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Regulating and Strengthening Tier 4 Microfinance Institutions in Uganda

Background Studies

Compiled by

Tier 4 Technical Working Subcommittee

Microfinance Forum

Association of Microfinance Institutions of Uganda (AMFIU)KAMPALA

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Published byFountain Publishers LtdP.O. Box 488KampalaE-mail: [email protected] site: www.fountainpublishers.co.ug

On behalf ofAssociation of Microfinance Institutions of UgandaPost Bank House, 2nd Floor, Plot 4/6 Nkrumah Road, P. O. Box 26056KampalaE-mail: [email protected] site: www.amfiu.org.ug

© Association of Microfinance Institutions of Uganda (AMFIU) 2005First Published 2005

All rights reserved. No part of this publication may be reprinted or reproduced or utilised in any form or by any means electronic, mechanical or other means now known or hereafter invented, including copying and recording, or in any information storage or retrieval system without permission in writing from the publishers.

ISBN 9970 02 567 8

Cataloguing-in-Publication Data

Regulating and Strengthening Tier 4 Microfinance Institutions in Uganda: Background Studies. – Kampala: Fountain Publishers, 2005__ p; __ cm.Includes bibliographical referencesISBN 9970-02-567-81. Regulating and Strengthening Microfinance Institutions in Uganda 2. Background Studies

This booklet was edited and printed with financial assistance from DFID’s Financial Sector Deepening Project Uganda (FSDU)

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Table of ContentsList of Acronyms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

List of Tables and Figures. . . . . . . . . . . . . . . . . . . . . . . . viii

Foreword. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi

Acknowledgement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiv

Chapter 1 Tier 4 of the Microfinance-Market in Uganda . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

1.1 Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

1.2 Background . . . . . . . . . . . . . . . . . . . . . . . . . . 5

1.3 Key findings . . . . . . . . . . . . . . . . . . . . . . . . . 6

1.4 Role for Apex Bodies in Tier 4 Regulation. 11

1.5 Overview of the Volume’s Chapters and Annexes. . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

1.6 Conclusion and Recommendations . . . . . . . 15

Chapter 2 Strengthening and Regulating Tier 4 Microfinance (“Roadmap”) . . . . . . . . . . . 17

2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . 19

2.2 Rationale and Vision . . . . . . . . . . . . . . . . . . 20

2.3 Core Principles . . . . . . . . . . . . . . . . . . . . . . 21

2.4 Critical Issues . . . . . . . . . . . . . . . . . . . . . . . 24

2.5 Action Steps for the Way Forward . . . . . . . 34

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Chapter 3 Issues Paper On Regulation of Tier 4 Financial Institutions . . . . . . . . . . . . . . . . 37

3.1 Background to the Work of the Committee. 39

3.2 Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . 41

3.3 Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . 42

3.4 Methodology . . . . . . . . . . . . . . . . . . . . . . . . 42

3.5 Composition of Financial Institutions in Tier 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

3.6 Apex Institutions/Organisations . . . . . . . . . 47

3.7 Targeted Results of Technical Committee. . 49

3.8 Key Issues/Areas Examined . . . . . . . . . . . . 51

3.9 Strategic Principles for the Way Forward . . 63

3.10 Next Steps . . . . . . . . . . . . . . . . . . . . . . . . . . 65

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

Annexes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

Annex A Is There a Case for Regulating the Entire Credit Market in Uganda? Lessons from South Africa . . . . . . . . . . . . . . . . . . . . . . . . 85

Annex B Report on Linkage Banking Mission to Cameroon . . . . . . . . . . . . . . . . . . . . . . . . . . 91

Annex C Possible Mechanisms to Regulate Tier 4 MFIs in Uganda. . . . . . . . . . . . . . . . . . . . . 101

Annex D Microfinance Regulation: Lessons from Benin, Ghana and Tanzania. . . . . . . . . . . . 148

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List of AcronymsADAF Appropriate Development for Africa

FoundationAFB Afriland First BankAGM Annual General MeetingAMFIU Association of Microfinance Institutions of

UgandaASCAs Accumulating Savings and Credit

AssociationsBODs Board of DirectorsBOU Bank of UgandaCEO Chief Executive OfficerCOWE Caring for Orphans, Widows and the ElderlyDANIDA Danish International Development

AssistanceDENIVA Development Network of Indigenous

Voluntary AssociationsDFID Department for International DevelopmentDNBFI Director Non-Bank Financial InstitutionsDPP Director of Public ProsecutionsEDS Executive Director SupervisionFCBO Financial Community Based OrganisationsFEW Financial Extension WorkerFIB Financial Institutions BillFINCA Foundation for International Community

AssistanceFIS Financial Institutions StatuteFSAIU Financial Services Associations International

Uganda

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FSD Financial Systems Development ProgrammeFSDU Financial Sector Deepening Project in

UgandaGoU Government of UgandaGTZ Deutsche Gesellschaft für Technische

Zusammenarbeit (GTZ) GmbH(German Technical Co-operation)

ICPAU Institute of Certified Public Accountants of Uganda

MAMIDECOT Masaka Microfinance Development Co-operative Trust

MCAP Matching Grant for Capacity BuildingMC2 Mutuelle Communuataire de Croissance

(Community Growth Co-operatives)MDI Microfinance deposit-taking institutionMFF Microfinance ForumMFI Microfinance institutionMFPED Ministry of Finance, Planning and Economic

DevelopmentMFRC Microfinance Regulatory Council MITFUND Micro Trust FundMOU Memorandum of UnderstandingMSEPU Micro and Small Enterprise Policy Support

UnitMTCS Medium Term Competitive StrategyMTTI Ministry of Trade, Tourism and IndustryMUFFA Women NGO working as MC2NABARD National Bank for Agriculture and Rural

Development

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NGO Non-government organisationNLR National Loans RegisterPEAP Poverty Eradication Action PlanPEARLS Protection; Effective financial structure;

Asset quality; Rates of return and cost; Liquidity and Signs of growth

PMA Plan for Modernisation of AgriculturePRSP Poverty Reduction Strategy PaperRCBs Rural and Community BanksROSCAs Rotating Savings and Credit AssociationsSACCO Savings and credit co-operative societySEEP Small Enterprise Education and Promotion SIDA Swedish International Development Co-op-

eration AgencySPEED Support for Private Enterprise Expansion &

DevelopmentSRO Self-regulatory organisationUCA Uganda Co-operative AllianceUCSCU Uganda Co-operative Savings and Credit

UnionUMU Uganda Microfinance UnionUWFT Uganda Women’s Finance TrustUWFT Uganda Women’s Finance Trust Ltd.WOCCU World Council of Credit UnionsVSCIs Village Savings and Credit Institutions

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List of Tables and FiguresFigure 1.1 Regulation by Product Rather than by

Institution. . . . . . . . . . . . . . . . . . . . . . . . . . 7

Table 2.1 Savings and Credit Services Permitted by Category of Legal Status. . . . . . . . . . . 26

Table 3.1 Summary of Regulation Environment of Tier 4 Microfinance Institutions in Uganda. . . . . . . . . . . . . . . . . . . . . . . . . . . 66

Figure A.1 Regulation of Credit Market.. . . . . . . . . . 89

Table C.1 Legal Frameworks for Tier 4 Institutions . . . . . . . . . . . . . . . . . . . . . . . 133

Table D.1 Regulatory Structure and Triggers, by Type of MFI.. . . . . . . . . . . . . . . . . . . 149

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ForewordUganda is committed to developing a dynamic, sound financial system that is inclusive in providing access to fi-nancial services for the poor and rural areas. A wide range of institutions, financial and non-financial, offer various kinds of financial services to the population – but outreach still falls short of national objectives for financial services to assist households at the grass roots to build assets, raise incomes and reduce their vulnerability. The papers presented here represent findings from more than two years of investiga-tions into ways of supporting not only the expansion of such financial services but also of ensuring that they are conducted in a sound, secure and well-regulated manner.

The 2002 Microfinance Deposit-taking Institutions (MDI) Act represented an important step towards integrating microfinance institutions, which use methodologies oriented towards the poor, into the financial system by providing a special category (“Tier 3”) for them to become licensed and supervised by the Bank of Uganda (BOU), enabling them to mobilise savings from the public as part of their capitalisa-tion for greater outreach. In passing this Act, Parliament also mandated Government to propose a bill for regulating the activities of community-based financial institutions in “Tier 4” – i.e., those not subject to licensing by BOU.

Tier 4 microfinance institutions (MFIs) vary widely in form and size, and the way forward to provide appropriate regula-tory structures was not clear. Efforts were made to gather lessons from other countries in Africa, prepare a background paper on the issues and possible mechanisms for regulating Tier 4, and undertake study visits to Cameroon and South Africa. This results of this background work are presented in the Annexes to this volume. During 2004 and 2005, a

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Technical Subcommittee was formed to take stock of the various laws and regulations and the roles of apex bodies concerned with Tier 4 MFIs. The Issues Paper resulting from this stock-taking exercise (Chapter 3) formed the basis for identifying basic principles, issues and areas for strategic ac-tions (Chapter 2), which were discussed in a Subcommittee workshop in June 2005.

The process has now reached the stage of formulating poli-cies and specific actions for appropriate regulations and their implementation. These background studies are intended to disseminate more widely the findings of these studies and discussions, facilitate common understanding of the issues, and contribute to building consensus on the way forward.

Lance KashugyeraCo-ordinator, Microfinance Outreach Plan

Chair, Tier 4 Technical Subcommittee

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PrefaceThe question of how best to ensure the soundness of a growing number of diverse microfinance institutions and regulate their activities has been raised ever since the 1999 Bank of Uganda policy paper on microfinance and discussions surrounding passage of the Microfinance Deposit-taking Institutions Act (MDI) in 2003. While it has been recognized that the high costs of regulating small institutions means that “self-regula-tion” by “umbrella bodies” will have an important role to play, these terms and how to implement them have not been well defined. As a key umbrella body, AMFIU is privileged to be able to publish this volume of papers documenting the discussion process and results of the technical subcommittee of the Microfinance Forum on Tier 4 regulation.

The technical expertise represented in this volume provides a comprehensive base for decision-making of Parliament and Government. The discussion process on Tier 4 regulation has now reached the stage of formulating policies for appropriate regulations and methodologies for their implementation. Recent announcements of the Government regarding SACCOs and their apex organizations show that the role of umbrella bodies will remain critical in this discussion. We hope that the technical expertise provided by this volume will become a benchmark and tool for addressing the challenges ahead.

David T. Baguma

Executive Director, AMFIU

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AcknowledgementMany people and organisations have contributed to the draft-ing, revision and discussion of the papers presented here. The principal authors are Charles Kilibo, Karen Losse, Patrick Mbonye, Christopher Musoke, Paul Rippey, Oliver Schmidt, Stefan Staschen, and William Steel. Special thanks go both to the many individuals (too numerous to name) who took the time to send in comments on draft papers and to those what participated in meetings and workshops. Leadership has been provided by the Microfinance Outreach Plan Co-ordination Unit and the Micro and Small Enterprise Policy Unit in the Ministry of Finance, Planning and Economic Development, with particular thanks to Lance Kashugyera, Henry Mbaguta and Patrick Mbonye. Organisations and programs that were particularly supportive in the process of gathering informa-tion include AMFIU, DFID, FSAIU, FSDU, GTZ, MTTI, UCA, UCSCU, and the World Bank.

Thanks also to DFID and FSDU for financial support in print-ing this document.

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Chapter 1

Introduction: Tier 4 of the Microfinance-Market

in Uganda

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Chapter 1 Introduction: Tier 4 of the Microfinance-Market in Uganda

1.1 OverviewEfforts to develop and expand the outreach to the poor and rural areas of Uganda’s micro-finance institutions (MFIs) have raised a number of important questions: What types of institutions can effectively improve access to financial services, especially in poor, rural areas? Can these MFIs be self-sustaining? Who is responsible for ensuring satisfactory performance of such institutions and the safety of savings by the poor in them?

These issues arise from real-life-experience in Uganda with the operation and expansion of MFIs. Practitioners, develop-ment partners, and politicians and government agencies share these concerns − although their perspectives and approaches may differ. This volume analyses microfinance regula-tory frameworks in Uganda in such a way as to represent or inform perspectives of various stakeholders that have been involved in the process, including MFI apex organisations,1 relevant Government of Uganda agencies,2 international development partners, and microfinance practitioners them-selves. Furthermore, given the stated interest of Parliament in the regulation of “Tier 4” MFIs that are not supervised by

1 In particular, the national umbrella organisation for microfinance, the Association of Microfinance Institutions of Uganda (AMFIU); apex bodies for savings and credit co-operatives (SACCOs), the Uganda Co-operative Alliance (UCA) and Uganda Co-operative Savings and Credit Union (UCSCU), and Financial Services Associations International Uganda (FSAIU).

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BOU, a number of parliamentarians have been included and informed during the consultative process.

This volume provides the technical expertise and background needed to establish a regulatory framework for the Tier 4 segment of Uganda’s microfinance industry that will be cost-effective in protecting the savings of the poor and in ensuring that weak MFIs do not undermine the stability of the financial system – the two major justifications for public intervention in regulating financial institutions and activi-ties. This introductory chapter provides an overview of the volume and guidance to its key findings. The next section (1.2) highlights the socio-economic and political background of microfinance in Uganda. Section 1.3 synthesises the key findings and recommendations regarding a future regulatory framework. Section 1.4 discusses the role of national apex institutions within such a framework. Section 1.5 describes the flow of chapters and annexes of this volume. Section 1.6 concludes by listing the recommendations.

2 In particular, the Ministry of Finance, Planning and Economic Development (MFPED) and the Ministry of Trade, Tourism and Industry (MTTI), as well as the Bank of Uganda (BOU). MFPED has overall responsibility for building the capacity and outreach of the mi-crofinance industry in support of Uganda’s Poverty Eradication Action Plan (PEAP), co-ordinated and implemented in particular through the Microfinance Outreach Plan. MTTI has overall responsibility for SACCOs. BOU is responsible for licensing and supervising financial institutions under the Financial Institutions Act and the Microfinance Deposit-taking Institutions Act, and for overseeing the soundness of the financial system.

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1.2 BackgroundMarkets are institutional settings for transactions between willing purchasers and willing providers of goods and services, governed by evolving rules and organisations, both formal and informal. Since the 1990s, Uganda has created a success story by developing the market for microfinance services, which has been considered a role model for Africa and even other regions (Goodwin-Groen et al. 2004). Development of the legal and regulatory framework for the microfinance industry has so far been focused mainly on integrating its upper segment into the financial system as a whole, with collaborative efforts of all stakeholders resulting in the Microfinance Deposit-taking Institutions (MDI) Act of 2003, enabling specialised MFIs to mobilise deposits from the public as a third tier of financial institutions licensed and supervised by BOU.3 By mid-2005, three MDIs had been licensed, with two more in the process. Together, these have over 80 branches around the country (about as many as the next-biggest 70 MFIs), of which 62 are in smaller towns serv-ing predominantly rural areas, including 10 towns that have no branches of Tier 1 or 2 financial institutions.

With the upper segment of MFIs maturing, attention has been refocused on Tier 4 – i.e. those not subject to BOU licensing – particularly those considered more suited to serving rural communities that are too remote or with too little economic opportunities to be attractive to commercial MFIs. These include over one thousand two hundred registered Co-opera-tive Savings and Credit Co-operative Societies (SACCOs), a

3 Tier 1 consists of commercial banks and Tier 2 of credit-only institu-tions.

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substantial number of registered non-governmental organisa-tions (NGOs; either specialised in microfinance or offering credit as one type of service), some companies limited by shares, an unknown number of moneylenders, and various types of community-based organisations (CBOs) and mem-ber-based savings and credit groups.The 2000 Cabinet Paper that formed the basis for drafting of the MDI Bill indicated that it was premature to address regulation of Tier 4 MFIs at that time.4 Nevertheless, in passing the MDI Act in 2003, Parliament mandated MFPED to come back with proposals on that issue. To meet this demand appropriately, GOU and its agencies, international development partners, MFIs and their apex organisations col-laborated in a consultative process through a Tier 4 Technical Subcommittee of the Microfinance Forum (MFF). The results of the consultations and other related work are presented here as essential technical background to inform forthcoming discussions on policies and a strategic action plan for Tier 4 regulation.

1.3 Key findingsA regulatory framework should set forth what is to be regu-lated, how to regulate, and who is responsible for regulating. Regulations describe the rules and the sanctions for failure to adhere to the rules. Negative sanctions can range from fines to de-registration or suspension of a license to operate. Positive measures encourage compliance with the rules through pro-motion, capacity building, ratings, and other incentives.

4 The Cabinet Paper draws on the BOU Policy Paper of 2000, which set forth the tiered approach and limited BOU supervisory role to the upper tiers. The BOU Policy Paper also mentioned a possible role for “umbrella bodies” in (self-)regulation of Tier 4 MFIs.

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What to RegulateThere is a strong consensus regarding what the subject of regulation should be. The focus of regulation depends first on the type of product.

The primary motivation for intervention by national au-thorities is to protect savings by the public, which is enforced through laws that set forth what types of institutions can be licensed to mobilise savings. Provision of credit, however, can most appropriately be addressed through regulations (e.g. concerning disclosure of fees and interest rates) that apply to all institutions engaged in lending, rather than by restricting who can engage in credit (Figure 1.1). This ensures that the growth potential of the system, in particular innovations in reaching rural poor clients, is not constrained by the regula-tory framework.

Figure 1.1 Regulation by Product Rather than by Institution.Credit Savings

Tier1

Regulate this columnTier2

Tier3

Tier4 Instead of this row

Source: AMFIU and GTZ 2003 (Annex A of this volume).

How to RegulateThe tiered structure guides the conclusions on how to regu-late savings and credits. A core principle is that the benefits should exceed the costs of regulation (to the MFI as well as the regulator). Saving products for the public can legally be offered only by financial institutions in Tiers 1, 2 and 3 that

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are licensed by BOU. BOU provides “prudential supervi-sion” to verify the compliance of these institutions with specific regulations that are intended to assure their financial soundness and the safety of the savings. While such supervi-sion is costly, it is justified by the public benefit of ensuring the stability of the financial system and the safety of savings, which in turn facilitate growth of the Ugandan economy.

Extending this logic to Tier 4, however, is not straightforward because of the conditions under which some mobilise sav-ings, the focus of many on credit only, and their small, decen-tralised nature. Registered SACCOs can legally take savings from and lend to their member-owners. Members of SACCOs (and small informal savings and credit groups) are considered to have primary responsibility for the management of their funds, making it extremely important that they have adequate internal controls and governance structures – which regula-tions governing the registration of SACCOs and requiring an annual audit are intended to ensure. Furthermore, many NGO MFIs take only “compulsory savings” as part of their microfinance methodology. These are not prohibited of long as they are held only as security (or “loan insurance funds”) and not used for lending (“intermediated’). In this volume, the term “savings” refers usually to deposits that are taken from the public (rather than members) and are intermediated as loans. Thus, the primary issue for regulation of Tier 4 MFIs as institutions is to ensure that they do not mobilise and intermediate savings from the public.

Concerning credit, the number of institutions is too great for direct supervision to be cost-effective. Therefore, the Subcommittee considered two positive approaches. One is for MFIs of a common type to subscribe to a self-regula-tory framework or code of conduct that defines standards,

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in particular for credit procedures and dealing with the public. Another (complementary) approach is to empower the consumers of financial services to understand both their rights and their responsibilities. Consumers making informed decisions will drive MFIs to improve the quality of their products. Effective implementation of such a framework would indirectly result in negative sanctions by educated consumers for those MFIs that fail to live by the standards or to join “branded” self-regulatory bodies.

A key implication of the above findings is that, for the vast majority of Tier 4 MFIs and their clients, the critical issue is capacity building rather than regulation per se. No amount of external supervision can substitute for good governance, internal controls, and proactive members who are aware of their rights and responsibilities in SACCOs and other mem-ber-based groups. Furthermore, even basic monitoring of the performance of MFIs requires significant improvements in the current ability of most of them in terms of accounting, auditing, management information systems, and reporting. Likewise, codes of conduct and regulations for disclosure are effective only to the extent that consumers understand them and how to exercise their rights.

An important principle for designing a strategy for both regulation of MFIs and building their capacity to comply is that supervision should be separated from providing capacity building. Effective external supervision requires independ-ence and avoidance of conflict of interest with promotional roles. On the other hand, monitoring and self-regulation may, to some extent, be carried out alongside capacity building given as an incentive for performance, as long as this is exercised separately from the responsibility for licensing and registration.

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Who Should RegulateThe findings above provide some preliminary guidelines as to who might suitably exercise different types of regulatory responsibilities. The regulation of public savings demands a strong, independent statutory authority, such as BOU. On the other hand, the high costs of supervising numerous, decen-tralised MFIs mean that primary responsibility for oversight in small member-based SACCOs and CBOs must rest with the members themselves – informed, to the extent possible, by audit requirements and consumer education. It is in the middle ground between the latter and those clearly falling un-der BOU that the thorny, and as yet unresolved, issues arise: who should be responsible for overseeing large SACCOs and for ensuring that SACCOs comply with basic audit and gov-ernance requirements? The current roles of and constraints on SACCO apex organisations and the Department of Co-opera-tives in the Ministry of Tourism, Trade and Industry (MTTI) are presented in Chapter 3 of this volume, and summarised briefly in the next section.

Regulation of credit is only at the drawing board stage, although there is growing interest both among Government officials and some other stakeholders in establishing regula-tions for transparency and disclosure in lending. Whether this would be backed by legal requirements with a body desig-nated or created to enforce them, or simply embedded into self-regulatory frameworks remains to be seen. Enforcement will inevitably be problematic due to the enormous size and variety of Tier 4 credit providers.

The capacity of regulators is also an important issue: one principle is not to issue regulations that one cannot enforce. BOU has undertaken substantial capacity-building efforts over more than two years to prepare for supervision of a

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limited number of MDIs. Recognising the much greater problems in dealing with the large number of Tier 4 MFIs, the volume outlines the need for capacity building also for the potential regulators. A well-designed strategy will bal-ance the nature and extent of supervision required with the capacity of the potential regulators, recognising that the costs of regulatory failure are usually much higher in the case of strict prudential supervision requirements than for voluntary self-regulatory mechanisms.

1.4 Role for Apex Bodies in Tier 4 RegulationA range of different options for regulatory bodies can be identified from the discussion documented in this volume, including:(a) Government directly through a ministry (e.g., MFPED)

or a government agency (e.g., the Registrar General;(b) Independent public agencies, such as BOU;(c) Private agencies mandated by government or legisla-

tion;(d) Private agencies, usually network organisations, through

voluntary association by private members.There has been a wide consensus that government should be the “regulator of the last resort”, i.e., that option (1) above should be considered only if any other would fail to achieve the desired objectives. The idea of regulation by an independent agency (option 2) has so far not been discussed explicitly, due to strong reservations regarding establishing a new regulatory body “from scratch” and to the absence of either a legal basis or interest from BOU to become engaged with SACCOs at this stage.Hence, the subcommittee’s discussion has focused on options (3) and (4). Three national apexes can be taken into considera-

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tion for a regulatory role: AMFIU, UCA and UCSCU are all private sector, voluntary member-based and member-driven organisations. The Association of Microfinance Institutions of Uganda (AMFIU) is the national apex of MDIs and MFIs, and the “voice of the MF-industry” in Uganda as a network open to all stakeholders. Its membership covers microfi-nance providers from all four tiers, and from all categories within Tier 4. The co-operative apexes, Uganda Co-operative Alliance (UCA) and Uganda Credit and Savings Co-opera-tive Union (UCSCU), are AMFIU-members. By collecting, analysing and sharing information on performance and other data, by disseminating of and capacity building towards sound practices and by establishing consumer education, AMFIU’s strategic goal is to establish its membership as a quality mark throughout the MF-industry. Thus, its mission includes self-regulatory functions of monitoring and setting standards, though not supervision of the operations of its members.UCA promotes the general welfare of co-operatives in Uganda as the apex body for all co-operative organisations, providing advocacy, resource mobilisation and capacity building to its members. Among its members are over 700 SACCOs. UCSCU is the apex specifically for registered SACCOs, of which over 500 have become members. UCSCU is committed to the development of safe and sound SACCOs countrywide. It monitors the performance of its members and assists them to build capacity to maintain and use financial management tools.5

5 UCSCU utilises the PEARLS system of the World Council of Credit Unions, while UCA encourages its members to use the Performance Monitoring Tool (PMT) that feeds into the Performance Monitoring System maintained by AMFIU. For effective industry-wide monitor-ing, it will be important to make the data collected for PEARLS compatible with the PMT.

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As the Annex papers show, the subcommittee discussed in particular the suitability and capability of AMFIU to take over a legally mandated regulatory function (option 3), in addition to its current limited activities in monitoring and setting standards (option 4). The opinions expressed are controversial and differ from one paper to another. It is important to understand the difference between options (3) and (4). The latter is a form of voluntary self-regulation, and it requires commitment from members and the ability to provide incentives for compliance. Option (3) is a form of su-pervision, which would require independence, competency, and wide geographical coverage. In September 2005 MFPED announced that UCSCU would be charged with regulatory responsibilities for Tier 4. However, the specifics remain to be discussed, and the costs of burdening the apexes with ad-ditional regulatory functions, and how to handle the potential conflict of interest between promotional and regulatory func-tions, have not yet been fully assessed or resolved.6

1.5 Overview of the Volume’s Chapters and Annexes

During 2004 and 2005, the MFF Subcommittee on Tier 4 Regulation identified the basic principles, issues and areas for strategic actions as the basis for a “roadmap” of the way forward, which is summarised in Chapter 2 of this volume. The results of the stock taking exercise of the various laws and regulations and the roles of apex bodies concerned with Tier 4 MFIs, which formed the basis for the roadmap, are presented in Chapter 3. Together, these provide a sound technical foundation for developing specific action steps in the areas identified in section 2.5.

6 AMFIU’s views are explained in the Preface.

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The Annex comprises four papers that document relevant background work over three years (2002 to 2004). To share international experiences, study visits were organised to South Africa in 2003 and to Cameroon in 2004.

The South Africa tour (Annex A) yielded two important find-ings. First, not only Tier 4 MFIs but rather the entire lending market is the appropriate focus for regulation on the credit side. Second, it is inappropriate for AMFIU to undertake Government-mandated responsibility for prudential supervi-sion, to avoid conflict of interest with its promotional and capacity-building role vis-à-vis its members and the microfi-nance industry as a whole.

One finding from the Cameroon tour (Annex B) is that linking formal and informal service providers may provide a cost-effective option to extend regulation beyond direct pru-dential supervision of the formally licensed financial sector.

A background paper (Annex C) was prepared to set forth the issues and possible mechanisms for regulation of Tier 4. It makes the case that a self-regulatory framework backed by statutory powers of government agencies could be a suitable option for regulating the Tier 4 market segment. Another background paper (Annex D) was used to draw lessons from Benin, Ghana and Tanzania that are relevant to Uganda. It indicates that financial markets work best when regulation takes different approaches to different tiers of the financial system and when capacity limitations of both MFIs and supervisory authorities are addressed.

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1.6 Conclusion and RecommendationsIn summary, the volume offers valid and valuable technical expertise toward establishing a regulatory framework that will support a continuation of the success story of Uganda’s growing microfinance industry. Key recommendations are:

(a) The proper focus of mandated external supervision is protecting voluntary savings from the public, under the authority of BOU, as set forth in the Financial Institutions and MDI Acts. Regulation of credit should be industry-wide, not directed at particular types of institutions. Consumer education is an important complement to effective regulation.

(b) MFIs offering savings to members, particularly SACCOs, need substantial capacity building to strengthen their internal controls and governance and to comply with regulations.

(c) Capacity building to apex bodies (in particular, AMFIU, UCSCU and UCA) is important for them to exercise voluntary self-regulatory functions, particularly moni-toring, information-sharing, and setting standards (or codes of conduct). Any expansion of their regulatory functions should be preceded by the requisite capacity building.

