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Why credit-only MFIs escape Central Bank of Kenya scrutiny

By Macharia Kamau | Jul 8th 2014 | 4 min read
By Macharia Kamau | July 8th 2014

Kenya’s microfinance industry is split into two sets of institutions, with the major differentiator being whether or not they are regulated.

One set is made up of deposit-taking MFIs (DTMs) that are regulated by the Central Bank and operate within the stipulations of the Micro Finance Act.

According to CBK, it has only licensed nine such MFIs, which can accept deposits from customers.

The other set comprises credit-only MFIs, where one only needs the minimum operating licences to start lending cash to individuals and businesses.

This set of MFIs is not under the MFI Act or any other regulation, despite being in the money business.

While there are legit credit-only MFIs that have even expressed interest in joining the league of regulated DTMs, there are many whose operations are a replica of shylock businesses and have been a source of much pain to their borrowers.

This cadre of MFIs, just like the money-hungry shylocks, lend money to desperate Kenyans under near-impossible terms.

Their loans are characterised by high interest rates, which they deduct upfront upon advancing the money to clients. The collateral required is in many instances more valuable than the loan advanced, and they will dispose of the asset to recover their money at the slightest provocation.

The chilling bit is that Central Bank appears not to have the power to penalise these institutions or even question their operations.

Meeting conditions

To illustrate how helpless CBK is in regulating MFIs that are not within its jurisdiction is a case concluded in 2012. Central Bank took Kenya Akiba Micro Financing Ltd to court for doing what it said was carrying out banking operations without meeting the conditions set by the Banking Act.

Central Bank had in November 2005, together with the Banking Fraud Investigation Unit (BFIU), raided the offices of Akiba and confiscated documents and equipment. It also froze the firm’s bank accounts in three banks, accusing it of being engaged in the banking business illegally.

It also queried why the firm was using “finance” in its name, yet it was not licensed.

Akiba’s founder, Mr Gideon Mwiti Irea, and three others were arrested and charged before the Nairobi Chief Magistrate with carrying out the banking business without approval, contrary to Section 3(1) and 3(2) of the Banking Act, and unlawfully accepting deposits without a valid licence, contrary to Section 16(1) and 16(9).

At the same time, Akiba had moved to court, claiming over Sh930 million in damages from Central Bank for crippling its business by confiscating its equipment and shutting down its offices in Nairobi, Kitengela, Ongata Rongai and Voi.

However, in 2011, six years after they were charged, the court acquitted the senior officials of Akiba Micro Financing Ltd, holding that they did not break the law.

After the acquittal, Akiba’s senior officials applied to have CBK ordered to release their property or deposit Sh2 billion as undertaking for damages.

The company explained the nature of its business, noting that at the time of its incorporation in 2004, there was no specific law governing microfinance institutions.

The company said it targeted borrowers who did not wish to be subjected to the rigours of the Banking Act. It further denied engaging in the banking business, saying it was only involved in the hire purchase business as a microfinance institution.

The court in May 2012 found CBK at fault and ordered it to pay Akiba Sh1 billion for damages caused when it raided the firm’s offices.

Initial outcome

The Court of Appeal in November 2013 set aside the ruling by the Commercial Court, and CBK has plans to appeal the case.

The initial outcome of the case is telling of the degree to which the banking industry regulator is toothless in regulating this segment of financial institutions.

In particular was the defence by Akiba that there were no laws regulating the industry in which it operates. To date, credit-only MFIs remain unregulated.

DTMs, however, must operate within legislation that stipulates ownership structure and lending limits.

These institutions now want Treasury to institute some level of control on the credit-only MFIs, with some of the players saying that they take the flack when a player in the non-regulated side of the industry goes rogue.

Mr Mwangi Githaiga, the managing director of the Kenya Women Finance Trust, said that while DTMs play by the book, a few credit-only MFIs have in the past mistreated their customers, which has damaged the credibility of the entire microfinance industry.

“People might not be able to differentiate between DTMs and credit-only MFIs. DTMs are regulated by Central Bank while the credit-only MFIs are not ... but this difference might not be captured when the story is told, and hence the entire industry suffers,” he said.

While drafting the Micro Finance Act, there were plans to come up with two sets of laws, one for DTMs and the other to oversee the operations of the credit-only MFIs. However, only regulations for DTMs went into the Act.

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