Emmanuel Tumusiime-Mutebile: The effect of regulation on financial
inclusion
Remarks by Mr Emmanuel Tumusiime-Mutebile, Governor of the Bank of Uganda, at the
National Microfinance Conference 2015 "Financial Inclusion in a Regulated Environment in
the East African Community", Kampala, 29 January 2015.
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Good morning, ladies and gentlemen,
My intention this morning is to outline the regulatory approach which we have adopted in
Uganda with regard to the promotion of financial inclusion and then to discuss the results of
that approach. I will start by expounding the principles which guide the regulatory approach.
The key principle which guides our regulatory approach to the promotion of financial
inclusion is that financial regulations cannot force financial institutions to provide customers
with financial services when this is not profitable for them to do so. The main cause of
financial exclusion is the difficulty in serving the financially excluded in a commercially viable
manner. These difficulties arise because the costs of serving the financially excluded are
high, especially in rural areas, whereas the income which can be generated from the poor is
low. Consequently financial exclusion can only be reduced through innovations which can
lower the cost of providing financial services or which can create new financial services
which are both wanted by and affordable to the poor.
In a market economy, the institutions best placed to generate these innovations are in the
private sector; institutions which have the incentives and expertise to do so. The rapid growth
of mobile banking in East Africa is a phenomenon which has been driven by private sector
initiatives. Private sector banks and telecommunications companies, driven by the profit
motive, have utilised new technologies to create new markets and have thus brought
financial services to millions of people who previously had no access to these services.
In these circumstances, what is the appropriate role of financial regulation? The primary
objective of financial regulation is prudential; it is to protect the savings of ordinary citizens
from reckless or abusive management of financial institutions, and to preserve the stability of
the financial system. To the extent that ordinary citizens have greater confidence in the
safety of their deposits in financial institutions, prudential regulation can contribute to the
deepening of the financial system.
Inevitably, however, there are often tradeoffs to be considered when innovations are
proposed by the private sector which have the potential to promote financial inclusion. The
approach which we have adopted in Uganda is to avoid placing regulatory restrictions on
innovations in the financial sector provided that these innovations do not conflict with the
primary objectives of prudential regulation. In some cases, this has meant that innovations
have had to be designed to incorporate safeguards to protect the public's savings, as is the
case with mobile banking, which I will discuss later. In other cases, such as with small
informal financial institutions, we have to recognise that it is not practically possible to
provide effective prudential regulation.
I would like now to highlight four innovations in the Ugandan financial markets which are
relevant for financial inclusion and explain the regulatory approach that we have adopted to
them.
Deposit taking microfinance institutions
The first innovation I want to discuss is the establishment of microfinance institutions (MFIs),
which began in Uganda in the 1990s. Initially these were not-for-profit institutions which
relied mainly on donor funding and did not take deposits. At around the turn of the
millennium, Uganda, along with many other countries, took the view that at least some of the
MFIs should be allowed to accept deposits, both because their customers would benefit from
access to deposit facilities and because MFIs could grow more rapidly and be more
sustainable if they could mobilise deposits. Therefore, specific legislation was introduced in
2003 to allow MFIs to take deposits. To provide safeguards for the deposits, the legislation
imposed prudential regulations on Microfinance Deposit Taking Institutions (MDIs) and
brought them under the regulatory aegis of the Bank of Uganda. However the prudential
regulations were specifically designed to take account of the fact that MDIs are generally
much smaller than commercial banks and have a very different business model. For example
the minimum start up capital requirement for a deposit taking microfinance institution is much
lower than that of a bank. For an MDI the minimum capital is Shs 500 million, whereas for a
commercial bank it is Shs 25 billion. In 2010, the coverage of the Deposit Protection Fund
was extended to include the deposits of MDIs.
It is fair to say that the growth of the MDIs has not been as rapid as originally hoped.
Although the number of deposit accounts with MDIs has increased five fold since 2006, as
shown in table 1, it is still small in comparison with the number of deposits accounts held in
commercial banks; commercial banks held more than five times as many deposit accounts
as MDIs in 2014. As such MDIs have only made a relatively modest contribution to reducing
financial exclusion over the past decade. It appears that the business model of MDIs, which
involves a high volume of small loans and deposits, has not always been successful in
Uganda, possibly because the operating costs have been too high. Several of the MDIs
which were licensed in the 2000s have since been converted into commercial banks.
Mobile banking
Mobile banking was first introduced in Uganda in 2009. The business model involves a
partnership between a mobile phone operator and a commercial bank. The services offered
have so far been restricted to basic retail payments and money storage services; money can
be transferred from one customer to another and it can also be stored in a customer's virtual
account.
