AN ASSESSMENT OF REGULATORY BARRIERS IMPEDING ENTRY

OR TRANSFORMATION OF NEW OR UNREGULATED

MICROFINANCE ENTITIES INTO REGULATED STATUS:

A Comparative Study of the East African Community Microfinance

Regulatory Regimes

A Technical Research Paper

presented to the Macro Economic and Financial Management Institute (MEFMI) in

Partial Fulfillment of the Requirements for

MEFMI Candidate Fellowship Program

By

Evelyne Kanini Kilonzo

Central Bank of Kenya

April 2012

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ABBREVIATIONS AND ACRONYMS

AfDB African Development Bank

AMFI Association of Microfinance Institutions of Kenya

AMFIU Association of Micro-Finance Institutions of Uganda

AMIR Association of Microfinance Institutions of Rwanda

ASCA Accumulating Credit and Savings Association

BAFIA Banking and Financial Institutions Act

BCBS Basel Committee on Banking Supervision

BIF Burundi Francs

BNR Banque Nationalé du Rwanda

BOT Bank of Tanzania

BOU Bank of Uganda

BP Banques Populaires

BPR Banque Populaire du Rwanda

BRAC Bangladesh Rural Advancement Committee

BRB Bank of the Republic of Burundi

CAR Capital Adequacy Ratio

CBK Central Bank of Kenya

CEO Chief Executive Officer

CGAP Consultative Group to Assist the Poor

COOPEC Coopérative d'Epargne et Crédit or Financial Cooperative

CRB Credit Reference Bureau

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DFI Development Finance Institution

DTM Deposit Taking Microfinance Institution (used in Kenya).

EAC East African Community

FIA, 2004 Financial Institutions Act, 2004

FICOs Financial Cooperatives Societies

FOSA Front Office Service Activity

FSA Financial Services Association

FSAP Financial Sector Assessment Program

IYMC International Year of Microcredit

KPOSB Kenya Post Office Savings Bank

KREP Kenya Rural Enterprise Program

LTD Limited

MDI Microfinance Deposit Taking Institutions (used in Uganda).

MDI, 2003 Microfinance Deposit Taking Institutions Act, 2003

MEFMI Macroeconomic and Financial Management Institute of Eastern and Southern Africa

MFC Microfinance Companies (used in Tanzania)

MFA Microfinance Association

MFI Microfinance Institution

MINICOM Translated as Ministry of Trade and Industry

MIX Microfinance Information eXchange

MoF Ministry of Finance

MSE Micro and Small Enterprises

MSME Micro, Small and Medium-sized Enterprise

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NBAA National Board of Accountants and Auditors

NBFI Non Bank Financial Institution

NGO Non Governmental Organization

NISR National Institution of Statistics of Rwanda

NMP National Microfinance Policy

RCA Rwanda Cooperative Agency

RIM Réseau des Institutions de Microfinance au Burundi

RIM Reseau InterDiocesain de Microfinance

RML Rwanda Microfinance Limited

ROSCA Rotating Savings and Credit Association

RwF Rwandan Franc

SACCO Savings and Credit Cooperative Organisation

SASRA Sacco Societies Regulatory Authority

SSA Sub-Saharan Africa

TAMFI Tanzania Association of Microfinance Institutions

UBPR Union des Banques Populaires du Rwanda

UN United Nations

UNCDF United Nations Capital Development Fund

URT United Republic of Tanzania

USH Uganda Shillings

VSLA Village Savings and Loan Association

WAEMU West African Economic and Monetary Union

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TABLE OF CONTENTS 

ABBREVIATIONS AND ACRONYMS ....................................................................................... ii

TABLE OF CONTENTS ................................................................................................................ v

CHAPTER ONE: INTRODUCTION ............................................................................................. 1

1.1 BACKGROUND OF THE STUDY ................................................................................ 1

1.1.1. State of Financial Inclusion/Exclusion. .................................................................... 1

1.1.2. Importance of access to financial services. ............................................................... 2

1.1.3. Definition of Microfinance ....................................................................................... 3

1.1.4. Microfinance regulation and supervision for enhancing financial inclusion ............ 4

1.2 PROBLEM STATEMENT .............................................................................................. 5

1.3 JUSTIFICATION AND SCOPE OF THE STUDY ........................................................ 7

1.4 HYPOTHESIS OF THE STUDY .................................................................................... 8

1.5 OBJECTIVES OF THE STUDY ..................................................................................... 8

1.6 ORGANISATION OF REMAINING CHAPTERS ........................................................ 9

CHAPTER TWO: LITERATURE REVIEW ON MICROFINANCE ......................................... 10

2.1 INTRODUCTION .......................................................................................................... 10

2.2 HISTORY OF MICROFINANCE ................................................................................. 10

2.3 TRANSFORMATION OF MICROFINANCE ENTITIES INTO REGULATED

STATUS ........................................................................................................................ 12

2.3.1 Definition of Transformation .................................................................................. 12

2.3.2 Motivation for Transformation ............................................................................... 13

2.3.3 Advantages and Disadvantages of Transformation ................................................ 14

2.3.4 Considerations for ease of entry or transformation of unregulated entities into

regulated status ....................................................................................................... 15

2.4 MICROFINANCE REGULATION AND SUPERVISION .......................................... 17

2.4.1 Definition of Regulation and Supervision .............................................................. 18

2.4.2 Rationale for Regulation and Supervision .............................................................. 18

2.4.3 Arguments regarding Microfinance Regulation and Supervision .......................... 20

2.4.4 Appropriate Regulation and Supervision for Microfinance .................................... 21

2.4.5 Key approaches for microfinance regulation .......................................................... 25

2.4.6 Prudential vs. Non-Prudential Regulation .............................................................. 27

2.5 CONCLUSION .............................................................................................................. 29

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CHAPTER THREE: RESEARCH DESIGN AND METHODOLOGY ...................................... 31

3.1 INTRODUCTION .......................................................................................................... 31

3.2 RESEARCH DESIGN ................................................................................................... 31

3.3 RESEARCH METHODOLOGY ................................................................................... 32

3.3.1 Literature Review and Expert Discussions on Microfinance within the EAC ....... 32

3.3.2 Data collection ........................................................................................................ 33

3.3.3 The Sample ............................................................................................................. 36

3.3.4 Data analysis ........................................................................................................... 36

3.2 CONCLUSION .............................................................................................................. 37

CHAPTER FOUR: MICROFINANCE IN THE EAST AFRICAN COMMUNITY .................. 38

4.1 INTRODUCTION .......................................................................................................... 38

4.2 HIGHLIGHTS ON MICROFINANCE LAWS IN THE EAC ...................................... 38

4.2.1 Burundi ................................................................................................................... 38

4.2.2 Kenya ...................................................................................................................... 41

4.2.3 Rwanda ................................................................................................................... 43

4.2.4 Tanzania .................................................................................................................. 47

4.2.5 Uganda .................................................................................................................... 50

4.3 COMPARISONS OF MICROFINANCE LEGISLATIONS IN THE EAC ................. 53

4.3.1 Definitions of microfinance in the EAC ................................................................. 53

4.3.2 Capital Requirements .............................................................................................. 54

4.3.3 Ownership/Shareholding Requirements ................................................................. 55

4.3.4 Insider Lending Limits ............................................................................................ 57

4.3.5 Credit exposure limits ............................................................................................. 58

4.4. LICENSING REQUIREMENTS AND PROCESSES .................................................. 59

4.5. CONCLUSION .............................................................................................................. 61

CHAPTER FIVE: DATA ANALYSIS, PRESENTATION AND INTERPRETATION ............ 62

5.1 INTRODUCTION .......................................................................................................... 62

5.2 DESCRIPTIVE STATISTICS ....................................................................................... 62

5.2.1 Summary of MFI and MFAs by country ................................................................ 63

5.2.2 Summary of General/Demographic characteristics of MFAs and MFIs ............... 63

5.3 KEY FINDINGS ............................................................................................................ 64

5.3.1 Profile of MFA respondents.................................................................................... 64

5.4 REASONS FOR ENTRY OR TRANSFORMATION INTO REGULATED DEPOSIT

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TAKING MFIS ............................................................................................................... 68

5.5 IMPEDIMENTS TO ENTRY OR TRANSFORMATION INTO REGULATED

DEPOSIT TAKING MFIS ............................................................................................. 70

5.6 CONSIDERATION FOR ENTRY OR TRANSFORMATION INTO REGULATED

DEPOSIT TAKING ....................................................................................................... 72

5.7 OWNERSHIP AND SHAREHOLDING REQUIREMENTS ....................................... 74

5.7.1 Breakdown of ownership and shareholding requirements ...................................... 74

5.7.2 Existence of shareholders/owners exceeding stipulated limits ............................... 74

5.7.3 Ease of effecting the necessary changes ................................................................. 75

5.7.4 Challenges regarding minimum ownership and shareholding requirements .......... 76

5.8 CAPITAL REQUIREMENTS ....................................................................................... 77

5.8.1 Ease or difficulty in meeting minimum capital requirements ................................. 77

5.9 OTHER LICENSING REQUIREMENTS..................................................................... 79

5.9.1 Constituting a Board of Directors ........................................................................... 79

5.9.2 Recruiting qualified management team .................................................................. 80

5.9.3 Raising funds for entry or transformation into regulated status ............................. 81

5.9.4 Preparing Feasibility Study or Business Plan ......................................................... 83

5.9.5 Setting up requisite premises .................................................................................. 84

5.9.6 Developing a suitable MIS and reporting system ................................................... 85

5.9.7 Length of the licensing process............................................................................... 87

5.9.8 Ideal time frame and process in obtaining a licence from the Central Bank .......... 89

5.9.9 Impeding non licensing requirements ..................................................................... 91

5.9.10 Impeding non-regulatory considerations ................................................................ 91

5.10 DISCUSSIONS AND INTEPRETATIONS .............................................................. 92

5.10.1 Motivations and Benefits of Transformation .......................................................... 92

5.10.2 Licensing and regulatory requirements and considerations .................................... 93

5.10.3 Cost of Transformation. .......................................................................................... 93

5.10.4 Inhibitive regulatory requirements .......................................................................... 94

5.10.5 Ownership and shareholding requirements ............................................................. 95

5.10.6 Capital Requirements .............................................................................................. 95

5.11 NON-LICENSING AND REGULATORY REQUIREMENTS AND

CONSIDERATIONS .................................................................................................. 96

5.12 CONCLUSIONS ........................................................................................................ 97

CHAPTER SIX: CONCLUSION AND POLICY RECOMMENDATIONS .............................. 98

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6.1 CONCLUSION .............................................................................................................. 98

6.2 ENABLING LEGAL AND REGULATORY FRAMEWORKS .................................. 98

6.3 APPROPRIATE LEGAL AND REGULATORY FRAMEWORKS ............................ 99

6.4 LICENSING AND REGULATORY REQUIREMENTS ............................................. 99

6.4.1 Cost sharing mechanisms ...................................................................................... 100

6.4.2 Inhibitive regulatory requirements. ....................................................................... 100

6.4.3 Ownership and shareholding requirements ........................................................... 101

6.5 NON-LICENSING AND REGULATORY REQUIREMENTS AND

CONSIDERATIONS .............................................................................................................. 102

6.5.1 Non-licensing requirements and considerations ................................................... 102

6.5.2 Non-regulatory requirements and considerations ................................................. 102

6.5.3 Peer Learning Mechanisms ................................................................................... 102

REFERENCES ........................................................................................................................... 104

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ACKNOWLEDGEMENTS

First and foremost, I would like to thank my God for His Love, Favour and unmerited Grace,

through which I would not have been able to complete this paper (MHIG). I thank my parents

and siblings, Caroline Mbinya, Denis Kaka and my late younger brother Victor Kyalo, for their

patience and the moral support and constant encouragement they accorded me as I finalised my

technical paper. They believed with, and in, me and have been there for me through this journey.

I thank my colleagues and friends from Central Bank of Kenya for their moral support as well as

support in reviewing the paper. Special thanks to Dr. Shem Ouma, John Mahasi, Mr. Daniel

Tallam, Joash Rono, Martin Gitu, Nsinazo Warrakah, Margaret Ndehi, Eric Mutai, John Kaloki,

Barako Galgalo, Peter Njuguna (SASRA), Kelevilin Kimathi and Elizabeth Onyonka. I also

thank my colleagues from the EAC Central Banks for their unwavering support and cooperation

as I sought information from them. In particular I thank Augustine Mwanje and Hannington

Wasswa (Bank of Uganda), Kavugizo Kévin, Jean Damascène Serugero, Phillip Nsenga and

Agathe Nyinawinkindi (National Bank of Rwanda), Hinaya Dimoso, Victor Tarimu, Peter

Mmari and Nangi Massawe (Bank of Tanzania), Innocent Ndabarushimana and Emmanuel

Niyonkuru (Bank of the Republic of Burundi).

I thank all the respondents from the microfinance associations (MFAs) and microfinance

institutions (MFIs) in the EAC for their cooperation in providing responses to the questions and

subsequent queries. I also thank the various microfinance practitioners I interacted with for the

cooperation and support. I especially thank Cyprien Ndayishimiye, Réseau des Institutions de

Microfinance au Burundi; Benjamin Nkungi and Caroline Karanja, Association of Microfinance

Institutions (AMFI); Joel Mwakitalu, Tanzania Association of Microfinance Institutions; Rita

Ngarambe and Peter Rwema, Association of Microfinance Institutions of Rwanda; David

Baguma and Robert Ntalaka, Association of Microfinance Institutions of Uganda; Nicodeme

Niyongabo, Twitezimbere Microfinance Burundi; Peter Mugendi, KADET Ltd, World Vision,

Kenya; John Kariuki, AAR Credit Services Ltd; Samuel Deya, Adok Timo Ltd.; Pauline

Githugu, Century DTM Ltd; Diane Uwimbabazi, Reseau InterDiocesain de Microfinance; Daniel

Mugisha, Amasezerano Community Banking; Anthony Nderitu, Rwanda Microfinance Limited;

Shimi Ntuyabaliwe, Pride Tanzania Limited; Annette Kanora, EFC Tanzania M.F.C. Limited;

Edward Kiyaga and Stephen Nnawuba, Mednet World Vision, Uganda; Abul Kashem

Mozumder, Saiful Islam Khan Nahid and Munshi Sulaiman, BRAC Uganda; 'Irene

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Mwoyogwona, Apollo Taremwa and Joel Masembe, Pride Microfinance (MDI); Gloria

Havyarimana, Kazoza Finance and Paul Kihiu, Select Microfinance Ltd.

I thank my friends who encouraged and supported me towards the finalisation of the paper. In

particular, I thank Pastor Simon Mwangi, Peace Niyibizi, Denis Muganga (Ministry of Finance),

Steven Chege, John Mutua, Tom Onyango, Anne Musyoki, Djibril Mbengue and Denise Dias

(CGAP), Eric Wafukho and Francis Mukusa (for assistance in translation). I also thank all

friends who supported and prayed with me. Last but not least, I thank the Macroeconomic and

Financial Management Institute of Eastern and Southern Africa (MEFMI) secretariat for

according me this opportunity to grow and learn through the MEFMI candidate fellows program.

I thank my mentor, Dr. Chiara Chiumya, for taking time to comprehensively critique the paper

and provide valuable guidance towards its completion. I also thank fellow MEFMI colleagues

Lekinyi Mollel, Ivan Ssetimba, Bob Takavingofa, Cappitus Chironga and Sylvester Kabwe for

their moral support and assistance.

Without all of you, I might never have been able to make it this far. I appreciate you all.

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ABSTRACT

About 2.5 billion adults, representing over half of the world’s adult population, have no access to

formal financial services to increase their incomes and improve their lives. Among them, 1.1

billion live on less than one dollar a day. While access to financial services is skewed in

developing nations, its importance cannot be overemphasized. Various reasons have been

advanced to explain the motivations for entry or transformation of microfinance entities into

licensed and regulated deposit taking microfinance institutions (MFIs) in developing nations.

However, it is noted that the pace at which MFIs in the East African Community (EAC) are

being licensed to mobilise deposits for on-lending purposes is rather slow. It is not clear whether,

and what provisions in, the EAC microfinance legislations impede or bar the entry or

transformation of MFIs into regulated status, or whether the slow pace or licensing deposit

taking MFIs is attributed to external impediments. Establishing the impediments is necessary if

they are to be avoided, as this will then make it possible to undertake necessary regulatory and

legislative reforms to facilitate the increased licensing of MFIs to enable them expand safe

financial inclusion.

The objective of this study was to establish whether there were any regulatory barriers that

impeded the entry or transformation of unregulated microfinance entities into regulated status

under the specific microfinance legislations in the EAC. In order to determine this, it was

necessary to establish why new or existing microfinance entities in the EAC are not increasingly

seeking to be licensed, regulated and supervised as deposit taking MFIs under the different

microfinance legal and regulatory frameworks in the EAC member countries. The methodology

of study of this research involved the use of literature review, secondary data collection and

administering of questionnaires to Microfinance Associations (MFAs) and MFIs within the EAC

member countries.

The findings of the research and literature review based on studies and surveys conducted in

several developing nations in Latin America, Asia and Africa indicate that indeed there are

motivations and benefits of entry and transforming into regulated deposit taking. Entities seek to

transform into licensed and regulated financial institutions in order to access diversified

commercial sources of funds, including voluntary savings, to fund growth and outreach; provide

a wider range of services, including savings; comply with legal requirements and ultimately

increase long-term development impact. Essentially, the regulation and supervision of deposit

taking microfinance leads to the ultimate goal of expanding outreach sustainably. The findings of

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the research study have corroborated this but have also established there are a number of

impediments that deter or slow entities from seeking entry or transformation into regulated

status, including the cost of transformation, inhibitive regulatory requirements and ownership

and shareholding requirements, among others. To continue to enable the entry or transformation

of entities and address the impediments and barriers of entry or transformation into regulated

status, the following policy recommendations are proposed.

On policy recommendations, the study proposes that there is need for EAC regulators to

continually adjust existing, or formulate clear and appropriate microfinance legislation to provide

appropriate and relevant provisions that create an enabling environment for ease of entry and

transformation. In addition, there is need for EAC regulators to revise the microfinance licensing

procedures and other inhibitive regulatory requirements in order to increase entry and

transformation of MFIs into the deposit taking regulated environment. Further, regulators in the

EAC should embrace financial innovations that make it possible to reduce costs of setting up

business for regulated deposit taking MFI. Enabling the use of alternative places of business and

allowing the sharing of the MIS and other infrastructure are some of the avenues that may be

explored by regulators to reduce costs of transformation for MFIs. Lastly, regulators in the EAC,

as well as other MEFMI member countries should develop a peer learning and networking

mechanism to share experiences and knowledge on regulatory and supervisory best practices

with the aim of improving the various microfinance regulatory and supervisory regimes in the

specific countries.

