The Overdraft That Never Clears: How Float Becomes Permanent Debt

There is a moment in many Kenyan business banking relationships that nobody marks at the time. The overdraft, taken out to bridge a two-week gap between paying a supplier and being paid by a customer, stops coming back to zero. First it dips below the line for most of the month instead of a few days. Then it never returns to credit at all. Then the business starts operating from a balance that is permanently negative, and the limit becomes the new zero.

Nothing was signed to make this happen. No decision was taken. The facility that was sold as flexibility quietly became the most expensive term loan on the balance sheet, one with no repayment schedule, no end date, and no reduction in principal.

This is the single most common facility mispurchase in Kenyan SME banking, and it is entirely fixable once you can see it. This guide covers how overdraft pricing actually works, the covenant most owners have never read, the diagnostic that tells you whether you have crossed the line, and the arithmetic of doing something about it.

For where the overdraft sits among the alternatives, see the complete guide to borrowing money in Kenya and the SME finance handbook.

Key Insight: An overdraft is priced for a balance that moves. Its whole economic logic is that you pay only for what you use, on the days you use it, in exchange for a higher rate than term debt. If your balance never returns to credit, you have taken the higher rate and given up the only benefit that justified it. You are paying a flexibility premium on a facility you are not using flexibly.

Part 1: What an Overdraft Actually Is

An overdraft is a revolving facility attached to your current account. The bank sets a limit, and you may draw the account into debit up to that limit. As money comes in, the balance rises back toward zero, and as money goes out it falls again.

Three characteristics define it, and each is regularly misunderstood.

It is repayable on demand. Unlike a term loan with a contractual maturity, an overdraft is legally repayable when the bank asks. In practice banks do not call facilities arbitrarily, but the legal position matters at annual review, and it is why an overdraft is a weaker foundation for long-term funding than owners assume.

It is reviewed annually. The limit is not permanent. At each review the bank reassesses your business, your conduct, and how you have used the facility. It can be renewed, increased, reduced, or withdrawn.

It is priced for fluctuation. The rate on an overdraft typically sits above comparable secured term lending, because the bank must hold capital and liquidity against the full limit while only earning interest on what you actually draw. You pay that premium for optionality. If you never exercise the optionality, you are simply paying more.

Part 2: How the Interest Actually Works

This is where most owners are genuinely surprised. Overdraft interest does not accrue on your limit, and it does not accrue monthly on a fixed balance. It accrues on the balance actually utilised, counted daily:

$$\text{Interest} = \sum_{d=1}^{n} \left( \text{Utilised balance}_d \times \frac{\text{Annual rate}}{365} \right)$$

Two consequences follow that are worth internalising.

Paying money in for a few days genuinely saves money. If a customer settles early and your balance sits KES 400,000 higher for eleven days, you have saved eleven days of interest on KES 400,000. Sweeping idle cash against the overdraft is one of the few genuinely free wins in SME treasury.

The cost is driven by average utilisation, not peak. A business that touches its KES 2,000,000 limit twice a year but averages KES 300,000 drawn is running a cheap facility. A business that sits at KES 1,900,000 every day of the year is running an expensive one, even though both hold the same limit.

Then there are the charges that do not depend on usage at all. Arrangement, commitment, or facility fees are typically charged on the limit, annually, whether or not you draw a shilling. A KES 2,000,000 limit at a 1.5% arrangement fee costs KES 30,000 a year in fees alone. An unused overdraft is not free, which is an argument against holding a limit far larger than you need, and the wider anatomy of these charges is set out in the hidden leak of fees and FX spreads.

One important gap: revolving facilities, including overdrafts and credit cards, sit outside CBK's revised risk-based credit pricing framework. The published-benchmark-plus-disclosed-margin transparency now applying to term loans and mortgages does not reach your overdraft, as covered in the guide to the revised pricing model. You have to do the cost comparison yourself.

Part 3: The Clean-Down Covenant Nobody Reads

Most business overdraft facility letters contain a clean-down or annual cleanse condition. It requires the account to swing into credit, or below a stated threshold, for a defined number of consecutive days at least once in each twelve-month period. Thirty consecutive days is a common formulation, though the specifics vary by bank and facility.

