Kenyan banks move to cushion borrowers and avert loan defaults

Earlier this week, the Kenya Bankers’ Association released a statement detailing a set of initiatives designed to avert possible bank loan defaults on the back of spiking interest rates occasioned by further monetary tightening by the Central Bank of Kenya (CBK).

The measures generally involve capping further interest rate increases for borrowers and renegotiating the tenor of loans with the aim of keeping instalments affordable.

The initiatives, while largely understandable due to the need to offer a “soft landing” for borrowers, may in fact, not have the full backing of all industry players.

Reuters reports that a senior trader remarked that, “… not increasing rates after the central bank rate hikes would be like someone telling you to stand outside in a thunderstorm as it will eventually stop.”

Our opinion, however is that this largely signals pressure on asset quality across banks and confirms interest margin squeeze at least up to the first half 2012 when inflation is expected to start decelerating.

Kenya’s banking sector has an asset base of KES 2 trillion of which 60% are loans and advances and the quality of these loans has greatly improved from the 2009 levels.

Lending rates have since soared to around 25% from under 14% in the first half of this year, tracking the bank rate that has been hiked 1,200 basis points to 18% over the same period.

High interest rates look set to negate gains made especially over the past twelve months as the CBK sponsored Credit Reference Bureau saw the ratio of non-performing loans (NPLs) to advances reduce significantly.

While the new initiatives are set to ease pressure on NPLs, a squeeze on interest margins looks inevitable, which does not augur well for profitability especially given mark-to-market losses on bond holdings.

Habil Olaka, the CE of Kenya Bankers’ Association announced the new measures at a press conference on Tuesday 13 December 2011, which include the following main action points:

  • In a bid to ensure that borrowers are able to continue servicing their loans during periods of upward revisions of interest rates, banks will negotiate with their customers to extend the loan repayment periods. This may entail extending the period to ensure that the repayments are retained at the existing instalment amounts. Additionally, banks will cap the increase in the instalment repayment to a maximum of 20% of the current level of instalment. The instalments will then be spread out leading to extension of the repayment period
  • Banks will not raise interest rates despite the recent further increase in the Central Bank Rate (CBR) by 150 basis points in December 2011. Banks will absorb this increase and mitigate the additional burden on existing borrowers; and
  • Where banks decide to increase the interest rates from the contracted rate, borrowers will have the discretion to repay the outstanding loan balance in full or in part without being subjected to early repayment penalties.

The CBK’s strategy in its fight against inflation and the depreciating shilling has been pushing interest rates up. A weakening external sector, driven in the main by an imploding import bill on the back of spike in food and oil prices coupled with a crippling drought saw the inflation climb from 3% in December 2010 to 19.72% for November 2011, while the Kenyan shilling set a new all-time low of KES 107 to the dollar in October 2011.

Inflation is yet to relent on its march north, though indications are that the first quarter of 2012 may bring relief as food supply improves and the effects of a high base kick in. The KES on the other hand has since appreciated 16.7% from its all-time low to close at KES 88.25 to the USD. Therefore, indications are that the high interest rate regime will stay for the better part of 2012, pointing continued pressure on the quality of Kenyan banks’ lending.

Imara is an investment banking and asset management group renowned for its knowledge of African markets.