Why are people defaulting on their loans in Uganda?

By Clever Nicholas

The COVID-19 pandemic had a significant impact on the economy, leading to job losses and reduced incomes for many individuals. This made it difficult for people to meet their financial obligations, including loan repayments.

According to the World Bank, Uganda’s economy is projected to grow at a slower rate of 5.7% in the Financial Year 2022/23, partly due to the pandemic’s impact and slow recovery.

The trend of people defaulting on their loans and struggling to manage their debts is not unique to Uganda, as many people in other countries around the world are also grappling with debts.

However, understanding the root causes of this phenomenon is critical to developing effective solutions that can help borrowers avoid default and financial ruin.

One of the primary reasons why people in Uganda are defaulting on their loans is the cost of credit. The interest rates are so high that people still have to borrow if they have to do business or move to another step.

When interest rates are high, borrowing becomes more expensive, as borrowers must pay back the principal amount along with a significant interest cost. This can be a deterrent for people who need funds for business expansion, investment opportunities, or personal reasons such as moving to the next stage in life.

The other factor responsible for high interest rate is the volatility of Uganda’s economy. Economic volatility refers to fluctuations and uncertainties in key economic indicators such as inflation, exchange rates, GDP growth, and government policies.

When an economy experiences significant volatility, it can increase the perceived risk for lenders, leading them to charge higher interest rates to compensate for the uncertainty and potential losses.

Rising prices for basic necessities such as food, housing, and healthcare are making it increasingly difficult for people to meet their financial obligations. This is compounded by many Ugandans living in poverty, with limited access to financial resources or credit. As a result, they are often forced to turn to informal lenders who charge exorbitant interest rates and fees.

The lack of financial literacy and education in Uganda is also contributing to the debt crisis. Many people are not fully aware of the risks and responsibilities that come with taking out loans, and they may not have the knowledge or skills needed to manage their finances effectively. This can lead to poor decision-making and financial mismanagement, which can ultimately result in default and other financial problems.

To address these challenges, there is a need for greater investment in education and job creation initiatives and efforts to improve financial literacy and access to affordable credit.

By empowering Ugandans with the knowledge, skills, and resources needed to manage their finances effectively, we can help to reduce the incidence of loan defaults and ensure that people are able to achieve financial stability and security.

To be specific, loan defaulting is a significant challenge that affects both lenders and borrowers and therefore, to reverse the trend, several measures can be taken;

a) Financial education should be provided to borrowers to ensure they understand the terms and conditions of the loan agreement. This education should include the importance of paying back loans on time and the consequences of defaulting on loans.

Borrowers should also be educated on how to manage their finances effectively to avoid overborrowing and
accumulating debts they cannot repay.

b) Lenders should conduct thorough credit assessments before giving out loans to borrowers. This assessment should include an evaluation of the borrower's credit history, income, and ability to repay the loan. Lenders should also ensure that the loan amount is reasonable and affordable for the borrower.

c) Government should enact laws and regulations that protect both lenders and borrowers. These laws should provide clear guidelines on loan agreements, interest rates, and debt collection practices. The government can also establish a credit bureau to track borrowers’ credit histories and prevent over-borrowing.

d) Lenders should be able to explain the details in the loan agreements so that borrowers make informed decisions. All the clauses in the agreements should be clear and, in a language, both the lender and borrower understand very well. Many people who default sometimes confess they did not read or understand the agreements, but signed them because they urgently needed money. That’s why some loan sharks take advantage and take an item 10 times of the loan amount disbursed.

In conclusion, reducing loan/debt defaulting in Uganda requires a collaborative effort between borrowers, lenders, and the government. Financial education for borrowers, thorough credit assessments by lenders, and government regulations are some of the measures that can be taken to address this challenge.

Clever Nicholas (cleverkikwaya2@gmail.com) is a Debt Recovery Expert and Managing Director of Smart Skills Uganda, a debt collection agency based in Kampala, Uganda’s capital.