Bank of Uganda
Working Paper Series
Working Paper No. 24/2020
Financial Innovation in Uganda: Evolution,
Impact and Prospects
Doreen Katangaza Rubatsimbira
June 2020
Working papers describe on-going research by the author(s) and are published to elicit comments and to further debate. The views expressed in the working paper series are those of the author(s) and do not in any way represent the official position of the Bank of Uganda. This paper should not therefore be reported as representing the views of the Bank of Uganda or its management
Doreen Katangaza Rubatsimbira: Bank of Uganda ([email protected])
Bank of Uganda WP No. 24/2020
\ Financial Innovation in Uganda: Evolution,
Impact and Prospects
Prepared by
Doreen Katangaza Rubatsimbira
June 2020
Abstract Financial innovations have reformed the global financial sector to an unprecedented landscape. In Uganda, Automatic Teller Machines, Mobile banking, Online banking, Mobile Money, Agency banking and others have altered financial services delivery beyond the traditional practice of physically visiting the institution to transact. They have also enlarged the scope of operation for financial institutions and expedited accessibility of financial services. This paradigm shift is critical in addressing high operational costs which continue to constrain the Ugandan financial sector. It also supports financial inclusion- a key channel of sustainable growth and development. Prospects for financial innovations in Uganda include usage of innovations to offer additional support to financial intermediation, as this would go a long way in addressing some of the major impediments to the financial services delivery in Uganda. A key issue of concern for policy makers and regulators is, the current and potential risks that innovations pose to consumers, individual financial institutions, the financial system and the economy at large. A supportive legal and robust regulatory framework is useful in ensuring a balance between potential benefits of and risks posed by financial innovations.
JEL Classification: O31; Q55; G20; P47
KEYWORDS: Financial Innovation; Financial Performance; Financial System; Risk Management; Uganda.
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1. Introduction
Technological advancement has transformed the global financial services industry through the emergence of unprecedented innovations. While the type and timing of the innovations differs across countries, common characteristics include the introduction of new products, instruments and systems to support intermediation and the modifications of traditional ones. In Uganda, such innovations include digital/electronic/internet banking, agency banking, mobile-device-based intermediation applications, and advanced payment systems. These innovations have the potential to improve efficiency in financial services delivery and promote financial inclusion. Indeed, more than half (56 percent) of people who access formal financial services have/use mobile money services (Finscope 2018). Improved efficiency potentially leads to welfare gains that are crucial for economic growth, sustainability and inclusiveness. As inferred by (Wieser, et al. 2019), mobile money can improve livelihoods of the poor and those in remote areas. Likewise, (Chibba 2009) stipulates that financial inclusion incrementally compliments conventional approaches to tackling poverty, promoting inclusive development and addressing millennium development goals.
Besides technology, variations in inflation and interest rates, new legislature and globalization stimulate the development of innovations (Silber, 1983). Imperfections could also drive innovations as new and more advanced products, instruments or systems are designed to address perceived deficiencies or gaps in the financial system (Sekhar 2018). Irrespective of their source, the literature points to two views of financial innovations: The traditional innovation-growth view that highlights cost reduction, risk sharing facilitation, market completeness, improvement in allocative efficiency and promotion of economic growth as benefits and, the innovation-fragility view that is associated with a more negative of innovations (Friedman, 1982). The global crisis of 2007-2009 provides some support for both theories and is a classic example of how the adverse effects of financial innovations can outweigh the benefits: Initially, welfare gains were realized as technological advancement lowered the cost of evaluating the risk of subprime mortgages and enabled the risk to be spread through securitisation, enabling households to acquire homes. Also, additional liquidity was raised from financial markets through securitization, a technology-led innovation. However, intermediaries and investors underestimated risks of the rapid unprecedented innovation and as such, a crisis resulted when borrowers were unsuccessful in refinancing their subprime mortgages amidst slumping housing prices.
Following the global financial crisis, policy makers, regulators and industry participants became generally more concerned about financial innovations and the associated risks particularly in balancing probable benefits with likely risks. This demand stimulated extensive research on the subject during the post-2008 era. In Uganda, ample work has been undertaken on one aspect of financial innovation-mobile money, perhaps due to its popularity. Mobile money systems have generally gained wide acceptance as an emerging payment method in both advanced and emerging economies (IMF 2014). To the best of my knowledge, there have been no on a comprehensive study of financial innovation in Uganda. The limited studies on other aspects of financial innovation could be because they are
2 | P a g e relatively new and/or the data is not publicly available, which could also be the reason behind the dearth of empirical research on the subject matter.
Consequently, it is imperative that other aspects of financial innovations be assessed to supplement existing literature. It is also worth noting that financial innovations are dynamic with new products, process and systems being continually developed or those in existence being modified, which may pose new risks. It therefore raises the necessity to regularly monitor innovations and to assess their impact on the financial sector and the economy. This would inform the risk management processes and be a supportive measure towards promoting the safety, stability and soundness of financial institutions.