 

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CHAPTER ONE: INTRODUCTION

1.1 BACKGROUND OF THE STUDY

1.1.1. State of Financial Inclusion/Exclusion.

About 2.5 billion adults, representing over half of the world’s adult population, have no access to

formal financial services to increase their incomes and improve their lives. Among them, 1.1

billion live on less than one dollar a day (Alberto et al. 2009; Collins et al. 2009). Collier (2007,

p.3) reinforced this position in his book “The Bottom Billion”. He argued that ‘for the last forty

years the development challenge has been a rich world of one billion people facing a poor world

of five billion people’. Amongst the poor, one billion people, referred to as ‘the Bottom Billion’,

are considered the world’s poorest. One might conclude from a simple analysis of these statistics

that not all people lacking access to formal financial services are poor but all who are poor have

no access to formal financial services.

Chaia et al. (2009) further noted that the greatest concentration of un-served adults,

approximately 1.5 billion, resided in East and South Asia while in Sub Saharan Africa (SSA),

80% of the adult population, approximately 325 million people, was un-served. Recent surveys

in ten African countries, Mozambique, Tanzania, Rwanda, Zambia, Malawi, Nigeria, Kenya,

Botswana, Namibia and South Africa established that apart from South Africa, Namibia and

Botswana, the adult populace accessing formal financial services in these countries was quite

low, at less than 40% of the population (FinScope Zambia 2009; FinAccess 2009). The survey

also revealed that slightly over half of the adult population on average (50.7%) was excluded

from accessing any financial services (Figure 1.1).

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Figure 1.1: Financial Access in selected African Countries

Source: FinScope Zambia (2009) and FinAccess (2009)

The major causes of financial exclusion identified in these surveys included: lack of physical

access to financial service providers; lack of traditional or conventional collateral which formal

financial institutions demanded as a guarantee to loans; low levels of education required for the

effective understanding of products and services; and cultural, religious and social barriers that

inhibited some groups (including women) from participating in financial transactions and

financial decision making (FinScope 2008, 2009; FinAccess 2009).

With so many people lacking access to finance and facing poverty, it is clear that there is great

demand and need for increased access to appropriate financial services for the large un-banked

populaces across the globe. This is particularly true of developing economies in Africa, Asia and

Latin America where nearly 90% of the world’s unbanked adults live (Alberto et al. 2009). It is

no wonder that considerable energy and resources have been devoted towards enhancing broad-

based financial access and reducing poverty using a number of innovative models and policy

solutions; one of the most critical being microfinance (Pande et al. 2010). Given the mounting

evidence that access to financial services can make a positive difference in the lives of the poor

(Robinson 2001; Cull et al, 2009; Helms, 2006), the expansion of financial inclusion must

remain core in the development agenda for policy makers globally.

1.1.2. Importance of access to financial services.

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While access to financial services is skewed in developing nations, its importance cannot be over

emphasized. Access to basic financial services, particularly for the poor, can be a critical

ingredient in reducing poverty (Helm 2006; Pande et al. 2010). Access to financial services

enables poor and low income individuals and households to tap into income generating

opportunities that enable them to raise their per capita income and wealth. As a result of the

improved incomes, they are able to rise out of poverty. Access to finance also assists generate

self employment opportunities for the poor (Ledgerwood 1998) and allows them to smooth

consumption, reduce vulnerability to economic shocks, raise productivity, obtain higher returns

on investments and improve quality of their lives (Helm 2006; Dupas & Robinson 2009).

Indeed the provision of financial services, and particularly microfinance, plays a critical role as

mentioned above. It is for this reason that a number of developing countries in the last ten years

have introduced new tiers of legislation to create and integrate specialised microfinance

institutions into their formal financial systems in order to enhance access to financial services to

those excluded from accessing formal financial services (Porteous, Collins & Abrams 2010, p.3).

1.1.3. Definition of Microfinance

A number of definitions have been proposed to define microfinance by different authors. For

instance, Ledgerwood and White (2006, p.30) and Otero (1999, p.8) define microfinance as the

provision of financial services to low income and poor individuals and households that do not

have access to formal financial institutions. Helms (2006, p.1), on the other hand, defines

microfinance simply as the provision of ‘financial services for the poor’. These financial services

generally include savings and credit but may also include a wider range of financial services

such as insurance and payment services (Ledgerwood 1998). Christen et al. (2011) further

suggest that microfinance is the provision of formal financial services to the poor and low-

income people as well as to those that are systemically excluded from the financial system. This

essentially includes individuals and households that are not necessarily poor yet have been

excluded from accessing formal financial services for one reason or another. Christen et al (2011,

p.10) also propose that the vision of enhancing access to financial services is broadening from

being regarded as ‘microfinance’ to ‘financial inclusion’ defined as “the policy goal of reaching

all financially excluded households with a full range of responsibly delivered, affordably priced

and reasonably convenient formal financial services.”

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While microfinance and microcredit are sometimes used interchangeably, there are clear

distinctions between the two terms. Microcredit is a component of microfinance in that it

primarily involves the provision of credit to the poor. Microfinance, on the other hand, is broader

as, in addition to the provision of credit, it involves the provision of a range of financial services

including savings, insurance, pensions and payment services (Christen et al. 2011). Porteous

(2009) argues that microfinance is differentiated from consumer credit; the key differences being

the profile of borrowers and the main usage of loan funds. He argues that while microfinance

serves low income and self employed clients who use loan funds for working capital for

microenterprises, consumer credit provides middle to high income consumers with credit

primarily for consumption purposes. However, given that money is fungible, it would not be

prudent to assume that microfinance loans are only channeled into microenterprises as working

capital. Often, funds intended for business are diverted to other uses for legitimate reasons, for

instance emergencies. Furthermore, it is a fact that the low income and poor do borrow for

consumption purposes and not necessarily just for investing in a microenterprise for working

capital (Christen et al. 2011).

Originally recognised for extending credit to poor and low-income earners, microfinance has

gained prominence over the last 30 years. The provision of microfinance is not confined to any

specialised or specific type of institution. It is estimated that there are thousands of MFIs

globally that offer a wide array of financial services and products to the poor and low income to

enhance financial inclusion (Christen et al. 2011). These institutions range from: formal

institutions under banking laws including commercial banks, agricultural banks, development

banks and non bank financial institutions; to semi-formal institutions, such as Non Governmental

Organisations (NGOs), member based Savings and Credit Associations (SACCOs) and

development programs; and informal institutions, such as rotating savings and credit associations

(ROSCAs), accumulating savings and credit associations (ASCAs) and self-help groups (Jansson

et al 2004; Siebel 1999). These MFIs, reaching hundreds of millions of clients globally and

achieving impressive repayment rates on loans, have empowered millions to work their way out

of poverty (Cull et al. 2009; Helms 2006, p.ix; Hulme & Moore 2006).

1.1.4. Microfinance regulation and supervision for enhancing financial inclusion

With the growth of microfinance, there is consensus that MFIs that mobilise public deposits for

on-lending should be prudentially regulated and supervised to enhance outreach while protecting

depositors and ensuring financial sector stability (Arun 2005; Staschen 1999). As a result, the

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regulation and supervision of the microfinance industry is one of the areas that has been

identified and prioritized as a key policy objective and reform agenda for enhancing financial

inclusion. Governments in a number of developing nations have thus extended the reach of

regulation and supervision to MFIs by undertaking institutional, regulatory and supervisory

reforms. These reforms have involved amending existing laws and regulations or enacting new

laws to open special windows for microfinance. The reforms have created an enabling

environment that allows unregulated MFIs to enter the formal financial system, increase

competition and enhance access to financial services (Porteous et al. 2010). In Sub-Saharan

Africa (SSA) all but three countries had legislations or regulations in place for microfinance by

the end of 2009. Twenty nine countries in the region had specialized microfinance laws1; five

countries were in the process of drafting specialised microfinance laws2; in fifteen countries,

MFIs fell under the broader banking or non banking financial institutions legislation3; and three

countries namely, Eritrea, Seychelles and Swaziland, had no legislation or regulatory framework

in place for microfinance (CGAP, 2010).

In the East African Community (EAC), all five member countries, Burundi, Kenya, Rwanda,

Uganda and Tanzania, have developed legislative and regulatory frameworks for microfinance.

In Tanzania, the regulation and supervision of MFIs falls under the broader banking legislation.

However Burundi, Kenya, Rwanda and Uganda have specialised microfinance laws in place

(CGAP, 2010). These laws have similarities and differences with regards to the definitions and

provisions therein as well as the approaches applied in regulating and supervising microfinance

business in the different EAC member countries.

1.2 PROBLEM STATEMENT

                                                            1 The 29 countries with specialised microfinance laws included: Burundi, CEMAC Countries (Cameroon, Central Africa Republic, Chad, Congo, Equatorial Guinea, and Gabon), Comoros, DRC, Djibouti, Ethiopia, The Gambia, Guinea, Kenya, Madagascar, Mauritania, Mozambique, Rwanda, Sudan, Uganda, WAEMU Countries (Benin, Burkina Faso, Cote d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo) and Zambia.  2 The five countries drafting specialised microfinance laws included: Cape Verde, Liberia, Malawi, Sierra Leone and Zimbabwe.  3 The 15 countries where MFIs implicitly or explicitly fall under the broader banking or non banking financial institutions legislation included: Angola, Botswana, Ghana, Lesotho, Liberia, Malawi, Mauritius, Namibia, Nigeria, Sao Tome, Sierra Leone, Somalia, South Africa, Tanzania and Zimbabwe  

6

 

Various reasons have been advanced to explain the motivations for entry or transformation of

microfinance entities into licensed and regulated deposit taking MFIs. Entities seek to enter or

transform into licensed and regulated financial institutions in order to access diversified

commercial sources of funds, including voluntary savings, to fund growth and outreach; provide

a wider range of services, including savings; comply with legal requirements and ultimately

increase long-term development impact (Rhyne 2002; Robinson 2004; Basel Committee on

Banking Supervision (BCBS) 2010; Christen et al. 2011). Lessons from a study of regulated

MFIs in Latin America showed that there are some benefits of regulating and supervising

microfinance, particularly associated with the expansion of reach of financial services. The

study, conducted by Accion International on seven of the largest regulated MFIs4 in Latin

America revealed that the MFIs had benefited from being regulated (Rhyne 2002). Six of the

seven institutions had transformed from NGOs to regulated institutions and realized the

following benefits: greater access to diverse sources of funds; enhanced outreach and service to

more low-income consumers; improved professionalism; enhanced range of products beyond

microcredit; and legitimacy in the financial sector (Robinson 2001; Rhyne 2002).

It is safe to assume that the same motivations and benefits of regulating microfinance are

applicable in the EAC context. However, only a few MFIs are licensed or regulated as deposit

taking MFIs. In Rwanda, Instruction Number 06/20025 was adopted to regulate the activities of

microfinance in 2002 and currently there are eleven licensed deposit taking MFI limited liability

companies that are regulated and supervised. In Burundi, the Microfinance legal and regulatory

framework (Decree Number.100/203) was enacted in July 2006 and, so far, there are eight

licensed deposit taking MFIs. In Kenya, since the implementation of the Microfinance Act, 2006

six deposit taking MFIs have been licensed to date. In Uganda, the Microfinance Deposit Taking

Institutions Act was enacted in 2003 and there are four deposit taking MFIs currently licensed. In

Tanzania, microfinance falls under the Banking and Financial Institutions Act, 2006 and

Microfinance Regulations, 2005. To date, only one deposit taking MFI has been licensed, having

been licensed in October 2011. It is observable that despite the introduction of microfinance

legislations and regulations to allow MFIs to take deposits and mainstream them into formal

                                                            4Institutions in the ACCION study include BancoSol (Bolivia), Banco Solidario (Ecuador), Caja Los Andes (Bolivia), Calpia (El Salvador), Compartamos (Mexico), Finsol (Honduras), and Mibanco (Peru). Three are commercial banks and four are non bank financial institutions and all but one, Banco Solidario, transformed from NGOs into regulated institution (Rhyne, 2002). 5 The term instruction is used in Rwanda to refer to Regulations or Guidelines 

7

 

financial systems in the EAC region, their uptake in terms of obtaining the required licences is

relatively low.

The slow pace at which MFIs in the EAC are being licensed to mobilise deposits for on-lending

purposes raises valid concerns and questions. It is not apparent why the microfinance legal and

regulatory frameworks in the EAC member countries are not attracting many licencees. In

particular, it is not clear whether and what provisions in the EAC microfinance legal and

regulatory frameworks impede or bar the entry of MFIs into regulated status. It is also unclear

whether the slow pace of licensing is because of external impediments that MFIs may be facing

outside the regulatory framework. An independent assessment was, therefore, necessary to

establish the impediments, internal or external, to the prevailing regulatory regimes in the EAC

region, particularly with regard to licensing deposit taking MFIs. Establishing the impediments is

necessary if they are to be avoided, as this will then make it possible to undertake necessary

regulatory and legislative reforms to facilitate the increased licensing of MFIs to enable them

expand safe financial inclusion.

1.3 JUSTIFICATION AND SCOPE OF THE STUDY

Comparative assessments have been carried out on microfinance models and regulatory

frameworks in different countries and regions across the globe. These include a study by Accion

International on seven institutions in Latin America to examine their experiences as supervised

entities (Rhyne, 2002); and studies of select countries by Iris Centre, covering Bolivia, Brazil,

Ethiopia, Ghana, Indonesia, Mexico, Peru, Philippines, South Africa, Uganda and the West

African Economic and Monetary Union (WAEMU) to assess the various aspects of microfinance

regulatory and supervisory frameworks (Meagher 2002; Meagher et al. 2006). These studies

have provided critical guidance and information on microfinance regulatory regimes in different

parts of the world. A comparative assessment of this nature to establish the regulatory barriers, if

any, that impede the entry of MFIs into regulated status in the EAC, is also quite a critical study

that is useful in generating information to guide policy reforms in the EAC and MEFMI member

countries. The outcome of this study will provide a better understanding of whether the

microfinance legal and regulatory frameworks in the EAC have appropriate provisions that

attract, or inappropriate and repressive provisions that deter, willing MFIs from acquiring

regulated status. This is very important for regulators to know so that they can ensure that

regulation and supervision of MFIs is not inappropriate or repressive. This knowledge is key in

preventing regulation and supervision practices that stifle the growth of the microfinance

8

 

industry (Gonzalez-Vega 1998) and limiting MFIs from enhancing financial inclusion (Cull et al

2008).

This study is timely because regulators in the EAC have committed to harmonising key financial

sector legislations, including the microfinance legal and regulatory frameworks, towards

promoting safe, sound, efficient and inclusive financial systems (African Development Bank

2010). In addition, the study will add to the field of research in the Macroeconomic and Financial

Management Institute of Eastern and Southern Africa (MEFMI). The study’s outcomes will also

be useful to regulators in MEFMI member countries as they endeavor to facilitate entry of new

and transforming MFIs into their formal financial systems.

There are various kinds of institutions offering microfinance. These range from: formal

institutions under banking laws including commercial banks, agricultural banks, development

banks and non bank financial institutions; to semi-formal institutions, such as NGOs, member

based SACCOs and development programs; and informal institutions, such as ROSCAs, ASCAs

and self-help groups (Jansson et al 2004; Siebel 1999). The research study will however focus on

the transformation of NGOs into regulated status as the primary focus of the study. This is

because given the diversity of institutional forms, the time and resources available to conduct the

study are not adequate to conduct a comprehensive review of all types of institution offering

microfinance services and products.

1.4 HYPOTHESIS OF THE STUDY

The study aims to test the hypothesis that ‘the microfinance legal and regulatory frameworks in

the EAC impede the entry or transformation of unregulated microfinance entities into regulated

status.

1.5 OBJECTIVES OF THE STUDY

The objective of this study is to establish whether there are any regulatory barriers that impede

the entry or transformation of unregulated microfinance entities into regulated status under the

specific microfinance legislations in the EAC. In order to determine this, it will be necessary to

establish why new or existing microfinance entities in the EAC are not increasingly seeking to be

licensed, regulated and supervised as deposit taking MFIs under the different microfinance legal

9

 

and regulatory frameworks in the EAC member countries. This will be done by addressing the

following research questions:

i. Do the microfinance legal and regulatory frameworks in the EAC impede the entry

or transformation of unregulated microfinance entities into regulated status?

ii. What are the specific licensing requirements that hinder entry or transformation of

deposit taking MFIs into the formal financial system in the EAC?

In order to answer the above research questions, it is necessary to carry out a comprehensive

assessment of the legal and regulatory frameworks in the EAC region. The assessment entails

a comparative review of the regulatory regimes for the regulation and supervision of

microfinance in the five EAC member countries, particularly focusing on the licensing

requirements and process. The review will identify key similarities and differences within the

microfinance regulatory regimes in the EAC member countries as well as identify key

challenges, opportunities and lessons to inform legal, regulatory and supervisory reforms to

spur licensing of MFIs in the EAC region.

1.6 ORGANISATION OF REMAINING CHAPTERS

To discuss study topic, the paper is organized as follows: Chapter 2 discusses the literature

on microfinance. It provides a brief history of the development of microfinance and a

summary of the debates around microfinance regulation and supervision. In this discussion,

the paper defines regulation and supervision, provides the rationale and arguments around

microfinance regulation and supervision and discusses the different approaches of regulating

and supervising MFIs. The chapter also discusses reasons why institutions seek to enter or

transform into regulated deposit taking MFIs. Chapter 3 provides the research methodology

used to meet the objectives of the research and discusses the findings of the research

regarding the research questions. It also provides information on the data collection tools and

methods and discusses how the data was analysed. In Chapter 4, a comparative assessment of

the microfinance regulatory frameworks in the EAC is discussed. Chapter 5 provides a

summary of the research findings, including concluding remarks and Chapter 6 provides

brief conclusions and policy recommendations.

 

10

 

CHAPTER TWO: LITERATURE REVIEW ON MICROFINANCE

2.1 INTRODUCTION

Although microfinance started with a primary focus on microcredit in many countries, it has

expanded to encompass the provision of a broader range of financial services including savings,

money transfer and insurance services (Ledgerwood 1998). In addition to financial services,

many MFIs also provide non-financial services, including training, marketing, managerial and

technical services (Christen et al. 2011; Helms 2006). With over 10,000 MFIs globally that offer

financial services to millions of poor and low income clients, microfinance has played, and

continues to play, a critical role in enhancing financial inclusion and promoting economic

development (Christen et al. 2011). With the rapid growth and development of microfinance, one

of the notable developments in the microfinance sector globally has been the regulation and

supervision of MFIs. Chapter Two discusses these developments. The chapter provides

highlights on the historical development of microfinance, the regulation and supervision of MFIs

and the topic of transformation of unregulated entities to regulated status. The chapter is

therefore arranged as follows: Section 2.2 briefly highlights of the history of microfinance.

Section 2.3 discusses the transformation of MFIs into regulated status while Section 2.4

discusses microfinance regulation and supervision including the rationale, arguments and

approaches of regulation and supervision.

