The global economy has been experiencing a deep recession with the world growth rate moving from 3.8% in 2007, 1.8% in 2008 to negative 2.3% in 2009. International trade in volumes (goods and services) moved from 7.3% in 2007, 3% in 2008 to negative 11.9% in 2009. The collapse in trade during the crisis was attributed in part to lack of credit to exporters and importers. Increased uncertainty led exporters and importers to switch from less secure forms of trade finance to more formal arrangements.

During the period under review, the Kenyan economy performed below its potential after a remarkable five-year economic growth expansion averaging 5.4% experienced over the period 2003-2007.

The economy recorded a growth of 7.1% in 2007, 1.7% in 2008 and 2.6% in 2009.The growth reversals experienced in 2008 largely extended to 2009 and was mainly occasioned by a combination of both domestic and external shocks. In the domestic scene, the post-election disturbances that followed the 2007 general elections, did not only adversely affect key sectors of the economy such as agriculture, Industry and Tourism but also dented investor confidence.

The associated food supply downturn created by the aftermath of the elections and adverse weather conditions saw the economy experience un-preceded rise in food prices and famine episodes. These internal socio-economic shocks coupled with external shocks such as the effects of global financial crises and global economic slowdown dampened the prospects for fast recovery to the growth experienced between 2003-2007 periods.

On a sector basis the agricultural sector performed dismally in 2009 as a result of poor weather, expensive inputs and depressed demand in the international market especially for horticultural produce, with the major sub-sectors of the manufacturing sector showing remarkable growth.

Cumulative tea production fell for two consecutive years from a total of 369,606.2 metric tonnes produced in the year 2007, 345,818.0 metric tonnes in 2008 and 314,193.9 metric tonnes in 2009. The decline in January - December 2009 was equivalent to 9.1 percent compared with the output for the same period in 2008. This followed the drought experienced in the early part of the year, and the poorly distributed rainfall in the tea growing areas. A rise in the average prices of tea worldwide was reflected in the monthly price of the Kenyan tea which increased to US$ 3.10 per kilogram in December 2009 compared with US$ 1.99 per kilogram in December 2008. Similarly, the yearly average price of Kenyan tea rose from US$ 2.38 per kilogram in 2008 to US$ 2.56 per kilogram in 2009.

Horticultural export volumes declined by 6.4 percent in the period January - December 2009 from 193,117.1 metric tonnes in the same period in 2008. The overall decline reflected reductions in the export volumes of flowers and vegetables as a result of insufficient rainfall in 2009. The reverse was true for fruit exports which increased to 21,223.0 metric tonnes in January - December 2009 from 17,122.9 metric tonnes in January - December 2008, equivalent to 23.9 percent increase, attributed to the dry and sunny weather which facilitated proper ripening of the fruits.

Coffee proved to be fairly resilient as output continued to grow despite the unfavourable weather conditions throughout the year in most parts of the country.

Cumulative production for the period January - December 2009 increased by 10,228.0 metric tonnes to stand at 48,933.0 metric tonnes compared to 38,705.0 metric tonnes produced during the same period in 2008. From the beginning of the year, coffee output responded well to improved export prices, reaching an all time high of US $ 4.69 per kilogram in December 2009, an increase of over 100.0 percent from a price of US $ 2.08 per kilogram in December 2008.

Total sugarcane deliveries in the period January - December 2009 increased by 11.9 percent to 5.6 million metric tonnes compared with deliveries amounting to 5.0 million metric tonnes in the same period in 2008.

In the Dairy sector, cumulative milk deliveries rose from 391.0 million litres between January and December 2008 to 406.3 million litres between January and December 2009 as a result of increased fodder following the rains experienced in the last quarter of the year.

In the manufacturing sector, cumulative sugar production increased from 512,192.3 metric tonnes in January - December 2008 to 547,998.0 metric tonnes in the period January - December 2009, equivalent to 7.0 percent increase.

Similarly, total cement production rose by 5.9 percent in the year 2009. Production between January and December 2009 amounted to 3.0 million metric tonnes, from 2.8 million metric tonnes in the period January - December 2008.

