The Effect of Systemic Risk and Financial Contagion in the Kenyan Banking Sector

Abstract

The intent of study was to understand the effect of systemic risk and financial contagion in the Kenyan banking sector since the year 1988 to 2018. Further, the study sought to make recommendations to mitigate contagion and increase preparedness to systemic risk in the Kenyan banking sector. The study analysed secondary data from Central Bank supervision reports for all commercial banks in Kenya for a period of 30 years starting from 1988 stretching to 2018 with a 5 year short term segmentation period. Through financial ratio analysis banks failures were analysed into short term time periods with correlation analysis used to see if past risk of bank failures led to present time failures. The study also adopted financial ratio analysis and panel data techniques to process and analyse the data. The study concludes that systemic risk and financial contagion has been the cause of 70% of the total 28 banking failures in the country for the last 30 years. The only problem with this type of risk unlike other major risk like Liquidity risk, Credit risk and Market risk; there exist no appropriate methodology that can be used to mitigate such risk and when it occurs, it’s usually after a build-up of so many factors in the past. The study therefore recommends that the 25% minimum cap that was placed to limit how much banks should lend to a single individual should be further lowered to around 15%. Further there should be a cap limit to how much banks in different Tiers can lend, this will rein in to the behaviour of small banks over exposing their lending portfolios.