Loan default risks persist on high public sector pending bills

The agency says the industry’s impaired loans are unlikely to decline materially, until substantial progress is made in reducing the outstanding public sector debt in arrears, which is likely to remain elevated in the short term despite efforts to improve public financial management.

“Impaired loans are unlikely to decline materially until substantial progress is made in reducing the outstanding public sector debt in arrears, which is likely to remain elevated in the short term despite efforts to improve public financial management,” the agency says in a statement dated November 12.

“Delayed government payments have significantly strained borrowers’ ability to service debt, which was further pressured by the pandemic and, more recently, by exchange-rate volatility, high inflation and interest rates.”

An impaired loan ratio is a measure of a bank's asset quality, calculated by dividing its non-performing loans (NPLs) by its total gross loans. It indicates the share of a bank's loan portfolio that is at risk of default, providing a key measure of potential credit risk.

A higher ratio suggests a greater risk in the bank's loan portfolio. Increased provisions for NPLs reduces banks’ profit margins and dividends for shareholders.

Fitch says the rise in the Kenyan banking sector’s impaired loans ratio in the last 10 years from 6.8 percent in 2015 to a peak of 17.6 percent at the end of June this year, has been heavily influenced by large public-sector arrears to contractors and service providers.

Kenya’s pending bills owed to contractors and suppliers have continued to grow, with unpaid obligations increasing to Sh524.84 billion by June 2025, up from Sh516.27 billion earlier in the financial year, according to figures from the office of the controller of budget.

Fitch however says the banking sector’s high pre-impairment operating profit (profit before setting aside money for loan losses), will be sufficient to comfortably absorb the loan impairment charges, while allowing for increased capital and loan growth.

In the nine months to September this year, the banking industry’s impaired loans to gross loans stood at 17.1 percent, a slight decline compared to 17.6 percent in the first half ( January-June ) of the year. In 2023 and 2024, the ratio stood at 15.6 percent and 17.1 percent respectively.

An impaired loan is a loan where there is clear evidence of a loss, meaning the lender expects to lose some or all of the money they loaned out.

This happens when a borrower is unlikely to repay the loan in full, and the lender has to recognise this potential loss in its financial statements.

According to Fitch, the banking sector’s total loan loss allowance coverage of impaired loans was 59 percent at the end of June this year, reflecting some reliance on collateral and recoveries.

The net impaired loans were 23 percent of the banking sector’s total equity in the first half of this year but risks to capital are mitigated by high pre-impairment operating profit which provides a large buffer to absorb loan impairment charges while allowing for capital accretion and increased loan growth.

“Though pre-impairment operating profit as a percentage of gross loans is expected to fall due to higher loan growth and net interest margin pressure from lower interest rates, it will remain sufficient to comfortably cover loan impairment charges,” the agency says.

Of the four Fitch rated banks — KCB, NCBA Bank Kenya, I&M Bank Ltd and Stanbic Bank Kenya Ltd— KCB had the highest impaired loans ratio of 21.3 percent in the first half of this year (2025), followed by NCBA Bank (13.2 percent), I&M Bank (12.9 percent ) and Stanbic Bank Kenya Ltd (9.5 percent).

“All four banks’ pre-impairment operating profit (ranging from an annualized 8 percent of average loans in [first half of 2025] to 10 percent) provides a large buffer to absorb potential loan impairment charges,” says Fitch.

Fitch says high interest rates have suppressed demand for credit while credit supply has been constrained by the weak credit landscape and comparatively favorable yields on government securities due to high government issuance, which incentivized banks to deploy funds into treasury bills and bonds.

“As a result, forex-adjusted loan growth was anemic in 2024 and second half of 2025 (one percent in each period), which contributed to the sector’s elevated impaired loans ratio,” it says.

The decline in the banking sector’s impaired loan ratio to 17.1 percent in the nine months to September this year was partly driven by resumed loan growth.

The central bank started easing monetary policy in August 2024 in response to moderating inflation and exchange rate pressures and has since cut the Central Bank Rate (CBR) by a cumulative 375 basis points (bp) to 9.25 percent, including by 200bp in 2025.

“A stable macroeconomic environment and lower interest rates will improve borrowers’ debt servicing capacity, given that most loans are issued at floating rates. It will also support accelerating loan growth in the banking sector, which we forecast in the mid-single digits in second half of 2025, increasing to double digits in 2026,” says Fitch.

“These themes will support a continued modest decline in the banking sector’s impaired loan ratio in 2026.”

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