In early 2009, soda ash mining was dealt a severe blow by the stiff competition from cheaper synthetic imports from China, which forced closure of some plants at Magadi Soda Company. This affected production in 2009 as a whole, causing a decline of 21.1 percent in the output. In January to December 2009 production fell to 404,904 metric tonnes from 513,415 metric tonnes produced in a similar period in 2008.

In the energy sector Local monthly generation of electricity , which has been on the decline since early 2008 reached 425.9 million Kilowatt hours in December 2009, the lowest it has been since February 2005. This decline in power production is attributed to a shortage in hydro-power occasioned by shrinking water levels in the various electricity producing dams due to drought conditions experienced in the country.

Tourist arrivals grew by 30.7 percent in 2009 from a total of 729,000 visitors in 2008 to culminate at 952,481 visitors as at end of December 2009, narrowly missing the 1,000,000 tourists' target. This increase of over 200,000 tourists in 2009 followed remarkable recovery from a decline of 30.5 percent, which resulted from the post election violence experienced during the same period of the previous year, where the numbers declined by over 300,000 visitors from 1,048,732 visitors in 2007 to 729,000 visitors in 2008.

The 12-month overall inflation declined from 17.8 percent in December 2008 to 5.3 per cent in December 2009. This is a positive development coming from the heightened inflation experienced in the year 2008, and early part of 2009. During the first half of the period under review, the economy experienced high inflationary pressures occasioned by high prices of food and oil. In the last half of the period under review, both overall and underlying inflation eased to average at 6.6 percent and 5.4 percent respectively. This was partly due to falling prices in some items in the inflation basket and partly because of the change in the computation method from the arithmetic mean based rate to the geometric mean which excludes the erratic food inflation behaviour and is therefore more stable. Average annual inflation decreased from 16.2 per cent in December 2008 to 9.3 percent in December 2009.

The 12-month underlying inflation declined from 8.4 percent in December 2008 to 5.2 percent in December 2009.

Year 2009 witnessed a steady decline in the average 91- day Treasury bills rate from a high of 8.59% in December 2008 to 6.82% in December 2009. The average inter-bank lending rate also decreased from 6.66 % to 2.95 % over the same period. The decrease is attributed to reduction in Cash Reserve Ratio (CRR) for commercial banks from 6.0% down to 5.0% effective December 01, 2008 followed by a further reduction from 5.0% to 4.5% effective July 23, 2009. The reduction of Treasury bill rate and inter-bank lending rate can also be attributed to systematic reduction of Central Bank Rate (CBR) from a high of 9.0% as at December 1, 2008 to a low of 7% effective November 24, 2009. These CBK induced stimulus have improved liquidity in the market leading to reduction in short term interest rates.

Throughout the year 2009, the commercial banks monthly average lending rates remained high, moving between 14.67% and 15.09%.

Contrary to turbulent exchange rate movements experienced in year 2008 mainly due to post-election violence, year 2009 saw the Kenya Shilling recollecting itself and maintaining a fairly stable exchange rate against major currencies throughout the year. The shilling strengthened marginally against US Dollar and the Japanese Yen but weakened against Sterling Pounds and Euro.

In December 2009, the Kenya Shilling appreciated to exchange at an average of Kshs 75.43 (2008:78.04) per US Dollar. The Kenya Shilling also appreciated to exchange at an average of Kshs 84.12 per 100 Japanese Yen in December 2009(2008: 85.42). The gain is attributed to increase in dollar inflows from tourism which was recovering from the effects of post-election violence, increase in dollar earnings from tea and coffee export as a result of improved prices and a general weakening of dollar exchange rate at international foreign exchange market mainly due to the global financial crisis. The Shilling, however depreciated against Sterling Pound and Euro to exchange at an average of Kshs 122.54 and Kshs 110.27 to Sterling Pound and Euro respectively as at December 2009 compared to Kshs 116.53 and Kshs 105.56 as at December 2008.

Against regional currencies the Kenya Shilling appreciated against both Uganda and Tanzanian Shilling to exchange at an average of Ush 25.2 per Kenya Shilling and Tsh 17.65 per Kenya Shilling in December 2009 compared to Ush 25.07 per Kenya Shilling and Tsh 16.64 per Kenya Shilling in December 2008.

Kenya's overall Balance of payments position recorded a surplus of Kshs 75.2 billion in 2009 compared to a deficit of Kshs 33.2 billion in 2008. This was on account of increased net capital inflows and improved current account balance from a deficit of Kshs 137.1 billion recorded in 2008 to a deficit of Kshs 124.4 billion in 2009.

