Q&A: Banking Expert Kayondo: Crane Bank had hit ‘Point of Non Viability’

Former Crane Bank management this week contested the manner in which the financial institution was taken over by Bank of Uganda (BoU) in 2016.

At the time, BoU said Crane Bank was “insolvent” and its continued operations posed a systemic risk to the financial sector.

Governor Tumusiime Mutebile would later tell bankers at an event in Kampala that the bank’s problems stemmed from “mismanagement and fraud”.

Mutebile further said Dfcu was a “suitable” bank which ensured no depositor lost money after the transfer of assets and liabilities from Crane Bank.

But appearing before Parliament on Wednesday, Crane Bank’s shareholders said BoU, as a lender of last resort, should have helped the bank address its liquidity challenges.

Sudhir Ruparelia accused BoU of frustrating investors who intended to inject capital in the bank and requested that the bad bank/book be returned to the shareholders.

ChimpReports (CR) caught up with one of Uganda’s finest lawyers, Silver Kayondo, to discuss the resolution on Crane Bank and lessons learnt in the process.

Kayondo is an Advocate with a Master of Laws specializing in Banking and Finance from the University of Pretoria, South Africa.


He also holds an Advanced Certificate in Insolvency and Restructuring under the auspices of the South African Restructuring and Insolvency Practitioners Association (SARIPA).

CR: What do you make of Sudhir Ruparelia’s request for the return of the bad bank and restoration of Crane Bank’s license?

Kayondo: Technically, in cases of bank distress, shareholders and regulators must take a decision whether to save/rescue the bank or dissolve it. A rescue can only work where the bank has not yet reached the Point of Non Viability (PONV). This is a point of no return where any prudent or reasonable regulator must declare that in public interest and in the interest of the depositors, the bank cannot continue as a going concern.

When in distress, a bank can be separated into the “good bank” and the “bad bank”. The illiquid and risky securities that are toxic to the banking system, along with other troubled assets such as nonperforming loans go into the “bad bank”. Also, the non-strategic assets from businesses it wants to exit, or assets it simply no longer wants to own as it seeks to lessen risk and deleverage the balance sheet are piled into this “bad bank” portfolio.

The bad part with the “gangerine” is cut off in order not to infect the good ones through contagion spread. Typically, these bad assets are sold off at discounted prices if buyers dealing in distressed assets eg Vulture Funds are identified. In Uganda, the Asset Reconstruction Company (ARC) is one of the entities that can acquire such assets/securities. They can be rehabilitated and sold off at a profit later.

The good assets that represent the ongoing business of the core bank are left in the “good bank”. However, it must be noted that this can be an internal reorganization plan before the regulator/the Central Bank moves in. Once the Central Bank moves in, then the distressed bank can be ordered/compelled by the Central Bank to recapitalize if it is under-capitalized as per section 86 of the Financial Institutions Act, 2004 (as amended).

Therefore, whereas the “good bank” and “bad bank” categorization can be done as a reorganization/rescue measure, it is not a magic solution for each and every type of bank insolvency. Secondly, it must be recognized that in terms of corporate set up, the bank remains one company. This “bad bank” and “good bank” categorization is at the level of books of accounts. Where the Central Bank endorses such a rescue model, the “good bank” portfolio is incorporated as a new and smaller bank which continues operations.

Rajiv Ruparelia (L) and his father Sudhir Ruparelia (all in white attire) listening to proceedings at Parliament this week

The “bad bank” with the toxic assets is sold to a reconstruction company, Vulture Funds, etc. An example of a bank rescued via the “good bank” route is African Bank in South Africa, which suffered distress and was placed under curatorship in August 2014 to “nurse it back to good health”.

The South Africa Reserve Bank/SARB (South Africa’s Central Bank) announced a restructuring proposal, which together with the financial support of other key financial stakeholders, including a consortium of six South African banks, the SARB and the Public Investment Corporation (Africa’s largest fund manager) and the restructuring of capital market liabilities of the predecessor African Bank Limited for the Bank was designed to create a new banking group to acquire the viable portion of the business of predecessor African Bank Limited.

