Chapter 4: Financial institutions in Kenya

4.1. Financial System in Kenya

The Kenyan financial system has a multi-regulatory regime where the financial system comprising of financial institutions, financial markets and financial infrastructure fall under different regulators, namely:

  • The Central Bank: for deposit taking institutions as well as the payments, clearing and settlement system.
    • Commercial Banks
    • Non-Bank Financial Institutions
  • Capital Markets Authority (CMA) for the capital markets intermediaries such as the stock exchange and investment banks.
    • The Nairobi Stock Exchange
    • Investment banks such as CIC
  • Insurance Regulatory Authority (IRA) for the insurance industry;
    • Insurance Companies
  • Retirement Benefits Authority (RBA) for the pensions industry
  • Sacco Societies Regulatory Authority (SASRA) for the deposit taking Sacco societies

The Central Bank of Kenya is the top financial institution that regulates the financial sector in Kenya. It plays the role of licensing, inspecting, and regulating financial intermediaries, commercial banks, and non-bank financial institutions. The Central Bank of Kenya also issues treasury bills and bonds through various intermediaries.

Banks and non-bank institutions are licensed by the Central Bank under the Banking Act, while insurance banks are licensed under the Company’s Act.

Commercial banks and non-bank financial institutions offer facilities for depositing and saving. In offering these facilities to savers, they consider savers’ needs like liquidity of savings – the financial security of savings. The institutions also lend or advance the monies deposited with them to borrowers in commerce, industry, agriculture and household sectors. Commercial banks, through branch banking systems, dominate the Kenya financial system – they account for the majority of all deposits from the public. However, non-bank financial systems attract an increasing volume of private savings.

The capital market is controlled by the Capital Markets Authority (CMA), whose role is to control activities of the capital market. The CMA is a regulating body charged with the prime responsibility of supervising, licensing and monitoring the activities of market intermediaries, including the stock exchange and the central depository and settlement system and all the other persons licensed under the Capital Markets Act.

Nairobi Stock Exchange (NSE) is part of the capital markets, and its role is to issue shares in the primary and secondary stock markets. In the primary stock market, new firms issue their shares to the public for the first time through an initial public offering (IPO). On the other hand, the secondary stock market involves the buying and selling of existing shares.

4.2. Financial Institutions in Kenya

A financial institution is a corporation that facilitate the supply and circulation of money through transfers from investors or lenders to borrowers. It is an institution that deals with financial transactions such as investments, deposits, loans, and foreign currency exchange. It includes a wide range of companies whose operations involve financial services, such as insurance companies, investment banks, brokerage firms, and trust companies. In Kenya, there are several types of financial institutions:

  1. The Central Bank
  2. Commercial/Retail Banks
  3. Investment Banks
  4. Savings and Credit Cooperative Societies (SACCOs).
  5. Microfinance Lending Institutions
  6. Insurance Companies
  7. Capital Markets

The Central Bank: A central bank is a public institution that is responsible for implementing monetary policy, managing the currency of a country, or group of countries, and controlling money supply. The functions of the Central Bank include:

  • To promote financial stability by regulating financial institutions
  • Regulating the operations of commercial banks
  • Implementing monetary policies to control money supply and inflation
  • Manages the country’s exchange reserves
  • Manages government’s domestic debt by issuing treasury bills and bonds
  • Regulating currency
  • Acts as the lender of last resort – commercial banks borrow from central banks.
  • Controlling credits
  • Protecting the interests of depositors and investors.
  • Acts as government’s bank, agent and advisor

Commercial Banks: These are financial institutions that issue loans and certificates of deposits, take deposits, and provide savings accounts to customers. They make money through loans, mortgages, and transaction charges. They act as financial intermediaries between depositors and borrowers because they use customers’ deposits to lend to borrowers. They play an important role in the economy because they create capital, provide credit, and enhance liquidity in the market.

The Central Bank imposes reserve requirements on commercial banks. This means that banks are required to hold a certain percentage of their consumer deposits at the central bank as a cushion if there’s a rush to withdraw funds by the general public. Some of the functions of commercial banks include:

  • Accepting Deposits
  • Providing loans
  • Promoting liquidity through credit cash
  • Providing interest-earning savings accounts
  • Discounting bill of exchange
  • Providing overdraft services
  • Purchasing and selling securities

Investment Banks: An investment bank is a bank that provides financial services for corporate and institutional customers, such as investing and raising capital and arranging mergers and acquisitions. They act as intermediaries in large and complex financial transactions. Commercial banks may have investment and retail banking sections; but investment banks can operate alone without providing retail banking services. Investment banks do not accept deposits like commercial banks. An investment bank also deals with the trade in bonds and securities of companies. They can buy new securities from a company and sell them to investors in smaller units. There are over 20 investment banks in Kenya such as Kingdoms Securities, NIC, Diamond Trust Bank, UAP Old Mutual, ABC Capital, Equity Investment Bank, etc.

