Government Policies and the Development of Banking in Kenya

The growth of the Kenyan economy since independence has been accompanied by an expansion and diversification of the financial system. In terms o f the numbers and range of financial institutions (FIs) and the depth of financial intermediation, financial development has proceeded further in Kenya than in most other countries in Sub-Saharan Africa (SSA). By the early 1990s the financial sector included commercial banks, non bank financial institutions (NBFIs), development finance institutions (DFIs), insurance companies and a stock exchange. The commercial banks and NBFIs, which are the focus o f this paper, include government owned, foreign owned and locally owned private sector FIs. Government intervention in the financial system has been extensive, although the degree and nature o f influence and control it has exerted has varied considerably both between and within the different sectors. This paper examines the development since independence o f the banking system (the commercial banks and the NBFIs) and in particular how it was shaped by government policies. The aim is to explore a number of related themes: whether financial repression retarded the development of the banking system, did the government attempt to influence credit allocation and did this undermine the quality of FIs' asset portfolios?, how effective was prudential regulation? have financial sector reforms achieved their objectives of promoting a more competitive, efficient and prudentially sound banking system? The organisation of the paper is as follows. Section 2 presents an outline o f the main elements o f government policy and intervention in the financial system. Sections 3, 4 and 5 review the experience and performance of the government owned commercial banks, the foreign owned commercial banks, and the local private sector commercial banks and NBFIs respectively. The emergence of the locally owned private sector financial institutions (FIs) has been characterised by several episodes of bank failure since the mid 1980s, the causes of which are discussed in section 6. Section 7 examines the links between financial fragility and the system o f prudential regulation and supervision: this section also assesses the impact o f the reforms to the regulatory system undertaken since the mid 1980s. Section 8 outlines the main elements of the financial liberalisation introduced since the early 1980s and discusses their impact on the banking system. Section 9 concludes.2 The rest of this introduction provides a very brief overview o f the financial system in Kenya and its development since independence. The financial system at independence in 1963 consisted of nine foreign owned commercial banks, of which the largest were Barclays, Standard Chartered and National and Grindlays, together with several NBFIs and DFIs. In the decade following independence the government established the Central Bank of Kenya (CBK), three parastatal commercial banks and a number o f DFIs.