REGULATION CAN ONLY HAVE A LIMITED IMPACT ON FINANCIAL INCLUSION

Emmanuel Tumusiime-Mutebile, Governor the Bank of Uganda.

The problem with a regulatory approach to the promotion of financial inclusion is that regulations cannot force financial institutions to provide customers with services when it 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, since the costs of providing such services are high, especially in rural areas, whereas the income that can be generated from the poor is low.

Consequently financial exclusion can only be reduced through innovations that lower the cost of providing services or which can create new services that 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 that have the incentive and expertise to do so.

The rapid growth of mobile banking in East Africa has thus been driven by the private sector. 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.

Given this, what is the appropriate role of financial regulation? The primary objective of regulation is prudential: To protect the savings of ordinary citizens from reckless or abusive management by 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 trade-offs to be considered when innovations are proposed by the private sector that have the potential to promote financial inclusion.

The approach 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. 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 will highlight four innovations in the Ugandan financial markets that are relevant for financial inclusion and explain the regulatory approach that we have adopted to them.

Deposit taking microfinance institutions

Microfinance institutions (MFIs) began operating in Uganda in the 1990s. Initially, these were not-for-profit institutions that 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 deposit taking microfinance institution 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 these institutions 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 at Ush500 million is much lower than that for a commercial bank at Ush25 billion. In 2010, the coverage of the Deposit Protection Fund was extended to include the deposits of deposit taking microfinance institutions.

It is fair to say that the growth of these institutions has not been as rapid as originally hoped. Although the number of deposit accounts with deposit taking microfinance institutions has increased fivefold since 2006, from 152,448 to 776,179 in 2014, it is still small in comparison with the number of deposit accounts held in commercial banks; commercial banks held more than five times as many deposit accounts in 2014.

As such, deposit taking microfinance institutions have made only a modest contribution to reducing financial exclusion over the past decade.

It appears that their business model, 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 deposit taking microfinance institutions 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 thus have a similar level of protection as that afforded to depositors in a commercial bank. The BoU 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 be used to authenticate all transactions.

As can be seen in the table at the top of the table, 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 per cent in 2009 to 54 per cent in 2014 and that almost all of this increase was due to access to mobile banking.

However, although the growth of mobile banking among 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 per cent 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 that 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 Co-operatives

There are currently approximately 2,000 savings and credit co-operatives 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 per cent 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 Co-operatives – 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 encourage some of the larger Saccos, which have hundreds or even thousands of members, to graduate to the status of Deposit Taking Microfinance 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 that 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 past 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 smartphones, 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 MDIs 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.

Prof Emmanuel Tumusiime-Mutebile is Governor the Bank of Uganda.

The East African