The creditors approved this restructuring plan and in April 2016, the new African Bank Limited opened its doors as the new entity, which is now a fully operational retail bank in South Africa.

Once a bank has failed, it fails as a whole. And once a license is revoked, it cannot be restored because the failed bank will have failed to comply with corrective actions under Part IX of the Financial Institutions Act, 2004 (as amended)- in this case, recapitalization in order to get out of “the red”. Bank take over, statutory management and resolution is a process and not an event.

CR: Whom do you blame for the Crane Bank mess?

Kayondo: I do not think it adds any value to play blame games at this point. Bank management, operations and regulation involves many players. Many times, when banks fail, most people are quick to look at the numbers: ratios of capital to the loans, equity to debt ratios, etc. But as most bank failures show, the explanatory power is not always in the numbers but in the people running and supervising those financial institutions.

CR: Why would BoU use Shs 400bn in the resolution of Crane Bank instead of bailing out the bank with Shs 200bn?

Kayondo: Bailout entails the Central Bank providing direct monetary and technical support to a failing bank. It was a common thing during the 2008 Global Financial Crisis. In fact, the US enacted The Emergency Economic Stabilization Act of 2008. However, this is very unpopular because tax payers’ money is used to rescue rich business people. Also, it causes moral hazard, where people may deliberately fail their business with an anticipation of government bailout.

On the cost, Crane Bank was a Domestically Significant Important Bank (D-SIB), making it a significant player in the market in terms of size, interconnectedness in the market eg to the business and mortgage sectors, etc. The Basel Committee on Banking Supervision framework for dealing with domestic systemically important banks looks at the following parameters;

  • Size
  • Interconnectedness
  • Substitutability / jurisdiction’s financial institution infrastructure
  • Complexity

As of 31 December 2015, Crane Bank’s assets were Shs: 1.81 trillion, with shareholders’ equity of Shs 281.43 billion. In October 2015, it had more than 750,000 customers. It was the third-largest bank in the economy.

When calculating resolution expenses, we also have to look at the opportunity cost (impact on the economy if 400bn had not been spent to resolve Crane Bank).

With such level of interconnectedness, size and complexity, the contagion spread would have expanded to other banks, associated markets eg real estate, mortgages, domestic SMEs, etc.

Furthermore, when calculating bank resolution expenses, we look at the wider economy as a whole and not just the insolvent bank. All the costs of resolution have to be recovered from the shareholders, because banks are a special type of company.

It touches the core of public trust and confidence in the banking system as a whole. A bail out is not a right, but it is a privilege. It is an exercise of the Central Bank’s Lender of Last Resort (LOLR) function and it is therefore a facility that can only be enjoyed in very exceptional circumstances. Bank failure in good faith arising from extreme market conditions can be understandable.

But bail-out cannot be enjoyed in circumstances where there is bad faith such as fraudulent banking activities, poor corporate governance, reckless lending practices, insider lending, etc.

CR: What do you consider as the main justification for the takeover of Crane Bank?

Kayondo: Crane Bank had reached the Point of Non Viability (PONV) and the shareholders did not comply with recapitalization requirements issued by Bank of Uganda as corrective measures.

Therefore, BOU had to safeguard the interest of depositors by taking it over, placing under statutory management, and eventual liquidation.

A takeover process has both substantive and procedural aspects. The substantive aspects relating to the 200bn “hole” in the bank are not in dispute. The dispute seems to be over the procedural (due process aspects) of the takeover.

CR: To what extent do you think insider lending affected the operations of Crane Bank?

Kayondo: Unlawful insider lending has been a major and historical cause of bank failures in Uganda. It depletes the bank’s capital and distorts the credit market. This is also noted in the Justice Ogoola report on bank failures in Uganda. In 2000, the then Minister of Finance, Planning and Economic Development set up a Judicial Commission of Inquiry to investigate the closure of three banks in 1999 and the subsequent sale of Cooperative Bank. Justice James Munage Ogoola chaired the commission, while Justice David Porter and Mr. Japheth Katto were members.