During the period ended 31st December 2009, the Kenyan Banking sector registered significant growth in asset base largely supported by growth in deposits, injection of capital and retention of profits. The sector registered high capital adequacy and liquidity ratios and a decline in the level of non-performing loans compared to 2008. Total net assets grew by 14.3 percent, customer deposits increased by 16.4 percent and profit before tax rose by 12.9 percent compared to performance in 2008. Institutions maintained capital adequacy ratios above the minimum requirement of 12.0 percent. However, return on equity dropped to 24.9 percent from 26.1 percent registered in December 2008 occasioned by an increase in equity at a higher rate than increase in income. The overall performance of the banking sector was rated strong in December 2009, a similar rating attained in December 2008.

The banking sector continued to register growth in 2009. Net assets of the banking sector grew by 14.3 percent from Kshs. 1,183.7 billion in December 2008 to Kshs. 1,353.5 billion as at December 2009. Gross advances increased from Kshs. 670.3 billion in 2008 to a level of Kshs. 757.8 billion in December 2009. Similarly, net credit and advances from the banking sector increased by 14.3 percent from Kshs. 631.2 billion in December 2008 to Kshs. 721.6 billion in December 2009. The sector's investment in government securities registered significant growth of 45.4 percent from Kshs. 179.0 billion in December 2008 to Kshs. 260.2 billion in December 2009. Total deposits which form a major component of the banking sector funding, grew by 16.4 percent from Kshs. 864.0 billion as at end of December 2008 to Kshs. 1,006.0 billion as at end of December. The growth in deposits was mainly supported by aggressive marketing campaigns adopted by financial institutions, branch expansion and inflows from exports and remittances.

Non-performing loans, net of interest in suspense, rose by 5.6 percent to Kshs. 50.9 billion in December 2009 from Kshs. 48.2 billion in December 2008. However, the asset quality, which is measured by the ratio of net non-performing loans to gross loans improved marginally from 3.4 percent in December 2008 to 3.2 percent in December 2009. Gross Non-Performing Loans (NPLs) declined by Kshs. 1.1 billion or 1.8 percent from Kshs. 61.87 billion in December 2008 to Kshs. 60.74 billion in December 2009. As a result, the ratio of gross non-performing loans to gross loans stood at 8.0 percent as at December 2009, compared with 9.2 percent registered in December 2008. The decline in gross NPLs was largely attributed to enhanced credit appraisal standards adopted by the financial institutions in 2009.

The loans and advances classified in the normal risk category increased by 18 percent from Kshs. 549.5 billion in December 2008 to Kshs. 646.1 billion in December 2009 occasioned by increased demand and the general improved credit appraisal standards employed by the banks. Similarly, loans and advances classified in the Watch, Substandard and Doubtful categories registered a decrease during the period under review. However, loans and advances classified in the loss category increased by 42.6 percent from Kshs. 6.1 billion in 2008 to Kshs. 8.7 billion in 2009 as a result of losses from the normal course of business.

The banking sector capital adequacy which is measured by the ratio of Total Capital to Total Risk Weighted Assets improved in 2009. The ratio rose from 20.0 percent in December 2008 to 21.0 percent in December 2009 well above the 12 percent minimum statutory limit. The capital and reserves of the banking sector increased by 18.5 percent from Kshs. 165.6 billion in December 2008 to Kshs. 196.3 billion in December 2009. The increase in capital and reserves was occasioned by fresh capital injection and retention of profits. In line with the Finance Act 2008, the minimum statutory core capital for banking institutions as at 31st December 2009 was Kshs. 350 million. This is set to increase to Kshs. 500 million by December 2010, Kshs. 700 million by December 2011 and Kshs. 1 billion by December 2012.

Liquidity which represents the ability to fund increases in assets and meet obligations as they fall due is crucial to the continued viability of any banking institution. The importance of liquidity goes beyond the individual bank as a liquidity shortfall at an individual bank can have systemic repercussions.

The liquidity ratio closed at 39.8 percent at the end of December 2009 in comparison with 37.0 percent reported in December 2008 and all institutions met the minimum liquidity ratio requirement of 20%.

