Burst looms as banks bleed from Covid-19 pandemic

While the extent of the adverse effects of the pandemic on the Kenyan economy is still evolving, it is already evident that the impact maybe severe

BY GILBERT NG’ANG’A

Kenyan banks face the biggest challenge for over a century as the COVID-19 pandemic tear down their foundation, with economic setbacks wiping out new loans and sending customers into non-payments, exposing them to potential failures.

It is estimated that billions of shillings in loans will go bad in the coming months and millions of customers will no longer afford loans—the nucleus of banking.

Economists and financial analysts are arguing that most of the banks will struggle to stay afloat in the event of a prolonged crisis as their capital and liquidity buffers, which they have built over time will not withstand the shocks from the pandemic.

Just how bad is the impact? With restricted movements, demands for social distancing in the banking premises and a raft of precautionary measures, banks are struggling to do business even as they turn to digital channels to reach their customers and continue doing business. As it is emerging now, by their nature, they were not designed for remote work. Having staff work from home is a tall order. 

This is how the crisis is unfolding. Salespeople who deliver millions of shillings in loan bookings daily across the country can no longer venture into the markets, residences or business premises where they usually hunt for loans. They can no longer meet customers and potential borrowers to pitch. They are all locked in their houses, and their movements restricted to certain hours.

Customers who had taken loans are increasingly reaching out to banks, as per the Central Bank of Kenya guidance,  to renegotiate loan contracts with the institutions. On March 18, sensing the disaster that was awaiting borrowers adversely impacted by the virus, the CBK asked banks to consider three things. First, to provide relief to borrowers on their personal loans based on their individual circumstances arising from the pandemic. This will see some customers get extension of loans running up to one year. Secondly, Medium-sized enterprises(SMEs) and corporate borrowers were allowed to contact their banks for assessment and restructuring of their loans based on their respective circumstances arising from the crisis. Lastly, banks are to meet all the costs related to the extension and restructuring of loans. This is not a good space to be as a bank as it’s a direct hit on interest incomes, which is the biggest driver of growth for any Bank in Kenya.

Patrick Njoroge, CBK Governor

Under more severely strained circumstances, for banks, we will have to rethink our playbook substantially. Some banking systems might have to be recapitalized or even restructured

Non funded incomes are also thinning. Last month, the government ordered banks to waive all charges for balance inquiry and fees for transfers between mobile money wallets and bank to facilitate increased use of mobile digital platforms. That’s a big deal for banks. 

Beyond that, the CBK lowered the Central Bank Rate (CBR) to 7.25% to signal commercial banks to lower their lending and deposit rates. Accordingly, depositors were urged to be accommodative of lower rates for their deposits which will lead to more affordable credit. 

The CBK also lowered the Cash Reserve Ratio (CRR) to 4.25% to provide additional liquidity of Sh35.2b to commercial banks. CBK said it will avail this liquidity to banks based on their demonstrated requirement to directly support borrowers who are distressed as a result of COVID-19.3.

To provide flexibility on liquidity management facilities provided to banks by CBK, the maximum tenor of Repurchase Agreements (REPOs) was extended from 28 to 91days. This was to enable banks access longer term liquidity secured on their holdings of government securities without having to discount them. Lastly, CBK said it will provide flexibility to banks with regard to requirements for loan classification and provisioning for loans that were performing on March 2, 2020 and whose repayment period was extended or were restructured due to the pandemic. 

Bankers are optimistic that the sector will largely remain resilient even with reduced business while playing a critical role in supporting economic activity during the pandemic. 

“We know that the pandemic has affected everyone and we are offering extended financial assistance to provide additional relief to our customers to meet their needs and ambitions. We believe this will go a long way in helping them navigate through their most urgent and challenging situations. We stand with the nation to help limit the spread of the virus and ease the related economic hardships faced by the communities in which we operate in,” said KCB Group chief executive Joshua Oigara.

Moody’s, the US-based rating agency in a March note to clients said that the measures put in place to shield Kenya’s banks from disruptions associated with the coronavirus outbreak, might not hold should the situation worsen. Prolonged disruptions in key sectors, said the firm, could significantly slow down the economy and cause severe problems to banks as customers default on their loans. 

According to Moody’s, among the rated indigenous Kenyan banks — KCB, Equity and Cooperative Bank— Equity faces the greatest exposure because 59% of its loan book is booked under SME as at December 2019.  Equity is rated B2 stable. Co-operative Bank, with a similar rating has a 6% SME lending exposure while KCB Bank (B2 stable) has a personal loans exposure of 4%. 

Data by the CBK show that by February, the ratio of gross non-performing loans (NPLs) to gross loans was begging to rise, standing at 12.7 % compared to 12% in December, mainly reflecting increases in NPLs in the manufacturing, energy and personal/household sectors.  

