Six out of 10 micro and small enterprises (MSEs) had defaulted on their loans by the end of June, reflecting a tough business environment characterised by a spike in interest rates and the prices of goods and services.

A new report of the MSE Tracker Survey published by the Central Bank of Kenya (CBK) and other partners, which tracks financial inclusion among small businesses, shows that 60.7 percent of small businesses had defaulted on their loans in June this year, an increase from 42.8 percent in October 2022.

The default rate among the small businesses far outpaced that in the overall banking sector where non-performing loans as a fraction of gross loans rose from 13.8 percent to 14.47 percent in the review period.

This points to increased cash being forced to dip into their savings, reduce household expenditures or take another loan to repay older credit.

Owner-operated businesses — the most popular form of business in Kenya’s largely informal economy — recorded the sharpest increase in default rates from 35 percent in October last year to 63 percent in June.

Most businesses are grappling with a myriad of economic headwinds including poor sales, high inflation and a spike in interest rates, which have reduced their cash flows and plunged those servicing loans into default.

The survey, done jointly by the CBK, the Kenya National Bureau of Statistics (KNBS) and the Financial Sector Deepening (FSD) Kenya, found that small traders took up loans to counter a myriad of challenges, including inconsistent cash flows arising from the high cost of doing business.

“To counter this, MSEs take loans to remain afloat. However, with persistent harsh economic conditions, these businesses tend to default on their loans by either paying late, miss a payment or pay less than expected,” reads part of the survey.

“The survey results indicate that 60.7 percent of MSEs defaulted on their loans in June 2023 compared to 42.8 percent in October 2022.”

This development is likely to call for interventions from the current administration which has prioritised the empowerment of individuals and small businesses by helping them to access affordable credit through a State-backed financial inclusion fund, popularly known as the Hustler Fund.

Most of the MSEs have been locked out of the formal credit market, with a lot of them resorting to expensive digital credit providers who charge exorbitant interest rates.

Among the respondents who reported having active loans at the time of the survey, about 45 percent of them had borrowed from Hustler Fund, pointing to the popularity of the State-backed mobile lending product.

Another 28 percent of the respondents borrowed from mobile banking platforms such as M-Shwari and KCB M-Pesa and 23.7 percent had borrowed from chamas or groups.

Market players say there are indications that the government micro loans are being used to service other digital debt as the borrowers juggle their borrowings.

John Gachora, the CEO of NCBA Group, which co-owns M-Shwari with Safaricom and KCB Group, said in an interview that the repayment ratios of these mobile lending platforms have been good.

“Repayment has been very good…And some of it we actually believe is from the Hustler Fund,” said Mr Gachora.

The growth in the Hustler Fund’s popularity, while helping with financial inclusion, has also come with its fair share of challenges, with 29 percent of outstanding loans, around Sh3 billion, not being serviced as per the agreed schedule.

Borrowers on the Hustler Fund are defaulting on payments at a higher rate than those at commercial banks, saccos and microfinance banks, pointing to a moral hazard that is common with State-backed financing programmes.

At 62.3 percent, the rate of default was high among female-owned businesses, an indicator that women have been hit the hardest with reduced cash flows more than men.

In October last year, 55 percent of female borrowers had defaulted. The default rate among males dropped from 45 percent to 58.6 percent in the review period.

While the rate of default increased among businesses with no employees, it declined among businesses with between one and nine employees.

Small businesses are among the first ones to capitulate to an economic crisis such as the Covid-19 pandemic due to their thin balance sheets.

Inflation, a measure of the increase of prices over a 12-month period, hit a five-year high of 9.6 percent in October last year, forcing the CBK to increase its benchmark lending rate to commercial banks.

Banks have in turn also had to raise their lending rates, a situation that has resulted in some borrowers, especially those with variable-interest loans, defaulting.

However, inflation has since come down, with consumer prices rising at an average of 7.3 percent, which is within the CBK’s target of between 2.5 and 7.5 percent.

Mr Gachora noted that due to the increased economic challenges, there have been increased requests for loan restructurings by borrowers so that they can afford payments.