes are unlikely to eat into their profits, independent analysts reckon the increased oversight could shake the sector.

CBK’s intention, analysts said, is to seal loopholes in the banking sector — which could send the industry reeling in times of economic turbulence — while at the same time create an environment that allows commercial banks to make money and continue lending.

“While we have stated that the hybrid system is not the best way to go, we are not opposing the changes,” said Willie Njoroge, the chief executive officer at the Kenya Association of Stockbrokers and Investment Banks, the industry’s lobby group.

Regulatory findings show that falling brokerage fees and fears over the upcoming elections have slashed Kenya’s stockbrokerage profitability by half, as local investors shied away from the bourse in the first half of the year. Results published showed that the stockbrokerage and investment bank industry made a combined profit of Ksh108.32 million ($1.3 million) in the first half of 2012, down 51 per cent from the Ksh223.85 million ($2.7 million) in the same period last year.

The brokers had argued that the OTC system was open to manipulation and underhand deals designed to benefit the more knowledgeable parties, namely banks. But banks denied this, saying the brokers were out to protect the commissions they get from bond deals.

Lower borrowing rates

Analysts said loosening commercial banks’ tight grip on the government bonds market would help to lower borrowing charges and boost lending to the private sector. With commercial banks holding nearly 60 per cent of government bills and bonds, concerns have been growing that this enabled them to keep high lending rates as they enjoyed high returns from the risk-free investments.

Despite having a relatively small bond market compared with South Africa and Nigeria, the Kenyan bond market is considered one of the most advanced in Africa. Last year for example the country bond turnover to GDP ratio stood at 19 per cent, the second highest in Africa behind South Africa.

Though 90 per cent of the bonds in Kenya have been issued by the government, more companies are turning to the bond market to raise funds. This year, Consolidated Bank and Centum Investments have issued corporate bonds, raising Ksh5.2 billion ($60 million) in total.