(d) In considering delegating supervisory functions to such apex bodies, Government should take care to develop cost-effective approaches and to avoid conflict with their promotional roles. Supervision of and capacity building for MFIs should be managed separately.

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Chapter One

Chapter 2

Strengthening and Regulating Tier 4

Microfinance (“Roadmap”)

19

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Chapter 2 Strengthening and Regulating Tier 4 Microfinance7

2.1 IntroductionStrengthening and regulating microfinance institutions (MFIs) in “Tier 4” (i.e., those not licensed by Bank of Uganda)8 is important to build a strong microfinance pillar for a pro-poor financial system. This note attempts to capture the emerging consensus on a number of issues and proposals that have been widely discussed by microfinance stakehold-ers, as a basis for further discussion and building consensus on a strategic action plan. The text sets out the key principles, issues and proposed action areas, as a basis for preparing a more detailed action plan and review of efforts already underway.

7 This paper draws on the findings of the Issues Paper (Chapter 3), and was prepared for and discussed by the Tier 4 Technical Working Subcommittee on 14 June, 2005 as a basis for charting a roadmap of actions to carry the process forward,

8 See Chapter 3.1 for a description of the Tiers. Estimates of the number of organised MFIs in Tier 4 are about 1500. Savings and credit co-operatives (SACCOs) are the most numerous; other member-based organisations engaged in savings and credit include Village Savings and Credit Institutions, Financial Service Associations, and rotating and accumulating savings and credit associations. Various non-gov-ernmental organisations (NGOs) and community-based organisations also engage in microfinance activities, some as a core business and others as a complement to other services. In addition, traders, money-lenders and other individuals also provide financial services in rural areas.

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Strengthening and Regulating Tier 4 Microfinance (“Roadmap”)

2.2 Rationale and VisionThe objective for building a strong Tier 4 sector is to increase the access of the poor, particularly in rural areas, to appropri-ate financial services from institutions that are sound and sustainable and deliver services efficiently, affordably and transparently. Tier 3 Microfinance Deposit-taking Institutions (MDIs) are one part of making financial services available to substantially larger numbers of the economically active poor, and some Tier 1 and 2 institutions are also targeting that market. However, Tier 4 MFIs are considered to have a special role in reaching deeper to those that are geographi-cally or economically beyond the current reach of MDIs and to take advantage of common bonds and co-operative efforts9. Savings and Credit Co-operatives (SACCOs), which dominate Tier 4 in terms of numbers, are of particular concern both because of their potential to achieve greater outreach and because of weaknesses that have been identified in their governance and capabilities.The vision is for a healthy Tier 4 microfinance sector in Uganda, in which:(a) a limited number of larger, well-run institutions are su-

pervised by a central body or bodies (deriving authority

9 It is important to note the existence of a large group of economically active vulnerable poor with special needs. Many Ugandans are only able to save amounts of 100 to 1000 shillings, and may occasionally want to borrow amounts from 5000 to 50,000 shillings. In most cases, such small transaction sizes cannot be sustainably supported by even semi-formal institutions, and these people are often better served by assistance allowing them to form well-run Accumulating Savings and Loan Associations (ASCAs), which have essentially no administrative costs, and which do not require any transfers from poor household economies to pay the administrative costs of financial institutions. Organising the very poor into SACCOs may lead to weak SACCOs, and put unsustainable financial strains on the members.

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from legislation for financial institutions) for compliance with prudential regulations;

(b) a larger number of smaller, solvent institutions observe the basic legal requirements for engaging in financial transactions (e.g., annual audit for SACCOs and com-panies, no intermediation of savings from the public for non-member-based institutions);

(c) those member-based savings and credit organisations (especially SACCOs) that are not externally supervised have internal controls and governance structures that are adequate to protect members’ savings and interests;

(d) codes of conduct guaranteeing transparency and redress to consumers are widely subscribed to and observed;

(e) basic performance and outreach data are systematically collected and monitored.

2.3 Core PrinciplesGovernment intervention to regulate financial services is warranted when the public’s savings or the stability of the financial system may be at risk. Nevertheless, regulatory measures should be designed so that public benefits exceed costs, and should be commensurate with the capabilities of the authorities charged with such regulation.

While the focus of assistance tends to be on the institutions, the ultimate orientation must be toward serving the custom-ers, supported by a system that provides adequate support and regulation. For many Tier 4 institutions, the highest priority may be capacity building and improved internal controls, rather than capitalisation for on lending or external super-

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vision. In particular, it should be recognised that external lending to SACCOs risks undermining their member-based savings-oriented culture.

Key ObjectivesCustomers should:

(a) have access to financial services that:

(i) are continuously available;

(ii) are appropriate to their circumstances, and afford-able;

(b) have protection for their savings and from aggressive marketing of credit;

(c) have enough information about different types of institu-tions and products to be able to make informed choices;

(d) have access to consumer complaint mechanisms and legal redress.

MFIs should:

(a) continue to reach out to poor and rural clients;

(b) avoid marketing credit services to people in amounts larger than they can manage or profitably invest;

(c) become operationally and financially self-sustainable;

(d) exercise sound financial management practices;

(e) provide services efficiently, transparently, and in re-sponse to consumers’ demands;

(f) comply with relevant laws and regulations.

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(g) investigate merger, linkage banking and other co-opera-tive arrangements if they cannot attain sufficient scale to be efficient through expansion and organic growth

The financial system should:

(a) provide supervision that is cost-effective (i.e., benefits exceed costs to the government, the MFIs involved, and the consumers);

(b) act collectively to obtain accurate, timely information on outreach and track progress towards serving different market segments

(c) assist in building the capacity of both MFIs and consum-ers;

(d) ensure adequate flow of information to regulatory authorities, especially through apex bodies;

(e) support consumer education and protection, e.g., through codes of conduct.

IndicatorsAccordingly, the health of the sector could be measured by indicators such as (but not limited to) the following:

Customers

(a) Availability of a range of products: savings, credit of various sorts, transfers, insurance;

(b) Quality of those products, particularly price of credit and security of savings;

(c) Consumer-friendly features, including transparency in pricing, redress, absence of predatory lending;

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MFIs

(a) Compliance with minimum legal requirements;

(b) Adequacy of capital relative to liabilities;

(c) Protection of stakeholders’ interests, including share-holders and employees;

Financial System

(a) Degree of systemic risk to the financial system posed by Tier 4;

(b) Financial system integration, both to increase efficiency and to reduce possibilities to evade regulations.

2.4 Critical IssuesThe Ugandan Government is committed to providing a legal, regulatory and institutional environment conducive to the development of the microfinance sector, rather than intervening directly.10 Regulation is a leading issue because passage of the MDI Act, which established BOU supervision of MDIs that it licenses, highlighted the question of how the Government and the microfinance industry can ensure safe and sound development of the large number of MFIs not under BOU supervision.

While donor-supported programs have focused heavily on building the capacity of MFIs in recent years, the ability of MFIs to provide accurate financial statements remains

10 As articulated in the Plan for Modernisation of Agriculture, the Medium-Term Competitiveness Strategy, and the Microfinance Outreach Plan.

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a critical issue not only for financial management but also for the adequacy of information both to regulators and to shareholders (especially SACCO members). Increased ef-forts to strengthen the Performance Monitoring Tool (PMT) and system and to standardise the reporting format for SACCOs are needed as a basis for more effective monitor-ing and supervision. Consumer education and protection are receiving increasing attention in Uganda due to realisation that consumers represent the base and the raison d’ệtre of microfinance and that this represents the most effective way to regulate lending. Finally, some agencies are exploring the possibility of creating a Ugandan rating service that would provide objective assessments of both the financial and social performance of a large number of stronger Tier 4 MFIs.

Who and What to Regulate?Discussion of regulation often tends to focus on institutions, because they are what are licensed or registered. The rationale for supervision of financial institutions is based on protecting the financial system and the savings of depositors. This means that, in designing a regulatory system, distinctions may be made between the treatment of savings and credit products, regardless of the institution providing the service. In this context, financial institutions can be categorised according to how they are (or are not) legally constituted to engage in savings and/or credit activities, as follows (Table 2.1):

(a) “Formal institutions” = those licensed to engage in financial activities (under FIS and MDI Acts);

(b) “Semi-formal institutions” = those not explicitly licensed to carry out financial activities, but registered, and engaging in legal financial activities [which may

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have some regulatory requirements associated with registration, even though not under BOU supervision — e.g., annual audit requirement for SACCOs] ;

(c) “Informal institutions” = neither registered nor licensed, but engaging in financial activities.

Table 2.1 Savings and Credit Services Permitted by Category of Legal Status.

Category of Institution by Legal Status

Services Provided

Formal (licensed by BOU) Tiers 1, 2 & 3

Semi-formal (Tier 4) (regis-tered, but not licensed by BOU)

Informal

Savings & Credit

Financial Institutions Act (Tiers 1 & 2) ;

MDI Act (Tier 3)

Co-operative Societies Statute (SACCOs)

Small, local member-based groups (e.g., ROSCAs, ASCAs)

Credit only

n.a. Moneylenders Act

NGO Registration Statute

Company Law

Non-registered individual moneylenders

External Regulation

Two types of regulation external to a financial institution (i.e., established by the Government or the industry) can be distinguished:

(a) Prudential regulation refers to requirements intended to ensure the soundness and safety of financial institu-

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tions, under the authority of financial legislation and the Central Bank (which usually supervises licensed institu-tions, though it can in principle delegate supervisory responsibilities to another agency if appropriate);

(b) Non-prudential regulation involves rules and guidelines regarding acceptable behaviour and business practices in the delivery of financial products or the operation of the financial institutions, which may be established and enforced either by a government agency or a non-governmental organisation (“self-regulation” refers to a situation in which an association or apex institution exerts control over its membership and their behaviour, including requirements to follow sound accounting principles, disclose fees and interest rates, provide information, and follow agreed codes of conduct).

Internal regulation

Perhaps the most important type of regulation for Tier 4 MFIs, for which enforcement by external bodies is impracti-cal or at best infrequent, is internal – embodied in the bye-laws or articles of association and the operating procedures of the institution. These include internal controls that enable management to detect fraud, transparently administered loan eligibility criteria and decision-making, and governance structures that involve members in oversight of the manage-ment of SACCOs . In NGOs and companies, board members and (if applicable) shareholders play a strong role in guar-anteeing a strong internal governance structure. In practice, however, internal controls are most effective if backed by some external oversight or enforcement mechanism (e.g., ensuring availability of annual audit or annual general meet-ing).

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Way Forward

The major focus for going forward is on establishing an or-derly system of progression to different levels of regulation, differentiating between:

(a) Size, with increasing regulatory requirements as institu-tions become larger players in the financial system;

(b) Product: Providing credit only (with consumer protec-tion being the main issue), vs. taking and intermediating savings from the public (where protection of people’s savings warrants public setting and enforcement of standards);

(c) Ownership: Member-based organisations (where, in principle, members bear responsibility for internal con-trols and self-regulation) and those serving the general public.

In general, external supervision is not warranted for credit-only MFIs (including those that take compulsory deposits that are held as security against loans), although their credit products may be subject to (non-prudential) regulations and voluntary codes of conduct.11

A more difficult issue is the role of public authorities in restricting and supervising the mobilisation of savings for the purpose of making loans.

While in principle there is a public interest in safeguarding the savings of the poor, Uganda’s current policy is that small

11 Nevertheless, enforcement of the prohibition against intermediating savings from the public and of non-prudential regulations would require monitoring and intervention by (or recourse to) an external authority.

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member-based intermediaries (including small SACCOs) should not be prohibited from taking deposits simply because they are too small to be supervised effectively, given the important services they render to local communities beyond the reach of other MFIs. As SACCO size increases, however, the increasing scale of members’ savings being mobilised, and the decreasing effectiveness of internal oversight by members, bring them closer to the category of deposits from the public and make potential risks of loss or mismanagement a matter of public concern. Hence, the challenge with respect to Tier 4 MFIs, especially SACCOs, is to establish thresholds at which more stringent requirements should be applied, and to build the capacity both of the MFIs to comply and of regulatory bodies to enforce.

Basic principles for moving forward, on which substantial consensus has emerged, include:

(a) Focus regulatory efforts on MFIs that take and interme-diate deposits;

(b) Avoid prudential regulation of MFIs engaged only in credit activities (with or without mandatory savings held as security); any efforts to regulate credit should be system-wide and centered on credit as a product, not on institutions;

(c) Before imposing external regulatory requirements, consider whether the benefits justify the costs, including both (i) the direct costs to the organisation charged with enforcing the regulations and (ii) the staff time and other costs to the MFI involved in complying with the regula-tions;

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(d) There should be a unitary regulatory authority for prudential regulation (BOU), but some supervisory functions could in principle be delegated to other agen-cies;12

(e) Prudential supervision of SACCOs should be done by a specialised financial authority, rather than by the govern-ment agency responsible for registering and promoting all co-operatives;

(g) Consolidation and mergers of Tier 4 MFIs could help reduce the number and increase the size and capacity of MFIs subject to regulation.

Accounting and AuditingFor implementation of such a regulatory system, whether involving external supervision or only internal controls, a critical issue is how to establish adequate accounting and auditing capacity. Co-operative Societies Statute 1991, sec-tion 21, provides for mandatory audits and submission of annual audited accounts to the Registrar of Co-operatives. However, application is weak because of shortcomings at four levels: (i) many SACCOs need training to enable them improve their production of reliable financial statements; (ii) few auditors have the capacity or interest to provide audit services to SACCOs at rates they can afford (especially the smaller ones); (iii) audits that are available are not specialised to the needs of SACCOs and the reports are perceived not to provide value for money; and (iv) the Department of

12 This would presumably require amendment of the existing Financial Institutions and Microfinance Deposit-taking Institutions Act, and perhaps the Co-operative Societies Statute in the case of SACCOs.

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Co-operatives lacks the staff and skills to enforce the require-ment (especially to carry out the audit function). Furthermore, there is a lack of standardised accounting systems and train-ing materials.

Proposals to address the above concerns include:

(a) Standardise the chart of accounts used by SACCOs and provide training to produce better accounting records, thus making audits less expensive;

(b) Encourage the development of smaller audit firms and accounting consultants who can provide more affordable services to the Tier IV institutions;

(c) Use the ‘Cluster Approach’ when auditing Tier IV institutions by engaging an audit firm to audit a number of institutions as a single package, and negotiate a low standard rate in exchange for a guaranteed level of busi-ness;

(d) Tie funding (for credit lines or training) to standardis-ing and improving financial accounting and producing better quality reports (including submitting Performance Monitoring Tool [PMT] reports to AMFIU);

(e) Create a donor-pooled fund to build the accounting/audit market for MFIs through partial subsidies audits (both for MFIs and service providers to develop products);

(f) Consumer education training of members/clients/owners of Tier 4 institutions to raise questions that will require leaders of these institutions to be more mindful of qual-ity accounting.

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Codes of ConductA Consumer Code of Practice (CCP) can guide MFIs and other financial institutions involved in the delivery of micro-finance services on how they should relate to consumers. The purpose is to:(a) Inform customers about the institution’s business aims

and operational practices;(b) Set out institutional procedures in dealing with customer

issues;(c) Communicate the terms and conditions of financial

products in consistent ways to allow consumers to make informed choices after comparison of options;

(d) Provide information on contacting the institution and other organisations concerned with consumer issues in the industry.

Although it is not a legal document and does not replace any institutional terms and conditions stated, it should move beyond general principles and guarantee substantial protec-tion to consumers in order to ensure fair competition in the financial services market.

Issues to considered when drawing up a code include custom-ers’ needs; whether they are fully informed and accessing the right product; and whether interest rates and other charges are correct and fully explained. To fulfil the objectives, the frame-work for an industry code would provide for an independent body13 for code formulation and administration; a mechanism to monitor, review and report a code administration; a mecha-nism for the resolution of consumer disputes; and a process for regular review and improvement of the code.

13 E.g., Uganda Consumer Protection Agency.

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Consumer Protection and EducationConsumer protection refers to actions taken by MFIs to assure transparency, disclosure of interest rates and fees, and other consumer-friendly actions. In Uganda’s financial markets, such measures are an appropriate next step for regulating credit – across all financial institutions, not only microcredit. The challenge of consumer protection is that, if it is not mandated by an authority with the ability to apply both positive and negative sanctions, it is not likely to produce any real change in behaviour. Either MFIs will create codes of conduct which express good intentions but do not require real changes in practices; or, if the code actually requires significant changes in behaviour, only the MFIs which are already committed to a client-friendly approach are likely to adopt the code.

Consumer education is not a substitute for needed reg-istration, regulation or supervision. However, educated consumers creating a responsible demand for transparency and accountability can make the challenge of regulation and supervision more manageable. In the case of member-owned institutions, educated consumers are a necessary element that no amount of supervision can replace. The smaller and more rural the institution, the more it must rely on owners, members or customers to fulfill various oversight functions. Ideally, a system of regulation would have break points at which primary responsibility for different oversight functions is progressively transferred from members (consumers) to a central regulatory agency.

Consumer education should aim to instill a sense of rights and responsibilities within consumers at all levels, so that they shop around among products and institutions, and negotiate for financial products in an atmosphere of trust. If systematic,

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consumer education can lead to less over-indebtedness (and thus help relieve repayment issues for MFIs). It can facilitate the action of market forces and thus reward stronger, more transparent and more efficient institutions.

Consumer education and disclosure requirements are particularly important to help the public understand the choices available as both the microfinance and moneylending industries expand. While the growing number of semi-formal moneylending operations (i.e., businesses registered with the Magistrates Court under the Moneylenders Act) offers consumers more choices to meet their short-term financial needs, they also increase the need to inform the public of differences in orientation and methodologies between MFIs and moneylenders, and of the implications, rights and responsibilities associated with different options. Consumer education, accompanied by codes of conduct and disclosure requirements for credit products generally, is likely to be more cost-effective than efforts to directly supervise credit institutions, which in any case is not warranted in terms of protecting savings and the financial system.

2.5 Action Steps for the Way ForwardThe following key steps for the way forward to address the above issues are grouped into categories relating to overall strategy, the financial system, strengthening MFIs, and consumers. Some may be absolutely necessary, others simply useful. The list is not in any chronological order, and further discussion is needed to review efforts already underway, establish priorities in terms of both feasibility and what is necessary or useful to facilitate the accomplishment of other tasks, and prepare an action plan for implementation.

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Strategic Principles1. Redefine “pro-poor finance” into a more manageable

model for Uganda’s current realities, with the four pillars of a pro-poor financial system: SME Finance, Traditional Microfinance, Agricultural Finance and Services to the Vulnerable Poor. Develop strategies for each pillar.

2. Obtain better information, especially information directly from consumers of financial service.

3. Learn from international experience, especially other African countries.

4. Involve all key actors, including the Bank of Uganda, in defining a way forward.

Information Gathering1. SACCO Census to update Registry and identify those

not in existence.

2. Assessment of SACCOs and other Tier 4 MFIs (basic indicators of viability and compliance).

3. Market study (FinScope).

House Cleaning1. Triage of SACCOs to distinguish those for closure, those

needing capacity-building to survive or thrive, and those in reasonably good health.

2. Clarify and publicise legal/illegal activities for Tier 4 institutions, and devise exit strategies for those illegally taking and intermediating savings.

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Regulatory Reform1. Review proposed amendments to Co-operatives

Societies Statute to incorporate SACCOs and their financial implications (as basis for MFPED approval to proceed).

2. Consumer protection legislation.

Support Institutions1. Assess and strengthen Apex organisations.

2. Strengthen PMT data collection and analysis systems.

3. Improved capacity of financial service and audit provid-ers to provide affordable services to Tier 4 MFIs.

Strengthening MFIs1. Other capacity building of Tier 4 MFIs.

2. Capacity building co-ordination among funding pro-grams.

3. Assist SACCOs to prepare auditable accounts and to improve their financial accounting systems and capabili-ties.

4. Agree on best practices in loan funding.

5. Support for consolidation.

Safeguarding Consumer Interests1. Model code of conduct (suitable for adoption by Tier 4

Apex organisations).

2. Consumer education.

3. Develop mechanisms for redress.

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Issues Paper On Regulation of Tier 4

Financial Institutions

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Chapter 3 Issues Paper On Regulation of Tier 4 Financial Institutions14

3.1 Background to the Work of the CommitteeThe Microfinance Deposit Taking Institutions Act, 2003 was enacted to provide the licensing, regulation and supervision of microfinance business in Uganda and to provide matters connected with or incidental to an efficient, reliable and ef-fective microfinance industry.The Financial Institutions Statute and the Microfinance Deposit Taking Institutions Act, 2003, when read together, define the four tiers of the microfinance industry as below:(a) Tier 1: Commercial Banks licensed under the Financial

Institutions Act 2004;(b) Tier 2: Credit Institutions licensed under the Financial

Institutions Act 2004;(c) Tier 3: Microfinance Deposit-Taking Institutions (MDIs)

to be licensed under the Microfinance Deposit-Taking Institutions Act 2003;

(d) Tier 4: Microfinance Institutions that are involved in microfinance but do not fall under the Tiers above mentioned.

However, the enactment of this Act still leaves significant need for legal and regulatory provisions for institutions that fall under the Tier 4 category. All the financial institutions categorised within Tier 4 are not authorised to intermediate deposit from the public other than their own membership or as collateral for loans (mandatory savings). The financial institutions in the Tier are governed loosely under different

14 Tier 4 Technical Working Subcommittee, Microfinance Forum, June 2005

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Issues Paper on Regulation of Tier 4 Financial Institutions

supervisory and/or regulatory environment. This has given rise to the impression that financial institutions in that Tier lack an effective regulatory or supervisory mechanism not only to help the concerned financial institutions to grow and professionalise, but also operate in a manner that is transpar-ent, responsive and protective of the consumers. Even where legal provisions exist, the question of capacity of the respon-sible agencies to effectively enforce the existing provisions i.e. policies, regulations and laws are also identified as a con-straint. Addressing the regulatory challenges within the Tier 4 category, thus builds on the need to protect the public from losing their savings (could be termed as deposits in cases of huge savings amounts collected) through mismanagement and bad governance practices. The need to have efficient and well-managed MFIs and consequently a reliable and sustain-able microfinance industry further strengthens the regulatory concerns raised in this document.The challenges highlighted above, were further re-echoed in Parliament and an understanding reached between the House and the Ministry of Finance to the effect that a proposal on Tier 4 regulation would be presented to Parliament. In an ef-fort to address this challenge, a technical working committee comprising of members of the National Microfinance Forum, took the lead in consultations on Tier 4 regulation.15 This committee has drafted a report on findings regarding legal and regulatory aspects of the Tier 4 category of MFIs and below is a presentation on the same.

15 Although the time frame given by Parliament was six months, this has proven insufficient even for the consultations with various stakeholders necessary to understand the existing legal and regulatory structures af-fecting the different segments of Tier 4. It may be noted that preparation of the MDI Bill involved three years of consultations leading to a Cabinet policy paper and two years to draft, consult on, and pass the Bill.

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3.2 DefinitionsFor the purpose of this report, “regulation” is taken to refer to four types of requirements that may be applied to individuals or organisations engaged in credit, savings or other financial activities:(a) Registration (to establish a legal status);(b) Monitoring (data collection; may be used to benchmark

and categorise MFIs)(c) Non-prudential regulation, which may include:

(i) Requirements, such as an annual audit, for MFIs to retain registered status;

(ii) Consumer protection requirements, such as dis-closure of rates and fees, which may be applied to products (e.g. loans) rather than institutions;

(iii) Standards (e.g., adhered to by members of a volun-tary association);

(d) Prudential regulation and supervision (aimed at protect-ing public savings that are being mobilised and lent out [“intermediated”]; involves verification by regulatory authorities of compliance with mandatory standards such as minimum capital levels and adequacy, liquidity man-agement ratios and asset quality standards, as measures for financial soundness).

“Microfinance business” is defined in the MDI Act as “ac-ceptance of deposits [and] employing such deposits wholly or partly by lending or extending credit…at the risk of the person accepting those deposits….” Prudential regulation and supervision are normally applied to protect public savings in institutions such as MDIs that take deposits from the public and make loans from the funds mobilised. MFIs that lend from other sources of funds do not come under the MDI Act, even if

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they require deposits “as security for a loan to be granted…to the person making the payment.” Member-based organisations such as Savings and Credit Co-operatives (SACCOs) that lend to members out of savings mobilised exclusively from those members are generally not considered to be taking deposits “from the public” and do not come under the MDI Act.

3.3 ObjectivesThe Tier 4 regulation committee, a working technical commit-tee was created to carry out consultations with the different partners involved in the Tier in order to:(a) Document the status quo, regarding provisions for super-

vision and regulation of Tier 4 financial institutions.(b) Identify capacity constraints in the mandated regulatory

agencies that affect the enforcement of the legislative/ regulatory provisions.

(c) Suggest and recommend on how the regulatory, legal, policy or supervisory environment of the Tier could be improved.

3.4 MethodologyThe Committee invited to meetings, strategic partners and regulatory organisations/agencies known to have direct responsibility for or indirectly influenced the operation of the institutions concerned.A template, was developed to guide the solicitation of relevant information, regarding the regulatory or supervisory status and/or requirements of financial institutions in the Tier. The resulting table (Appendix 3.1) summarises the issues of regis-tration, monitoring prudential and non-prudential regulations, among others in terms of regulatory bodies, apex organisa-tions, and other support institutions.

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The committee also reviewed existing laws and literature to provide an insight into the current legal and regulatory envi-ronment relevant to tier 4 MFIs (see References).

3.5 Composition of Financial Institutions in Tier 4The current regulatory environment is diverse, both in the types of MFIs and also the relevant regulatory bodies. In the case of SACCOs, there are some regulatory provisions that require certain performance in order to stay registered (sub-mission of annual audit; maintenance of at least 1⁄3 subscribed capital). Following is an analysis of each type of financial institution and the relevant regulatory body.

Savings and Credit Co-operatives Organisations (SACCOs)The Ministry of Trade, Tourism and Industry (MTTI) has a Co-operatives Department mandated with the registration, dereg-istration, and supervision of Savings and Credit Co-operatives (SACCOs) (and all other types of Co-operatives) in Uganda. A Registrar of Co-operative Societies who performs these func-tions heads the Department. The Registrar is also responsible for monitoring, supervising and auditing of SACCOs, as an auditor of last resort. The department is also responsible for the promotion of the co-operative policy leading to the growth of co-operatives in the country. At each District, the Registrar has a representative, the District Co-operative Officer (DCO) who is a decentralised staff. The Registrar is mandated to enforce the Uganda Co-operative Societies Statute 1991 and the Regulations 1992 and also functions as the Auditor of last resort for all types of Co-operatives (SACCOs inclusive). Currently, over 1,200 SACCO have been registered. The capacity of the Registrar of Co-operatives is however, inad-equate to discharge the prescribed mandate.

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SACCOs are a form of microfinance institutions formed, owned, financed, controlled, and used by their members. They mobilise and intermediate savings exclusively within their membership. They operate under the Uganda Co-op-erative Societies Statute 1991 and the Uganda Co-operative Societies Regulations 1992 together with their individual Bylaws.

SACCOs have formed an apex organisation called Uganda Co-operative Savings and Credit Union Limited (UCSCU). UCSCU is registered under the Uganda Co-operative Societies Statute 1991, as a member-owned organisation whose mission is to promote the organisation and develop-ment of safe and sound SACCOs in the country. Only registered SACCOs affiliate to UCSCU and membership is voluntary. Currently, over 500 SACCOs are affiliated to UCSCU (not all actively). Some SACCOs use the PEARLS monitoring system, a performance-monitoring tool that is promoted by UCSCU.

In addition, SACCOs together with all other types of co-operatives in Uganda may join the Uganda Co-operative Alliance (UCA), which is registered under the Co-operative Statute. 16

UCA is mandated to carry out advocacy, resource mobilisa-tion, capacity building and promote the general welfare of co-operatives in Uganda. Membership is voluntary and currently over 700 SACCOs are affiliated to UCA (not all actively).

16 The Co-operative Societies Statute, 1991, provides for the Board of Directors of Uganda Co-operative Alliance being an advisory body to the Government on Co-operative affairs; and being able to represent Government as and when requested by Government.

