Why getting a bank loan will be difficult as new standard run into rate cap impact

On March 15, 2017, Equity Bank CEO James Mwangi spent close to an hour highlighting how the cap on interest rates had complicated the banking sector as he had known it for about 30 years.

When he was done, he announced a profit of Sh16.5 billion and hurriedly left without taking questions from the press. His communication team said he had a “busy schedule.” For the first time since going public in 10 years, profits had dropped.

Such is just a sneak preview of the changing environment in the banking sector. Changing regulatory environment and shifting customer tastes have forced banks to bite more than they can chew.

The banking management is facing one of the toughest test in the sector. From the time banks began chasing customers to digital platforms, pressure has been piling on management to balance interests of shareholders, regulators and customers.

According to Charles Muchene, a non-executive chairman at East African Breweries and Barclays Bank of Kenya (BBK), directors will have to dedicate more time on strategy to meet the changing needs.

“Organisations have to accept that business models have to be disrupted and human resource models changed. We are going to see boards that will require constant consultation with shareholders and customers,” says Mr Muchene.

Speaking in a Corporate Governance Conference in Nairobi, Muchene said boards will require continuous engagements as opposed to just quarterly meetings since strategy will be key in quelling the impact of disruptive environment.

As debate on whether or not banks should be handed back a free hand in pricing loans continues, profitability has dropped and lending to private sector has grown at the slowest pace in 10 years. Yet, a new accounting standard is coming up that will shake the sector’s profits.

Latest data from Central Bank of Kenya (CBK) shows that for the first time since August 2015 when growth of credit embarked on a downward trend, only last August did it record a growth. This was just a slight jump of 1.6 per cent.

Despite the slowed lending, the amount of money that customers are borrowing but not repaying is also rising, therefore hurting the asset quality of banks. The gross non-performing loans (NPLs) to gross loans rose to 10.7 per cent last month, meaning that for every Sh1,000 loaned out, banks may never get about Sh100 back.

Overall, of the Sh2.36 trillion gross loans, more than Sh230.6 billion is in the books of banks as NPLs, an indication that borrowers have not made any scheduled payments for at least 90 days since being granted the loan.

Increased pressure

Against this unfavorable statistics are banks facing increased pressure from shareholders to keep margins growing. However, even before banks can get used to a capped interest rate regime, a new accounting standard is set to come into effect in January.

With International Accounting Standard (IAS) 39 having been blamed for the 2008 financial crisis, the International Financial Reporting Standards Board has made changes whose impact will further disrupt the Kenyan banking sector.

Come January, banks will switch to International Financial Reporting Standard (IFRS) 9, which promises to increase the level of provisioning in the sector.

Unlike IAS 39, that only used to look at historical factors to make loan loss provision, IFRS 9 is forward looking and will require data on historical, current and future forecasts of the client before making a provision.

According to KPMG Kenya Advisory Services Limited Director, Joseph Kariuki, loan loss provisions could jump by between 50 per cent and 100 per cent forcing banks to be very selective in granting loans.

“Banks will re-assess how they do business. The kind of customers they bring on board will be very critical. We expect most banks to shift to secured lending as banks strike balance between the new standard, liquidity challenge and capped interest rates,” says Mr Karuki.

IFRS 9 will also require banks to make a provision on facilities that they have signed with customers even before they actually extend to the customers.

For instance if a customer enters into an agreement with a customer to lend them Sh10 million and only gives out Sh5 million for a start, the bank will still be required to make a provision both on the Sh5 million drawn out as well as on the remaining sum that the customer is yet to draw out. The current practice has been that banks only make provisions for loans they have actually given out.

Even items such as government securities that have for long been viewed as risk free will require a provision based on the risks that banks see in the macro-environment the government operates in.

According to Mr Karuki high levels of provisioning will eventually affect the capital base since the increased impairment will wear down retained earnings, which is a component of core capital. “If the capital is not strong, applying the standard will hurt capital ratio and banks may need to ask now if they need investors to pump in fresh capital,” he said.

