Banks will use treasury bills as loan collateral

Capital markets

Banks will use treasury bills as loan collateral

Central Bank of Kenya. FILE PHOTO | NMG

Banks will soon be able to borrow from each other using government debt securities as collateral in reforms aimed at boosting liquidity in the industry while freeing the Central Bank of Kenya (CBK) from frequent bailouts of institutions in lack of cash.

The use of bonds and treasury bills as collateral has had minimal success, mainly because ownership of the assets remains with the borrower.

It is therefore difficult and time-consuming for creditors to recover their funds in the event of default. The main change in the ongoing reforms is for a borrowing bank to cede ownership of the securities to the credit institution, which will retain the assets until the loan is settled.

Anthony Musila, treasurer for East Africa at Absa Bank Kenya, said the move would provide more certainty for lenders and encourage lending across the sector under what are technically known as horizontal repo transactions.

“The first phase will be to allow commercial banks to borrow from each other using government securities,” Musila said.

“What will change now is that they have found a way to ensure that title to the collateral that the bank uses will pass to the lender. The lender will retain the security until the debt is settled while the borrower receives the money.”

He added that banks are currently signing master repurchase agreements with a deadline of December 31, 2022, meaning the use of fixed-income securities for borrowing could begin immediately after.

Horizontal repo transactions are designed to facilitate short-term borrowing ranging from one to six months. Mr Musila said there were plans to expand the model to allow bank customers to also use their holdings of treasury bills as collateral for bank loans.

“The horizontal repo transactions were not implemented because title to the security did not pass to the lender,” Musila said.

“He stayed with the borrower and therefore if the borrower went bankrupt you would find that as long as he has a repo in place the lender will still be asked to join the queue and wait to recover his money.”

Small banks should be the main beneficiaries of the reforms, which are currently being tested.

Recent bank failures and concentrated distress among small and medium institutions have seen them shunned by big banks, forcing them to rely on the CBK to access liquidity.

The implementation of horizontal repos will ensure the recovery of funds from creditors, encouraging inter-bank lending regardless of size.

The big banks are currently borrowing from each other without collateral, confident in their balance sheets and able to access additional funds from their shareholders.

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