On November 8, 2024, Uganda’s Parliament enacted a law capping interest rates for moneylenders at 2.8 percent per month and 33.6 percent per annum. Lately, interest rate caps have become a popular policy tool in several African countries. This tool is currently used by at least 17 African countries to shield borrowers from exploitative practices by moneylenders. However, such restrictions often lead to unintended consequences, including limited financial innovation, increased informal lending, and reduced credit availability for small businesses and individuals perceived as high-risk. To address these problems, governments should promote financial literacy, encourage investment in alternative lending models, and adopt tiered interest rate structures.
Interest rate caps, while aimed at protecting borrowers, can undermine economic freedom by restricting credit access for high-risk and marginalized groups. Standardizing rates without considering borrower risk profiles discourages lenders from serving vulnerable populations like rural entrepreneurs and small-scale traders, which worsens financial exclusion.
In Kenya, for example, the Banking (Amendment) Act of 2016 capped the lending rate at four percentage points above the central bank rate, while the deposit rate was set at 70 percent of the same rate. Commercial banks, constrained by the cap, opted to focus on lending to large, established businesses instead of small-scale traders or rural entrepreneurs. By 2019, Kenya repealed the law due to its detrimental impact on financial inclusion.
Many borrowers in Africa lack an understanding of loan terms, risks, and the long-term implications of borrowing. The level of financial literacy in African countries like South Africa (42 percent), Tanzania (40 percent), Kenya (38 percent), and Nigeria (26 percent) lag significantly behind those of European nations, where literacy ranges between 65 percent and 75 percent.
Promoting financial literacy is a key step towards financial stability and inclusion. Governments in Africa should implement community-based financial education programs to provide more information on lending practices, enabling borrowers to make informed decisions and negotiate better terms.
Rwanda, for instance, has taken a different approach by avoiding strict interest rate caps and instead fostering financial literacy programs and promoting competition among financial institutions. Empowering individuals with knowledge about financial products and the dangers of over-indebtedness could reduce reliance on laws and regulations that punish moneylenders.
Interest rate caps worsen the financial exclusion gap. In this regard, credit unions, cooperatives, and fintech platforms have emerged as viable options for offering affordable and inclusive credit solutions. In Nigeria, fintech companies like Carbon (formerly known as ‘Paylater’) and Flutterwave provide low-cost, short-term loans through mobile platforms, bypassing traditional banks and moneylenders.
These models emphasize community-based trust, innovative technology, and lower administrative costs, making them ideal for addressing the needs of underserved populations. Governments should encourage investing in these alternative lending models by offering tax incentives for investments in such models and establishing clear and consistent financial regulations for the benefits of such alternative lending models. By implementing these measures, governments can create a supportive environment for alternative lending models, thereby bridging the gap left by restrictive interest rate caps. Increasing investment in such models can drive fairer lending practices and ensure that traditional moneylenders are not the sole providers of credit.
Overly restrictive interest rate caps drive moneylenders out of the market, particularly for high-risk borrowers. Adopting a tiered interest rate structure that aligns with market realities could mitigate the risks of moneylenders leaving the market. Rather than a blanket cap, lenders should be allowed to charge slightly higher rates for riskier loans while adhering to the cap for standard borrowers. This approach balances the need to protect borrowers from exploitation with maintaining incentives for lenders to serve diverse market segments. Countries like Kenya have successfully implemented flexible frameworks that allow lenders to manage risk while safeguarding borrowers’ interests.
Interest rate caps must not come at the expense of economic freedom and financial innovation. Policymakers should rather aim for a balanced approach that combines borrower protection with measures to preserve credit access and financial inclusion. A progressive credit system requires collaboration between regulators, lenders, and civil society to meet the financial needs of people from different backgrounds. With the right policies, African countries can safeguard economic freedom while protecting their most vulnerable citizens. The future of Africa’s financial sector could be one where fairness, freedom, and innovation coexist harmoniously.
Calvin Kahiigi is a writing fellow at African Liberty.
Article first appeared in The Chanzo.
Photo by Ibrahim Boran via Unsplash.