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SACCOs voluntarily provide periodic reports (PMT and/or PEARLS reports)17 to the two apex organisations. Currently over 1,200 SACCOs have been registered in the country with a majority being small and facing capacity problems to fulfill regulatory provisions. SACCOs that do not comply with the requirement to provide annual audited accounts or that have disspated two-thirds of their capital can be deregistered, as stated in the law. Nevertheless about 25% of active SACCOs (as well as inactive ones) are not audited as per the legal requirements and yet continue to operate. It should also be noted that SACCOs can wind up or merge voluntarily.

Money LendersThe Magistrates Courts are mandated to register and license moneylenders, under the Money Lenders Act 1952. It should be noted that the law has out-dated provisions (interest rate cap in a liberalised interest rate regime), which raises the con-cern of its relevance in its current status. The Law does not require the Magistrates Courts to monitor the performance of the moneylenders, and no annual returns are submitted. The exact number of moneylenders in the country is not yet known, considering that they can be registered and licensed from any magisterial area countrywide.

17 PMT – Performance Monitoring Tool is a tool that has been gener-ally accepted by microfinance industry stakeholders, to be used in assessing and monitoring growth trends amongst the microfinance institutions. PEARLS – is a set of financial ratios or indicators that help to standardise the terminology between SACCOs. It is an acronym for – Protection; Effective financial structure; Asset quality; Rates of return and cost; Liquidity; and Signs of growth.

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It should also be noted that the moneylenders are supposed to re-apply for renewal of their license from the Magistrate’s Court annually. However, it is not clear how many do operate on renewed licenses.

Companies and Non-Government Organisations (NGOs)The Registrar General is mandated to register: Business names (single proprietorship), Limited Companies (by shares or guarantee), Public Limited or Private Limited Companies, and unlimited companies.

The Registrar does not license any of the entities registered with his office, they are only required to present annual returns.

An NGO is required first to register as a company (limited by guarantee) before it can be registered by the NGO Board to carry out the activities of the NGO’s choice. However, subsequent to registration, the board does no licensing or supervision to enable the registered organisations carry out their activities according to set rules and regulations. Any monitoring of the NGO’s activities has been constrained by the board’s lack of capacity and expertise in the field of financial services provision to perform this function.

OthersRotating Savings and Credit Associations (ROSCAs) and Accumulating Savings and Credit Associations (ASCA) are the other forms of member based financial community based organisations, where members make regular contribu-tions with the objective of accumulating capital that can be paid out for specified purposes, e.g., funerals, Christmas, emergencies; may lend out the funds at interest to speed up

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the accumulation. The difference between the two is that the ROSCAs pay out each collection completely.

On the general, these are voluntary associations among indi-viduals, and are not covered by any legal requirements.

3.6 Apex Institutions/OrganisationsApex bodies are of particular interest because of their actual or potential role in monitoring and self-regulation of MFIs. Following are the various apex organisations and regulatory bodies for Tier 4 Institutions:

Uganda Co-operative savings and Credit Union Limited UCSCUUCSCU is registered under the Uganda Co-operative Societies Statute 1991, as the apex for all SACCOs in the country. It is a member (SACCO) owned organisation whose mission is to promote the organisation and development of safe and sound SACCOs in the country. Only registered SACCOs affiliate to UCSCU and membership is voluntary. Currently, over 500 SACCO’s are affiliated to UCSCU. UCSCU monitors SACCO’s, of which an unspecified limited number were reported to be using the PEARLS Monitoring Tool.

Uganda Co-operative Alliance – UCAUCA is registered under the Uganda Co-operative Societies Statute 1991 as the apex organisation for all co-operatives including SACCOs, in the country. UCA is mandated to carry out advocacy, resource mobilisation, capacity building and promote the general welfare of co-operatives in Uganda. Membership is voluntary and currently over 700 SACCOs are affiliated to UCA.

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District Promotion Centres – DPCsDistrict Promotion Centres (DPCs) are registered under the Companies Act as Companies Limited by Guarantee. Their mission includes provision of: policy advocacy, resource mobilisation, computerisation, policies and procedural guidelines, governance and management systems for MFIs.DPCs serve MFIs that are called Village Savings and Credit Institutions (VSCIs). VSCIs are essentially SACCOs, compa-nies limited by shares, and companies limited by guarantee.The DPCs formalised their relationship with the VSCIs through a Memorandum of Understanding (MOU), and they monitor the latter’s’ performance using the Performance Monitoring Tool (PMT) and the PEARLS Monitoring Tool.

Association of Microfinance Institutions of Uganda – AMFIUAMFIU is registered under the NGO Registration Board as a Non Government Organisation. Its operations are governed by the NGO Statute and other related laws. Its members include institutions that are engaged in microfinance business as a core or secondary activity. These include, but are not limited to, SACCOs, VSCIs (village banks), Limited Companies, NGOs, MF support Agencies and Government projects. AMFIU promotes and protects the interests of its members.AMFIU is the national apex of Microfinance Institutions of all tiers and categories, ranging from: microfinance-oriented commercial banks and credit institutions (Tiers 1 and 2, licensed by the Bank of Uganda), such as Centenary Rural Development Bank, Post Bank, and Commercial Microfinance Ltd.; to the newly-licensed Microfinance Deposit-taking Institutions (MDIs) in Tier 3 (FINCA Uganda Ltd, PRIDE Microfinance Ltd, Uganda Microfinance Ltd); to

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the wide variety characterized as Tier 4, including savings and credit co-operative societies, NGOs, companies limited by guarantee, and companies limited by shares, AMFIU’s associate membership also includes all kinds of stakeholders, such as international development partners, the Government’s Microfinance Outreach Plan, and organizations such as the co-operative apex bodies. As such, it is the most important formal network representing the Microfinance Industry of Uganda. Throughout its existence, AMFIU has been working towards a role in self-regulation. Commitment of its members is high, and AMFIU has a valuable name among MFIs.Membership in AMFIU is voluntary and currently stands at 98 institutions plus 20 associate members. It monitors the per-formance of its members using the Performance Monitoring Tool (PMT). However, the efficacy and extent of the utilisa-tion of the PMT by the MFIs is constrained by low capacity of the potential users to prepare accounts as well as lack of a workable mechanism with AMFIU to enforce the use of the Tool.

3.7 Targeted Results of Technical CommitteeThe wider Microfinance Forum, and the relevant legislative and regulatory agencies established the Committee to analyse and prescribe legal and regulatory concerns for consideration. Amongst the issues of concern include:

Legal statusThe Microfinance industry has been faced with the challenge of growing number of SACCOs, most of them not effectively supervised despite the existence of a legal framework within which they are registered and licensed. The existing laws are by and large sufficient for legal registration of Tier 4 Institutions. What is, however, necessary for the most part may

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be (i) better enforcement of the existing regulations in the laws pertaining to SACCOs; and (ii) possible regulations covering certain financial products, regardless of the registration of the institutions engaged in them.The committee will therefore make recommendations that will ensure that the statutory instruments available for use by the microfinance industry provide for an enforcement of the regulations of the SACCOs, considering their peculiar nature. Especially, the mobilisation of member-savings by SACCOs needs to be subject to sufficient control (internal control by SACCO members and/or external control by supervisory authority) to ensure safety of the population’s monies.

Professionalism and full disclosure concernsIt is becoming more and more urgent to develop and enforce standards of service delivery in the microfinance industry, in light of the industry’s rate of growth. There have been wide spread concerns about the rates of loan interests charged by different MFIs, which has led to adverse public perceptions about microfinance. The interest rate concern was investigated and found to be based mainly on a lack of understanding of the relationship between interest rates and the costs of provid-ing microfinance on a sustainable basis, and also on the lack of full disclosure of MFIs to their clients with regard to true costs of products. The lack of disclosure is not one-sided and is also prevalent in client’s presentation of loan proposals to the MFIs without full disclosure of their financial situation and existing debts.Disclosure of information by providers to consumers is a source of empowerment to the latter. Whereas information and education of the consumers is a means to their protec-tion, there is always need for consumer self-protection to be reinforced through some formal regulatory mechanism.

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The above-mentioned concerns will therefore need to be addressed in the review of the existing legal and regulatory environment to ensure symmetrical better disclosure of infor-mation. Moreover, the prohibition of deposit-taking (except members’ savings in SACCOs) without a license under the FIA or MDI Act should be enforced.

Addressing Parliament on Regulation/Supervision of Tier 4The report of the Committee if adopted by the MFF could form a basis for the Ministry of Finance, Planning and Economic Development to address both Cabinet and Parliament on the issue of legislating or regulating financial institutions under Tier 4.

3.8 Key Issues/Areas ExaminedThis section examines key issues regarding different levels of regulation that may be appropriate for different categories of institutions. On a general note, it is widely agreed that informal small-scale organisations such as ROSCAs are best left out of any system of registration and regulation, in order to avoid stifling financial innovation at the lowest levels. In the following, they are not included under the category of ier 4 institutions. On the other extreme, it is also widely agreed that large MFIs that mobilise and intermediate savings should be licensed and supervised – the rationale for the MDI Act. A more difficult issue is whether institutions that do not take savings warrant regulation and if they do, what kind of regulation would be relevant for them. In many countries, the need for transparency, market stability, and control of unfair practices is a rationale for some form of regulation – though this can be of the credit product rather than institutions per se.Regulation and supervision need to be targeted in such a way that their benefits in terms of consumer and depositor protec-

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tion and the safety of the financial system generally outweigh the costs and risks involved. This implies that certain classes of institutions may be fully regulated, while others may face less stringent control measures.

Prudential and Non-prudential Regulation

Prudential Regulation

Prudential regulation here refers to a public sector regulation to ensure the efficiency and safety of financial institutions, the basic elements of which are:

(a) Authoritative government involvement e.g. through the central bank or an accredited agency;

(b) Regulatory authority ensuring safety and soundness of the financial institutions.

A nuanced argument is that prudential regulation should be applied only to deposit-taking institutions, since they are the only ones that intermediate deposits from the general public and thereby put poor people’s money at risk. Within this view, credit-only institutions should be governed by the general legal and regulatory norms applicable to firms and lenders – and their owners, investors, and creditors supervise them.

Non-prudential Regulation

Non-prudential regulation involves far less rigorous measures and simply sets rules and guidelines regarding acceptable be-havior and business practices in the operation of the financial institutions. These rules or guidelines can be enforced by a non-governmental establishment i.e. network/apex institu-tion or a private institution.

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Implications of regulation on tier IV MFIs

In this regard, the issues that require deeper consideration include the cost of regulation both to the financial institutions themselves and the regulatory authority as well as the issue of capacity of the identified institutions or agencies to carry out those regulatory functions.

The costs of regulation include both (i) the direct costs to the organisation charged with enforcing the regulations and (ii) the staff time and other costs to the MFI involved in complying with the regulations (compliance costs) and (iii) indirect/structural costs (the costs of reduced competition, imposed uniformity, moral hazard created by the safety net). In this context the costs and risks of transforming a private body with self-regulatory functions into, essentially, a regula-tory department of government are also to be considered. This is due to a conflict of interest that arises when promotional, capacity-building, and supervisory functions are handled within one institution. The benefits of regulation may accrue (and the costs borne) at three different levels:

(a) The general public, from preserving the soundness of the financial system and making information publicly avail-able;

(b) MFIs, from membership in voluntary associations that maintain certain standards in order to enhance their performance and public image;

(c) Individual clients, from protection of their savings de-posits and their rights as clients of financial institutions.

In the present situation and with respect to Tier 4, non-pruden-tial regulation is exercised by the Department of Co-opera-tives over the SACCOs and other co-operatives that are not SACCOs. The execution of the regulations is operationally

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the responsibility of Co-operative Officers who are decentral-ised staff in districts. Other Tier 4 microfinance institutions e.g. those registered under the NGO Statute, the Companies Act and the Moneylenders Act are also not prudentially su-pervised nor even effectively monitored under non-prudential regulatory arrangement.The information gathered on the financial institutions in Tier 4, which are by and large SACCOs with relatively small amounts of savings at risk, suggests that prudential regulation of the whole Tier is not sustainable or viable (more costs than benefits involved, and low prospects for making the users bear the costs). On the other hand, the effectiveness of non-prudential regulation of the Tier 4 financial institutions appears to be jeopardised by problems of fragmented / un-standardised modes/forms of supervision and low capacity on the part of the prescribed or mandated agencies to execute supervisory roles.Here again, the policy challenge is to design non-prudential standards and controls in ways that accommodate the reali-ties of microfinance and help stabilise the market rather than suppress it.“Setting up self-regulatory measures to improve the efficiency and security of financial services might be done on a volun-tary and free basis for members only, or in cooperation with the state and for a defined part of the MF-industry. There is an underlying role conflict when a member-based organization regulates its members, but the deficiency of state control calls for self-regulation… Taking over [supervisory power] trans-forms a self-regulator on behalf of members into a mandated regulator on behalf of government and consequently destroys the property of being member-based.” (Sound Practice in Microfinance, p. 59; Study, published by AMFIU 2005).

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Registration/DeregistrationRegistration is the enrolling of an organisation in the register of a particular agency, which includes spelling out the different activities that will be involved in the course of existence’.

The financial institutions categorised under Tier 4 are already subjected to registration requirements with one or more dif-ferent agencies. The Company Law, NGO Statute, and the Co-operative Statute, do not provide for licensing lending activities, nor does it prohibit them.

NGOs are also registered as limited companies with the Registrar of Companies, while Moneylenders register with the Magistrates Courts. SACCOs and other co-operatives are mandated to register under the Co-operative Societies Statute.

While it has been observed that the requirements for registra-tion of Tier 4 institutions, especially the SACCOs are too lax, resulting in the registration of many unviable institutions, there should be some resistance to the temptation to institute rigid entry requirements for the small member owned/governed institutions. It should be noted that the responsible agency also handles co-operatives whose core activities are of a non-financial nature.

On the general outlook, it would appear that the registration of the financial institutions under the Tier have sufficiently clear requirements and points for registration. Given the different institutional profiles and objectives of the institutions in Tier 4, the standardisation of registration requirements across all categories would not seem plausible or necessary.

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There are a number of issues relating to deregistration of financial institutions in Tier 4 that may need redress. A case in point is that the Registrar of Co-operatives, which registers co-operatives, is the same agency that is charged with the responsibility of fulfilling conditions against deregistration. An example is where the Registrar of Co-operatives is made by his mandate the Auditor of last resort for the SACCOs and yet 75% of the SACCOs maintain un-audited accounts. The law provides that a SACCO may be deregistered if the audit reports document that 2/3 of the capital has been dis-sipated. On these grounds however, a number of moribund SACCOs, which are still on the register of the Registrar of Co-operatives, have not submitted their accounts and thus their deregistration can not be effected.

As regards the FSAs, deregistration is contingent upon per-formance as agreed with shareholders. This is the one case in which Tier 4 institutions are being effectively supervised, with penalties for non-compliance (although in practice, sanctions have been limited to firing of FSA officers rather than closure of FSAs, despite shortcomings in compliance with performance standards). However, whereas closure of non performing institutions may be a worthwhile sanction for some FSAs, FSAIU does not have the statutory powers to effect these closures, among other sanctions.

Financial institutions which are members of AMFIU could face deregistration on account of flouting of stipulated code of conduct and agreed practices. However, the lack of incen-tives for compliance and for AMFIU as an advocacy body to sanction its members appear to undermine the effectiveness of the code of conduct as an instrument for ensuring standards among members.

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LicensingLicensing, starts with ensuring that the intended activity/business is included as part of the objectives spelt out in the registration documents of a particular entity. Subsequent to this verification, the institution may be legally accepted to en-gage in that particular activity. Legally defined – “Licensing is irrevocable permission to commit an act that would otherwise be unlawful”. Summarily put, licensing is activity specific, while registration is institution specific.The central question is whether Tier 4 institutions should be subjected to special licensing requirements to engage in finan-cial activities. With the MDI Act, there is provision for those that wish to mobilise savings from the public to be licensed by the Central Bank (while SACCOs can also mobilise savings from members, subject to regulation by MTTI).Firstly, licensing in itself would not be effective in regulating the financial sector if operations of MFIs are not prudentially supervised. The regulatory environment should also provide for de-registration of MFIs that operate outside the stated regulations under which they have been registered. The situ-ation for the SACCOs is worsened by the fact that there is almost nonexistent supervision that could provide informa-tion for deregistration.Licensing of lending activities (outside the FIS and MDI Acts) is only evidenced under the moneylenders’ category, which is done by the magistrate’s courts. However, the courts have expressed their concern as to the lack of capacity to ef-fectively perform this function.One school of thought for consideration is that it does NOT make sense to require a special license to engage in credit, rather, it makes more sense to provide some consumer protec-tion regulations that apply to the entire credit market. (Such

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regulations could distinguish between sizes of the product, so that interest rate and fee reporting requirements for small loans might be less stringent than for larger ones.)

Monitoring and SupervisionThe only institutional providers of microfinance services whose activities and operations are subject to monitoring by government agencies other than BOU and or private sector organisations are the SACCOs. The activities of the SACCOs/co-operative are subject to mandatory monitor-ing by the Department of Co-operatives in the responsible Ministry (MTTI), however they (SACCOs) may also choose (voluntary decision) to be members of apex bodies like UCA and UCSCU.Evidently, notwithstanding the stipulated mandate, the SACCOs and other co-operatives are presently subject to little effective regulation and supervision by governmental agencies because the Co-operatives Department does not have adequate capacity (both human and logistical) to moni-tor activities of the financial institutions under its jurisdiction. The SACCOs themselves have weaknesses in operating administrative management, especially in the areas of ac-counting, governance and internal control systems.Regarding AMFIU, membership is voluntary and the adop-tion of the use of PMTs has been sub-optimal. Whether or not membership to AMFIU should be compulsory is still debatable. It was also noted that AMFIU presently has no capacity or institutional infrastructure to monitor the activities of its members. The enforcement of reporting or compliance without significant incentives to the members for an umbrella body like AMFIU could be difficult. It was however sug-gested that categorisation of institutions which are members of AMFIU, using specified criteria and involving a grading

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system based on conduct, performance and such other vari-ables, could encourage efforts by the members to raise their standards to higher benchmarks, as well as providing useful information to the authorities to monitor the overall evolution of the sector.Monitoring was noted as inadequate if not inexistent, with regard to the NGO-MFIs, the Moneylenders, ROSCAs as well as a number of similar institutions about which informa-tion is hardly available. However, efforts have been made to ensure that such institutions that are members of apex bodies like AMFIU do submit PMT reports that provide a basis for monitoring of their growth and development. This step has provided valuable input for mapping out of MFIs in the country including important statistics to be used to assess performance growth. Strengthening of this process will be desirable for the growth and development of the microfinance industry. To this end, submission of PMT reports should be made a condition of support through Government or donor programs.The Registrar of Companies does not effectively monitor in-stitutions registered under the Companies Act, 1991. Besides, data on the registered companies does not appear to be well up-dated regularly.At the moment, different institutions use different tools for monitoring the performance (PMTs, PEARLS etc,) of their member institutions and an attempt to standardise them is inconclusive and may as well be undesirable.

Consumer Education and ProtectionOperating regulations should also include sufficient rules for fair treatment and information disclosure to borrowers or financial service consumers. A critical observation in this

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regard amount to a truth-in-lending standards and fair credit reporting standards. The present situation is devoid of these important requirements that impose transparency on the documentation and procedures of lenders and credit rating agencies.It was identified that whereas consumer education is in itself a remedy for consumer exploitation, without instituting a well-regulated financial environment, achievement of con-sumer protection could never be easy. Consideration should be made for the introduction of disclosure requirements for loan products as a suitable form of regulation of credit-only institutions. Appreciably, the need for disclosure is a policy matter of concern across the entire financial sector, with a view to encouraging the compliance with truth-in-lending requirements.It should be noted that, whereas rules and standards can be established in law, top-down enforcement may be difficult and costly. Hence the most effective approach is likely to be consumer education on their rights and responsibilities. In the case of member-based (user-owned) savings and credit institutions (SACCOs, VSCIs, FSAs, ROSCAs, ASCAs, etc.), education should include their role/responsibilities in governance to ensure sound management of their savings.External prudential supervision is very costly and requires that the MFIs have the capacity to supply the financial data required. E.g., estimated cost per annum of monthly supervi-sion of a member-based savings & credit institution can cost up to Uganda shillings 6 million. Hence introduction of regulations must consider: who bears the cost? To the extent that the general public benefits, or that Government bears responsibility for protecting deposits mobilised from the public, the case can be made for paying from public funds – but only to the extent that these benefits exceed the costs

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involved. To the extent that MFIs benefit from a regulatory environment that enhances their performance and reputation, they can be expected to bear part of the cost. But in practice, this can only be applied to MFIs that earn sufficient profits to cover the costs involved.

Standards MaintenanceEffective maintenance of standards among Tier 4 microfi-nance institutions is undermined by factors including:(a) Unclearly defined profile of the institutions in the Tier.(b) Low capacity of the MFIs as well as the agencies charged

with the responsibility of maintaining standards.(c) Weak or obsolete legal and regulatory provisions.(d) Difficulty in standardisation of the performance require-

ments.(e) Weak or obsolete contract enforcement mechanisms.

Code of Conduct

Enforcement of codes of conduct, as with AMFIU, requires authoritative mandate given to the apex institution by legal provisions. Alternatively, incentives for compliance could be prescribed. In the present state, the codes of conduct used by AMFIU are not effectively applied, partly because of voluntary membership to the apex institution.

Accounting and Auditing

The key challenges in this regard, include:(a) Financial accounting management capacity is weak at

the institutional level(b) Need for common accounting methods and standards

among MFIs

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(c) Limited understanding of MFIs among the accounting and auditing profession

It was noted that compounding the shortage of technical and managerial skills in the financial sector and the microfinance industry in particular, is the lack of practical application of prudent and acceptable accounting practices and standards appear to be increasingly lagging behind the needs of a dynamic and modern financial sector.As was identified, without universally understood and ap-plied accounting methods and practices used in preparation of financial accounts and reports, the regulatory framework whose core mandate consists of compliance even with non-prudential standards, cannot be effectively implemented.However, it was established that a further adverse condition for most MFIs is that full compliance with the accounting methods and standards and practices in the preparation of their accounts as well as ensuring routine auditing (both internal and external), could be too expensive for these institutions to maintain.As a way forward however, the following are proposals on action to be taken:(a) Financial accounting management capacity is weak

at the institutional level; More effective application of existing or new regulations will require a capacity-building program at the MFI level (especially SACCOs and NGOs); MCAP will help subsidise MFIs that want to improve their training; but there is need for a special program to get SACCOs on board

(b) Need for common accounting methods and standards among MFIs. SACCOs, need to implement the Standardised Accounting System developed by UCSCU

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(c) Limited understanding of MFI operations by the ac-counting and auditing profession. There is need to build up their capacity to provide financial accounting and audit services to MFIs probably through ICPAU (an umbrella body for Ugandan accountants and auditors)

Other issuesThe special features of Microfinance that were identified for accommodation within any regulatory structure include:(a) Deepening financial markets to serve micro-enterprises

and poor households;(b) Reducing the high unit cost lending; e.g., concern about

the high cost of lending by MFIs would be addressed through consumer protection regulations, as well as encouraging competition among MFIs;

(c) Un-diversified and sometimes volatile nature of MFI credit portfolios;

(d) MFIs operating as unregulated financial services deliv-ery NGOs with a focus on social rather than financial accountability and sustainability.

3.9 Strategic Principles for the Way ForwardGeneral Principles for RegulationGovernment intervention to regulation financial services is warranted when the savings of the public or the stability of the financial system may be at risk. Nevertheless, regulatory measures should be designed appropriately so that the public benefits exceed the costs, and should be commensurate with the capabilities of the authorities charged with such regula-tion.

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It should also be noted that SACCOs primarily need capacity building and improved supervision, as priority, rather than capitalisation for on lending. Lending to SACCOs can de-stroy their corporate culture and damage their balance sheet, if initial appraisal is not done comprehensively before an institution is capitalised.

SavingsIn principle, financial institutions (including MFIs) that mobilise deposits from the public and put them at risk (e.g., through lending) should be supervised to ensure the safety of the public’s savings. In the case of member-based savings and credit co-operatives and other associations, external supervi-sory requirements are generally minimal, on the grounds that members bear primary responsibility for ensuring the safety of their own savings. In practice, this principle applies most effectively to very small, informal groups such as rotating savings and credit associations, and is less applicable as such groups become too large for effective internal governance or reach the scale of formally licensed institutions (e.g., when SACCOs reach the minimum capital for MDIs).There is no immediate need for additional legislation to ac-commodate mobilisation of savings, which can be done either in commercially oriented MFIs through Tiers I, II and III, or in member-based organisations through the Co-operatives Act. For more effective implementation of the latter, there is a consensus that three basic strategies should be pursued:(a) Strengthening internal supervision and management

capabilities of SACCOs (member-based MFIs)18

18 The currently proposed amendments of the Co-operative Act explicitly recognise SACCOs as a distinct type of co-operative; and that regulatory forbearance with respect to other types of member-based organisations that have emerged (such as FSAs and VSCIs) is permitting a gradual convergence toward the SACCO format.

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(b) Improving accounting systems, monitoring and perform-ance benchmarking

(c) External regulation, including non-prudential require-ments such as audits, and prudential supervision when size and risks are large (especially large SACCOs).

CreditWith regard to credit, focus has been put on the credit product [activity], rather than on the institution. This means disclosure requirements with respect to interest rates and fees, consumer protection law relevant to finance, and consumer education, so that clients are better informed and have recourse to an ap-propriate authority, would be the most appropriate approach.

3.10 Next Steps1. Prepare a ‘Roadmap’ that describes the way forward

and actions to be taken regarding the above issues (see Chapter 1).

2. Hold technical discussions to agree on draft Roadmap, critical issues and priorities (held 14 June, 2005).

3. Share Roadmap and background materials with key stakeholders (possible Microfinance Forum Workshop).

4. Prepare report or strategy paper for Ministry of Finance, Planning and Economic Development.

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Table 3.1 Summary of Regulation Environment of Tier 4 Microfinance Institutions in Uganda

Regulatory Bodies Apex Organisa-tions Apex Organisations Support Institu-

tions

Regulatory Param-eters

MTTI Registrar Of Companies

Chief Magistrates Court UCSCU UCA AMFIU FSAIU District Promotion

Centres (DPCs)

Form of Organisa-tion

Government Depart-ment under Ministry of Trade, Tourism and Industry.

Government Department under Minis-try of Justice

Statutory authority under Judiciary

Member-owned Co-operatives Union

Co-operative Um-brella Organisation (Member based)

NGO registered with the NGO Registration Board and company limited by guarantee.

Company Limited by Shares

(Members are registered as SACCOs)

Companies Lim-ited by Guarantee

Mission/ Objec-tives

Mandated to register, monitor and supervise co-operative activity. It promotes policy for growth of the Co-opera-tive movement.

Registers companies limited by shares and by guarantee

.Registers, certifies and licenses money lenders.

Promoting the gen-eral interest of the SACCOs.

Advocacy; re-source mobilisa-tion; capacity building

Promote and protect interest of members.

Resource mobilisation, promotion, start-up, capacity building, computerisation, monitoring, supervision, and enforcement of policies and of loan contracts

Policy advocacy; resource mobi-lisation; compu-terisation; support development of policies and proce-dural guidelines

Governing Legis-lation/ Regula-tions and Mandate

Co-operative Socie-ties Statute and the Co-operative Societies Regulations.

Company Law – ‘Laws of Uganda’

Moneylenders Act, 1952

Uganda Co-op-erative Societies Statute, 1991.


NGO Statute. Company Law Company Law

Types of MFIs cov-ered

SACCOs; and Co-op-erative Societies.

Companies limited by shares and by guarantee (including NGOs)

Money lenders SACCOs Co-operative Soci-eties and SACCOs

SACCOs; Credit Un-ions; NGOs; Money-lenders; Village Banks; Government projects, etc. – institutions en-gaged in microfinance business as a core activity.