2.2 HISTORY OF MICROFINANCE

Different writers suggest varied timelines regarding the history and development of microfinance

in various countries. For example, Leipold (2008) dates microfinance back to the 18th and 19th

centuries in Europe and as far back as the first millennium BC in India. Robinson (2001), on the

other hand, suggests that microfinance dates back to the 19th Century where it was practiced in

Europe and exported to various countries during colonial reign. Regardless of the timelines, the

different literature clearly shows that over the years the nature and forms of ‘providing financial

services to the poor’6 have changed and evolved.

In the 1950s, 1960s and 1970s, governments in many nations were heavily involved in the

initiation and sponsorship of heavily subsidised credit programs to serve poor households,

                                                            6 Definition of microfinance by Helms (2006, p.1). 

11

 

particularly in rural areas. These programs were however not successful. They were plagued by

high loan defaults, high losses and a general inability to reach the intended poor rural households

(Cull et al. 2009; Morduch 1999; Robinson 2001; Kirkpatrick & Maimbo 2002). Although the

intentions of these programs were noble, their administration was not well managed. Some of the

key deficiencies of the programs were: poor credit administration, management and follow-up

procedures as well as deficient financial reporting practices. With such inadequacies, these well

intentioned government subsidised credit programs proved too costly, inefficient and ineffective

in reaching the poor rural households as intended (Cull et al.2009).

The 1970s also represented a landmark in the history of microfinance. What is referred to as

‘modern microfinance’ began in the early 1970s in both Latin America and Asia (Chu 2007).

NGOs increasingly began to provide microfinance. One of the more momentous milestones in

the history of microfinance was in 1976 when Mohammed Yunus began his experimentation on

the Bangladeshi poor with the Grameen Model. The Grameen model soon became the new

model of microcredit and its founder the ‘prophet’ of the microcredit movement (Siebel 2005).

As a result, the Grameen model was widely adopted by many institutions across the globe

(Hashemi & Schuler 1997). This model focused on providing small loans to groups (and

individuals), using basic loan appraisal techniques and unique methods to motivate repayment.

The model established that, despite lack of collateral, the poor were capable of repaying loans if

provided with appropriate incentives (Kirkpatrick & Maimbo 2002, p.294).

In the 1980s, numerous institutions in developing nations were providing microfinance and

recovering their loans quite effectively. By the end of that decade, some of the thriving

institutions, including Grameen Bank7 in Bangladesh, Bank Rakyat Indonesia and BancoSol in

Bolivia, demonstrated that MFIs could reach millions of borrowers while maintaining very high

repayment rates (Robinson 2001). Also in the 1980s and 1990s, due to the growth of demand for

microfinance, there was a great push for MFIs to become profitable or at least financially

sustainable. This ‘microfinance revolution’ led to the introduction of commercial approaches to

financial intermediation for the poor and low income individuals and households (Robinson

2001; Helms 2006). One of the commercial approaches was the transformation of NGO MFIs to

regulated status as deposit taking MFIs. It was also in the 1990s that there was increased

                                                            7 The Grameen Bank, which is Bangladeshi for the “Village Bank”, became a financial institution in 1983 offering specialised financial services and informal banking to the rural poor as a result of the Grameen model experimentation (Hashemi and Schuler, 1997). 

12

 

attention given to the development of appropriate regulation and supervision for formalising

MFIs or integrating them into the formal financial system (Robinson 2001). 

In the last thirty years, although the market penetration of microfinance has been relatively small

compared with its potential, the microfinance industry has witnessed remarkable growth. MFIs

now reach well over 100 million clients and achieve impressive repayment rates on loans (Cull et

al. 2009). The Sub-Saharan Africa microfinance analysis and benchmarking report indicated that,

by the end of 2008, MFIs in Sub-Saharan Africa had 6.5 million borrowers and 16.5 million

depositors. It further reveals that MFIs in East Africa alone had over 3.5 million borrowers,

accounting for over half of the microfinance borrowers within Sub-Saharan Africa (CGAP &

MIX 2010).

2.3 TRANSFORMATION OF MICROFINANCE ENTITIES INTO REGULATED

STATUS

As indicated in the preceding section, the 1980s and 1990s saw an increase in the

commercialisation of microfinance. An increasing number of unregulated microfinance entities

sought to be more market driven, profitable and financially sustainable in order to sustain their

existence and enhance outreach (Robinson 2001; Helms 2006). This drive led to an increasing

number of NGO MFIs transforming into licensed and regulated financial institutions. Some of

the cases of successful transformations from NGOs into regulated financial institutions are

BancoSol in Bolivia, Mibanco in Peru, Compartamos in Mexico and Kenya Rural Enterprise

Program (KREP) in Kenya (Robinson 2004; Marulando & Otero 2005). Evidence from some of

these transformations show that, although quite costly, microfinance transformation allows

institutions to provide better services, improve access to commercial funding, and ultimately

increase outreach to clients (Helms 2006). The transformation of NGO MFIs into regulated

financial institutions is therefore viewed as one of the more effective strategies for achieving

significant scale sustainably (Campion and White 1999). The transformation of NGO MFIs into

regulated status is the focal strategy of the research study.

2.3.1 Definition of Transformation

While institutional or organisational transformation is broadly defined as a process of changing

an organisation’s context, principles, business processes or direction (Venkateswaran 2007),

microfinance transformation, specifically, is defined as a change of an MFI from one

13

 

organisational or institutional type to another (Christen et al. 2011). Given the diversity of the

types of institutions that serve microfinance clients, there are four key transformation strategies

that are said to facilitate the delivery of microfinance services (Siebel 1999). These include:

downscaling of regulated financial institutions to provide financial services for the poor and

serve the needs of the ‘micro-economy’; upgrading of non-formal8 financial institutions or ‘up

scaling’, which generally refers to the conversion of NGO MFIs into licensed and regulated

financial institutions; linking of formal and non-formal financial institutions to enhance

synergies; and establishing of new regulated financial institutions9 that are created exclusively to

provide microfinance services (Seibel 1999; Marulanda & Otero 2005). Whereas each of these

transformation strategies has unique dynamics that warrant in-depth discussion, the paper

focuses on the transformation or conversion of NGO MFIs into licensed and regulated financial

institutions; one of the more common transformation strategies (Christen et al. 2011).

2.3.2 Motivation for Transformation

Various reasons have been advanced to explain the motivations for transformation of

microfinance entities into licensed and regulated deposit taking MFIs. Although MFIs have had

diverse institutional forms over the years, many operate as NGOs with their subsistence hinged

on donor funds, grants and government subsidies (Leipold 2006). This is attributed to the notion

that NGOs are more inclined to advancing the social mission of alleviating poverty rather than

being profit driven (Leipold 2006). With increasing demand for financial services and in order to

support business growth and enhance operational capacity, these NGOs cannot rely purely on

donor funds or subsidies. These funds are not only unsustainable but they cannot sufficiently

meet the increasing funding needs of growing MFIs (Leipold 2006; Helms 2006). If this donor

funding was to completely cease, majority of these MFIs and their clients are likely to fail. In

order to reduce donor dependency, attain self sustainability, reach significant scale and enhance

outreach, MFIs need to mobilize savings and attract private capital (Seibel 1999; Robinson 2001;

Helms 2006; Christen et al. 2011). For this to happen, they seek to be regulated and supervised to

provide them these alternative avenues to raise funds, particularly voluntary savings (Chavez and

Gonzalez Vega 1993, p.21; Jansson &Wenner 1997, p.6; Staschen 1999, p.1).

In particular, entities seek to transform into licensed and regulated financial institutions in order

to access diversified commercial sources of funds, including voluntary savings, to fund growth                                                             8  This includes semiformal and informal financial institutions (Seibel 2006). 9   Newly established financial institutions that are created exclusively to provide microfinance services are also

referred to as “Greenfield” or start-up operations (Gallardo 2002). 

14

 

and outreach; provide a wider range of services, including savings; comply with legal

requirements and ultimately increase long-term development impact (Rhyne 2002; Robinson

2004; Basel Committee on Banking Supervision (BCBS) 2010; Christen et al. 2011). The goal of

transformation is presumed to lead to MFIs that can operate profitably on a large scale and

serving many clients sustainably (Robinson, 2004). It is argued that the MFIs that have the

largest and longest-term impact are those that are financially sustainable. To underscore this

observation, data from the MIX Africa Report (CGAP& MIX 2011) suggests that sustainable

institutions reach more clients than unsustainable ones, In SSA, particularly, regulated profit

making MFIs accounted for over 70 percent of the total gross loan portfolio and 71 percent of

total deposits in 2009; although they were much fewer in number than unregulated nonprofit

making ones (CGAP& MIX 2011).

In spite of these gains, transformation does not apply to all unregulated entities as the process of

transformation is rather difficult. Only strong and sustainable institutions with a good financial

record should strive to transform (Robinson 2004).

2.3.3 Advantages and Disadvantages of Transformation

The benefits of transformation are manifold. By being regulated, MFIs are able to diversify their

funding sources’, including mobilising deposits. This allows them to increase their capitalisation

in order to expand lending activities and decrease funding dependency (Rosengard 2000). They

are also able to grow in scale and scope, thereby reducing unit operational costs (Robinson

2004). Besides this, the process of regulation and supervision improves internal processes of

MFIs including governance, internal controls and operations as a result of high standards set for

compliance by their regulators (Rhyne 2002).

The transformation process is however extremely difficult and time-consuming and may present

some threats or challenges that may compromise the same goals for transforming (Rosengard

2000; Gallardo 2002; Robinson 2004). For instance, while the attainment of profitability and

financial sustainability is one of the core goals of transformation, it can lead to mission drift,

being a deviation from the institution’s mission and niche market (Rosengard 2000). Rosengard

(2000) argues that MFIs typically are guided by a common mission of alleviating poverty. Their

main focus therefore is to grant microloans to poor and low income clients to finance Micro and

Small Enterprises (MSEs). However, as an outcome of transformation some MFIs may be forced

to make larger loans to less poor clients to achieve economies of scale in the quest for continued

profitability and sustainability, hence deviating from its intended market.

15

 

Transformation can be made more difficult where legislation and regulations are inappropriate

and rigid (Rosengard 2000; Christen et al. 2011). Legislation and regulations whose provisions,

requirements and standards are not adapted appropriately to the microfinance industry are likely

to present regulatory obstacles that inhibit the entry and participation of new or transforming

entities in the regulatory space (Gallardo 2002). This point is a particularly important aspect of

this study in the case of the EAC. Despite the development of legal and regulatory frameworks,

transformation of MFIs has not been embraced widely in the EAC region; hence the need to

establish the fundamental reasons why the slow build up of licensed and regulated deposit taking

MFIs.

2.3.4 Considerations for ease of entry or transformation of unregulated entities

into regulated status

Considerations of ease of entry or transformation of unregulated entities to regulated status are

key to understanding barriers to entry of new entities or transformation of existing microfinance

entities into regulated status as deposit taking MFIs. The study carried out on seven transformed

institutions in Latin America mentioned previously (section 1.3) established that these

institutions were able to improve their operational structures and processes in areas such as

governance, internal controls, security standards and reporting capabilities as a result of

transformation. The transformation process however was found to be quite difficult, with the

most challenging aspect being the licensing requirements and processes. Not only was the

process extremely arduous, but it was also extremely long, with many of them taking up to two

years or more to complete the licensing process (Rhyne 2002). This is due to the stringent

regulatory requirements they were expected to meet prior to being licensed as regulated deposit

taking MFIs. Stringent regulatory requirements can, to a large extent, deter or inhibit entities

from entering or transforming into regulated status.

To facilitate the entry of new entities and the transformation of unregulated entities into licensed

and regulated deposit taking MFIs, regulators may need to adjust existing, or formulate clear and

appropriate microfinance legislation to create an enabling environment for ease of entry and

transformation (Rosengard 2000; Gallardo 2002; Christen et al. 2011). For instance, with regard

to the licensing requirements specifically, consideration may be put on specific provisions

relating to ownership requirements, capitalisation requirements, board and management

16

 

qualifications and cost of transformation to ensure that new and existing entities are enabled to

enter or transform into regulated status with less difficulty.

i). Ownership Requirements

Placing ownership and shareholding limits for single, group or related shareholders in deposit

taking MFIs is accepted as one of the prudent principles of good corporate governance (BCBS

2010; Christen et al. 2011). A number of NGOs tend to have amorphous ownership structures,

with the majority of them being ownerless (BCBS 2010; Christen et al. 2011). The Basel

Committee recommends that they should not be allowed to operate as deposit taking institutions.

This is a reasonable recommendation because without clear ownership, it would be difficult to

call on NGOs to recapitalise in the event that the institution is undercapitalised or facing a threat

of insolvency (BCBS 2010). Transforming NGOs, therefore, are expected by regulators to

comply with prescribed shareholding limits. This may present some challenges, especially where

new shareholders and strategic investors have to be sourced. For instance, the dilution of

ownership, where a NGO wholly owned the entity, may result in loss of control or influence of

original shareholders over the direction or mission of the business (Christen et al. 2011). Where

investors recruited are more profit driven than social mission driven, an MFI may face increased

risk of drifting from its social mission.

In addition to these concerns, very stringent shareholding and ownership limits are perceived to

be unattractive and may inhibit entry by promoters or applicants seeking licences to establish

deposit taking MFIs (Gallardo 2002). Regulators should provide clear standards for ownership

(BCBS 2010); and may provide a grace period for new and transforming entities to comply with

the ownership and shareholding limits. This would provide the transforming entities with

adequate time and opportunity to attract socially minded investors in order to avert the risks of

mission drift.

ii). Capitalisation Requirements

Minimum capitalisation requirements at entry into regulated status tend to be, and should be,

lower for regulated MFIs compared to commercial banks (Gallardo 2002; BCBS 2010). Capital

adequacy ratios, on the other hand, are higher for MFIs than for commercial banks. It is argued

that this is because of the risk that shareholders of regulated deposit taking MFIs may have

greater difficulty in raising resources if additional capital is required (Gallardo 2002). In some

17

 

instances, for example in Bolivia, raising the necessary capital is identified as one of the difficult

licensing requirements and thus most entities are heavily dependent on donors or private

investors for their survival (Hussein 2007). Regulators must therefore ensure that minimum

capital requirements are not too high to inhibit entry into regulated status or too low to attract

unviable candidates (BCBS 2010).

iii). Board and management qualification

Regulators must ensure that deposit taking MFIs have very strong corporate governance

standards (BCBS 2010). This includes having board members and critical management staff who

are competent and well qualified to provide adequate oversight and management of the financial

institution (Robinson 2004). In some cases, the board members and managers are expected to

have prior banking and finance experience. For transforming NGO MFIs, this is often not an

easy transition, and transformation thus can be a prolonged, expensive and difficult process

(Robinson 2004; Gallardo 2002). This is especially true where existing board members and

managers who served before the entity sought to transform did not have the minimum

qualifications required by the regulator (Rhyne 2002). Although this is an area that must not be

compromised, regulators may be flexible in allowing some of the board members and managers

to be assessed using alternative criteria, for instance specialised knowledge alongside the

adequacy of the board and management mix (Rhyne 2002).

i). Costs of Transformation.

Prudential regulation has cost implications on regulated institutions and their clients (Porteous,

Collins & Abrams 2010). The cost of transformation is one of the most common challenges of

transformation. Costs incurred during the transformation process cover investments to develop

policies, processes and infrastructure including management information systems (MIS),

recruiting and training staff and preparing of premises. These costs tend to be heavy and

prohibitive and may not be afforded by most MFIs (Robinson 2004). Regulators must therefore

embrace innovations that make it possible to reduce costs of setting up business as a regulated

entity. Enabling the use of alternative places of business and allowing the sharing of the MIS and

other infrastructure are some of the avenues that may be explored by regulators to reduce costs of

transformation for MFIs.

2.4 MICROFINANCE REGULATION AND SUPERVISION

18

 

The subject of whether or not to regulate and supervise MFIs has been one of the greatest

debates in the global microfinance sector. The key questions have been whether regulation is

really needed and, if this is the case, what are the best options to be employed without replicating

the practices in the formal financial sector (Arun 2005). Before delving deeper into the

arguments around this debate, it would serve well to discuss the definition of regulation and

supervision and the broad rationale for regulating and supervising the financial sector. Later this

section will highlight the key approaches for regulating and supervising the microfinance sector.

2.4.1 Definition of Regulation and Supervision

Regulation is defined by Chavez and Gonzalez-Vega (1993:1) as ‘a set of enforceable rules that

restrict or direct the actions of market participants, altering, as a result, the outcomes of those

actions’. Supervision, on the other hand, refers to the adoption of specific procedures to ensure

regulatory compliance. In short, regulation refers to the set of government rules while

supervision is the process of enforcing compliance with those rules (CGAP 2003). Regulation

and supervision are complementary functions whose key objectives are to protect depositors and

safeguard the safety and soundness of individual institutions and that of the financial system

(Chavez & Gonzalez-Vega 1993; Jansson & Wenner 1997; Staschen 1999; Arun 2005).

2.4.2 Rationale for Regulation and Supervision

Regulation and supervision are important policy instruments used to minimize the effects of

market failure or imperfect markets (Staschen 1999; Arun 2005). It is therefore important to

understand what causes market failures or imperfect markets. Two key reasons for market

failures are information asymmetry, where one party has less information than another, for

example when consumers are less informed than financial service providers (Llewellyn 1999),

and erosion of public confidence in the financial system (Staschen 1999).

a. Information Asymmetry

It is argued that with deposit taking business in the financial sector there sometimes tends to be

an asymmetric distribution of information between depositors and financial institutions leading

to divergent interests between the two parties (Jansson & Wenner 1997; Staschen 1999).

Regulation, therefore, aims to ensure that as much information is made available between the

19

 

depositor and financial institution’s to balance or harmonise their interests (Chavez & Gonzalez-

Vega 1993; Jansson & Wenner 1997).

For example, to increase shareholders returns, a financial institution may be inclined to

undertake excessive risks. While this may be beneficial to the institution, depositors and

creditors, on the other hand, are not likely to gain much and may suffer financial loss from

increased risk. Where depositors and creditors are unable to know and monitor the decisions of

financial institutions, financial institutions have an informational advantage over them (Arun

2005; Jansson & Wenner 1997). Lack of information prevents them from knowing the position

of shareholders and the risk profile of the financial institution as a guide to decision making. It is

also likely to result in a conflict of interest between shareholders and depositors (Jansson &

Wenner 1997). Therefore, regulation protects the interests of the depositors by ensuring that

there is proper and complete information disclosure by financial service providers (Jansson &

Wenner 1997; Staschen 1999).

b. Erosion of Public Confidence in the financial system.

