Loan default risk cover eases lending to SMEs

A new insurance product that covers against the risk of loan default is promising to change Kenya’s lending market, offering opportunities for banks to lend more to small businesses with sound business plans.

The product is being offered by Africa Trade Insurance Agency (ATI), with local insurance companies set to become marketing agents.

While insurance against loan default exists in Kenya, the cover only pays claims upon death or permanent disability of the borrower like in the case of mortgages where one is required to have a life insurance cover.

But the new product from ATI covers default risks when the borrower is alive but in financial difficulties, waiving the need for collateral altogether.
Lack of collateral has been a major impediment to borrowing especially for small and medium scale entrepreneurs, even when they have sound business ideas.

“It’s a major development that will push lending faster, said Mr Ochieng Oloo, a consultant on banking and insurance.

The product comes at a time when small businesses in Kenya may be compelled to increase their production to service markets within the East Africa region especially after the coming into force of the EAC Customs Union.

ATI introduced the insurance product last year but its roll out has been in the back burner as the company prioritised the political risk insurance cover that is being sold through UAP, APA and Jubilee Insurance companies.

“We are going to do major marketing of the product this year,” said Mr Humphrey Mwangi, ATI’s chief underwriting officer.

The new product could have a huge impact on reducing the amount of non-performing loans in the banking industry because the risk of default will be substantially reduced, resulting in a significant drop in interest rates. Central Bank of Kenya data shows that overall, gross non-performing loans increased by Sh4.1 billion or 7.1 per cent from Sh57.4 billion in November, 2008 to Sh61.5 billion in November, 2009.

CBK attributed high non-performing loans to slowdown in economic activity because of drought, the negative effects of the post election crisis and the global financial crisis.

The data also shows lending by banks was less than in the previous year because of fear of default as general economic activities slowed down.
Domestic credit grew by 15.7 per cent in the year to November, 2009 compared to 22.6 per cent in the year to November 2008, reflecting reduced appetite for credit in the private sector and the lenders aversion to risk in a depressed economy.

Private sector borrowing decelerated from 32.1 per cent in the year to November, 2008 to 10.8 per cent in the year to November 2009, remaining below the targeted growth rate of 12.0 per cent.

Credit insurance is a growing business in Africa and with ATI having monopoly in the region, it forecast that it will be a key driver in its revenue in 2010.

Growth is expected from the rebounding global economies and growing interest to invest in emerging markets like those of the region.

Recent survey by AfricaPractice showed business leaders in Africa are optimistic for 2010, with 95 per cent of the respondents expecting to expand their businesses over the year.

The survey, which featured 37 Executives drawn from telecoms, beverages, banking, media, private equity and mining businesses in African Countries, supported the growing belief that Africa is beginning to recover from the global financial crisis.

Mr Mwangi said growth will be led by the manufacturers who realising that banks are not slower in lending have started their own financing models to help their clients acquire the assets they need quickly.

“We have started seeing equipment providers, especially to telecommunication companies choosing to finance their clients through loans,” said Mr Mwangi. “They see credit insurance as a critical component of the financing to hedge against default risks.”

Because of competition, suppliers are being forced to give products and services on credit and seen credit insurance as key to default risk mitigation.

“Businesses have become cautious of trading on credit but the reality is that they do not have options,” said Mr Mwangi.

Credit insurance is usually shunned by most insurers because of the complexities involved in analysing the risk and therefore coming up with an adequate premium.

Failure to come up with adequate premiums means the compensation and reinsurance will be compromised and the whole process could result in losses that drain the insurer.

Local insurers

ATI officials said for such product to be sold by local insurers, capacity building is required. What the agency plans to do is to partner with locals as marketing agents. The Insurance Act does not also allow local insurers to sell credit insurance.

The advantage for locals is that credit insurance can be offered for loans as little as Sh10,000. SMEs can also pay their premiums insurance in installments for a period of six months.

The premium for credit insurance varies based on the risk profile on the borrower or the business the loan is intended to take care of.

The premium averages 2.5 per cent of the total loan and covers 90 per cent of the indemnity risk.