Bank rule change to hit bor­row­ers

ACCOUNTING: New global stan­dard re­quires pro­vi­sion for de­fault even from lend­ing to govt, trade fi­nanc­ing

The East African - - FRONT PAGE - By GE­ORGE KAMAU Spe­cial Cor­re­spon­dent

Bor­row­ers will take the big­gest hit when banks in East Africa be­gin to im­ple­ment a new in­ter­na­tional accounting stan­dard takes ef­fect on Jan­uary 1, 2018. The In­ter­na­tional Fi­nan­cial Re­port­ing Stan­dard (IFRS) 9 will in­tro­duce a more strin­gent way of pro­vid­ing for bad loans. This is ex­pected to eat into bank prof­its and erode their re­serves which form part of their core cap­i­tal. Small lenders in par­tic­u­lar will be dealt a ma­jor blow while small and medium-sized busi­nesses will suf­fer a credit squeeze.

Banks in East Africa are ex­pected to take a ma­jor hit in their earn­ings and cap­i­tal lev­els when a new in­ter­na­tional accounting stan­dard takes ef­fect on Jan­uary 1.

The In­ter­na­tional Fi­nan­cial Re­port­ing Stan­dard (IFRS) 9 will in­tro­duce a more strin­gent way of pro­vid­ing for bad loans. This is ex­pected to eat into bank prof­its and erode their re­serves which form part of their core cap­i­tal. Small lenders in par­tic­u­lar will be dealt a ma­jor blow while small and medium-sized busi­nesses will suf­fer a credit squeeze.

The stan­dard re­quires lenders to con­sider all credit, in­clud­ing to gov­ern­ment, as risky and to set aside money that would cush­ion them in case of ac­tual de­fault. This is called pro­vi­sion­ing for bad loans. Set­ting aside of huge pro­vi­sions will de­prive banks of cash that could have oth­er­wise been used to trade with to in­crease rev­enues.

Pre­vi­ously, banks were only re­quired to pro­vide for loans that had not been ser­viced for a pe­riod ex­ceed­ing 30 days, while lend­ing to gov­ern­ment was con­sid­ered risk-free and did not re­quire pro­vi­sion­ing.

The mea­sure is ex­pected to shield banks from sov­er­eign de­faults like those by Greece and Ar­gentina, en­sur­ing sta­bil­ity of the global sec­tor. Greece failed to hon­our its debt pay­ment in the af­ter­math of the global fi­nan­cial cri­sis of 2007–08 re­quir­ing bailouts. In 2001, Ar­gentina suf­fered a se­vere fi­nan­cial cri­sis caus­ing it to de­fault on its ex­ter­nal debt, lead­ing to a se­ries of aus­ter­ity mea­sures.

Lenders will also be re­quired to set aside money for trade fi­nanc­ing transactions such as letters of credit and guar­an­tees, which were pre­vi­ously con­sid­ered risk-free.

In Kenya, banks are hold­ing Trea­sury bills and bonds val­ued at over Ksh990 bil­lion ($9.9 bil­lion) and have off bal­ance sheet items of Ksh804 bil­lion ($8 bil­lion). Were they to pro­vide just one per cent for the as­sets, the stock of im­pair­ments would be up­wards of Ksh18 bil­lion ($180 mil­lion). This would be the best case sce­nario, as banks are re­quired to make a gen­eral pro­vi­sion of one per cent for loans that are per­form­ing.

“We see the stock of im­pair­ments by banks grow­ing by any­thing be­tween 15 to 40 per cent in line with in­ter­na­tional es­ti­mates,” said Bar­clays Bank of Kenya chief fi­nan­cial of­fi­cer Yusuf Omari.

None of the lenders was will­ing to in­di­cate the di­rect hit it would suf­fer from the in­tro­duc­tion of the new re­port­ing stan­dard.

A re­port by KPMG re­leased last week said it ex­pects the stock of im­pair­ments in Kenya to in­crease by 50 to 100 per cent on the first day of 2018 when IFRS 9 takes ef­fect.

Banks are to deduct the dif­fer­ence be­tween what IFRS 9 re­quires them to pro­vide and what they cur­rently have from their re­tained earn­ings. Small lenders who have low re­tained earn­ings and an ap­petite for risky lend­ing will be left heav­ily ex­posed.

Un­der the new re­quire­ments any loan that falls due by more than a day will be re­quired to be moved to a new clas­si­fi­ca­tion, re­quir­ing more pro­vi­sion­ing un­like in the pre­vi­ous case where loans were re­clas­si­fied af­ter they fell 90 days due.

Bar­clays Bank said it ex­pects lenders to be more ag­gres­sive in their debt col­lec­tion ef­forts in or­der to en­sure a loan does not fall due, and be choosy on which sec­tors they lend to in or­der to keep their prob­a­bil­i­ties of de­faults low.

Al­ready, Eq­uity Bank has said it will be mov­ing out of un­se­cured lend­ing which is as­so­ci­ated with salaried staff whose de­fault rate has been ris­ing ow­ing to re­trench­ments as the econ­omy took a down­turn.

Fur­ther con­ser­va­tive lend­ing by com­mer­cial banks in the East African re­gion will de­ter eco­nomic growth with cen­tral banks al­ready cit­ing slow credit growth to the pri­vate sec­tor as a con­cern.

In Kenya, the sce­nario is ag­gra­vated by the in­ter­est rate caps, which have been blamed for re­duced pri­vate sec­tor lend­ing hav­ing lim­ited lenders ap­petite for risk.

“Clearly, the com­bined ef­fect of the two will not be good for the econ­omy in terms of credit growth and the im­pact it has on the econ­omy,” said Kenya Bankers As­so­ci­a­tion (KBA) chief ex­ec­u­tive Ha­bil Olaka.

KCB, which is the largest lender by as­set base in the re­gion — with op­er­a­tions in all East African mar­kets — is ex­pected to feel the great­est pinch from the new stan­dards ow­ing to its huge statu­tory loan re­serve book. As at end of June, KCB was hold­ing Ksh11 bil­lion ($110 mil­lion) as statu­tory re­serve, mean­ing the in­tro­duc­tion of IFRS 9 — which is tighter than the CBK pru­den­tial guide­lines — may wipe out th­ese re­serves be­fore shav­ing off its re­tained earn­ings.

“It is bet­ter if you have nil fig­ures on your statu­tory loan bal­ance sheet items in­di­cat­ing it will have to take a ma­jor hit.

KBA noted that small and medium-sized banks were lag­ging in the im­ple­men­ta­tion of the new stan­dard, with large banks al­ready in the process of test-run­ning their fi­nan­cial strength against IFRS 9.

“Most Tier 1 banks are well ad­vanced in terms of readi­ness; tier two and three are a bit be­hind,” said Mr Olaka.

One of the con­cerns by small banks is whether their sys­tems will be able to gen­er­ate suf­fi­cient data to al­low them to make the pre­dic­tive anal­y­sis re­quired in de­ter­min­ing the prob­a­bil­ity of de­fault of each bor­rower.

Coun­tries where data on the gen­eral econ­omy is hard to get will also pose a chal­lenge for bankers who have to fac­tor gen­eral eco­nomic en­vi­ron­ment in their de­fault prob­a­bil­ity. This is set to be a prob­lem for most East African coun­tries given the scarcity of data and even where it is avail­able it faces queries of au­then­tic­ity and con­sis­tency.

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