When a new international accounting standard takes effect on January 1 2018, banks in East Africa are expected to take a major hit in their earnings and capital levels.

The International Financial Reporting Standard (IFRS) 9 will introduce a more stringent way of providing for bad loans.

The standard requires lenders to consider all credit, including to government, as risky and to set aside money that would cushion them in case of actual default.

This is called provisioning for bad loans. Setting aside of huge provisions will deprive banks of cash that could have otherwise been used to trade with to increase revenues.

This is expected to eat into bank profits and erode their reserves which form part of their core capital. Small lenders in particular will be dealt a major blow while small and medium-sized businesses will suffer a credit squeeze.

Previously, banks were only required to provide for loans that had not been serviced for a period exceeding 30 days, while lending to government was considered risk-free and did not require provisioning.

The measure is expected to shield banks from sovereign defaults like those by Greece and Argentina, ensuring stability of the global sector. Greece failed to honour its debt payment in the aftermath of the global financial crisis of 2007–08 requiring bailouts.

Lenders will also be required to set aside money for trade financing transactions such as letters of credit and guarantees, which were previously considered risk-free.

In Kenya, banks are holding Treasury bills and bonds valued at over Ksh990 billion ($9.9 billion) and have off balance sheet items of Ksh804 billion ($8 billion).

Under the new requirements any loan that falls due by more than a day will be required to be moved to a new classification, requiring more provisioning unlike in the previous case where loans were reclassified after they fell 90 days due.

Barclays Bank said it expects lenders to be more aggressive in their debt collection efforts in order to ensure a loan does not fall due, and be choosy on which sectors they lend to in order to keep their probabilities of defaults low.

Already, Equity Bank has said it will be moving out of unsecured lending which is associated with salaried staff whose default rate has been rising owing to retrenchments as the economy took a downturn.

Further conservative lending by commercial banks in the East African region will deter economic growth with central banks already citing slow credit growth to the private sector as a concern.

In Kenya, the scenario is aggravated by the interest rate caps, which have been blamed for reduced private sector lending having limited lenders appetite for risk.