5.1 Credit arrears

Credit arrears are instalments of principal, interest, fees or charges that have fallen due under a credit agreement but have not been paid. A facility is in arrears from the first day after a missed due date, and the longer the amount stays unpaid the less likely it is to be recovered in full. Collecting arrears quickly protects the lender's income and capital and also protects the borrower from penalties, adverse Credit Reference Bureau listing and possible loss of the security. Example: a commercial bank branch in Habaswein finds that a livestock trader has missed two monthly instalments of Ksh 22,000 after a drought and starts its arrears collection process.

Meaning of key terms

• Arrears amount: The total of all unpaid instalments and charges that are already due; it is different from the outstanding balance, which also includes amounts not yet due.
• Days past due (DPD): The number of days since the oldest unpaid instalment fell due.
• Past due loan: A loan with any amount in arrears.
• Non-performing loan (NPL): In Kenya, a loan whose principal or interest is past due for more than 90 days, or which is classified substandard, doubtful or loss under the CBK prudential guidelines.
• Penalty (default) interest: Additional charges on arrears where the agreement provides for them, subject to the law on interest.

Causes of credit arrears

• Business failure or decline: Falling sales, loss of a major customer or poor management.
• Diversion of funds: Loan money used for purposes other than the approved project.
• Poor appraisal: Instalments set above the borrower's real repayment capacity.
• Loss of income: Job loss, salary delays or a check-off deduction stopped by the employer.
• External shocks: Drought, floods, price falls, disease outbreaks, insecurity or economic downturn.
• Delayed payments to the borrower: Contractors and suppliers waiting for payment from government or other clients.
• Wilful default: Borrowers who can pay but choose not to.
• Weak monitoring by the lender: Arrears that are not followed up early grow harder to collect.

Effects of credit arrears

• On the lender: Lost interest income, higher provisions, reduced capital, weaker liquidity and regulatory attention when the NPL ratio rises.
• On the borrower: Penalty charges, negative CRB listing that blocks future credit, legal costs and loss of the security.
• On guarantors: Guarantors may be called upon to pay, and in SACCOs their own deposits may be used to recover the loan.
• On the economy: High NPLs make lenders cautious, reducing credit to businesses and households.

The in duplum rule

Section 44A of the Banking Act limits what a bank can recover on a non-performing loan: once a loan becomes non-performing, the bank may recover no more than the principal owing at that time, plus interest (including any penalty interest) not exceeding that principal, plus the expenses of recovering the money. Credit staff must therefore keep accurate records of when a loan became non-performing, because interest charged above this limit cannot be recovered.

Example: a loan becomes non-performing with principal owing of Ksh 400,000.
Maximum principal and interest recoverable = principal + interest up to an equal amount
= 400,000 + 400,000
= Ksh 800,000, plus the recovery expenses

Process of collecting credit arrears

1. Reminder before the due date: SMS or email a few days before each instalment reduces simple oversights.
2. First contact after a missed payment: A call within one to three days to find out the reason and agree a payment date.
3. Follow-up and promise to pay: Each promise is recorded in the collection system with the date and amount, and checked on that date.
4. Customer visit: If payment is not made, the officer visits the borrower's home or business to assess the situation and negotiate.
5. Formal demand: A demand letter is issued, stating the amount in arrears and the consequences of non-payment.
6. Involving guarantors: Guarantors are notified and asked to help the borrower pay or to pay under their guarantee.
7. Restructuring where viable: Where the borrower has a genuine temporary problem, the facility may be rescheduled under the bank's policy and the CBK guidelines.
8. CRB notification: The borrower is notified before negative information is submitted to a licensed Credit Reference Bureau, as the CRB regulations require.
9. Recovery action: Statutory notices and realisation of security through licensed auctioneers, or legal action, under the Land Act, the Movable Property Security Rights Act or the loan agreement, handled with the legal department.
10. Write-off: When recovery efforts are exhausted, the debt is written off with board approval, while recovery efforts may continue.