Distressed Debt Management & Lessons Learnt Through Case Management: Banking Industry in Kenya
Authors: Muriithi Robert Githua 
Published: February 2022

Deteriorating and troubled assets must be subjected to enhanced risk oversight and monitoring to ensure that appropriate action is taken in a timely manner, allowing a high level of obligor turnaround success and reduced risk of loss for the Lender/Financial Institution/Bank. It’s important for a Bank to harmonize Distressed Debt Management approach, called the Watch List (WL) Framework, and details the requirements to ensure timely adherence to regulatory requirements. The impairment requirements of International Financial Reporting Standards (IFRS 9) Financial Instruments, effective as of 1 January 2018, are based on an Excepted Credit Loss (ECL) model and replace the IAS 39 Financial Instruments; Recognition and Measurement incurred loss model. IFRS 9, recognizes impairment allowances on either a 12-month or lifetime ECL basis, dependent on whether there was a significant increase in credit risk (SICR) since initial recognition (being either asset origination date or ‘base date’, whichever is most recent). The measurement of ECL reflects both a probability-weighted outcome and the time value of money, using the best available forward-looking information. There should be relevant policies that would require to be read in conjunction with relevant manuals and Accounting Standards. It’s equally important to detail the monitoring objectives for consistent management of wholesale impairment and the provisions necessary to meet regulatory requirements. It is imperative that when dealing with Distressed Debt/Assets, that attention is given to the requirements detailed under Conduct Risk and that client confidentiality is maintained. Mostly, business failure is a result of financial and/or economic distress. A firm in financial distress experiences a shortfall in cash flow needed to meet its debt obligations. Its business model does not necessarily have fundamental problems and its products are often attractive. In contrast, firms in economic distress have unsustainable business models and will not be viable without asset restructuring. In practice, many distressed firms suffer from a combination of the two. Many factors contribute to the high number of business failures. Some common failures include and are not limited to the below. Poor operating performance and high financial leverage. A firm's poor operating performance may result from many factors, such as poorly executed acquisitions, competition, overcapacity, new channels of competition within an industry (e.g., retail), commodity price shocks (e.g., energy), and cyclical industries (e.g., airlines). High financial leverage exacerbates the effect of poor operating performance on the likelihood of corporate failure. Lack of technological innovation. Technological innovation creates negative shocks to businesses that do not innovate. The arrival of a new technology often threatens the survival of firms that possess related, yet less competitive, technologies. There needs for a business to strategically position itself in the market through digital transformation in its processes, product development and operations Liquidity and funding shock. In periods of weak credit supply, some businesses are unable to roll over maturing debt because of illiquidity in credit markets. Relatively high new business formation rates in certain periods. New business formation is usually based on optimism about the future. But new businesses fail with far greater frequency than do more seasoned entities, and the failure rate can be expected to increase in the years immediately following a surge in new business activity. Deregulation of key industries. Deregulation removes the protective cover of a regulated industry (e.g., airlines, financial services, HealthCare, energy) and fosters larger numbers of entering and exiting firms. Competition is far greater in a deregulated environment. Unexpected liabilities. Businesses may fail because off-balance sheet contingent liabilities suddenly become material on-balance sheet liabilities.