Management Magazine

High non-performing loans in real estate worrying


How could the drop in the lending rates that was expected to grow in credit through affordable loans be counterproductive?

Recently, news sources have been awash with stories of how borrowers are struggling to repay their loan facilities. Some sections of the media have intimated that even the dreaded auctioneers are no longer at ease. It is becoming increasingly difficult for them to sell some of the property offered to the market at auction prices. If such information is factual, this is a harbinger of tough times ahead. The question therefore remains: What happened? Why the sudden spike in the non-performing loans (NPLs)? Are non-performing loans a product of tough operating business environment or weak credit risk management practices? It is evident that institutions that have crafted a robust and reliable credit risk management system stand a better chance in facing the daunting challenge. 

Soaring nonperforming loans

The latest quarterly report by the Central Bank of Kenya indicated that the levels of nonperforming loans continue to soar. As at end of October 2018, the ratio of the NPLs to the total gross loans was 12.3 per cent. The International credit rating agency, Moody’s in a recent report attributed the huge levels of NPLs in the Kenyan banking sector and the deterioration of the asset quality to weak credit risk management practices and noted that delays by government in paying contractors and suppliers has aggravated the situation. Equally, key changes in the international financial reporting set by International Financial Reporting Standards (IFSR) effective January 2019 will impact the financial system even further, thus, an agile lender must prepare for the worst-case scenario. The expected increase in loan provisions will lead to lower profits and increase in NPLs will lead to an increase in risk-weighted assets, which leads to a lower capital adequacy ratio.

Global challenge

Increased NPLs challenge not only faces the local financial system. It is not even regional. It is global. Mid last year, the World Bank Group organised a two-day conference in Vienna, Austria whose only agenda was to devise a comprehensive approach in resolving NPLs. The conference attracted enormous attention from many countries that acknowledged that high levels of NPLs is a challenge that must be addressed. Such conferences and meetings demonstrate how significant the issue of the asset quality is to the performance of the individual banks and the entire financial system – nationally and globally.

Various stakeholders including the central banks take keen interest in the performance of loan assets and related credit facilities. This is because a properly-functioning banking system translates into a stronger financial system and ultimately demonstrates the solidness of the economy. If the banking system is bullish, the general economy is exposed to huge economic and infrastructural developments. A strong economy is home to decent employment numbers and leads to better economic growth.

Let’s go back to the basics

Loans or credit facilities are the major “stock-in-trade” of many commercial banks or lending financial institutions. A lender faces several challenges in the business such as raising sufficient funds to ensure they remain in the trade, and perhaps the toughest is to ensure the loaned funds are repaid and within the pledged timeframes. Banks or lenders experience the sharpest of the pounding of tough economic environment and therefore must take great interest in the economic changes in the environment where they are operating. Different countries will face different economic times at a specified period. Changes in the inflation rates, GDP growth rates, levels of interest rates, foreign exchange rates amongst other key economic fundamentals could change the business environment.

Net drainer

However, according to the CBK figures, the real estate sector continues to be generator of the biggest chunk of NPLs in the banking sector. This changes from one market to another. According to the Central Bank of Nigeria (CBN), the oil and gas industry accounts for about 30 per cent of the total gross loans and about 47 per cent of the NPLs in the entire banking sector. May factors have been attributed to the undesirable situation of real estate business in Kenya. Some analysts have opined that the capping of interest rates that was introduced in 2016 could be one of the major reasons. But how could the drop in the lending rates that was expected to grow in credit through affordable loans be counterproductive? Why would such a change so hugely impact the real estate in a country whose total stock of mortgages is a paltry 30,000? Others have attributed the slowdown in the real estate market to oversupply of housing units. But how, in a country whose annual deficit in housing units, according to the World Bank, is estimated at 2 million units? Of course, these figures must be more granular. When one discusses housing deficit, it is important to indicate which segment of the market is affected by the oversupply. Is it the high-end, middle or lower segments of the pyramid? 

Undoubtedly, construction business is highly sensitive to many changes in the market. Proper appraisal of a real estate project is paramount, and all the cost parameters need to be itemised and properly assessed. Projected revenue from such a project need not be as totally conservative but must be as realistic as possible. These estimates must also be stress tested to ascertain how the worst-case scenario would look like in case of adverse changes in the business environment. Failure to adhere to these simple procedures will guarantee a ‘white elephant’ project that will end up being a non-performing loan. 

Macharia Kihuro is a Credit Risk Expert working with a Pan African financial Institution and a PhD student in Finance at the University of Nairobi. Email:

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