Hello

Your subscription is almost coming to an end. Don’t miss out on the great content on Nation.Africa

Ready to continue your informative journey with us?

Hello

Your premium access has ended, but the best of Nation.Africa is still within reach. Renew now to unlock exclusive stories and in-depth features.

Reclaim your full access. Click below to renew.

Caption for the landscape image:

Interest rates caps: Fighting predatory lending or hurting the poor?

Scroll down to read the article

Katsibayo Kagumya

As the New Year gets underway, a curious paradox re-emerges - even those with formal bank accounts continue to turn to the thriving informal lending sector. This raises two critical questions: a) What lures borrowers into the informal moneylenders' financial world? and b) How can authorities bring these informal lenders under effective supervision, given the recent ministerial legal notice capping their interest rates?

Under the Tier 4 Microfinance Institutions and Money Lenders Act, Uganda's Minister of Finance, on November 20, 2024, instituted a legally mandated interest rate ceiling of 2.8 percent monthly (equivalent to an annual simple rate of 33.6 percent) for money lenders. The Uganda Microfinance Regulatory Authority (UMRA), established by Section 6 of the same Act, regulates, supervises, and licenses all Tier 4 microfinance institutions and money lenders nationwide. 

Previously, some unregulated moneylenders conducted their unregulated practices that involved exorbitant interest rates, rudimentary and aggressive debt collection tactics, including property confiscation, and misleading clients through deceptive agreements, such as disguising loan agreements as sales agreements. The coming into existence of UMRA is supposed to have eliminated the informal money lending business, but experience shows that this unregulated business is well and thriving. We must then ask if Uganda's recent money lender interest rate cap policy reforms are going to have any impact on predatory lending practices?

Interest rate caps on loans have been employed in at least 76 countries to varying degrees. While intended to curb predatory lending practices, these caps often yield unintended consequences. For example, regulated financial institutions tend to withdraw from serving low-income or higher-risk market segments, effectively reducing access to credit for those who need it most. Additionally, formal sector lenders attempt to compensate for lost revenue by increasing fees or reducing price transparency, ultimately increasing the overall cost of borrowing.

Therefore, while interest rate caps can play a role in consumer protection, their implementation requires careful consideration to avoid inadvertently harming the borrowers they aim to protect. Their use tends to create a pool of unbankable borrowers who resort to informal money lenders at more usurious interest rates. 

It is in this context that Uganda's new interest rate cap of 33.6 percent annually for moneylenders seems to have sparked controversy, because of its tendency to drive lenders into a black market.
Ugandan moneylenders contend that the interest rate cap is a discriminatory and ineffective measure that contradicts Uganda's free market principles. They argue that targeting a single sub-sector with interest rate caps creates unfair competition and unequal treatment within the financial industry. This mirrors Kenya's failed 2016 interest rate cap experiment, which was repealed in 2019 due to adverse economic impacts.

Licensed moneylenders in Uganda dispute the Ministerial legal notice, arguing that it is based on the misconception that they operate illegally and exploit borrowers. They maintain that licensed lenders are regulated and supervised and do not charge exorbitant rates. They attribute the alleged predatory practices to unlicensed operators and digital lenders who operate outside regulatory oversight. But what is not being addressed by the cap and the prevalence of unregulated money lenders?
This calls for the Government to conduct thorough research and engage in open dialogue with all stakeholders before implementing policies that could have further unintended consequences. While consumer protection is paramount, fostering a fair and competitive lending environment that does not stifle legitimate businesses or drive lending underground is important. A balanced approach that addresses equity and market realities is essential for promoting financial inclusion and protecting vulnerable borrowers.

Long-term solutions for improving financial access should focus on fostering competition, innovation, consumer protection, financial literacy, and promoting microcredit products instead of interest rate caps. While acknowledging the potential role of interest rate caps,  there is a need to carefully consider the unintended consequences. Working with all stakeholders to address the problem of unlicensed lending is a positive step towards finding a more effective and balanced solution.

Mr Katsibayo Kagumya is a financial inclusion commentator and enthusiast