He adds that most tier II and III banks may require significant capital addition to be compliant with CBK capital adequacy ratios.

Increased lending, when the capital is thin, may be a temptation many banks may want to avoid since any increase in impairment will further hurt their capital position. Lower tier banks are likely to switch their attention to capital raising at the expense of growing loan books.

“Shareholders should not expect the kind of earnings they have seen five years ago,” cautions Kariuki who adds that banks will also need intensive data collection.

In a recent survey by CBK, many banks indicated that they want to allocate more resources on monitoring and recovery of loans as well as use of external parties in the recovery process.

Barclays Bank of Kenya Chief Executive Jeremy Awori, whose bank started preparing for IFRS 9 two years ago, says that banks now find themselves in even more tricky situation. He feels that some banks may be tempted to abandon high risk segments.

“We are going to have both interest rate cap and now IFRS 9 which might put pressure on some of the riskier segments. If you have high impairment in high risk segments and you can’t fully price it, then you are in a situation where you may say you don’t want that segment anymore,” cautioned Mr Awori.

As part of risk appraisal process, Awori thinks that some of the higher risk customers might find it harder to get loans because the standard will result in increased level of provisioning yet they can’t fully price the risk.

“I expect banks to start thinking more about the conditions of their previous loans before they grant unsecured loans. This comes down to the strategy of each bank and where it wants to play,” says Awori.

Combined effect

According to Kenya Bankers Association (KBA) CEO Habil Olaka, personal loans are likely to be affected.

“With introduction of IFRS 9 and the rate cap in place, the combined effect of the two won’t be good for the economy. Lending is likely to slow as banks assess the impact of the standard,” said Olaka in a forum to demystify IFRS 9.

Banks such as Equity have already announced that they will be considering their stand on issuing unsecured loans. In contrast to this conservatism, Standard Chartered Bank of Kenya is hawking Sh10 billion unsecured loans up to mid next month.

According to StanChart CEO Lamin Manjang, this is response to the slowed lending in the retail segment that has been witnessed in the industry for the past one year.

“During the period, we have put in a lot of work in segmenting our customers and identifying their credit needs,” he said.

His line of thought mirrors that of BBK boss who says that going forward, it will not be possible for banks to play in every segment but rather identify areas they are best at and put more focus.

With the new standard, data analytics is going to be unavoidable because there will be much more requirement to analyse customer portfolios to make appropriate provisions.

According to KPMG, banks may have to invest in retraining or hiring employees with data analysis skills. The firm sees actuaries, economists, credit analysts and statisticians finding more space in the banking halls.

This may complicate the strategy of many banks. So far, job cuts have been implemented at KCB, Standard Chartered, BBK, Family Bank, National Bank of Kenya, NIC bank, Ecobank, Bank of Africa, First Community Bank and Sidian Bank.

Banks have been cutting on branch size and trimming workforce to align themselves with the fast growing segment of digital customers. Equity Bank CEO James Mwangi, has said severally: “A bank is on-longer a place you go but what you do on your phone.”

Skilled employees

However, with the new standard, they may have to bring on board more skilled employees and invest in more sophisticated systems to store and analyse data. This could defeat their efforts to cut on costs.

“IFRS 9 will require banks to implement statistical tools and technologies. Firms will have to be proactive in quality data,” says Noel Ikiara, audit Manager at KPMG.

Banks will try to avoid customers whose behavior of repayment keeps shifting from stage one (performing) and two (under-performing) because it will have implications on their level of exposures.

“Customers should not worry about IFRS 9 but how they behave with regard to their loan repayments because what we will clearly want to do is to differentiate between behaviors of different customers,” says Awori.

Njoroge says that his team is in discussions with lenders and doesn’t expect the standard to be “catastrophic.”

“The IFRS 9 is a good initiative but of course the issue is the timing and things like that, we are discussing that with banks,” he said.