Notwithstanding the tight economic conditions, the banking sector pre-tax profits increased by 12.9 percent from Kshs. 43.3 billion in December 2008 to Kshs. 48.9 billion in December 2009. The growth was largely supported by expansion in credit, cost control and reduced bad debts charge. Total income rose by 13.6 percent from Kshs. 151.8 billion in December 2008 to Kshs. 172.5 billion in December 2009. This was occasioned by an increase in interest on advances by 21.3 percent from Kshs. 75.2 billion in December 2008 to Kshs. 91.2 billion in December 2009.

Interest income accounted for 52.9 percent of total income in 2009 up from 49.5 percent in 2008. The increase in interest income was attributed to expansion of credit and an improvement in the quality of the loan portfolio.

Total expenses increased by 13.8 percent from Kshs. 108.5 billion in December 2008 to Kshs. 123.5 billion in December 2009. The increase in expenses was attributed to increase in interest expenses and salaries and wages. Interest expenses increased from Kshs. 30.2 billion in 2008 to Kshs. 35.1 billion in 2009. Salaries and wages increased from Kshs. 33.5 billion in 2008 to Kshs. 38.8 billion in 2009 as institutions focused on retaining high calibre staff to support expansion initiatives.

During the period ended 31st December 2009, CBK in conjunction with the Ministry of Finance undertook a number of reforms geared towards the stability, safety, efficiency, accessibility and integrity of the banking sector. Consequently, the Proceeds of Crime and Anti-Money Laundering Act (AML Act), was enacted into law in December 2009 and the President also assented to the Finance Act in December 2009.

Finance Act, 2009

The Finance Act amends several statutes including the Banking Act, the Central Bank of Kenya Act and the Microfinance Act. The commencement date of the amendments to the Banking Act, the Central Bank of Kenya Act and the Microfinance Act was 1st January 2010.

The key amendments to the three statutes are:

1. Introduction of agent banking. Under this model, commercial banks, financial institutions and mortgage finance companies are allowed to contract third parties (agents) to conduct banking business on their behalf.
2. Introduction of the definition of the term "place of business". The Central Bank has been given the mandate to prescribe to commercial banks what premises constitute places of business.
3. Institutions have been permitted to invest more than 25% of their core capital in foreign institutions, subject however to the prior approval of the Central Bank.
4. Institutions are now required to make provisions for other assets before declaring dividends.
5. The Central Bank is permitted to share bank information with fiscal or tax agencies and fraud investigation agencies.
6. Introduction of a general penalty clause for offences arising from foreign exchange dealings in cases where no specific penalty is provided for.
7. Introduction of a general penalty clause for offences whose penalties are not specifically provided for under the Central Bank of Kenya Act.
8. Deposit-taking microfinance institutions are permitted to share information on nonperforming loans with the Deposit Protection Fund Board.
9. The Central Bank and deposit-taking microfinance institutions are permitted to share any other information apart from information on non-performing loans.
10. The Central Bank has been given the power to issue guidelines and directions to deposit taking microfinance institutions for the better carrying out of their functions.

The Proceeds of Crime and Anti-Money Laundering Act, 2009

The Proceeds of Crime and Anti-Money Act, 2009 was passed by Parliament in December 2009 and assented to by His Excellency the President on December 31st 2009. The Minister for Finance is now expected to gazette an operational date for the Act by July 2010.

The Act criminalizes the offence of money laundering, establishes the Financial Reporting Centre, the Assets Recovery Agency and the Anti-Money Laundering Advisory Board. The AML Act also stipulates anti-money laundering obligations for Reporting Institutions and spells out elaborate procedures for both civil and criminal forfeiture. These procedures are essential in establishing a robust framework that would deny money launderers the opportunity to enjoy their ill-gotten wealth. The AML Act also establishes procedures for international assistance in investigations and proceedings.

These procedures are important as they give our national authorities engaged in the fight against money laundering the much needed tools to enable them cooperate with their counterparts across the globe in combating the money laundering menace given that is a Trans-national crime.

Agent Banking

The Finance Bill, 2009 sought to introduce agent banking. Institutions would be allowed to conduct banking business through third party agents duly approved by the Central Bank. The Central Bank would be required to prescribe the manner of carrying out agent banking business.

