Introduction
Kenya recorded an economic performance of about 5 per cent in 2005, up from the previous 4.3 per cent in 2004, continuing a growth trend that started in 2003. The favourable economic performance was reflected in the financial results achieved by the banks. Money markets were relatively steady, as was the case in the previous year. Interest rates were generally low as illustrated by the 91-day Treasury bills that stabilised at less than 2 per cent since 2004. The banks liquidity levels was high at over 40 per cent, which was well above the statutory minimum of 20 per cent for commercial and non-commercial financial institutions.

The inflation rate averaged 7 per cent, while the banks lending and deposit rates rose by 13.16 per cent and 4.52 per cent respectively. Another feature of the banking sector during the year was government’s decision to borrow from local non-banking institutions and moving away from the traditional practice where it used to borrow from the banking sector.

Generally, the interest rates remained stable and as competition intensified, banks were compelled to improve efficiency. Moreover, as market players shifted to raising capital from alternative sources such as the equity and bond markets, commercial banks’ lending rates declined. Further, the competition was bound to edge the deposits upwards.

According to the estimates by the Central Bank of Kenya, the economy was marked by the following characteristics:
• Overall inflation remained low and stable, having declined to single digit levels since August 2005.
• Prudent monetary policy that aims to balance the demand and supply of liquidity in the money market.
• Adoption of risk based lending procedures by commercial banks to reduce the burden of non-performing loans that always lead to high interest rates.
• Exchange rate was generally strong and stable.

However, the impressive economic performance was severely affected by long drought in the last quarter of the year and its impact was likely to be felt in 2006. Long droughts means low agricultural productivity, which in turn, slows economic growth. It also reduces electricity and water supplies, which are integral components for industrial and economic growth. However, there was general optimism that the growth momentum achieved in 2005 was likely still to hold despite the drought threat. Independent surveys supported the view that confidence among the business community remained high despite the vagaries of the weather. Much of the optimism about the economy was derived from:

• Sustained tourism boom and excellent performance in other service sectors;
• Continued positive performance in manufacturing sector;
• Increased demand for residential housing that is expected to sustain the building and construction boom;
• On-going rehabilitation of the country’s road infrastructure;
• Ready availability of markets for light manufactures in the East African Community and the COMESA region;
• Improved environment for the private sector business; and
• Availability of affordable credit in the banking system.

Inasmuch as the banking sector did well, it still faced many challenges, including inaffordability of its loans and competition from cooperative societies that have now started offering banking facilities.

Insurance industry largely depends on the performance of the other sectors like transport, health, construction and trade. Given the general improvement of the performance of most of the sectors, the insurance industry also recorded some gains in 2005. Following on the initiated in the public transport sector in 2003, where the government introduced limits on the speed and the number of passengers, there has been a general decline in the cases of motor vehicle accidents, leading to reduced claims from the insurance companies.

In general, an analysis of the insurance trend shows that the bulk of the policies are for short-term businesses, accounting for 70 per cent. Life insurance takes the remaining 30 per cent. It is noted, though, that there has been a significant increase in the number of life policies in recent times.

Banking sector
The banking sector remained generally steady in 2005, with the asset reaching KSh.641.2 billion. Loans and advances comprised 58 per cent of the assets. Asset quality has also declined from 22.0 per cent in October 2004 to 19.3 per cent in October 2005. Part of the reason for the increase portfolio base was the rising in local and foreign currency deposits.
Also, the Central Bank continued to intensify its inspection and monitoring processes to ensure that the banks complied to established institutional frame-work, which among others, were intended to ensure an efficient and stable payments and settlement system. The successful launch and smooth running of the Real Time Gross Settlements System (RTGS) attests to the efficiency was one of payments system introduced.
The other crucial element in financial stability was the soundness of the financial institutions. Financial institutions were healthier than they were before. Non-performing loans in financial sector were reduced remarkably due to improved financial management and partly due to improvements in corporate governance and supervisory role of the CBK. The CBK was pursuing a Risk Based Supervision System that emphasised pre-emptive measures in ensuring financial sector soundness and stability.

However, the number of financial institutions went down to 48 in 2005, down from 51 in 2004. This followed the liquidation of one commercial bank and one building society. One commercial bank was also converted into a development finance institutions. Of the 48, there were 42 commercial banks, one non-bank financial institutions, two mortgage finance companies and two building societies. There was also one non-financial institutions that was in the process of being liquidated.