The second key objective of regulation and supervision is to prevent the erosion of public

confidence in the financial system. Public confidence is critical to the success of any business

and particularly in the financial sector. It is argued that the failure of a single financial institution

can undermine the stability of the financial system as a whole (Chiumya 2006). Where an

institution fails, public confidence in the financial institution is quickly eroded, often eliciting a

chain reaction among clients. It may create panic leading to massive withdrawals of deposits by

clients (Chavez & Gonzalez-Vega 1993, p.7). The effect of a run on deposits10, described by

Staschen (1999, p.5) as the ‘herd instinct’, could affect even the most prudent and healthy

financial institution (Chavez & Gonzalez-Vega 1993). Further, due to the interconnectedness of

the financial system, the spillover effects of a failed institution could endanger the financial

system as a whole (Arun 2005). Regulation is therefore critical in safeguarding the safety and

soundness of the financial system by ensuring that there is no unwarranted run on a financial

institution that could result in a system-wide panic (Chavez & Gonzalez-Vega 1993).

As explained above, the core objectives for regulating and supervising microfinance activities

and institutions are the same as for other segments of the financial system, including commercial

                                                            10 Runs on deposits are sudden, massive, unexpected withdrawals that endanger prudent and imprudent institutions alike (Chavez/Gonzalez-Vega 1993:7) 

20

 

banks. The key principles and standards for regulating and supervising the microfinance sector,

however, are likely to be different from those for traditional formal banking and finance

institutions. This is because they must be adapted to the unique characteristics of the

microfinance sector (Staschen 1999:7; World Bank 2005).

2.4.3 Arguments regarding Microfinance Regulation and Supervision

The question of whether regulation and supervision is needed in the microfinance sector is a

critical one. Many theories and arguments have been advanced to explain the success and failure

in MFI regulation and supervision.

Wright (2000) argues that despite the gains of microfinance over the years, in terms of client

outreach and financial system deepening, MFIs have not achieved adequate market penetration

to pose any systemic risk to warrant regulation and supervision. In fact, the total value of assets

of MFIs is often relatively small compared to the system as a whole (Jansson & Wenner 1997).

Based on these arguments, one may conclude that failures of MFIs are not likely to have any

systemic effects. However, Arun (2005) argues that the failure of MFIs can have a bearing on

systemic risk if considered on the basis of their relationship with other institutions in the

financial sector. For instance, the financial failures in the microfinance sector could directly

affect commercial banks that lend wholesale credit to failed MFIs. This spillover effect could in

turn erode public confidence and have a negative impact on the financial system.

It has also been argued that the cost of regulating and supervising the microfinance sector far

exceeds the benefits (Arun 2005). A World Bank study carried out in Ghana established that the

supervision of rural and microfinance institutions (RMFIs) was rather costly in comparison to

their potential impact on the financial sector. The assets of RMFIs represented only 7% of the

total assets in Ghana’s financial sector, yet the costs of supervising them was costly relative to

their potential impact on the financial system (Steel & Andah 2003:2,29). Findings from a study

of twelve regulated institutions in Latin America (Theodore & Loubiere 2002, cited in Arun

2005), however, revealed that the benefits of regulation exceeded the costs of regulation.

From the foregoing, it is clear that the question of whether or not to regulate and supervise the

microfinance sector is determined by the peculiarities, including size, complexities and inherent

risks of specific MFIs and microfinance sectors across the globe. Given that an increasing

21

 

number of countries have developed regulatory frameworks for their microfinance sectors, we

may conclude that the merits of regulating and supervising microfinance surpass the demerits.

2.4.4 Appropriate Regulation and Supervision for Microfinance

When considering the regulation and supervision of MFIs, it is important to carefully consider

the distinct features and characteristics of MFIs and their clients as well as the various

institutional types or forms of MFIs. This will help determine how regulatory standards must be

customized to suit the unique nature of different MFIs.

a) Unique Characteristics of Microfinance Institutions

The regulatory environment created for deposit taking MFIs should be considered critically if

they are to develop and innovate. The general principles of regulating and supervising traditional

financial institutions11, for instance commercial banks, are usually not appropriate for MFIs as

MFIs, regardless of their institutional form; differ in several ways from traditional financial

institutions (Jansson & Wenner 2005). This is because microfinance has very distinct features

from commercial banking. Some of the differences between microfinance and commercial

banking have to do with client and loan features, lending methodology and institutional culture.

i). Client Features: MFIs typically serve low income households who may be informally or

self employed. More often than not, these clients do not have physical collateral to allow

them access traditional banking services (Jansson & Wenner 1997).

ii). Loan Features: Microfinance loans are usually small, short term and are subject to

shorter loan terms and more frequent repayments. These loans are usually unsecured due

to the fact that most clients do not have physical collateral. As a result, alternative

collateral, referred to as collateral substitutes, is used to secure the loans. Group

guarantees, joint liability and peer pressure are some of the forms of collateral substitutes

used (BCBS 2010).

iii). Lending Methodology: MFIs largely rely on group lending methodologies which

emphasise lending premised on character and the willingness of clients to repay due to

the unavailability of traditional collateral (BCBS 2010). Due to the nature of clients and

                                                            11 For purpose of this report, traditional financial institutions will refer to financial institutions in formal financial sector not engaged in microfinance, for instance commercial banks. 

22

 

required credit analysis prior to granting of loans, MFIs require minimal documentation

to appraise their clients and conduct labour intensive credit analysis.

iv). Institutional Culture: While commercial banks are driven primarily by profit making

goals, the majority of MFIs are guided by the social mission of alleviating poverty. Their

main focus, therefore, is to provide financial services to poor and low income clients to

finance MSEs and aid them out of poverty (Robinson 2001). However in order to be

sustainable, as has been discussed in this paper in previous sections, they must at the

same time seek to attain profitability. Consequently, they are driven by a dual mission of

alleviating poverty (social mission) while making profits.

Table 2.1 below illustrates key differences between MFIs and traditional financial institutions. It

compares the characteristics of the two using client features, loan features, lending methodology

and institutional culture as discussed above.

Table 2.1: Differences between features of MFIs and Traditional Financial Institutions

Microfinance Institution Traditional Financial Institution

Client

Features

i) Low income individuals and

households

ii) Informally or self employed

iii) Lack physical collateral

i) Middle to high income

ii) Self employed and employed

iii) Physical collateral

Loan

Features

i) Small loan amounts

ii) Shorter term loans

iii) Short repayment period

iv) Collateral substitutes

i) Medium to large loan amounts

ii) Longer term loans

iii) Longer repayment period

iv) Traditional/conventional collateral

Lending

Methodology

i) Character based

ii) Less documentation

iii) Labor intensive

i) Collateral based

ii) More documentation

iii) Less labor intensive

Institutional

Culture

i) Double bottom line – profit

making and social mission driven

i) Purely profit making

Source (Jansson& Wenner 1997, p. 9; Van Greuning et al. 1998, p. 4; Staschen 1999, p. 9)

In recognition of the unique characteristics of MFIs in comparison to traditional financial

institutions, regulators should attempt to understand the dynamics of the microfinance sector and

23

 

develop appropriate regulations to allow sufficient flexibility for their prudent growth and

development.

b) Different Institutional types of MFIs

According to Van Greuning et al. (1998), MFIs can be categorized across a continuum of three

broad types depending on their sources of funding. These sources of funding include: contributed

equity capital, donor funds, concessional commercial borrowings, members’ savings, wholesale

deposits from institutional investors and retail savings and deposits from the public. Each of the

three institutional categories requires specific regulatory approaches because each institution has

unique characteristics. Furthermore, each one faces different risks and threats which have a

bearing on the best regulatory framework to choose (Chavez &Gonzalez-Vega 1992, p.19f). The

three categories of MFIs according to Chavez and Gonzalez are as follows:

i) Category A - MFIs in this category are referred to as credit-only institutions. They

depend on ‘other people’s money’ to finance their lending business. These are mainly

NGOs whose sources of funds are primarily grants, donations and concessionary loans

from donors, although these funds may be supplemented by commercial bank loans or

commercial paper (Van Greuning et al. 1998). It is argued that the MFIs that depend on

donor grants, for instance, may be self-regulated or even remain unregulated; while those

that depend on commercial paper and certificates of deposit) may be regulated by

Companies’ Registry Agency, Bank Supervisory Authority or Securities and Exchange

Agency (Van Greuning et al. 1998; Staschen 1999; Wright 2002).

ii) Category B - MFIs in this category consist of member-based institutions which may be

registered on the basis of an open or closed common bond membership. They use

‘members’ money’ to grant loans exclusively or primarily to members, with more than

half of their total funding generated from members’ savings and share capital

contributions. Some examples of these MFIs include SACCOs, ROSCAs and ASCAs

(Van Greuning et al. 1998). MFIs that depend on members’ money may be regulated by

the Cooperatives’ Authority or Bank Supervisory Authority and are usually subject to no

prudential regulation. (Wright 2002, p.4)

iii) Category C - Comprises all MFIs that mobilise and use public deposits to finance their

lending business. These do not include financial institutions that employ forced savings

24

 

to secure their lending transactions as long as their clients are net borrowers (Staschen,

2005). They, however, include specialised banks or finance institutions authorised to

accept deposits from the public. These institutions should be regulated by the Bank

Supervisory Authority and subject to prudential guidelines and standards (Van Greuning

et al. 1998).

Table 2.2 below highlights the continuum of MFIs under the three broad categories and the

regulatory requirements for each.

Table 2.2: Microfinance Institutional Types and Approaches of Regulation

Institutional Type Possible Activities

requiring regulation

Resultant need for

external regulation

Proposed

Regulatory

Authority/ Agency

Category A - (other

people’s money) with

finance from donor

funds

Exploitation of borrowers;

opportunistic behaviour on

the part of the borrowers;

sector refinance sources

dependent on confidence

in sector

Conducive environment

(enhancing competition,

market transparency,

certainty in law.

No or Self-regulatory

Body

Category A – (other

people’s money) with

finance from

commercial loans or

securities issues)

In addition: wholesale

deposit taking with

possible harm to investors

through opportunistic

behavior

Investor protection through

incorporation, stock

exchange supervision and

rules

Hybrid or Self

Regulatory Body e.g.

Companies’ Registrar

or Securities and

Exchange Agency.

Category B –

(members’ money)

with finance from

member contributions

and deposits

Deposit taking from

members

Small, informal savings and

credit groups: no need for

regulation. Recommended:

registration as a cooperative

or RoSCA; compulsory

membership in association

Umbrella Body or

Cooperatives’

Authority.

Category C - public’s

money (savings

deposits)

Retail deposit taking

from general public with

danger of a run and

opportunistic behavior by

the MFI

Law tailored to specific

features of MFIs

Government or

hybrid

regulation, with

possible delegation

of supervision to a

private institution

Adapted from Staschen (1999: Table 3) and Van Greuning et al. (1999: Table 2)

25

 

2.4.5 Key approaches for microfinance regulation

Today, most developing countries regulate their microfinance sectors in one way or other. It is

important to note that not every regulation is appropriate. Repressive and inappropriate

regulation may be worse than no regulation at all (Gonzalez-Vega 2002). In this regard,

regulators must ensure that they apply the appropriate regulatory approaches to their

microfinance sectors. The regulation of MFIs can range from no regulation to full regulation,

either through an existing regulatory framework or by modifying the existing regulatory

requirements to suit the unique characteristics of MFIs (Van Greuning, 1998: iv). There are five

broad approaches of regulating MFIs: no regulation, self-regulation, hybrid regulation, regulation

by existing banking laws and the regulation by special MFI laws (Greuning et al. 1998;

Berenbach et al. 1998; Staschen 1999; Christen & Rosenberg 2000).

a) No Regulation

As discussed above [section 2.4.4(b)], most category A MFIs, which use grants and concessional

loans to lend, may not be prudentially regulated. The high cost of regulating these MFIs relative

to benefits, the limited risk or threat to the overall stability of the financial system are some of

the reasons why it is advocated that category A are best left unregulated (Arun 2005; Steel &

Andah 2003). Wright (2002) argues that in some cases, having no regulation is conducive for

growth and innovation. This was the case in Bangladesh where the lack of regulation is claimed

to have produced an innovative and strong microcredit industry. However, it can also be argued

that all MFIs need some form of regulation, be it self-regulation, existing regulation or special

regulation, if the microfinance industry is to develop more holistically (Kirkpatrick & Maimbo,

2002).

b) Self-regulation

With self-regulation, the regulation and supervision of MFIs is conducted without recourse to a

regulatory authority. The primary responsibility for monitoring and enforcing regulation lies

within the MFI or an apex (umbrella) body (Staschen 1999). The umbrella body lays down the

regulatory rules or codes of conduct, specifying minimum standards for the industry, and

supervises compliance (Kirkpatrick & Maimbo 2002; Staschen 2009). In this regulatory

approach, onsite inspection is not conducted but rather institutions are expected to publish

information which is reviewed to ensure compliance (Staschen, 2009). Self regulation is a cost-

26

 

effective mechanism that may be appropriate for relatively smaller MFIs or in a microfinance

industry still in its infancy. However, as the industry grows, this approach is unlikely to succeed

because of the increased diversity in size, scale of operations, objectives and resources of the

various MFIs (Kirkpatrick/Maimbo, 2002).

c) Hybrid approach

The hybrid approach of regulation and supervision is a blended approach where the regulator

maintains legal responsibility of supervised MFIs but delegates regular monitoring and on-site

inspections to a different agency (Arun 2005). This agency could be a consulting firm, an apex

association or an independent entity with relevant expertise. With this approach, the regulatory

authority determines the standards that MFIs must comply with, but may contract a third party to

monitor compliance to those standards. For example, to ensure compliance with financial

reporting standards, the regulator could contract an accounting firm to conduct routine financial

audits of MFIs (Wright, 2002). This is a useful approach where supervisors do not have the

interest or adequate capacity and capabilities to regulate MFIs.

d) Use of existing banking law

This regulatory approach is premised on the assumption that MFIs are doing bank-type business,

that is financial intermediation12 and should be subject to existing banking legislation and

government banking supervision, just like all other financial institutions (Staschen 1999). With

this approach, the same legal regulatory rules apply for MFIs as for traditional banking

institutions. The approach was common in the early days of regulating MFIs because most

developing countries lacked specific regulatory framework for MFIs and did not allow them as

unregulated institutions to mobilize savings from the general public. So the only choice open to

MFIs was to continue as credit-only institutions or meet the requirements of banking legislation

(Staschen 1999). There are a number of MFIs which applied for a standard banking licence to

carry out microfinance business, such as BRAC in Bangladesh and KREP in Kenya (Wright

2002).

This approach has high costs associated with it. Compliance with bank regulations may require

significant changes in the organisational structure of an MFI, and the additional reporting

                                                            12  Mobilising public deposits and granting loans 

27

 

requirements may lead to an increase in operational costs (Kirkpatrick & Maimbo 2002).

Further, it does not accommodate the unique characteristics of MFIs. Some rules that are

applicable to banking institutions should not apply to microfinance at all. For instance, in the

formal financial sector, at times of distress, regulators can instruct commercial banks to stop

lending without affecting the debt collection process. However, in the microfinance sector, an

action of this nature would seriously affect the repayment of outstanding loans. (Arun 2005:

351). This is because relationships between microfinance providers and their clients are based on

trust. If at any one point, an MFI fails to provide services to its clients, the client in turn does not

feel obligated to repay any outstanding loans they may have.

e) Special microfinance law

With this regulatory approach a special legal framework is set up for MFIs taking into account

their unique features (Staschen 1999). This approach is one of the more ideal ones because

special microfinance laws or regulations allow MFIs to maintain their distinct characteristics

while providing a specified range of financial services without necessarily becoming banks.

Kirk and Maimbo (2002), argue that this approach may not be ideal because it has the potential

to create an imbalance in the treatment of other deposit-taking institutions in the financial system

because of the reduced capital requirements. However this approach allows specialised

institutions to enter into regulated status with lower entry requirements to provide much needed

financial services to clients safely and sustainably. This is in line with the objectives of financial

inclusion which are to have a variety of financial institutions serving as many people that need

financial services as possible. With this approach, supervision may be carried out by an existing

regulatory authority or by delegating the supervisory task to a competent independent institution

(Staschen 1999).

2.4.6 Prudential vs. Non-Prudential Regulation

In the literature of microfinance regulation and supervision, a distinction is also made between

prudential and non prudential regulation (Staschen 2003; Arun 2005; Christen et al. 2011). The

discussion below provides distinctions between the two.

a) Prudential regulation

28

 

Prudential regulation can be defined as public sector regulation to ensure the safety and

soundness of financial institutions in the interest of protecting depositors. It involves government

overseeing the financial soundness of deposit taking financial institutions (Staschen 2003;

Christen et al. 2011). The regulatory authority not only monitors performance, but also ensures

the safety and soundness of financial institutions, intervening in their management if the

financial health of the institution is compromised.

Prudential regulation establishes and enforces minimum standards for doing deposit taking

business in areas such as licensing, corporate governance, permissible activities, capital,

liquidity, financial reporting, internal controls, risk management and supervisory requirements,

among others (Arun 2005; Porteous, Collins & Abrams 2010). By setting these minimum

standards, regulatory authorities are able to establish standards for entry into deposit taking

business and enforce prudent management of existing institutions (Porteous, Collins & Abrams

2010).

b) Non prudential regulation

Non-prudential regulation, also referred to as “conduct of business” regulation, does not entail

the assessment and monitoring of the financial health of a regulated MFI by a regulatory

authority. Rather it establishes rules and guidelines about appropriate behaviour and business

practices and monitors the performance of financial institutions in relation to these rules

(Staschen 2003; Christen et al. 2011). Non prudential regulation focuses on three main types of

objectives: (i) protecting consumers of financial services, (ii) creating an enabling environment

to foster the participation of a diverse range of institutions that provide appropriate products and

services, and (iii) providing governments with information to carry out economic, financial, and

criminal enforcement policy (Christen et al. 2011). A non-prudential regulator can be a

government agency, or a private institution such as a federation, a network or an apex institution

that is essentially controlled by the regulated institutions themselves (Staschen, 2003).

It is important to note that the costs and benefits of different regulatory approaches are an

important criterion when deciding the most appropriate approach to regulate financial

institutions. For instance, because prudential regulation is usually more complex, difficult, and

expensive than nonprudential regulation, it should only be applied to deposit taking financial

institutions that fund their operations with deposits from the public (Wright 2002; Staschen

2003; Arun 2005; Christen et al. 2011).

29

 

2.5 CONCLUSION

Chapter Two provided highlights on the historical development of microfinance. It highlighted

the different phases and practices of microfinance in several countries across the globe, which

according to Leipold (2008) dated as far back as first millennium BC in India. Section 2.3 further

discussed the different practices in the provision of microfinance services over the years.

Regardless of the varied timelines proposed by different authors, it was clearly demonstrated that

over the years the nature and forms of ‘providing financial services to the poor’13 had changed

and evolved. Indeed, microfinance has evolved from being primary concerned with providing

only credit services to a full suite of appropriate financial services for the poor, with MFIs now

serving millions of clients worldwide.