I am indeed very pleased to report that despite a very challenging year, the bank continued with its exceptional all round performance in 2009.

Profit before tax increased to Kshs. 802 million from Kshs. 673 million in 2008 which represents a growth of 19% (2008: 19%). The growth was largely driven by interest from lending and non-funded incomes.

The total income grew from Kshs 2,880 million in 2008 to Kshs. 3,200 million in 2009. Overall total operating expenses as a percentage of total income of 32% still remained below the industry average.

The average interest rate on advances and deposits remained stable at 13% and 4% respectively.

The bank achieved earnings per share of Shs 512 (2008: Shs 429). Return on core capital and return on gross assets stood at 43% and 6% respectively, again above the industry averages. Although the Kenyan economy performed below its potential because the growth reversals experienced in 2008 largely extended to 2009, there was overall growth in our lending portfolio.

Net loans and advances to customers grew from Shs 8.3billion to Shs 9.7billion an increase of 17%. The bank continued to exercise caution in lending by adopting risk based credit policies.
Gross non-performing advances stood at Shs 664 million. After a specific provision of Shs. 396 million, the carrying value of these advances is Shs 268 million. Non-performing advances less total provisions to total advances stood at 3%, making the asset quality of the bank strong.

Total assets grew by 14.3% from Shs 13.432 billion to Shs.15.358 billion in 2009. The increase was largely attributed to a 17% increase in loans and advances and investments in government securities of 144%. The growth was funded by an 18% increase in customer deposits which grew from Shs 10.414 billion to Shs.12.27 billion and a 22% increase in shareholders' funds. The sustained growth in our customer deposit base is largely attributed to the level of confidence our customers have in our bank and the expansion strategies adopted by the bank

The ratio of core capital to total risk weighted assets and total capital to total risk weighted assets stood at 20% and 21% respectively, in excess of the statutory requirement of 8% and 12%.

Once again, the above reflects a strong performance in all areas of the bank's activities.

The bank will continue to maintain strong governance structures by defining the roles of the board, board committees, chairman, managing director and the management. These are covered in the Corporate Governance Report.

The bank fully complies with the CBK Prudential Guidelines, the Banking Act and other statutory requirements as required bylaw. Risks are only warranted when they are understandable, measurable, controllable and within the banks capacity to readily withstand adverse results. The bank continued to enhance its sound risk management framework in the year 2009 that enabled the managers to take risks knowingly, reduce risks where appropriate and strive to prepare for a future that cannot be predicted with absolute certainty. This has and will continue to assist the management and the board to respond to changes in the risk profiles in a very effective manner.

Throughout the year the bank has continuously looked into rejuvenating the existing products and modifying the same to meet the needs and wants of their target segment.

The bank also launched Insurance Premium Financing as a value added product to our existing product that is Asset Financing. Insurance premium financing is a product that works well in providing a tool for entities to stagger their insurance premium payment so as not to disrupt their cash flows.

In order to support the growth and expansion strategy, a Management Development Programme was introduced during the year to augment staff learning and development initiatives as well as reinforce the Bank's talent management strategy.

In line with the bank's expansion strategy the bank plans to extend its presence within the east Africa region in 2010.

Locally the Bank has widened its service delivery network by opening its 12th branch in Thika town and will continue to open more within the country as prudent demands.

The domestic economy is expected to continue on a recovery path in 2010 with real GDP projected to grow by a rate between 4% and 5%. However, going forward this projected economic recovery may be dampened by happenings in the global economy. The slow and fragile recovery in advanced countries is likely to continue impacting adversely on the demand for Kenya's main exports, reduce earnings from tourism, remittances and private capital flows. On the domestic front, while the short rains registered in the fourth quarter have helped to reduce the magnitude of food, water and energy shortage, the negative effects of climate change is likely to worsen the situation unless deliberate and appropriate policy measures are taken up by the policy makers.

The focus in 2010 will once again remain on providing personalized services to our clients and increasing the range of banking products making it easier for the customers to access deposits and services through new delivery channels.

In addition, the bank will further enhance the existing risk management parameters through the effective use of the core banking software.

The Bank will continue to focus on prudent management of its human resources through application of best practice in its policies and procedures.

The key focus for HR for 2010 and beyond will be provision of enhanced and integrated Human Resource Management offerings in order to drive performance and meet business objectives.