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. * * * 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

these actions have sharply lowered money market spreads and encouraged some lending at longer maturities, conditions remain far from normal. bond issuance has been slow to return, which is putting greater pressure on banks as the sole source of lending growth. in tandem, financial institutions have curtailed their central roles as intermediaries and market - makers. this feeds illiquidity and volatility in financial markets and delays the return of confidence in the financial system. this could aggravate the adverse feedback loop between the financial system and the real economy. in essence, we have gone from one extreme – with overabundant liquidity leading to the misallocation of capital – to another – where, in some systemically important markets, capital is barely being allocated at all. the challenge for policy - makers is to provide transition support that effectively restarts rather than replaces markets. as i have argued elsewhere, this may require structural changes to some markets, including the greater use of clearing houses, and a re - thinking of the scale and frequency of central bank liquidity operations. 6 procyclical capital adequacy the second risk identified in the fsr is the procyclicality of bank capital. put simply, banks characteristically increase leverage in a boom, further feeding the expansion, before reducing leverage in a downturn, exacerbating the slowdown. regulation often reinforces these tendencies when it should lean against them. this is now a serious global problem. banks outside of canada are under enormous pressure to reduce leverage. given the scope of likely ultimate losses from structured products alone, it would take an enormous amount of capital to reduce average leverage ratios to canadian levels. bank of canada research estimates that u. s., u. k. and european banks would need to raise a combined us $ 1. 2 trillion to bring their leverage ratios down to canadian levels. these capital needs will rise linearly with any recession - induced writedowns. in this environment, banks are inclined to hoard capital, rather than deploy it. in a world with guarantees, liquidity and funding support, regulators should not reinforce this tendency. m. carney, " building continuous markets " ( speech to the canada - united kingdom chamber of commerce, london, england, 19 november 2008 ). in canada, our banks are not facing the same pressures to de - lever as their counterparts abroad. still, their loan portfolios would experience higher credit losses in a deep or prolonged downturn