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Banks brace for mass loan defaults as economic outlook dims

Two of Kenya’s biggest banks have collectively set aside Sh7.2 billion for loan losses since last year as concerns about an economic slowdown and higher defaults in commercial real estate mount.

Equity Group and KCB Group have singled out elevated risks in various sectors of the battered economy as the reason for ratcheting up credit loss reserves.

At the same time, a surge in interest rates has pushed up debt servicing costs, piling up risks, they have warned.

Non-performing loans (NPLs) reduce banks’ earnings and cause losses, which weigh down on their financial soundness.

Banks with high levels of non-performing loans are also unable to lend to households and companies. This is harmful to the economy as a whole.

When granting loans to their clients, banks always expose themselves to credit risk – the risk that the borrower may not pay back the loan. When this happens, the loan is said to become non-performing.

A loan becomes non-performing when the bank considers that the borrower is unlikely to repay, or when the borrower is 90 days late on a payment.

Equity Group, Kenya’s largest bank by customer base, said its provisions more than doubled to Sh3.1 billion in the first quarter of this year from Sh1.4 billion a year earlier.

The 127 per cent growth in provisions came as the lender’s gross non-performing loans grew by by more than a third to Sh80.28 billion as of March 31, 2023.

“The increase in loan loss provisions of 127 per cent to Sh3.1 billion, up from Sh1.4 billion raised the cost of risk to 1.9 per cent, up from 1.2 per cent and was caused by a slight deterioration in NPLs to 9.1 per cent up from 8.65 per cent,” said Equity Group Chief Executive James Mwangi.

He said during an investor briefing recently the background of a turbulent macroeconomic environment characterised by sticky inflation, high interest and the depreciation of the shilling against the dollar justified the need for caution and prudence in provision.

KCB, on its part, says its loan loss provision rose by 99 per cent to Sh4.1 billion as of March 31, 2023, driven by increased credit risk and the impact of forex devaluation in Kenya.

Its provisions stood at Sh2 billion in a similar period a year earlier.

Group Chief Executive Paul Russo cited a challenging operating environment, “which has greatly impacted asset quality.”

KCB Group’s non-performing loans jumped by more than a third to Sh176.4 billion as of March this year compared to a similar period last year.

Kenya’s economy experienced a slower growth rate of 4.8 per cent in 2022 compared to 7.6 per cent the previous year, according to official statistics.

The Kenya National Bureau of Statistics (KNBS) 2023 Economic Survey attributed the sluggish growth of the economy to several factors, chief among them the Covid-19 pandemic and a prolonged drought that impacted most parts of the country.

Kenya’s medium-term growth remains bright as the economy recovers from a poly-crisis of global and domestic factors.

But risks to the economy remain as captured by a new World Bank report.

“Not only was the economy’s growth momentum affected by the multiple challenges experienced in the year, but the cost of living rose on account of surging inflation,” says the World Bank in its latest Kenya Economic update, underlining the challenges faced last year.

“Real GDP is anticipated to rise to 5.0 per cent in 2023 and 5.2 per cent on average in 2024-25.”

This near-term growth forecast is above Kenya’s estimated potential GDP growth rate of 4.9 per cent and the pre-pandemic average (2010-2019) of 5.0 per cent, says the World Bank.

“However, downside risks remain substantial, and Kenya’s growth could be lower in the medium term in the event they materialise,” says the global lender.

The share of loan defaults increased to Sh539.3 billion as of March this year, pointing to a cash crunch in the economy that could set up thousands of borrowers for property seizures.

Defaulted loans

Central Bank of Kenya (CBK) data shows that 14 per cent of all loans were defaulted by the end of March this year, a sharp increase from 13.3 per cent or Sh500 billion in December 2022.

CBK said the defaulted loans are mainly in the building and construction, manufacturing, trade as well as transport and communication sectors, signalling that firms and individuals who had taken new loans on the strength of increasing cash flow with the reopening of the economy are struggling to service their loans.

“The asset quality, measured by gross non-performing loans to gross loans ratio deteriorated from 13.3 per cent in December 2022, to 14.0 per cent in March 2023,” said CBK.

“This was due to a 10.9 per cent increase in gross NPLs compared to a 4.8 per cent increase in gross loans.”

The share of bad loans rose as gross loans increased by 4.8 per cent from Sh3.6773 trillion in December 2022 to Sh3.8523 trillion in March 2023.

“The increase in gross loans was largely witnessed in the Financial Services, Transport and Communication, and Manufacturing sectors,” said the regulator.

“The increase in gross loans was mainly due to increased credit granted for working capital purposes, and loans granted to individual borrowers.”

CBK said banks that had gone slow on property seizures could now be forced to step up debt recovery efforts to clean up their loan books, which could lead to a spike in auctions.

“For the quarter ended June 30, 2023, banks expect to intensify their credit recovery efforts in eight economic sectors and retain them in three sectors (mining and quarrying, energy and water, and financial services),” said CBK.

“The intensified recovery efforts are aimed at improving the overall quality of the asset portfolio.”

Businesses that tapped loans based on their projected cash flows are also struggling to meet the loan obligations, the regulator’s data shows.

The manufacturing and building sectors are currently grappling with escalating costs of raw materials and soft demand as rising prices of final products hit consumers’ spending power.

The real estate sector is also a victim of the loss of income among households and businesses as a result of the lingering economic effects of the Covid 19 pandemic, with owners of land and developed properties taking longer to sell their assets or are faced with lower asking prices.