“Pressure on the banking system is growing and higher defaults on debt are imminent. And many now expect a shock to the financial sector similar in magnitude to the 2008 crisis. Under more severely strained circumstances, for banks, we will have to rethink our playbook substantially. Some banking systems might have to be recapitalized or even restructured,” said the International Monetary Fund (IMF) in a commentary of march 31
published on its website. 

For Kenyan banks, the policy shift limiting who can be listed with credit reference bureaus (CRBs) for defaulting on loans has also left them significantly exposed as they will have to find ways of dealing with such un-creditworthy borrowers. Following the CBK directive, over 300,000 borrowers who had been listed with the bureaus for defaulting loans worth Sh1,000 or below have been let off the hook. Before this directive, banks were on an overdrive to pursue defaulting borrowers, leading to massive property seizures. 

Latest CBK data shows that loan defaults increased 55.6% in the three years to December, hitting Sh333.3b of the country’s Sh2.77m loan book. 

As a result of COVID-19, major sectors like real estate, retail, and manufacturing, which have been the biggest drivers of NPLs, are expected to suffer the biggest blow.

Before the pandemic, lenders such as Stanbic Holdings had suffered huge impairment losses from ARM, having lent the manufacturing company Sh3.3 billion. Similarly, KCB Group and Co-operative Bank got a hit from Uchumi Supermarket’s loans default, which translated to the lenders having to write off loans valued at Sh656m with Co-operative Bank waiving 40% of its loan. 

“If the asset deterioration trend persists, this will likely impact the bank’s bottom line due to the associated impairment charges, especially after the adoption of the new IFRS 9 standard,” said Cytton Investments in a research note dated April 19. 

CBK Governor, Dr Patrick Njoroge, has raised a red flag that Banks will be hardly hit in the coming months. In march, he downgraded economic growth prospects for 2020 from 6.2% to a conservative 3.4% due to the pandemic, adding that Kenya will require a Sh100 billion emergency funding from the International Monetary Fund (IMF) and the World Bank to fight off the economic shocks. 

“While the extent of the adverse effects of the pandemic on the Kenyan economy is still evolving, it is already evident that the impact maybe severe. Growth in private sector credit will likely moderate due to the expected weakening in economic activity in the key sectors affected by COVID-1,” said Dr. Njoroge. 

The Shilling is facing huge pressures over rising uncertainties in the global market due to the Coronavirus outbreak, which has seen the disruption of global supply chains. The shortage of imports from China for instance, which accounts for an estimated 21% of the country’s imports, is likely to cause local importers to look for alternative import markets, which may be more expensive and as such higher demand for the dollar from merchandise importers. Additionally, analysts said, there will be reduced diaspora remittances, owing to the decline in economic activities globally hence a reduction in disposable incomes. This, coupled with increased prices of household items abroad might see a reduction in money expatriated into the country.

Owing to COVID-19, the IMF has revised Kenya’s 2020 GDP growth rate to 1%, from the 6% projected at the beginning of the year, with the global economy expected to contract by 3% this year, a worse outlook than the one seen in the 2008 – 2009 financial crisis. 

The playing field hasn’t been good of late for banks, for a good reason. According to CBK statistics, lending rates averaged 12.19% in February, the lowest since January 2005 when it was at 12.12%. And this is worrying bankers. 

“There is also a question of demand in the sense that we haven’t seen a huge growth in new lending and so the old lending which was pegged on CBR continues with the original pricing, meaning a cut in CBR (Central Bank Rate) also reduces overall pricing. We acknowledge that we have a central role to play in supporting individuals, businesses and the economy during this crisis and facilitating a rapid and sustained recovery,” said John Gachora, the managing director at NCBA. 

But it is not all gloom. Should the pandemic end within the quarter and economic activity resume, some analysts are projecting a quick turnaround of the downturn for banks.  The banking sector showed improved performance in the year ending December 2019, which was largely attributable to persistent revenue diversification evidenced by the 17.4% growth in non-funded income from 3.8% growth the previous year. 

“We expect banks to refocus on lending once they recalibrate their models to adjust for new loan pricing, therefore, increasing the loan to deposit ratio. With the loosening of the regulations particularly the repeal of the interest rate cap, the sector can focus on increased growth and profitability” said Cytonn Investments in an assessment on banks issued at the
end of March.

Data shows that last year, listed Banks recorded a slower 3.2% growth in interest income compared to the 6.5% recorded in 2018. This may be attributable to the lower yields on interest-earning assets which declined to 9.9% from 10.7%. The lower yields on interest-earning assets are attributable to a decline in lending rates which were pegged to the Central Bank Rate (CBR). In FY’2019, the CBR was lowered by 50 bps from the 9.0% set in July 2018 to 8.5%. Consequently, the net interest margin in the banking sector as at FY’2019, stood at 7.3%, a decline from the 7.9% recorded in FY’2018, mainly due to the faster growth in average interest-earning assets.  

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