Emmanuel Tumusiime-Mutebile: Financial inclusion and the
development of the financial system
Speech by Mr Emmanuel Tumusiime-Mutebile, Governor of the Bank of Uganda, at the
3rd Graduation Ceremony of the Uganda Institute of Banking and Financial Services,
Muyenga, Kampala, 4 October 2013.
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The Board Chairperson of the Uganda institute of Banking and Financial Services,
Members of the Board of Directors of the institute
Members of the Institute present
The Graduands
Invited Guests in your respective capacities
Ladies and Gentlemen
First I would like to thank the Board Chairperson, Mrs. Balaka, for inviting me to officiate at
this function. I would also like to congratulate all those who are graduating today.
Financial inclusion, which is defined as expanding access of low income families to a broad
range of formal financial services, has become a priority for financial sector policy makers
across the developing world in recent years. The main reasons for prioritizing financial
inclusion as a policy objective are threefold.
First, expanding the opportunities of people to trade is almost always welfare enhancing; this
applies to financial markets as well as other types of markets. Secondly, access to financial
services may help poor people to finance investment in micro-enterprises, for example the
purchase of farm inputs, which will enable them to raise their incomes. Thirdly, financial
inclusion can help to deepen financial markets, for example by attracting more savings into
banks, although it is not the only channel through which financial markets can be deepened.
Empirical research has shown that a deepening of the financial system supports higher
levels of private investment and economic growth over the long term.
These are sound reasons for supporting efforts to promote financial inclusion, but I also think
that the policy challenges pertaining to promoting financial inclusion are more complex than
is often realised, in two important respects. The first is that access to financial services may
not be the only constraint, or even the most important constraint to achieving a strategic
policy objective. For example, it is unlikely that expanding access to financial services in rural
areas will enable smallholder farmers to expand their output and raise their incomes unless it
is supported by efforts in other areas, such as the provision of agricultural extension services
and better rural feeder roads, to help smallholders to modernise their farming practises.
Secondly, although there may be synergies between financial inclusion and other strategic
objectives of financial sector policy, such as the deepening of financial markets, there may
also be trade-offs with other objectives. It is important to comprehend clearly what these
trade-offs and synergies might involve if sound policies for the development of the financial
sector are to be designed. This requires an understanding of the economic reasons why so
large a share of the population is excluded from access to financial services.
The vast majority of the Ugandan population have virtually no access to formal financial
services, other than the use of mobile money. The latest FINSCOPE survey, which will be
published shortly, found that only 8 percent of Ugandans save money in a bank account,
while another 6 percent save money with a savings and credit cooperative (SACCO). The
financially excluded are the poor, especially those living in rural areas.
The main reason why the poor are excluded from access to formal financial services is
because serving this segment of the population entails financial institutions incurring much
higher transactions costs, relative to the value of the services provided, than is the case for
more wealthy customers. These costs may be prohibitive for the bank or for the customer to
bear. Furthermore, the costs of operating branches in rural areas are large relative to the
rather limited volume of revenues which can be generated from these branches, especially
as many of the basic requirements of operating a bank, such as the provision of electric
power, are more expensive in rural areas than in urban areas.
Serving the financially excluded may also entail higher risks for financial institutions, because
the poor have fewer resources to cushion themselves against adverse shocks and fewer
assets which can serve as collateral for loans than wealthier customers have. As such
financial exclusion reflects the economic reality of conducting the business of financial
services in a poor and largely rural society; it is not just a form of market failure which can be
easily rectified through policy intervention. That is why promoting financial inclusion involves
potential trade-offs with other policy objectives. I will give one example of such a potential
trade-off.
A major concern of the Bank of Uganda (BOU) is the very high interest rate spreads of
commercial banks, as I have made clear on several occasions. The average net interest
margin of the Ugandan banking system in the last financial year was 12 percentage points.
High interest rate spreads lead to high real lending rates, which constrains borrowing by
productive enterprises, especially those which operate in competitive markets where profit
margins are thin. This is especially the case for small and medium scale enterprises (SMEs)
which provide the main source of formal sector employment for Ugandans, and are thus
essential in the struggle to eradicate poverty. The respondents of the World Bank's Doing
Business Survey reported in the 2013 African Competitiveness Report cited access to
finance as the second most problematic factor for doing business in Uganda (after
corruption). The main reason why interest rate spreads in Uganda are so wide is the high
fixed and operating costs of the banks. Interest costs comprise less than a third of the total
expenses of commercial banks in Uganda; the rest of the costs comprise salaries, utilities,
the maintenance of buildings and provisions for bad debts.
