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Microcredit world record

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“Prime example of pro-poor growth”

Mitigating risks in Uganda

Never too little


01/2006 		 

Mitigating risks in Uganda

So far, international development debate has focused on microcredit and tended to neglect other financial services. This trend stems from the belief that credit is the service the poor need most. However, savings and insurance schemes are the instruments that people use to mitigate risks – and poverty always results from unmitigated risks beyond victims’ control.


[ By Charles Kilibo and Oliver Schmidt ]

Uganda’s microfinance sector is very heterogeneous. It exhibits a duality characterised by formal as well as informal actors, regulated as well as unregulated institutions. Thanks to concerted efforts by government, civil society organisations and the private sector, Uganda has become a model case of microfinance promotion in sub-Saharan Africa. In itself, however, that does not mean that all is well. Indeed, Uganda’s microfinance sector is still better designed to provide microcredit than to help poor people to save.


The relevance of savings

It is often assumed, that MFI clients are primarily interested in credit. This belief is mistaken, as elaborated on in a recent study done by USAID-Project Rural SPEED in Uganda (Pelrine 2005). We need to take into account the following factors:
– Poor people are interested in saving money. The
most important motivation is to provide for medical emergencies and other unforeseeable future problems. However, saving for school fees is also highly relevant.
– Particularly rural savers rate accessibility to savings institutions and the security such institutions provide very high. On the other hand, interest rates on savings were not of great concern.
– In Uganda, many formal savings programmes charge service fees – which, of course, is a major disincentive, particularly for poor people.

In 2003, the outreach of Ugandan microfinance institutions (MFIs) excluding formal banks was estimated at just over 600,000 clients in a population of roughly 24 million. The outstanding loan portfolio was one of Uganda Shilling (Ush) 87 billion (roughly ¤41 million). Mobilised savings, however, stood at over Ush130 billion.
A typical MFI in Uganda offers limited financial products beyond basic credits. An exception are Savings and Credit Cooperatives (SACCOs) that are allowed to mobilise savings from their registered members and use these funds for loans to other members. Of course, regular banks and credit institutions offer a wider range of services, but they usually do not reach the poor, particularly not in rural areas.

While the major institutions are regulated and supervised by the Bank of Uganda, the central bank, there are also many other small institutions for which these rules do not apply. The financial sector in Uganda has four tiers (see table). Commercial banks (“Tier 1”) and credit institutions (“Tier 2”) are licensed and regulated by the Bank of Uganda under the Financial Institution Act 2004 (FIA 2004). In 2003, the Microfinance Deposit-taking Institutions (MDI) Act created a tier for MDIs that are also under Bank of Uganda’s purview and supervision. These “Tier 3” institutions, and all other MFIs that are not regulated by Bank of Uganda (“Tier 4”) form the microfinance sub-sector.

Among other things, the MDI-Act allows qualifying MFIs to collect and intermediate deposits from the general public. So far, four MDIs have been licensed. They account for the lions’ share of Uganda’s Microfinance Portfolio. The four MDIs licensed so far have as many branch outlets as the next 70 MFIs (NGOs and SACCOs), but reach far more clients than do the latter. Legislation suits MDI operations quite well.

That, however, is not the case for most other MFIs. Collection of savings from the public is a regulated undertaking under the supervision of the central bank. Unlicensed operators may not legally mobilise and intermediate deposits. In legal terms, they are not considered safe and sound enough to provide custody for depositors’ funds. Regulation thus strictly reduces the scope of “Tier 4” MFIs. It is, to a large extent, based on unrealistic assumptions. Indeed, MFIs often provide the only available access to basic financial services for many clients. Many MFIs register as SACCOs, since doing so, at least, allows them to mobilise savings from members and then to lend to other members. While this method does grant them access to relatively inexpensive funds, the situation is still not entirely satisfying. For instance, activities are still strictly limited to members.

Unlike other financial institutions, SACCOs do not fall under the jurisdiction of the central bank but rather under that of the Ministry of Trade, Tourism and Industry. The assumption is that SACCOs are cooperatives like any other. In truth, however, they trade in money. It would probably be preferable to have pragmatic and operational regulations enforced by the central bank which is more competent to handle financial businesses.

Moreover, the law has not stopped non-SACCO MFIs from mobilising microdeposits. Many MFIs have accumulated considerable cash collaterals. These are compulsory savings, without which clients do not qualify for credit. As such deposits are defined as a security against a loan, MFIs are not legally permitted to use them for on-lending purposes. Nonetheless, many MFIs do so, since this practice is convenient and costs much less than re-financing loans through commercial sources.

