No hornbill’s problem

Implications on sector of successive collapse of banking institutions

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By Shadrack MuyesuB

An external audit is “a periodic or specific purpose (ad hoc) audit conducted by external (independent) qualified accountant(s). Its objective is to determine, among other things, whether (1) the accounting records are accurate and complete, (2) prepared in accordance with the provisions of Generally Accepted Accounting Principles (GAAP), and (3) the statements prepared from the accounts present fairly the organisation’s financial position, and the results of its financial operations.”

At a time when the mandate of auditors has increasingly come under scrutiny, this definition of an external audit given by the Business Dictionary makes it very difficult to see beyond the culpability of external auditors in the fall of a number of local lenders. Yet, this is the position the Institute of Certified Public Accountants of Kenya (ICPAK) has taken. The institution has, on a couple of occasions, sought to reiterate the position that external auditors could only assume criminal liability to the extent of the information availed to them by directors. As long as they followed the correct procedure and qualified their final report on grounds of limitation of scope, it is very difficult to lay blame at the foot of external auditors.

Positives

As expected, there has been a public outcry about this position taken by ICPAK. Many have come out to say that the Institute reserves the sinister motive of protecting auditors, especially the big ones such as Deloitte. But they couldn’t be further from the truth. There is, in fact, no contradiction between the role of external auditors, according to the Business Dictionary, and their role as imputed by the Institute. The Institute only acknowledged that in executing their mandate, external auditors were reliant on records availed to them by directors. Going beyond their traditional reliance on the information availed to them by directors would be akin to conducting a forensic audit and such would require a civil warrant.

Yet such supposed grey areas wouldn’t have come to light had it not been for the recent collapses. Stakeholders are moving swiftly to correct these anomalies so as to revive collapsed banks and strengthen the remaining ones. Already, there are calls to have the Banking Act amended to expand the mandate of external auditors as well as clearly define the roles of auditors vis a vis bank boards. There are voices that also believe that as a long term solution, the scope and objectives of an audit ought to be revisited.

Speaking of first moves, through letter to external auditors of commercial banks dated 11 November 2015, the Central Bank granted auditors power to assess the IT environment of commercial banks and issue a report of findings to the Central Bank of Kenya – a bold move believed to be behind the recent findings. Central bank has also pledged financial support to small lenders to keep them alive “should depositors come calling in a similar panic withdrawals that sank Chase Bank.” Raising minimum core capital has also meant that small lenders could be forced to merge. By and large, a new regime of scrutiny means better liquidity for local lenders.

Negatives: Deposits

The most obvious effect of the collapse we are witnessing is that there will likely be a slump in the financial market since people will shy away from keeping their monies in banks, resulting to a less profitable financial market. Banks have the unique capacity to finance production by lending their own debt to agents willing to accept it and to use it as money-making healthy banks as perhaps the best indicator for stable economies. More savings has always meant more public investment.

In his paper, “A Macro Analysis of Bank Performance in Debt-Burdened Countries”, Obademi Olalekan Emmanuel even argues that a drop in savings forces banks to access high-risk funds in order to boost their capital reserves. This makes banks more susceptible to distortions introduced into the financial system as a result of a country’s high debt profile. Public spending has seen both our internal and external debt profile rise at an alarming rate recently. If Obademi’s argument holds true, then the current banking shocks couldn’t have come at a worse time.

Cost of capital

Cost of capital is likely to go up to discourage public borrowing so as to shield other financial institutions from collapsing. In an environment of relatively low interest rates borrowing is high – a situation which if not monitored could negatively impact a bank’s capital. To strengthen capital bases, loan interest rates are bound to rise and therefore drive the cost of borrowing upwards. Though guaranteeing greater stability for banks, a high cost of borrowing is bad news for the average citizen who depends on loans to finance investment. Starting a business will be much harder and the cost of business expansion will be likely passed to the consumer, hence driving the cost of commodities upwards. In an environment of costly multiplier effects, the economy could witness a cost-driven inflation.

Impact on foreign investment

Inflation impacts negatively on our ability to acquire external debt. Kenya’s debt volumes are already too high, a cost driven inflation coupled with current state of the global economy is enough to convince many external lenders that our economy cannot produce enough surplus to pay off debts. Like banks, the Government could likely turn to riskier sources for capital. Domestic borrowing, for instance, would only drive the cost of capital further up.

A significant section of investors might as well interpret the collapses as being as a result of poor monitoring by the regulators and/or a weak finance regime. They could lose confidence in our financial systems, leading to decline in foreign investment.

Jobs

That said, the most obvious consequence of the fall has to be job losses. Lost jobs mean a punctured tax basket for Government and an increase in poverty levels. But former bank employees are not the only victims. A rise in the cost of doing business means that many businesses will have to trim their work force as well. Remaining employees could see their benefits slashed.

The general misconception has been that the collapse of the three banks does not necessarily mean a crisis in the banking sector. But the effect highlighted above are net effects that may arise from measures taken by the regulator to stem further falls in the industry – not measures aimed at curing individual banks. As such, they deeply affect the entire banking sector with secondary effect to the general economy.

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