Financial Services Associa-tions operating under FSAIU Franchise

All referred to as Village Savings and Credit Institu-tions (VSCIs) that can be catego-rised as SACCOs; companies Limited by shares; and Companies limited by guarantee

Registra-tion

The Registrar is respon-sible for the registration of the SACCOs and Co-operative Societies.

Registration is com-pulsory to operate as SACCO or Co-operative Society.

Registrar registers Companies (both limited by shares and by guar-antee)

Chief Magistrates Courts registers, certifies and li-censes Moneylend-ers within its area of judicial jurisdiction

Membership is voluntary and restricted to regis-tered SACCOs.

532 currently reg-istered with 143 active members (27%)

Membership is vol-untary and restrict-ed to registered co-operatives

Currently over 700 SACCOs are on the register of UCA.

Enroll on voluntary basis institutions whose core business is Micro-finance or with activities that promote Microfi-nance.

Membership presently is at 96 of which about 70% are active.

FSAs operate under FSAIU as de facto branches using FSAIU’s logo, premises, operating systems, and registration; each FSA pays for a trading license in the location where it operates as a branch of FSAIU

M.O.Us formalise relationship with the VSCIs;

MFIs registered with MTTI and Registrar General

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Table 3.1 Summary of Regulation Environment of Tier 4 Microfinance Institutions in Uganda

Regulatory Bodies Apex Organisa-tions Apex Organisations Support Institu-

tions




Centres (DPCs)

Form of Organisa-tion

Government Depart-ment under Ministry of Trade, Tourism and Industry.

Government Department under Minis-try of Justice

Statutory authority under Judiciary

Member-owned Co-operatives Union

Co-operative Um-brella Organisation (Member based)

NGO registered with the NGO Registration Board and company limited by guarantee.

Company Limited by Shares

(Members are registered as SACCOs)

Companies Lim-ited by Guarantee

Mission/ Objec-tives

Mandated to register, monitor and supervise co-operative activity. It promotes policy for growth of the Co-opera-tive movement.

Registers companies limited by shares and by guarantee

.Registers, certifies and licenses money lenders.

Promoting the gen-eral interest of the SACCOs.

Advocacy; re-source mobilisa-tion; capacity building

Promote and protect interest of members.

Resource mobilisation, promotion, start-up, capacity building, computerisation, monitoring, supervision, and enforcement of policies and of loan contracts

Policy advocacy; resource mobi-lisation; compu-terisation; support development of policies and proce-dural guidelines

Governing Legis-lation/ Regula-tions and Mandate

Co-operative Socie-ties Statute and the Co-operative Societies Regulations.

Company Law – ‘Laws of Uganda’

Moneylenders Act, 1952



NGO Statute. Company Law Company Law

Types of MFIs cov-ered

SACCOs; and Co-op-erative Societies.

Companies limited by shares and by guarantee (including NGOs)

Money lenders SACCOs Co-operative Soci-eties and SACCOs

SACCOs; Credit Un-ions; NGOs; Money-lenders; Village Banks; Government projects, etc. – institutions en-gaged in microfinance business as a core activity.

Financial Services Associa-tions operating under FSAIU Franchise

All referred to as Village Savings and Credit Institu-tions (VSCIs) that can be catego-rised as SACCOs; companies Limited by shares; and Companies limited by guarantee

Registra-tion

The Registrar is respon-sible for the registration of the SACCOs and Co-operative Societies.

Registration is com-pulsory to operate as SACCO or Co-operative Society.

Registrar registers Companies (both limited by shares and by guar-antee)

Chief Magistrates Courts registers, certifies and li-censes Moneylend-ers within its area of judicial jurisdiction

Membership is voluntary and restricted to regis-tered SACCOs.

532 currently reg-istered with 143 active members (27%)

Membership is vol-untary and restrict-ed to registered co-operatives

Currently over 700 SACCOs are on the register of UCA.

Enroll on voluntary basis institutions whose core business is Micro-finance or with activities that promote Microfi-nance.

Membership presently is at 96 of which about 70% are active.

FSAs operate under FSAIU as de facto branches using FSAIU’s logo, premises, operating systems, and registration; each FSA pays for a trading license in the location where it operates as a branch of FSAIU

M.O.Us formalise relationship with the VSCIs;

MFIs registered with MTTI and Registrar General

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Table 3.1 Summary of Regulation Environment of Tier 4 Microfinance Institutions in Uganda (continued)




Centres (DPCs)

Deregis-tration

SACCOs whose ac-counts have not been audited can be deregis-tered. Inactive SACCOs and about a quarter of those active do not have audits filed.

SACCOs can voluntarily wind up or merge with others.

Renewal of license may be denied where mal prac-tices by the money lender, are reported by clients.

SACCOs de-registered by the Registrar of Co-operatives are deregistered from UCSCU.

Deregistration of the members is the responsibility of the Registrar of Co-operatives.

Grounds for deregistra-tion of a member:

*Non-compliance or indulgence in illegal practices.

*Voluntary withdrawal

Revocation of FSAIU mem-bership in case of poor per-formance as per agreement with the shareholders

As spelt out in M.O.U, in case of failure to agree through arbitration

Problems/Issues related to Regis-tration/ Deregis-tration

Low capacity among SACCOs to prepare books of account and have them audited.

Lack of capacity with the auditor of last resort to audit the SACCO ac-counts.

Co-operative Officers not skilled to financially oversee the operation of the SACCOs.

Chief Magistrates’ courts lack the ca-pacity to effectively monitor money lend-er’s activities, so that they are able to renew licenses in a prudent manner.

Criteria for registration/deregistration of SACCOs neither stringent nor imple-mented.

Weak co-ordi-nation between Registrar, UCA and UCSCU at regis-tration/ deregistra-tion.

Capacity con-straints.

Existence of stand-alone SACCOs/MFIs

Difficulty in monitor-ing the activities of the members as well as enforcement of compli-ance/ imposition of sanctions.

FSAs must sign the franchise/branch agreement before starting operations

Closure has never hap-pened; it would be a major issue as shareholders would loose their share capital

In case of closure, savings are protected by FSAIU

Enforcement of critical decisions especially related to managers and B.O.D. M.O.U has no enforcement strengths apart from termination of support to VSCIs

Monitor-ing Tools and Out-puts

Co-operative Depart-ment mandated to moni-tor and supervise the SACCOs.

The Department is sup-ported in that function by the apex institutions i.e. UCSCU and UCA.

Use of PEARLS.

Data collected and analysed for technical support to SACCOs.

Quarterly data include financial statements

Use in-house per-formance monitor-ing tools complet-ed and submitted by SACCOs on a monthly basis.

Subscribe to the recently introduced PMTs by AMFIU and the microfi-nance industry.

Use of PMTs. In-house software (FSA Master) for front-office teller transactions and back-office accounting and reporting

Reporting is obligatory and is done by 100% of the FSAs; reports available by the 15th day of the following month

Use of Finance Solutions as MIS for those that have been computer-ised.

Use of PMT and PEARLS (gradual shift to PMT)

(14 of 22 MFIs providing reports)

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Centres (DPCs)

Deregis-tration

SACCOs whose ac-counts have not been audited can be deregis-tered. Inactive SACCOs and about a quarter of those active do not have audits filed.

SACCOs can voluntarily wind up or merge with others.

Renewal of license may be denied where mal prac-tices by the money lender, are reported by clients.

SACCOs de-registered by the Registrar of Co-operatives are deregistered from UCSCU.

Deregistration of the members is the responsibility of the Registrar of Co-operatives.

Grounds for deregistra-tion of a member:

*Non-compliance or indulgence in illegal practices.

*Voluntary withdrawal

Revocation of FSAIU mem-bership in case of poor per-formance as per agreement with the shareholders

As spelt out in M.O.U, in case of failure to agree through arbitration

Problems/Issues related to Regis-tration/ Deregis-tration

Low capacity among SACCOs to prepare books of account and have them audited.

Lack of capacity with the auditor of last resort to audit the SACCO ac-counts.

Co-operative Officers not skilled to financially oversee the operation of the SACCOs.

Chief Magistrates’ courts lack the ca-pacity to effectively monitor money lend-er’s activities, so that they are able to renew licenses in a prudent manner.

Criteria for registration/deregistration of SACCOs neither stringent nor imple-mented.

Weak co-ordi-nation between Registrar, UCA and UCSCU at regis-tration/ deregistra-tion.

Capacity con-straints.

Existence of stand-alone SACCOs/MFIs

Difficulty in monitor-ing the activities of the members as well as enforcement of compli-ance/ imposition of sanctions.

FSAs must sign the franchise/branch agreement before starting operations

Closure has never hap-pened; it would be a major issue as shareholders would loose their share capital

In case of closure, savings are protected by FSAIU

Enforcement of critical decisions especially related to managers and B.O.D. M.O.U has no enforcement strengths apart from termination of support to VSCIs

Monitor-ing Tools and Out-puts

Co-operative Depart-ment mandated to moni-tor and supervise the SACCOs.

The Department is sup-ported in that function by the apex institutions i.e. UCSCU and UCA.

Use of PEARLS.

Data collected and analysed for technical support to SACCOs.

Quarterly data include financial statements

Use in-house per-formance monitor-ing tools complet-ed and submitted by SACCOs on a monthly basis.

Subscribe to the recently introduced PMTs by AMFIU and the microfi-nance industry.

Use of PMTs. In-house software (FSA Master) for front-office teller transactions and back-office accounting and reporting

Reporting is obligatory and is done by 100% of the FSAs; reports available by the 15th day of the following month

Use of Finance Solutions as MIS for those that have been computer-ised.

Use of PMT and PEARLS (gradual shift to PMT)

(14 of 22 MFIs providing reports)

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Centres (DPCs)

Problems/Issues related to Monitor-ing

Capacity constraints with the SACCOs,

Capacity and monitoring of the District Co-opera-tive Officers.

The Registrar only moni-tors through receiving an-nual returns, however the capacity to assess and analyse them is lacking.

Capacity constraints limit effective moni-toring

Low staff capac-ity to prepare ac-counts/ audit.

Submission of data not compulsory.

Legally, the monitor-ing and supervision of the SACCOs is not the responsibility of UCA, but of the Reg-istrar. However, UCA has, for ensuring the sustainability of the SACCOs undertaken the supervisory role.

Voluntary member-ship.

Low capacity of the members to use the monitoring tools.

Challenges of en-forcing the code of Conduct.

Need for FSAIU to visit FSAs for uploading data.

Backlog in old FSAs.

Occasional incorrect posting of entries by FSAs (need for checking and correction by FSAIU on a continuous basis)

Low management capacity to prepare periodic reports as well as use of the tool.

Data submitted not very reliable (poor record keeping inhibits reliable reports)

Non-Pru-dential Regula-tion

Annual audit require-ments:

SACCOs to put in place governance infrastruc-ture:

* AGM

*BoDs

*Management staff

*Supervisory Commit-tees

*Adopt best practices

SACCOs to ensure:

*transparency

*accountability

*effective participation by members

*separation of powers/duties.

Companies submit annual returns

Money lender licenses renewed on annual basis, on condition of good practices (not usu-ally verified)

Members expected to provide, annu-ally:

*Audit

Report.

*Management

Report. *Super-visory

Committee

Report.

*Business

Plan and

Strategic

Plan.

Members ranked on standards according to PEARLS.

Disclosure is a prerogative of the SACCOs except annual audit.

Performance stand-ards for the members.

Ensuring that man-agement information systems and reporting formats are followed by the SACCOs.

Analysis of SACCOs financial and manage-ment reports to check for compliance with agreed standards

Establish Supervisory Committee with affili-ate members to help in terms of manage-ment and control.

The PMT is used by AMFIU.

All FSAs provide monthly computerised information on an obligatory basis.

Standardised reporting format

Policies and Procedures are standard and FSA staff and officeholders receive training by FSAIU.

FSAs ranked according to performance and receive specific supervision support.

All FSAs supervised twice per month following a stand-ardised supervision check list.

Supervision includes cash control, budget control, loan appraisal,

repayment, and recovery monitoring.

FSAIU sets and monitors quarterly budgets based on income and arrears levels.

All FSAs were audited by Ernst & Young in 2003

Standardised re-porting format

Ensuring that poli-cies and procedur-al manuals for VS-CIs are followed.

Analysis of VSCIs financial and man-agement reports to check for perform-ance trends

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Centres (DPCs)

Problems/Issues related to Monitor-ing

Capacity constraints with the SACCOs,

Capacity and monitoring of the District Co-opera-tive Officers.

The Registrar only moni-tors through receiving an-nual returns, however the capacity to assess and analyse them is lacking.

Capacity constraints limit effective moni-toring

Low staff capac-ity to prepare ac-counts/ audit.

Submission of data not compulsory.

Legally, the monitor-ing and supervision of the SACCOs is not the responsibility of UCA, but of the Reg-istrar. However, UCA has, for ensuring the sustainability of the SACCOs undertaken the supervisory role.

Voluntary member-ship.

Low capacity of the members to use the monitoring tools.

Challenges of en-forcing the code of Conduct.

Need for FSAIU to visit FSAs for uploading data.

Backlog in old FSAs.

Occasional incorrect posting of entries by FSAs (need for checking and correction by FSAIU on a continuous basis)

Low management capacity to prepare periodic reports as well as use of the tool.

Data submitted not very reliable (poor record keeping inhibits reliable reports)

Non-Pru-dential Regula-tion

Annual audit require-ments:

SACCOs to put in place governance infrastruc-ture:

* AGM

*BoDs

*Management staff

*Supervisory Commit-tees

*Adopt best practices

SACCOs to ensure:

*transparency

*accountability

*effective participation by members

*separation of powers/duties.

Companies submit annual returns

Money lender licenses renewed on annual basis, on condition of good practices (not usu-ally verified)

Members expected to provide, annu-ally:

*Audit

Report.

*Management

Report. *Super-visory

Committee

Report.

*Business

Plan and

Strategic

Plan.

Members ranked on standards according to PEARLS.

Disclosure is a prerogative of the SACCOs except annual audit.

Performance stand-ards for the members.

Ensuring that man-agement information systems and reporting formats are followed by the SACCOs.

Analysis of SACCOs financial and manage-ment reports to check for compliance with agreed standards

Establish Supervisory Committee with affili-ate members to help in terms of manage-ment and control.

The PMT is used by AMFIU.

All FSAs provide monthly computerised information on an obligatory basis.

Standardised reporting format

Policies and Procedures are standard and FSA staff and officeholders receive training by FSAIU.

FSAs ranked according to performance and receive specific supervision support.

All FSAs supervised twice per month following a stand-ardised supervision check list.

Supervision includes cash control, budget control, loan appraisal,

repayment, and recovery monitoring.

FSAIU sets and monitors quarterly budgets based on income and arrears levels.

All FSAs were audited by Ernst & Young in 2003

Standardised re-porting format

Ensuring that poli-cies and procedur-al manuals for VS-CIs are followed.

Analysis of VSCIs financial and man-agement reports to check for perform-ance trends

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Centres (DPCs)

Problems/Issues related to Non-Pru-dential Regula-tion

Low capacity in the Department of Co-op-eratives to enforce the regulations.

Too many unviable/ dor-mant SACCOs.

Low capacity at Registrar’s office, for interpretation to be made out of annual returns.

Low capacity in the Magistrate’s courts, for money lending activity to be ably monitored (thus bad practicing money lenders continue to get their licenses renewed)

Several money lenders continue to operate without cer-tificates or licenses.

Non-standardised financial reporting formats.

Capacity con-straints e.g. lack of qualified staff.

Capacity con-straints with the Alliance offices, to ably support Registrar in moni-toring activities of co-operatives.

Code of Conduct still in draft form.

Ensuring compliance by the members, of the code, is still a challenge since the members are the owners of the insti-tution.

Ensuring regularity of in-ternal audit by FSA’s own auditors.

Poor credit culture and the need for much greater sensitisation of members on the need to respect the terms and conditions of loan contracts

MOUs, which define the relation-ships between DPCs and MFIs, do not have the “teeth” to bite ef-fectively. Sanc-tions can only be effected through withdrawal of sup-port to the MFI.

Prudential Regula-tion and Methods of En-forcement

Dept of Co-op. has Co-operative Officers in the districts to inspect the SACCOs and enforce regulations, policies, standards, etc.

(No prudential regu-lation.)

Ensuring cash levels at the FSA do not exceed Ush. 2 million at any time.

Ensuring that keys to the safe are always held by dif-ferent persons.

Ensuring that savings are not used for lending and are not overdrawn by individual savers.

Problems/Issues related to Prudential Regula-tion

Capacity constraints at the department level, as well as legal and struc-tural weaknesses across the board.

No capacity at Mag-istrates courts to ensure effective pru-dential regulation

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Centres (DPCs)

Problems/Issues related to Non-Pru-dential Regula-tion

Low capacity in the Department of Co-op-eratives to enforce the regulations.

Too many unviable/ dor-mant SACCOs.

Low capacity at Registrar’s office, for interpretation to be made out of annual returns.

Low capacity in the Magistrate’s courts, for money lending activity to be ably monitored (thus bad practicing money lenders continue to get their licenses renewed)

Several money lenders continue to operate without cer-tificates or licenses.

Non-standardised financial reporting formats.

Capacity con-straints e.g. lack of qualified staff.

Capacity con-straints with the Alliance offices, to ably support Registrar in moni-toring activities of co-operatives.

Code of Conduct still in draft form.

Ensuring compliance by the members, of the code, is still a challenge since the members are the owners of the insti-tution.

Ensuring regularity of in-ternal audit by FSA’s own auditors.

Poor credit culture and the need for much greater sensitisation of members on the need to respect the terms and conditions of loan contracts

MOUs, which define the relation-ships between DPCs and MFIs, do not have the “teeth” to bite ef-fectively. Sanc-tions can only be effected through withdrawal of sup-port to the MFI.

Prudential Regula-tion and Methods of En-forcement

Dept of Co-op. has Co-operative Officers in the districts to inspect the SACCOs and enforce regulations, policies, standards, etc.

(No prudential regu-lation.)

Ensuring cash levels at the FSA do not exceed Ush. 2 million at any time.

Ensuring that keys to the safe are always held by dif-ferent persons.

Ensuring that savings are not used for lending and are not overdrawn by individual savers.

Problems/Issues related to Prudential Regula-tion

Capacity constraints at the department level, as well as legal and struc-tural weaknesses across the board.

No capacity at Mag-istrates courts to ensure effective pru-dential regulation

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Centres (DPCs)

Com-ments/ Sugges-tions

The role of the Registrar in the regulation of the SACCOs and socie-ties should be reviewed in the context of the contribution by the apex institutions.

Weak SACCOs should, where possible be strengthened or dereg-istered.

The Co-operative (Amendment) Bill 2002 should be considered by the Committee for input

The registrar should delegate supervisory and audit functions to agencies with proven track records in these areas. This could reduce on the backlog in the registrar’s office as well as strengthen regula-tions on SACCOs.

Company registrar should be computerised and annual returns re-viewed to en-able effective monitoring of company activities.

Magistrates courts should not Certify, monitor, license and effect sanctions.

Whereas the capac-ity is lacking, an element of conflict of interest will also prevail.

Review the present status of the SAC-COs for possible revitalisation or deregistration.

Improve intera-gency linkages for effective supervi-sion and regulation of the SACCOs.

Compel SACCOs to affiliate either of the apexes.

Increase collabo-ration between the apexes and the Registrar’s office.

AMFIU should develop a code of conduct for its members and encour-age them to comly with these, while creating incentives and punitive measures for non-com-plying members. The benefits accruing from compliance should be ably shared and under-stood by the member-ship.

Performance bench-marks should be devel-oped on agreed criteria for scoring and rating of the MFIs

Promote consumer edu-cation and protection as a way of enforcing best practice microfinance by the members.

AMFIU to present for comment, the grading system for the MFIs that was being worked upon.

Establish obligatory report-ing standards.

Establish loan portfolio qual-ity standards.

Establish and implement clear sanctions for non-per-forming FSAs/SACCOs staff and management commit-tees

Introduce compulsory quar-terly budget revisions in line with income and arrears levels

Introduce a deposit-insur-ance scheme for accredited tier 4 organisations

Company Law should be amend-ed to prevent com-panies registering and operating outside financial sector regulatory boundaries.

Tier 4 institutions should be required by law to prepare particular reports and maintain certain standards in service provi-sion (protection of public from extor-tionists) Support institutions would then assist regula-tory agencies in promoting compli-ance to set stand-ards and reporting formats.

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Centres (DPCs)

Com-ments/ Sugges-tions

The role of the Registrar in the regulation of the SACCOs and socie-ties should be reviewed in the context of the contribution by the apex institutions.

Weak SACCOs should, where possible be strengthened or dereg-istered.

The Co-operative (Amendment) Bill 2002 should be considered by the Committee for input

The registrar should delegate supervisory and audit functions to agencies with proven track records in these areas. This could reduce on the backlog in the registrar’s office as well as strengthen regula-tions on SACCOs.

Company registrar should be computerised and annual returns re-viewed to en-able effective monitoring of company activities.

Magistrates courts should not Certify, monitor, license and effect sanctions.

Whereas the capac-ity is lacking, an element of conflict of interest will also prevail.

Review the present status of the SAC-COs for possible revitalisation or deregistration.

Improve intera-gency linkages for effective supervi-sion and regulation of the SACCOs.

Compel SACCOs to affiliate either of the apexes.

Increase collabo-ration between the apexes and the Registrar’s office.

AMFIU should develop a code of conduct for its members and encour-age them to comly with these, while creating incentives and punitive measures for non-com-plying members. The benefits accruing from compliance should be ably shared and under-stood by the member-ship.

Performance bench-marks should be devel-oped on agreed criteria for scoring and rating of the MFIs

Promote consumer edu-cation and protection as a way of enforcing best practice microfinance by the members.

AMFIU to present for comment, the grading system for the MFIs that was being worked upon.

Establish obligatory report-ing standards.

Establish loan portfolio qual-ity standards.

Establish and implement clear sanctions for non-per-forming FSAs/SACCOs staff and management commit-tees

Introduce compulsory quar-terly budget revisions in line with income and arrears levels

Introduce a deposit-insur-ance scheme for accredited tier 4 organisations

Company Law should be amend-ed to prevent com-panies registering and operating outside financial sector regulatory boundaries.

Tier 4 institutions should be required by law to prepare particular reports and maintain certain standards in service provi-sion (protection of public from extor-tionists) Support institutions would then assist regula-tory agencies in promoting compli-ance to set stand-ards and reporting formats.

References

79

79

ReferencesAssociation of Microfinance Institutions of Uganda (2005):

“Sound Practices in Microfinance – A Compilation of International and Ugandan Good Practices for Microfinance Stakeholders.” Kampala: AMFIU.

Baldwin, Robert, and Martin Cave (1999): Understanding Regulation: Theory, Strategy, and Practice. Oxford: Oxford University Press.

Bank of Uganda (1999): BOU Policy Statement on Micro-Finance Regulation. Kampala, Uganda: BOU. .

Better Regulation Task Force (1999): Self-Regulation: Interim Report. Available from http:// www.cabinet-office.gov.uk/regulation/TaskForce/1999/self_regulation.rtf.

Christen, Robert Peck, and Richard Rosenberg (2000): The Rush to Regulate: Legal Frameworks for Microfinance, in: Occasional Paper 4. Washington, DC: CGAP. Available from http://www.cgap.org/assets/images/En4occ.pdf.

Consultative Group to Assist the Poorest (2002): Consensus Microfinance Policy Guidance: Regulation and Supervision. Washington, DC:CGAP. Available from http://tinyurl.com/ anbm.

Goodwin-Groen, Ruth, Till Bruett, and Alexia Laortue (2004): Uganda Microfinance Sector Effectiveness Review. Washington, DC: CGAP.

Government of Uganda (2001): Medium-Term Competitive Strategy for the Private Sector (2000-2005). Kampala: Ministry of Finance, Planning and Economic Development.

80

References

81

References

(2002): The Poverty Eradication Action Plan (PEAP): A Summary Version. Kampala: Ministry of Finance, Planning and Economic Development.

Hannig, Alfred, and Edward Katimbo-Mugwanya (eds. 2000): How to Regulate and Supervise Microfinance: Key Issues in an International Perspective, FSD Series No. 1. Kampala, Uganda: BOU-GTZ-SIDA FSD Project. Available from http://www.ids.ac.uk/cgap/download/RegUganda.doc.

McAllister, Patrick (2003): Trust through Transparency: Applicability of Consumer Protection Self-Regulation to Microfinance. Washington, DC: SEEP Network.

Meagher, Patrick (2002): Microfinance Regulation in South Africa: A Comparative Perspective. Development Bulletin (57): 48-52.

Meagher, Patrick, and Betty Wilkinson. (2002): Filling the Gap in South Africa’s Small and Micro Credit Market: An Analysis of Major Policy, Legal and Regulatory Issues, The Iris Discussion Paper on Institutions & Development. College Park, MD: IRIS, University of Maryland. Available from http://tinyurl.com/anbt.

Microfinance Regulatory Council (2001): The Second Annual Report of the Microfinance Regulatory Council.

Namara, Suleiman et al 2003. Towards Self Regulation of Tier 4 MFIs in Uganda, The Microfinance Banker, Kampala: AMFIU/MCC.

Ogus, Anthony I. (1998): Rethinking Self-Regulation. In: A Reader on Regulation, edited by R. Baldwin, C. Scott and C. Hood. Oxford: Oxford University Press: 374-388.

80

References

81

References

Schreiner, Mark (1999): Aspects of Outreach: A Framework for the Discussion of the Social Benefits of Microfinance. St. Louis, MO: Center for Social Development, Washington University St. Louis. Available from http://www.microfinance.com/English/Papers/ Aspects_of_Outreach.pdf.

Staschen, Stefan (1999): Regulation and Supervision of Microfinance Institutions in South Africa. Eschborn, Germany: Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ). Available from http://www.staschen.net/PaperRSA.pdf.

Uganda, Republic of. Company’s Act, Laws of Uganda 2000, Vol 5, Chapter 110

. Micro Deposit Taking Institutions Act, 2003

. The Money Lenders Act, 1951

. Uganda Co-operative Societies Statute, 1991 and the regu-lations, 1992

Vogel, Robert C. (2002): Key Issues in Regulation and Supervision of Credit Co-operatives. Finance for the Poor 3 (4): 1-6.

WOCCU (2002): WOCCU Guide to International Credit Union Legislation and Model Law for Credit Unions. Madison, WI: World Council of Credit Unions.

Annexes

A. Is there a Case for Regulating the Entire Credit Market in Uganda? Lessons from South Africa

B. Report on Linkage Banking Mission to Cameroon

C. Possible Mechanisms to Regulate Tier 4 MFIs in Uganda

D. Microfinance Regulation: Lessons from Benin, Ghana and Tanzania

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85

Annex A Is There a Case for Regulating the Entire Credit Market in Uganda? Lessons from South Africa

by Amfiu and GTZ1

Table of Contents1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

2 The MFRC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

3 Structure and Functions of a SRO . . . . . . . . . . . . . . . . . . . . . . . 88

4 Business Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

5 Lessons for Uganda . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

1 IntroductionFollowing a study commissioned by AMFIU on ‘Possible Mechanisms to Regulate Tier 4 MFIs in Uganda’ (see annex C of this volume), a group of microfinance industry stakeholders visited the South African Microfinance Regulatory Council (MFRC). The objective of the visit was to study the MFRC as a self-regulatory institution for micro lenders in South Africa and to find out if the institution could provide a model for the regulation of tier 4 MFIs in Uganda and specifically, whether AMFIU could assume the role of a Self-Regulatory Organisation (SRO) for MFIs in Uganda.

1 The report was written by Charles Kilibo ([email protected]), Programme Manager AMFIU, and Karen Losse ([email protected], Programme Advisor FSD (GTZ/SIDA).

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87

Is there a Case for Regulating the Entire Credit Market in Uganda?

The group learnt two major lessons: first, not only tier 4, but the entire credit market should be subject to non prudential regulation and second, AMFIU cannot assume the role of a SRO because it is controlled by its members, the MFIs that are to be regulated.

