This archive report was first published on 20 August 2019.
Kenya has been listed as one of the countries facing a systematic banking crisis, with significant banking policy intervention measures implemented by the authorities in response to losses among individual banking components.
According to experts, the country needs an extensive regulatory regime due to weak market discipline. This raises questions about why banks are heavily regulated in most economies, yet financial crises still occur in both developed and emerging economies.
Banks provide critical services to the economy, including money transmission, credit allocation, and payment. When banks fail in these activities, individuals and the economy suffer.
Effective regulations are necessary to protect borrowers, lenders, and investors, prevent unfair practices, and stabilize the economy. For instance, if banks fail to provide payment services for a day, it can lead to catastrophic disruption in the entire economy.
Central Banks face challenges in supervising commercial banks, particularly in monitoring how they create loans from existing deposits. The intermediary role of banks is being challenged, and the idea that more banks create credit than being an intermediary is gaining ground.
Regulations can pre-empt moral hazard and adverse selection problems, which occur when banks approve loans with incomplete information or borrowers invest in too risky ventures without the lender's knowledge.
However, regulations can also have unintended consequences, such as deposit insurance cultivating laxity in banks and retarding financial development.
Effective regulations should address banks' liquidity problems and excessive risk-taking, which is often due to a lack of capacity to credit evaluation or ownership of banks by crooks.