The purpose is not administrative. It is a test of whether the facility is doing the job it was priced for. An overdraft that cleans down is genuinely funding a fluctuating working capital gap. One that cannot clean down is funding something permanent, which means the bank is carrying term risk at overdraft documentation, without amortisation and without the security package that term debt would normally attract.

Two practical points:

Find out whether your facility has one. Read the facility letter, not the marketing. If a clean-down condition exists and you have never met it, that is a live covenant breach, and you would rather discover it yourself than have it raised at review.

Do not fake it. Borrowing elsewhere for thirty days to force a clean-down, then drawing straight back, is visible in the statement and it damages credibility precisely when you need it. Lenders have seen the manoeuvre.

Part 4: The Diagnostic, or What Your Statement Tells a Lender

Pull twelve months of current account statements and plot the closing balance. The shape tells you which of three businesses you are.

The third pattern has a specific name in credit conversations: hardcore utilisation, the portion of the overdraft that never gets repaid. A lender reviewing your file will identify the lowest balance reached in the period and treat everything below it as permanent borrowing, because that is exactly what it is.

Here is the part worth planning around. When a lender concludes your overdraft is hardcore, the outcomes available to them are mostly unpleasant for you: reduce the limit at review, decline an increase you have requested, require a formal restructure into amortising debt, or in a deteriorating case, withdraw the facility. The business that recognises the pattern first, and proposes the restructure itself, controls the timing and the terms. The business that waits gets whichever option suits the bank.

The self-test is one question: over the last twelve months, what is the least amount I owed on this account? If that number is large and stable, it is not an overdraft. It is a term loan you have not documented.

Part 5: The Arithmetic of the Trap

Consider an SME with a KES 2,000,000 overdraft limit. All figures illustrative.

Scenario A, the product used correctly. The balance fluctuates with the trading cycle, averaging KES 600,000 drawn across the year, at an overdraft rate of 18%.

• Interest: KES 600,000 × 18% = KES 108,000 a year
• Plus arrangement fee on the limit at 1.5%: KES 30,000
• Total: KES 138,000, for a facility that absorbs every timing mismatch the business meets

Scenario B, the trap. The same business, same limit, but the balance sits at KES 1,900,000 permanently.

• Interest: KES 1,900,000 × 18% = KES 342,000 a year
• Plus the same KES 30,000 fee
• Total: KES 372,000 a year, and the principal never reduces

Now compare Scenario B against terming out that same KES 1,900,000 over three years at 16%:

The term loan costs roughly KES 521,000 less in interest over three years, and at the end of it the debt is gone rather than sitting exactly where it started.

The monthly payment is higher, and that is the honest catch: KES 66,798 against roughly KES 28,500 of interest-only servicing. That difference is not a new cost. It is principal repayment, the thing the overdraft was letting you avoid, which is precisely why the balance never moved. A business that genuinely cannot fund the amortisation does not have an overdraft problem; it has a profitability or working capital cycle problem, and the honest place to diagnose that is the working capital cycle and the three financial statements.

Part 6: Matching the Facility to the Actual Gap

The overdraft is often the wrong instrument not because it is bad, but because it is the one the business already had when a different need appeared.

That last row matters more than the others. If the overdraft has crept up because the business is not profitable, restructuring it changes the shape of the debt but not the trajectory. The restructure buys time to fix the underlying business; it is not itself the fix.

Part 7: How to Convert, and How to Ask

If the zero test says your overdraft is hardcore, the move is to propose the restructure rather than wait for it.

Establish the hardcore number. Twelve months of statements, lowest balance reached. That figure is the term loan you should be asking for.

Split the facility. The standard structure is to term out the hardcore portion into an amortising loan, and retain a smaller overdraft for genuine fluctuation. A business with a KES 2,000,000 limit and KES 1,500,000 hardcore might convert KES 1,500,000 to a three-year term loan and keep a KES 500,000 overdraft that can actually clean down.

Bring the evidence. A restructure request is a credit application. It needs current management accounts, twelve months of statements, an explanation of what drove the hardcore build-up, and a credible account of why it will not rebuild. The preparation is set out in the anatomy of a bank proposal.

