Legal Avenue to Exploitative Microfinance in Sri Lanka
Sri Lanka, June, 04 2018 -
Microfinance provides a gateway for financial institutions to reach and exploit the earnings of poorer sections of society by charging high interest rates. The unregulated and exorbitant interest rates have attracted many finance companies to enter the microfinance market
Microfinance provides a gateway for financial institutions to reach and exploit the earnings of poorer sections of society by charging high interest rates. The unregulated and exorbitant interest rates have attracted many finance companies to enter the microfinance market. The microfinance industry has trapped people into debt and even led to suicides. Changes to legal principles and laws governing the financial sector have enabled such an expansion of microfinance, providing financial institutions with unfettered powers while offering very little recourse to those who have been affected by their actions. While unfair interest rates are charged from the people, the laws of interest are partial towards the powerful financial institutions. Therefore, there is an urgent need to review such laws.
Barriers on interest
Interest, to describe it simply, is a sum paid for the use of borrowed money by debtor to the creditor. Our laws pertaining to the charging of interest are governed by a series of Acts introduced during the colonial period and subsequently after 1990.
The law enforced in the colonial period with respect to interests was clearly based on English justice concepts. The concept “no interest shall be recoverable to an amount in excess of the sum then due as principal” was an important principle in charging interest. This was introduced by the Civil Law Ordinance No.5 of 1852.
The same principle was affirmed and brought into practice by the Money Lending Ordinance in 1918. The Money Lending Ordinance also prohibited unfair interest rates and undue influence in making lending contracts. However, barrier on interest built in by English Law to protect the community was partially removed by the legislature by passing fourteen Acts in 1990. Significantly, the Debt Recovery Act No.2 of 1990 amended by Act No.9 of 1994 lifted the principle of “no interest shall be recoverable to an amount in excess of the sum then due as principal”.
Simultaneously Act No.6 of 1990 (Amendment to Sec 192 of CPC) allowed the creditors to recover the aggregated interest from the date of action to the date of payment without any classification. In other words, the amendment allowed debtors to charge penalties in addition to imposing unfettered interest rates. In this way, barriers on exorbitant interest rates were removed, with the court deciding that the Civil Law Ordinance is not applicable for transactions. Such a move is contrary to the principles of Jurisprudence. Furthermore, the court neglected and avoided applying other principles based on justice pertaining to the interest such as unfair interest and undue influence introduced by the Money Lending Ordinance.
The implications of such changes to legal principles is that the interest charged can be ten times, hundred times or more of the principal amount. To understand the seriousness of these changes, a closer look at the classification of interest as practised in Sri Lanka is useful.
Classification of Interest
According to the Civil Law Ordinance two types of interest are applicable to transactions, namely the legal interest and interest agreed upon between the parties.
The legal interest was introduced to our law by the Civil Law Ordinance No.5 of 1852. The first introduced rate of the legal interest was 5%. Section 5 of the Civil Law Ordinance states as follows, “Provided that no person shall be prevented from recovering on any contract or engagement any amount of interest expressly reserved thereby or from recovering interest at the rate of five percent per annum on any contract or engagement”
According to Section 5, when parties have not agreed upon the interest component in the contract, the creditor is legally entitled to recover 5% interest per year from the debtor. If the parties have agreed upon the interest, the creditor is entitled to recover the interest agreed upon in the contract. Section 5 of the Civil Law Ordinance was amended by act No.36 of 1981 and legal interest was increased up to 12%.
Until 1990, the legal interest rate was governed by the Civil Law Ordinance and the rate could only be changed by the Parliament. In 1990, the authority of determining the legal interest was given to the Monetary Board established under the Monetary Law Act.
Section 192 of the Civil Procedure code amended by Act No.6 of 1990 states that legal interest is applicable only where the parties have not agreed on interest rates in lending contracts. Conditions with respect to the interest are the most important terms in such contracts. Applicable interest rate is decided by the financial institution and included in the agreement. When such an agreement is present, the Central Bank / Monetary Board cannot control or influence the financial institution to implement the legal interest. The Civil Law Ordinance states that the parties are at liberty to make the contracts and can agree on any rate of interest by contract. At the same time, Section 5 of the Civil Law Ordinance is very clear that the interest or arrears of interest which exceed the principal is not recoverable. It provides that:
"Our laws pertaining to the charging of interest are governed by a series of acts introduced during the colonial period and subsequently after 1990"
"Default or penalty interest rates are similarly considered to be interest agreed to between the parties. The debtor becomes liable to pay when he/she has defaulted or delayed payment on installments"
“in any case in which interest is payable by law and or different rate of the interest has been specially agreed upon between the parties, but the amount recoverable on account of interest or arrears of interest shall in no case exceed the principal.”
Section 5 of the Money Lending Ordinance of 1918 provides that the court should follow the principle of “no interest shall be recoverable to an amount in excess of the sum then due as principal”. However, by the Debt Recovery Act No.2 of 1990 amended by Act No.9 of 1994, the legislature lifted the limit set out in Section 5 of the Civil Law Ordinance, applying to the cases filed under the Act. The said provisions of the Debt Recovery Act were extended to all bank transactions by Justice Amarathunga in Nimalarathne Perera Vs The People’s Bank 2 SLR 67, by saying that the provisions of the Civil Law Ordinance are not applicable to bank transactions. Amending Section 192 of the Civil Procedure Code by Act No.6 of 1990, the legislature passed that the creditor is entitled to recover the aggregated amount of interest from the date of action to the date of payment according to the agreed rate on the principal. That section does not refer to the provisions of the Civil Law Ordinance. The court is of the view that the provisions of the Civil Law Ordinance have no application to financial transactions, though the Civil Law Ordinance has not been repealed by the legislature. The law is so vague that nobody knows what the limits of the interest rates are, and thus is interpreted as absolutely limitless.
Default or penalty interest rates are similarly considered to be interest agreed to between the parties. The debtor becomes liable to pay when he/she has defaulted or delayed payment on installments. It is a penalty for default or delay of payment of debts. In practice, default interest rates agreed in contracts are excessively higher than normal interest. They include 4% to 8% default interest per month (48% to 96% per annum) in contracts. Sometimes the debtor becomes liable to 10 or 20 times of the principal amount because of penalty interest.
The recent Microfinance Act has to be considered together with applicable laws pertaining to interest. The Microfinance Act No.6 of 2016, legitimized the target market of banks and finance companies to go beyond the middle and upper classes. The so called lower classes were not considered creditworthy by financial institutions. Therefore, they escaped from the clutches of big capital induced debts. The Microfinance Act will contribute towards legally converting the poor into debtors.
Prior to the introduction of microfinance companies, a local credit system, mainly handled by women and co-operative societies, was in existence. No money from the capital markets directly flowed into the system and funds of the community circulated within themselves. While the middle-class was attracted to capital markets after the reforms in 1990, microcredit remained in the hands of women and rural folk.
The exploitative credit system including microfinance promoted by the Finance Companies should be stopped. And community strengthening forms of microcredit as with the co-operative credit system should be encouraged.