CBK Mismanagement of the Discount Window

*My apologies for any technical language but I shall try to simplify the blog post to appeal to all my readers. Suggestions/Corrections are welcome. Not complete coz I need to clean it up as well + complete it*

Banks just like retail/corporate borrowers need to borrow money.

Banks lend money they 'borrow' from depositors (you & I). Sometimes, due to various reasons, they need 'cash' which does not mean the banks are 'broke' but they face a liquidity (cash) shortfall due timing issues.

Banks lend to customers/borrowers.
Banks buy T-Bills & T-Bonds (lending to governments) for interest or trading income.
Banks buy other assets which might not be cash-like (i.e. not very liquid) for income.
Banks buy corporate Bonds or other instruments for income.
Banks buy/hold Foreign Exchange for trading or business dealing.

Therefore a bank at a specific point in time may be 'illiquid' i.e. it does not have the'cash' it needs therefore at the end of that day it needs to borrow 'cash' from other sources. These sources are:
- Depositors/Customers
- Other Banks
- Central Bank

Getting last minute cash from Depositors/Customers is a tough call but the first port of call NORMALLY are other banks in the 'Interbank' market. If the cost or availability in the Interbank market is too high then the 'illiquid' bank can approach the Discount Window of the CBK.

CBK's Discount Window - The borrowed funds are normally short-term in nature and at rates higher (often punitive) than the benchmark or prevailing T-Bill rates.
* Different CBs may use different benchmarks including 30-day T-Bills.

There is a Monetary Policy Committee that seems out of sync with the 'real' economy. The MPC sets the Central Bank Rate (CBR) which was at 6.25% which the CBK used as the DWR (Discount Window Rate) but which was not correlated to the T-Bill Rates.

So the 'smart' banks:
- Borrowed at the CBR at 6.25% & bought T-Bills at 8%+ (Almost risk-free arbitrage)
- Lent in the Interbank at 6.25%+ then borrowed at the CBR at 6.25% (Risk-free arbitrage)
- Borrowed KES at 6.25%, converted into USD/Euro/Forex then lent the forex at 7.5%+
*So the bank benefits from arbitrage in interest rates but also potential depreciation*

Sensible Central Banks make the DWR higher than the benchmark i.e. there is a 'haircut' to borrow from the CB. Not so in Kenya where CBK's DWR < T-Bill Rate.

Not surprisingly banks loaded up on T-Bills while borrowing from the CBK. Other banks went all out to buy Forex (hard currencies). This led to a rapid drop in the KES vs 'hard' currencies.

What did the CBK do? Nothing at first. Then some 'hidden' moves which were promptly ignored by the banks concerned. Ndungu (CBK Governor refused to reveal the banks' names).

Next: CBK Governor blamed KenolKobil for the rapid increase in inflation & depreciation of the KES. So while he refused or was afraid to tell Kenyans which banks were behind the rapid & massive depreciation of the KES, he was happy to blame KenolKobil about an opinion!

Next: Issue circulars that were contradictory or at the minimum confusing!
The new DWR = CBR + Prior Day's Interbank Rate - CBR + 3% = Huh?
*Why not just say IBR + 3%? No need to "+ CBR - CBR" coz = ZERO

And the crap hit the fan! The overnight IBR started jumping 2-3% daily and soon breached 30%. Crazy! The KES remained 'weak' since the banks paid more for large short-term (wholesale) deposits but paid peanuts to small depositors. The lending rates started creeping up for ALL borrowers. Go figure!

The banks that had 'hoarded' forex were sitting pretty as long as they were not very illiquid. They simply waited it out.

*Still more to come*