THE GLOBAL FINANCIAL
CRISIS : ITS IMPACT ON
KENYA AND POSSIBLE
STRATEGIES TO
MITIGATE THE EFFECTS
Capital Markets Authority
November 14, 2008
Capital Markets Authority
Presentation Outline
 RECENT TRENDS IN GLOBAL FINANCIAL
MARKETS
 FACTORS BEHIND THE FINANCIAL TURMOIL
 IMPACT OF THE CRISIS – GLOBALLY; ON KENYA
 MAIN LESSONS & POLICY IMPLICATIONS FOR
KENYA
Capital Markets Authority
Recent trends in global financial
markets
 Since September 2008:
 World stock markets’ performance have fallen
substantially. We have witnessed the largest
bailouts and bankruptcies in the history of finance of
large financial institutions.
 Stock Market indices have dropped to between five
to nine year lows;
 The downturn is after four years of relatively fast
growth.
Capital Markets Authority
Factors behind the financial
turmoil
 Key Players in the global turmoil
 Financial Institutions:
Commercial Banks
Mortgage Companies
Investment banks
Insurance Companies
Hedge Funds
Pension Funds
Capital Markets Authority
Factors behind the financial
turmoil
 Key Players in Global Turmoil
 Financial Products:
Mortgage loans including subprime
Asset-backed securities (ABS)
Mortgage-backed securities (MBS)
Collaterised Debt Obligations (CDO)
Credit-default swaps (CDS)-Insurance
against a company defaulting on its debts
Capital Markets Authority
Factors behind the financial
turmoil
 January 2001: US interest rates fall – Fed
reserve benchmark interest falls from 6.5% to 1%
over a 2-year period.
 2002: Mortgage loans packaged as
securitizations and marketed as Collaterised Debt
Obligations (CDOs) on secondary mortgage
market. The assertion was that CDOs would help
reduce and disperse risks.
 2002: Home prices begin to rise-low borrowing
costs & more risky loans
Capital Markets Authority
Factors behind the financial
turmoil
 2006: Risky loans at peak due to easy access
–no sufficient collateral or proof of financial
condition required by banks/mortgage
companies. Mortgages not backed by
government authorized Fannie Mae & Freddie
Mac.
 2007: US interest rates rise, home prices fall
due to over supply, American incomes
unchanged – Tightening of credit market.
Capital Markets Authority
Factors behind the financial
turmoil
 2007: Defaults on home loans rise –
homeowners unable to refinance loans or sell
their depreciating homes.
 2007: New Century Financial, US sub-prime
mortgage lender files for bankruptcy.
 2007: Northern Rock, UK mortgage lender
unable to raise financing and Bank of England
grants it emergency loan.
Capital Markets Authority
Factors behind the financial
turmoil
 Jan 2008: Fed cuts benchmark interest rates to
ease tight credit market.
 July 2008: Fannie Mae & Freddie Mac shares fall
as required to raise more capital which was not
forthcoming.
 Sept 2008: US Government takes control of
Fannie Mae & Freddie Mac to avert spillover on
the economy.
 Sept 2008: Banks tighten their lending standards
and credit further tightened.
Capital Markets Authority
 Sept 2008: Merrill Lynch sold and Lehman files
for bankruptcy.
 Sept 2008: AIG (Insurance) bailed out by the US
Govt.
 Oct 2008: US Government agrees to bail out by
US$700 bn financial institutions facing bad
mortgages and loss of investor confidence
Previous global financial crises 1929
 The Wall Street Stock market crash of 1929
occurred during a period of declining real
estate values in America (which peaked in
1925).
 1920s, a precursor to the Crash, was a time of
prosperity and excesses (high price levels) in
USA, despite warnings against speculation.
 NYSE was the largest stock market in the
world then. DJIA took 25 yrs thereafter to
attain pre-1929 levels.
Capital Markets Authority
Previous global financial crises 1929
 Due to the 1929 stock market crash,
nationwide commercial bank failure and the
Great Depression, the Glass-Steagall Act
(GSA) 1933 was developed.
 GSA mandated separation between
commercial banks, which take deposits and
extend loans, and investment banks, which
underwrite, issue and distribute securities.
Capital Markets Authority
Previous global financial crises 1929
Commercial banks too speculative in the preDepression era-investing their assets & buying new
securities issues for resale to the public, & issuing
unsound loans to companies in which the bank had
invested, and encouraging its bank clients to invest in
those same stocks.
Capital Markets Authority
Previous global financial
crises-1987
 The 1987 market crash in USA
 Causes:
 sales through program trading,
 overvaluation,
 illiquidity,
 market psychology.
 In program trading, computers perform rapid stock
executions based on external inputs, such as the price
of related securities using common strategies e.g.
arbitrage and portfolio insurance .
Capital Markets Authority
1987 : Stock Market Crash
 With the proliferation of computer technology,
the use of program trading grew dramatically
within Wall Street firms. The strategies therein
resulted in blind selling of stocks as markets
fell, exacerbating the decline.
 Another reason was overvaluation hence
crash was a return to normalcy.
