Transformation of Microfinance Institutions in Uganda – Government Regulation, Sources of Funding and Market Development

Project description

Microfinance institutions (MFI) have expanded rapidly in many developing countries. In Africa their establishment since the 1990s has been mainly driven by donors, with a large number of small, predominantly NGO-funded non-profit institutions and a small number of larger MFI, financed by multilateral and bilateral donors. KfW is the largest official donor in microfinance, with € 1.4 billion invested in MFI worldwide (equity and loans), and increased funding for African MFI (new REGMIFA fund: € 200 million to be invested in African MFI).

Due to the rapid expansion of MFI, an increasingly commercial orientation of profit-seeking larger MFI, and technical innovations (mobile banking, branchless banking, smart cards) the sector is facing several challenges:
(1) Product diversification: From micro-credit to savings, micro-insurance and payments services. MFI have to adapt their business models and become more professional in order to cope with the demand for new financial services beyond the traditional micro-credit.
(2) Commercialization: To ensure financial sustainability MFI have to either charge high interest rates or to use low-cost financial technologies and exploit economies of scale. This raises the issue of “mission drift” from small scale financing of poor households to scaled-up commercialized operations.
(3) Responsible finance: Intransparency in the sector, inadequate or no consumer protection regulation, low financial capability levels of customers and the dangers of fraud and over-indebtedness challenge microfinance sectors world wide.
(4) Financial system stability and deposit safety: The larger the operations of deposit mobilising MFI, the stronger the need for government regulation and for the introduction of instruments for safeguarding deposits of poor customers, similar to the regulation of the banking sector in general. However, over-regulation can inhibit the dynamics and innovations of the sector and overburden small MFI.

Uganda has a comparatively well-developed financial sector with a large number of MFI, including the Savings and Credit Cooperatives (SACCO), and several initiatives to introduce new banking technologies, similar to neighbouring Kenya, where mobile banking has been a success in scaling-up microfinance. The Microfinance Deposit Taking Institutions (MDI) Act of 2005 regulates deposit mobilising MFI (called MDIs) and provides a legal framework for savings mobilisation of those microfinance institutions which comply with these regulations and have received a MDI licence from Bank of Uganda, the prudential regulator.
German development cooperation has a comprehensive program for supporting financial sector development in Uganda, with an emphasis on supporting the development of microfinance.

The country working group analysed the sector from a financial systems perspective. Possible research questions were:

• How has the Ugandan Microfinance sector developed since the implementation of the MDI Act in 2005?
• How has the branch network of MDIs and MFIs developed?
• Is competition driving MDIs into rural areas?
• How has the number of savers developed since the first MDI (Uganda Microfinance Limited at the time, now taken over by the Kenyan Equity Bank) was licensed in 2005?
• How have the non-transforming MFIs developed since the MDI Act is being implemented?
• Have MDIs moved away from their original client base and gone upmarket, serving SMEs rather than economically active poor households?
• What is the scope for the commercialization of MFI and how do small non-profit MFI cope with market developments and regulatory requirements?
• To what extent is external funding by donors still predominant and what is the scope for funding from the domestic capital market?
• Can a regional perspective – integration of financial markets in the East African Community – be relevant for Ugandan MFI?
• Will the MDIs be able to advance into SME-lending, thereby exercising a more transformative developmental effect than the predominantly non-productive use of micro-credit?

The research focus of the country working group was determined in close cooperation with Ugandan institutions (Bank of Uganda, Association of MFI of Uganda/AMFIU) and the financial sector development program of German development cooperation.