Loan defaults rose by Sh133.6 billion in the financial year ended December 2023, overtaking levels recorded during the Covid-19 pandemic era and sinking the banking sector into a rare profit drop as economic hardship ravaged households and businesses.

This is a record jump in the value of loan defaults in a single year and erodes the banking sector’s unaudited net profits for the period to Sh172.9 billion from Sh175.5 billion the previous year.

A disclosure by the National Treasury showed that loan defaults rose by 27.4 percent from Sh487.7 billion to Sh621.3 billion, marking the largest rise in a single year since CBK started making the data public.

The Treasury said manufacturing and trading sectors accounted for about Sh248.52 billion or 40 percent of the Non-Performing Loans (NPLs) at the end of December, pointing to struggles among businesses and an elevated fear of layoffs and slowdowns in new jobs.

The Sh133.6 billion rise in the value of defaulted loans raced past the Sh99.2 billion that was added in the year ended December 2020 when households and businesses were battling Covid-19 economic disruptions.

The defaults took the NPLs ratio—a measure of the proportion of loans for which interest has not been paid for at least three months— to 14.8 percent at the end of December, compared with 13.3 percent in a similar period in 2022.

“The slightly elevated NPL ratio is due to a higher government spending bill as well as the economic slowdown. Approximately 40 percent of total NPLs are concentrated in the manufacturing and trade sectors, thus reducing contagion to the banking sector,” the Treasury said in its newly published $2 billion (Sh319 billion) Eurobond buyback prospectus.

The rare Sh2.6 billion decline or 1.5 percent drop was in contrast with a similar period last year when the banking sector’s net profit jumped by 22.5 percent from Sh143.3 billion.

The only recent years in which the sector returned a drop in profits was in 2017 on the impact of interest rate capping law and in 2020 when Covid-19 disrupted businesses. On both occasions, they rebounded within a year.

Factors such as the elevated price of goods and services, new statutory deductions including housing levy, and increased interest rates in line with a higher Central Bank Rate (CBR) — now at 13 percent, the highest point in 12 years—have combined to weaken borrowers’ ability to service loans.

Borrowers were last year hit with three rises in the CBR, which has translated to increased prices of loans and ultimately caused many borrowers to struggle with monthly repayments.

The Monetary Policy Committee of the CBK in December last year, served one of the biggest surprises by raising the CBR to 12.5 percent from 10.5 percent. The committee last week increased this to 13 percent, matching the September 2012 rate.

The new rate is set to usher in a fresh round of upward repricing of loans, giving borrowers a new pain point as they start 2024.

Weighted average lending rates for banks stood at 14.63 percent in December—the highest since August 2016 when it averaged 17.66 percent.

CBK Governor Kamau Thugge last Wednesday said he is “concerned” about the NPLs and what impact the rising interest rates will have on them but said the focus now is on controlling inflation and managing the weakening of the shilling.

“We continue to keep an eye on them (NPLs) but we are convinced that stabilising inflation and exchange rate at this time is the most critical thing we can do to stabilise the macro-economic environment,” he said.

Borrowers are already grappling with elevated prices of goods and services even as new deductions hit the salaried.