Section 2.3 discussed the transformation of MFIs into regulated status. The section discussed the

definition of transformation, and discussed the four key transformation strategies that are said to

facilitate the delivery of microfinance services. The section then focused primarily on the

transformation of NGOs into regulated deposit taking MFIs. The paper went on to discuss the

motivations for transformation which ultimately are: reducing donor dependency, attaining self

sustainability, reaching significant scale and enhancing outreach. Besides this, the advantages

and disadvantages of transformation were discussed, highlighting that although the

transformation process is quite difficult and time-consuming, there are benefits to it. These

benefits are closely linked to the motivations for transformation. Further the section discussed

factors that needed to be considered to ease entry or transformation of unregulated entities into

regulated status. The specific factors discussed included: ownership requirements, capitalisation

requirements, board and management qualifications and cost of transformation. From the

discussions, it was clear that regulators have a key role in facilitating ease in entry and

transformation by ensuring microfinance laws and regulations, and particularly entry

requirements are appropriate for entities seeking to be licensed as deposit taking MFIs.

The final section, section 2.4 specifically discussed microfinance regulation and supervision

including the definitions, rationale, arguments and approaches of regulation and supervision. The

subject of whether or not to regulate and supervise MFIs was discussed and it was clear that

regulation and supervision was necessary for MFIs, however the approaches should be

                                                            13 Definition of microfinance by Helms (2006, p.1). 

30

 

considered carefully to ensure that the microfinance sector is regulated appropriately. The

approaches of regulating MFIs were discussed as follows: no regulation, self-regulation, hybrid

regulation, regulation by existing banking laws and the regulation by special MFI laws. It was

apparent from literature that when considering the regulation and supervision of MFIs, regulators

ought to carefully consider the distinct features and characteristics of MFIs and their clients as

well as the various institutional types or forms of MFIs. This is key in determining how

regulatory standards must be customized to suit the unique nature of different MFIs.

31

 

CHAPTER THREE: RESEARCH DESIGN AND METHODOLOGY

3.1 INTRODUCTION

This chapter presents the research and methodology of study used in this research paper. The

choice of the research design and methodology was informed by the research objective and

questions that the study sought to answer as well as its hypothesis. As indicated in Chapter 1, the

key objective of the research study was to establish whether there were any regulatory barriers

that impeded the entry or transformation of new and unregulated microfinance entities into

regulated status under the various microfinance legislations in the EAC. In order to determine

this, it was also necessary to carry out a comparative assessment of the legal and regulatory

frameworks/regimes in the EAC. The chapter, therefore, provides an overview of the research

design and methodology used to collect and analyse data in order to meet the objectives of the

research. The subsequent sections of the chapter are as follows: Section 3.2 highlights the

research design used. Section 3.3 covers the research methodology employed including the data

collection and analysis tools and techniques.

3.2 RESEARCH DESIGN

The comparative design, which entailed a direct comparison between two or more cases (either

countries, communities or organisations) or situations in order to discover something about the

cases or situations being compared, was employed (Bryman 2001, p.52). In this regard, a

comparative assessment of the microfinance legal and regulatory regimes in the five EAC

member countries; Kenya, Uganda, Tanzania, Rwanda and Burundi was conducted. To this end,

the specific microfinance policies, laws and regulations in the five EAC member countries were

reviewed and comparatively assessed. Through the review, it was possible to identify, analyse

and document the broad similarities and differences in the regulatory regimes of the five

countries. Similarities and differences in the licensing requirements and processes for deposit

taking MFIs across the countries were thus highlighted. The aim of this was to provide a

background on the different microfinance regulatory regimes and particularly the licensing

requirements and processes in the EAC member countries as a precursor to addressing the

specific research questions. The study also sought to establish similar or dissimilar impediments

that inhibited the entry or transformation of new or unregulated microfinance entities into

regulated status under the microfinance legislations in the EAC member countries.

32

 

To conduct the necessary comparisons, a matrix was prepared with a column designated for each

of the five EAC countries. Key provisions of the microfinance policies, laws and regulations

were identified and the similarities or differences in the provisions for each of the countries

recorded. This analysis aided in providing a good understanding of the areas of convergence and

divergence in the microfinance legislations in the EAC. Some of the areas that were compared

included the definitions of microfinance, categorisation of microfinance business and

institutions, licensing, shareholding, capital and liquidity requirements, among others.

Questionnaires were used to gather additional information from MFAs and MFIs from the five

EAC countries. In addition, electronic and face-to-face interviews were conducted with

regulators and senior officers from licensed entities as well as entities seeking to transform or

enter into regulated deposit taking MFIs to gather additional information. The purpose of

interviewing regulators was to gather information on the microfinance landscape in the EAC

member countries as well as to seek clarification on various aspects of the microfinance

legislation and regulations that needed expounding. Senior officers from licensed institutions, on

the other hand, provided additional information on their experiences with entry or transformation

into regulated status.

The comparative assessments of the microfinance regulatory regimes in the EAC member

countries served to provide a better understanding of the microfinance landscapes and the

different policy, legal and regulatory frameworks in the countries under study. The assessments

also helped identify common problems and make recommendations, particularly on how to

reduce the regulatory barriers that impede entry or transformation of MFIs to regulated status in

the EAC. The study also provided deeper insights into other broader issues, for instance the

broader challenges of regulating and supervising microfinance in the EAC.

3.3 RESEARCH METHODOLOGY

3.3.1 Literature Review and Expert Discussions on Microfinance within the EAC

The study methodology involved the review of literature and discussions on microfinance within

the EAC. This review and discussions are provided in chapter four. The review entailed the

analysis of the various approaches adopted in the regulation and supervision of microfinance in

the EAC, including the creation of microfinance windows within existing banking laws and the

development of specialised microfinance laws and regulations. The review provided an overview

of the microfinance landscape and microfinance legal and regulatory frameworks in the five

33

 

EAC member countries. Particular focus was placed on the licensing requirements for setting up

deposit taking MFIs in the region. This was achieved by drawing insights from literature

reviewed as well as discussions with selected interviewees.

3.3.2 Data collection

Two data collection approaches were employed to collect both primary and secondary data to

meet the objectives of the study, as follows:

a) Secondary Data

Secondary data was collected through a desktop study and review of literature covering the

microfinance landscapes and legislations in the five EAC members. This involved the review and

analysis of documents to acquire information on the status of microfinance as well as provisions

of the microfinance policies, laws and regulations in the five EAC member countries. Documents

reviewed were sourced directly from the five Central Banks, internet and various publications.

The selection of documents to be reviewed was done with careful consideration to ensure that

they were legitimate, reliable, easy to understand and interpret and credible. They included:

i) Microfinance policy documents including the relevant Banking, Non Bank

Financial Institutions and Microfinance Acts and Regulations.

ii) Other relevant official documentation from the EAC central banks.

iii) Quantitative data from the EAC central banks on the status or performance of the

microfinance industries in the EAC member countries.

iv) Printed publications and materials including books, journal articles, and reports

relating to the subject under study.

v) Virtual reports and articles downloaded from websites of CGAP and World Bank,

Accion, among others.

The information gathered was collated in the matrix and documented for ease of reference.

b) Primary Data

To address the objective of the study, primary data was collected using self administered

questionnaires. These were complemented by semi structured and unstructured face to face

interviews, telephone calls and email. The purpose of this was to gather views of various key

34

 

respondents on the experience of licensing, if any, and particularly on the enablers and barriers

of transformation or entry of entities into regulated status.

i). Self Administered Questionnaires

Primary data was collected using a standardised questionnaire incorporating both close-ended

and open ended questions. In line with the research questions tied to objective one, the purpose

of using the questionnaire was to gain information from respondents on their thoughts on:

1. Whether the microfinance legal and regulatory frameworks in the respective EAC

member countries enabled or barred entities from entering into regulated status.

2. If (i) above was the case, what specific clauses or provisions in the legal frameworks

enabled or barred new or transforming entities from entering or transforming into

regulated status.

3. Which specific clauses or provisions regarding licensing requirements were easiest or

most difficult to comply with

The questionnaire was administered to two groups of respondents:

a. A senior officer from the MFAs in each of the respective EAC member countries. This

was based on the assumption that responses received from the Associations would be

representative of responses from the microfinance industry. This is due to their

interactions with the different classes and types of regulated and unregulated

microfinance entities that are members in the Associations. In this regard, the responses

from the Association were presumed to provide an industry perspective on the key issues.

In this regard, five respondents representing the Microfinance Associations were

identified and questionnaires sent to them. The respondents included Chief Executive

Officers (CEOs) of the regional Associations including Réseau des Institutions de

Microfinance au Burundi (RIM Burundi), Association of Microfinance Institutions-

Kenya (AMFI), Association of Microfinance Institutions of Rwanda (AMIR), Tanzania

Association of Microfinance Institutions and Association of Microfinance Institutions of

Uganda (AMFIU).

b. To complement the responses received from the Associations, the questionnaire was also

administered to at least two unregulated MFIs and one regulated MFI in each respective

EAC member country. The purpose of selecting a small number of MFIs was not to

provide a representative sample of the microfinance industries in the EAC, but to

35

 

complement the responses from the Associations. The purpose of administering the

questionnaire to unregulated entities was to establish if they had any interest in

transforming or entering into regulated status as deposit taking institutions. It was also

aimed at establishing the greatest challenges they would face in the transformation

process from an individual institution’s perspective. Within this group of respondents,

there were possible applicants who had considered, or were considering becoming

regulated deposit taking MFIs. The purpose of administering the questionnaire to selected

regulated entities, on the other hand, was to gather their views on the greatest challenges

they faced in the licensing process and what they felt were the greatest impediments to

institutions seeking to be licensed and regulated as deposit taking MFIs. The respondents

from various MFIs in the EAC included: Twitezimbere Microfinance in Burundi;

KADET Ltd, World Vision, AAR Credit Services Ltd Adok Timo Ltd. and Century

DTM Ltd from Kenya; Reseau InterDiocesain de Microfinance (RIM), Asezerano

Community Banking and Rwanda Microfinance Limited (RML) in Rwanda; PRIDE

Tanzania Limited and M/s EFC Tanzania M.F.C. Limited in Tanzania; and MEDNET

World Vision, BRAC Uganda and Price Microfinance MDI in Uganda.

The convenience sampling technique was used, where respondents were selected because of the

convenience in accessing them (Bryman, 2001). They were identified with the assistance of

peers in the other central banks in the EAC member countries. The choice of this sampling

technique was primarily due to time and budgetary constraints.

Close ended questions provided a list of pre-set responses, e.g. yes/no, while the few open ended

questions allowed the respondent(s) discretion in answering the questions in their own words.

The questionnaires were sent to the two groups of respondents and follow up was conducted by

telephone calls and emails. The follow-up allowed the researcher to conduct semi - structured

and unstructured interviews to clarify any issues that were not clearly documented in the

questionnaires and ask additional questions to acquire further information, as need arose.

ii). Semi structured Interviews

As indicated in the section above, semi structured interviews were used in addition to the self-

administered questionnaires to interview senior officers of MFIs already operating as licensed

and regulated deposit taking institutions. The purpose of this was to collect information on their

experiences in meeting the licensing requirements. The specific focus of this exercise was to

36

 

establish what hurdles or challenges they faced during the licensing process. Their responses

provided insights into the possible impediments of entry or transformation into regulated status

by new or unregulated entities.

Senior officers working in microfinance policy and surveillance sections of the EAC central

banks were interviewed as well. The interviews with the officers were conducted using phone

calls and emails as well as face to face meetings during workshop meetings. The purpose of

these interviews was to get additional information on the microfinance legal and regulatory

processes and particularly the licensing process. The responses helped determine what challenges

MFIs, in the regulators perspective, faced in meeting licensing requirements and broadly when

operating as regulated deposit taking entities.

3.3.3 The Sample  

The study targeted to sample two key data sources in microfinance. These are the MFAs in the

five East African countries and at least three MFIs in each country; two unregulated and one

regulated MFI. The MFIs were identified and selected with the assistance of key microfinance

staff in the various Central Banks in the EAC. This was necessitated by the need to capture as

much information as possible. The sample chosen was also informed by the fact that MFAs were

assumed to have very well documented information of the member MFIs in the respective EAC

countries. Therefore the information from the MFAs was key in determining the barriers that

impeded the transformation of MFIs. The sampling process involved identification of candidate

MFIs through the respective central banks and MFAs. Respective questionnaires were then

administered to the selected institutions.

3.3.4 Data analysis

After data collection was completed and all administered questionnaire received, data coding and

cleaning were done to minimize errors and ensure data credibility. Out of 16 questionnaires

administered to the MFI interviewees, 15 of them, with the exception of Finca Tanzania, were

returned for data analysis translating to 93.75 percent response rate. At the same time out of 5

questionnaires which had been administered to the MFAs, 5 of them were returned for data

analysis realizing 100 percent response rate. Overall, the response rate was very high.

37

 

Data analysis was conducted using the MS Excel spread sheet and SPSS software. Both were

used to analyse quantitative and the qualitative data. These software packages both have the

capability of using various mathematical functions to perform data analysis for given sets of

data. The results of the analysis were presented in frequency tables, graphs and charts. In

conducting the analysis, the questions provided guidance on specific concerns to be addressed by

the respondents. They were classified into three as follows: Part A provided the general

demographic information of the respondents. Part B, looked at the decisions on entry or

transformation into regulated deposit taking MFIs while part C looks at the specific licensing

requirements for regulated deposit taking MFIs. The specific benefits or motivations of entry or

transformation as well as the challenges of entry or transformation into regulated status were

investigated. Specific focus was placed on the licensing requirements that may impede entry or

transformation including cost of transformation, ownership and capital requirements; however

non-licensing and non-regulatory requirements and considerations were also assessed.

3.2 CONCLUSION

The chapter on the research design and methodologies provided the basis of the choices of using

the comparative research design and the methods of collecting data, using desktop studies,

literature review, self administered questions and semi structured and unstructured interviews. It

also highlighted the data analysis tools employed. Chapter Five that follows discusses the

findings and provides emerging insights from the study.

38

 

CHAPTER FOUR: MICROFINANCE IN THE EAST AFRICAN COMMUNITY

4.1 INTRODUCTION

The EAC member countries have adopted diverse approaches in the regulation and supervision

of microfinance ranging from windows being created within existing banking laws to the

development of specialised microfinance laws and regulations. While in Tanzania, MFIs fall

under the broader banking legislation; Burundi, Kenya, Rwanda and Uganda have specialised

laws for microfinance (CGAP 2010). In order to meet the objective of this study, it was

necessary to conduct a comprehensive assessment of the microfinance legal and regulatory

frameworks in the EAC region. The assessment entailed a comparative review of the

microfinance regulatory regimes in the five EAC member countries, particularly focusing on key

licensing requirements and processes. One of the main aims of this assessment was to identify

key similarities and differences in the legal and regulatory frameworks in the region. This

chapter, therefore, provides a brief overview of the microfinance landscape and microfinance

legal and regulatory frameworks in the five EAC member countries. Particular focus is placed on

the licensing requirements for setting up deposit taking MFIs in the region. The chapter draws

insights from literature reviewed as well as from discussions with interviewees. The chapter

begins with the short overview of the microfinance laws and regulations in the EAC in Section

4.2. Section 4.3 provides a summary of a comparative assessment of key indicators observed

from the legislative and regulatory frameworks in the EAC countries. Finally, section 4.4

provides highlights of the specific licensing requirements in the five EAC countries.

4.2 HIGHLIGHTS ON MICROFINANCE LAWS IN THE EAC

4.2.1 Burundi

Burundi is situated at the heart of the African Great Lakes region on an area of 27,834 sq km.

The General Population and Housing Census established that the country’s population totaled

8.05 million inhabitants in 2008 (IMF 2011). Currently the country has a population of 8.6

million people of which 80% are based in rural areas and 4 million people are estimated to be

over 18 years (Bank of the Republic of Burundi (BRB) 2011).14It is also estimated that 90% of

                                                            14 Presentation made by BRB at the ‘Workshop on Harmonisation of Microfinance and SACCOS Laws in the EAC’, September 8-10, 2010 in Kigali, Rwanda. 

39

 

the country’s population is financially excluded15.The country’s banking sector is relatively

small, comprising eight commercial banks, 40 forex bureaux, one mortgage finance company

and 24 MFIs (of which two were approved in 2012).These are all regulated by the BRB (BRB

2011).16A Financial Sector Assessment Program (FSAP) study of 2009 indicated that only about

1.9 percent of the total adult population held bank accounts, 0.42 percent used bank lending

services, while 4 percent were served by MFIs (IMF 2009).

Microfinance Legal, Regulatory and Supervisory Framework

To regulate and supervise the microfinance industry, Burundi has in place a comprehensive

microfinance legal and regulatory framework (Decree Nr.100/203 of July 22, 2006). Article 2 of

the Decree defines microfinance as ‘an activity carried out by legal entities engaged in credit

operations and/or savings collection and offer specific financial services to benefit populations

largely outside the traditional banking system." It also defines a MFI as a ‘company with limited

corporation status providing financial services to the general public but without the status of

bank as defined by the Banking Act.’ The framework covers all institutions involved in

microfinance activity in Burundi including both deposit and non- deposit taking MFIs. These

institutions are grouped into three categories as highlighted here-below.

Category One: SACCOs

This category of institutions comprises SACCOs. The BRB regulates one SACCO network with

116 SACCOs spread throughout the country and ten (10) individual SACCOs with a total of

fifteen (15) branches and agencies17.

Category Two: Deposit Taking MFIs

Category two comprises deposit taking MFIs registered as limited liability companies that

provide financial services to the general public. These MFIs are allowed by law to receive

voluntary deposits from, and grant loans to, their clients or members as well as general public.

                                                            15  Presentation made by BRB at the ‘2011 Regional Microfinance Supervisor Training Program for the EAC’, November 7-10, 2011, Nairobi, Kenya. Burundi is yet to conduct its first national financial access/FinScope survey. 

16 Presentation made by BRB at the ‘2011 Regional Microfinance Supervisor Training Program for the EAC’, November 7-10, 2011, Nairobi, Kenya. 

17  Presentation made by BRB at the ‘2011 Regional Microfinance Supervisor Training Program for the EAC’, November 7-10, 2011, Nairobi, Kenya. 

40

 

This category, however, does not include banks or financial institutions as defined under the

Banking Act. There are currently nine (9) deposit taking MFIs, majority located in Bujumbura

and one in Rumonge, with a total of fourteen (14) branches and agencies18.

Category 3: Non Deposit Taking MFIs

Category three institutions are comprised of microcredit programs of NGOs, nonprofit

organizations, projects and other programs granting only credit to their clients. There are four (4)

non-deposit taking MFIs or NGO microcredit programs in Burundi whose financial activities are

limited to granting credit to their clients or members as well as the general public19.