It would make sense for the law to adequately regulate such an – overall reasonable – practice. MFIs in rural Uganda may not score the highest marks in safety. They do, however, provide the convenience of location in communities mostly ignored by mainstream financial institutions. Accordingly, microdepositors continue to entrust MFIs with handling their hard-earned money. Furthermore, there are still significant numbers of unbanked savers. 80% of rural Ugandans save in cash or in kind, and 41% of rural Ugandans do not belong to any organised savings institution.


Microinsurance

For poor people, insurance products might well be more important than any other financial service as they, very obviously, have become victims of risks beyond their control. However, insurance providers face serious challenges.

For instance, consumers are often unaware of the options. They are unwilling to invest in products they do not fully understand, the agents and companies of which they do not know and the systemic context of which they have no initial reason to trust. This demand-side challenge has not been systematically addressed yet in Uganda. The Association of Microfinance Institutions of Uganda (AMFIU) has been disseminating some information. Two insurance companies are AMFIU members, AIG Uganda and MicroCare (the following examples draw mostly on the latter). The most important microinsurance products in Uganda cover health risks. For the insurance companies involved, one obstacle is clearly identifying their customers. They need to make sure they know exactly who is entitled to treatment. Uganda does not have a central identity register.

One solution is to hand out chip-cards to all customers. These cards do not only carry relevant information on treatments received or premiums paid but also a photo of the customer – and of other relatives covered by the insurance contract. These cards have become very popular because most customers, for the first time in their life, own a real identity card, which also serves as a photo-album of close relatives.

For the insurance company, this card combines sales data – making the product tangible – and cost control, as relevant information is easily accessible. The insurer has contracts with various hospitals that treat card-holders and entitled relatives. The advantages for the customers are manifold:

– They are treated when they need it, rather than when they can afford it.
– They are treated by experts whose qualifications have been evaluated by the insurance company.
– They are exposed to prevention measures. For instance, insurers have distributed mosquito nets, because they wanted to reduce their spending on malaria.
– Insurers negotiate more favourable rates than customers can on their own.

Payment modes can – and should – take into account the situation in which poor people live. For instance, insurance agents may accept payments in kind or in certain seasons (according to harvest times et cetera). A reliable base to make such systems work is solidarity within precisely defined groups of customers that support (and control) one another – a method typical of many microcredit schemes. For this reason – as well as to gain access to rural customers – it makes sense for insurers to cooperate with regionally established MFIs. Uganda has already made some progress in this field. However, microinsurers still do not even reach ten percent of all microfinance customers in Uganda.

Another category of insurance mechanisms should address risks typical of farming. These fall into two categories: pre-harvest ((heavy rains, thunderstorms, drought or locusts and other insects) and post-harvest (mice or insects infiltrating harvest stores). In Uganda, the latter are clearly the most critical. Such risks can be insured. Discussing all implications is beyond the scope of this essay, a detailed elaboration will be found in Meyer/Roberts/Mugume (2004).

However, one point deserves to be raised in our context. Rather than glorifying microfinance as a magical bullet against poverty, it should be seen as a well-defined tool that will be most efficient in combination with other tools. In Uganda, a pro-poor financial sector has begun to grow. It builds on microfinance as one of four pillars – the others being agricultural finance, small and medium enterprise finance and vulnerable groups finance. Note however, that this concept addresses accurately the integration of financial sector, but fails so far to define the interfaces between the financial sector and the specific production spheres.


Conclusion

Microfinance is much more than microcredit. Microfinance is, first of all, about saving. Creditors are relatively easy to come by – but poor people only rarely find a place to keep their savings safe, accessible and soundly accounted for. Microfinance products are key to overcome that access-restraint.

Moreover, microfinance should grow into insurance to better mitigate risks. Poverty is the result of unmitigated risks. It is fundamentally unfair that those people suffering from the unmitigated risks of yesterday are also those least likely to mitigate the risks of tomorrow. Microfinance has begun tackling the issue, but international assistance should pave the path and speed-up the journey.



Dr. Oliver Schmidt
 is Technical Advisor at AMFIU, seconded by German Development Service (DED).
oliver@amfiu.org.ug
http://uganda.ded.de


References:
Meyer, R. L., Roberts, R., Mugume, A., 2004: Agricultural Finance in Uganda – The Way Forward, in: FSD-Series, No. 13, Kampala.
Pelrine, R. J., 2005: New Study’s Initial Findings Help Define Rural Ugandans’ Priorities for Saving, in: The Microfinance Banker, Vol. 5, Issue 3 (forthcoming).