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Banks smell consumer loan defaults, credit losses

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Commercial banks should expect rising debt burden, credit losses and possible higher interest rates in the post-covid-19 period, new findings show.

The report, Finding Balance: The Post-COVID Landscape for Financial Institutions by Baker McKenzie has warned local banks to expect a bumpy ride ahead from significant credit losses brought by the pandemic and who ‘must agree to either restructure debt or write off much of their exposure.’

Due to the lockdowns imposed by many governments including Kenya to tackle the public health emergency, the consequent disruption to supply chains and the reduction in demand for those corporates whose business models are most impacted by social distancing, will almost certainly trigger defaults and bring their viability into question, noted the report released yesterday.

While organizations currently remain well capitalized and banks having the liquidity to cushion businesses from crumpling, the position could deteriorate, according to the report, adding that banks will face increasing levels of non-performing loans, with corporates drawing down pre-existing credit lines.

“While the big banks have been affected by the pandemic, they still have liquidity and strong capital levels and should not need to raise capital as a result of the impact of COVID-19.  However, pandemic relief programmes will soon need to be paid back and it remains to be seen how this debt will be managed in the current economic environment,” says Wildu du Plessis, Partner and Head of Banking & Finance at Baker McKenzie.

Banks are further being warned to expect higher interest rates in the future should the aforementioned factors begin to be felt.

“A further unknown concerns the path of interest rates in the future, currently at historic lows,” reads in part the report.

Currently interest rate in Kenya is capped at 7 per cent and is expected to remain so by the end of this quarter, according to Trading Economics global macro models and analysts’ expectations which also projects such rates in Kenya to stand at 6.75 in the next 12 months.

When interest rates rise, ordinarily the cost of borrowing goes up, which can discourage consumers from borrowing. People with existing variable loans or credit card debt might have less disposable income if they need to pay more in interest costs. In either case, consumer spending falls which has a slowing effect on the economy.

The report also outlines the trend towards increasing regulation and supervision of financial institutions – which will require organizations to act in their clients’ best interests over and above strict contractual obligations. This will include paying close attention to their regulators’ expectations and receiving added motivation in light of the flexibility and restraint shown towards customers in the opening stages of the lockdown.

Du Plessis notes that financial services regulatory frameworks in Africa have improved substantially in recent years, which has aided regulators in their response to the COVID-19 crisis.

The report comes in the wake of an expected consumer demand for credit is likely in the coming weeks leading to December festivities according to financial expectations – with the belief that many Kenyans will continue to borrow but their ability to do so will be limited.

The banking industry, which has been touting its capital levels as robust will see many of its prospective customers not qualifying because they are out of a job and those who do get approved will pay double or triple-digit annual percentage rates.

“From a small one-third seeking moratorium when the CBK gave the directive in April, we now see almost two-thirds seeking it. It clearly shows depletion of household savings in the last 6 months despite the reopening of the economy,” says Kamau Macharia, a financial expert.

Stress in the financial sector has soared since the coronavirus pandemic hit in March with about 70 per cent of borrowers seeking moratorium on loan repayments as their incomes dipped and savings were eroded.

The jump in the uptake of the loans emerged in a period when the economy shed more than two million jobs on the back of sluggish corporate earnings in the wake of Covid-19 economic hardships brought by lockdown restrictions and closure of several workplaces.

With most Kenyans still out of work and several others operating on pay-cuts and reduced earnings, demand for loans and especially small loans will spike in the next two months with looming December festivities and possible full reopening of schools in January 2021.

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