Besides these three categories, there is also one Development Bank offering microfinance

services. According to BRB20, these MFIs (excluding the development bank) had 129,021

borrowers with total outstanding loan balances of USD 44.4 million and 463,527 depositors with

deposit accounts valued at USD 49.5 million by December 31, 2011. Table 4.1 below provides a

summary of the status and performance of the different categories of institutions in terms of

deposits and loans by December 31, 2011.

Table 4.1: Microfinance in Burundi

Category Category 1 Category 2 Category 3

Institutional

type/form

SACCOs Deposit Taking

MFIs

Non deposit taking

MFIs

Capital Required None prescribed (but

must have a minimum

number of 300

members at least one

share each)

BIF 200 mn

(USD 152,086)

None prescribed (but

must have a credit

fund)

Regulator BRB BRB BRB

Number of

institutions I SACCO network of

116 SACCOs

9 deposit taking

MFIs with 14

4 non-deposit taking

MFIs

                                                            18 Presentation made by BRB at the ‘2011 Regional Microfinance Supervisor Training Program for the EAC’, November 7-10, 2011, Nairobi, Kenya. 

19 Presentation made by BRB at the ‘2011 Regional Microfinance Supervisor Training Program for the EAC’, November 7-10, 2011, Nairobi, Kenya. 

20 Information received from BRB on February 16, 2012.

41

 

10 individual

SACCOs with 15

branches

branches

Number of

Borrowers

79,050 36,466 13,505

Value of outstanding

loans

BIF 46,552,674,420

(USD 35.4 million)

BIF 10,520,378,400

(USD 8.0 million)

BIF 1,315,047,300

(USD 1.0 million)

Number of

depositors

397,525 66,002 N/A

Value of deposits BIF 55,626,500,790

(USD 42.3 million)

BIF 9,468,340,560

(USD 7.2 million)

N/A

Note: The exchange rate as at 30th December 2011 was $1 = BIF 1315.05. Information on the single development

bank in Burundi that offers MFI is not available (BRB 2012)

4.2.2 Kenya

The CIA Factbook indicates that Kenya sits on an area of 580, 367 sq km21. According to the

Kenya National Bureau of Statistics (2011), Kenya’s population is 38.6 million with a population

growth rate of 2.4%. A national survey on financial access conducted in 2009 established that

22.6% of the adult population was formally banked22; 17.9% used semi-formal financial services,

including MFIs and SACCOs; and 26.8% used informal services. However, 32.7% of the

Kenyan adult population was financially excluded and did not use any financial services and

products (FinAccess 2009).

By 31st December 2011, the banking sector comprised 43 commercial banks, 1 mortgage finance

company, 112 licensed forex bureaus, 6 Deposit Taking Microfinance Institutions (DTMs) and 2

Credit Reference Bureaus (CRBs), all supervised by the Central Bank of Kenya (CBK). The

CBK also regulates and supervises building societies but none was licensed by the end of

2011.There are over 5,000 SACCOs in Kenya. According to the Sacco Societies Regulatory

Authority (SASRA) there were 96 SACCOs that were licensed and regulated by the independent

government regulatory authority23, by the end of January 2012. These SACCOs are licensed to                                                             21 https://www.cia.gov/library/publications/the-world-factbook/geos/ke.html

22 Where formally banked according to the survey refers to use of formal financial services, including banks, the postal savings bank and insurance companies (FinAccess 2009). 

23 http://www.sasra.go.ke 

42

 

operate Front Office Service Activity (FOSA) offering financial services to their members as

well as non members.

Microfinance Legal, Regulatory and Supervisory Framework

Microfinance in Kenya is provided by a variety of institutions with different institutional forms,

registered and regulated and/or supervised under various legislations. These include commercial

banks; the Kenya Post Office Savings Bank (KPOSB); MFIs of different institutional forms such

as Companies, Trusts and NGOs; SACCOs; and informal MFIs such as ASCAs and ROSCAs

(CBK 2008). Given this diversity, a three-tiered approach was adopted for categorising,

regulating and supervising the microfinance industry (Omino 2005). The tiers are as follows:

Tier I: Deposit Taking MFIs

Tier 1 MFIs comprise of formally constituted deposit taking microfinance institutions (DTMs)

which are licensed, regulated and supervised by the Central Bank of Kenya under the

Microfinance Act, 2006 and Regulations which came into effect from 2nd May 2008 (CBK

2009). These DTMs are further categorized as either: nationwide DTMs (operating nationwide)

whose minimum capital is set at KSh. 60 million (USD 705,317) and Community DTMs

(operating within a specific geographical region)24, whose minimum capital is set at KSh. 20

million (USD 235,106) (Omino 2005; CBK 201125).

Tier II: Credit only or non deposit taking MFIs

Tier II MFIs are formally constituted credit-only or non-deposit taking MFIs that do not take

deposits from the public but accept cash collateral tied to loan contracts (Omino 2005). These

institutions fall under the purview of the Ministry of Finance (MoF) as prescribed under the

Microfinance Act, 2006. The MoF is in the process of discussing the best way forward for

licensing, regulating and supervising the non-deposit taking microfinance business (CBK 2008).

Tier III: Informal MFIs

Tier III MFIs comprise of informally constituted MFIs including ROSCAs, ASCAs, Financial

Services Associations (FSAs) and money lenders, amongst others. These are member based or

donor funded entities and they are unregulated.

                                                            24 Community DTMs operate within specified districts; however in a city, they can only operate within specified

divisions.

25 http://www.centralbank.go.ke accessed on 14 March 2011. 

43

 

Commercial Banks that offer microfinance services are regulated under the Banking Act by

CBK; while the KPOSB, which offers microsavings products, operates under the KPOSB Act

and the State Corporations Act under the oversight of the MoF (Omino 2005; CBK 2008). Table

4.2 below provides a summary of the status and performance of institutions in the three tiers at

the end of December 2011.

Table 4.2: Microfinance in Kenya

Category Tier 1: Tier 2: Tier 3:

Institutional Type/Form Deposit taking MFIs Credit Only FIs Informal MFIs

Regulator CBK Self regulated26 Unregulated

Capital Required Community – KSh.20

mn. (USD 235,106)

Nationwide – KSh.60

mn. (USD 705,317)

N/A Not available

Number of institutions 6 licensed deposit

taking MFIs with 60

branches

Numerous Not available

Number of Borrowers 0.5 million Not available Not available

Total Value of loans KSh. 16.5 bn

(USD 194 million)

Not available Not available

Number of depositors 1.4 million N/A N/A

Value of deposits KSh. 10.2 bn

(USD 120 million)

N/A N/A

Note: The exchange rate on December 31, 2011 was approximately $ 1 = KSh. 85 (CBK 2012)

4.2.3 Rwanda

Rwanda, which sits on an area of 26,338 sq km27, was estimated to have a population of 10.72

million in 2011 according to the National Institution of Statistics of Rwanda (NISR)28. 80% of

                                                            26    Credit-only MFIs in Kenya fall under diverse legal frameworks, for example, NGOs, Societies, Trusts, Companies, among others. The MoF is looking into the best way forward for licensing, regulating and supervising the non-deposit taking (credit only) microfinance business (CBK, 2008), however the Association of Microfinance Institutions (AMFI) in Kenya provides a self regulatory framework for its members of 51 diverse institutions. 

44

 

the population is based in rural and remote areas. Of the total population, those over 18 years are

estimated at 3.69 million. According to the Rwanda FinScope (2008) study, it was established

that 21% adult Rwandans were formally banked (14% in formal banks and 7% served by other

formal financial institutions like MFIs); 26% was informally banked whilst 52% was unbanked.

Out of these approximately 88% were in rural areas.

The banking sector in Rwanda is relatively diverse comprising 14 commercial banks; 157

Foreign Exchange Bureaus and 490 MFIs, including 11 licensed MFI limited liability companies,

63 ‘MFI SACCOs’, of which 53 are licensed and 10 are unlicensed, and 416 Umurenge

SACCOs, of which 139 are licensed while 277 are not licensed (National Bank of Rwanda

(BNR) 2012)29.

Microfinance Legal, Regulatory and Supervisory Framework

The financial sector’s overall legal and regulatory framework was initiated in July of 1997, when

the Rwandan government passed instruction No.11/1997 to establish the statutes for the BNR. In

1999, the Banking Law No.08/99 was promulgated assigning the responsibility for regulation

and supervision of MFIs to BNR (Enterprising Solutions Global Consulting 2005; UNCDF

2009). In 2002/2003, two specific instructions30 were adopted to regulate the activities of MFIs

(Instruction No.06/2002) and financial cooperatives (Instruction No.05/2003) (Enterprising

Solutions Global Consulting 2005; Kantengwa 2005, 2008). In 2008, the laws were amended and

Law No 40/2008 of 26/08/2008 was gazetted in March 2009 to establish the organisation of

microfinance activities in Rwanda. Further to this, BNR enacted Regulation No.02/2009 in May

2009 on the organisation of microfinance activities. This regulation brings the responsibility for

all microfinance activities, regardless of institutional type, under the BNR (CGAP & MIX

2011).The Rwandan microfinance laws categorize MFIs into four categories as highlighted here

below.

Category 1: Informal MFIs.

                                                                                                                                                                                                27 http://www.state.gov/r/pa/ei/bgn/2861.htm and https://www.cia.gov/library/publications/the-world-factbook/geos/rw.html

28 http://statistics.gov.rw/index.php?option=com_content&task=view&id=201&Itemid=203

29 http://www.bnr.rw/supervision accessed on February 19, 2012 

30 This is the terminology used in Rwanda to mean Regulations or Guidelines 

45

 

This category comprises of informal MFIs constituted as tontines31 and member based entities

that provide financial services using member contributions. They require no legal status or

licence from BNR and are not subject to regulation and supervision by BNR. However, these

MFIs are expected by law to register with the local authorities and their members are expected to

develop and adopt internal by-laws. This category of institutions has no capital requirements

(Kantengwa 2005, 2008; Republic of Rwanda 2009, s.1, Art.4).

Category 2: ‘Small’ SACCOs/MFI SACCOs

The second category comprises MFIs that are registered as SACCOs with the Rwanda

Cooperative Agency (RCA) and whose deposits are less than the threshold set by BNR of RwF

20 million (USD 33,105). Where deposits of these ‘small’ SACCOs equal or exceed the

thresholds set by the Central Bank, they are automatically required to be licensed and regulated

as category three institutions. Although these institutions have no minimum capital requirements,

they are not allowed by law to have more than one point of operation or service outlet. They are

also licensed by BNR, which has specific regulations that provide oversight for this category of

MFIs (Kantengwa 2005, 2008; Republic of Rwanda 2009, s.1, Art.5).

Category 3: Deposit Taking MFIs and ‘large’ SACCOs

The third category consists of deposit taking MFIs that are registered as limited corporations and

are allowed to mobilise and on-lend public deposits. This category also constitutes large

SACCOs whose deposits are equal to or above the thresholds set by BNR of RwF 20 million

(USD 33,105). This category of MFIs is subject to licensing, regulation and supervision by BNR

and they are also registered with the RCA. The minimum capital for deposit taking MFIs is RwF

300 million (USD 496,573) whilst for SACCOs is RwF 5 million (USD 8,276) (Kantengwa

2005, 2008; Republic of Rwanda 2009, s.1, Art.6).

Category 4: Credit Only MFIs

The fourth category constitutes of MFIs that are not allowed by law to mobilise public deposits.

MFIs in this category may operate as limited companies or as limited liability companies. BNR

licenses these credit-only MFIs and has developed specific regulations for this category of MFIs.

                                                            31 BNR defines “Tontine” as the ‘principle by which a group of people whose members are committed to pay a

predetermined sum at a given frequency to a common fund in order for one of them to take it. The arrangement determines how each member pays, the period to pay and how each member receives the funds in the right time’.

 

46

 

Their minimum capital requirement, like deposit taking MFIs is RwF 300 million (USD

496,573) (Kantengwa 2005, 2008; Republic of Rwanda 2009, s.1, Art.7).

In addition to the above four categories, there are some commercial banks that offer

microfinance services including Zigama Credit and Savings Bank, a Cooperative Bank, Urwego

Opportunity Bank (UOB), Agaseke Bank Limited (ABL) and Unguka Bank limited (UBL), all

microfinance banks. With minimum capital requirements of 1.5 billion RwF (USD 2.5 million),

they are authorized to provide a range of financial services, including microfinance. Regulation

and supervision of microfinance banks is conducted by BNR as per the banking laws

(Kantengwa 2005, 2008; BNR 2012).

Table 4.3 below provides a summary of the status and performance of institutions in the four

categories of MFIs at the end of December 2011.

Table 4.3: Microfinance in Rwanda (excluding informal MFIs)

Category MFIs - Limited

Co's

Small SACCOs /

MFI SACCOs Large SACCOs

Credit

Only

MFIs

Regulator BNR

Regulated by BNR

but also registered

with RCA

Regulated by BNR but

also registered with

RCA

BNR

Capital

Required

Deposit taking

MFIs is RwF 300

million (USD

498,720)

None prescribed SACCOs is RwF 5

million (USD 8,300)

RwF 300

million.

(USD

498,720)

Number of

institutions 11 (all licensed)

63 (53 are licensed

and 10 are

unlicensed)

416 (139 are licensed

and 277 are

unlicensed)

1

Number of

Borrowers 80,186 57,159 26,698 4,449

Total Value of

loans

RwF.16,134,432,94

9 (USD 26.7mn)

RwF.19,840,590,73

3 (USD 32.8mn)

RwF.4,748,884,490

(USD 7.9mn)

USD

3.2Million

Number of

depositors 297,581 265,295 955,065 None

Total Value of RwF.9,856,912,462 RwF.13,572,061,76 RwF.22,423,448,322 None

47

 

deposits (USD 16.3mn) 1 (USD 22.5mn) (USD 37.1mn) Note: The exchange rate on December 31, 2011 was approximately $ 1 = RwF. 604 (BNR 2012)

In an email from P. Nsenga, BNR, on 28th December 2011, it was clarified that under the current

microfinance law, no one is allowed to undertake microfinance business or activity in Rwanda

prior to receiving a BNR licence, apart from small ROSCAs and Village Savings and Loan

Associations (VSLAs). The mandate given to BNR to regulate all microfinance providers was

followed in 2007 by a strong country wide campaign (mainly by the Finance Minister and the

Governor) which caused all existing providers to seek for licences from BNR. Consequently, all

microfinance providers in Rwanda are licensed and regulated.  

4.2.4 Tanzania

Tanzania is situated between Kenya and Mozambique on area of 947,300 sq km32 . The country

has a population of 43 million, of which over 80% of the population is based in rural areas. A

FinScope (2009) study of Tanzania established that 12.4% of the country’s adult population was

formally banked; 4.3% served by semi-formal entities; 27.3% was informally banked whilst 56%

was unbanked.

Tanzania’s financial services landscape constitutes: 46 commercial banks (of which 17 provide

microfinance services. Among the 17 banks, 6 are commercial banks with microfinance

windows, 9 are regional banks and 2 are non bank financial institutions. In addition, there is one

mortgage finance institution, 8 regional banks and 5 financial institutions regulated by the Bank

of Tanzania (BOT); 5,314 SACCOS under the Cooperative department of the Ministry of

Agriculture, Food and Cooperatives; 71 financial NGOs and companies, and 166 government

programs offering microfinance. Informal financial institutions are numerous and their actual

numbers are not known (BoT 2012).

Microfinance Legal, Regulatory and Supervisory Framework

Microfinance operations in Tanzania are guided by the National Microfinance Policy (NMP) of

2000; Banking and Financial Institutions Act (BAFIA), 2006 and Microfinance Regulations,

                                                            32 https://www.cia.gov/library/publications/the‐world‐factbook/geos/tz.html

 

48

 

2005. The NMP was approved by Cabinet in May 2000 to provide a framework for governing

the microfinance industry in Tanzania. The policy recognises microfinance as a line of business

that can be undertaken by diverse institutions applying a variety of service delivery

methodologies. The NMP therefore provides an appropriate framework for all microfinance

service providers to extend their services to their clients (Rubambey 2005). In addition to the

NMP, microfinance operations are legislated through the existing banking legal framework

which facilitates the creation of specialised institutions to carry out microfinance and SACCO

business (Rubambey 2005).Specific regulations that focus on microfinance business activities in

Tanzania were developed as highlighted here-below.

Banking and Financial Institutions (Microfinance Companies and Microcredit Activities)

Regulations, 2005

These are prudential regulations provided under the BAFIA that are applicable to all banks and

non bank financial institutions engaged in microfinance business activities, including

Microfinance Companies (MFCs). The minimum core capital is TZS 200 million

(US$129,032.26) for MFCs with a single branch and TZS 800 million (US $516,129) for MFCs

with a national branch network. Although the microfinance regulations were gazetted in March

2005, there is only one licensed deposit taking MFI which was licensed in October 2011. The

reason for the slow uptake is due to challenges relating to ownership structure and governance

requirements and transformation costs. These reasons make it easier to operate credit only

institutions (NGO&MCC) outside BOT regulations. However, initiatives are underway to review

the regulations to smoothen the licensing process, and particularly with regard to

transformation33

Banking and Financial Institutions (Financial Cooperatives Societies) Regulations, 2005

Financial Cooperatives Societies (FICOS) regulations are also provided under the BAFIA. The

minimum capital requirements for FICOS are similar to MFCs with a national branch network,

TZS.800 million (US $516,129), and they are required to comply with similar adequacy ratios.

According to Rubambey (2005), the justification of placing FICOS under BOTs supervision is to

ensure consistent accountability and transparency as member-based organizations grow. An

email from H. Dimoso on 21st February 2012 confirmed that there are no licensed FICOs.

                                                            33 Presentation made by BoT at the ‘Workshop on Harmonisation of Microfinance and SACCOS Laws in the EAC’, September 8-10, 2010 in Kigali, Rwanda; and Presentation made by BoT at the ‘2011 Regional Microfinance Supervisor Training Program for the EAC’, November 7-10, 2011, Nairobi, Kenya.

49

 

Savings and Credit Cooperative Societies (SACCOS) Regulations, 2005

SACCOS are registered by the Registrar of Cooperatives under the Cooperative Societies Act

2003 and subjected to the Cooperative Rules issued by the Ministry of Cooperatives and

Marketing. However, in accordance with the legal framework, the Registrar of Cooperatives

applies similar prudential regulations on SACCOS as those applied on MFCs. However, they

also take into account the fact that SACCOS are cooperatives and need to conform to

Cooperative principles.

Table 4.4 below provides a summary of the status and performance of the various types of MFIs

in Tanzania at the end of December 2011.

