The profit recovery path of Kenyan banks may be disrupted by the Russia-Ukraine conflict through second-order risks to the banks' operating environment, a report by Fitch Ratings noted.

Kenyan banks' 2021 results were supported by a significant fall in loan impairment charges from the prior year's high base, and healthy operating profit growth.

"We expect the recovery in earnings to be sustained in 2022, supported by an improvement in margins, following the approval of the banks' own risk-based pricing models by the Central Bank of Kenya, leading to a faster extension of higher-yielding credit."

However, Kenyan banks are not immune from global risks exacerbated by the conflict in Ukraine. These combined with any potential disruption due to Kenya's August general election, threaten to stall a post-pandemic recovery. Credit demand could weaken if operating conditions worsen. While expected interest-rate hikes to counter inflation will benefit banks' margins, they will be counterbalanced by higher loan impairment charges if asset quality deteriorates.

Fitch expects economic momentum in Kenya to continue but certain sectors will be affected by higher global commodity prices. As a net oil importer, Kenya is particularly sensitive to rising energy prices, which directly affects manufacturing and transport.

As an agriculturally dependent economy, Kenya is also sensitive to rising fertiliser costs and declining exports (Kenya is a major tea exporter to Russia). "We also believe construction, which faces rising input costs and government payment arrears, will continue to be affected. The pandemic-hit tourism sector will take longer to recover, in our view."

Kenya is also a major wheat importer from Russia and Ukraine which, in addition to rising food prices, could also lead to shortages of staples. With rising cost of living, consumers will see disposable incomes decline. "This could further fuel social unrest risks. Rising pressures on consumers and businesses will culminate in renewed asset-quality risks, in our view."

Global financing pressures will limit banks' external financing options and raise the cost of funding. Nevertheless, large Kenyan banks have strong deposit franchises with low reliance on market funding, which will offset risks to funding and liquidity, said Fitch. Capital buffers will allow large Kenyan banks to grow and absorb asset-quality risks. "We believe the banks will focus on regional expansion to offset domestic challenges."

(Writing by Brinda Darasha; editing by Daniel Luiz)