The Tier 3 Microfinance Bank's Liquidity Squeeze
Mwangaza Microfinance Bank is a Tier 3 deposit-taking MFB with 14 branches and KES 2.8 billion in deposits. Its audited capital adequacy ratio is 8.1% against the 10% minimum, and liquidity ratio is 17% against 20%. NPLs are 29%, including KES 180 million of restructured loans that the credit director wants to reclassify as 'current' after borrowers make one small payment. The CFO proposes declaring a 12% dividend to the family shareholders, using a KES 300 million overdraft from the parent to plug the liquidity gap, and accepting a KES 250 million deposit from a PEP without enhanced due diligence. The bank also plans to launch a mobile deposit product with an unlicensed fintech partner that will hold customer funds overnight. The board meeting is in 10 days.
1. What should the board do about the capital and liquidity breaches, and should it approve the dividend?
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The board should treat the capital and liquidity ratios as supervisory triggers, not as accounting inconveniences. A bank below minimum capital adequacy and liquidity is expected to notify the CBK promptly, adopt a capital restoration plan and a liquidity contingency plan, and avoid actions that further weaken the balance sheet.
The dividend should not be approved. Paying 12% to family shareholders while the bank is below minimum capital is inconsistent with capital conservation and may breach the legal restrictions on distributions where capital is impaired. The CBK is likely to prohibit or condition the dividend, and directors who approve it may face personal regulatory exposure.
The parent overdraft is not capital. It may ease daily liquidity, but it is a related-party liability that requires board approval on arm's length terms, disclosure and CBK engagement. It does not cure the capital shortfall. The board should present a realistic plan covering capital injection, asset-quality cleanup, cost reduction and recovery of insider exposures.
The board should also consider whether current management can restore compliance. If not, the CBK may require changes in management or impose restrictions on new lending and deposit-taking.
2. Can the bank reclassify the KES 180 million restructured loans after one small payment? Explain the asset-quality and provisioning consequences.
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No. Reclassification should follow the borrower's ability to service the loan on the revised terms, not the receipt of one token payment. A single small payment may show willingness, but it does not prove sustainable cash flow. The credit director's proposal looks like evergreening: masking overdue loans to avoid provisioning and to protect reported capital.
The bank should:
- assess each borrower's repayment capacity, business prospects and collateral;
- verify that the restructure is commercially justified and not merely a postponement of loss recognition;
- classify the loan according to the applicable CBK prudential rules on arrears and restructured facilities;
- provide for expected credit losses and write off exposures that are no longer collectible;
- document the rationale and have it challenged by the board risk committee.
If the bank overstates asset quality, its reported capital ratio is unreliable. That undermines the capital restoration plan and may mislead depositors and the CBK. The auditor and the board should be told that a requested reclassification is not supported.
A credible cleanup may increase reported losses in the short term, but it is necessary for a realistic recovery.
3. Assess the PEP deposit, the parent overdraft and the fintech mobile deposit proposal from an AML and regulatory-perimeter perspective.
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The PEP deposit requires enhanced due diligence. A politically exposed person, or a close associate or family member, presents higher money-laundering risk. The bank should establish source of funds and source of wealth, screen against sanctions and adverse media, obtain senior-management approval, and monitor the relationship. Accepting KES 250 million without EDD would breach the bank's AML obligations and could expose it to a suspicious-transaction report to the FRC.
The parent overdraft is a related-party transaction. It needs arm's length pricing, board approval with conflicted directors recused, disclosure and compliance with exposure limits. It should not be presented as a substitute for capital.
The fintech proposal raises three issues. First, if the partner is unlicensed and holds customer funds overnight, it may be conducting deposit-taking, payment services or remittance without authorisation. Second, the bank remains responsible for outsourcing risk and customer protection. Third, customer funds must be safeguarded and not commingled with the partner's working capital. The bank should obtain CBK approval for the outsourcing and confirm the partner's licensing status before launch. If the partner cannot be licensed or safely integrated, the product should not proceed.