Businesses left high and dry as banks tighten lending

It’s easy for Kenyan businesses to find something to stress about these days. 

Six months and four days into 2023, fears now centre around a potential credit crunch following the hiking of the key lending rate by the banking regulator. 

Firms are already feeling the squeeze.

A consumer expectations survey by the Financial Standard found out that a rising number of local firms believe their access to credit has deteriorated.  

Finance leaders, used to years of easy credit, now face a new environment where capital is neither cheap nor abundant in the wake of high interest rates. 

“We expect more stringent lending standards going forward. Whether this qualifies as a full-blown ‘credit crunch’ remains to be seen,” the chief finance officer of a leading blue chip company told the Financial Standard in an interview.

The official sought anonymity so as to speak freely. 

A credit crunch refers to a dramatic reduction in lending by banks to consumers and businesses, meaning loans become harder to obtain and more expensive.  The Central Bank of Kenya (CBK) last week issued the highest interest rate hike in seven years, raising the benchmark rate by 100 basis points from 9.5 per cent to 10.50 per cent.  

The increase aims to rein in the stubborn inflation, which measures the rate of rising prices and remained at 8.0 per cent in May despite CBK’s efforts to tame it. 

The prices of key food items have climbed significantly over the last couple of months, adding pressure on cash-starved households still reeling from the economic hit of the Covid-19 pandemic.  

Jumbo hike

The jumbo rate hike left borrowers bracing for a big jump in their monthly loan repayments.  

The tightening of liquidity is expected to have a negative effect on access to credit for individuals and companies, with borrowers set to feel the financial pain of the increased cost of loans.  

This could translate into banks tightening their lending standards.  

The sharp rise in interest rates already threatens to choke economic growth as it has lifted borrowing costs and encouraged cutting costs or saving over spending, investing, and hiring. 

If lending dries up, that could weigh down on the value of stocks, real estate and other assets besides crimping overall demand—a recipe for a painful recession.  

At the same time, higher rates have increased borrowing costs.

This is a concern for banks because borrowers faced with elevated costs may not be able to repay and service their loans – and that could lay the groundwork for banks to toughen their lending standards.  

Moreover, a credit crunch could lead to a spike in loan defaults and bankruptcies as financing opportunities evaporate, which could hammer banks and the wider financial system, worsening the economic downturn, analysts have warned. 

Official statistics have in recent times shown steadily worsening conditions each successive quarter. 

The most recent statistics are no exception, pointing to the continued decline in both the quality and availability of credit, with a rise in defaults. 

Overall, going forward after the key lending rate hikes, people are expected to pay higher rates for smaller loans which now require more negotiation and due diligence to approve, and more collateral to support them.

This has served to increase stress and reduce wiggle room for businesses of all sorts.  In the face of such challenges, many companies are seeking to aggressively cut costs.   This was long coming, however, as a CBK survey tipped business leaders to cut spending for the remainder of the year amid fresh economic worries. 

The survey noted that CEOs would also seek to diversify their businesses and increase sales while a portion of them would consider restructuring their businesses, which could lead to a freeze in expansion and salary hikes or even job losses. 

The study found out that the rising cost of living - which remains stubbornly high - and the worsening business environment over high costs and planned taxation, are some of the biggest impediments to the growth and expansion of firms in the remainder of this year as they could slow consumer demand but also ramp up production costs. 

It also revealed the CEOs are worried over newly introduced taxes, high-interest rates, the rising cost of electricity, and the weakening of the shilling. 

The credit market had already tightened after banks in recent months steeply increased the cost of loans with interest rates of up to 19 per cent, leaving their customers with a massive debt servicing burden. The increments came at a time when the high cost of living is already squeezing Kenyans hard. 

Ratings of loans

This followed the widespread adoption of the risk-based rating of loans by a majority of the country’s nearly 40 banks. 

The repeal of the interest rate cap regime in November 2019 set the stage for price hikes for borrowers. 

An earlier spot check by The Standard showed several banks have been writing to their customers, explaining the change under the new terms. 

Risk-based pricing refers to the practice of setting or adjusting the price and other terms of credit offered or extended to a particular consumer to  reflect the risk of nonpayment of their loan by that consumer. 

Information from a consumer report is often used in evaluating the risk posed by the consumer. 

Banks are under the new regime expected to offer more favourable terms to consumers with good credit histories and less favourable terms to consumers with poor credit histories. 

The bad loans book has since shot up to Sh570.6 billion in April, signalling tougher economic conditions for borrowers in key sectors of economy amid high inflation. 

Banks have been facing ever-rising loan defaults, after the onset of the Covid-19 pandemic in March 2020, which affected millions of households as their incomes dropped and businesses ground to a halt. 

Households and businesses across the country are currently reeling from the effects of high inflation, which has lowered demand for goods and services as their prices increasingly get out of reach for many consumers.