Following the lifting of a freeze on licensing of new foreign exchange bureaus, their numbers shot up to 89, up from 84 in the previous year. To ensure that they operated competitively and above board, the Central Bank issued new guidelines that enjoined to follow strict rules and were under obligations to submit to stiff inspection procedures.

Monetary policy reforms
The government has put a lot of efforts on the monetary policy reforms because that is core to the economic recovery. At the heart of the monetary policy reform is the need to create stable environment where the supply of money corresponds to the economic growth. The monetary policy also aims at ensuring a viable balance of payments as well as checking inflation. In turn, that should lead to good economic performance and create an environment where job and wealth are guaranteed. Under the current monetary policy reform, the focus is on the following specific areas. One, maintaining a low inflation rate at less than 5 per cent. Two, maintaining a competitive exchange rate that is commensurate with an export-driven economic recovery. Three, maintaining an interest rate structure that promotes financial savings and measures efficient allocation of the same and lastly, ensuring adequate growth in credit to the private sector, which is seen as core to the economic growth.

Central Bank of Kenya.

To realise these objectives, the government set out to strengthen the monetary policy committee by incorporating in it professionals and experts from outside the government and also adopting a more transparent operating system of the committee, whereby minutes of the committee’s monthly meetings are publicised. It also sought to empower the Central Bank to take charge of issuing banking licences and where necessary, revoke them. Further, efforts were made to strengthen the coordination mechanism for fiscal and monetary policy to ensure that the conduct of fiscal policy does not undermine monetary objectives.

Forecast for
the banking Industry
Based on the successes realised in 2005, there are indications that the sector will continue doing well in the coming years. At least, the economy is picking up and that means better performance for financial institutions. With the enforcement of the Banking Act and Central Bank’s prudence regulations, irregular dealings will end in the banking sector resulting into good services and value for the customers. The Central Bank will also continue to publish bank charges thereby increasing customer aware-ness of products and services available and their associated costs and consequently enhance competition in the sector as customers opt for the most competitive charges.

Insurance industry
Insurance industry operates under the Ministry of Finance and is headed by a commissioner. There are a number of organisations that are involved in managing the industry. They are the Association of Kenya Insurers, which supervises and regulates operations of insurance companies and insurance agents. The other is the association of insurance brokers, which deals with insurance brokers and insurance agents.
There are some 41 registered insurance companies in Kenya, with 15 transacting general insurance business, two deal in life business, while 24 were composite insurers doing both life and general insurances. The industry, which has witnessed an 8.6 per cent growth in the past five years, employs more than 10,000 people and plays a significant role in the country’s economic growth. The largest 10 insurers handle about 70 per cent of the motor business with a similar number handling above 90 per cent of the property business in the market.

Issues and challenges
Like in 2004, the insurance industry recorded significant growth in 2005, recording improved turnovers as a result of increased policy sales. Apart from the commercial policies, many people now go for personal insurance cover — health, life and education — because of increased awareness of the benefits of insurance policies.

However, the sector has to contend with several challenges, chief among them false repayment claims and series of litigation. Despite efforts made to change the public perception about insurance companies, there are still a lot of negative images people hold about the industry. Among others, the delays in processing repayment claims has generally created wrong impression about the industry, with the feeling being that the companies are never keen to pay. But the greatest challenge to the industry is HIV/ AIDS, which has complicated cases for those holding or seeking life insurance policies. The nature of the scourge make it a high risk insurable item yet the insurance companies are also under obligation to respect people’s rights to services like insurance cover. The costs involved are necessarily and this again goes against the principles of natural justice. In sum, HIV/AIDS presents a major challenge to insurance companies, forcing some even to pull out of life policy.

Conclusion
Performance in the banking and insurance sectors reflects the general economic trends in a country. With the economy having recorded a 5 per cent growth in 2005, there was a considerable number of people, who were able to deposit or seek loans from banks, boosting the incomes of the financial institutions. Similarly, more businesses opened and sought insurance policies, increasing the levels of policies and capital held by the insurance companies.
The legal and policy frame-works instituted by the Central Bank aimed at securing banks against bad loans and other bad practices were beginning to bear fruit, as they brought discipline and stability in the industry. The task ahead is to intensify them and ensure that the gains so far made are not lost.
The challenge, however, emerged towards the end of the year when the long-drought hit the country and started taking toll on economic units, which ultimately reduced earnings and there-fore, impacted on deposits at the banks or the people’s capacity to secure loans or start businesses. It was hoped, though, that the other signals from the other sectors like tourism and improvements in infrastructure would cushion the country against the negative impacts of bad weather, hence stem the decline in earnings.