The main regulatory concern of the BOU has been to safeguard customers' virtual money
which they purchase, with cash, from mobile money agents. The BOU has only allowed
mobile money operations when this is done in partnership with a supervised commercial
bank. Mobile money operators have to hold, in an escrow account in their partner
commercial bank, the equivalent in value of all the mobile money that they have sold to their
customers. This means that the mobile phone operators, which are not licensed financial
institutions, cannot themselves intermediate the funds that they have mobilised through the
sale of mobile money. Customers who purchase mobile money have a similar level of
protection as that which is afforded to depositors in a commercial bank. The BOU has also
issued mobile money guidelines in 2013. The guidelines stipulate an approval process for all
agents who wish to engage in the provision of mobile money services and the roles and
responsibilities of all parties involved. They also stipulate the safeguards to protect
customers, such as the requirement that customers' PIN numbers must be used to
authenticate all transactions.
As can be seen in table 2, the growth in mobile banking has been phenomenal. The number
of registered mobile money customers exceeds half of the total population of Uganda,
although this number may include some people who are registered with more than one
operator. In terms of extending access to financial services, mobile banking has made a
much larger contribution than any other recent innovation. The regular FINSCOPE surveys
reveal that the share of the population with access to formal financial services increased from
28 percent in 2009 to 54 percent in 2014 and that almost all of this increase was due to
access to mobile banking. However, although the growth of mobile banking amongst the
previously financially excluded has been impressive, we should also bear in mind that the
range of financial services available through mobile banking is very narrow; as I have already
noted it is restricted to basic payment transactions and storage of money.
Agent banking
Although the number of deposit accounts held in commercial banks in Uganda has grown
rapidly, tripling since 2005, commercial banks only serve 20 percent of the adult population,
according the 2013 FINSCOPE survey. The provision of banking services involves
substantial fixed costs, which is an obstacle to expanding services to the unbanked,
especially in rural areas. As such, an expansion of banking services requires new business
models which can deliver services at much lower costs.
One such model is agent banking. Agents are normally people with small businesses, who
are contracted by the banks to undertake transactions on their behalf, such as collecting
deposits, facilitating customer withdrawals and making payments, for a fee. The advantage
for the bank is that it can avoid the heavy expenses involved in setting up a bank branch.
Agent banking is restricted under the existing banking laws, hence we are currently in the
process of amending the Financial Institutions Act to permit the use of authorised agents by
banks, with safeguards for bank customers.
Savings and Credit Cooperatives
There are currently approximately 2,000 savings and credit cooperatives in Uganda. These
are mutual associations whose members make deposits in, and can access loans from, their
SACCO. Although there are a handful of quite large SACCOs, whose members comprise
employees of large organisations, the vast majority are very small. SACCOs undoubtedly
play an important role in extending financial services to the unbanked. The 2013 FINSCOPE
survey revealed that 622,000 adults, about four percent of the adult population, held
accounts in SACCOs in 2013, a fivefold increase since 2009. Although SACCOs are
registered with a public agency - the Registrar of Cooperatives - they are not subject to any
prudential regulation, and hence there are no safeguards for members' savings.
The dilemma for regulatory policy is that effective prudential regulation of a very large
number of small, informal financial institutions, such as the SACCOs, is not feasible. It is far
too costly for any regulator to supervise effectively any more than a tiny fraction of the
existing SACCOs. Consequently the approach we have adopted at the BOU is to try and
encourage some of the larger SACCOs, which have hundreds or even thousands of
members, to graduate to the status of Microfinance Deposit Taking Institutions (MDIs), and
thus become subject to the MDI Act. To facilitate this, the MDI Act is being amended to make
it more compatible with the organisational structure of SACCOs, for example, by allowing
institutions which are not limited liability companies to be licensed as MDIs. The remaining
SACCOs may eventually be brought under the umbrella of an apex body, but it will clearly
not be possible for this body to provide the same degree of regulatory safeguards to the
savings held in SACCOs as that afforded to deposits in banks and MDIs.
Conclusion
Uganda has made some progress towards greater financial inclusion over the last 10 years.
The most important contribution has been made by the rapid spread of mobile banking,
although the range of services offered is still quite narrow. However, commercial banks
should be able to harness new technologies, especially through the use of smart phones, to
provide a wider range of services through mobile banking in the future. We also hope that the
graduation of some of the larger SACCOs into Microfinance Deposit Taking Institutions and
the adoption of agent banking by the commercial banks will also boost financial inclusion.
The priority objective of financial regulation will continue to be ensuring the safety of
customers' deposits.