Banks just can’t catch a break, can they? In December 2015, Honorable Jude Njomo introduced a bill to ostensibly tame obscene profits that banks in Kenya were deemed to be enjoying. Having appealed to the hearts and pockets of his fellow legislators, who had unfettered and exclusive access to their own parliamentary low rate mortgages with a Kshs 20 million limit, free car privilege for the first car and Kshs 7 million low rate loan for the second car, the interest rate-capping bill sailed through and was signed into law in August 2016.
The mischief that the legislators should have sought to cure was the undifferentiated risk pricing that banks were levying on borrowers. A borrower who had a long history of taking loans and repaying them successfully would be charged at the same rate as a new borrower with zero credit history, which was in the range of 19 to 30 per cent depending on the bank.
What Honorable Njomo had no idea was the double whammy that banks were going to get once the International Financial Reporting Standard 9 (IFRS 9) replaces the International Accounting Standard 39 (IAS 39) with effect from January 2018. IFRS 9 aims at helping banks become more rigorous and prudent in the management of their existing stock of loans by setting an even higher standard on the amounts they must set aside as provisions for those loans, what accountants call impairment. While the previous standard IAS 39 required banks to make provisions only if the client started to demonstrate loan repayment stress, in other words reactively, IFRS 9 requires banks to look ahead, anticipate repayment stress and start making the provisions from the first day that the loan is booked.
What does this mean? Say John has a credit limit of Kshs 1 million issued on 1st January 2016. Under the previous standard of IAS 39, if he did not demonstrate any repayment stress then there was no requirement to set aside a provision for his loan. However, at the first sign of stress, say for instance he was retrenched and missed a payment that was due on 30th April 2016, the bank would be required to assume a probability of default of 5% from May 2016 and a provision would have to be made. Under IFRS 9, that probability of default has now been increased to a mandatory 10% in the first year of the loan whether or not the customer has demonstrated repayment stress. It doesn’t end there. There is an assumption that if John has a loan limit of Kshs 1 million but is only currently utilizing half of that, the unutilized portion of that loan is also included in the calculation for impairment. Thus the mandatory provisions for all loans regardless of their performance, as well as the inclusion of unutilized facilities means that the provisioning can go up to three times or more of the amount required before IFRS 9 standard was applied. This therefore applies to customers with credit card facilities or for those business borrowers who have working capital facilities like overdrafts or revolvers that tend to have fluctuating amounts during their lifetime. It gets even better. Even unutilized off balance sheet items like letters of credit and guarantees largely used by business borrowers, which previously did not need to be included in the calculations for provisions will now be required to be incorporated in the total calculations.
Simply put, banks will have to set aside income to create a bigger buffer for the loan stocks they have on their balance sheet, whether that committed loan is fully drawn or not. Setting aside that income can only be mitigated either through pricing, reducing availability of undrawn limits or both. Whatever the case, the current interest cap at 14% ensures that the pricing option is simply unavailable on most existing facilities. The danger that now lies on the horizon come January 2018 is that even overdraft and trade facilities that were previously being enjoyed by the privileged few business borrowers that survived the Njomo chop, will now either be removed or renegotiated as to be available on application rather than on available on standby as is currently the case.Trade is the oil that drives the economic engine of a country. When the instruments that enable that trade such as overdrafts, letters of credit and guarantees are imperiled, we can no longer make banks the whipping boys of our warped sense of social injustice.