On the applicability of the ‘in duplum’ rule to micro-finance institutions

Different jurisdictions have introduced variations to the rule. For instance, South Africa has a version of the in duplum rule that outlines, with great specificity, what amounts may not exceed the unpaid balance of the principal debt under a credit agreement.[2] Kenya is no exception. Section 44A of the Banking Act introduces the rule into Kenyan law, with certain important limits:

(1) An institution shall be limited in what it may recover from a debtor with respect to a non-performing loan to the maximum amount under subsection (2).

(2) The maximum amount referred to in subsection (1) is the sum of the following—

(a) the principal owing when the loan becomes non-performing;

(b) interest, in accordance with the contract between the debtor and the institution, not exceeding the principal owing when the loan becomes non-performing; and

(c) expenses incurred in the recovery of any amounts owed by the debtor.

…(emphasis mine).

The provision applies only to “institutions”. Section 2 of the Banking Act defines “institution” as “a bank or financial institution or mortgage company”. A “financial institution” is defined in the same provision of the law as “a company other than a bank which carries on … financial business”,that is, taking deposits repayable on demand from members of the public, and using at least part of the money held on deposit for one’s own gain and at one’s own risk.[3] In other words, the provision applies specifically to banks and bank-like institutions – to deposit-taking lenders – and not to other lenders.[4]

The place of lenders who do not fall within the scope of Section 44A of the Banking Act is not clear-cut. A High Court decision issued by Justice Majanja on 7 October 2022 holds that such lenders are subject to the law governing the enforcement of the contract at the basis of their lending transactions.[5] While the court may deem such a contract unconscionable – that is, unsustainable because of its unfairness – the court is in no way obligated to do so.[6] Justice Majanja himself declined to interfere with the contract at issue in the dispute before him, limiting himself to the ground that the respondent had relied on: breach of Section 44A of the Banking Act. Justice Majanja found that this provision applies to deposit-taking institutions and institutions declared in the Kenya Gazette to be financial institutions for purposes of the Banking Act – and that did not include the appellant, Momentum Credit Limited, a micro-finance institution.[7] However, in another High Court decision issued by Justice Mabeya less than 2 months earlier, where the court was willing to read the in duplum rule into the terms of loans that are governed not by contract, but by a statute other than the Banking Act. In this case, the petitioners argued that the hefty interest and penalties charged in accordance with Section 15(2) of the Higher Education Loans Board (HELB) Act on non-performing HELB loans contravened the in duplum rule. Having in mind the intention of the rule, namely, protecting borrowers from exorbitant interest accumulation on loans, the honorable judge declared that the in duplum rule would be applicable to all who lend money.[8] He refrained from declaring Section 15(2) of the HELB Act unconstitutional, but instead read the in duplum rule into the provision,[9] an approach that Justice Majanja refused to take with regard to the Microfinance Act.

Justice Mabeya’s phrasing of the intention behind the in duplum rule is not far from the truth. Section 44A of the Banking Act entered the law through the Banking (Amendment) Act of 2006. This amendment had a precedent, however, in the Central Bank of Kenya (Amendment) Act of 2001, a Bill introduced into Parliament by Joe Donde, who was the Member of Parliament for Gem at the time.[10] The Donde Act, as it has since been called, engendered polarized debate between banks and external donors on the one hand, and the more public-minded advocates of the amendment on the other. External donors, including the IMF and the United States, had it in their interests to maintain the deregulated interest rates and thus, to safeguard the handsome bank profits that they would share.[11] The Donde Act was repealed before its intended effects were ever felt.[12]

Whether the in duplum rule should apply to lenders other than banks is a complex question. It is instructive to compare banks to other lenders, such as micro-finance institutions (MFIs). Many think that banks act simply as intermediaries, lending out the deposits that savers place with them. This is false. The cash deposits that savers place with banks form part of the bank’s reserves – the other part of the bank’s reserves consist of deposits held in the bank’s account with the central bank of the country. Yet, if everyone were to demand cash for the deposits that they hold with their bank, that bank would be unable to pay out all the money requested. This is what happened, for instance, in the collapse of Chase Bank.[13] What actually happens is that commercial banks create money, in the form of bank deposits, by making new loans. New money is created on the consumer’s balance sheet without any change in the amount of money held in the bank’s account with the central bank.[14] MFIs, on the other hand, do act as intermediaries. Some take deposits. Others rely solely on external funding sources such as grants, donations, or loans from development finance institutions.[15] MFIs do not create money. Instead, they simply extend access to money.

Banks create money by issuing loans, and then charge interest on those loans. In other words, they require beneficiaries of loans to pay for the production of money – production which happens without the need for anything more than a few mouse-clicks. Banks sell money (not real wealth, real embodiments of energy)[16] for real wealth in monetary terms, that is, interest. For this reason, banks have been called usurious and exploitative. Some would say that moves to limit the amount of interest that a bank can charge are steps in the right direction, but that the end of that pilgrimage would be a bank-free society, similar in that regard, at least, to the economic freedom of the average European in the 14^th century.[17] Others do not go so far, but do say that a healthy economy is one in which production has a priority over consumption. In a modern economy, consumption (spending) is used as a stimulus for production. However, only those with disposable income spend more. Encouraging consumption apart from production encourages the production of luxuries, of goods we may even call unhelpful, funneling the energy and creativity of workers towards futile activity.[18] Either way, an economy based on the accumulation of money is harmful and undesirable. Limiting the interest charged on bank loans would seem to be a sensible decision.

As for MFIs, they extend access to money to persons who are likely incapable of procuring bank loans. Such work is a service and needs to be kept financially sustainable. Interest is one possible way of achieving this motive. However, it is clearly possible that the interest charged by an MFI may become exploitative at a certain extreme. The application of the in duplum rule to MFIs on a case-by-case basis is one possible solution to this problem. Justice Mabeya’s decision encourages just such an application of the rule and is a step in the right direction.

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By Adrian Nyiha, LLB Hons, Strathmore University and a legal assistant at Nyiha, Mukoma & Co. Advocates.