Commercial banks feel the weight of high priced loans

Commercial banks reported a steep rise in the volume of non-performing loans in the month of May, underlining the pain that businesses and households are suffering under a high interest rates regime that has persisted since the third quarter of 2011.

Central Bank of Kenya (CBK) data shows that non-performing loans rose by Sh10 billion or 14.2 per cent to Sh80.3 billion between March and May this year – the highest in six years.

Bank loans are officially classified as non-performing if they are not serviced for a period exceeding three months.

At Sh80.3 billion, the non-performing loans (NPLs) are equivalent to 5.6 per cent of the total industry loan book of Sh1.44 trillion, up from 4.4 per cent a year ago.

The rise in the volume of NPLs came even as the wide interest margins enjoyed by the lenders pushed the industry’s profits before tax to Sh48.7 billion or 11.2 per cent higher than last year’s Sh43.8 billion.

Kenya National Bureau of Statistics (KNBS) on Friday released fresh economic data showing that the financial sector growth had suffered from a slowdown in credit demand. “The sector’s growth slowed to 1.2 per cent during the first quarter of 2013 compared to a growth of 3.1 per cent in the same period last year,” says the report.

The slowdown in growth in the first quarter of the year is, however, linked to the dark political clouds that hang over the Kenyan economy as the country prepared for the March 4 election – the first after the tumultuous December 2007 poll.

Economic activity slowed down to a near standstill as the country came under intense election campaigns that suppressed productivity in the manufacturing, hotels and restaurants and financial intermediation sectors, said KNBS.

“The general economy had been sub-par up to the election. This was a near perfect example of the cause and effect of political risk,” said Aly-Khan Satchu, the managing director of Rich Management, a financial advisory and data vending company.

The increase in non-performing loans was against industry expectations as captured in the CBK’s Credit Survey report released in April.
“For the quarter ending June 2013, institutions forecast that the NPLs will generally remain unchanged,” said the report, which also indicated that the lenders expected bad loans to increase in the building and construction, transport and communication and real estate sector. The increase of bad loans in the three sectors would, however, be offset by a drop in the tourism, restaurant and hotels sector as well as in the trade segment, says the report..

“This is a matter that should be of concern to economic managers. Bad loans generally show that resources are not being channelled to the most productive sectors of the economy,” said Dr X.N. Iraki, a lecturer at the University of Nairobi’s Business School.

Interest in bad loans is linked to the dark history Kenya had with them in the 1990s when they caused a number of bank collapses.
Banks have more recently been able to absorb the defaults shock through robust loan books growth that has kept the proportion of non-performing loans in check.

It has been difficult for banks to sustain that method of operation in an environment of high lending rates that has persisted in the past two years, slowing down the growth of their loan books.

CBK’s series of policy rate cuts has seen commercial banks set their base lending rates at 18 per cent, leaving effective rates above 20 per cent.

The astronomically high interest rates have persisted for close to two years, putting pressure on households and businesses, whose monthly repayment instalments increased to reflect the changes.

“The key challenge for the Central Bank is not the CBR Rate. It is the failure to transmit the CBR Rate into commercial lending rates that is the policy dilemma,” said Mr Satchu. The monetary policy committee is set to meet in two weeks to review the policy rate.

Kenya has since March been on a loose monetary policy path, aiming to increase money supply into the economy and snap it from the lull it has been suffering since the beginning of the year.

A rapid growth in the bank’s total loans gives hope that the economy could be picking up following a slowdown in the first quarter.
Banks advanced Sh40 billion in credit between March and May, an amount matching the industry’s lending in the first three months of the year.

“The growth in loan books is linked to credit that was approved before the elections but was not drawn until after the peaceful elections,” said Francis Mwangi, the head of research at Standard Investment Bank.

In recent weeks, banks are said to have been reducing their loan growth expectations for the year, driven by expectation that interest rates are unlikely to fall to the levels the CBK is targeting.

Commercial banks have argued that although CBK has been cutting the CBR and T-Bill rates to increase liquidity, it has diluted the impact of the policy action through its mop-up activities using short-term instruments such as repurchase agreements and term auction papers.

The disconnect has been manifested in the continued rise of repo rates even as the T-bill rates declined in the past weeks.

“I know a number of banks have cut down their loan growth expectations because they do not see their lending rates falling that fast,” said Mr Mwangi.

The volume of cash deposited with the banks also shot up by Sh60 billion to Sh1.84 trillion in the two months to May – a huge improvement from the Sh20 billion that was deposited in the first quarter of the year.

The increase is attributed to liquidity in the market following CBK’s decision to ease cash circulation by lowering the policy rate. Keeping lending rates high and the cost of funds low has ensured that commercial banks continue to rake in higher revenues despite the slow growth in the loans book.

Official data shows that high interest margins have become key drivers of commercial bank profits growth in a slow economy.

Profit before tax rose to Sh48.7 billion in the first five months of the year compared to Sh43.8 billion in a similar period last year.

Lenders are closely monitoring the teachers’ strike fearing that withholding the tutors’ salaries could have a big impact on their books, forcing them to increase their loan loss provisions, which affects profits.

Teachers are some of the major borrowers with most of their loans being deducted from their pay slips as they are unsecure.

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