2 The MFRCThe MFRC was established by a Ministry of Trade and Industry decree. Under the decree, financial institutions that do not comply with the Usury Act and charge interest rates that exceed a certain percentage2 are man-dated to join the MFRC and to be regulated by it. The MFRC is entrusted with the core responsibility to regulate the micro lending sector, promote its sustainability and protect consumers against unfair lending practices.

Given the importance attached to non-prudential regulation of financial institutions in recent years, any entity established to affect this function should have a strong legal foundation. Such a foundation should in turn ensure the body’s independence and lay out its mandate in an unambigu-ous way. In this regard, such a mandate should confer explicit powers to the regulatory body to enforce rules and regulations and impose sanctions for non-compliance, such as the cancellation of an MFI’s operating license.

South Africa’s MFRC was established by decree and mandated to regulate and sanction that segment of the micro lending sector that does not comply with the Usury Act and/or charges interest rates that exceed a certain percentage. The overall objective of MFRC’s mandate is to ensure that the micro lending sector operates sustainably and that consumers are protected against unfair lending practices.

The MFRC’s mandate gains importance when one considers that South Africa’s micro credit market is characterised by:

(a) A host of micro lenders who include moneylenders, SACCOs, furniture stores, clothing retailers, insurance, NGOs, Banks, and employers organisations;

(b) Micro lenders who focus on salary earners as their main clientele and

2 Determined by the Consumer Credit Regulatory Council of the Department of Trade and Industry.

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(c) Relatively high interest rates averaging 30% per month for short term lenders;

In addition, many clients of micro lenders are unaware of their rights. Moreover, micro lenders do not always make adequate disclosure to allow borrowers to make informed choices. It is for these reasons that MFRC has been instituted to oversee the micro lending sub sector of the financial sector by providing information and protection to borrowers.

It is common knowledge that MFIs charge “high” interest rates for their loans. This is because MFIs face higher administrative costs (i.e., from the disbursement and collection of numerous small loans and/or because they operate in infrastructure deficient areas that traditional financial institutions avoid) than traditional commercial banks. Therefore, to attain sustainability, MFIs generally charge higher interest rates than commer-cial banks. However, most MFI borrowers do not know the effective cost of borrowing and are not in a position to compare interest rates charged by different lenders. Nonetheless, in South Africa, the MFRC requires its members to disclose the “Total Charge of Credit” (TCOC) and to use a loan contract format that complies with its (MFRC) standards.

The MFRC defines reckless lending as “loans made in reliance on the bor-rower’s collateral, without proper evaluation of, or reliance on, the bor-rower’s independent ability to repay, with the possible or even intended result of foreclosure or the need to refinance under duress”. Reckless lending may be exacerbated by a lack of knowledge on the part of micro lenders about the borrowers’ level of indebtedness that may accrue from multiple borrowings and other commitments.

To mitigate reckless lending practices by its members, the MFRC has contracted two private Credit Reference Bureaus to maintain a National Loans Register (NLR) of all micro loans advanced by its (MFRC’s) members. In this regard, micro lenders have been availed information on the credit history of potential borrowers and their ability to afford new loans. Credit reference services have thus proved to be an important tool for the development and regulation of the credit market in South Africa. It is compulsory for every registered lender to submit loans advanced to borrowers on the NLR and to enquire from the NLR before extending a facility to a borrower. In addition, the MFRC has introduced a “Reckless Lending Rule” in its rules, which every registered lender has to comply with.

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3 Structure and Functions of a SROGovernance issues are of critical importance where the success of any SRO is concerned. The composition of the governing body of the regula-tory body should be balanced and take into account fair representation of all major stakeholders, such as government, micro lenders, consumers, and service providers. This wider industry involvement is vital for cred-ibility, relevance, and ownership. In addition, by having government representation on a SRO’s Board, allows it (government) to juggle its dual roles of developing a strong financial sector and protecting borrow-ers from unscrupulous micro lenders.

The MFRC takes governance issues seriously and attempted to enforce wider industry participation on its board. Thus, three broad categories of stakeholders are represented on MFRC’s board. The first category of stakeholders includes government, regulators and development finance institutions. This category is represented on MFRC’s board by the Department of Trade and Industry; the South African Reserve Bank; the Financial Services Board; Khula Enterprise Finance Limited and National Housing Finance Corporation Limited.

The second category of stakeholders includes consumer representatives. Here, board representatives include the Legal Resource Centre, Provincial Consumer Directorates, Housing Consumer Protection Trust, and Ad Hoc special expertise. Finally, lenders’ representatives on the board include the Banking Council, the Micro Enterprise Alliance, the Micro Lenders Association, and the Consumer Credit Association. Such industry encom-passing board representation has ensured MFRC’s independence and cut down on bureaucracy. Independence of action is based on a competent team of industry stakeholders.

4 Business ModelAny successful SRO should possess a business model that addresses the cost of supervision. The cost of supervision can be high in terms of money, time and attention, especially when numerous but small institutions are to be regulated. The MFRC’s business model has the following features.

Sustainability: The MFRC is mandated to fund itself through contribu-tions made by its members and other sources. Member contributions come in the form of application fees, annual registration fees, certificate fees, and fines. Over 80% of MFRC’s activities are funded by internally

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generated income. In addition, MFRC receives grants from government (DTI) and donors such as FinMark Trust, Ford Foundation, Sida, and USAID. It is important to note that the grants do not subsidise MFRC’s operational expenses but improve its capacity for research, regulatory reform, and consumer education, which are services with very strong “public goods” features.

Task assignment: MRFC has identified core functions that it handles directly and others it outsources to other service providers either because it is more economic and faster to do so, or because such functions require specific expertise that MRFC might not possess. Some functions that MRFC handles directly include accreditation and compliance, complaints and enforcement, investigation and prosecution, education and commu-nication, and special projects. Functions that MRFC outsources include inspections and credit reference services.

5 Lessons for UgandaIn discussing non-prudential regulation of tier 4 financial institutions in Uganda, we must consider the views of all stakeholders. This is especially the case where the introduction of good business conduct and transpar-ency in the entire Ugandan credit market is concerned. The Ugandan credit market is largely unregulated with many different players that are engaged in lending transactions ranging from moneylenders through fur-niture stores, motorcar dealers, SACCOs, FSAs, MFI NGOs, to financial institutions regulated by the Central Bank. Therefore, non-prudential regulation of the entire credit market is required and not the regulation of Tier 4 institutions alone as illustrated in the figure below.

Figure A.1 Regulation of Credit Market.

Credit Savings

Tier 1 – Banks

Regulate this column

Tier 2 – Non-bank financial institutions

Tier 3 – MDIs

Tier 4 – MFIs, SACCOs, FSAs, FCBOs, money lenders, commercial lenders

Instead of this row

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Any attempt to regulate Tier 4 MFIs (which include credit-only NGOs, SACCOs which can legally mobilise and intermediate members’ savings, and an unknown number of MFIs that illegally collect savings) would focus on a rather narrow segment of the credit market, leaving other lend-ers to continue with poor and non-transparent business practices. AMFIU in its current form and with its current mandate cannot be the regulator of Tier 4 MFIs. The main reason for this is that AMFIU is the umbrella body for MFIs and the MFIs control AMFIU.

Thus, while consumer-protection issues are very important not only for microfinance institutions but for all lending entities, including formal financial institutions, these issues cannot be addressed by AMFIU. What is needed is a national policy for protecting borrowers against abusive lending and collection practices, and providing borrowers with adequate disclosure (truth in lending) of accurate, comparable, and transparent information about the cost of loans.

Many lenders in Uganda continue to grant loans to their clients without ample knowledge about the borrowers’ level of indebtedness. Multiple borrowings have led to over-indebtedness in an environment that lacks a developed credit reference system. This is a challenge that needs to be addressed. However, unlike the MRFC, AMFIU cannot provide credit reference service for its members, as there are a vast number of microfi-nance institutions that are not AMFIU members, but also because of the lack of a national identification system in Uganda.

Thus, the focus of the discussion on tier 4 regulations in Uganda has to shift from the Tier 4 segments to the entire credit market. In this regard, the challenge is to address the issues of non-prudential regulation of the entire credit market, consumer education and protection and the creation of a credit reference system.

To further this debate, AMFIU with the support of donors (GTZ, DFID/FSDU) is planning to undertake a study on the entire credit Market. The study will among other things look at mortgages, consumer credit, MFI lending, money lenders, and formal banks. The study will also quantify the different segments of the credit market, identify dysfunctional areas, and assess the constraints of putting in place a system of non-prudential regulation.

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Annex B Report on Linkage Banking Mission to Cameroon

assembled by Patrick Mbonye and Paul Rippey from conclusions drawn by the Cameroonian Mission Members

Table of Contents1 Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

2 Cameroon at a glance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92

3 Afriland First Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93

4 Appropriate Development For Africa Foundation (ADAF). . . 94

5 MC2s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95

6 Vision and Corporate Culture . . . . . . . . . . . . . . . . . . . . . . . . . . 97

7 Tripartite Arrangement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

8 Challenges for adaptation into the Ugandan Context . . . . . . . 98

9 Some Ideas on the Way Forward . . . . . . . . . . . . . . . . . . . . . . . . 99

1 BackgroundLinkage banking is a business partnership between a regulated financial institution (bank, credit institution, or microfinance deposit-taking institu-tion) and one or many independent, non-regulated institution(s), such as Savings and Credit Co-operatives (SACCOs) or credit-only MFIs. Unlike the case of mergers and acquisitions, linked institutions remain distinct, independent firms. The linkage may include other partners, such as an NGO or a service company as well. The relationship between the parties should be formal, mutually beneficial, long-term, creative and evolv-ing. Simple refinancing arrangements, where the regulated institution provides loan capital to the non-regulated institution, may be the first step in establishing a linkage banking arrangement, but is not in and of itself typically thought of as linkage banking.

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Report on Linkage Banking Mission

Not surprisingly, linkage banking is creative and there is no unique model to respect. Linkage banking relationships develop over time, with an increasing level of inter-relationship between the parties.

Common components of Linkage Banking include: use of the financial services of the bank by the MFI or its clients; provision by the regulated partner of capacity building in such areas as accounting, internal controls and audit, treasury management, customer service, and human resource management; back office co-ordination in areas such as portfolio tracking or accounting; co-branding, particularly of savings and electronic banking products; agency relationships, in which the MFI increases the outreach of the bank through selling the bank’s products and services; and, eventu-ally, an equity stake of the MFI in the bank, or vice versa.

Linkage banking can be a way of increasing product diversity, profession-alism, and security of savings. For this reason, the Microfinance Forum with the support of DFID’s Financial Sector Deepening Project (FSDU), the United Nations Development Program (Ugandan Office) and Danida organised a study tour to Cameroon to visit the Afriland First Bank (AFB), from 10th to 14th May 2004. The Ugandan delegation consisted of nine people representing the Bank of Uganda; UNDP/Ministry of Finance; the Outreach plan co-ordination unit; FSA International Uganda (FSAIU); DFCU Bank; Nile Bank; Masaka Microfinance Development Co-operative (MAMIDECOT); Kyamuhunga Rural Savings and Credit Co-operatives; and FSDU.

The mission was organised because Afriland First Bank is an African pioneer in linkage banking and has perhaps the longest track-record of any linkage banking program in Africa. It has developed a particularly rich model: AFB provides a governance and audit function to a network of member owned organisations called MC2s, with a third party (ADAF) providing training, on-going support, and performance monitoring. Remarkably, AFB has been delegated by the supervisory body of mem-ber-based MFIs, the Ministry of Finance, to carry out supervision of the MC2s in its name.

The organisers and participants hoped that the mission would find ways of encouraging similar integration within the financial sector in Uganda.

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2 Cameroon at a glanceCameroon is a bilingual country, with a population of approx. 15 million people and a per capita income of USD 1,200. Its political capital is Yaounde while the business/commercial capital is Douala. Principal forex earners are timber, petroleum, coffee, cotton, and fruit juices. There are two official languages French and English, and all official documents are written in both languages. There are about 400 local languages.

Subjective impressions of the members of the mission were that Cameroon has a much more developed road network, but much less developed telecommunications, than Uganda. Above all, the population density in Cameroon, especially in rural areas, seemed much lower than in Uganda.

3 Afriland First BankAFB was founded in 1988 as CCEI Bank, and later changed its name to Afriland First Bank. It is the fourth largest bank in Cameroon, with assets of about USD 280 million in 2002, and profits of USD 2.7 million in the same year. The bank is remarkably African in its conception, manage-ment, and capitalisation. A visionary chairman has surrounded himself with senior staff sharing a similar way of operating, people who believe that, in the words of one of their slogans, “If we are afraid to fail, we will never know how far we could have gone.”

In that spirit, the bank has a very long-term view of its initiatives, not always expecting them to make a profit in the short term. Rather, the bank invests in projects which have the potential to become profitable, and which will contribute to the development of the country.

Besides support to the MC2 network, the bank has launched a number of innovative products, all of which are marketed or promoted not only through the bank, but also through the MC2s. Amongst the various products and services offered by the bank, is:

(a) MITFUND, or the Micro Trust Fund, is a venture capital fund for micro-projects. Typical activities funded include: animal husbandry, fish farms, tailors, agriculture, rural pharmacies, restaurants, and Internet cafes. MITFUND’s investments typically last between one to five years, and MITFUND shares in the financial outcome of the

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enterprise during that period in proportion to their share of the total capital. So far, the fund is losing money, but the manager reports that he has learned a lot about managing risk, and customers have gotten used to the idea of being transparent about their earnings, and sharing them with the fund. As is the case with many AFB initiatives, the objective of starting MITFUND seems to be to change people’s attitudes and outlook in the long term, as much as to make money in the short term.

(b) FlashCash, is a travelers cheque-like instrument, sold in the AFB and in the MC2s. It guaranties security of cash especially during travel. The Bank developed FlashCash after realising that there was a market for secure, low cost transport of funds in an economy still heavily reliant on cash transactions. It is profitable for the bank, in large part because it has amassed a float of over a million dollars.

(c) CDI, or Islamic Savings Account. Because of the prohibition in Islam against accepting interest, many Muslims are uncomfortable keeping their money in savings accounts. The only alternative for them has been to keep money in current accounts, in which they lose money, because of fees. AFB developed the CDI to provide an attractive alternative for Muslim savers: the accounts pay no interest, but also charge no fees. Holders of CDI accounts have access to banking op-erations, including transfers and cheque cashing. These accounts are quite profitable for the bank, which makes an off-setting contribution to the Islamic community, including sending bank representatives on the Haj to assist Cameroonian pilgrims, and charging no conversion fee between FCFA and Rials. Minimum balance is 100,000 FCFA, about $170. As a result of this and similar efforts, the bank has an ex-cellent reputation among Cameroon’s large and prosperous Muslim business community.

The bank also has savings accounts with low minimum balances, and subscribes to a money transfer service (MoneyGram). It has set up an of-fice in China to facilitate technological and financial exchanges between that huge country and Africa, and sees other developing economies as being more likely to provide appropriate models and approaches than Europe and the US.

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4 Appropriate Development For Africa Foundation (ADAF)

In order to create effective supervision of the MC2s a Non-Governmental organisation funded by donors was created in 1992 called Appropriate Development for African Foundation (ADAF). AFB signed a memoran-dum of understanding with ADAF. The linkage model includes a tripartite arrangement among the AFB, the MC2 network and ADAF. ADAF provides institutional support in the form of capacity building for the MC2s, staff on-the-job training, improvement in accounting procedures, community mobilisation and sensitisation, research and feasibility studies and promotion of individual, carefully selected, micro enterprises.

In addition to training and supervision of the MC2s, ADAF has supported small enterprises and activities, chosen because of their developmental impact, such as the following:

(a) The agricultural School of Baham in West Province, which trains rural entrepreneurs and undertakes experimentation on agricultural and breeding techniques.

(b) A training and wood processing Centre in Central Province, which trains rural entrepreneurs to produce furniture.

(c) Training and research on appropriate technologies such as corn mills, oil presses, and wood lathes.

(d) A computer centre, which ADAF uses in monitoring the MC2s, but which also provides training to Cameroonians wanting to learn computer skills.

ADAF also has a Marketing Centre, which undertakes market studies, and works to create market linkages.

5 MC2sMC2 is an abbreviation of Mutuelle Communautaire de Croissance (in English, Community Growth Co-operative), and the name is a deliberate echo of Einstein’s famous equation E= MC2.

MC2s are SACCOs, tied by agreements to the AFB and to ADAF. The Bank and ADAF are patient, and the creation of an MC2 takes anywhere from a year to four years, and follows these nine steps:

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(a) Information and consciousness raising of the “elites” of the village, both local and in the diaspora, and of the local population

(b) Feasibility study including an assessment of the proposed location(c) Mobilisation of funds through the sale of shares(d) Constitutive General Assembly(e) Selection of staff by the Board of the MC2(f) Training of staff by the bank and ADAF(g) Identification and rental of an office(h) Acquisition of equipment(i) Opening of the MC2There are now about 70 MC2s, with another thirty in various stages of development. They have a combined membership of over 40,000 people; about half the MC2s are net borrowers, half are net savers. (In addition to the MC2s, Afriland works with a smaller network called MUFFA, made up of structures similar in function to MC2s, but exclusively targeting women.)

For people familiar with SACCOs elsewhere, the following characteris-tics of MC2s are noteworthy:

(a) Apparently high levels of staff competence. The staff are recruited locally by the board, and undergo four months of training before they begin their jobs: one month doing a rotation of banking functions at AFB; two months of training in MC2 theory and practice with ADAF; and a one-month apprenticeship in another MC2.

(b) MC2s offer a large range of financial products, including various savings options, group and individual loans, FlashCash sale and redemption, access to MITFUND investments, and in some cases MoneyGrams.

(c) Agriculture is treated like any other business, and some MC2s have a substantial percentage of their portfolio in agricultural loans. The relatively well-trained staff are able to tailor loans to the cash-flow of the supported agricultural investment.

(d) In addition to the other structures one normally finds in a SACCO, the MC2s have a Council of Elders, composed of respected people

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from the community, whose role is to assist in dispute resolution, governance, or problem solving.

(e) Financial reporting includes specific mention of numbers and amounts of loans to Board, Elders, staff, and staff of ADAF, MUFFA, or AFB, and for each category, the numbers and amounts in arrears.

AFB claims that MC2s generally have arrears rates between 0% and 2%. They are expected to become profitable no later than their fourth year of operation, and most attain that goal.

6 Vision and Corporate CultureAFB’s developmental and visionary corporate culture is quite palpable to visitors, and is widely shared by staff at all levels of the bank, and also amongst all the three partners in the linkage banking model. The follow-ing elements are striking:

While in no way denying the many real problems of Africa in terms of human resources, HIV/AIDS, infrastructure, finance, and so on, AFB be-lieves that a pervasive pessimistic attitude about Africa, among Africans and foreigners alike, is itself a barrier to development. It strives to over-come that attitude, in part by setting an example of an African-owned, African-managed financial institution that is steadily profitable, innova-tive, and growing. Their confidence is contagious, and seems to transmit out to their developmental partners, and down to their customers.

Their business plan is firmly based on the idea that rural economic devel-opment is good business. They want their customers to succeed, and they want to have a very large base of customers. They think that development in Africa has to be bottom up, and must work in the countryside where most people live. The MC2s were set up as an affordable way of bringing banking products to people living outside of the cities. The bank looks at the MC2s as clients, and the MC2 members as potential clients, and the bank is willing to wait the time necessary for them to develop into profitable clients. They claim that their growth strategy is not based primarily on increasing their slice of the pie, but rather on growing the pie by investing in rural development.

Their mission is not simply a statement that appears on a wall or in a brochure: the senior staff and the various partners do not hesitate to speak

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in very strong terms of their commitment to development and to helping the poor.

For a commercial bank, AFB is remarkably open to taking risks, and does not mind trying ideas that might not be profitable for many years. It attaches a great deal of importance to its image and brand, and wants to be (and is) seen as innovative and pro-poor.

It would be difficult to determine whether AFB’s support of the MC2s, on balance, leads to a profit or loss for the bank. To know that, it would be necessary to know the impact of the partnership on increasing outreach, the value of banking products sold through the MC2s, the cost of supervi-sion, audit, and product development, and so on. However, the senior staff of AFB would suggest that the question is misplaced. They seem quite sincerely to be taking such a long view that they do not concern themselves with short-term profits.

However, whatever the financial outcome of the MC2 programme, there are probable collateral advantages to the Bank. It is likely that among the many MC2 customers are some future Afriland clients, and the visible commitment to rural development has given the Afriland brand consider-able luster in Cameroon.

7 Tripartite ArrangementRemarkably, AFB has been delegated by the Ministry of Finance with the authority to supervise the MC2s. This means that AFB has both a carrot and a stick in its relations with its MC2 partners. In practice, an intricate web of agreements, services, loans and borrowings, joint ventures, and co-investments, join together the MC2s, AFB and ADAF.

The three parties hold regular meetings to monitor the activities of each partner. The glue that holds the partners together certainly seems to be more common values among refreshingly independent institutions, largely free of donor support. They seem to be among the fairly rare institutional networks who succeed in the commercial arena, while reinforcing their social objectives.

Donors and national organisations can operate either as partners by bring-ing institutional support through ADAF, working with individual MC2s, or entering into more commercial relationships with AFB.

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8 Challenges for adaptation into the Ugandan Context

The mission team agreed that the model is a way to increase outreach of the formal financial sector, better products for rural consumers, and positive developmental impact, and members were impressed with the business acumen of the Bank. The following were identified as some of the challenges that will have to be faced to introduce some version of the AfriLand model into Uganda:

From the Bankers’ Perspective(a) Selling the concept of networking Banks, MFIs and support agencies

in the absence of any short-term commercial payoff.(b) Pricing of the concept of linkages of the different shareholders.

From the Support Agencies’ Perspective(a) Ugandans will need to be sensitised for implementation of proposals

arising out of the visit.(b) The Ugandan policy and regulatory environment would have to

evolve to permit co-branding, agent relationships, and other aspects of linkage banking.

(c) Strong leaders would need to work hard to incorporate the develop-ment agenda into the commercial one.

(d) MFIs are donor driven. They need to begin to look at using donor resources to support their own missions, rather than the reverse.

9 Some Ideas on the Way ForwardThe team thought that some regulatory reform would be necessary to create an environment in which Linkage Banking could prosper, and that with that reform, it would be necessary to find strong and patient leaders to communicate a clear vision of the concept. It is noteworthy that the recommendations which follow require little donor resources, but are rather based on local initiative.

(a) The institutions need laws and regulations governing member-based institutions (SACCOs) in Uganda that will be conducive to growth

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and development of MF service provision. Uganda still regulates financial institutions according to the institutional form, treating large co-operative societies differently from small banks, even if both carry out similar activities and have similar resource bases.

(b) Many SACCOs suffer from a lack of sensitisation of the community at the on-set, to issues such as productivity, savings culture, member rights, ownership, and true costing of products and services. Staff and BOD also need to be trained in setting up of policies and byelaws; community participation in survival and development of MFI; link-ages between commercial and development objectives.

(c) While many systems exist, the Ugandan Tier 4 industry needs to adopt standardised and simple reporting.

(d) Regarding agricultural lending: financial products need to be based on the whole agricultural calendar and intelligently adapted to the farming cycle.

(e) Commercial Banks, MFIs and support agencies should strengthen their linkages and look towards formalising them.

(f) Capacity building should focus on bringing the CBs, MFIs, and the end beneficiaries together utilising the networks proposed above.

(g) A long term initiative fund should be set up (learning from MITFUND), which could be used to fund particularly promising sec-tors of the economy without losing sight of commercial investment best-practices.

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Annex C Possible Mechanisms to Regulate Tier 4 MFIS in Uganda1

by Stefan Staschen with contributions from Michael Akumpirira2

Table of ContentsExecutive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

2 Scope and Methodology. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

3 Possible Options to Regulate Microfinance Institutions. . . . . 108

4 Current State of Tier 4 Institutions . . . . . . . . . . . . . . . . . . . . . 114

5 Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133

6 The Way Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141

Executive SummaryThis report summarises the results of a study on regulatory options for tier four MFIs in Uganda. It is based on an analysis of available documenta-tion and legislation for this sector and numerous interviews, which the consultants conducted between February 26 and March 18, 2003. The following are the most relevant laws for tier four MFIs: The Money-lenders Act, 1952; the Companies Act, 1961; the Non-Governmental Organisations Registration Statute, 1989; and the Co-operative Societies Statute, 1991.

1 First published as FSD Series No. 11 by the BOU-GTZ-SIDA Financial System Development Programme and AMFIU, Kampala, May 2003.

2 The author of this report can be reached at the following address: Stefan Staschen at [email protected]

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Possible Mechanisms to Regulate Tier 4 MFIs

Three types of MFIs can be found in the sector: SACCOs, tier four MFIs other than co-operatives (referred to as non-coop MFIs) and money-lend-ers (the last category comprises not only institutions, but also individu-als). Money-lenders should not be regarded as tier four MFIs unless they are registered either as NGO or as a company.

International experience and the theory on financial regulation clearly show that all three types of MFIs need and should not be prudentially regulated by the central bank. Unlike tier one, two and three institutions, they do not intermediate public deposits. A possible exemption to this rule might be, at least in the medium term, very large SACCOs.

The study concludes that tier four MFIs should be subject to non-pru-dential regulation focusing on performance monitoring. Such a regula-tory system would neither be pure self-regulation nor direct government regulation, but self-regulation backed by statutory powers of government agencies.

The following are our recommendations with regard to institutions in tier four:

(a) SACCOs: Preferably, SACCOs are brought under the Ministry of Finance. Even if the decision is taken to leave them under the current Ministry (MTTI), supervisory tasks could be delegated to an existing umbrella body (such as UCA or UCSCU), while some statutory pow-ers (e.g. to deregister errant members) and the authority to conduct on-site inspections would remain with the Ministry.

(b) Non-Coop MFIs: Our findings suggest that neither the NGO Board nor the Registrar of Companies is well positioned to effectively moni-tor non-coop MFIs. Supervision should therefore be delegated to a Self-Regulatory Organisation (SRO). As for the power to close down non-complying members, this could either remain with a government agency or also be delegated to the SRO. It would be essential to have mandatory membership with the SRO to ensure the effectiveness of this approach. Rules and a code of practice of the SRO are to be approved by a government agency. The government could also be represented on the Board of the SRO. At least as an interim solution, a specialised department in AMFIU could take over the role as SRO.

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To implement these recommendations, the following laws would have to be amended:

(a) NGO Statute and Companies Act: In both laws, a provision would be included that companies or NGOs engaged in ‘microcredit busi-ness’ must be registered with an SRO and that a still to be specified government agency is authorised to make microfinance-specific regulations under this Act. Furthermore, the NGO Statute should confer corporate status to non-coop MFIs so that double registration under the Companies Act is no longer required.

(b) Co-operative Societies Statute: Specific sections on SACCOs would be added to the Act, even better were the introduction of a separate Act for SACCOs. A provision has to be included to delegate some supervisory power to an existing umbrella body, approved by the Ministry. In the medium term, larger SACCOs (in terms of number of members or volume of deposits) would be brought under the purview of the central bank.

(c) Money-Lenders Act: The Act would be repealed. For this sector, the focus would lie on consumer education and an effective complaint mechanism for aggrieved customers.

1 Introduction

1.1 Background of the StudyWhen the MDI Bill was discussed in Parliament in November 2002, a number of MPs expressed their concerns about the fact that it does not cater for the majority of MFIs, but only for a tiny fraction of about six to nine micro deposit-taking institutions (MDIs) in the medium term. These institutions are referred to as tier three institutions, while all other micro-finance institutions (MFIs) — arguably more than 500 — are called tier four MFIs.3 After intense discussions, it was agreed to split both issues concerning tier three and tier four MFIs.

3 Tier one institutions are commercial banks and tier two institutions credit institutions, both regulated under the Financial Institutions Statute (FIS) 1993.

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Firstly, the majority of MPs passed a motion regarding tier four MFIs with the following content:

“It is hereby resolved that the Cabinet undertakes to bring to the August House within 6 months a Bill regulating the activities of Community-Based Financial Institutions referred to as Tier IV in the Report of the Committee on Finance, Planning and Economic Development guaranteeing affordable interest rates and reasonable period of repayment to the borrowers.”