Focused on that potential, the study employs a Bank of Uganda supervisory database on various financial products and services to assess evolution of and outlook for financial innovation developments. It particularly investigates the trend of financial innovation in Uganda during the last two decades including its impact on the financial system. Supplemented with follow-up telephone conversations with relevant managers in financial institutions, it considers challenges in the implementation of financial innovation and presents prospects upon which policy recommendations may be based. The Ugandan financial system is characterized by a high share of the population without access to banking services, very low private credit to GDP ratio, very high real lending rates, lack of credit for Small and Medium Enterprises (SMEs) and small farmers, high operating costs of banks and lack of long-term capital for business investment among others. To determine the implications of innovations on the financial sector and assess the prospects therefore, each innovation is considered in terms of addressing these weaknesses.
The objectives of the study include addressing the following questions: (i) How have financial innovations evolved during the period 2000-2020? (ii) What products, processes or systems have been adopted? (iii) How bank customers are using financial innovations? (iv)What are the implications of the innovations on the financial sector? (v) What are the prospects for financial innovation in Uganda? The organization of this descriptive study is as follows. Section 1 covers the introduction, section 2 presents the evolution of financial technology and section 3 includes a review of the relevant literature. The trend and impact of financial innovation is presented in section 4 while section 5 presents findings and conclusions and section 6, the prospects.
2. Evolution of Financial Innovation
Financial innovation can be referred to as the creation or adoption of new financial products, services or processes. It encompasses innovative ways of undertaking financial intermediation as well as advances in supportive payment systems. This implies that financial innovation is not a new phenomenon per se. Moreover, technology has always been the foundation of the financial industry’s internal operations. Overtime, banks and other financial institutions have increasingly used technology to improve their operations such as the gradual replacement of paper-based transactions with computer processes. The difference between recently innovated products and the previous ones is, partly, the speed at which changes are
3 | P a g e happening. For the purposes of this study therefore, financial innovation is considered as the introduction of a new product that trades in a new market setting thereby reducing the reliance upon traditional instruments, processes and institutions (Levich, 1987). This terminology is the basis of selecting the products and services analyzed in this study. Although payment systems maintained by Bank of Uganda fit within the definition, they are excluded from the analysis because of their cross cutting properties, for they are both innovations and supportive platforms. The focus of the study therefore is on innovations by Supervised Financial Institutions and not by the Central Bank. The analysis highlights the gradual developments of innovations in Uganda over the period 2000-2020.
According to (Arner, Buckley and Barberis 2016), the interlinkage of finance and technology has a long history and has evolved over three distinct eras. The first, 1866-1967, was largely an analogue period even though the financial services industry relied heavily on technology. The second, 1967-2008, was the transformation from analogue to digital. It was characterized by increased usage of communications technology to deliver financial services and faster processing of transactions due to improved payment systems1. Dominated by traditional regulated financial institutions that used technology to provide financial products and services, it is within this era that the financial sectors of developed countries become highly globalized and digitalized. The third era starting from 2008 changed the landscape of financial intermediation in both developed and developing countries as new start-ups and technology companies started to offer financial products and services.
The evolution of financial innovations in Uganda is somewhat similar to the global trend but with relatively delayed implementation. It can also be distinguished into two phases: the first phase, 2000-2010 includes largely, technology-driven innovations. These include, ATMs, mobile banking, internet banking and payment cards. The second phase; 2011-2020 is the introduction of products, instruments and processes that leveraged technology to either broaden the market, manage risk or arbitrage. According to the Economic Council of Canada, market-broadening innovations increase the liquidity of the market and availability of funds by attracting new investors and offering new opportunities for borrowers. Risk management innovations reallocate financial risks to those who are less averse to them or who are presumably better able to handle them. Arbitraging instruments enable investors and borrowers to take advantage of the difference in costs and returns between markets. Consistent with this classification, innovations like mobile money, agency banking, bancassurance and Islamic banking seem to fall under both market-broadening and risk- management while derivatives are risk-management and arbitraging instruments.
During the pre-2008 period of the first phase, Uganda’s financial sector benefited from the digitalization in the developed countries through technology transfer from international banks to local affiliates, building onto the foundation laid by installation of the first ATM in 1997.
1 Inter-Computer Bureau was established in 1968 while the US Clearing House Interbank Payments System (CHIPS) was established in 1970. Fedwire, originally established in 1918, became an electronic instead of a telegraphic system in the early 1970s. Society of Worldwide Interbank Financial Telecommunications (SWIFT) was established in 1973. Online banking in the US in 1980 and in the UK in 1983. Bloomberg in 1981
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Another innovation was in 2001, when internet banking was introduced that enabled customers to access their bank accounts anytime, anywhere using an internet enabled device. By June 2007, there were about 3000 users of internet banking who were using their personal computers to access their accounts mainly for account balance inquiry (BOU 2007). During 2001-2006, a number of payment systems were introduced including, EFT, SWIFT, ECS and RTGS2. These payment innovations supported further revolutions in the financial sector including expansion of ATM services to vendor machines for mobile phone airtime, usage of telephone banking and acceptance of credit cards. Bank customers begun to use telephones to access their accounts mainly for account details inquiry, mini-statement requests, transfer of funds between customer’s accounts, cheque book requisition and stop-cheque instructions. By the end of 2006, telephone banking was operational in five banks. (BOU 2001-2006).
