(MENAFN- The Arabian Post) Kenya's banking sector is under pressure as impaired loan ratios hover at elevated levels even though pre-tax profits and capital buffers point to resilience, according to a recent assessment by ratings agency Fitch Ratings. The sector's net impaired loans to equity stood at around 23 per cent in the first half of this year, reflecting persistent debt servicing challenges.

Fitch estimates that the sector-wide ratio of impaired loans to gross loans was about 17.1 per cent at the end of September, supported by a modest improvement from 17.6 per cent at mid-year. The agency warns that this rate is likely to remain elevated through 2026, citing large outstanding arrears owed by the public sector that continue to weigh on banks' asset quality.

Even as impairment risk remains high, banks have been posting strong operating profits before provisions, which provides a cushion against loan losses. Fitch points out that pre-impairment operating profit remains adequate to absorb expected stresses. For example, four rated institutions-KCB Group, NCBA Group, I&M Bank and Stanbic Bank Kenya-recorded pre-impairment operating profits that translated into buffers between 8 per cent and 10 per cent of average gross loans, a level viewed as satisfactory for stress mitigation.

The primary driver of the elevated impaired loan ratio is the build-up of public sector obligations to contractors and suppliers. Government arrears had risen to 524.84 billion Kenyan shillings by June 2025, up from 516.27 billion shillings earlier that financial year. These unpaid bills impact borrowers' ability to service debt, particularly for businesses dependent on government contracts, thereby increasing the risk of defaults in the banking system.

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Monetary conditions have started to ease. The Central Bank of Kenya cut its policy rate by a cumulative 375 basis points to 9.25 per cent as of August 2025, following the shift away from peak inflation and sharp currency depreciation. Lower interest rates are expected to enhance borrowers' debt-servicing capacity and spur loan growth. The bank asset growth was forecast by Fitch to accelerate into the“mid-single digits” in the second half of 2025, possibly rising to double digits in 2026.

Still, Fitch cautions against expecting a sharp drop in impaired loans in the near term. While banks like Stanbic Kenya recorded a lower ratio for the first half of the year, others such as KCB showed a tougher profile in the same period. Recovery of collections is expected to be gradual, with the overall ratio declining“modestly” rather than dramatically.

On the earnings front, banks have shifted funds into government securities, drawn by high yields amid sluggish loan growth. This dynamic may dampen future net interest margins and loan expansion, underscoring the importance of improving macro-economic conditions for sustained growth. Regulatory capital buffers remain strong, allowing banks room to absorb further shocks, though vigilance remains necessary given the external and domestic headwinds.

Investor sentiment around Kenyan banking stocks has become somewhat more cautious. While asset quality risks persist, key positives such as robust profitability, steady capitalisation, and improving macro-conditions lend some support. Analysts note that if loan growth recovers and collections improve, banks could regain investor favour, but such upside remains conditional on the broader economy.

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One of the risks flagged by Fitch includes an extended period of elevated public-sector arrears and weak borrower credit disciplines, which could keep impaired loan levels elevated despite improving macro-conditions. Banks are also exposed to shifts in interest rates, currency volatility and potential regulatory changes that could impact profitability and asset quality.

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