Detailed analysis of various business sectors in Uganda

What’s the deal with money lending?

 

About my guest writer:

Ssaabwe Ronald is a money lender in Kampala operating in Wandegeya and having an office opposite the Law development centre he has been in the money lending business for over five years being the source of financing to Makerere university students and the business men in wandegeya. Ronald has a bachelor’s degree in Business communication and his experience in the business has kept him above the curve. Speak to us if you would like his contacts.

About the writer

For over 9 years I have worked with several clients in Uganda, The Bahamas and the United Kingdom in providing audit, tax, accounting and advisory services. My sector experience with clients in various sectors including banks and other financial services entities enables me have good understanding of this sector. To see the full depth of my experience, please see my profile

Article summary

The archaic money lenders law is a minefield to navigate if you are to succeed in this sector. In addition you need to grapple with the ever increasing competitive field comprised of not only banks and alternatives like SACCOs and MFIs but also now more advanced options like mobile money platforms and online lending (including peer to peer lending/crowd funding models).

Despite this, is the sector profitable?

Background

I have generally steered away from money lending. I must have been scared when as a child, one of the first books I read being Shakespeare’s “Merchant of Venice” where Shylock a Jewish  money lender demanded as security for money lent: “a pound of flesh, the one closest to the heart”.

When I asked my colleagues though about their  experiences, I got the following from one associate:

“Personally I have had a good experience with borrowing money from money lenders  as it has been a great breakthrough in my times of need when am most desperate and in need for financial assistance. The system is friendly because I sign an agreement with the lender and put security and in just a few minutes I get the money I want and the business goes on. It is cheap for me to obtain a loan from a money lender who is a friend of mine. It only takes me a phone call and the money is availed to me. However, not all clients of money lenders are happy as for example SSebunya Lawrence a close friend of mine, a resident of Namasuba a Kampala suburb, lost his piece of land in Wakiso valued at Shs 6 million to money lenders.

 He told me he was in desperate need of Shs 4 million to recapitalize his then failing poultry business. He could not turn to his bankers because he owed the bank an outstanding balance of Shs 3 million. He found himself at the door step of a money lender, and he was fascinated at how quick and easy it was for him to obtain the loan. The money lenders just told him to complete a form and then attach his passport size photographs, then hand in his piece of land as collateral. Within two days, money was at his disposal. Lawrence was given two months within which to pay the loan. He was optimistic that he would be able to pay the loan since he had "ready orders" from some of his customers in hotels and restaurants. But, this was not so. The two months elapsed without him raising sufficient money to pay the loan, and before he knew it; his piece of land was up for auction. Many Ugandans have lost their personal property as a result of dealing with money lenders and as a result they have lost interest and are exhausted about the system but because of the economic situation in the country, borrowing money has become inevitable if you want to succeed in the business world.”

Foreword

The rise of money lenders in Uganda has probably arisen owing to the desire for Ugandans to “cut corners”. As a number of them are borrowing for business, I believe many of them would be eligible for bank or MFI loans but in these instances they would need to present accounting and other records. As there is no compliance culture in Uganda, they therefore take the easy way out: The Shylocks of this world.

The above argument of course is partially simplistic as there is the other side of the coin that banks are overly inefficient and Uganda has not developed a credit rating system which would enable lenders to very quickly and efficiently assess client risk.

The Credit Reference Bureau set up by Bank of Uganda will hopefully in a few years go a long way towards solving this problem, particularly if they (together with Bank of Uganda) are able to advance and be able to allow various lenders (if regulated in some form) to access this information.

What is in the future for the sector?

In addition to the existing players waking up to the opportunity and streamlining their operations to offer loans  and say overdrafts faster, there are two other trends worth noting.

Mobile money lending

The mobile money revolution has been sweeping Uganda. In Kenya it has however become advanced even further. One company, M- pepea for example provides automated loans 24/7 using the mobile money platform.  They provide loans to employees/members of organisations (such as SACCOs or companies) registered to them.

Online lending and crowd funding (or peer to peer lending)

Online lending. We are still some years (perhaps decades) away from advanced money lenders such as in the UK where you can get a loan in 15 minutes, using an online application. This is done by companies such wonga.com.

Crowd funding or Peer to Peer lending on the other hand is spearheaded by companies like kickstarter and kiva.org. The peer to peer lending model, for example the one done by Kiva.org is that a business say in Uganda is “fronted” by a local Micro Finance Institution (MFI) (such as BRAC) and highlights entrepreneurs who need loans. Say a loan of $1,000. The information on the borrower is put on the internet (Kiva for example is US based). Different lenders like you and I contribute small amounts each ($25 in Kiva’s case) until the $1,000 is raised. The money is transferred to the lender and then they repay this regularly. The MFI does the collection and monitoring of loan repayment.