The setup of an inter-bank payment switch, Bankom, in June 2005 extended the use of financial innovations beyond cash transactions, account balance enquiries and airtime loading. It ushered into the financial sector new innovation, point-of-sale, which facilitates the payment of purchases at various sale points. In 2009, a paradigm shift was realized when Mobile Network Operators (MNOs) partnered with financial institutions to offer mobile payment services such as mobile money. This innovation leveraged the high number of mobile phone subscribers in the country who stood at about eight million at that time relative to 4 million account holders in commercial banks. The growth in mobile money has been astonishing, with the number of registered subscribers growing from just above half a million in 2009 to 21 million in 2015 and 28 million in March 2020, which is more than half of Uganda’s population. After 2011, a second phase of financial innovations started that includes introduction of agency banking, islamic banking and bancassurance. The analysis in this paper excludes islamic banking and bancassurance partly due to scarcity of data given their novelty. For islamic banking in particular, the absence of a sharia advisory board has delayed its operationalization. Figure 1: Evolution of Financial Innovation in Uganda
2009 2006 Mobile Money Telephone 2005 Banking Point-of- 2001 Sale Credit Cards Internet Banking 1997 Debit Cards First ATM installed
Source: Author
2 Electronic Funds Transfer (EFT) in 2003; Real Time Gross Settlement (RTGS) in 2005; Electronic Cheque-Clearing System (ECS)
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3. Literature Review
The literature on financial innovation goes as far back as the 1930s during which (Schumpeter 1939) defined financial innovation as the implementation of a new process or method that alters the production possibilities of a firm. Generally, the literature is categorized into understanding financial innovation and determining its causes and implications for the financial sector and the economy. In the 1960s, considerable research focused mainly on the characteristics of the innovative firm was undertaken by (Cyert and March 1963), (Becker and Stafford 1967), and (Knight 1967) among others. In addition, work by (Schmookler 1966), (Mansfield 1968) and (Nelson and Winter 1982 ) concentrated on product and process innovation in firms. The 1970s research was focused on studying the stimulants and theories of financial innovation. (Silber 1975) outlined factors that induce financial institutions to create new instruments or adopt new practices. (Ben-Horim and Silber 1977) studied the microeconomics of financial innovation and empirically tested the theory of financial innovation within the context of a linear programming model of commercial bank behavior. Another study by (Finnerty and Douglas 2002) involves a compilation of an informative list of products relating to the financial innovations and factors that are primarily responsible for innovation.
Building onto that earlier work, (Friedman, 1982) highlighted two views of financial innovations: The traditional innovation-growth view that highlights cost reduction, risk sharing facilitation, market completeness, improvement in allocative efficiency and promotion of economic growth as benefits and, the innovation-fragility view that is associated with a more negative of innovations. Additionally, (Silber 1983) identified technology (information processing and data transmission), volatility in inflation and interest rates, legislative initiatives (agency regulations or congressional legislation) and internationalization (expansion in foreign trade) as stimulants of financial innovations.
Studies that investigate determinants of financial innovations include (Marshall and Bansal. 1992) who indicate that increased risk coupled with major developments in finance create the right environment for rapid growth in financial innovation. (Tufano 2003) highlights the need to lower taxes or to avoid the effects of financial regulations as important motivations for financial innovation. He also states that financial innovations correct market inefficiency or imperfections to some extent. His view is also supported by (Sekhar 2018) who stipulates that imperfections can also stimulate the development of innovations as new and more advanced products, instruments or systems are designed to address related drawbacks.
While the motivation for financial innovations is well covered in the literature, impact assessment studies are not as widespread. The first assessment of developments in financial innovation and their impact on financial stability and the economy was perhaps by (Levich, Corrigan, et al. 1988) who highlighted product and process changes that had occurred in the United States and international financial markets. The study was timely for the USA as it had been 20 years since the introduction of the first ATM in 1967, which arguably marked the commencement of the modern evolution of financial technologies, (Arner, Buckley and Barberis 2016).
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The need to identify changes in financial products and processes on account of innovation was underscored by (Verghese 1990) who in undertaking a comprehensive study of financial innovations in India indicated, the necessity to objectively evaluate achievements of financial innovation and the related costs as well as, identifying the lessons of the financial change and innovation. Substantially, literature that highlights the financial system’s importance to the economy is primarily the motivator of investigations regarding the role of financial innovations in stimulating the economy (Levine 1997).