Expect security questions. Term debt usually attracts a stronger security package than an overdraft of equivalent size. That is part of the trade for the lower rate and the defined end date.

Ask early. A borrower proposing a restructure while performing is a business managing itself. The same conversation after a covenant breach, a declined increase, or arrears is a workout. The facts are identical; the outcomes are not, and the difference in pricing and appetite is real. More on the mechanics in debt consolidation and refinancing.

Risk Factors

Decision Framework: Six Questions About Your Overdraft

What is the lowest balance in the last twelve months? This is the hardcore figure and the single most informative number about your facility.

Does my facility letter contain a clean-down condition, and have I met it? Read the letter. If not met, plan the conversation before review.

What is my average utilisation, and what am I paying in fees on the limit? Average utilisation drives interest; the limit drives fees. Both are managed differently.

Is the underlying gap timing or structural? Timing gaps suit an overdraft or receivables finance. Structural gaps need term debt.

Could a cheaper instrument fund this specific need? Match the facility to the transaction, not to what you already hold.

If the bank halved my limit at the next review, what would happen? If the answer is serious disruption, you are too dependent on a demand facility and should be restructuring now.

Bengula View

Three points from the desk.

First, the overdraft is the right product for a narrow job and it is routinely asked to do a much wider one. Its logic is that you pay a premium for the days you need money and nothing for the days you do not. A business permanently at its limit has inverted that bargain completely: maximum cost, zero flexibility benefit, no principal reduction. Nobody chooses this. It accumulates.

Second, the zero test should be an annual habit, not a crisis response. Once a year, pull the statements and find the lowest balance. That one number tells you whether your facility is still doing the job it was priced for. It takes ten minutes and it is the cheapest early warning available to an SME owner.

Third, whoever raises the restructure first sets the terms. A hardcore overdraft is visible to the bank long before it becomes a problem for the business, because the pattern is unmistakable in the account conduct. Bringing a proposal to convert it, with evidence and a plan, reads as competence and usually gets a constructive hearing. Waiting until the annual review raises it converts the same facts into a defensive conversation where the available options are narrower and more expensive.

Conclusion

An overdraft that clears is one of the most useful facilities a Kenyan business can hold. It absorbs the mismatch between when you pay and when you are paid, it costs nothing on the days you do not use it, and it requires no renegotiation every time the cycle moves.

An overdraft that never clears is the same product doing none of that: a permanent debt at a flexibility price, with no repayment schedule, no maturity, and an annual review at which someone else decides what happens next.

The distinction is not visible in the facility letter or the monthly charge. It is visible in twelve months of statements and one number, the lowest balance you reached. Find that number. If it is large and it has not moved in a year, you do not have an overdraft. You have a term loan that nobody has agreed the terms of yet, and it is worth being the one who proposes them.

Related Reading

• The Complete Guide to Borrowing Money in Kenya for where the overdraft sits among the alternatives.
• The Working Capital Cycle for diagnosing whether the gap is timing or structural.
• What Accounts Receivable Really Costs You for the receivables-linked alternative.
• LPO and Purchase Order Finance for order-backed funding.
• Debt Consolidation and Refinancing in Kenya for the restructure mechanics.
• The Anatomy of a Bank Proposal for preparing the ask.
• How to Read Financial Statements and the seven ratios for diagnosing the underlying business.
• The Revised Risk-Based Credit Pricing Model for why revolving facilities sit outside the new transparency rules.

References

• Central Bank of Kenya. Banking sector lending rates and the risk-based credit pricing framework, including the treatment of revolving facilities.
• Total Cost of Credit portal. Published pricing disclosures for covered facilities, useful when comparing a term restructure against an existing overdraft.
• Kenya Bankers Association. Industry practice on business lending facilities.

All rates, fees, and worked examples in this guide are illustrative and used to show the mechanics. Overdraft pricing, arrangement fees, and clean-down conditions vary by lender and by facility; read your own facility letter and confirm current terms with your bank.

General business education, not individualized financial, tax, or legal advice.