The above model is already working so it is not technically in the future, but the future we mean is that soon this model of lending is going to become main stream and legislation has to be made to govern the sector as for example has been done by the SEC in the US and the Ontario Securities Commission in Canada.

Perhaps in a few years, Bank of Uganda will also legislate this sector as part of its overhaul of the Money Lenders Act 1952 which is a pretty outdated act that has not kept up to date with the financial sector in Uganda and the role of money lenders. That said:

Why open up a money lending company in Uganda?

Money lending is one of the fastest growing financial industries being operated by the formal sector (banks, credit and microfinance institutions) and the informal sector (individuals known as loan sharks, village savings and loans schemes).

The 2010 FinScope report on Uganda concludes that 70% of Ugandans are financially served, a good growth over 2006 where the level of financial inclusion stood at 57 percent for the 18+ years population.  Of the 70% served:

  • 20% use formal financial services (e.g banks) loan.
  • 50% Rely in the informal financial services channels (e.g SACCOs)

30% of Ugandans are completely financially excluded and rely primarily on family and friends for their borrowings, and on their ‘secret hiding places’ for their savings.

With the growth of the economy, we are seeing an increase in investment in the money lending sector. In Kikuubo, the busy business trading lane in downtown Kampala, the money lending business has attracted foreigners, including Chinese and Indians, who lend big money.

Usually they use local front men (Ugandans) to get customers for a commission. They can even lend Shs 500 million to a client as long as collateral that almost doubles the money being lent is staked.  They usually charge 15% percent interest per month which is many times higher than the official rate but they often negotiate in case of defaulters.

So with the above in mind, how do you start to set up a company?

FIRST THE CONS

Outdated legislation

The sector is regulated by the Money Lenders Act, 1952. This is a fairly outdated law that for example makes interest above 24% a year to be “harsh”. It also places restrictions on advertising.

The reason it is outdated is because, for example:

Whilst the official commercial bank rate at June 2013 is 22.58%, if you include arrangement and other fees, then these fees would exceed 24% . The whole sector is therefore “harsh” and dare we say, illegal as per the act.

Money lenders charge an average interest of 20% a month which works out at 240% a year.

MFIs as per a DFID study on the money lending sector charge interest in the range of 100%.

This is nevertheless not as bad as in the UK for example where online lender Wonga.com charges interest equivalent to 350% per year!

The law is further outdated in the various restrictions it places on advertising. It for example says:

No person shall knowingly send or deliver or cause to be sent or delivered to any person except in response to his or her written request any circular or other document advertising the name, address or telephone number of a moneylender, or containing an invitation—

to borrow money from a moneylender;

to enter into any transaction involving the borrowing of money from a moneylender;

to apply to any place with a view to obtaining information or advice as to borrowing any money from a moneylender.

In order to succeed in the start up, therefore it is worth getting legal counsel to ensure that you can navigate this minefield of an archaic law, including registering the business with a magistrate and getting a license certificate. Before one gets a money lender's license, one has to first get a certificate from a Magistrate having jurisdiction in the place in which the money lender's business is to be carried out. This certificate expires every 31st day of December.

Late payments

Not all borrowers are able to pay up their loans on the agreed period of time and some even go as far as a week after the dead line of payment has passed which means that the money lender will not be able to reinvest the money if the potential client needs it. A big number of Ugandan moneylenders do not like to seize borrowers’ collateral, particularly due to the costs of administration and eventual auction. They are often tolerant of a borrower who explains anticipated delays in good faith.

In these cases, the advanced thinking businessman (lender) may waive the interest for the period extended or request that the interest due be rolled forward into a new contract. Alternatively the lender may assist the borrower by purchasing the collateral at a more or less fair price to cover the debt. This is common among moneylenders who are also car dealers.

A third “advanced thinking” alternative is for the money lender to enter into partnership with a professional services firm such as an accountancy firm to provide services such as business turnaround services or business reviews or even discounted bookkeeping/tax services.

The reason this is a good idea is because since many borrowers borrow for business purposes, a discounted service fronted by a lender might help them not only to get information on these services but to also ultimately be able to repay loans and continue borrowing from a lender, who operates in some ways akin to a bank (through providing some advisory).

Defaulters

Like the law of gravity, one constant about the money lending business is dealing with defaulters. When a loan falls in arrears, the lender tries to collect through phone calls, messengers or visits. Afterwards, the lender will turn to debt collectors or lawyers.