Recently, a number of studies on implications of financial innovation in developing countries have been authored, albeit the findings are mixed. (Gakure and Ngumi 2013) and (Jagede 2014) indicate that financial innovation moderately supports bank performance and, (Cherotich, et al. 2015), (Ngari and Muiruri 2014) and (Gichungu and Oloko 2015) show a strong positive impact. On the contrary, (Victor, Obinozie and Echekoba 2015) that indicate that financial innovation does not improve bank performance. Studies on financial innovation in Uganda are largely focused on mobile money. While mobile money is a leading innovation in Uganda as will be shown later in this study, it is important to incorporate other innovations as well for comprehensiveness. In cases where other innovations have been considered, survey methodologies have been used to assess the impact of innovations from a very micro level. These include (Turihamwe and Kakuba 2014) and (Sewali 2012) and (Conrad, Zacharia and Gokyalya 2013) among others who use cross sectional survey designs on a sample of particular banks’ clientele on the use of financial innovations.
This study supplements the literature by undertaking a review of financial innovations in Uganda from a macro perspective. It highlights the genesis of selected innovations, assesses their trend overtime and implications in terms of addressing weaknesses in the financial system. Following that analysis, the study includes the prospects for financial innovation in Uganda as this is one area that is of little focus in the literature. According to (Miller 1992) on the future perspective of financial innovation, the growing need of financial innovation in stimulating economic growth and businesses operations can be viewed by explaining functions it has performed. Another contribution of this study is the regional comparison of the trend of innovative products in the banking system of Uganda versus other countries in the East African region subject to data availability. A potentially useful investigation, which lies beyond the scope of this paper, would be to empirically determine the relationship between financial innovations and bank performance.
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4. Trend and Impact of Financial Innovation
This section assesses how financial innovations have progressed in Uganda and their impact on the financial sector.
4.1 Analysis of the Trend of Financial Innovations
Information on how various products and services have progressed overtime, their uses and how they compare with selected benchmarks is presented in this section. Attempts have been made to benchmark trends of innovative products in Uganda with those in Kenya, as an attempt to undertake a regional comparison. The choice of Kenya as a benchmark is because it is East Africa’s largest economy with a dominant financial sector. In addition, Kenya's financial system is relatively more developed and diversified (Thorsten and Fuchs 2004). The availability of data on Kenya and the similarity in economic setting with Uganda are other reasons for the selection. The trend analysis in this study is focused on technologically-led products and services and/or market-oriented innovations. However, BOU’s payment systems are excluded because they simultaneously fall into two categories that is, process innovation and supportive systems for other innovative products, which would complicate the analysis.
Automated Teller Machines (ATMs)
ATMs are cash machines that facilitate automatic transactions like depositing, withdrawing and making transfer transactions, enabling the customer to access his/her account any time outside the physical setting of the financial institution. The first ATM in Uganda was installed in 1997 by Standard Chartered bank and since the early 2000s; an accelerated growth in the number of ATMs has been registered as financial institutions leverage technological advancement. The number of ATMs has increased by 323 from February 2010 to May 2020. Notwithstanding, the increase in ATMs has fluctuated with sharp movements mainly driven by new entrants (increases) and bank closures (declines). The fluctuations are more pronounced in 2017 reflecting the closure of the third largest bank (based on loan size) at the end of 2016 and subsequent distribution of its assets in 2017 and in 2011, reflecting cost cutting measures by banks as a measure of dealing with effects of the global financial crisis. In comparison with Kenya, the trends of ATMs are similar during the period 2010- 2016 and contrary thereafter3. However, the number of ATMs in Uganda lags behind that of Kenya by far (Figure 2) which is consistent with the difference in the size of the financial sectors in the two countries.
3 The drop in Kenya reflects a cost cutting measure as banks embarked on measures to boost profitability during an environment of interest rate caps of implemented in 2016.
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Figure 2: Comparison of Number of Automated Teller Machines in Uganda and Kenya
Source: Author
The growth in the number of ATMs in Uganda though increasing, has recently grown at a slower rate relative to pre-2017 partly because of implementation of the agency banking model that is cheaper to maintain. The slower growth also reflects increased usage of other innovative products that are free to acquire like internet and mobile banking that come along with relatively more convenience. Increase in ATM costs around the same time could partly be at play. An analysis of commercial banks’ ATM charges indicates that more than half of the commercial banks (13) charge 15000-20000 Ugandan shillings for issuance of a new ATM card, 5 banks charge 10,000-14,999 Ugandan shillings, 2 banks charge 5,000-9,999 Ugandan shillings while only 2 banks issue ATM cards for free. Moreover, there are additional costs; of replacement in the event that the card is lost/faulty and, transaction charges whenever a customer uses an ATM.
