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 bis central bankers ’ speeches 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