Banks’ bad debts double, force repayment deferrals

Wednesday, August 30th, 2023 07:00 | By
Central Bank of Kenya. PHOTO/Courtesy

The rate of growth of bad loans doubled in the first-half of 2023 forcing banks to extend the repayment period, Central Bank of Kenya (CBK) report says.

Majority of the credit officers with commercial banks surveyed further expected the ratio of bad loans to increase during the third quarter of the year, the banking sector regulator states in its latest Credit Survey Report.

According to the report, an estimated 42 per cent of the respondents indicated that non-performing loans (NPLs) are likely to rise in the third quarter of 2023. “Thirty-four per cent of the respondents expect the level of NPLs to fall while 24 per cent of the respondents expect the level of NPLs to remain constant in the third quarter of 2023,” the survey says.

Central Bank has attributed the trend to the impact of rising interest rates, as highlighted in the survey. The CBK’s credit survey sheds light on a notable deterioration in asset quality, quantified by the gross non-performing loans to gross loans ratio.

Concerning shift

From March to June 2023, the ratio exhibited a concerning shift, escalating from 14.0 per cent to 14.5 per cent.

“This was due to a 6.5 per cent increase in gross NPLs compared to a 3.3 per cent increase in gross loans.,” CBK said in the survey. The primary driver behind this development was a striking 6.5 per cent surge in gross NPLs, in stark contrast to the comparatively modest 3.3 per cent uptick in gross loans over the same period.

As a result, banks are extending loan maturity periods for customers squeezed by the highest interest rate and state deductions such as the housing levy and pension to stave off the risk of mass defaults. The surge in deductions and increased interest rates in line with higher Central Bank Rate (CBR) — now at 10.5 per cent, the highest point in nearly seven years—has hit borrowers with higher monthly deductions, putting many at the risk of defaulting on loans.

“Banks have been keen not to increase interest rates immediately following the CBR rise but to adjust loan tenors so that the repayment schedule remains the same,” said Samuel Tiriongo, director of research at Kenya Bankers Association during the release of the banking sector report covering 2022.

Central to this turn of events is the recent trajectory of interest rates. Commercial banks, the bedrock of financial intermediation, have been grappling with the repercussions of higher borrowing costs since the past quarter.

The crux of the matter lies in the Central Bank of Kenya’s decision to raise the policy rate from 9.5 per cent to a more restrictive 10.5 per cent.

This policy manifests in the lending practices of commercial banks.

Once characterised by its relative ease, the lending landscape has transformed as banks grapple with tighter margins and the potential for increased credit risk.

Consequently, there has been a discernible uptick in the value of bad loans – those that have defaulted or are unlikely to be fully repaid – during the second quarter. Experts say the shift in asset quality poses many challenges. For borrowers, the burden of servicing higher interest rates might become an onerous task, leading to potential financial distress.

The surge in non-performing loans not only affects individual borrowers but also weakens the financial position of lending institutions, which have to set aside provisions to cover potential losses.

In the broader economic context, the deterioration of asset quality and the surge in bad loans have ripple effects.

Financial institutions might become more risk-averse, potentially curtailing lending to productive sectors of the economy. This, in turn, could stifle economic growth and hamper investment and job creation.

Balancing act

The CBK’s survey underscores the delicate balancing act central banks often face. While raising interest rates is a tool to control inflation and stabilise the economy, it can inadvertently amplify financial stress for borrowers and banks alike.

As policymakers navigate these complexities, stakeholders across the financial spectrum will be closely watching for the potential repercussions and the central bank’s response. This survey serves as a stark reminder of the interconnectedness of interest rates, lending behaviour, and overall economic health.

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