Subscribe to our free newsletter to read all our in-depth commentaries and to have the latest insights sent to your email!
Register participation
Register participation
MARK RUHINDI
Towards the end of last year, the Minister for Finance gazetted The Tier 4 Microfinance Institutions and Money Lenders (Lending Conditions) Regulations, 2024. These regulations were gazetted alongside The Tier 4 Microfinance Institutions and Money Lenders (Prescription of Maximum Interest Rate) Notice, 2024.
Whereas both these instruments were gazetted at the same time, The Lending Conditions regulations provided for a Transition period for entities that were in existence on or before the commencement of the Regulations.
A transition period of three months from the date of commencement was therefore allowed for sector players to adapt their commercial processes to align with the new compliance requirements introduced by the regulations.
These regulations significantly altered the money lending landscape and it is Important to note at this point that the money lending business is now riskier as a result of these regulations.
It is now easier to impeach a money lending transaction as illegal in a Court of Law, with far reaching consequences to a lender with a large exposure to similar transactions already undertaken with several other lenders.
The other important observation I should perhaps make at this point is the third party risk exposure from lenders operating through digital lending platforms, but who have yet to review commercial processes to take into account the conditions ushered in by the regulations.
Operators of payments systems, such as (MTN MoMo and Airtel Money) through which digital lending is conducted may find themselves entrapped in compliance risk and potential litigation risk arising out of their clients’ compliance breaches against the new law; This risk exposure may be contractual, regulatory or both.
Two of the several stringent conditions in these regulations that may be of interest to both lenders and borrowers are;
- The cooling period provisions
Bearing in mind that the regulations were enacted to act as safeguards against exploitation of would-be borrowers by money lenders, at the direction of the Head of State himself, these provisions were bound to become foundational and are therefore the main focus for this commentary.
A cooling off period is not a new regulatory safeguard in the credit sector. The Bank of Uganda Consumer protection guidelines already provide for a cooling off period of 10 Working days within which a borrower may terminate a credit contract and repay the loan amounts and only administrative fees incurred by the lender in arranging the facility, without any penal or hidden charges levied. The Minister benchmarked this to incorporate a cooling off period in the Regulations.
Institutions or money lenders are now under a mandatory obligation to allow borrowers at least five working days after signing a lending contract, to revoke or terminate the contract by written notice delivered to the institution or money lender. The revocation termination is effective if the borrower repays the full amount of the loan at the time of cancellation of the contract and any other administrative charges, or fees which have been reasonably incurred in arranging the loan and these must not exceed two percent of the value of the loan.
Borrowers in money lending transactions are usually do or die transactions with time being of utmost essence. The bulk of money lending transactions are also short term in nature normally solve short term liquidity and cash flow constraints. It therefore means borrowers will easily take advantage of this cooling off period to avoid meeting heavier interest burdens if they can find the money to repay loans or if they can find better terms with competitors.
- Interest, fees and charges provisions
Additionally, the regulations read together with the Legal notice prescribing the interest cap, have effectively not only outlawed and made illegal any money lending transaction which levies interest rates above the prescribed cap but gone further to outlaw hidden charges and fees which would exceed one hundred percent the of principal amount per annum of the total loan amount.
The implication of this is that should a borrower default or refuse to pay, and the dispute becomes the subject of litigation, at best only the principle is recoverable.
The regulations enjoin institutions and money lenders to disclose all third party fees and charges relevant to their products in relation to services from the third parties and agents involved in transactions. An obvious example here is a digital lender who uses and pays commissions or fees to a payment system service provider such as MTN MOMO or Airtel Money.
Effectively, a money lender who has been charging 10% MONTHLY interest on loans is not at liberty to charge 2% interest and characterise the remaining 8% as arranging charges or other hidden fees undisclosed at the time of the contract. This would bring such a transaction into the illegal territory.
Commercial and Regulatory Implications;
The money lending business has as a result of the regulations changed fundamentally and as the first victims of badly structured transactions take the fall and lose money in transactions that would have been struck down by the courts, we will likely see money lenders winding up business.
Overall below is my own assessment of who the likely winners and losers will be in the long run.
The winners:
1. Banks;
There will be more demand for short term credit from Banks as more risk averse money lenders opt to hold onto liquidity or to invest elsewhere.
There might be an increase in bank deposits from liquid money lenders who are unwilling to lend at the capped rates.
2. Lawyers;
Money ending transactions are increasingly riskier and it may be prudent to let technical people handle the bulk of the workload that goes into de-risking credit transactions. Institutions and Money Lenders will require more transaction advisory, due diligence and documentation services of lawyers.
3. URA;
Enhanced compliance requirements will improve tax enforcement, since it is now harder for money lenders to operate informally.
More transactions will now be structured in a way that makes it impossible for Institutions and money lenders to escape the tax net, since the compliance threshold is now higher. There will be more third party information to be relied upon by the taxman when raising assessments for non-tax compliance. URA has in the past carried out electronic data seizures and retrieved electronic data to be used in tax audits.
You may read my commentary here, on the role of third-party transaction information in tax administration to understand the manner in which URA leverages third party transaction information and the categories of third party data used to raise tax assessments.
The losers:
1. Borrowers;
Money lenders might simply fix their money in Banks for negotiated interest to escape heightened legal risk in money lending transactions.
Desperate borrowers might be forced to sell off assets for short term liquidity needs that would have been solved by money lenders.
It might become harder to come by urgent short term credit especially where hefty amounts are involved due to corporate bureaucracy in Banks, and lead to lost opportunities.
2. Money Lenders;
Money lending transactions may no longer be as lucrative as under the past regulatory regime, and will be much riskier for businesses that are not properly advised.
Recommendations;
It may be prudent for Tier 4 Institutions, Money Lenders and FINTech businesses to conduct both operational and corporate restructuring to align with the new legal framework and to resolve the commercial and compliance issues raised among many others that have arisen as a result of this enactment, as soon as it practical, in order to mitigate legal, compliance risk as well as tax risk.
And to Review lending models to ensure compliance with interest rate caps and disclosure requirements and to engage legal and regulatory experts to de-risk credit transactions and avoid legal challenges.
Follow and Connect with me.
TAXATION OF BANKING AND FINANCIAL SERVICES MASTERCLASS
I am pleased to invite you to participate in our taxation of banking and financial services tax risk training tailored for the banking and financial services industry.
This training is tailored to corporate teams and is most beneficial to professionals in credit risk, legal, taxation and finance roles in the banking and financial services industry but generally to all individuals with a keen interest in understanding legal and tax risk in transactions.
It’s aimed at enhancing participants’ knowledge and understanding of the legal and taxation peculiarities of banking and financial services and the transaction legal and tax risk mitigation strategies applicable.
This is also an opportunity to self check and alter or tweak risk positions that might hurt institutions in the midterm.
Register participation
Discover more from MRT Tax
Subscribe to get the latest posts sent to your email.