Banks to take a hit as KRA unmoved by high loan loss

Kenya Bankers Association CEO Habil Olaka. FILE PHOTO | NMG 

By CHARLES MWANIKI

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Summary

• The new accounting rules, known as the International Financial Reporting Standard 9 (IFRS 9), came into effect at the beginning of this year.
• The rules require banks to make larger provisions for expected loan losses rather than actual losses incurred.
• The taxman has, however, thrown a spanner in the works by retaining the income tax rules that say a tax deduction cannot be made on general provisions.

The Kenya Revenue Authority (KRA) has maintained rules that do not allow tax deduction for the higher loan loss provisions expected with the new accounting guidelines, setting commercial banks on the path to lower profitability, industry insiders said.

The new accounting rules, known as the International Financial Reporting Standard 9 (IFRS 9), came into effect at the beginning of this year and require banks to make larger provisions for expected loan losses rather than actual losses incurred.

Tax experts say the higher provisions, which should ideally translate to lower taxes, will eat into the lenders’ profits.

READ: New accounting rules signal rise in monthly loan charges

The taxman has, however, thrown a spanner in the works by retaining the income tax rules that say a tax deduction cannot be made on general provisions, and can only apply where the reporting entity demonstrates that all efforts have been made to collect the bad debt.

This means that for computation of tax, the KRA will be adding back any deductions arising from the provision to bank profits before calculating tax due.

It effectively means banks will be required to pay higher amounts compared to what they would ideally pay on actual earnings.

Edwin Makori, the Institute of Certified Public Accountants of Kenya (ICPAK) chief executive, said there is no need for ploughing back the deductions because it is all recognised in the profits as the provisioning diminishes and impairments get discharged.

“KRA should rest assured that it will still recover the money since the provisioning falls as you move from one year to another and the amount is recognised in the profit and loss account. There is no loss to KRA in any way,” he said.

“It’s not fair, and it is a conversation [treatment of that provisioning] that should be had between KRA and the banks. KRA’s suggested formula means tax will be charged on amounts that have not been earned.”

The biggest effect will be seen this year, when the higher provisioning will be applied on existing loans amounting to trillions of shillings.

READ: What the new global accounting standards mean for your business

10-year high

Ironically, the new rules came into effect at a time when the non-performing loans ratio stands at a 10-year high, partly due to the difficult economic environment seen last year.

Banks have therefore been anticipating changes in the KRA guidelines to recognise the different kind of provisioning required in the new accounting rules to protect their profitability, which is already suffering because of the cap on interest rates.

Industry lobby Kenya Bankers Association (KBA) said discussion with the taxman on application of the new accounting rules will seek to effectively address the matter of provisioning.

“The discussions with KRA will attempt to bridge the gap between anticipated losses vis-a-vis actual loss incurred in the long run,” said KBA chief executive officer Habil Olaka.

Banks will also have to incur higher staff and audit expenses in preparing their accounts to satisfy KRA requirements, given the revisions needed on the profit and loss account for tax purposes.

Customers can also look forward to a tightening of credit standards, with credit reference bureaus (CRB) set to become more prominent as banks rush to weed out risky borrowers to minimise provisions.

Loan tenures may also be reduced, especially on unsecured facilities, to enable banks minimise the cost of provisioning for the credit.

Shift in lending

The latest credit officer survey by the Central Bank of Kenya (CBK) showed that the majority of banks expect the IFRS9 rules to demand a review of their accounting models, including a shift to collateral-based lending as opposed to unsecured lending.

Mr Makori added that overall, he expects a big hit on bank sector profits this year.

“The shareholders will have to be given the profit warnings early so that they know this is going to be a slim year because of the provisioning,” said Mr Makori.

Dividend payouts for the shareholders that had gone up in the wake of the rate cap, which left lending-shy banks with a larger pool of idle cash, are likely to come down as a result.

Banks expect the higher provisions to eat into retained earnings, which will also affect their capital adequacy and ability to expand.

The CBK has, however, offered a transition period of five years for banks to meet the capital adequacy and liquidity requirements under the new rules.