What you need to know:
- Under-provisioning for bad loans is said to expose lenders to financial difficulty or even collapse if a large number of borrowers fail to meet their obligations.
- According to Central Bank’s latest data, in December non-performing loans in Kenya stood at Sh107.1 billion — the highest in six years — rising by 30.9 per cent compared to a similar period in 2013.
- The new rules require all lenders to maintain a minimum core capital to risk-weighted assets ratio — a measure of a bank’s financial strength based on what shareholders have put in — of 10.50 per cent, up from the current eight per cent.
Kenyan banks have dismissed remarks by the International Monetary Fund that they are not setting aside enough cash to shield themselves against shocks that could arise from bad debts.
The banks say the lending system in Kenya is well-structured to cushion lenders from any eventualities caused by borrowers who fail to honour their repayments.
In its February 3 statement, IMF said although Kenyan banks are profitable and well-capitalised, their failure to adequately provide for bad loans exposes them to shocks.
“The banking sector remains profitable and well-capitalised but provisions are lately lagging behind a pickup in non-performing loans,” IMF said. The Treasury has also, in this year’s budget policy paper, asked the Central Bank to be more stringent in monitoring banks to ensure adequate provision for bad loans.
In an interview with Smart Company, however, Kenya Commercial Bank chief executive officer Joshua Oigara attributed the observation by IMF to a mismatch in the country’s lending regime in relation to mature markets.
“The lending system in Kenya is predominantly collateral- (security) based. Seventy per cent of the total value of the loan and regulations also require a further one per cent cover of the loan value to be applied which increases the more a loan stays in default,” said Mr Oigara, who is also the chairman of the Kenya Bankers Association.
Mr Oigara said locally, lenders are well-protected from effects of bad loans due to the prudential guidelines by the Central Bank and the lending regime used.
Central Bank has stipulated five stages that an un-serviced loan goes through before it is declared a loss. Banks are required to set aside an amount equivalent to the bad loan as cover.
A loan which falls overdue by up to 30 days is classified as normal with banks required to set aside one per cent of the loan amount as cover, which is besides its security that is 70 per cent of the loan.
Loan that has been defaulted for between one and three months is declared as “watch” and the lender is required to cover it with 3 per cent of the loan value.
Under-provisioning for bad loans is said to expose lenders to financial difficulty or even collapse if a large number of borrowers fail to meet their obligations.
A substandard loan is one that remains un-serviced beyond three to six months and the Central Bank requires a lender to set aside 20 per cent of the loan amount as cover in the event of default.
Loans whose repayments fall behind for between six months and one year, and one year onwards are classified as doubtful and loss respectively. They attract 100 per cent provisioning (cover).
“Therefore, by the time a loan is at the level of doubtful or loss, full provision for the same has been passed through the books. Considering the loan is fully provided for and the collateral is held by the bank, the coverage is above even the loan value,” argued Mr Oigara.
In mature markets, however, lending is mainly based on a borrowers’ character, a thing that Mr Oigara said calls for higher provisioning measures unlike in a collateral-based lending.
“In a character-based lending model where no collateral is availed or required, all the cover available is in the form of provisions,” the banker’s chairman noted.
The debate on how well to prepare against effects of bad loans has preoccupied stakeholders in the financial sector globally in the past few years following the 2007/2009 financial crisis that hit lenders in the West.
According to Central Bank’s latest data, in December non-performing loans in Kenya stood at Sh107.1 billion — the highest in six years — rising by 30.9 per cent compared to a similar period in 2013.
Fresh guidelines on capital adequacy ratios come into force in January as the regulator strives to ensure lenders are properly prepared to absorb any shocks in the market such as bad loans.
A capital buffer refers to additional capital above the minimum regulatory ratios and they enable banks to continue lending even in difficult times since the buffers are used to absorb any resultant losses without breaching the minimum regulatory capital limit.
The new rules require all lenders to maintain a minimum core capital to risk-weighted assets ratio — a measure of a bank’s financial strength based on what shareholders have put in — of 10.50 per cent, up from the current eight per cent.
The banks are also required to maintain a total capital to risk-weighted assets ratio — a measure of a bank’s financial strength based on total capital including items such as goodwill and revaluation — of 14.50 per cent, up from the current 12 per cent.
“The buffers have enabled the banks to absorb additional loan loss provisions required for the slight increase in non-performing loans registered in 2014,” CBK notes.