The solution for the advanced thinking businessman (lender) would be to partner with the borrower and sell off the collateral, deducts the amounts owed and gives any balance to the borrower. This way the borrower will leave as a satisfied customer and bring in more business as opposed to confiscating the collateral selling it and owning all the profits as some of the unscrupulous lenders do in Uganda.

Competition

As mentioned in the introduction, the sector has stiff competition from both traditional and alternative lending sources, including those coming in the future.

In order to counter this, we would recommend that the advanced thinking businessman (lender) considers the M-pepea concept which is to sign up organisations (such as SACCOs, NGOs, Companies) and offering discounted rates. These will encourage regular customers and make administration easy as for example if it’s a company, the money can be deducted direct from payroll.

High fixed costs

In the model we explain later on, there will be fixed costs incurred like rent, salary and so such costs coupled with restrictions on advertising mean that the business person faces a huge challenge of ensuring the income is regular through an advanced marketing strategy.

Infact the DFID study on the sector  seems to indicate that the streets of money lending are not paved with gold and there are some high costs to contend with. As a result some “advanced thinking” lenders, share an office and hence share rent and other fixed costs like legal charges for collection of debt. This is something worth extending by the lender choosing to deliberately seek out other lenders and enter into a Memorandum of Understanding (MOU) such that rather than competing, they can share costs.

THE PROS

Higher interest rates

Assuming the business person gets reasonable legal advice on the “harsh and unconscionable” clause of the Money Lenders Act in respect of interest above 24% per annum, then there is sufficient return to be made.

In our model we assume an interest of 15% a month. This is not far off from an industry  study as per a DFID report where interest was estimated at an average of 20% (with rates ranging from 8% to 30%). We believe there is a legal argument for this “harsh” rate considering the cost of doing business in the sector necessitates higher interest than the outdated act provides for.

The link to the model is below:

Money lending ROI model

P.S Clicking the above link will take you to the Inachee Databank where the full version of this document can be dowloaded after you register.

As seen from our analysis, we estimate the Return on Investment (ROI) from this sector as follows:

  • Startup capital (A) : Shs. 45,432,420
  • Profit (B): 18, 493, 578
  • Return on Investment (C= A/B): 2.457 years

My Guest writer weighs in.

I have been in the money lending business since 2009 serving the market of University students and business men in wandegeya and from the years of experience in this business I can say it’s a worthy and profitable business if the borrowers are paying.

I have had my trying moments here and there with some borrowers showing up innocent when they want to get money and opening a fist fight when you come to collect your money and there collateral is at stake. One thing I can advise people looking to invest in this business is to have enough money on them because we use money to make money.

Now the basics you must get right before entering in the sector

Legal requirements

Starting a money lending business is rife with various laws and regulations, in addition to the outdated, albeit applicable Money Lenders Act that you need to be fully understood before you can officially open your doors for business.  Consult with a lawyer to inquire about legal requirements and procedures for the company. He will guide you in the necessary steps to attain approval for your lending company and will handle the application processes as well as legal issues.

Strategy

In Uganda a big number of money lenders are not registered and therefore they are illegal which means they can charge any interest rates that they please and therefore to compete with them you will need a great strategic plan and consider how you will market and hence navigate the advertising restrictions.  The M-Pepea strategy on using mobile money is for example brilliant.

Another consideration is partnering with other lenders to share costs. There is sufficient demand in the sector and so viewing them as partners, not competitors often helps.

As part of that strategy, you want to for example focus on larger loans to fewer clients where the cost of administration can be made much lower.  Our guest writer alludes to this in that he is speaking about having enough capital. This can allow you to spread your fixed costs and to target larger individual borrowers.

FINAL WORD

Don’t be discouraged if you believe the competition and regulation is not for you, there is always a solution. If you cannot charge high interest, how about becoming smarter than Shylock the Jew and “charging a pound of flesh, and one pint of blood.” [This last comment is made in jest, to appreciate its full context, go get yourself a free copy of the “Merchant of Venice”]

Otherwise, best of luck and of course if you need some help, do not hesitate to speak to us to get the ball rolling, Inachee after all represents Home Grown Energy in Motion.

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And now the disclaimer: While I have taken steps to research this information as well as based on my experience, you should not solely rely on the information given here to base your investment decisions. You should seek business advice from a professional knowledgeable of your specific circumstances. I (or Inachee) shall therefore not be held responsible for any loss you may incur when acting on this information.

6 thoughts on “What’s the deal with money lending?

  1. Thank you very much for your periodic posts, they are not only ansipiring but what we meet in rael business life too.

    Infact, this is the very business am planing to engage in. You have given me more ideas about the project. Am very happy.

  2. thank you very much for the advice , i believe some years down the road i will too be writting to encourage other young minds.

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