THE PEER MONITORING ROLE OF THE INTERBANK MARKET IN
KENYA
AND IMPLICATIONS FOR BANK REGULATION
By
Victor Murinde, Ye Bai, Christopher J. Green, Isaya Maana, Samuel
Tiriongo, Kethi Ngoka-Kisinguh
Murinde: University of Birmingham
Bai: University of Nottingham
Green: Loughborough University
Maana: Central Bank of Kenya
Tiriongo: Central Bank of Kenya
Ngoka-Kisinguh: Central Bank of Kenya
We acknowledge financial support by the Kenyan Ministry of Finance and the Central Bank of Kenya under contract
Kenya/SPN/FS/CBK/05/2010-11 and without implication, research funding from DFID and ESRC under the DEGRP
Call 3, Research Grant No. ES/NO13344/1.
The usual claimer applies.
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1. Research focus
The peer monitoring implication of the participating banks in the
Kenya interbank market
2. Research Motivations
1) Lessons learnt from the 2007/08 financial crisis
• Necessary but insufficient government discipline
• Renewed interest in market discipline
• However, ineffective private monitoring due to…
• deposit insurance could weaken market discipline
(Demirguc-
Kunt and Detragiache, 2002)
• Hence another possible market discipline candidate:
interbank market
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• The interbank market: where individual banks transact with
one another to meet their demand for and supply of short
term funds.
• Interbank Market discipline: large, collateralized interbank
loans … credit risk … motivated to monitor … amounts to a
market peer monitoring mechanism
2) The dark side of interbank market: contagion
• interbank market: unsecured, based on lines of credit, the
network of lending relationships
• direct credit exposures…network…domino effects
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3) Research gap in emerging economies’ interbank
market
• ‘One size fits all’ type of official bank regulation…side-stepped
(Murinde, 2010)
• Kenya banking sector: exemplary
 most developed in Africa
 credited for its size and diversification
 e.g. private credit to GDP in Kenya was 23.7% in 2008 vs. a
median of 12.3% for Sub-Saharan Africa (Beck, Demirguc-Kunt and
Levine, 2009)
 but largely bank-based with shallow capital market
2006)
 entrenched interbank market (Green, et al., 2017)
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(Ngugi et al,
3. Data and key variables
• 43 banks participating in Kenya interbank
• between 2003Q1 and 2011Q1
Table 2 Panel A: Sample composition by three categories
Freq. %
Freq. %
public bank
private bank
small size
medium size
large size
total
6
foreign owner
66.67
6
33.33
3
55.56
5
22.22
2
22.22
2
20.93
9
local owner
26.47
9
73.53
25
50.00
17
38.24
13
11.76
4
79.07
34
local owner
foreign owner
small size
medium size
large size
total
Freq.
%
private bank
89.29
25
10.71
3
64.29
18
32.14
9
3.57
1
65.12
28
Freq.
%
public bank
60.00
9
40.00
6
26.67
4
40.00
6
33.33
5
34.88
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• Bank risks: the ratio of net charge-offs to equity in log form
(lognco) Dinger and Von Hagen (2009)
• the interbank exposure measurements:
1) the ratio of interbank liabilities to total assets (ibl_ta)
2) the ratio of interbank assets to total assets (nia_ta)
•
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Important to consider interbank borrowing and lending
separately (Huang and Ratnovski, 2009)…funding risk of equal
importance
4. Empirical results
lognco
ibl_ta
squ_ibl_ta
nia_ta
squ_nia_ta
interbank liability exposure
Coef.
z-stat
-2.842
0.482
[-3.76]
[2.33]
interbank asset exposure
Coef.
z-stat
***
**
-0.177
0.004
[-5.14]
[3.58]
***
***
1) Both interbank liability and asset positions are reversely
linked with bank risk - support the ‘peer monitoring’
hypothesis
2) However, if the interbank borrowing and lending position
reaches a threshold, the impact reverses from risk
reducing to risk increasing
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interbank liability exposure
interbank asset exposure
lognco
Coef.
z-stat
Coef.
z-stat
size_logta
-1.791
[-2.6]
*** -3.416
[-9.73] ***
squ_size_logta 0.077
[2.19]
** 0.154
[8.67] ***
• Size matters
• Larger banks are exposed to smaller risks.
• however such advantage reverse to a disadvantage when
its size reaches certain threshold.
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interbank liability exposure
Coef.
z-stat
-10.337 [-6.73]
***
-0.669
1.112
[-7.54]
[6.57]
***
***
ibl_ta
nia_ta
foreign_owner
foreign_ibl
foreign_nia
-2.635
[-4.41]
***
-1.271
1.600
[-6.87]
[5.62]
***
***
ibl_ta
nia_ta
public
pub_ibl
pub_nia
-2.593
[-4.880]
***
-1.194
1.756
[-5.960]
[6.100]
***
***
ibl_ta
nia_ta
age_dummy
age_ibl
age_nia
-3.166
[-4.36]
***
-1.100
1.958
[-5.05]
[5.32]
***
***
lognco
ibl_ta
nia_ta
size_logta
logta_ibl
logta_nia
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• As expected larger, foreign,
listed and older banks are
less risky.
• When they are the
borrowers, the risk reduction
effect due to interbank peer
monitoring becomes
smaller.
• The usual bank risk
determinants: capitalization,
credit risk, liquid liability,
managerial efficiency and
macroeconomic variables
can also be applied to
Kenya banks.
5. Public policy implications
• The interbank market in Kenya provides a mechanism for
peer monitoring and discipline
 Complements the regulatory oversight of the central bank
and the usual private monitoring candidates
 Provides market signals to identify risky banks
• During the further transition to Basel III, Kenya should
consider the option of exploiting interbank market discipline
as a complementary regulatory tool
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Continue…
• Empirical evidence support the role of capital adequacy
• However, we do not recommend an over-reliance of capital
adequacy ratio as a regulatory device
• official regulators have important roles to play…monitoring
the contagion risk…overly connected interbank network
• Not only exemplary implications for the East African regional
block
• But also for other countries at a relatively early stage of
financial development
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Thank You!
Questions?
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