ATMs are mainly used for withdrawing funds. On average, ATM withdrawals as a share of total withdrawals increased from 5.4 percent in 2010 to 9.5 percent in 2020 equivalent to 8.4 percent over the period 2010-2020, the share of ATM withdrawals to total withdrawals was higher in 2014 and 2015 at 11.9 percent and 13.7 percent respectively. On the contrary, ATM deposits as a share total deposits has been on average less that 1 percent over the same period. The relatively lower deposit transactions are partly explained by the fewer number of ATMs with the option of accepting deposits; out of the 23 banks, only 9 have ATMs with that option. According to respondents from commercial banks, ATMs that have an option of taking deposits require more advanced technology if they are to automatically credit the customer’s account with received cash, which is an additional cost to the bank. An alternative, where the customer’s account is credited after cash deposited via the ATM is verified, as is the practice in some banks, is associated with safety and workflow concerns.
Of the ATM withdrawals, about 90 percent are withdrawn using cards issued by the same bank in which the withdraw is taking place, about 5 percent are by cards issued by banks outside Uganda and 5 percent by cards issued by other local banks. Regarding card types,
9 | P a g e credit cards are not as popular as debit cards. While the share of number of credit cards to total cards is between 10-15 percent, the share of debit cards is 90 percent, on average. Use of credit cards is low compared to debit cards because issuance of credit cards involves some form of credit scoring which makes the process selective.
Internet Banking
Also, commonly known as electronic banking (e-banking), internet banking enables customers to access financial services from anywhere, anytime, using the internet. Internet banking is slowly picking up in Uganda. As a share of active deposits (current and savings) accounts, internet banking stood at an average of 9 percent over the last 4 years. The low internet usage in Uganda could be behind this modest level of usage. According to (UBOS 2016), only 6 percent of household members utilized the internet of which 50 percent was for purposes of social networking while 16 percent was for academic work. Internet banking is largely used for funds transfer, with international transfers taking the largest share. Other uses of internet banking include paying bills and checking for account details. Despite the significant number of people using the internet for international transfers, the value of transactions is much lower. As at end-2016, internal bank transfers and interbank transactions amounted to Shs. 1.5 trillion and Shs. 1.1 trillion respectively while international funds transfer and bill payments accounted for Shs. 65 billion and Shs. 26 billion respectively There has been an increase in intrabank payments during the most recent period, 2018-2019, superseding interbank payments made during 2016-2017.
Mobile Banking
Mobile banking is the type of innovation where customers access products and services of financial institutions through the institutions’ mobile applications. Mobile banking has picked up over the years from 47,354 users in 2015 to over a million users in 2019 which represents 1.2 percent and 21.6 percent of active deposit accounts respectively. Mobile banking is mainly used for account detail enquiries. When compared to total number of active deposit accounts, account check transactions are 26 percent in 2018 and 33 percent in 2019. In addition, it facilitates bill payment and transfers. Bill payments account for 6.4 percent and 6.0 percent of total number of active deposit accounts in 2018 and 2019 respectively while internal transfers account for 1.5 percent and 1.8 percent respectively.
Table 1: Mobile Banking Users as a Percentage of Deposit Account Holders
2015 2016 2017 2018 2019 Active number of users 1.2 9.3 10.7 17.0 21.6 Internal Transfers 3.0 5.5 19.3 1.5 1.8 External Transfers 0.0 0.0 0.2 0.3 0.2 Checking Account details 0.4 2.8 4.1 26.1 32.8 Paying bills 1.6 2.0 5.1 6.4 6.0 Others 0.0 0.4 1.0 19.1 10.0 Source: Author
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Point-of-Sales Another innovation is point-of-sale where customers of financial institutions are able to pay for goods and services at selected places using bank cards and the equivalent amount is automatically debited from their accounts. Point-of-sales transactions have increased from 29,374 as at December 2015 to 197,640 as at December 2019. Nonetheless, this accounts for only 4 percent of active deposit accounts, with the equivalent proportion of the amount of the transaction being less than 1 percent. In comparison, Uganda has 146,857 point of sales as at May 2020, much more than Kenya which has 42,544. In Uganda, Point-of Sales have increased the scope of operation for financial by taking financial services to areas where institutions could not set up facilities. The significant usage of point-of-sales is due to more flexible entry conditions for agents and relatively lower operational risk on account of minimal involvement of cash.
Agency Banking
The 2016 amendment of the Financial Institutions Act 2004 provided for agency banking. This innovation allows supervised financial institutions to enter into a contract with a third party referred to as agent, who must be approved by Bank of Uganda (BOU), to provide permitted services on the institution’s behalf. Business units that are fully licensed and have been in existence for at least one year qualify to be agents of agent banking. The objective is to take financial services closer to the community and by doing so reduce the costs associated with operating bank branches. According to (UBOS 2016), the most commonly used method of saving in several districts is keeping the money at home. Agency banking therefore provides an opportunity for such an unbanked population to access financial services. Over time, the innovation would yield efficiency gains to implementing institutions as it is a cheaper alternative to maintaining a wide branch network.
