Uganda: Microfinance Muddle
Kampala, Uganda, December, 09 2007 -
Microfinance institutions have been operating in Uganda since the early 1990s but never has there been a loud outcry by the public against the behaviour of these institutions as it is now.
The Bank of Uganda (BoU) has again given an unequivocal warning to the general public regarding dealings with microfinance institutions saying, "Before you deposit money with an institution, first ask it to show you a copy of the license it obtained from the central bank."
Given the high level of financial illiteracy among the public, it is likely that the warning will be of limited usefulness.
The immediate reason for the BoU warning is the recent outcry by people who saved with microfinance institutions or Savings and Credit Cooperative Societies (Saccos) but when they went to withdraw their money, the institutions were unable to meet their requests.
Many people wonder why BoU has not taken any action against the 'offending institutions.' The short answer is that it is not that simple. First, we need to appreciate that BoU is only responsible for regulating and supervising institutions that it has licensed.
Second, we need to appreciate the meaning of deposit taking.
There are many credible microfinance institutions that are not licensed by BoU but provide vital and legitimate financial services to people who want to save or borrow. These institutions are variously registered as NGOs, private companies and Saccos.
Such an institution does not break the law regarding deposit taking so long as it does not use the money from savers to fund their loan books. It is when an institution uses deposits received from the public to fund its loan books that such an institution is said to engage in deposit taking.
The manner in which the BoU warning has been carried by sections of the media would make it appear that it is illegal for non-deposit taking institutions to provide savings products to their clients.
What should be at stake is that an institution that is not licensed to take deposits does not use the savings of its customers for lending or operational purposes.
Microfinance institutions have been operating in Uganda since the early 1990s but never has there been a loud outcry by the public against the behaviour of these institutions as it is now. The spread of banking institutions in Uganda is very narrow and thin.
For many people in rural Uganda, the only known and available financial institution is the microfinance organisation. In short, the Ugandan economy needs the microfinance sector. But why are these institutions becoming a burden rather than a blessing to the population?
The problem that savers as well as microfinance institutions now find themselves in cannot be de-linked from politics. After the February 2006 elections, the government embarked on the "Prosperity for All" campaign; many politicians started campaigning for the establishment of Saccos in every sub-county.
Some of these institutions boldly placed advertisements in the media asking the public to open accounts with them. While the law says only institutions licensed by BoU can participate in deposit taking, the law also allows Saccos to use the savings of their members to make loans to members interested in borrowing.
Politics aside, there are well known loopholes or challenges regarding the regulation and supervision of microfinance institutions that have provided the perfect environment for crooks and opportunists to fleece unsuspecting depositors. "Regulation" refers to the set of government rules that apply to microfinance. Supervision is the process of enforcing compliance with those rules. The regulatory and supervisory loopholes in the microfinance sector include:
The fact that there is no single institution that handles the registration or de-registration of microfinance institutions. The microfinance institution might be an NGO, a cooperative society, a non profit or profit company or an association. No single institution controls who can register or be de-registered as a microfinance institution.
Because of the sheer number of microfinance institutions and their spread all over the country, it is not possible for the central bank to supervise all the institutions. Many microfinance institutions that do not hold deposit taking licenses from Bank of Uganda do not use depositors' money for lending or operational purposes. It has been argued in the past that it makes no sense to impose the burden of regulation and supervision on such institutions.
If the microfinance sector is severely weakened, there will be no winners but many losers. Action is therefore required to urgently and adequately address the challenges in the microfinance sector with the view of strengthening it.