Secondly, the MDI Bill was passed with only minor amendments. The motion underlines the importance to study different options for regulating tier four institutions. As the motion mentions a clear time frame (the six months will be over on May 20, 2003), it is now much more urgent to come up with concrete proposals how to address the concerns raised.

1.2 Tasks of the StudyThe main tasks of this study were the following:

(a) To compile and study the different laws under which tier four MFIs are operating and to identify weaknesses in these laws in relation to microfinance business;

(b) To propose ways and mechanisms through which these legal weak-nesses can be overcome;

(c) To suggest areas for legal amendments to strengthen the existing laws; and

(d) To propose mechanisms through which these laws can be enforced — either through the central bank, meso level organisations other than existing networks or through existing networks, giving pros and cons in each case.

1.3 Structure of the ReportThis report is structured in the following way. First, we describe the main subject of our analysis and the methodology we used. In chapter 3, the theoretical background is given and the experiences with regulating simi-lar institutions in other countries summarised. The following chapter then analyses existing legislation, and institutions in tier four in Uganda and

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list the most important shortcomings in this sector. On the basis of this analysis, some recommendations are given in chapter 5. The concluding chapter describes the way forward to implement our recommendations.

2 Scope and Methodology2.1 Scope of the StudyTier four is a diverse sector, and it is extremely difficult to get reliable figures on the number of institutions, let alone their performance. As of now, the sector is defined negatively, i.e. all those financial institutions not belonging to tier one, two or three are called tier four institutions. Thus there is a clear upper boundary to this sector, but not a lower boundary. For the sake of this study, the lower boundary has been set by dealing only with those institutions which can sue and can be sued, i.e. which are incorporated or registered under any one law.

The upper boundary has been set by defining ‘microfinance business’, which in the context of this law is micro deposit-taking business, in the MDI Bill. Contrary to the suggestion of the BOU Policy Statement on Microfinance Regulation (cf. Ch. 2.3), all member-based institutions (and not only the very small ones) are excluded from the ambit of this law. Furthermore, compulsory savings are seen as part of the lending technol-ogy of MFIs. The mobilised funds, also referred to as ‘loan insurance fund’, may not be used for on-lending.

As long as MFIs do not mobilise voluntary savings from the public, they are allowed to operate as tier four institutions without being licensed by BOU. Previously, only financial institutions regulated under the FIS (the Financial Institutions Statute) have been authorised to mobilise and on-lend deposits from the public. With the enactment of the MDI Bill, also MDIs, which constitute the small group of strongest MFIs, will be permitted to intermediate savings.

Three types of MFIs can essentially be found between the upper and lower boundary of tier four: First, the savings and credit co-operative societies, for which the availability of data is best; second, MFIs licensed under the Companies Act and (only some of them) under the NGO Registration Statute; and third, money-lenders registered under the Money-lenders Act. Ch. 4.1 will describe these different types of institutions in more detail.

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2.2 Main Legislation for Tier 4 MFIsTier four MFIs exist in a number of different legal forms. All informal MFIs, i.e. those that are not incorporated under any law, are explicitly excluded from this study. This means that all MFIs that are only regis-tered on district level are not included in this study because this kind of registration is not a legal requirement. The consultants have focused their attention on the following laws:

(a) Money-lenders Act, 1952.(b) Companies Act, 1961.(c) Non-Governmental Organisations Registration Statute, 1989.(d) Co-operative Societies Statute, 1991 and Co-operatives (Amendment)

Bill, 2002.In addition, the Financial Institutions Statute (FIS) 1993, the Financial Institutions Bill (FIB)

2003, the MDI Bill 2002 and the Bank of Uganda Statute 1993 are important for this study as they guide the conduct of micro deposit-taking and banking business.

2.3 Policy Documents with Relevance for Tier 4A number of policy documents will guide future policy decisions in Uganda in the field of microfinance. The most important general govern-ment policy is set down in the Poverty Eradication Action Plan (PEAP). With regard to financial services, the following objectives have been stated:

“There is a large unmet demand for financial services among the poor. Access (availability and affordability) is the main constraint. Government schemes for providing credit have not been successful. […] Government will withdraw from direct delivery of credit but will provide a conducive macroeconomic environment; and provide a legal and regulatory framework for microfinance institutions.” (Government of Uganda 2002: 20f., emphasis by consultants)

The Medium Term Competitive Strategy (MTCS) is much more detailed when it comes to government policy towards MFIs. Yet it mainly deals

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with deposit-taking MFIs and the need to bring these under the purview of BOU. With regard to small community-based organisations, it seems to recommend a more cautious approach: “The [new legal] framework should recognise informal and community-based organisations with credit-programs, which bring financial services to the grass roots with little effect on the stability of the whole financial system.”(Government of Uganda 2001: 18) An entire section of the MTCS deals with the need for MFIs to charge market-determined interest rates. It culminates in the sentence: “The policy of no restrictions on maximum interest rates shall continue in the case of MFIs that want to charge high interest rates for their operations because this is absolutely an essential precondition to the success of credit delivery systems for micro enterprises.” (Government of Uganda 2001: 19).

Most important for microfinance regulation is the BOU Policy Statement on Microfinance Regulation from July 1999 as this document has been approved by Cabinet and defines the general government policy in this field. The policy statement introduces the tiered concept as described above, with tier four MFIs not being subject to BOU regulation and supervision. Tier four comprises two types of institutions:

First, all those that are non-deposit taking institutions such as credit-only NGOs or any other non-deposit taking initiatives. Second, all those very small member-based organisations mobilising subscrip-tions from their members, whose size will be determined.(Bank of Uganda 1999:7f.)

The proposed regulatory authority for tier four is an umbrella body, which has not been further specified. It is only stated that “BOU will be actively involved in the discussions on the financial standards of self-regulation under tier 4 and provide guidance in the establishment of the umbrella body”.

The official reports of the parliamentary debates on the MDI Bill (November 19 and 20, 2002) are important background documents. They include the motion moved by Hon. Aggrey Awori. Moreover, they help to identify positions of supporters and opponents on regulating tier four institutions.

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2.4 MethodologyThe study was conducted by an international microfinance expert with contributions of a Ugandan lawyer. The consultant had three weeks to carry out interviews with stakeholders in the industry and to come up with some preliminary recommendations, which he presented in a well-attended stakeholder workshop on March 17, 2003.

More than twenty interviews were conducted with individuals or with stakeholder groups (in the case of donor agencies, MPs and tier four institutions). The main stakeholder groups were the following: MPs and Ministry of Finance, (potential) tier three and tier four MFIs, representa-tives from regulatory bodies such as the Registrar of Co-operatives, the Registrar of Companies and BOU staff, networks and associations (AMFIU, DENIVA, UCA, and UCSCU), and donor agencies. However the consultants did not meet any officer from the NGO Board. A complete list of interviewees can be found in the Annex.

Although at one occasion one of the consultants also talked to a number of representatives of MFIs from upcountry, which happened to be in Kampala, the composition of respondents might nevertheless be biased towards the upper end of the market and those institutions with headquar-ters in Kampala.

As will be shown in chapter 4.2, data on tier four can at best be described as sketchy and the problem analysis had mainly to rely on anecdotal evi-dence, as there is no in-depth study available of problems and constraints in the sector. Due to the short time of three weeks, the consultants were not able to collect primary data or to assess unwanted practices in tier four themselves.

3 Possible Options to Regulate Microfinance Institutions

Before turning to the Ugandan case, it is essential to define terms, distin-guish regulatory approaches and summarise other countries’ experience with the regulation of MFIs not mobilising deposits from the public.

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3.1 Prudential vs. Non-Prudential RegulationPrudential regulation can be defined as public sector regulation ensuring the safety and soundness of financial institutions. Two elements are au-thoritative for prudential regulation. First, governments must be in some way involved in regulation to ensure a credible enforcement mechanism (usually prudential regulation is the task of the central bank or a special-ised superintendency). And secondly, the regulatory authority not only monitors performance, but also vouches for the safety and soundness of financial institutions. The two most important objectives of prudential regulation are to protect the deposits of the public and to guarantee the stability of the financial system.

Non-prudential regulation, on the other side, is a much less arduous task. It simply establishes rules and guidelines about appropriate behaviour and business practices in dealing with customers and monitors the perform-ance of financial institutions. A non-prudential regulator can be a govern-ment agency, or a private institution such as a federation, a network or an apex institution.

Neither prudential nor non-prudential regulation should be seen as a way to promote the development of the microfinance industry. For deposit-taking institutions it is essential that they are already sound and mature institutions before they start deposit-taking. A non-prudential regulatory system can, by definition, not guarantee the soundness of MFIs. It can improve transparency about the performance of institutions, but not the performance of institutions itself.

3.2 Different Approaches to Self-RegulationThere is a general consensus that MFIs need not be subject to prudential regulatory requirements as long as they do not mobilise deposits from the public (i.e. from non-members) and lend them out (what one calls financial intermediation). Non-prudential regulation is at the core of this study as tier four MFIs are those that are not mobilising and intermediat-ing deposits from the public (cf. Ch. 2.3). As became clear from the above definitions, non-prudential regulation is not necessarily the task of a government agency, but can also be carried out by a self-regulatory organisation, i.e. by an organisation that is essentially controlled by the regulated institutions themselves.

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Most microfinance publications assert that self-regulation suffers from severe conflicts of interest and thus cannot be effective for deposit-taking MFIs (e.g. Christen and Rosenberg 2000:20; Hannig and Katimbo-Mugwanya 2000: 45 and 125; Consultative Group to Assist the Poorest 2002: 24). The most important reference in this regard is the experience with self-regulatory systems of financial co-operatives, which has in most cases been rather unsatisfactory. Studies of self-regulatory frameworks for non deposit-taking MFIs are rare.

There is a vast amount of literature on self-regulation, yet mostly in other industries than the financial industry. Self-regulation usually plays a much stronger role in areas such as food safety regulation, environmental regulation, or work place security. What becomes clear from this literature is that it is not a decision between self-regulation on one side and external regulation on the other side. One can think of a continuum between pure self-regulation and externally enforced government regulation: “The process of self-regulation may be constrained governmentally in a number of ways – for instance by statutory rules; oversight by a govern-mental agency; systems in which ministers (one may add: or the central bank) approve or draft rules; procedures for the public enforcement of self-regulatory rules; or mechanisms of participation or accountability.” (Baldwin and Cave 1999: 126)4 Baldwin distinguishes five criteria for comparing self-regulation with government regulation: Expertise, ef-ficiency, mandates, accountability, and fairness of procedures (Baldwin and Cave 1999: 126-133). Expertise refers to the technical knowledge of the regulatory body, efficiency to the costs incurred by this body to fulfil its tasks. Under ‘mandates’ Baldwin understands that the regulation serves legitimate objectives. This, in turn, generally requires that these objectives are set by bodies which are accountable, i.e. democratically elected. Finally, fairness of procedure demands that all institutions af-fected by the regulation must be consulted while defining regulatory requirements.

It will be useful to refer to these criteria when comparing different regula-tory options for tier four MFIs in Uganda. Another important aspect is the question of voluntary or mandatory membership of a self-regula-tory organisation. A mandatory system clearly has stronger enforcement

4 Ogus talks of “a spectrum containing different degrees of legislative con-straints, outsider participation in relation to rule formulation or enforcement (or both), and external control and accountability”; Ogus (1998: 376).

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mechanisms as deregistration not only means exclusion from the self-regulatory body, but from the industry in general. On the other side, such a system imposes restrictions on non-members and must therefore be accountable for its actions to the government.

The costs and benefits of different regulatory approaches are an important criterion when deciding about the most appropriate approach to regulate financial institutions. The costs of introducing new regulation can be con-siderable. The main costs are direct (i.e. budget) costs of the supervisory agency, and compliance costs incurred on those MFIs that have to comply with new regulatory provisions.5

The main benefits of regulating MFIs in tier four should be a decreasing incidence of fraud and exploitation of customers, and access to better products, which are offered on a more sustainable basis. Products can be better because they have become cheaper (through increasing competi-tion and operational efficiency of MFIs) or because customers select bet-ter products (through more transparency in the market or a larger choice of products). More sustainable provision of products is made possible through improving the soundness of institutions and thereby their life span.6

3.3 Other Countries’ Experience with Regulation of Credit-Only MFIs

At this point, it might be helpful to look at other countries’ experience with regulating MFIs that are not mobilising deposits from the public, even though it is scarce.

South Africa is probably the most interesting and also a well-documented case when it comes to the regulation of credit-only MFIs. The South African approach has been termed ‘hybrid’ as government agencies

5 A third cost category are structural costs, i.e. costs caused by changing the structure of the market, e.g. through raising the barriers to entry in the market and thereby reducing beneficial competition. These costs are very difficult to measure.

6 Schreiner (1999) has tried to quantify costs and benefits of access to microfi-nance services. Of this rather academic paper the categorisation of costs and benefits might be of interest for some readers.

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are represented on the Board of the Microfinance Regulatory Council (MFRC), an independent body which supervises all money lending institutions (Staschen 1999; Microfinance Regulatory Council 2001; Meagher 2002; Meagher and Wilkinson 2002). The South African case is rather unique as it does not use a strong enforcement mechanism such as mandatory membership with the MFRC, but simply relies on the fact that only members of the MFRC are exempted from very strict interest rate limits under the Usury Act.

Thus all MFIs have a strong incentive to join. Especially the institutional set-up might be of interest for Uganda as well, as this is a hybrid approach, where the government is strongly represented on the Board of the MFRC and the Department of Trade and Industry must approve MFRC’s rules.

In India, self-regulation of all microfinance NGOs has been recommended as the preferred way forward, while the central bank has delegated the supervision of co-operative banks and regional rural banks to the apex institution NABARD. The regulatory structure for NGOs is still very much in change. The report of the Task Force on Supportive Policy and Regulatory Framework for Microfinance recommends the establishment of self-regulatory organisations (SROs) and the compulsory registration of all microfinance NGOs with one of these SROs.7 According to the report, major functions of the SRO would be i) overseeing functioning of MFIs as baselevel regulators, (ii) undertaking registration, (iii) evolving proper systems for maintenance of accounts and reporting, (iv) setting performance standards, (v) conducting inspections, (vi) undertaking training and, (vii) representing MFIs in various fora.8 Certain thresholds have been defined which will trigger the application of tighter regulatory requirements.9 The rules of the SRO are supposed to be approved by a government agency (a proposal is the Reserve Bank of India as the central bank).

7 Cf. http://www.gdrc.org/icm/country/india-mftaskforce.html

8 The full version of the report is available at: http://www.nabard.org/whats/tfr.htm

9 MFIs having mobilised savings not exceeding USD 4,200 are only required to register with an SRO. Savings mobilisation above USD 4,200 triggers pru-dential regulatory requirements, while the mobilisation of savings exceeding USD 53,000 leads to even stricter prudential requirements.

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What becomes clear from these examples is that self-regulation needs some kind of backing from the government to be credible and effective. This can be achieved by, for example, representing government on the board of the self-regulatory organisation or by charging the banking supervisor with the approval of rules and regulations.

3.4 Other Countries’ Experience with Regulating Co-operatives

An interesting case with regard to regulating co-operatives is the co-op-eratives with a limited banking transaction license in Nepal. As co-opera-tives, they are supervised by the Registrar of Co-operative Societies. Yet in 2002, the central bank issued a directive stipulating regulatory require-ments for obtaining a limited banking transaction license. This directive brings all financial co-operatives under the purview of the central bank (currently 34) without curtailing the responsibilities of the Registrar of Co-operative Societies. The central bank has now the authority to issue directives for all co-operatives with a limited banking transaction license, i.e. for all SACCOs, and to supervise them.

In at least ten Latin American countries, the bank supervisor directly supervises large SACCOs, as this seems to provide for the most reliable prudential supervision.10 Yet there is no uniform criterion for defining the threshold, above which co-operatives come under the purview of the banking supervisor. Four possible options are to stipulate a specific number of members, a volume of deposits, assets or capital. The criterion ‘volume of deposits’ might be preferable to ‘volume of capital’ (can easily be manipulated, e.g. by increasing the leverage) and to ‘volume of assets’ (without risk-weighting, this is a very crude measure of overall risk). After all, deposit protection is the main rationale for regulating co-operatives.11 Using ‘number of members’ as criterion, takes directly into account that the more members a co-operative has the less internal

10 Another country with direct central bank supervision of SACCOs is Mozambique, yet there are only seven of them and the capacity of the central bank is not sufficient.

11 This goes in line with the view of Tor Jansson from the Inter-American Development Bank, as expressed in personal correspondence with the author.

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surveillance by members will be possible. An additional criterion might be number of branches, as this, again, makes it more difficult for members to exert control over the co-operative. Finally, some countries distinguish closed, affinity-based and open, community-based SACCOs. In affinity-based co-operatives, all members have for instance the same employer or come from the same, clearly defined geographical area. These co-operatives need not be regulated by the bank supervisor, but are only required to follow certain reporting and external audit requirements. An interesting case is Brazil, where SACCOs (all of them must be of the closed, affinity-based type) are only subject to off-site supervision, but the superintendency can summon a co-operative if the figures appear problematic (Vogel 2002). This reduces supervisory costs, but allows for at least some degree of external oversight.

With regard to regulation of co-operatives, the World Council of Credit Unions (WOCCU) has extensive experience. It has recently published a Model Law for Credit Unions, which is very informative with regard to appropriate legislation for savings and credit co-operative societies (SACCOs) (WOCCU 2002).

In summary, one cannot necessarily rely on strong enough internal controls by members of SACCOs. How much external oversight by a prudential regulator is required very much depends on the size of the co-operative (in terms of number of members, assets, deposits and/or branches) and the affinity of its members.12

4 Current State of Tier 4 InstitutionsThis chapter is looking at the current state of the tier four microfinance sec-tor in Uganda from four different angles: firstly and most importantly, by critically analysing existing legislation catering for this sector; secondly, by looking at different institutional types operating in this sector; thirdly, by describing the main sector-wide problems; and finally by describing role and performance of networks and associations in the sector.

12 Vogel (2002: 5) mentions another important aspect for determining the need for external regulation, which is the composition of capital. In some co-op-eratives, the possibility to take “automatic loans” of up to 90 percent of the share contribution blurs the distinction between deposits and share capital.

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4.1 Existing Legislation for Tier 4 InstitutionsA critical review of the current legislation under which tier four MFIs operate is imperative. Tier four institutions in Uganda are currently regu-lated and registered under four different laws. It is important to examine how each piece of legislation affects the operations of MFIs registered thereunder.

The Non-Governmental Organisations Registration Statute 1989“Organisation” is defined under S.13 of the Statute as an NGO established to provide voluntary services including religious, educational, literary, scientific, social or charitable services to the community or any part thereof. In simple terms these are organisations outside the traditional government which provided charitable social services to the communities they operate in. Prior to the enactment of the NGO Registration Statute in 1989, charitable organisations could register as companies limited by guarantee under the Companies Act, 1961. However some of the organi-sations operated informally, i.e. without any legal registration. Under the Statute, S.1(1), it is provided that no NGO shall operate in Uganda unless it has been registered with the Board established under S.3 of this Statute. The provisions of S.1 are mandatory, i.e. before an NGO can register with the Registrar of Companies it is a requirement that it obtains a Certificate of Registration from the NGO Board. However, some of the NGOs have continued to operate informally without any registration with the NGO Board.

The Ministry responsible for the registration, operations and monitoring of the NGOs is the Ministry of Internal Affairs. The responsible body is the National Board for Non-Governmental Organisations formed under S.3 of the Statute, called the NGO Board. The Board consists of two members of the public and one member from the following ministries or departments:

(a) Ministry of Internal Affairs;(b) Ministry of Relief and Social Rehabilitation;(c) Ministry of Justice;(d) Ministry of Lands and Surveys;

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(e) Ministry of Planning and Economic Development;(f) Ministry of Finance;(g) Ministry of Foreign Affairs;(h) Ministry of Local Government;(i) Office of the Minister of State for Women in Development in the

President’s Office;(j) Office of the Prime Minister(k) Internal Security Organisation; and l) External Security

Organisation.However, it must be noted that some of the above ministries have been merged or abolished and this has affected the composition of the board as envisaged by the law. The following are the critical issues for MFIs registered under the NGO Registration Statute 1989:

Financial services are not mentioned in the lawThe definition of the term “organisation” under S.13 of the Statute omits “financial services” as a category of services provided by the NGOs. While the definition is inclusive, a reference to financial services would be important for NGOs engaged in provision of financial services to the community.

Incorporation only with simultaneous registration as companyUnder S.1(3) it is provided that no NGO shall be incorporated under the Companies Act or Trustees Incorporation Act, before that NGO is regis-tered with the NGO Board.13 The effect of this section is that Registration

13 Trusts are corporate bodies formed under the Trustees Incorporation Act, 1939. Under this Act, trustees or a trustee may be appointed by anybody or association of persons established for any religious, educational, literary, scientific, social or charitable purpose and such trustees or trustee may apply to the Minister for a Certificate of Registration. The Ministry responsible is the Ministry of Lands. The Trustees Incorporation Act, confers corporate status under S.2(3). A trust may sue and be sued under the law. According to our knowledge, some MFIs which are engaged in microfinance business are registered as trusts.

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with the NGO Board does not confer a corporate status to the applicant organisation. Yet financial institutions and other legal entities insist on presentation of the Certificate of Incorporation under the Companies Act before they enter into any contractual dealings with NGOs. As a result, all microfinance NGOs have to register twice, under the NGO Statute and under the Companies Act. It is important to note that limited companies engaged in microfinance business are permitted to share dividends whereas NGOs engaged in microfinance business and also registered under the Companies Act, are not allowed to do so but must re-invest profits into the business.

Irregular meetings of NGO BoardUnder S.10 of the Statute, the Board shall meet at least once a month. It was established during our interviews that the meetings of the board were very irregular with the result that most of the urgent business such as applications for registration remains unattended to for long periods.

Lack of guidance and monitoring by NGO BoardUnder S.6 of the Statute, one of the functions of the Board is to “guide and monitor organisations in carrying out their services”. During our interviews, it was established that the NGO board or its officers do not guide or monitor the operations of the MFIs registered thereunder. The Board lacks the capacity to effectively monitor MFIs. Furthermore there are no monitoring criteria upon which such monitoring exercise can be done. Although the Board has the authority to withdraw the license, this instrument has only rarely been used due to the lack of regular informa-tion about MFIs.

Narrow conditions for revocation of licenseThe board is empowered under S.9 of the Statute to revoke a certificate of Registration under certain circumstances. The conditions for revocation are narrow and do not include revocation on grounds of fraud, unfair practices and such other matters which are peculiar to MFIs. It is therefore not surprising that the NGO Board has rarely invoked this provision, not even where it was considered appropriate. De-registration by the board creates a practical problem as the concerned NGO may remain registered under the Companies Act and would therefore still be able to enter into contractual dealings with other parties.

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Proposed changes under the NGO Registration (Amendment) BillIt must be observed that the Non-Governmental Registration Statute 1989, is to be amended. The salient features of the bill are as follows:

1. The organisations which choose to register under the Companies Act or Trustees Incorporation Act will not be required to register under the NGO Statute.

2. Upon registration, the organisation shall become a corporate body under the statute.

3. The bill also introduces currency points as a basis for imposing fines for offences created under the statute.

In summary, the most critical issues for MFIs registered under the NGO Statute are the lack of effective oversight by the Board and the need for dual registration to become incorporated.

The Companies Act 1961Under the Companies Act, a company engaged in microfinance business may be registered as private limited liability company or as a company limited by guarantee. In both cases, registration under the Companies Act confers corporate status, i.e. the company attains the capacity to sue and be sued under the law. The Registrar of Companies in the Ministry of Justice and Constitutional Affairs is the legal authority over companies. The following are the critical issues for MFIs registered under the Companies Act 1991:

Lack of capacity to monitor companiesIn our interviews, it was established that the Registrar of Companies deals with all companies generally. Several Assistant Registrars assist him in his tasks. The Registrars Office has no capacity to provide adequate oversight for MFIs registered under the Companies Act.

Poor availability of data from the company registryThe company registry is not yet computerised and it was not possible to establish the number of companies, let alone of MFIs registered under the Companies Act.

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Fines under the Act are outdatedThe Companies Act creates offences under SS.396 – 397. It shall be an offence under S.396 of the Companies Act for any officer of the company to make false statements. The penalty is two years of imprisonment or a fine not exceeding USh 10,000. It is clear from this that the fines that are imposed under the Companies Act are outdated.

Responsibilities and capacity of the Director of Public ProsecutionsUnder S.399 of the Companies Act, the Director of Public Prosecutions (D.P.P.) is mandated to initiate investigations into the company’s affairs. Investigations can be ordered by court on application by the D.P.P. or the Registrar of Companies acting on a complaint or on their own motion.

This procedure presupposes that there is a good record keeping mecha-nism in place at the Company Registry. It was established that the office of the D.P.P. is overstretched with prosecution of serious offences and has no capacity or training to follow up frauds and other malpractices within the area of MFIs registered under the Companies Act.

Legal redress for membersFurthermore, under S.402 of the Companies Act, any member of the company or any other person who is aggrieved may institute criminal pro-ceedings against the offender. The law therefore provides a mechanism where the persons aggrieved by actions of the officers of the company may seek redress. However it is noted that the consent of the Director of Public Prosecutions’ office has to be sought. Taking into account the above-mentioned limited capacity of this office, this avenue of redress may be inaccessible to the members who are aggrieved.

Legal redress for third partiesThe provisions of the Companies Act apply both to companies limited by shares and companies limited by guarantee. Most of the MFIs are registered as companies limited by guarantee. This means that members undertake to contribute a certain amount to offset the company’s liability. The sum guaranteed is usually very small. In effect any third party ag-grieved by the actions of MFIs may not be in a position to recover its money.

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In summary, the most critical issues for MFIs registered under the Companies Act are to be found in a lack of supervision from the Registrar of Companies and inaccessible avenues for redress for members ag-grieved by actions of MFIs.

The Co-operative Societies Statute 1991The law regulating the conduct of co-operative societies is to be found in the Co-operative Societies Statute, 1991. It must be observed that the law is currently under review and the Co-operative (Amendment) Bill 2002 has been drafted and is pending discussion by the Cabinet. The Ministry of Tourism, Trade and Industry is responsible for the co-operatives in Uganda. S.1(1) of the Statute provides for the Registrar for Co-operatives who shall also be the Commissioner for Co-operative Development. The Registrar is the responsible person for registering all co-operative societies.

There are several co-operative societies engaged in various activities. Only co-operative societies engaged in microfinance business, popularly known as Savings and Credit Co-operative Societies (SACCOs), are of interest for our study. The SACCOs must have bye-laws which are de-signed to assist SACCOs in management. Bye-laws must be approved by the Registrar of Co-operatives. Model bye-laws for SACCOs have been developed and are widely used. Adoption of these bye-laws is optional, but, according to the Commissioner, some areas are more or less compulsory.

Co-operative societies are permitted by law to give loans to members under S.41 of the Co-operative Societies Statute 1991. However the law restricts loans to non-members except with the approval of the Registrar. The following are the critical issues for MFIs registered under the Co-operative Societies Statute 1991:

Limited capacity of the Office of the CommissionerS.1(1) of the Co-operative Societies Statute 1991, provides for the office of the Registrar of Co-operatives, who shall also be the Commissioner for Co-operatives. The Statute also provides for Deputy Registrars to assist the Commissioner in supervising co-operative societies.

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The Registrar is given powers of supervision and inspection under the Statute. Our interviews indicate that the Registrar has limited capacity to monitor the performance of the SACCOS countrywide. The Commissioner and only two more staff in his office are responsible for the registration and supervision of about 5,000 co-operatives currently operating in Uganda, out of which at least 680 are SACCOs.

Weak reportingS.21 and 22 of the Co-operative Statute imposes a duty on every society to subject its account to audit at least once in every year by an auditor appointed at the Annual General Meeting approved by the Registrar.