There are currently 15 banks undertaking agency banking including Equity, Tropical, KCB, Finance Trust, Stanbic, Centenary, Housing Finance, Exim, DFCU, ABSA, Diamond Trust, Bank of Africa, United Bank of Africa, Ecobank and Opportunity. Total transactions by agents have grown from Shs. 457 billion in December 2018 to Shs. 1.6 trillion in February 2020. However, transactions dropped in April 2020 to Shs. 900 billion during the lockdown to mitigate COVID-19 spread and recovered in May 2020 to Shs. 1.4 billion. Agency banking is mainly used for depositing, with deposits received through agency banking accounting for 12 percent of total deposits as at May 2020 while withdrawals are less than 1 percent of total withdrawals.
Mobile Money
In 2009, MNOs partnered with financial institutions to deliver financial services through the mobile phone and as a result, mobile money was developed. Mobile money is the use of a mobile phone to access products and services offered by a financial institution. When accessed using mobile money, the products/services are electronic, may or may not be
11 | P a g e directly linked to an account in a financial institution and can be easily converted into cash. Mobile money has been the most popular innovation by far because of its accessibility, ease of use, cost effectiveness, user friendliness and security which have enabled the innovation to gain public trust (Intermedia 2016). Consumers are able to access financial products with just a few simple steps on a phone menu. There are currently seven mobile money providers in Uganda including MTN, Airtel, Uganda Telecom, Africell, M-cash, PayWay and Ezeey, Micropay Money. The Bank of Uganda together with the Uganda Communications Commission have been regulating mobile money providers as a shared responsibility until May 2020 when a bill that assigns the supervisory responsibility to BOU was passed .
Mobile money is largely used as a medium of exchange and serves as a store of value as well, as consumers, especially low-income earners, use it as a savings channel. Indeed, 23 percent of savers (2.3 million) keep money on their mobile phones4. Moreover, it completes financial intermediation by enabling borrowers to access credit. Mobile money loan products currently available on the market include mokash by MTN, Msente by Uganda Telecom and Twewole by Airtel. The loans comprise of unsecured loans with a 30 day repayment period at an average interest rate of 9 percent that are disbursed to the borrower’s mobile money wallet as electronic cash (e-cash). Upon receipt of e-value, the borrower can withdraw the equivalent cash less applicable fees from a mobile money agent. To assess the creditworthiness of the borrower, a credit score is derived based on the borrower’s mobile money transactions, balance information, mobile phone activity and repayment history of previous loans.
Since its introduction, mobile money has registered remarkable growth from just above 11,000 registered subscribers in March 2009 to 28 million subscribers with transactions worth Shs. 6.9 trillion as at May 2020 (Figure 3). The high number of mobile phone ownership by adults has been supportive of the growth in mobile money5. While an upward growth is observed for both number of registered users and value of transactions, there are notable sharp declines in the value of transactions in some periods. The sharp drops accompanied by a reduction in registered users except for most recent period are associated with system upgrades (September 2014), regulatory intervention (February 2016), taxation (July 2018) and the covid-19 pandemic (April 2020).
4 FINSCOPE 2018
5 According to the FINSCOPE 2018, 52 percent of adults have mobile phones of which 46 percent are rural-based adults and 70 percent are urban-based adults
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Figure 3: Number of Mobile Money Users and Value of Transactions
Source: Author
Further analysis of mobile money transactions shows that mobile money usage in Uganda is mainly used for cash-in (depositing), cash out (withdrawing) and person-to-person (P2P). Other types of transactions include Person-to-Business, Business-to-Person and mobile credit6. At the end of 2019, deposits, withdrawals and P2P transactions accounted for 28 percent, 27 percent and 12 percent of total number of transactions respectively. On average, mobile credit as a share of mobile money deposits is 4 percent and less than 1 percent of total transactions. In comparison with personal and household loans in local currency disbursed by financial institutions, mobile credit is about 2 percent.
4.2 Impact of Financial Innovations
As aforementioned, undertaking an impact assessment of financial innovations is crucial for evaluating achievements and related costs, drawing lessons from the implementation process and determining economic consequences. The mixed findings from the studies on developing countries underscore the need for such assessments for countries like Uganda. Moreover, efficient delivery of financial services in Uganda is challenged by access barriers, elevated lending interest rates, very low private credit to GDP ratio, lack of credit for Small and Medium Enterprises and Farmers, high operating costs of banks and lack of long-term capital for business investment.
To determine the implications of innovations on the financial sector therefore, an analysis of the innovations is undertaken in terms of addressing the stated weaknesses. In particular, focus is on evaluating the expected and actual achievement of the innovation. Generally, the financial innovations considered in this study are technology-driven and market- oriented. In terms of implementers’ objectives, the innovations can be broadly categorized into
6 P2P is the transfer of money from one individual’s mobile money wallet to another individual, P2B is the transfer from an individual’s mobile wallet to a business entity, B2P is the transfer from a business entity’s wallet to an individual
13 | P a g e convenience, lowering operational costs, reducing access barriers to financial services as well as deepening and broadening financial intermediation.