Table 4.4: Microfinance in Tanzania

Category Banks Deposit

Taking MFC

SACCOs Financial

NGOs &

Microcredit

Companies

Informal

providers

Regulator BoT BoT

Ministry of

Agriculture,

Food and

Cooperatives

Not availed Not availed 

Capital Required TZS 5bn for

commercial

banks (USD

3.2mn) 

TZS 800mn

for country-

wide MFCs

(USD

516,129) 

Not availed  Not availed Not availed 

TZS 250mn

for community

banks (USD

161,290)

TZS 200mn

for unit MFCs

(USD

129,032) TZS 2.5bn for

financial

institutions

(USD 1.6mn)

Number of

institutions

17 of 48 total

banks provide

microfinance

1 5,314 (of

which 3,413

are verified to

71 Numerous

50

 

services exist by BoT)

Number of

Borrowers

811,580 491 1,521,693 688,701  Not availed 

Total Value of

loans

TZS 7 trillion.

(USD 4.5bn)

TZS 549

million (USD

354,194)

741 billion

(USD

478mn)

119 billion

(USD

76.8mn)

Number of

depositors

5,441,829

48 Not availed Not applicable  Not applicable 

Total Value of

deposits

TZS 11 trillion

(USD 7.1bn)

TZS 125

million (USD

80,645)

TZS60 billion

(USD

38.7mn)

Not applicable  Not applicable 

Note: The average exchange rate in December 2011 was $ 1 = TZS1550 (BOT 2012)

4.2.5 Uganda

Uganda, which spans an area of approximately 241,038 sq km, has a population of 34.6

million34. Its financial sector comprises of a diverse array of financial entities including: 23

commercial banks with over 455 outlets (of which 2 banks provide microfinance services); 184

forex bureaus; 3 credit institutions with 45 outlets; 4 Microfinance Deposit Taking Institutions

(MDIs) with over 95 outlets; 2 Development Banks; over 300 private moneylenders; NGO-

Credit only MFIs, whose number is not known; and over 3000 Savings and Credit Coops

(SACCOs). Although there are diverse types of financial institutions, a national survey on access

to financial services carried out in 2009 established that only 27% of the Ugandan adult

population uses formal institutions, 34% use informal institutions, whilst 61% percent of

Ugandans are financially excluded (FinScope, 2009)

Microfinance Legal, Regulatory and Supervisory Framework

The Bank of Uganda’s (BOU) “Policy Statement on Microfinance Regulation in Uganda” was

approved in July 1999. Its main objective is to improve access of the poor to financial services

by facilitating the growth of safe and sound microfinance deposit taking institutions. It therefore,

                                                            34 https://www.cia.gov/library/publications/the‐world‐factbook/geos/ug.html 

 

51

 

maps out the strategy in the regulation and supervision of all microfinance deposit taking

institutions in Uganda (Kalyango, 2005).

The microfinance policy defines a tiered approach to regulating and supervising microfinance in

Uganda. This approach recognises microfinance as a line of business rather than an institutional

type. It also recognises that microfinance can be carried out by a varied number of institutional

types across four categories. Thus it is necessary to regulate different intermediaries in a

different manner. (Kalyango, 2005)

Category or Tier 1: Commercial Banks

The 1st Category of institutions (Tier I) comprises of commercial banks, which are licensed,

regulated and supervised under the Financial Institutions Act, 2004 (FIA, 2004). According to an

email from H. Wasswa received on February 16, 2012, the minimum paid-up capital is Ush. 10

billion effective from March 1, 2011 and will be increased further to Ush.25 billion on March 1,

2013). Within this category, microfinance is treated as a financial product in the Banks’ lending

portfolio. Currently, two banks are engaged in microfinance business35. Banks are required to

segregate the microfinance loan portfolio and also subject it to the regulation of asset quality

issued under the MDI Act, 2003.

Category or Tier II: Credit Institutions

The 2nd category (Tier II) comprises of credit institutions, which are not allowed to take demand

deposits. These institutions are also licensed, regulated and supervised under the FIA, 2004.

Within this category, microfinance is also recognised as a product line within the lending

portfolio. The minimum paid-up capital for a credit institution is Ush.1 billion (approximately

US$386,000). Currently, there is only one licensed credit institution engaged in microfinance

business, Opportunity Bank Uganda Limited36.

Category or Tier III: Microfinance Deposit Taking Institutions

The 3rd category of institutions (Tier III) comprises of MDIs which are licensed under the MDI

Act, 2003. The MDI Act was passed by Parliament in November 2002 and promulgated into law

in May 2003. The law clearly provides conditions on entry, operations and exit of licensed

                                                            35 Presentation made by BRB at the ‘2011 Regional Microfinance Supervisor Training Program for the EAC’, November 7-10, 2011, Nairobi, Kenya. 

36 BOU Website http://www.bou.or.ug/export/sites/default/bou/bou-downloads/financial_institutions/2011/Credit_Institutions_in_Uganda_as_at_31_Dec_2011.pdf access on 10/10/11 

52

 

MDIs. They are licensed, regulated and supervised by BOU to mobilize public deposits.

Minimum paid up capital required is Ush.500 million (equivalent to about US$193,000).

Currently, there are 4 licensed MDIs: FINCA Uganda Ltd., PRIDE Microfinance Ltd., Uganda

Finance Trust Ltd37 and UGAFODE Microfinance Ltd. The Act is currently under review.

Category or Tier IV Non-Deposit Taking or Credit-only MFIs

The 4th category of institutions (Tier IV) comprises non-deposit taking institutions or credit-only

institutions, which are not allowed to mobilize public deposits. These include NGOs, SACCOs,

ROSCAS, private money lenders and member-based organizations. They are currently

unregulated.

Table 4.5 below provides a summary of the status and performance of the MFIs in the four

categories of MFIs in Uganda at the end of December 2011.

Table 4.5: Microfinance in Uganda

Category Category 1 Category II Category III Category IV

Institutional Type Commercial banks Credit

Institutions

MDIs Credit Only

Regulator BOU BOU BOU Unregulated

Capital Required Ush. 10 billion

(USD 4.1 million)

Ush. 1 billion

(USD 408,678)

Ush. 500

million

(USD 204,339).

None

prescribed

Number of

institutions

23 commercial

banks with over 455

outlets (2 banks

provide

microfinance

services)

3 credit

institutions

with 45 outlets

4 MDIs with

over 95 outlets

Numerous

(unknown)

Number of

Borrowers/loan

accounts

336,871 43,753 158,896 Not available

Total Value of Ush. 6,980.98billion Ush. 107,220 Ush. Not available

                                                            37 BOU Website http://www.bou.or.ug/export/sites/default/bou/bou-downloads/financial_institutions/2011/MicroFinance_Deposit_Taking_Institutions_as_at_31_Dec_2011_.pdf accessed on 10/10/11 

53

 

loans (USD 2. 9 million) million

(USD 43,818)

171,385.82

million (USD

70,042)

Number of

depositors/deposit

accounts

3,102,719 533,954 592,758 Not applicable

Total Value of

deposits Ush. 8,903.71billion

(USD 3.6 million)

Ush. 121,563

million

(USD 49,680)

Ush. 76,753.50

million

(USD 31,367)

Not applicable

Note: The average exchange as at 30th December 2011 was $1 = Ush 2,446.91 (BOU 2012)

4.3 COMPARISONS OF MICROFINANCE LEGISLATIONS IN THE EAC

In most countries with regulated financial systems, regulatory provisions are specified to

facilitate entry of financial institutions into the market, smooth operation and an orderly exit,

either voluntarily or by directive of the regulator (Staschen 2003). In the same manner, there are

provisions for the entry, regulation and supervision and exit of MFIs in the EAC, of which some

of the key regulatory provisions are discussed here-below. The discussion in this section will

compare the definitions of microfinance as well as key regulatory provisions including capital,

ownership and shareholding, insider lending and credit requirements and limits. This will

provide insight into the similarities and differences of the microfinance regulatory regimes in the

EAC.

4.3.1 Definitions of microfinance in the EAC

There is no single universal definition for microfinance in the different microfinance legislations

and regulations in the five member countries of the EAC. The definition of microfinance varies

for the different countries as highlighted in the Table 4.6 below.

Table 4.6: Definitions of microfinance in the EAC

Burundi Kenya Rwanda Tanzania Uganda

An activity

carried out by

legal entities

engaged in credit

Acceptance of

deposits and

lending of short-

term loans to

Acceptance of

deposits and

lending

clientele not

Definition of

microfinance not

provided: however,

MFC is a limited

Acceptance of

deposits and

lending of short-

term loans to

54

 

operations and/or

savings collection

and offering

specific financial

services to

benefit

populations

largely outside

the traditional

banking system

((Decree

Nr.100/203 2006,

Art. 2).

MSEs or low

income

households and

characterized by

the use of

collateral

substitutes

(MFA 2006, s.2)

usually served

by banks and

ordinary

financial

institutions.

(Law 040/2008,

Art. 2.

company providing

banking services

primarily for

households, small

holder farmers and

microenterprises in

rural or urban areas

(URT 2006, s.5)

MSEs or low

income

households and

characterized by

the use of

collateral

substitutes.

(MDI Act 2003,

Part I)

Source: Various microfinance legislations in the EAC member countries.

While the focus of microfinance in Kenya, Tanzania and Uganda and Rwanda is on the low

income populaces including MSEs, low income individuals and households; in Burundi, MFIs

offer financial services to the general public.

4.3.2 Capital Requirements

The types of MFIs in the EAC member countries differ, ranging from banks, deposit taking

MFIs, non deposit taking (credit only) MFIs, SACCOs and financial NGOs to informal

providers. In this regard, the capitalisation requirements for the various types of institutions in

the region differ. Table 4.7 gives an overview of minimum capital requirements for the different

MFIs and other related institutions in the EAC.

Table 4.7: Capital Requirements

Country Institutional Types Minimum Capital

Burundi SACCOs None prescribed (but must have a

minimum number of 300 members with

at least one share each)

Deposit Taking MFIs BIF 200 mn (USD 152,086)

Non deposit taking MFIs None prescribed (but must have a credit

fund)

55

 

Kenya Community Deposit taking MFIs KSh.20 mn. (USD 235,106)

Nationwide Deposit taking MFIs KSh.60 mn. (USD 705,317)

Credit Only MFIs None prescribed

Informal MFIs None prescribed

Rwanda MFIs - Limited Co's None prescribed

‘Small’ SACCOs /MFI SACCOs None prescribed

Deposit Taking MFIs RwF 300 million (USD 496,573)

‘Large’ SACCOs /Umurenge SACCOs RwF 5 million (USD 8,276)

Credit Only MFIs RwF 300 million. (USD 496,573)

Tanzania Banks Not availed

Deposit Taking MFC

TZS 800 million (USD 516,129)

TZS 200 million for a unit MFC (USD

129,032)

SACCOs Not availed

Financial NGOs & Microcredit Companies Not availed

Informal providers Not availed

Uganda Banks Ush. 10 billion (US$ 4.1 million)

Credit Institutions Ush. 1 billion (US$408,678)

MDI Ush. 500 million (US$204,339).

Credit Only None prescribed Source: Various microfinance legislations in the EAC member countries.

Information on minimum capital requirements across the various types of MFIs in the EAC is

also referred to in section 4.1 above.

4.3.3 Ownership/Shareholding Requirements

One of the most critical regulatory provisions for MFIs, as is the case for all deposit taking

financial institutions, is the stipulation of a specified maximum percentage of share capital that

can be held by a single owner. The rationale for this requirement is to prevent an ownership

concentration by a single majority shareholder or owner leading to undue control in decision

making by the single majority shareholder or owner. Having diverse shareholders is preferred

because it balances the representation of shareholders ‘interests.’ Balanced representation of

interests within an MFI aids in maintaining the MFIs mission of profit maximization and poverty

56

 

alleviation (Staschen 2003). Table 4.8 below shows the ownership and shareholding

requirements for deposit taking MFIs in the EAC.

Table 4.8: Ownership and Shareholding

Country Institutional Types Ownership and Shareholding

Burundi MFI Currently not provided; however ownership and

shareholding limits will be introduced in the new

legislation currently under preparation.

Every institution must request permission from the Central

Bank to make any changes in major shareholders

Kenya DTM No more than 25% shareholding per person

Significant Shareholding - 10%

Prior approval by CBK for transfer of 10% or more shares

Rwanda MFC No shareholding limits prescribed in regulations.

Tanzania MFC No more than 20% shareholding per person

Significant Shareholding - 5%

Prior approval by BOT for transfer of ≤ 5% or more shares

Uganda MDI No more than 30% shareholding for person or group of

related persons.

Prior approval by BOU for transfer of 10% or more shares Source: Various microfinance legislations in the EAC member countries.

The MFIs in the EAC have in place ownership and shareholding limits to ensure good corporate

governance. Tanzania has the strictest requirements, which limit shareholding per person to 20%

while Uganda is more lenient, allowing shareholding per person or group to 30% per person or

group of related persons. In Kenya, shareholding per single shareholder is restricted to 25%. In

Rwanda, shareholding limits are not prescribed in the microfinance regulations.

In the EAC countries, changes in, or transfer of, shares are subject to approval by the Central

Banks. For example, in Burundi, any changes in major shareholding must be approved by BRB;

while in Uganda no one may hold more than 10% shareholding without the approval of BOU. In

Uganda, Kenya and Tanzania, the transfer of 10%, 10% and 5% of shareholding, respectively,

must be approved by BOU, CBK and BoT, respectively. There are exceptions to some of these

requirements. For instance, Kenya and Uganda allow banks and other defined financial

institutions to set up subsidiaries to hold 100% shares with the approval of the Central Banks.

57

 

4.3.4 Insider Lending Limits

Insider loans are loans made to persons that are in a position of influence within the MFI or those

connected with that person in one way or another. Some of these persons include directors,

management officials, employees, affiliated persons, founders and other connected parties

(Staschen 2003). The EAC member countries define and place various limits on insider lending

to prevent the inherent conflict of interest arising from issuance of such loans. Table 4.9 below

provides a summary of the provisions on insider lending in the EAC.

Table 4.9: Insider Lending Limits

Burundi Kenya Rwanda Tanzania Uganda

Maximum of

20% of total

capital (2.5%

where MFI does

not mobilise

deposits)

Aggregate

maximum of

100% of total

capital (10%

where MFI does

not mobilise

deposits)

Single Insider

and Associate

Lending Limits

≤ 2% of Core

Capital

Aggregate

Insider Lending

Limit ≤ 20% of

Core Capital

Maximum

of 15% of

MFIs net

worth.

Single Insider

and Associate

Lending Limits

≤ 10% of Core

Capital

Aggregate

Insider Lending

Limit ≤ 25% of

Core Capital

Single Insider and

Associate Lending

Limits ≤ 1% of core

capital in aggregate

and outstanding

capital at any one

time.

Source: Various microfinance legislations in the EAC member countries.

As indicated above, insider loans to connected parties of deposit-taking MFIs are restricted to

less than or equal to 2% in Kenya, 10% in Tanzania and 1% in Uganda to single insider together

with their associates; with the aggregate insider lending limit of less than or equal to 20% and

25% stipulated in Kenya and Tanzania respectively. In Burundi, the maximum insider lending

limit is 20% of total capital for a deposit taking MFI and 2.5% of total capital (where the MFI

does not mobilise deposits) while the aggregate maximum limit is stipulated at 100% of total

capital for deposit taking MFIs and 10% (where MFI does not mobilise deposits). In Rwanda, the

maximum insider limit is capped at 15% of the MFIs net worth.

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4.3.5 Credit exposure limits

Given that the core business of microfinance is lending, credit exposure limits are critical in

order to reduce credit risk, which is defined as the risk of loan losses due to the borrower’s

inability or unwillingness to repay (Staschen 1993). Increased credit risk can ultimately impair

MFIs ability to satisfy its clients demand for credit. In this regard, MFIs in the EAC region have

in place credit exposure limits for individuals and group borrowers as well as aggregate credit

exposure limits. Table 4.10 below provides a summary of these limits.

Table 4:10: Credit exposure limits

Burundi Kenya Rwanda Tanzania Uganda

Single and

Group

borrower

limits ≤ 2.5%

of total

deposits with

this institution.

Credit risk

must not

exceed 100%

of total

deposits.

Single Borrower

Limits ≤ 5% of

Core Capital

Microfinance Loan

Limit ≤ 2% of Core

Capital

Aggregate

Microfinance Loan

Limit ≤ 5% of

Total Loan

Portfolio

Large Exposures ≤

2% of Core Capital

( 70% of Total

Loan Portfolio) and

up to maximum 5%

(30% of Total Loan

Portfolio)

Single

Borrower

Limits ≤

2.5% of total

deposits

Single

Borrower

Limits ≤ 5%

of total net

worth of the

MFI.

Single

Borrower

Limits ≤ 3%

of Core

Capital

Single

Borrower

Limits ≤ 1%

of Core

Capital

Group

borrower

limits ≤ 5% of

Core Capital

Source: Various microfinance legislations in the EAC member countries.

Uganda has the lowest single borrower limit at 1% of core capital while Kenya has the highest at

5% of core capital followed by Tanzania at 3% of core capital. Burundi and Rwanda on the other

hand place limits against total deposits, stipulating single borrower limits of not more than 2.5%

59

 

of total limits in both cases. Group borrower limits are also indicated by Uganda and Kenya at

5% of core capital. In addition to this, Burundi provides credit risk limits of not more than 100%

of total deposits. Rwanda on the other hand has stipulated that a single borrower cannot borrow

more than 5% of the MFIs’ total net worth.

4.4. LICENSING REQUIREMENTS AND PROCESSES

Licensing for deposit taking microfinance business is a very intricate matter that involves

thorough vetting and due diligence to ensure fit and propriety of officers (being shareholders,

directors and management; feasibility of the business model and readiness to conduct deposit

taking business. There are specific licensing requirements that have to be adhered to in the

different EAC member countries. Some are similar whilst others are unique to specific countries

as indicated in Table 4.11 below. They are as follows:

Table 4.11: Licensing requirements and processes

Licensing requirement and process

Burundi Kenya Rwanda Tanzania Uganda

Name approval or use of specific

acronym

Application Form with supporting

documentation, including constitutive

documents e.g. incorporation

certificate, memorandum and articles of

association

Evidence of minimum capital

Comprehensive feasibility study and /or

business plan

Financial projections or profoma

statements (balance sheet, income and

cash flow statements over set period

Fit and proper vetting

Registration of all natural persons

proposed as shareholders

Vetting of significant shareholders

for fitness and propriety

60

 

Licensing requirement and process

Burundi Kenya Rwanda Tanzania Uganda

Vetting of directors for fitness and

propriety

Vetting of senior management for

fitness and propriety

Risk management and operational

policies, procedures and manuals

Additional requirements for transforming entities or wholly owned subsidiaries

Board or AGM resolution

approving the transformation

 

Audited financial statements for

last number of years

 

Due diligence report on

performance.

 

Additional requirements for foreign companies setting up a local subsidiary

Board resolution authorizing the

investment.

 

Historical background of the

foreign entity

 

Signed declaration by the board of

directors to adhere all host

supervisory authority’s laws.

 

Endorsement letter, approval or

certification from the home

supervisory authority.

Issuance of letter of intent

Prescribed application and licence fees

Inspection and approval of premises.

