Bad debts to hurt lenders’ profits on tight CBK scrutiny

Profitability of Kenyan banks will take a hit from increased provisioning for bad loans as Central Bank of Kenya (CBK) heightens its scrutiny on their books, says a new report by Citigroup’s investment banking arm.

The international research firm noted CBK had previously encouraged restructuring of loans by banks to keep their risk low but it had indicated a change of tack in a letter of intent to International Monetary Fund (IMF).

“Heightened regulatory scrutiny could cause Kenyan banks to increase their loan loss provision expense, which in turn would lower profitability,” said Citi analysts in a report on Kenyan banks.

Citi analysts noted previous concerns raised on provisioning had been ignored but the CBK has made a commitment to IMF to enforce set guidelines on provisioning, which was likely to see banks set cash more aggressively hurting their profits.

Banks will also be required to provide the Central Bank with information on a monthly basis on loans whose terms were amended or restructured.

Restructuring of loans through change of terms such as extending the repayment period and inserting moratorium clauses is usually used to avoid classifying loans as non-performing.

Citi joins a list of international institutions including IMF and credit rating agency Moody’s that have also raised the red flag on low loan provisioning by banks.

READ: Moody's urges African banks to cut bad loans

Banks are required to set aside cash, which is deductible as an expense, to ensure they are able to absorb any losses that it may incur from loan defaults.

Cash set aside by Kenyan banks for the losses are widely seen as dropping even when they are booking more defaults.

Citi noted that despite a series of negative credit events including a decline in tourism due to terrorism and poor performance of agricultural goods, bank metrics did not appear to reflect any deterioration in credit.

The IMF had warned that the coverage ratio, the amount set aside as provision for bad loans, as a proportion of total non-performing loans, has been declining.

Moody’s had argued that rapid growth of loans to the private sector in Kenya was usually followed by a spike in bad loans and it expected the mountain of bad loans to grow in the next 12 to 18 months.

Even as it committed itself to more stringent scrutiny of banks, the CBK has, however, pointed out that the institutions are currently holding higher capital levels giving them room to absorb any risk that may arise from bad loans.

“The buffers have enabled the banks to absorb additional loan loss provisions required for the slight increase in non-performing loans registered in 2014,” said CBK in a recent note.

Banks have argued that most of their loans were backed by assets allowing them to hold lower provisions as they can recover the principal debt from selling the security.