Their report led to enactment of strict provisions in insider lending under the Financial Institutions Act, 2004 (as amended). Under section 34 of that Act, loans to insiders must be made at the same interest rate, repayment terms and credit evaluation criteria applicable to outsiders.

Concerning specific reference to Crane Bank, you will find your answer in the “Report on the preliminary forensic review at Crane Bank” (December 2016), which was authored by PricewaterhouseCoopers (PwC) Uganda.

CR: Using examples from developed countries, what does BoU need to do to make the banking industry stronger and resilient?

Kayondo: Bank of Uganda and Parliament need to re-examine the current Central Bank model. In my view, it has remained too static yet the market has moved on. We can explore models such as;

The “Twin Peaks” model of financial regulation where we have one dedicated department/peak to deal with prudential regulation of regulated financial institutions in terms of capital adequacy requirements, management, liquidity, etc and a separate peak to deal with market conduct enforcement (consumer protection).

The unified model of financial regulation is also worthy of consideration. The present regulatory regime in Uganda is fragmented and works in silos. BOU regulates commercial banks and MDIs, Capital Markets Authority regulates the capital markets, the Uganda Retirement Benefits Regulatory Authority (URBRA) regulates pensions, the Insurance Regulatory Authority (IRA) regulates the insurance industry.

However, in terms of market reality, with Bancassurance, banks can now provide both banking and insurance services. The traditional market segment lines are shrinking because we are now moving towards “unified banking”, and banks can participate as market intermediaries not just in banking, but also pensions, insurance, instalment credit arrangements, fintech, etc. This cannot be regulated in silos anymore. With the proposed merger of government entities, the financial sector regulators can be brought into one big house.

Improving internal resources and capabilities of the central bank in terms of skill and expertise is critical. Modern banking is very complex and sophisticated. You need a new skill set  in terms of computer forensics teams, specialized lawyers, forensic auditors and accountants, Research and Development investment, communication, etc.

Establish a stronger “Bank Rescue and Resolution Framework”. The cost of bank closures is enormous in terms of eroding the tax base, loss of jobs, loss of critical skills, loss of trust and confidence in the financial system, reputational damage, etc.

Yet, BOU has been very prolific at bank closures, not rescues. They move in too late. That is why all their previous attempts with “open resolution” of banks (resolving failing banks while keeping them open) have failed. Even in Crane Bank’s case, there was a run on the bank which worsened the deterioration of its liquidity and it because unsustainable for the Central Bank to continue propping it up.

There has to be a mind-set and attitudinal change to move from a liquidation culture to a rescue culture. There is need for rescue and insolvency guidelines for banks and other financial institutions because of the special category of banking business. Ordinary insolvency law is inadequate when it comes to the rush and speed required to resolve bank failures.

Out of this process, there is need to have a “lessons learned” report/toolkit that can be shared with other financial and non-financial sector regulators. There is need for simulation exercises on how to deal with rescue and resolution issues if failure happens to other industries such as insurance companies, payment platforms, pension funds, utility companies, telecoms, etc because business insolvency is a fact of life. Even the best fail, and most times, it takes regulators and customers by surprise.

There is also need to review the BOU Rules Governing the Lombard and the Rediscount window. Lombard credit involves actual granting of credit to banks against securities such as Treasury Bills and Bonds at the prevailing Central Bank rate. At present, a bank is restricted to borrow not more than 25% of its cash reserve under this facility for a period not exceeding three (3) months, except in very limited circumstances with approval of the Governor. This means that the financial institutions have the opportunity of acquiring money in the short term from central banks.

However, these rules treat both the Significantly Important Financial Institutions (SIFIs) and small “non-significant” banks the same, yet the rescue arrangements of the SIFI category may be longer than 3 months due to size and complexity issues. There is also need to lay out clear parameters on how the Central Bank officials will exercise their discretion, review process, appeal process, etc so as to make the process more fair and transparent.

Kayondo’s thesis title was “Legal Aspects of Distressed Bank Rescue: Lessons for Uganda from the English and South African Experience”. A copy can be obtained via this link He tweets @SilverKayondo

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