It is observed that the requirement for approval by the registrar is not practicable due to the huge number of co-operatives countrywide. Furthermore, the Registrar does not receive all audit reports from co-operatives on a regular basis, but lacks the capacity and instruments to follow up non-submission of reports.

Fines under the Act are outdatedS.79 of the Statute creates offences. Any registered society or officer who fails to do any act required by the Statute commits an offence. The offender shall be liable on conviction to a fine of USh 5,000 or a period of imprisonment not exceeding six months or both. It is observed that the fines imposed under the statute are very low and outdated.

Weak supervisionWith regard to Co-operative Societies engaged in microfinance, the Office of the Registrar has no mechanism for monitoring the performance of MFIs. In addition, it is not specialised on financial services business, which bears higher risks and therefore demands a higher degree of exter-nal oversight than other business areas.

Uganda Co-operative Alliance (UCA) is provided for under S.28 of the Statute and is charged with the responsibility of making recommenda-tions to government on matters of policy relating to the co-operative movement. However, UCA lacks any enforcement mechanism for errant members. There is no delegation of supervisory task from the Ministry to UCA.

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Proposed changes under the Co-operative (Amendment) Bill 2002It is to be pointed out that the Co-operative Societies Statute 1991 is to be amended by The Co-operative (Amendment) Bill 2002. There are a number of provisions in the new law, which touch the operations of SACCO’s.

Under the proposed amendments Part IVA thereof, the law makes provi-sions for the proper and efficient administration of SACCOs. However these amendments do not exhaust the specific concerns of SACCOs. The Bill has to date not been tabled before Parliament for debate.

It has become clear from our interviews that some stakeholders would have preferred a higher degree of consultation in drafting the Amendment Bill.

In summary, the most critical issue for SACCOs registered under the Co-operative Societies Act is that they are not subject to regulations, which are specifically addressing the needs of financial institutions. Furthermore, the capacity of the Office of the Commissioner is not suf-ficient to effectively supervise the large number of SACCOs, which do not even report on a regular basis.

The Money-Lenders Act 1952This Act makes provision for the regulation of money-lending. A money-lender is defined as a person who engages in money-lending as his sole business or who does it as part of his business whether as an agent or principal. Under S.3(20 and 4(3) of the Money-Lenders Act, companies, firms and individuals may lawfully engage in money-lending business.

The Money-Lenders Act is a legacy from colonial times. It has not been revised since its enactment. Its approach is to control all money-lending transactions, what is not consistent with the requirements of a market-oriented economy. A money-lending contract should be governed by the general principles of the law of contract and it is unnecessary to provide specifically for a money-lending contract. The general law of contract would handle any disputes arising out of money lending transactions.14

14 In the United Kingdom, the corresponding Money-Lenders Act was repealed in 1987.

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It was difficult to establish the responsible Ministry, as there seems to be no strong feeling of ownership in any single agency. To our knowledge, it is the Ministry of Finance, Planning and Economic Development. The following are the critical issues for MFIs registered under the Money-Lenders Act 1952:

No reporting or follow-up after granting of the licenseUnder S.4(2) of the Money-Lenders Act, money-lenders are required to obtain a licence from

the Magistrate who has jurisdiction over the respective area. The law requires that money-lenders obtain licences annually in order to oper-ate money-lending business under S.3(1) of the Act. The procedure for obtaining a licence is to be found in Money-Lenders Rules made by the Ministry of Finance under this Act. The application is lodged with the Magistrate and if not opposed by the police, the magistrate will usually grant the licence. S.4(5) provides for reasons upon which the license may be refused, which are, inter alia, failure to adduce satisfactory evidence of good character.

Interest rate limit too low and not enforcedUnder S.13 of the Act, the money-lender is prohibited from charging interest beyond 24% per annum. The interviews confirmed that interest charged by most money-lenders is well beyond this limit. Even formal microfinance institutions must charge much higher interest rates to cover the relatively high costs of granting small loans.

Fines under the Act are outdatedThe law creates offences under S.14 and 15 of the Money-Lenders Act. It is an offence for any money-lender to make false statements in order to induce any person to borrow from him. The penalty imposed is a term of imprisonment not exceeding two years or a fine not exceeding USh 10,000 or both.

It is observed that the fines imposed under the Act are too low and outdated.

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Illegal practice of concluding sales agreements instead of loan contractsUnder S.7(1) of The Money-Lenders Act, all money lending contracts should be in writing. The interviews we conducted established that the money-lenders would instead cause the borrower to sign “sale agree-ments” for the property given as security. This practice offends S.7(2) of the Money Lenders Act, which clearly prescribes the specifics of a loan contract. A money-lending transaction must not be a sale. A sale of security should only be conducted where the borrower has failed to pay. However there is no enforcement mechanism under the law.

Poor record keepingThe Money-Lenders are required under S.10 to keep proper record of accounts. However, money-lenders do not comply with this provision.

No supervisory authority exists or could possibly existThe Magistrate is given power under the law to licence money-lend-ers. There is no complaint mechanism against errant money-lenders. Furthermore there is no recognised authority over money-lenders. After obtaining the licence, the money-lenders are not duly bound to report their activities to any regulatory office or authority. Instead to a supervisory authority, aggrieved customers must direct their complaints directly to the courts. Even if such authority existed, there would be too many money-lenders in the market so that regulation would be almost impossible.

In summary, the most critical issue of the Money-Lenders Act is that it is an outdated piece of legislation. The Act does not provide for an effective institutional structure to supervise money-lenders after granting a license. In addition, it would be virtually impossible to effectively supervise the large number money-lenders.

4.2 Institutions Offering Financial Services in Tier 4In the following, problems with tier four institutions are described accord-ing to their institutional type.

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SACCOsIn October 2002, 6,580 co-operatives were registered with the Registrar of Co-operatives, of which 680 were SACCOs. The Commissioner estimates that at least 60% of tier four MFIs (except money-lenders) are SACCOs. Yet a high percentage of these is dormant or have already been dead for some time. According to the General Secretary of UCA, about 300 SACCOs are active, a number which is increasing rapidly.

From the early 1970s onwards, the co-operative movement in Uganda has suffered from political interference, mismanagement and accumulating losses. It is only now that the government has created a high-level task force for the revival of the co-operative movement, chaired by the Deputy Speaker of Parliament. The SACCOs play a very strong role in this as their number is increasing by about 30% annually. They are seen as “the engine for the revival of the co-operative sector”. Some people say that the current government strategy is too much focused on increasing the number of SACCOs without sufficiently taking into account the demand side and the capacity of these new institutions.

According to our interviews, the most serious problems in the sector are weak management and leadership, fraud, insider lending, poor financial performance, and improper record keeping. There is not a strong sense of ownership and leadership tends to change too often. In addition, some of the District Co-operative Officers, which are responsible for the reporting to the Commissioner’s Office, suffer from conflicts of interest as they at the same time supervise SACCOs and assist with the bookkeeping. They lack strong incentives to regularly report to the Ministry.

WOCCU is currently supporting 16 SACCOs with an overall membership of about 15,000 members, all of which are members of UCSCU.15 These SACCOs, which are certainly some of the biggest and best performing in the country, have an average share contribution of USh 34,000 and are sufficiently capitalised.16 Reportedly, many other SACCOs collect only

15 At the end of 2002, these 16 SACCOs together held a share capital of US$ 270,000 (of which 98.7% were mandatory share contributions), had mobilised US$ 1.85m in savings and had an outstanding loan portfolio of US$ 1.25m. The same figures as averages per member are US$ 18 share contribution, US$ 124 savings and US$ 84 outstanding loans.

16 The leverage ratio, computed as total capital over total assets, is 6.8.

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symbolic share contributions from their members, sometimes as low as USh 5,000. This definitely leads to weak ownership of these institutions.

It was reported that some microfinance NGOs, which do take deposits from the public, have now applied for a license under the Co-operatives Statute as alternatively they would have to apply for a license under the upcoming MDI Act.17 These NGOs are taking advantage of much less onerous regulatory requirements under the Co-operative Statute. This is an alarming development as the NGOs do not really change from a credit-driven institution to a member-based institution, but simply ask their clients to contribute small amounts as share subscriptions to put a co-operative structure on.

According to our interview partners, some co-operatives have a strong growth potential and might even outgrow some of the tier three MFIs in the future. International experience shows that such large institutions with more than 10,000 members are not any longer effectively controlled by their members. Thus the need for prudential regulation by a special-ised financial regulator becomes much more acute. The Co-operative Department in MTTI presumably cannot fulfil this role in its current capacity.

A recent trend seems to be that village banks, which were either informal or simply registered on district level, but not registered under any one law, apply for a license as SACCO. The Financial Institutions Statute does not allow other institutions than banks licensed under this law to bear the name bank, but BOU up to now has not enforced this provision.

NGOs and Companies Limited by SharesA second large group of tier four institutions are microfinance NGOs and/or companies. The majority of these institutions are registered both as NGOs and as companies limited by guarantee. Yet there are also some examples of MFIs which are only companies limited by shares without being an NGO (e.g. FAULU). This brings the advantage that

17 Even though it was also prohibited under the FIS 1993 to mobilise deposits from the public, this provision has generally not been enforced by the central bank in relation to MFIs. It is expected that this will change in the future as there is now a specific regulatory window for deposit-taking MFIs.

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transformation to an MDI does not require a change of the legal form and commercial borrowing is much easier as banks are interested in having real owners of an MFI.

There are twelve market leaders in this segment, of which six to nine are expected to apply, at least in the medium term, for a license as MDI.18

The number of tier four MFIs other than co-operatives (from now on called ‘non-coop MFIs’) is not exactly known, as neither the NGO Board nor the Registrar of Companies keeps separate records of registered MFIs. Yet there are certainly hundreds of them.

Two strong supporters of smaller MFIs are the Microfinance Support Centre Limited and the SUFFICE project. These two donors exert a cer-tain degree of external oversight as they monitor the performance of MFIs they support. To our knowledge, this oversight might yet not be strong enough to prevent unwanted behaviour like fraud. Yet the largest number of non-coop MFIs (even though these are certainly the rather small institutions) has simply been registered with the Registrar of Companies and maybe also with the NGO Board without being subject to any follow up supervision by one of the agencies.

Money-LendersMoney-lenders are quite different from the other tier four institutions as they are not incorporated, but mainly individuals lending money from their own sources and on their own account. All those money-lenders not being incorporated under any other law should not be regarded as tier four institutions.19 The simple reason why they have been included in this study is that there is a specific law for them.

As there is no central registry for money-lenders, the size of the sector is completely unknown. Even magistrates cannot tell how many licenses they have issued in their area of operation.

18 According to AMFIU’s categorisation, these are all category A and B MFIs, which do not have a license as bank or credit institution. All of them are members of AMFIU. There are no co-operatives in category A or B.

19 The consultants came across cases where MFIs are registered both as money-lenders and as companies.

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Money-lenders can be found on all social levels, from the remote rural village to the Parliament’s floor. Experience from all over the world shows that money lenders have always been around and will always be around as long as there is a demand for their services. Reportedly some of them are dealing with large sums of money.

It became quite clear from our interviews that a high number, if not the majority of money-lenders either have never applied for a license or have failed to renew it on an annual basis. This is not surprising as there are no mechanisms for follow-up after the granting of a license and there is no strong incentive to register in the first place. The only possible incentive is that a money-lender may find it difficult to enforce a transaction in a court of law without being able to present a valid money lending license. But then most of the money-lenders prefer to seize the security pledged, what they can easily do if a sales contract instead of a loan agreement had been signed.

According to our knowledge, lending rates vary between 10% to 25% per month. A common practice seems to be that borrowers sign a sales contract instead of a loans contract. In case of a default, the money-lender simply appropriates the security, even if it is of higher value than the original loan amount. Yet for such a transaction not the Money-Lenders Act ap-plies, but the Mortgage Decree 1975. S.22(1) of the Money-Lenders Act does not allow for transactions secured by a mortgage over immovable property. Under the Mortgage Decree, transforming a mortgage loan into a sale is explicitly prohibited.

Community-Based OrganisationsThere are other community-based organisations engaged in microfinance business, which are only registered at District Level. It must be pointed out that registration at the district level confers no corporate status. The registration at the district level is for administrative purposes. It is to be noted that these informal organisations are outside the scope of our study.

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4.3 Sector-Wide Problems in the IndustrySome of the current problems in tier four do affect all MFIs regardless of their institutional type. According to anecdotal evidence from our interviews, illegal deposit-taking from the public and the prohibited in-termediation of loan insurance funds (i.e. compulsory savings) are major problems in the sector. As there is currently no mechanism to follow-up on these activities, they are usually not avenged.

A typical case is the NGO under the beguiling name ‘Caring for Orphans, Widows and the Elderly’ (COWE) which last year promised customers access to USh 180,000 loans after having deposited USh 63,500 with the institution. When it came to paying out the loans, the NGO did not held its promise. Subsequently, it was deregistered by the NGO Board. Many similar cases were reported to the consultants. It is quite easy to mobilise savings unnoticed by masking them as compulsory savings. Furthermore, only experienced accountants would be able to prove that these savings have been intermediated.

In theory, BOU has the authority to investigate such cases and to close down institutions doing banking business without holding a license (cf. S.48 FIS 1993 and S.8 FIB 2002). Yet it does neither have the capacity nor the necessary physical proximity to know about such illegal activities and to initiate the adequate investigations. BOU sees its own role limited to the regulation and supervision of financial institutions such as banks and credit institutions (and MDIs in the future), as it is defined in S.5 (2) of the Bank of Uganda Statute 1993.

Closely related to this is the current trend of new MFIs mushrooming all over the country. There are some indications that the growth rate of the sector is huge. The danger is that this high growth can only be achieved by compromising on soundness and professionalism of new institutions.

Another sector-wide problem is that private law remedies and criminal sanctions do not provide adequate redress for the aggrieved party. Criminal sanctions only impose fines and imprisonment on the wrong-doer, which do not benefit the aggrieved party. The introduction of Commercial Courts has made the justice system faster and more efficient. But still there are many cases where the disputed amount is lower than the direct and indirect costs of using the justice system. In addition, many clients are not aware of the legal options available to them for redress in

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case of any grievances. To give an example: While it is not allowed to do money-lending business without being registered as a money-lender, reports of clients complaining about unregistered lenders are rare.

Finally, as has become clear from the last sub-chapter, the legal system for tier four MFIs is characterised by considerable overlap and fragmentation. Quite a number of institutions are registered under more than one law.20 Furthermore, MFIs doing basically the same business might be registered under different laws, i.e. there is no level playing field.

4.4 NetworksThere are three networks with relevance for tier four, the Uganda Co-operative Alliance (UCA) and the Uganda Co-operative Savings and Credit Union (UCSCU) in the co-operative sector and the Association of Microfinance Institutions of Uganda (AMFIU) for all tier four institu-tions.

The Association of Microfinance Institutions of UgandaAMFIU is a network of MFIs from all different tiers. Currently it has 78 MFIs as members. Among these there is one commercial bank, and one credit institution, both also being registered as companies limited by shares. Of the remaining 62 MFIs, of which we could establish the legal form, 39 are registered both as NGOs and companies limited by guarantee, 5 as companies only and 18 as SACCOs.

AMFIU’s main activities are lobbying and advocacy, information dis-semination, performance monitoring and capacity building for members. The capacity building support does not target single members, but is open for non-members and visitors from abroad.

Although the capacity of AMFIU has improved considerably since the recruitment of an Executive Director and an Accountant/Administrator in 2001 and a Database Manager and Front Desk Officer in 2002,

20 Yet it should be mentioned here that also banks, credit institutions and MDIs are both regulated under the FIS and MDI Act, respectively, and registered as companies.

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the Secretariat is still small compared to the diverse range of tasks it is trying to shoulder.21

Of particular interest for this study is the recently launched Performance Monitoring System. This system is planned to be rolled out in May to all AMFIU members and later on also to non-members on a voluntary basis. It will allow for standardised reporting to AMFIU and increase transpar-ency in the industry. MFIs will be categorised into category A to E and will then be able to compare their performance with that of their peers, i.e. those in the same category.

The Uganda Co-operative AllianceUCA is the umbrella organisation of all co-operatives. It currently has 300 ordinary members, of which around 80 are SACCOs. In former times, UCA only worked with tertiary (national co-operative unions) and sec-ondary (district unions) co-operatives. Under the new network structure, it can also deal directly with primary co-operatives.

UCA manages a number of projects with funding from different donors. One of these projects aims to improve accounting standards of co-op-eratives. Another specifically assists old SACCOs, which have failed, to become profitable institutions. Since 1998, UCA has started more than 60 new SACCOs.

Under the Co-operative Societies Statute, UCA is not charged with any supervisory tasks. The General Secretary of UCA favours the delegation of some supervisory responsibility from the Ministry to UCA. At the mo-ment, UCA monitors its members’ activities, but it does not have a strong enforcement mechanism. Good performance is rewarded by better access to promotional activities. UCA currently supports 60 SACCOs, some of them being old SACCOs that have failed and are now transformed into new, well-performing societies.

21 During the course of this year, a Programme Officer it to be recruited who will directly assist the Executive Director.

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Uganda Co-operative Savings and Credit UnionFinally, UCSCU is another umbrella body in the co-operative sector. Other than UCA, it has only SACCOs as members and, as a tertiary co-operative, it is member of UCA itself. UCSCU has a political (promotion of and advocacy for SACCOs), a financial (liquidity support to members) and a developmental role (technical assistance to members).

Currently UCA has about 300 SACCO members. After UCA has started working with primary co-operatives, the division of tasks between the two networks has not always been clear. While UCSCU is specialised on SACCOs, UCA has also a strong interest in this sub-sector as it has the highest growth potential. In addition, UCA has recently been much more successful in acquiring donor support. UCSCU sometimes feels left out if it comes to discussions about the reform of the co-operative sector, although it is also a member of the Task Force for the Revival of the Co-operative Movement.

In 1999, UCSCU (together with WOCCU) spearheaded the process of drafting a Savings and Credit Co-operative Societies Act. Yet at that time, such a separate Act for SACCOs was met by reservations from the Office of the Commissioner. Enacting a specialised Act for SACCOs would require the transfer of the responsibility from the current Office to a newly created specialised department for SACCOs, whereas the Commissioner of Co-operatives preferred to keep the responsibility for all co-operatives in one office.22 Thus this plan was ultimately abandoned.

The table below summarises some features of the four main pieces of legislation with relevance for tier four MFIs.

22 The SACCO Bill from 1999 does not specify, in which Ministry the new department would have been set up.

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Table C.1 Legal Frameworks for Tier 4 Institutions

Name of Parent Act

Co-operative Societies Statute, 1991 and Co-operative (Amendment) Bill, 2002

Non-Governmental Organisations Registration Statute, 1989

Companies Act, 1961

Money-Lenders Act, 1952

Secondary Legislation

None Non-Governmental Organisations Regulations, 1990

None The Money-Lenders (Licences and Certificates) Rules

Responsible Ministry

Ministry of Tourism, Trade and Industry

Ministry of Internal Affairs

Ministry of Justice

To our knowl-edge: Ministry of Finance, Planning and Economic Development

Licensing Authority

Registrar of Co- operatives / Com- missioner

NGO Board Registrar of Companies

Chief Magistrates

Associations / Networks

UCA and UCSCU NGO Forum; DENIVA (for indigenous NGOs

None None

MFIs falling under this legislation

SACCOs Microfinance NGOs

Microfinance NGOs and/or limited companies

Individual and corporate bodies doing money-lending business

Number of MFIs

around 680, of which maybe 300 are active

Hundreds At least as many as NGOs

Thousands

5 RecommendationsOn the basis of the analysis of existing literature on self-regulation and the current state of and legislation for tier four MFIs in Uganda, the consultants came up with recommendations in the following three areas: Firstly, for drawing the line between different regulatory tiers; secondly, for evaluating options for self-regulation of SACCOs and non-coop MFIs; and, thirdly, for specifying the role of AMFIU.

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5.1 Drawing Lines Between Regulatory TiersIt has become clear from the analysis that tier four is not a homogenous sector, but can be broken down into two sub-tiers. First, the SACCOs are a distinct institutional type, which – at least if they have 10,000 or more members from a wide community – are more similar to tier three institu-tions than to the non-coop MFIs. Second, all tier four institutions other than co-operatives form the second large group in the tier.

As for the upper boundary of tier four, drawing the line according to the question whether deposits are mobilised from the public or from members does not seem to sufficiently take into account the fact that the more members a co-operative has the weaker its internal control through members is. In addition, there is no clear distinction between closed, af-finity-based and open, community-based SACCOs in Uganda.

One option, which was also part of earlier drafts of BOU’s Policy Statement on Microfinance Regulation, would be to set a limit in terms of number of members above which SACCOs would have to come under central bank regulation. Such an approach would provide a disincentive for SACCOs to grow beyond this hurdle. Yet this disincentive could easily be offset by introducing certain advantages for all SACCOs under the purview of BOU.23 Another option would be to stipulate a cut-off amount for deposits mobilised without being subject to BOU supervision. Available data on SACCOs in Uganda is scarce. What seem to be clear is that none of the SACCOs currently has more than 10,000 members (most of them having less than 5,000 members), but that annual growth rates for numbers of members above 100 percent are quite common. Thus at least in the medium term, the upper boundary of tier four should be reconsidered.24

23 One option is to allow all SACCOs under central bank supervision to mobi-lise deposits from the public.

24 In Ecuador, all credit unions that have assets above USD 1m should be supervised by the Superintendency. These are currently around 350 co-operatives. In Paraguay, the threshold is much higher as only co-operatives having a deposit volume above USD 1.5m are under direct central bank regulation. Finally, Bolivia uses a limit of USD 207,000 in capital. In the case of Uganda, more detailed figures than those available to the consultants would be required to propose such a cut-off level.

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Another critical point is that currently no ceiling has been set for compul-sory savings, which are allowed even without a license as MDI.

MFIs in tier four might accumulate compulsory savings in a way that they ultimately outgrow the outstanding loan portfolio.25 To prevent this, one could limit the size of the loan insurance fund to a percentage of the outstanding loan portfolio. This could easily be stipulated in statutory regulations to be issued by the central bank.

With regard to the lower boundary, in our view only those MFIs should be included in tier four which are registered either as NGO or as company or both. It is a demanding task to set-up a non-prudential regulatory system even only for these. Even if it might be politically desirable to include small, community-based organisations in such a framework, it is practi-cally not feasible.

Individual money-lenders should definitely not be regarded as part of tier four. Our recommendation is to repeal the Money-Lenders Act 1952 (cf. Ch. 6.1.4).

5.2 Scope for Self-Regulation of Tier 4We share the view that pure self-regulation without any legal backing suffers from conflicts of interest and the lack of a credible enforcement mechanism. Yet we must also concede that neither SACCOs nor non-coop MFIs can be effectively supervised by government agencies without huge efforts to build their capacity to do this job. We therefore recommend the division of tasks between a government agency and a self-regulatory organisation (SRO), an approach that can bring down costs while not comprising on the effectiveness and thus the benefits of regulating tier four MFIs.

Self-Regulation of SACCOsWe have clearly established from our interviews that the current degree of external regulation of SACCOs is insufficient. We would like to make two recommendations, which can be considered separately.

25 This would contradict the net-borrower concept, which assumes that most clients are most of the time net-borrowers with the MFI, i.e. cannot lose any money when the MFI experiences financial problems.

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Recommendation 1: Move SACCOs from MTTI to MFPEDSACCOs should be treated differently from other, non-financial co-opera-tives. One way to do this is to bring them under the ministry, which is re-sponsible for the financial sector, that is the MFPED. This would require the enactment of a separate law for SACCOs as all other co-operatives remained under the MTTI. This might meet reservations from the current ministry, which is clearly in favour of keeping all co-operatives under its roof. UCA has also expressed some reservations as it sees the danger of the fragmentation of the movement. Furthermore, to move SACCOs to another ministry would require the consent of the President and setting-up a new department in MFPED responsible for SACCOs. This is therefore a far-reaching change of the current structure. Nevertheless, we think that SACCOs as financial institutions would be better placed under the MFPED. We also think that it is better to separate SACCOs from other co-operatives as financial services business is unique in so far as it requires a higher degree of external oversight.

When SACCOs remain under the MTTI, the legislation for co-operatives should still be amended in a way to cater specifically for SACCOs, either through the introduction of SACCO-specific requirements under the cur-rent Statute or through the enactment of a separate SACCO Act.

Recommendation 2: Delegate Supervisory Authority to UCA or UCSCUNotwithstanding the question whether SACCOs are moved to MFPED or not, it is in our view recommendable to delegate the supervisory authority for SACCOs to a self-regulatory organisation. The statutory powers, e.g. to deregister errant members, would stay with the responsible Ministry. The Ministry would also be authorised to do on-site inspections itself in case need arises.

Potential institutions that could take over the role as SRO are UCA and UCSCU. It goes beyond the scope of this study to compare the potential of these institutions to play a stronger role in the supervision of SACCOs. There are indications that UCA is the stronger network and has therefore more potential for this role. On the other hand, UCSCU has the advantage of being specialised on SACCOs and having more SACCO as members as UCA. In both cases, membership with the SRO would have to be

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mandatory. The creation of a separate supervisory department of the SRO would be highly recommendable.26

Self-Regulation of Non-Coop MFIsThe non-coop MFIs in tier four are not yet supervised by any single authority. Neither the NGO Board nor the Registrar of Companies has the capacity and the potential to effectively monitor the performance and the conduct of these MFIs. A self-regulatory organisation with a strong enforcement mechanism is probably the most cost-effective solution for this part of tier four. There are basically two options to create such an en-forcement mechanism. The first option is to use the legal power of BOU to follow-up on breaches of current legislation, namely the FIS and in the future also the MDI Act. BOU could suspend the microfinance operations of tier four MFIs.27 The SRO would be able to use its greater proximity to smaller MFIs for generating relevant information. It would be legally authorised to report misconduct to BOU. A clear disadvantage of this approach is that BOU can only follow up violations of current financial laws, of which none is specifically targeting tier four. Besides, BOU does not have sufficient capacity to follow-up on tier four MFIs nor the explicit mandate under the 1999 policy statements to look into this sector.

The second option is to authorise the SRO itself to suspend microfinance operations of non-coop MFIs. This option has the advantage that the rules of the SRO can be much more detailed and more specific to the kind of problems in the sector.

There is no need for prudential regulation of non-coop MFIs. The focus should lie on performance monitoring and conduct of business regula-tion. The latter can be achieved by introducing a Code of Practice.28 The compliance with this code should be easily verifiable and enforceable.

26 A longer-term plan could be to move this department out of UCA/UCSCU, i.e. to create an specialised SRO. Both UCA and UCSCU and the Commissioner could then be represented on the Board of this SRO.

27 As long as these MFIs are still registered as NGO or company, it would not be possible for BOU to completely close down all their operations.

28 Cf. McAllister (2003).

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The main elements of this self-regulatory system could be the following:

(a) A standardised financial reporting system along the lines of AMFIUs Performance Monitoring System;

(b) Minimum fit and proper criteria for directors/CEOs of MFIs;29

(c) Mandatory follow-up of complaints by clients or MFIs through the SRO;

(d) On-site inspections either by the SRO staff or by authorised third party (e.g. accounting professionals) at the discretion of the SRO without the need to give notice before;

(e) Introduction of a “cooling-off period” of some days during which a loan contract can be reversed and all moneys will be paid back.30

To be effective, membership with such an SRO must be mandatory. We understand that a voluntary system relying on the signalling effect of a ‘stamp of approval’ would not be understood by many of the frequently illiterate customers of tier four MFIs.

Each member of this self-regulatory framework would have to sign a contract with the SRO which clearly spells out the SRO’s power to sanction misconduct. To ensure sufficient accountability of a mandatory self-regulatory framework, government must be involved in defining the rules and code of practice of the SRO.