Capital Markets Authority
1997 : Asian Crisis
 Triggered by the devaluation of the Thai currency in
July 1997 which prompted attacks on East Asian
stocks and currencies.
Other causes:
 Widening current account deficit resulting from falling
export performance due to exchange rate
appreciation;
 Rising capital inflows encouraging excessive imports.
Capital Markets Authority
1997 : Asian Crisis
 Exchange rates pegged to the US dollar
resulted in Asian currency appreciation in line
with US dollar but this made Asian exports
uncompetitive. Insufficient foreign exchange
reserves resulted in devaluation of Asian
currencies and increased interest rates.
 Increased financial liberalisation-foreign bank
lending to private sector on short term.
Capital Markets Authority
Previous global financial crises –
1999
 Arguments against Glass Steagall Act were: -reputation had
come to mean everything in today's market, and that could be
enough to motivate banks to self-regulate; - allowing banks to
diversify in moderation offers the banking industry the potential to
reduce risk
 Consequently, in November of 1999 Congress repealed the GSA
with the establishment of the Gramm-Leach-Bliley Act, which:
a) eliminated the GSA restrictions against affiliations between
commercial and investment banks;
b) established the Federal Deposit Insurance Corporation (FDIC)
in the USA;
c) allowed banks to provide a broader range of services,
including underwriting, insurance, and other dealing activities.
Capital Markets Authority
Impact of Global Financial Crisis
 As at October 2008, the Bank of England said the
world’s financial firms had lost USD 2.8 trillion as a
result of the continuing credit crisis. This is 133 times
Kenya’s current Gross Domestic Product (GDP) in
absolute terms!!
 Globally taxpayers have now spent around USD 8
trillion to shore up the world’s banks.
 These amounts will increase as the crisis spreads into
the real economy.
Capital Markets Authority
Impact of Global Financial Crisis
 Mechanical phenomena (domino effects, as many institutions
had financial links), psychological contagions resulted in
simultaneous spread worldwide to many financial and economic
areas:
1. Financial markets (stock exchanges and derivative markets
notably) where it developed into a bear run
2. Various equity funds and hedge funds going short of cash and
consequently forced to liquidate assets
Insurance companies and pension funds facing a receding asset
portfolio value to cover their commitments
Capital Markets Authority
Impact of Global Financial Crisis
3.
Effects on public finance by Governments due to the bailout
actions (May lead to serious budget deficits).
4.
Increased volatility of Foreign currencies (Icelandic crown,
various Eastern Europe and Latin America currencies)
5.
Nationalization of Banks and pension funds (Latin
America/Spain)
6.
Drastic cut in interest rates by Central Banks
7.
Job costs and other cost cuts by banks/IBS – worldwide mainly
in IB and related trading business.
Capital Markets Authority
Impact of Global Financial Crisis
8. Governments guaranteeing interbank loans
and deposits to encourage banks to lend to
each other
9. Asia suffered from shrinking demand for its
products
Capital Markets Authority
Impact of Global Financial Crisis
10. China: Fiscal policy to focus on infrastructure
development for the next two years
11. Nigeria: In September 2008 - The Central
Bank of Nigeria (CBN) reduced the interest
rate the liquidity rate and cash reserve
requirement. The policy adjustments were
designed to and improve liquidity in
economy.
Capital Markets Authority
Impact of Global Financial Crisis
 Kenya: The formation of a Taskforce to inform
the Government on how to shield the economy
from the adverse effects of the global financial
crisis
 The IMF has committed itself to assist
countries in difficulty through quick lending
Capital Markets Authority
Impact of Global Crisis on
Kenyan Economy
 The impact on Kenya is both direct and indirect exposure
 Indirect effects include slowdown of the tourism sector that relies
heavily on foreign tourists, the construction industry and the stock
market that benefit from remittances by Kenyans living abroad
and foreign institutions e.g. hedge funds
 Exports, especially horticulture, lower which will impact on foreign
exchange earning .
