Evaluation of Sectoral Loan Performance and Share of Loan Allocation to the Agricultural Sector Within the Banking Industry in Kenya

Abstract

Agriculture is the mainstay of Kenya’s economy providing substantial contribution to the country’s Gross Domestic Product, labour force and foreign exchange earnings, yet the current share of lending to this critical sector amounts to only approximately 3.5 percent of the total bank lending. Commercial banks have taken a cautious approach towards lending to this largely due to the inherent risks associated with farming which make it vulnerable to relatively higher loan defaults, as well as the high costs of administering agricultural financing. This study sought to evaluate the influence of sectoral loan performance on the banking industry’s share of loan allocation to the agricultural sector in Kenya, with non-performing loans used as a proxy for performance. A theoretical study was undertaken using descriptive research design with three objectives in mind: to establish how sectoral non-performing loan ratios influenced the share of loan allocation to the agricultural sector, to assess how sectoral contributions to the total NPLs value influenced the share of loan allocation to the agricultural sector and to determine how the growth rates of sectoral NPL values influenced the share of loan allocation to the agricultural sector. Quantitative secondary data was obtained electronically from the Central Bank of Kenya Bank Supervision Annual Reports for 2013 up to 2023. The data was compiled onto data sheets and Microsoft Excel program used for descriptive analysis of the variables. The findings of the study revealed that the share of loan allocation to the agricultural sector by the banking industry was largely influenced by the non-performing loan ratios of both the agricultural sector and the consolidated sectoral NPLs ratio, with a strong negative linear relationship exhibited in both cases. No association was established between the variables with respect to the second objective. A very strong linear relationship was identified between growth rates of total sectoral NPL values and the share of loans allocated to the agricultural sector, but no association was established when NPL growth rates specific to the agricultural sector were used. Key recommendations made from this study include change of approach by the banking industry in response to high NPL ratios with more focus on remedial action as envisaged by the performance feedback theory, in collaboration with other stakeholders including development partners willing to support de-risking of the agricultural sector. A further recommendation is for the banking regulator to consider setting a specific target for the banking industry’s share of loan allocation to the agricultural sector as a key performance indicator to provide more focus on growth given that there has been little traction over the years, including the period of study. Further studies are recommended to understand the strong positive linear relationship in the third objective. There is also an opportunity for further study with a focus on loan allocation to the other sectors of the economy.