MFPED or, as the regulator of the entire financial sector in Uganda, BOU would have to approve the SRO’s rules. Furthermore, government could be represented on the Board of the SRO, which in turn is responsible for disciplinary actions against MFIs.31

29 They could be asked to sign a self-declaration as criminal and civic clear-ance.

30 This list has borrowed heavily on the South African case of the Microfinance Regulatory Council.

31 The composition of the SRO’s Board is a delicate issue, as one would have to balance different objectives such as accountability, effectiveness, and independence. Wide participation of different stakeholder groups would be preferable. Too much government involvement has not proven to be recom-mendable as one could observe in the case of the NGO Board.

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An important decision will be the funding of such an SRO. As self-regula-tion can be seen as aservice of an umbrella body for its members, it is usually financed by membership fees. Yet if the membership becomes mandatory and the SRO takes on statutory tasks, which have been del-egated by the government, at least a partial funding through the govern-ment seems reasonable. Besides, the supervision of financial institutions in tier one to three is fully financed by the central bank, so that some government support in tier four can also be expected.32

How could be ensured that all MFIs apply for registration with the SRO? Obviously, it would be difficult to charge the SRO alone with this task. We recommend three strategies in this regard. Firstly, all donor agencies should agree to assist only those MFIs, which are registered with the SRO.

Secondly, a complaint office should be set up, where people could report about MFIs doing business without being registered. The same complaint mechanism could be used for reporting tier four MFIs (be they registered or not), which do take illegal deposits. Presumably, there is a strong incentive for competitors in tier three to report about these activities. In addition, the licensing agencies, i.e. the NGO Board and the Registrar of Companies, should report regularly about deposit-taking activities of NGOs or companies.

Thirdly, doing microfinance business without being registered with the SRO must have clear legal consequences. It could, for example, deprive lenders of their rights to seize a security.

32 Such a self-regulatory framework would fall in the category of “alternatives to state regulation” according to the UK Better Regulation Task Force: “Self-regulatory schemes that have developed as genuine alternatives to state regulation, such as codes of practice initiated or encouraged by government, work effectively if they harness the commercial interests of the industry. For example, a scheme that helps to raise standards in the industry or to improve its image could encourage more business. To ensure that these schemes oper-ate effectively, government needs to monitor their operation and to retain a credible mechanism for intervening if problems arise. Government and con-sumers benefit from the operation of these schemes through lower costs and, arguably, better enforcement. Industry benefits from its involvement in the rule-making process and the flexibility to adapt to changing circumstances that such schemes offer.” Better Regulation Task Force (1999:5)

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5.3 Role of AMFIUEstablishing a new SRO for non-coop MFIs from scratch is an expensive and time consuming undertaking. The question arises whether AMFIU as an existing, well established umbrella institution could take over this role. During our interviews, this idea evoked both reservations and support. The main reservations expressed were the following:

(a) AMFIU is a voluntary membership organisation. Mandatory mem-bership would change its character;

(b) AMFIU does not have sufficient capacity to take over the role as SRO for non-coop tier four;

(c) Membership of AMFIU is still very limited. Only 39 of the 62 ordi-nary members, of whom AMFIU has information about their legal status, belong to this segment of tier four. Furthermore, SACCO-members of AMFIU might get marginalised as they would not fall under this self-regulatory system;

(d) The tasks of promoting the industry and at the same time policing non-compliant members can lead to conflicts of interest.

These points have to be taken seriously. Yet we are convinced that these reservations can be counteracted and that they do not outweigh the advantage of making use of an already existing and well-established institution.

Including non-practitioners such as BOU on the Board of AMFIU can alleviate potential conflicts of interests. In addition, AMFIU should es-tablish a separate supervisory department to organisationally separate its different tasks. Support to members should be granted in a non-discrimi-natory manner. If AMFIU would promote individual member institutions, it would take over some responsibility for their well-being, which makes it difficult to sanction these members.

Finally, looking at Baldwin’s five criteria for the assessment of regulatory frameworks (cf. Ch. 3.2), charging AMFIU with the self-regulation of non-coop MFIs seems clearly preferable to direct government regula-tion:

(a) Expertise: AMFIU’s Board represents experts from the industry. It’s Secretariat has gathered considerable expertise about tier four institu-tions.

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(b) Efficiency: Self-regulatory frameworks in general have a number of advantages, which render them more efficient than government regulation. AMFIU has much lower costs to generate the necessary information about the tier four sector. It enjoys trust and good reputa-tion in the industry, which makes it easier to resolve disputes. Finally, a complaints mechanism will be much more cost-effective than dispute resolution via the legal system.

(c) Mandates: This is the question whether regulation serves legitimate ends. It can be achieved by clearly spelling out the objectives of such a self-regulatory framework in the beginning. All regulatory initiatives of AMFIU would then be measured against these previ-ously agreed upon objectives.

(d) Accountability: Rules and the Code of Practice of AMFIU would be approved by a government agency with a good knowledge of the sector, such as the central bank.

(e) Fairness of procedures: A consultative process for setting-up the self-regulatory system, which includes all stakeholder groups which will be affected by it and the government, can ensure fairness of procedures.

6 The Way ForwardAs mentioned earlier, the Ugandan Parliament has resolved that Cabinet should come up with a proposal to regulate tier four institutions by May 2003. Thus there is some time pressure to come up with concrete propos-als for the next steps. In this final chapter, we would like to clearly spell out the next steps in the fields of legal amendments, capacity building, consumer education, and, finally, further research which is still needed to be done.

6.1 Laws to Be AmendedIn the following, we have summarised the main legal amendments, which would be required to put our recommendations into practice.

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Non Governmental Organisations Statute 1989It should be pointed out that the Non-Governmental Registration (Amendment) Bill 2000 has been tabled before Parliament. The object of the amendment is to provide, inter alia, for the modification of the functions of the NGO Board and to remove dual registration. It should be therefore quite easy to include some microfinance-specific requirements in the current Bill.33

First, the NGO Statute should be amended so that registration under the board confers corporate status to the organisation. Such an amendment would remove the need for dual registration so that there is no require-ment to register under the Companies Act or Trustees Incorporation Act.

Second, there should be an amendment of the Statute requiring NGOs engaged in ‘microcredit business’ to register with a Self-Regulatory Organisation formed for that purpose. ‘Microcredit business’ is different from the definition of ‘microfinance business’ under the MDI Bill as it does not allow for deposit taking. It could be defined as “the provi-sion of short term loans to small or micro enterprises and low-income households, usually characterised by the use of collateral substitutes, such as group guarantees or compulsory savings”. The maximum amount of compulsory savings (e.g. as a percentage of the outstanding loan amount) should also be specified.

Furthermore, a government agency (e.g. BOU) should be authorised to issue regulations specifying minimum requirements for the SRO.

Companies ActIt is to be noted that the Companies Act is under review by the Commercial Justice Reform Programme. A number of areas have been proposed for amendment. This, again, provides a good opportunity to include some microfinance-specific requirements.

In our view, the areas proposed for amendment affect the management of companies generally, but not the specific needs of tier four MFIs

33 For a critical view on this NGO Amendment Bill, check DENIVA’s webpage: www.deniva.or.ug/deniva_meet.htm

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registered as companies. The registrar of companies cannot and should not play the main role in monitoring tier four MFIs.

Even if the NGO Statute is amended in a way that no double registration under the Companies Act will be required, some MFIs may still choose to be registered as companies only. It is therefore necessary to amend this Act in the same way as the NGO Statute, i.e. to include a requirement that companies engaged in ‘microcredit business’ must be registered with a Self-Regulatory Organisation, and to authorise BOU to make regulations under this Act.

Co-operative Societies Statute 1991As mentioned above, the Co-operative Societies Statute 1991 is to be amended. Currently the Co-operatives (Amendment) Bill 2002 has been tabled before Cabinet for discussion. The process is ongoing, which gives us the opportunity to suggest some additional amendments for SACCOs.

It is proposed that the Co-operative Societies Act be amended to provide specifically for SACCOS, i.e. for co-operatives engaged in microfinance business. We understand that the Amendment Act includes a separate section for SACCOs only. We also understand that this section does not yet satisfy the requests of the main stakeholder groups. More consultation would be required.

A separate Savings and Credit Co-operative Societies Act would be clearly preferable, particularly if SACCOs were moved to MFPED. The draft Act from 1999 would be a good starting point for discussion. A comparison with the Model Law for Credit Unions from WOCCU could help to show areas, which have not yet been sufficiently covered.

It is also proposed that either UCA or UCSCU is given a role in monitor-ing the performance of SACCOS on behalf of the Registrar of Co-opera-tives, even though statutory powers would stay with the Ministry. In order to perform its functions, UCA/UCSCU must be authorised to supervise SACCOs and report to the responsible ministry (be it MTTI or MFPED). The ministry, in turn, should be legally bound to act if problems arise. It might be useful to look at the system of prompt corrective actions under the MDI Bill.

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Finally, we recommend considering at least in the medium term to bring larger SACCOs under the purview of BOU. Such an approach would not require the introduction of a new law, but only the authorisation of BOU to issue specific regulations for SACCOs, which are beyond a still to be specified cut-off level (in terms of numbers of members or volume of deposits). Similar to the co-operatives with a limited banking transac-tion license in Nepal, these larger SACCOs would then still be subject to the regulations under the Co-operatives Societies Act, but in addition come under direct central bank supervision. The regulations would be quite similar to those under the MDI Bill, only that they take the specific governance structure of co-operatives into account.

Money-Lenders Act 1952The Money-Lenders Act of 1952 is outdated. The Magistrates lack the capacity to monitor and supervise this sector. There are numerous money-lenders in the market and regulating them would be an impossible task. The Act itself lacks any complaint and enforcement mechanism. The general law of contract is sufficient to govern the relationship between the money-lender and the borrower since this is a freely entered agreement.

Thus it is proposed that the Money-Lenders Act is repealed. Money-lend-ers will always be around. The best way to protect costumers is to enable them to make an informed choice between a number of institutions offer-ing microfinance services. A self-regulatory system for tier four is trying to achieve this. In addition, consumers must be educated about their rights and options (cf. Ch. 6.2).

Furthermore, the Money-Lenders Act is not needed as a legal basis for preventing the transformation of lending contracts into sales contracts as such a transaction is prohibited under the Mortgage Decree 1975.

6.2 Consumer Education and ProtectionConsumer education will be essential to make whatever regulatory sys-tem is chosen effective. Clients of tier four institutions must know about their rights. They must understand the difference between well and poor performing MFIs. They must be empowered to make an informed choice.

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To give an example: The best mechanism to bring interest rates down is to improve transparency and educate clients. Only then MFIs have an incentive to undercut the rates offered by their competitors.

The following steps can be taken:

(a) More choice and more transparency in the market will be the single most important way to protect consumers from exploitation. Setting-up a self-regulatory system for tier four institutions leads in this direction.

(b) AMFIU is best positioned to educate consumers about their legal rights and potential pitfalls of lending from informal sources. For example, instead of the current prohibition to offer a sales contract instead of a lending contract under the Money-Lenders Act, which cannot be effectively enforced and potentially creates huge costs for the aggrieved lender ex post, consumers should know about the implications of signing such a contract ex ante. Different media such as radio, newspapers, TV, flyers, and workshops could be used to reach as many borrowers as possible.

(c) To improve information dissemination in rural areas, the planned Financial Extension Workers (FEWs) under the “Strategic Plan for Expanding the Outreach and Capacity of Sustainable Microfinance in Uganda” could play a potential role in educating consumers.

(d) Currently, the Consumer Protection Bill 1999 is pending before Parliament for debate. It is important that Parliament recognises the need to protect consumers of microfinance services. Provisions to this effect could be incorporated in the proposed law. With regard to consumer protection in lending, the analysis of experiences in other countries such as the Truth in Lending Act in the US might be of interest.34 Yet one should not expect too much of this as, one again, enforcement will be the main bottleneck.

(e) A complaint mechanism can play a major role as a cost-effective alternative to enforcing a case in a court. As mentioned earlier, the

34 The full text of the Act can be accessed here: http://tinyurl.com/af7l

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SRO should set-up such a complaint mechanism. In addition, an independent appeals committee can serve as an effective dispute settlement instrument.35

6.3 Capacity BuildingExcept for the repeal of the Money-Lenders Act, all these recommenda-tions require some capacity building. While regulating tier four, the relation between costs and benefits should always be born in mind. The more regulation you want, the higher the supervisory and compliance costs for the sector. Capacity building should focus on the following two institutions:

(a) AMFIU: Charging AMFIU with the task of supervising non-coop MFIs, educating consumers about their rights and setting-up a complaint mechanism will require more staff and better funding of this institution.

This task has the character of a public good and should at least partly be funded from third sources.

(b) UCA/UCSCU: The same is true for UCA or UCSCU, if one of these networks will be responsible for the supervision of SACCOs.

The Bank of Uganda and the Ministry of Tourism, Trade and Industry will only play a minor role in the supervision of tier four institutions. They will retain the power to close down MFIs or at least suspend microfinance operations of non-complying institutions.

6.4 Fields for Further InvestigationsThe scope of this study was limited. As mentioned earlier, the consultants were not able to collect primary data on the sector or to do an in-depth analysis of problems in the sector. Even under the current time pressure, it would be recommendable to collect more information about institutions and problems in tier four.

This is particularly true for the money-lenders. There are numerous money lenders in the market. Most of them are not registered. It is impossible to make a serious analysis of this sector without proper investigations.

35 Cf. the Disciplinary & Appeals Committee of the MFRC

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It is proposed that a serious study of this sector is undertaken to assess its impact on the economy and the most critical issues.

On the institutional side, the potential of UCA, UCSCU and AMFIU to play a stronger role in supervising tier four institutions should be assessed. None of these institutions should be charged with any additional tasks without having been subjected to an analysis of strengths and weaknesses and the preparation of financial projections.

AMFIU, in particular, should be scrutinised with regard to its potential role as Self-Regulatory Organisation. In our opinion, AMFIU is a good starting point for developing a self-regulatory system for non-coop MFIs. Yet it has to prove that it can fulfil this role in an effective and efficient way. There is always the option of sourcing the supervisory tasks out at a later point in time.

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Microfinance Regulation

Annex D Microfinance Regulation: Lessons from Benin, Ghana and Tanzania

World Bank Africa Region1

Table of Contents1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148

2 Tiers of Microfinance Institutions and Regulation . . . . . . . . . 150

3 Country Experiences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151

4 Key Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153

5 Lessons Learned. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155

1 IntroductionThis article identifies key issues and lessons about how the overall regula-tory framework affects the ability of microfinance institutions (MFIs) to become more market-oriented and integrated with the financial system. It is based on a review undertaken by the World Bank of microfinance regulation in Benin, Ghana and Tanzania to better inform its advice and project design regarding the appropriate balance between the objectives of promotion, performance, and prudential supervision.

African countries increasingly promote microfinance as part of their strategies to reduce poverty. Donors are demanding higher performance in terms of financial sustainability and outreach of the microfinance

1 Originally published as Findings No. 243, Washington, D.C.: World Bank, 2004. This article is based on “Comparative Review of Microfinance Regulatory Framework Issues in Benin, Ghana, and Tanzania” by Joselito Gallardo, Korotoumou Ouattara, Bikki Randhawa, and William F. Steel (World Bank Africa Region Financial Sector Group and Financial Sector Operations and Policy Department, Africa Region Working Paper, 2005). It can be downloaded from: www.worldbank.org/afr/findings.

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Table D.1 Regulatory Structure and Triggers, by Type of MFI.

Type of MFI Activities that trigger regulation

Forms of external regulation

Recommended regulatory authority

Informal savings and credit groups funded by member fees and savings

None None required None required

Category A: Nongovernmental organisations (NGOs) funded by donor funds

Category A1: Donor funds only

None, if total loans do not exceed do-nated funds, grants and accumulated surplus

Registration as a nonprofit society, association or trust

A registrar of societies, self-regulatory body if any

Category A2: Also borrowing com-mercially or issuing securities

Generating liabilities through borrowings to fund microloan portfolio and opera-tions

Registration as a corporate legal entity, authorisa-tion by a banking authority or securi-ties commission

A registrar of companies, banking authority, securities agency

Category B: Financial co-operatives and credit unions funded by members’ money and savings

Accepting deposits from and making loans to members

Registration as a financial co-opera-tive

A registrar of co-operatives or banking authority

Category C: Special-licensed banks and MFIs funded by the public’s money (deposits, investor’s capital, commercial borrowings)

Accepting wholesale and retail public deposits for inter-mediation into loans and investments

Registration as a corporate legal entity, licensing as a finance company or bank (with full prudential require-ments)

A registrar of companies, bank-ing authority

Note: This regulatory classification of MFIs was originally proposed in Hennie Van Greuning, Hennie, Joselito Gallardo, and Bikki Randhawa, “A Framework for Regulating Microfinance Institutions,” Policy Research Working Paper no. 2061, World Bank, Washington, D.C. (1999).

institutions (MFIs), to better leverage their support. As MFIs grow and begin mobilising substantial savings, legal and regulatory frameworks are demanding greater prudential regulation by central banks – which often lack the staff and a clear understanding of microfinance methodologies.

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In the underdeveloped financial markets typical of African countries, legislation intended to promote MFIs may impose untenable supervisory burdens, while an excessively restrictive approach may constrict innova-tion and expansion. Microfinance regulation works best when it applies different approaches appropriately to different tiers of the financial system and when capacity limitations of both MFIs and supervisory authorities are also addressed.

2 Tiers of Microfinance Institutions and Regulation

Regulations may be applied in “tiers” by defining different categories for which different degrees of regulation and supervision may (or may not) be warranted. In principle, tiers should be defined as a function of the responsibility of the authorities to safeguard the public’s deposits and the safety of the financial system. “Microfinance” refers to small financial transactions with low-income households and microenterprises (both ur-ban and rural), using non-standard methodologies such as character-based lending, group guarantees, and short-term repeat loans. Such methodolo-gies can be applied in a wide range of financial (and even non-financial) institutions, which can be grouped under three main regulatory tiers according to whether they: (A) are conduits for other people’s money; (B) serve to mobilise and lend out members’ own money; or (C) utilise funds mobilised from the general public (Table 1).2

Regulation of MFIs (or microfinance products) may take three main forms: simple registration; (non-prudential) regulation that provides some standards (e.g., audits or interest rate information to protect the interests of members or consumers) and oversight, and may include criteria for membership in an association; and prudential supervision, which in-volves authority to sanction institutions that fail to comply with specified requirements (e.g., minimum liquidity and adequacy of capital, portfolio quality). Prudential supervision of category C institutions most clearly has a role to play in protecting public savings that are being mobilised and lent out (“intermediated”), which puts them at risk of being lost if loans are not repaid. But in some countries, microfinance legislation has extended the authority of supervisory authorities beyond what it can – or needs to – manage.

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2 Entities that are normally beyond the scope of regulation include semi-formal groups registered for non-financial purposes that mobilise their own funds and establish rules for their use, as well as informal rotating or accumulating savings and credit associations and individual agents such as moneylenders and savings collectors.

While member-based MFIs in category B are assumed to be self-regulat-ing through their governance structure, this principle may break down in practice as they become larger. Non-prudential regulation may be appropriate to improve information and governance, for example a re-quirement to provide audited financial statements. While small groups are beyond the reach and necessity of regulation, for more formal (registered) Savings and Credit Co-operatives (SACCOs) and credit unions a transi-tion to external supervision may be appropriate at some stage of growth – which is hard to define in general, but should be related to the size at which their assets approximate those of licensed financial intermediaries or pose risks that could destabilise the financial system.

Although there is little public benefit in external supervision of NGOs (category A) or informal moneylenders that don’t utilise public funds, some monitoring may be needed to forestall fraudulent abuses such as pyramid schemes when registered non-financial organisations can legally engage in financial operations. In some countries, such as South Africa, non-prudential regulation such as interest rate disclosure is applied for consumer protection by an independent regulatory agency. Some degree of reporting consistent with central bank requirements may be suitable for NGOs that have organised as companies limited by shares, as part of a transition to licensed status.

3 Country ExperiencesGood microfinance legislation, regulation and supervision involves adapting basic principles to the conditions prevailing in a given country in terms of the varieties of institutions engaging in microfinance, the thresholds already established in the financial system, and the capacity of the regulatory and supervisory authorities. Although they represent comparable levels of economic development, low but growing income per capita, and shallow financial sectors, Benin, Ghana and Tanzania vary in the nature of their MFIs and in their experiences with microfinance regulation.

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BeninDespite its relatively small size, Benin has a diverse array of MFIs and the largest number in the West Africa Monetary Union (WAMU), which controls banking and finance in eight member states through a unified central bank. These consist of licensed credit unions or mutuelles (the only officially-recognised licensing format), registered credit-only MFIs, several donor projects with microcredit components, and a variety of in-formal groups and associations. The microfinance sector has an estimated outreach of 700,000 clients, with some US$ 33 million in loans outstand-ing and US$ 40 million in savings deposits.

WAMU’s law for microfinance was intended both to promote and to bring order into the sector. The law defined SACCOs (or mutuelles) as the only officially sanctioned format, but allowed NGOs, donor projects and informal organisations to engage in microfinance if registered with the Ministry of Finance, which was tasked with supervising the entire sector.

GhanaGhana’s formal and semiformal MFIs reach some 1.5 million clients, members and depositors, of which less than a third have loans. They include 115 licensed rural and community banks (RCBs) with over a million depositors and 150,000 borrowers; 9 licensed savings and loan companies (S&Ls) with more than 160,000 depositors and 10,000 borrowers; and 253 credit unions with over 120,000 members. Some 60,000 borrowing clients are served by 50 microcredit non-government organisations (NGOs), but most of these entities, as well as even smaller community-based organisations, have fewer than 1,000 clients each.

Ghana’s multi-tiered regulatory structure evolved through early efforts in the 1970s to extend the outreach of the formal financial system and service the cocoa sector by permitting locally-owned unit Rural Banks and through the 1993 Non-Bank Financial Institutions Act, which was intended to diversify the financial sector. Credit unions were included in the latter, but central bank supervision proved unworkable, and a new Credit Union law was prepared that envisages dual responsibility of the central bank and the Department of Co-operatives, which registers credit unions.

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TanzaniaThree categories of registered financial institutions provide financial serv-ices to Tanzanian households, micro and small enterprises: (i) licensed commercial, regional and rural banks, (ii) SACCOs, and (iii) NGO-based MFIs. In contrast to Benin and Ghana, the Tanzania Postal Savings bank and several commercial banks are the leading providers of microfinance services, with outreach that exceeds the combined outreach of SACCOs and MFIs. The 650 active urban and rural SACCOs have an estimated membership base between 130,000 to 160,000, only a fifth of them bor-rowers. The 60 NGO MFIs are dominated by two large NGOs that have three-quarters of the market, estimated at 100,000 client-members.

Establishment of a National Microfinance Bank to retain the rural branch network of the privatised National Bank of Commerce helped motivate Tanzania’s establishment of an explicitly multi-tiered regulatory frame-work, both to facilitate engagement of formal financial institutions in microfinance and to ease the graduation of unregulated microfinance in-stitutions to formal status. The regulatory requirements are still emerging, and so far there has been little entry or conversion to licensed categories such as regional and rural community banks.

4 Key IssuesCommercial microfinance on a well-organised, national scale is a rela-tively new development in the three case study countries. Formally estab-lished and regulated microfinance providers are still relatively few, and a significant portion of microcredit services are provided by the numerous informal and semi-formal entities which are mostly not regulated and often not registered. The case studies raised a number of issues pertinent to microfinance promotion and regulation.

Can regulation promote growth of microfinance? Incorporating micro-finance into the formal financial system offers an attractive alternative to using microcredit as an instrument for socially-motivated poverty alleviation projects in that it emphasis the financial sustainability neces-sary to continue serving the poor over time without subsidy dependence. However, regulatory frameworks designed for objectives other than regulating the taking of deposits from the public and intermediating them into loans often result in standards that are disproportionately restrictive and unmanageable. On the other hand, vigorous microfinance industries

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have developed without conducive regulatory environments in countries such as Uganda and Kenya – where specialised legislation has become necessary to enable growing MFIs to mobilise deposits.

New legislation has not proven very effective in establishing well-regulated microfinance systems when MFIs brought under new regula-tory regimes are unable to comply and when supervisory authorities lack adequate capacity. Benin’s Ministry of Finance was unable to cope effectively with the large number of MFIs it was supposed to regulate under its microfinance law, and the central bank now plans to take over supervision of the largest MFIs. While new laws and regulations in Ghana encouraged entry of rural unit banks and savings and loan companies to serve rural areas and microenterprises, the excessive regulatory burden on the central bank led to creation of an Apex Bank to help service the rural banks, and to raising the minimum capital requirement for savings and loans to restrict entry.

Capacity to supervise and be supervised: The benefits from regulating microfinance may be limited when commercial banking standards are applied to MFIs without adequate consideration of microfinance method-ologies. For supervision to be effective, the data requirements and the in-dicators used must be relevant to the operations of MFIs, and they in turn must adapt their systems to central bank reporting requirements. A further issue that has received scant attention is measuring and paying for the costs of supervision. The costs of supervising MFIs may well be greater than for commercial banks, but their much smaller asset base makes it more difficult for them to bear the costs. Donors have generally supported central banks in developing regulatory guidelines and standards for MFIs, as in Ghana and Tanzania. However, more resources will be needed to address deficiencies in technical capacity – not only for the supervisory agencies, but especially for the MFIs subject to regulation.

Who should regulate? An important issue is the extent to which regulatory authority should be centralised, delegated, or decentralised. Like many other countries in Africa, regulatory responsibilities in Benin, Ghana and Tanzania have been fragmented among a central bank responsible for prudential supervision of licensed financial institutions, a co-operatives authority responsible for member-based SACCOs, and other government agencies that register NGO MFIs. In deciding how to implement regula-tory responsibilities, two distinctions are important: regulatory policy

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should have a single locus, while application of regulatory functions can be delegated to different regulatory units with specialised responsibilities; and the criteria and authorities for prudential supervision should differ from those for non-prudential regulatory oversight, along the lines indi-cated in Table 1.

Co-operative financial institutions: Financial co-operatives offer important potential for decentralising financial services, but integrat-ing them into formal financial regulatory systems has proven difficult. While Benin’s microfinance law prioritises financial co-operatives, the supervisory burden has proven overwhelming. Financial policy-makers in Ghana and Tanzania have recognised the need to incorporate financial co-operatives into the regulatory framework, and Ghana’s proposed ap-proach of recognising dual responsibilities of central bank and co-opera-tives authorities for credit unions bears watching.

5 Lessons LearnedThe experience in the three countries does not support the proposition that establishing new regulatory categories will necessarily promote com-mercialisation of microfinance or the creation of financially sustainable MFIs where few or none exist. The capacities of authorities to implement their regulatory obligations and of MFIs to comply are a critical constraint on the effectiveness of new legislation in promoting and regulating micro-finance. Key lessons include:

(a) MFI legislation has limited use as a promotional tool, and excessive coverage risks giving legal authority to weak institutions that cannot be adequately supervised; licensing criteria should balance ease of entry for financially sustainable MFIs against the capacity of supervi-sory authorities to provide effective prudential supervision;

(b) Licensing and supervision of MFIs works best when it is narrowly targeted on enabling commercially-oriented MFIs to take deposits and attract investors in order to fund their growth;

(c) Legal and regulatory requirements should distinguish between when prudential supervision is warranted and when non-prudential regula-tion is sufficient, with different criteria and regulatory authorities; in particular, regulations should distinguish between deposit-taking MFIs, whose financial soundness needs to be verified through pru-

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dential supervision, and MFI categories that may simply be registered and subjected to non-prudential regulations and standards, but do not pose financial system risks for which the financial authorities should bear responsibility;

(d) While the self-governance mechanisms of financial co-operatives may be sufficient at relatively small sizes, external prudential supervision is warranted as they reach the financial size of licensed financial intermediaries,

(e) Regulatory policy should have a single locus, while application of regulatory functions can be delegated to different regulatory units with specialised responsibilities;

(f) Capacity-building of supervisory authorities and development of ap-propriate regulatory requirements in parallel with application of new legislation is essential;

(g) Development of the regulatory framework should be accompanied by complementary development of other business laws and regula-tions, especially taxation, contract enforcement, collateral, securities regulation, and consumer protection.