Some of the functions of an investment bank include:

  • Acting as a Financial Advisor for investors
  • Underwriting stocks and bonds
  • Facilitating mergers and acquisitions and offering advice on the same
  • Providing risk management services to corporations
  • Conducting research on the financial market
  • Structuring derivatives
  • Carrying out money market operations

Savings and Credit Cooperative Societies (SACCOs): Savings and Credit Co-operatives (SACCOs) are community membership-based financial institutions that are formed and owned by their members in promotion of their economic interests. These institutions mobilize and intermediate savings exclusively with in their membership under the Sacco Societies Act and they are regulated by the Sacco Societies Regulatory Authority (SASRA).

SACCOs are non-profit financial cooperatives owned by their members and governed by a member-elected board of directors. To join, individuals, businesses or savings groups must complete the necessary paperwork and purchase a minimum number of non-refundable shares. They also commit to a minimum monthly savings contribution. Although many SACCOs were originally informal community savings groups, the government’s regulatory framework now covers SACCOs, and once licensed, they are formal financial institutions.

Some of the roles and functions of a SACCO include:

  • Offering savings accounts and loans – deposit based loans. You save for six months and you are eligible to borrow.
  • Provide low-income families with safe place to save their income
  • Allows members to join groups to pool funds

Microfinance Lending Institutions: Microfinance is a banking service provided to unemployed or low-income individuals or groups who otherwise would have no other access to financial services. Microfinance lending institutions are alternative forms of providing financial services such as loans and deposits to individuals who have little access to the formal commercial banks. It is a provider of credit in smaller quantities to serve small businesses and households who do not have security or employment status to guarantee loans in larger financial institutions. Examples of microfinance lending institutions in Kenya include KWFT, Faulu, Okash, and Platinum Credit.

Insurance Companies: insurance companies are institutions that enable businesses and individuals to transfer risks or losses. They take on risks in return for payment of premiums. Customers pay regular premiums such as monthly or annually, and the insurance company compensates them in case of a loss or injury. Some of the insurance services offered by such financial institutions include: life insurance, health insurance, accident cover, car insurance, fire insurance, property insurance, and disability insurance. Insurance companies in Kenya include: Jubilee Insurance, Britam, Allianz, AON Minet, APA Insurance, etc. These organizations are important because they protect people from losses, help businesses to recover losses, boost the economy by saving businesses, recovering lost property, and improving the wellbeing of individuals.

Capital Markets: Capital markets or money markets are financial systems where capital is raised through shares, bonds, debentures, etc. They are places where investors engage in buying and selling of financial securities such as stocks and bonds. The Nairobi Stock Exchange (NSE) is a good example of a stock market where the shares of companies are traded. Some of the companies listed in Nairobi Stock Exchange include Safaricom, Equity Bank, KPLC Cooperative Bank, Total, and KenGen. Traders in the NSE buy shares to benefit from capital gains and dividend payments. Capital gains are the profits that a person receive when they sell shares above the amount they used to buy them; while dividends are the share of profits that the company distributes to shareholders.

4.3. Functions of Financial Institutions in Kenya

Financial Institutions play a significant role in the economy of every country. Their primary role is to act as intermediaries between those who have surplus and those who have shortage of money, they between savings and investments; those who want to save and those who want to borrow; lenders and borrowers; consumers and borrowers. Those who need money for consumption will need to borrow money from those who want to invest their idle money. However, it is very difficult for those who have surplus to know or trust those who genuinely need money. Financial institutions come in to link the two parties to ensure constant supply of money. The major functions of financial institutions include:

  • Regulating money supply: Financial institutions help in regulating money supply and ensure stability in the economy. For example, the Central Bank of Kenya uses monetary policy to regulate the amount of money in circulation and control inflation.
  • Providing banking services: financial institutions such as commercial banks also provide banking services such as taking deposits and providing loans.
  • Providing insurance services: financial institutions provide insurance to cover for losses of life and property. They manage and minimize risks through insurance and risk management.
  • Capital formation: Financial institutions also play the role of capital formation by facilitating the trade in shares and bonds in the capital market. For example, the Nairobi Stock Exchange helps companies to access equity capital by engaging in the trade of shares in the primary and secondary market.
  • Investment advice: financial institutions also provide financial consultancy and advisory services. For instance, stock brokers provide advice to investors regarding their shares. Investment banks also advise companies on various investment options.
  • Brokerage services: providing access to investment options in the market is also the role of financial brokerage firms. Some investment options include stock bonds, hedge funds, mutual funds, and private equity investments.
  • Pension fund services: Financial institutions also have several investment plans or portfolios that can help individuals to develop pension funds for their retirement. Individuals contribute to an investment pool held by financial institutions such as banks and they can be able to get lump sum or monthly income after retirement.
  • Financing SMEs: Financial institutions such as SACCOs and microfinance institutions facilitate the financing of small and medium sized businesses. They provide loans or credit for businesses to fund their investments and operations.
  • Agent for economic growth: All the above functions contribute to economic growth. Financial institutions act as agents of economic growth by facilitating economic transactions, investments, financial management, and risk management. Examples of financial institutions that provide pension funds are: Zimele Asset Management Company, Absa Asset Management Ltd, Old Mutual Investment Group, CIC Asset Management Ltd, etc.