Reducing bank operating costs is essential if interest rate spreads are to narrow and lending
rates for borrowers are to be made more affordable. However, reducing bank operating costs
may not be compatible with expanding access to banking services to the poor, if the
transactions costs and the risks involved in providing banking services to the poor are higher
than those involved in serving existing bank customers. That does not make it undesirable to
expand financial services to the vast majority of the population currently unbanked, but it
does mean that it must be done in a cost effective manner which does not force up the
average cost to asset ratios of banks or increase the risks in their loan portfolios.
How might it be possible to promote financial inclusion in a manner which does not conflict
with other strategic goals of financial sector policy? Branchless banking innovations like
Mobile Money and Agent Banking offers a solution to some aspects of the problem of
financial exclusion, although not all. Over eleven million people, comprising a third of
Uganda's population, are registered as mobile money customers. Mobile banking in Uganda
currently only offers payment and money transfer services, but it has the potential to provide
a platform for other financial services; for example linking customers to savings accounts in
banks, as is starting to happen in Kenya through the agent banking model. However mobile
banking per se will not alleviate the main constraints facing the poor in accessing credit from
formal financial institutions.
Microfinance institutions, which utilise innovative modalities for serving low income
households, such as group lending, and provide financial products which are tailored to the
needs of this segment of the population, offer another channel for expanding financial
inclusion. When microfinance first emerged in Uganda, in the 1990s, it was undertaken by
not for profit organisations using concessional finance from abroad and did not involve taking
deposits from customers. In 2003, Uganda enacted legislation to allow microfinance
institutions to take deposits and for those that do so to be regulated by the BOU, as a third
tier of supervised financial institutions (after banks and credit institutions). This reform was
motivated by the recognition that access to deposits is often equally as important as access
to loans for low income customers and that microfinance institutions would be more
sustainable over the long term if they could build a domestic deposit base, rather than having
to rely on donor funds, to finance their lending.
The growth of deposit taking microfinance in Uganda over the last 10 years, since the
Microfinance Deposit Taking Institutions Act was passed in 2003, has not really met
expectations. Only a few microfinance institutions applied for licenses as tier III microfinance
deposit taking institutions (MDIs). The total deposits of the MDIs are less than one percent of
the deposits of the commercial banks. At the same time a plethora of semi formal and
informal financial institutions, which include nearly two thousand SACCOs, have grown up.
All of these semi-formal and informal financial institutions, which are not subject to any
prudential regulation, are collectively referred to as tier IV financial institutions.
The growth of the unregulated financial sector has prompted the BOU to rethink its strategy
towards the tier IV financial institutions. It is not feasible to try and regulate all of the
SACCOs and other tier IV institutions, because there are far too many of them to do this
effectively. However, we believe that the larger SACCOs, those with hundreds or thousands
of members, should be encouraged to graduate to become microfinance deposit taking
institutions, licensed and regulated by the BOU. This will enhance their financial stability and
therefore help to protect their savings. We are currently in the process of preparing
amendments to the MDI Act to make it easier for the larger tier IV institutions to graduate to
become licensed MDIs, for example by removing the requirement that MDIs should be
limited liability companies, rather than mutual associations. In addition, the amendments to
the MDI Act will create an obligation on SACCOs which hold total savings of more than
Shs 1.5 billion to convert to tier III status. We anticipate that approximately 13 of the existing
tier IV MFIs and SACCOs will graduate to tier III status.
Financial exclusion is not caused only by constraints on the supply side of the financial
market. Many people are discouraged from participation in formal sector financial markets
because of a lack of knowledge, or misinformation, about financial products and insufficient
knowledge about their rights as consumers of these products. To address these problems,
the BOU has launched a program to promote financial literacy, through educational activities.
The BOU has also prepared consumer protection guidelines for commercial banks and
publicized these in the media.
To conclude, I want to emphasize the complex challenges facing policymakers. There are
fundamental economic reasons for why large parts of the population are excluded from
financial services. We need to promote financial inclusion, but this objective must be
balanced against other priorities for financial sector development.
We should, therefore, aim to encourage innovations to promote financial inclusion which can
minimise the trade-offs and maximise the synergies with other policy objectives.
Thank you for listening.