Microfinance lenders seek law review on capital requirements

Kenya's microfinance institutions (MFIs) are escalating calls for a legislative review of capital and liquidity requirements that they argue are strangling operational flexibility and constraining credit supply to small businesses.

The core complaint centers on the 20 percent cash or near-cash liquidity ratio mandate embedded in Kenya's Microfinance Act and Central Bank reporting standards. MFI leaders say this threshold—which requires one-fifth of lendable assets to sit idle in highly liquid form—has created a structural drag on cash flow management, forcing institutions to maintain capital reserves that could otherwise deploy into productive lending.

## Why Are Microfinance Lenders Facing Liquidity Pressure?

The 20 percent reserve requirement was designed as a prudential safeguard to ensure MFIs could meet withdrawal demands and absorb shocks. However, Kenya's microfinance sector operates in a high-margin, high-risk environment where portfolio yields (often 25–40 percent annually) must compensate for default rates of 8–15 percent. When capital sits locked in low-yield liquid instruments—treasury bills, bank deposits, cash—it directly erodes profitability and limits the number of microloans institutions can originate. For MFIs operating on thin operating margins (often 5–8 percent net), this becomes material.

The liquidity squeeze has coincided with rising funding costs. As the Central Bank has maintained elevated interest rates to combat inflation, MFI deposit costs have risen sharply. Institutions now face a squeeze: they must pay 10–12 percent on savings deposits while the liquidity ratio forces them to hold 20 percent of assets earning only 4–5 percent in treasury securities. The math is unsustainable for smaller institutions.

## What Are the Real-World Implications?

For Kenya's SME sector, the implications are direct. Microfinance lenders represent the primary credit channel for traders, artisans, and agricultural producers below the bank lending threshold. When MFIs contract lending due to liquidity constraints, loan disbursement slows and interest rates rise to compensate. Data from the Central Bank of Kenya shows MFI loan growth has decelerated from 18 percent (2019) to 9 percent (2024), a trend MFI associations link partly to regulatory burden.

The sector's regulatory backdrop remains fragmented. While deposit-taking MFIs face strict Central Bank oversight, non-deposit MFIs operate under lighter regulatory touch—yet both compete for the same borrowers. This creates a perverse incentive: lighter-touch competitors gain cost advantages while heavily regulated MFIs shoulder compliance costs that ultimately translate to higher borrowing costs for end customers.

## Will Regulatory Reform Happen?

The National Treasury and Central Bank have acknowledged MFI concerns in regulatory forums, but no formal legislative amendment is imminent. A phased reduction—from 20 percent to 15 percent, with a two-year transition—would be the pragmatic middle ground: it preserves prudential safety while freeing an estimated KES 8–12 billion for lending nationwide. However, any change requires legislative action, and Parliament's 2025 agenda is crowded.

Investors and SME borrowers should monitor this closely. A positive regulatory shift would unlock microfinance growth and lower credit costs across Kenya's informal economy.