4.4. Factors That Have Led To Rapid Growth of Financial Institutions

Kenya has experienced rapid growth of financial institutions in the past few decades. Apart from over 40 banks in operation, there are thousands of microfinance institutions, SACCOs, fintech firms, insurance companies, capital markets, and other financial institutions. The number of deposit accounts in commercial banks in Kenya increased from 2.5 million in 2005 to 66.3 million in 2021. So what are the factors that have led to this rapid growth of commercial banks and other financial institutions in Kenya? Here is a list of the factors that have promoted the growth of financial institutions in Kenya and other sub-Saharan countries:

  • Government policies: Several government policies have seen a rapid growth of financial institutions over the years. The creation of regulatory agencies, simplification of registration processes, and liberalization of the financial markets have led to the growth of financial institutions.
  • Economic factors: Kenya and other African countries have also seen significant increase in national GDPs. The Kenyan GDP has grown by an average of about 5% in the past 20 years. This economic growth and increase in trade and investment flows have led to increased income and created demand for financial services, leading to the growth of the financial sector.
  • Human resource factors: the availability of human resources in the country has enabled financial institutions to expand and provide more financial services to customers.
  • Education and Literacy: Growth in education and literacy in Kenya has increased the number of people in employment who need financial services. It has also enhanced financial literacy and improved people’s attitudes towards banking and investment.
  • Urbanization: There is also a rise in movement of people, especially the youth, from rural to urban areas in search of employment and business opportunities. This has increased demand for financial services in towns and cities.
  • Infrastructural Development: infrastructural developments such as roads, electricity and markets have opened up rural areas for investments and business, leading to increased demand for financial service; hence contributing towards the growth of financial institutions.
  • Globalization: trade across countries, including direct foreign investments, have opened up the Kenyan economy to foreign investment banks. Investors from abroad have also brought in investment capital to fund the growth of financial institutions such as KCB, Equity, CIC and the NSE.
  • Technological Innovation: Lastly, improvement in technology and innovation has enabled financial institutions to reach more people with their financial services. Mobile money, internet banking, and other innovative ways have helped more people to register for various financial services.

4.5. Factors Leading To Failure of Indigenous Financial Institutions

While the financial sector in general is growing, indigenous financial institutions are slowly declining in popularity and influence. Traditional banks are becoming less preferable for various financial services as alternative methods are made available for consumers. For instance, many people prefer using mobile money to save, borrow and transact rather than having a bank account for the same purpose. Several traditional banks have failed in the past decade, including Dubai Bank, Imperial Bank, and Chase Bank. Some of the factors leading to the failure of indigenous financial institutions include:

  • Corporate Governance: Weak corporate governance practices have led to the collapse of indigenous financial institutions. They lack proper corporate governance structure and transparency standards to prevent corporate failure.
  • High Default Rates: Non performing loans are those that have a high risk of default. They cause a financial institution to fail due to losses caused by the default, which means the firm is not able to recover its money.
  • Poor Regulatory and Supervisory Systems: Poor regulatory and supervisory systems also give financial institutions the loophole to engage in poor decisions that may cause corporate failures. Weak regulation means that there is no clear way of checking what banks are doing, leading to lack of accountability in the financial sector.
  • Insider Trading: This is one of the major causes of the failure of financial institutions. Insider trading refers to the illegal practice of trading in the financial market to one’s own advantage through having access to confidential information.
  • Poor Risk Management: Some financial institutions are not able to assess their risks effectively. This leads to increased risks of failure.
  • Lack of Internal Control: Large corporations require sound internal control systems to ensure that their operations and decisions are in line with the required standards and regulations of the industry. Without internal control, the company may not be able to detect financial fraud or errors that could lead to failure.
  • Emergence of New Technologies: The rise of innovative technologies such as mobile and internet banking has led to the loss of popularity of indigenous banks among customers. This leads to loss of revenue and reduced profits, which means that traditional financial institutions will not be able to support its operations as it makes losses. Firms need to adapt to the new realities by developing innovative technologies to provide more services to their customers.
  • Increased Competition: with emergence of Fintech and other financial institutions, indigenous firms feel the pressure. Those that are not able to adapt to the new competitive forces may collapse.