The impact of financial innovations that goes without saying is greater customer convenience. Prior to the introduction of financial innovations, customers would trek long distances to access basic financial services7 such as depositing or withdrawing. This is contrary to the present day where most of these basic services are within reach through agents, point-of-sales and mobile money. Convenience has also been realized in the flexibility of the time of accessing financial services. Mobile banking and internet banking have supported customers to access financial services beyond the normal time of operation of the brick and mortar institution. The time saved, if used productively can lead to greater efficiency and economic well-being of the customer. Relatedly, credit cards and mobile credit enable consumers to smoothen their expenditure in the short-term by providing credit during periods of need or no income. Also, by saving on mobile money, consumers are able to postpone consumption to another period of their lives or save up for investment. Smoothening expenditure and investment is crucial for managing business cycle fluctuations.
Another impact of financial innovation has been cost reduction in bank operations. Since 2016, banks have closed on average 20 branches as they increasingly implemented the agency banking model. Bank operations have overhead costs like payment of rent, salaries and utilities which reduce their profit margin. Research shows that operating costs are high and are the main drivers of high lending rates especially for small-sized banks where they account for approximately 71 percent of the intermediation margin. (Mugume and Rubatsimbira 2009). With financial innovations at play, formal financial institutions do not have to open or operate branches that are not economically viable, hence reducing the cost of operations and in turn, contributing to a better financial position. Indeed, overhead costs are higher for the period 2000-2008, on average accounting for 73 percent of total expenses as compared to 63 percent for 2009-2019. Besides overhead costs, other expenses incurred by banks include interest payments and provisions for bad loans.
The greatest tangible impact of financial innovations has been increasing the scope of operation for formal financial institutions especially in extending deposit, withdrawal and payment services. Point-of-sale, agency banking and mobile money have extended financial services to sections of the population that were unbanked and brought on board a significant number of people to the formal financial system. This has resulted into a widening of the geographical location of financial services that is not just concentrated in urban centers but extended to rural areas as well. A comparison of financial access points in 2013 and 2019 reveals that, districts of Kabarole, Jinja, Mbale, Mukono, Kabale, Gulu, Lira, Hoima and Masaka and Luwero have benefited greatly from the point-of-sale innovation (Figure 4). The districts initially had a limited number of financial access points indicated by fewer bank branches and ATMs, but of recent, point-of-sales have boosted the numbers. Increased access
7 Finscope and world bank surveys
14 | P a g e to financial services by people in the rural arears coupled with deposit mobilization augers well with deepening financial inclusion which is a priority on Uganda’s development agenda.
Figure 4: Comparison of Access Points in selected Districts
Source: Author
On the negative side, developments in financial innovations pose risks to the financial system as they are electronic-based which makes them more exposed to cyberattacks. In addition, due to the interoperability involved, a disruption in the financial infrastructure of one product or service can interfere in the operations of others posing systematic risk for the entire banking system. Based on the analysis of the type of products and the means of delivery, the greatest risk by innovations posed to the stability of the financial system is operational risk. In 2018, loss on account of fraud and forgeries arising from online payments, payment cards and mobile banking accounted for 60 percent of total fraud. In addition, there were system disruptions / failures that occasionally affected operations. However, the operational risk incurred by the financial institutions does not pose grave threats to the financial sector. Firstly, risk incidents have been well managed, reflected by the relatively lower incidents reported in recent years. During the period, 2015-2019 reported system disruptions were on average 14, being highest in 2015 and 2015 at 19 and lowest in 2017 and 2019 at 10. Secondly, the operational risk is relatively small. Banks might incur losses because of operational risks but these losses are rarely big enough to cause a bank to collapse.
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Furthermore, credit granted by Uganda’s banking sector is relatively low, PSC/GDP is 14 percent as at 2019 relative to an average of 46 percent for SSA8. With the exception of mobile money, none of the other innovations provide loans. Moreover, the proportion of mobile money credit is small when compared to unsecured credit to households and the savings mobilised through mobile money. This is partly because mobile money service providers that are not regulated by Bank of Uganda were unable to intermediate funds that have been mobilized through the sale of mobile money. The unavailability (at least up to May 2020) of a distinct legal framework for regulation of non-financial institutions providing payments solutions has limited mobile money service providers in availing additional intermediary services. Although Bank of Uganda issued mobile money guidelines in 2013, uncertainty regarding the licensing and supervision of payment systems service providers that are not financial institutions prevailed.
Additionally, when MNO and a financial institution enter into a partnership to provide mobile credit, the roles are shared between the parties. Both the MNP and the financial institution manage the customer while financial institutions manage the credit risk and the associated regulatory requirements. The MNP is a channel through which the customer can access the funds. The challenge however is, the credit score for mobile money credit is independent of the credit reference bureau score, which poses credit risk to the financial institution.
5. Findings and Conclusion
Uganda’s banking sector has undergone a massive transformation over the last 20 years driven by financial innovations. Leveraging technology, financial institutions have adopted unconventional products and services and, operated outside the traditional brick and mortar setting, beyond normal operational hours and in a wider geographical setting. The innovations include Automated Teller Machines, payment cards, internet banking, and mobile banking, point of sales, agency banking and mobile money. While most of these innovations are technology-led, there is an element of risk-sharing where the risk is shared between the bank and the agent and, market-broadening as well.
