Unregulated Microfinance Interest Rates: The Hidden Driver of Default in Kenya Introduction

Kenya’s financial landscape has transformed dramatically over the past two decades, with commercial banks, digital lenders, and microfinance institutions (MFIs) expanding credit access to millions. Microfinance was introduced with a noble mission to extend small loans to the financially excluded and empower low-income communities.

Yet, beneath this success story lies a troubling reality. Many borrowers are trapped in cycles of debt not because they lack discipline, but because microfinance interest rates remain unregulated, opaque, and disproportionately high. The absence of clear, enforceable limits on what MFIs can charge has allowed excessive interest accruals to thrive pushing vulnerable clients into default and undermining the very goal of financial inclusion.

The Regulatory Gap

Kenya’s Banking Act and the Central Bank of Kenya (CBK) Prudential Guidelines provide strong borrower protections for regulated commercial banks and licensed deposit-taking MFIs. These laws prohibit compounding of interest on non-performing loans and promote fair lending practices.

However, a large segment of the microfinance sector non-deposit-taking MFIs and digital lenders operates outside CBK’s direct oversight. This regulatory gap means there are no uniform ceilings or disclosure requirements for the interest, fees, and charges they impose.

Consequently, many lenders design loan products with effective annualized rates that exceed 30–40%, often compounded by hidden administrative fees, insurance premiums, and penalties. Borrowers, most of whom have limited financial literacy, sign up without fully understanding the total repayment obligation. This has increasingly manifested in courtrooms, where numerous cases have been filed by financial institutions seeking to enforce repayment, while borrowers contest the interest rates and charges applied. These disputes highlight the growing tension between credit accessibility and fairness, and underscore the urgent need for regulatory clarity in the microfinance sector.

How Unregulated Interest Fuels Default

In this unregulated environment, default has become systemic rather than incidental. Borrowers are not merely failing to meet obligations they are being priced out of repayment.

Common practices include:

• Rolling over arrears into new loans, turning unpaid interest into “fresh principal.”
• Applying layered charges that inflate loan balances beyond reach.
• Using short repayment cycles that leave little room for income fluctuation.

The outcome is predictable: borrowers repay multiples of their original loan amounts before defaulting, often losing household assets or productive tools in recovery processes. For many low-income families, a loan intended to provide relief instead becomes a catalyst for deeper financial distress.

The Need for Clear Regulation

To curb rising defaults and restore confidence in microfinance, Kenya must move toward uniform regulation across all credit providers. The solution lies not merely in capping interest, but in clarifying and enforcing what constitutes the “true cost of credit.”

A reformed regulatory framework should:

1. Bring all MFIs and digital lenders under CBK supervision, regardless of deposit-taking status.
2. Broaden the legal definition of “interest” to include all ancillary charges and fees.
3. Mandate standardized cost disclosure, requiring lenders to provide total repayment figures before loan issuance.
4. Establish reasonable interest rate ceilings aligned with market realities and consumer protection principles.
5. Strengthen borrower education and recourse mechanisms to make justice accessible and affordable.

Such clarity would promote fairness, sustainability, and accountability ensuring that access to credit does not come at the cost of perpetual indebtedness.

The Role of Our Law Firm

As a firm committed to advancing financial justice and consumer protection, we at ESK Advocates LLP recognize that legal advocacy is key to bridging the gap between policy intent and borrower reality.

We are actively engaged in:

• Strategic litigation, challenging exploitative lending practices and excessive interest accruals that violate public policy.
• Public legal education, empowering borrowers with knowledge of their rights and remedies under Kenyan law.
• Collaborations with civil society and financial inclusion partners, promoting ethical, transparent lending practices.

Through these interventions, we seek to realign microfinance with its original mission: enabling, not impoverishing, the financially excluded.

Conclusion

Kenya’s microfinance sector stands at a crossroads. While it remains a crucial pillar of financial inclusion, its credibility is being eroded by unchecked interest practices that push borrowers into default and despair. The solution is clear: every credit provider must operate under one transparent and enforceable regulatory framework.

Microfinance should empower households, not entrap them. By closing the regulatory gap and enforcing fair lending standards, Kenya can turn microfinance back into a tool for growth and dignity.