Capital Markets Authority
Impact on Kenya
NSE Market Capitalization Trends 2007
Year
Month
2007
January
824.3
February
723.7
March
697.3
April
Market Capitalization (Kshs bn)
702
May
709.7
June
743.9
July
780.7
August
813.2
September
791.7
October
745.5
November
804.1
December
851.1
NSE Market Capitalization Trends 2008
Year
Month
2008
January
777.1
February
830.6
March
781.7
April
908.2
May
916.8
June
1230.7
July
1122.2
August
Market Capitalization (Kshs bn)
1102
September
972.27
October
764.98
Trends in NSE Market Capitalization for period covering Jan 2007-Oct 2008
1400
1200
800
600
400
2007
2008
Market Capitalization
Capital Markets Authority
October
September
August
July
June
May
April
March
February
January
December
October
September
August
July
June
May
April
March
February
0
November
200
January
Kshs (bn)
1000
Impact on Kenya
2008
Foreign Investors
(Net Outflow Flow Kshs Mn)
January
143
February
779
March
624
April
45
May
570
June
-3076
July
-121
August
3
September
-283
October
-879
Impact on Kenya
Net Foreign cash flow activity for the period March-October 2008
1000
779
500
Kshs (mn)
-1000
570
143
0
-500
624
y
ar
u
n
Ja
y
ar
u
br
e
F
45
ch
ar
M
ril
p
A
-121
ay
M
ne
Ju
ly
Ju
-1500
-2000
-2500
-3000
-3076
-3500
Net Foreign cash flow
t
us
g
Au
3
r
be
m
te
p
Se
-283
er
b
o
ct
O
-879
Impact on Kenya
 Strengthening of US Dollar against other
currencies has resulted in depreciating Kenya
Shilling
 Foreign Debt Service will be more expensive
(more Kshs to pay)
 Likely to boost tourism due to weaker shilling
(cheaper to come to Kenya)
 Implies that imports will be more expensive Diaspora remittances remains relatively low
Capital Markets Authority
Impact of Global Crisis on
Kenyan Economy
 Falling oil prices likely to result in lower fuel
and energy costs (subject to strength of the
Kenya Shilling)
 Reduced direct investment in Kenya by
developed countries due to foreign investors
focus on consolidating their financial position
Capital Markets Authority
Way Forward – Regulatory
Perspective
 Failures identified as cause of the crisis:
 Regulatory and supervisory failure in advanced
economies
 A failure in risk management in private financial
instructions
 Failure in market discipline mechanisms
Capital Markets Authority
Way Forward – Regulatory
Perspective
Key Players in Financial Crisis
 How did this Build Up in Financial
System & Capital Markets?
Excess Liquidity
Solvency
Capital Adequacy
Loss of Investor Confidence
Capital Markets Authority
Way Forward – Regulatory
Perspective
1. There is a case for highly capitalized financial
institutions in Kenya.
 This is in line with the Finance Bill 2008-2009 for
investment banks and stockbrokers and the Finance
Act 2007-2008 requiring banks to inject higher capital
 Asian banks escaped largely due to well capitalized
banks, cautious regulation and huge forex reserves
Capital Markets Authority
Way Forward – Regulatory
Perspective
2.
3.
4.



Investors have buying opportunity - Prices at the
NSE have never been so good
Tougher rules on operation of credit rating agencies
for ABS products which require this.
The right regulation model
The deregulated and fragmented model of the US &
Europe did not foresee the collapse.
The institutions which collapsed were considered too
big to fail & reliance on institutions to monitor.
Investment banks reverted to commercial bank
holding companies.
Capital Markets Authority
Way Forward – Regulatory
Perspective
 Multi-Partite Memorandum of Understandings (MoUs)
between all the financial sector regulators to share
information on risk & other cooperation to ensure no
gray areas that are unregulated.
 Greater laws prohibiting predatory or subprime lending
practices;
 Several factors to evaluate performance of a fund
manager to ensure underlying funds are not subjected
to undue risks. Where fund managers are evaluated
on the basis of recent performance only, there may be
incentive for managers to invest the funds in the
riskiest vehicles that somehow reflect highest returns
Capital Markets Authority
Way Forward – Regulatory
Perspective
5. All financial sector regulators adoption of riskbased supervision.
 Risk management by each financial institution, with
the regulator risk profiling and continuously reviewing
the risks independently.
 More information sharing by the financial sector
regulators in Kenya on the risk profiles as well as other
pertinent information
Capital Markets Authority
Way Forward – Regulatory
Perspective
6. Review of Legal Framework
Currently ongoing - includes Regulations on Asset
Backed Securities. Stakeholder exposure &
presentation on proposed changes will be held in
November 2008
7. Investor education and public awareness
 Measures to make the public more knowledgeable
on products so that they make informed investment
decision
 An informed investor is a protected investor
i.
Capital Markets Authority
Way Forward – Regulatory
Perspective
8. Good Corporate governance is required to restore
market confidence, attract FDI/ Private capital inflows
and investments and promote economic growth. This
will be achieved by increasing;
a. the accountability of directors,
b. the transpercy of corporate structures
c. valuation models
d. transparency of financial transactions
 There is need for an inclusive global governance
serving literacy needs of all stakeholders large and
developing economies
Capital Markets Authority
Way Forward – Regulatory
Perspective
9. International Surveillance: who will play the
role of “policing” the global financial system
and warn of potential trouble spots and crisis
and to what extent? Multilateral organizations
especially IMF.
 Kenya should be able to utilize the
surveillance information available and act
quickly to prevent any crisis. Commitment by
all countries to cooperation and policy
coordination
Capital Markets Authority
Way Forward – Regulatory
Perspective
10. Media coverage of credit crisis in US,UK etc. as more
investors received the news even in Kenya, they opted
to get out of the market, both foreign and domestic
investors. In Kenya, this was despite the fact that the
fundamentals of our companies and banking system
remained strong. (“Herd Mentality”)
 Continuous communication to public, through media,
by regulators, related government officials to provide
position on the ground, shape opinion and perception.
Capital Markets Authority
Conclusion
Thank you