The evolution of financial innovations in Uganda starts with the installation of the first ATM in 1997 and is gradually followed by, introduction of internet banking in 2001, point-of-sale in 2005, credit cards in 2006, mobile money in 2009, agency banking in 2016 and bancassurance and Islamic banking in 2017. A number of supportive payment systems like EFT, RTGS, SWIFT and ECS were also introduced during 2001-2006. The use of innovations introduced over the past 2 decades is specialized. ATMs and point-of-sales are largely used for withdrawals; internet banking for transfers (intra, inter and external); mobile banking for account details enquiries, bill payments, accessing bank statements and transfers; and agency banking for depositing. Mobile money is mainly used for depositing, withdrawing and person to person transfers.
8 World Bank Database
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Growth in ATMs accelerated faster in the pre-2017 period compared to post-2017 period due to a substitution effect, as financial institutions increasingly implemented alternative innovations that are relatively cheaper. On the customer’s side, the cost of accessing the ATM (issuance of a new card) is generally higher than utilizing alternatives like agency banking and point of sale. The combination of the banks’ and customers’ reduced reliance on the ATM might result into a decline in the number of ATMs in the next decade. Deposits made through ATMs are minimal due to limited availability of the service as it entails acquisition of the necessary system which is an additional cost to the institution. Use of credit cards is low compared to debit cards because issuance of credit cards involves some form of credit scoring which makes the process selective.
Mobile money completes financial intermediation by availing both loans and saving options. The above coupled with its accessibility, ease of use, cost effectiveness, user friendliness and security make mobile money a popular innovation. However, mobile money loans account for a low share of total transactions and only 2 percent of personal and household credit. Moreover, they are relatively expensive for the borrower at 9 percent per month. There is also a possibility of credit risk given the difference in the source of credit scores and, further financial intermediation through this innovation is partly limited by an incomplete legislative process.
Financial innovations have had a profound impact on the financial services industry in particular, increasing the scope of operation for formal financial institutions, cost reduction in bank operations, providing greater customer convenience and contributing to smoothening of consumption expenditure. However, technology-based innovations pose risks to the financial system as they are susceptible to cyber-attacks like fraud and forgeries. Moreover, for most of the products and services, a high level of interoperability is involved. This makes operational risk the main risk posed by the innovations. Notably risk occurrences have been well managed and do not pose grave threats to the financial sector. Indeed, very few banks fail because of operational risks. The main type of risk incurred by banks in Uganda is credit risk and it has a possibility of occurrence through differences in sources of credit score ratings and mobile money loan defaults. However, mobile money loans which are still very small in size and their impact on the risks facing banks is also relatively modest.
6. Prospects for financial innovation in Uganda
Efficient financial services are essential for economic growth, sustainability and financial inclusion. Advanced countries lead developing countries in terms of having broader and deeper financial sectors, markets and more sophisticated products. The increased usage of technology coupled with other objectives of financial institutions, has motivated emergence of innovative financial products and services. While the growth and impact of financial innovation in Uganda is obvious as earlier indicated, there are potential opportunities going forward.
The impact of financial innovations in Uganda has been more transactional that intermediary. Given that most of the constraints in the delivery of financial services surround financial
17 | P a g e intermediation, more efforts are warranted in promoting this cause. Although several innovations have supported deposit, withdrawal and payment services to a large extend, they are limited in providing of credit facilities. Mobile money has attempted to fill this gap but has been partly limited by lack of a comprehensive legal framework. The recently enacted National Payments Systems Bill therefore presents an opportunity to address this challenge. Non-financial institutions can leverage their extensive client base to provide additional roles that promote further use of financial innovation and consequently increased financial intermediation. Further, on-going efforts by the Bank of Uganda to incorporate mobile money borrowers into the credit reference bureau would also support risk management efforts and efficiency in services delivery.
Leveraging agency banking to promote savings mobilization is another prospect. Uganda’s savings/GDP stands at 21 percent as at 2018. While this is slightly better than the average for SSA for the same period, a substantial number of Ugandans prefer to keep their money outside the formal financial system-at home. Since agency banking is already being used by a reasonable number of people for deposits, more effect could be devoted to encouraging savings. Improved savings would provide a larger pool of funds for onward lending which could lower the cost of lending and consequently lead to efficiency in financial services delivery.
A fundamental question that is common amongst policy makers and regulators is, how should central banks regulate financial innovations given their rapid growth? In Uganda, like in many other countries, financial innovations keep evolving. Therefore, it’s important to maintain a robust regulatory and supervisory framework that would identify risks posed by the transformation and provide timely mitigation measures. However, as (Draghi 2008) advises, focus on regulation should not impede innovation which is necessary for further credit extension. Regulators should aim at meeting midway between strengthening the resilience of the system without hindering the process of market discipline and innovation as this would eventually ensure a balance between potential benefits of and risks posed by financial innovations.
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