Recently, during a retreat at the National Leadership Institute Kyankwanzi, President Museveni expressed concern over monthly lending rates that go as high as 20% per month and asked the Attorney General to clarify on why there is no law regulating lending rates offered by moneylenders.
Indeed, the Tier 4 Microfinance Institutions and Money Lenders Act, 2016 doesn’t specify a lending rate. Contemplating the implementation of a lending rate cap demonstrates Uganda’s commitment to fostering a business-friendly environment. Such a cap would propel the growth of small businesses, ultimately contributing to an upswing in our GDP.
However, in our pursuit of reforming lending rates, it is imperative to acknowledge the role played by licensed moneylenders. Currently, approximately 897 licensed moneylenders in Uganda collectively disburse over $300 million to Micro, small and medium enterprises (MSMEs), serving as a crucial source of capital that fuels economic growth across diverse sectors.
DIAGNOSING THE PROBLEM: THE DRIVERS OF HIGH LENDING RATES IN UGANDA
The Bank of Uganda’s working paper titled “What Explains High Lending Interest Rates in Uganda?” reveals that lending rates have averaged 21% per annum since the early 1990s.
The primary driver behind these rates is the substantial overhead expenditures faced by financial institutions. To counter these costs, higher interest rates become a necessity for lenders.
A significant portion of lenders in the market are small-scale, operating with loan book sizes ranging from Shs 25m to Shs 100m and catering to an average clientele of 50 borrowers. Given their reliance on interest incomes from loans, particularly from MSMEs and households, the risk of default is a legitimate concern, leading to high lending rates.
Another significant factor is high credit risk. Lenders have little to no information on potential borrowers and, therefore, employ alternative methods, such as continuous monitoring, to manage credit risk. These measures, while essential for risk mitigation, contribute to the overall cost of lending, further impacting the interest rates charged.
An encouraging development is the inclusion of alternative lenders in the Credit Information Sharing (CIS) system following the introduction of the Financial Institutions (Credit Reference Bureau) Regulations of 2022. This enhanced cooperation between lenders and Credit Reference Bureaus offers the potential to positively influence lending rates.
Furthermore, moneylenders in Uganda obtain capital from various sources, and one significant source is commercial banks. The disparity in lending rates compared to other economies within East Africa becomes evident. As of 2018, Kenya’s lending rates averaged at 13.1%, Rwanda at 16.9%, Tanzania at 17.4% while Uganda was at 19.8% according to data by the World Bank.
It is important to note that high borrowing costs from commercial banks often have a correlation to higher interest rates charged by moneylenders on borrowers.
A COMPREHENSIVE APPROACH TO RESPONSIBLE LENDING
Rather than hastily implementing interest rate caps, it’s crucial to understand that high lending interest rates are determined by socio- economic factors on which legislation should be built; therefore, to effectively address this complex issue, a comprehensive approach is needed.
Firstly, we must foster an environment of transparency and competition while encouraging responsible lending practices. Collaboration among lenders, regulators, borrowers and consumer protection agencies can lead to effective solutions that promote a healthier lending ecosystem.
Secondly, enhancing financial literacy and consumer awareness is key. Educating borrowers about the responsible use of credit and financial planning can help reduce instances of loan defaults, contributing to a decline in lending risks and potential interest rate reductions.
Lastly, boosting access to capital for moneylenders, through partnerships with development finance institutions or policy interventions, can alleviate borrowing costs and, in turn, influence lending rates positively.
As we embark on this journey, we urge policymakers and government authorities to embrace a prudent approach that combines progressive regulation and sustainable economic growth. Let us work together to strike a balance between borrower protection and lender profitability, fostering an inclusive financial landscape.
The author is an advocate of the High court and CEO at Social Lend Africa