Due diligence of management and

information systems.

Additional Requirements for financial

cooperatives under MFI legislation.

Source: Various microfinance legislations in the EAC member countries.

61

 

The requirements for institutions in the EAC are largely similar. However, in Uganda, in

addition to submitting evidence of capital, the applicant must provide a time deposit certificate

equivalent to 75% of required minimum paid up capital to be held in the BOU until the licence is

approved. In Rwanda, applicants are not required to pay any application or licence fees while in

Tanzania, no annual renewal licence fees are expected from licensed deposit taking MFIs. While

Rwanda does not vet significant shareholders, Tanzania registers all natural persons that are

proposed to be shareholders of the entities. There was no indication of provisions for foreign

companies seeking to establish local subsidiary MFIs in Rwanda and Burundi. Only in Kenya

and Tanzania are letters of intent issued to applicants prior to licensing. The letter of intent is a

conditional approval for license subject to the Applicant fulfilling certain requirements prior to

commencing the deposit taking business.

4.5. CONCLUSION

This chapter provided an overview of the microfinance landscapes and microfinance legal and

regulatory frameworks in the five EAC member countries. The chapter drew insights from

literature reviewed as well as from discussions with interviewees from the various Central Banks

in the EAC. The comparisons established that the provisions in the microfinance regulatory and

legal frameworks are largely similar, with some variations from country to country in some

aspects. The information generated in this chapter will be useful in providing the context to

analyse the findings generated by the responses detailed in the following chapter five.

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CHAPTER FIVE: DATA ANALYSIS, PRESENTATION AND INTERPRETATION

5.1 INTRODUCTION

The key objective of this study was to establish whether there were any regulatory barriers that

impeded the entry or transformation of unregulated microfinance entities into regulated status

under the specific microfinance legislations and regulations in the EAC. To determine this, it was

necessary to establish whether the respective microfinance legislations and regulations in the

EAC member countries actually impeded or enabled the entry or transformation of unregulated

microfinance entities into regulated status. This was with particular regards to the licensing

requirements for entry or transformation of deposit taking MFIs into the formal financial

systems. The study was conducted on the five major EAC microfinance associations (MFAs),

selected MFIs in the region; and reference was made to practices of Central Banks towards the

regulation and supervision of MFIs as highlighted in chapter four to address this objective. This

chapter submits the findings of the study. In addition, the results and interpretations of the

findings are discussed.

Section 5.2 provides the descriptive statistics while sections 5.3 to 5.9 presents the findings of

the study in three sub-sections namely, part A, part B and part C. Part A provides the general

demographic information of the respondents. Part B, looks at the decisions on entry or

transformation into regulated deposit taking MFIs while part C looks at the specific licensing

requirements for regulated deposit taking MFIs. The responses were analysed using descriptive

statistics and the results are presented in various formats including frequency tables, pie charts

and bar graphs that are relatively easy to understand. Section 5.10 discusses the interpretation of

the findings.

5.2 DESCRIPTIVE STATISTICS

This subsection of the paper presents descriptive statistics on the number of MFAs and MFIs

interviewed from the selected sample. The descriptive statistics show that five MFAs were

interviewed from the EAC member countries, with one MFA being interviewed in each country.

All five questionnaires that were administered to the five MFAs were filled and returned for data

analysis. In addition, out of 15 questionnaires that was administered to CEOs of sampled MFIs in

the region, 14 of them, with the exception of one, were filled and returned. This therefore

63

 

translated to a response rate of 100 percent for MFA respondents and 93.75 percent of MFI

respondents. The results are shown in Table 5.1 and Table 5.2 below.

Table 5.1: Summary of Institutions that responded

Institutions Target Actual/Realized Percent

MFAs 5 5 100

MFIs 15 14 93.75 Source: Research study findings, 2012

5.2.1 Summary of MFI and MFAs by country

The summary of MFIs and MFAs by country shows that the sample was very well distributed

within the EAC and therefore it was fairly representative of the regional MFI industry. The

summary is provided in Table 5.2 below. The summary shows that the total institutions that

responded in Burundi were four (3) while in Kenya five (5) institutions responded. In Rwanda,

Tanzania and Uganda the total number of institutions that responded was four (4), three (3) and

four (4) respectively. In total nineteen (19) institutions were interviewed and whose data was

analysed.

Table 5.2: Summary breakdown of MFAs and MFIs by country

Country MFAs MFI Total

Burundi 1 2 3

Kenya 1 4 5

Rwanda 1 3 4

Tanzania 1 2 3

Uganda 1 3 4

Total 5 14 19 Source: Research study findings, 2012

5.2.2 Summary of General/Demographic characteristics of MFAs and MFIs by

country

This subsection provides a summary of demographic characteristics for MFAs and MFIs within

the EAC region. The demographic characteristics examined include year of registration, legal

status and whether the institution was licensed and regulated by the Central Bank as a credit only

64

 

MFI, deposit taking MFI or any of the two (for MFIs). In addition, information was sought on

numbers of members (for MFAs), the aggregate number of borrowers and depositors and value of

outstanding loans and deposits. Information on infrastructure was also sought including number of

branches and other places of business as well as staff numbers. This information was useful in

painting a clearer picture of the size and characteristics of the institutions and the markets they serve.

5.3 KEY FINDINGS

This subsection of the paper provides key findings of the research study. This includes further

analysis of demographic and other market factors, decisions on entry or transformation into

regulated deposit taking MFIs and lastly analysis of the specific licensing requirements for

regulated deposit taking MFIs.  

Part A: General demographic and market information of MFIs and MFA

This subsection analyses and presents results on general demographic and market information of

MFIs and MFAs within the East Africa region. The sub section first provides profile of MFA

respondents, number of MFA members, branch/office network and staffing, aggregate number of

depositors in MFAs member institutions and lastly, aggregate number of borrowers in MFA

member institutions.

5.3.1 Profile of MFA respondents

Highlighting the profile of MFA respondents in this study is important. This is because such a

profile provides a quick comparative analysis of the context they are operating in and

performance. MFAs provide a self regulatory mechanism for MFIs and therefore conducting an

analysis of MFIs through their membership and participation within these institutions is

paramount. The study results revealed that the MFAs in the EAC varied in size and numbers

with regards to their member base, members’ clients (depositors and borrowers), branch

networks or outlets as well as staff complement. These differences are highlighted in the sub

sections here-below using various charts, tables and figures.

5.3.1.1 Total number of MFA members

Analysis of MFAs by the number of members is critical in determining performance of MFIs and

more so the entire sector in a country or region. The membership of MFIs within MFAs provides

65

 

a picture of the level of penetration of these institutions as they endeavor to bridge the gap in

financial inclusion. The study findings show that the MFAs in the EAC varied in size with

regards to their membership base, ranging from 18 to 117 members. The study established that

20% of the MFA respondents had 11-20 members, 20% had 41-50 members, 20% had 51-60

members, 20% had 71-80 members and 20% had 111-120 members. The analysis was done at

the aggregated level. Analysis by country further showed variances across the five states within

the EAC. The results are presented in Table 5.3 below.

Table 5.3: Total Number of Members

Number of MFA Members Country Frequency Percent

11-20 Burundi 1 20

41-50 Tanzania 1 20

51-60 Kenya 1 20

71-80 Rwanda 1 20

111-120 Uganda 1 20

Total 5 100 Source: Research study findings, 2012

Analyses by specific MFAs and by country show that the Reseau des Institutions de

Microfinance au Burundi (RIM) had a total number of 18 members, the Tanzania Association of

Microfinance Institutions (TAMFI) had 49 members, the Association of Microfinance

Institutions (AMFI) in Kenya had 51 members, the Association of Microfinance Institutions in

Rwanda (AMIR) had 72 members, and the Association of Microfinance Institutions (AMFIU) in

Uganda had 117 members.

5.3.1.2 Branch/Office Network and Staffing

The nature of branches or office network and staffing is critical in evaluating the performance of

MFAs in discharging their mandate as they self regulate the microfinance sectors within their

jurisdictions. The study revealed that the size of operations, in terms of offices or branch

networks and staff complement varied amongst the MFAs in the EAC. AMFIU had one office

with eleven staff members, AMIR had one office with eight staff members, RIM Burundi and

AMFI had one office with six staff members each and TAMFI had 2 offices with four staff

members. It is likely that the need for branch offices and staff would be commensurate with the

66

 

size and dynamism of the microfinance sector, where the different sectors were discussed in the

preceding chapter 4. The results are presented in Table 5.4 below.

Table 5.4: Branch/Office Network and Staffing

MFA Branches/Offices Staff

TAMFI (Tanzania) 2 4

RIM Burundi 1 6

AMFI ( Kenya) 1 6

AMIR (Rwanda) 1 8

AMFIU (Uganda) 1 11

Total Source: Research study findings, 2012

5.3.1.3 Aggregate number of depositors in MFA member institutions.

Another important aspect in establishing the penetration of the MFAs as an extension of its

members’ outreach was to determine the aggregate number of depositors in the MFA member

institutions. The study revealed that the aggregate number of depositors with the MFAs’ member

institutions varied, from 200,000 to over 1 million depositors. Table 5.5 below shows that one of

the MFA respondents, representing 20% of respondents, had between 201,000-500,000

depositors, another had between 501,000-750,000 depositors and a third MFA had over one

million depositors. However two MFAs, representing 40% of respondents, did not provide

responses to the question, of which one respondent did not have the information available while

the other indicated ‘non applicable.’

Table 5.5: Aggregate number of depositors in MFA member institutions

Depositors Frequency Percent

201,000-500,000 1 20.0

501,000-750,000 1 20.0

Over 1 million 1 20.0

No response 2 40.0

Total 5 100.0 Source: Research study findings, 2012

5.3.1.4 Aggregate number of borrowers in MFA member institutions

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The aggregate number of borrowers in MFA member institutions is another indicator of

performance and outreach and therefore has implications on the penetration of the MFAs, by

extension of its members in the EAC. The study findings revealed that the aggregate number of

borrowers of member institutions in the respondent MFAs varied as highlighted in Figure 5.1

below. Two of the MFA member institutions, representing 40% of respondents, had an aggregate

of between 501,000 -750,000 borrowers, one MFAs member institutions had an aggregate of

over 1.25 million borrowers. A fourth MFAs member institutions had an aggregate of less than

250,000 borrowers while one MFA was unable to provide the information due to its

unavailability.

Figure 5.1: Aggregate number of borrowers

Source: Research study findings, 2012

Out of these MFAs, one respondent, which had 2.3 million borrowers, further broke down the

borrowers by gender, indicating that they had an aggregate number of 767, 800 male borrowers

and 1.54 million female borrowers. This could be an indication that most clients that are covered

by MFIs are female.

Part B: Decisions on entry or transformation into regulated deposit taking MFIs

This subsection of the paper provides an analysis of entry or transformation into regulated

deposit taking MFIs. It summarizes the various reasons for entry or transformation into regulated

deposit taking MFIs submitted by the respondents. The key issues discussed include, response by

MFAs and MFIs on reasons for entry or transformation into regulated deposit taking MFI.

68

 

Garnering responses from both MFAs and MFIs is important because MFAs may have different

views from those held by MFIs themselves. It also examines the impediments to entry or

transformation into regulated deposit taking MFIs and lastly evaluates considerations for entry or

transformation into regulated deposit taking MFIs.

5.4 REASONS FOR ENTRY OR TRANSFORMATION INTO REGULATED

DEPOSIT TAKING MFIS

Different entities or applicants are motivated to enter or transform into regulated deposit taking

MFIs for different reasons as indicated in section 2.3.2 presented earlier. This was the case with

institutions in the EAC member countries as well. According to the study results (Table 5.6),

MFA respondents submitted that three of the primary reasons for entry or transformation of

entities into regulated deposit taking MFIs were: (i) requirements by law (ii) ability to mobilize

public savings, and (iii) credibility or perceived stability due to regulation by the Central Bank,

all indicated by three of the five MFAs, representing 21% of responses each. Other reasons

indicated included access to commercial capital, expanded outreach, diversification of product

range and improved governance, professional standards and accountability

Table 5.6: Reasons for entry or transformation into regulated deposit taking MFIs

(Responses from Associations)

Reason Burundi Kenya Rwanda Tanzania Uganda Total Percent

Requirements by law 1 1 1 3 21%

Access to commercial

capital

1 1 2 14%

Ability to mobilise public

savings

1 1 1 3 21%

Improved customer

service

0 0%

Expanded outreach 1 1 7%

Diversification of the

product range

1 1 7%

Improved institutional

governance, professional

standards and

1 1 7%

69

 

accountability

Credibility or perceived

stability due to regulation

by the Central Bank

1 1 1 3 21%

Total 3 2 1 4 4 14 100% Source: Research study findings, 2012

In order to improve on the results, MFI respondents were also asked the same question to

validate the responses from the Associations (Table 5.7). The key motivations for entry or

transformation into regulated status as deposit taking MFIs identified by Burundi were:

requirements by law, ability to mobilise public savings, improved customer service and

diversification of product range. In Kenya, the main reasons were: diversification of product

range, ability to mobilise savings, improved institutional governance and increased credibility or

perceived stability. In Rwanda, expanded outreach, diversification of product range and

improved customer service were indicated as the main reasons. In the case of Tanzania, reasons

submitted were: improved institutional governance and increased credibility or perceived

stability. Finally in Uganda, the key reasons included ability to mobilise public savings, and

diversification of product range. Essentially, the most common reasons submitted by the MFI

respondents were: diversification of product range (23.4 percent), ability to mobilize public

savings (14.9 percent), and credibility and perceived stability (14.9 percent). When assessed

against the responses from the MFAs, (i) the ability to mobilise deposits and (ii) credibility and

perceived stability due to regulation by the Central Bank stood out as the most common reasons

for entry or transformation. These findings are similar to the key motivations of transformation

documented in section 2.3.2 for other institutions in different developing nations across the

globe.

Table 5.7: Reasons for entry or transformation into regulated deposit taking MFIs

(Responses from MFIs)

Reason Burundi Kenya Rwanda Tanzania Uganda Total Percent

Requirements by law 1 2 0 0 0 3 6.4

Access to commercial

capital

0 2 1 1 0 4 8.5

Ability to mobilise

public savings

1 3 0 0 3 7 14.9

70

 

Improved customer

service

1 0 2 1 0 4 8.5

Expanded outreach 0 1 3 1 1 6 12.8

Diversification of the

product range

1 4 3 1 2 11 23.4

Improved institutional

governance,

professional standards

and accountability

0 3 0 2 0 5 10.6

Credibility or perceived

stability due to

regulation by the

Central Bank

0 3 1 2 1 7 14.9

Total 4 18 10 8 7 47 100

Percent 8.5 38.3 21.3 17.0 14.9 100 Source: Research study findings, 2012

5.5 IMPEDIMENTS TO ENTRY OR TRANSFORMATION INTO REGULATED

DEPOSIT TAKING MFIS

Given the objective of this study, it was necessary to establish the reasons why some entities

opted not to enter or transform into regulated deposit taking MFIs. The question was posed to

both the MFA and MFI respondent groups and results were tabulated accordingly (Table 5.8 for

MFAs). The MFA respondents indicated that the greatest factors that led MFIs not to consider

being licensed and regulated as deposit taking MFIs were (i) the costs of entry or transformation,

as indicated by 38% of the respondents, and (ii) the decision not being in line with the

institution’s mission and vision, as indicated by 25% of the respondents. Other reasons included:

the licensing process being too lengthy, the regulatory policy and reporting requirements being

too stringent or onerous and the microfinance laws not being easy to understand, as indicated by

13% of the respondents. These responses are also consistent with those from studies conducted

as documented in sections 2.3.3 and 2.3.4 above.

Table 5.8: Impediments to entry or transformation into regulated deposit taking MFIs

(Responses from Associations).

71

 

Reason Burundi Kenya Rwanda Tanzania Uganda Total Percent

Licensing process too

lengthy

1 1 13%

Entry or transformation

into regulated status as a

deposit taking MFI is too

costly

1 1 1 3 38%

Regulatory policy and

reporting requirements too

stringent and/or onerous

1 1 13%

The microfinance laws are

not easy to understood

1 1 13%

The institution’s strategic

plans do not include entry

or transformation into

regulated deposit taking

MFI

0 0%

Benefits of DTM are not

yet evident in short term

0 0%

Decision is not in line with

the institution’s mission

and vision

1 1 2 25%

Total 0 1 0 5 2 8 100% Source: Research study findings, 2012

To elaborate further, respondents indicated that the costs of setting up MFIs which were too high

in terms of corporate governance, information technology, branch physical infrastructure,

staffing, reporting requirements, and other transformation costs. To add to the impediments, one

MFA respondent indicated that leaving some MFIs outside of a legal framework (unregulated)

weakened their desire to transform while another pointed out the challenge of transforming

NGOs into limited liability companies as another impediment to entry or transformation into

regulated status. These findings are also similar to the literature documented in sections 2.3.3 and

2.3.4 above.

72

 

5.6 CONSIDERATION FOR ENTRY OR TRANSFORMATION INTO

REGULATED DEPOSIT TAKING

The decision by an MFI regarding whether or not to enter or transform into a regulated deposit

taking MFI, including the timeframes, is one of the key factors that sets the pace of the

implementing activities to be undertaken to actualize this. The study revealed that 28 % of the

MFI respondents had considered entry or transformation into regulated deposit taking MFIs

while 36% were currently in the process of entering or transforming into regulated deposit taking

MFIs, representing 64% of respondents. However 36% of the respondents did not respond to the

question (Figure 5.2).

Figure 5.2: Consideration for entry or transformation into a regulated deposit taking MFI

Source: Research study findings, 2012

As a follow up to the preceding question, over half of the respondents (57.1%) indicated that

they intended to get licensed and regulated as a deposit taking MFI within a period of 0-3 years.

One respondent, representing 7.1% of the respondents, went to the extent of explaining that it

planned to set up a separate deposit taking MFI instead of converting the existing one; although

the time frame was not provided. However, 35.7% did not respond to the question on the reasons

for not considering entry or transformation into a regulated deposit taking MFI indicating ‘not

applicable’. Table 5.9 below summarises these findings.

Table 5.9: Period within which to get licensed and regulated as a deposit taking

microfinance institution

73

 

Period Frequency Percent

0-3 years 8 57.1

Plan to set up a separate deposit taking MFI instead of

converting the existing one (no time frame provided)

1 7.1

No response 5 35.7

Total 14 100.0 Source: Research study findings, 2012

The purpose of the analysis questions in this subsection was to establish if new or existing

entities considered entry or transformation as a regulated status and what, if this was the case,

time frames they were considering doing so, given the licensing requirements stipulated by EAC

central banks. Further to this, the section sought to establish if the institutions were aware of the

challenges and opportunities in being regulated. Ultimately the aim is to establish if it is the will

(or lack thereof) or ability (or lack thereof) that determines the choices made by MFIs to seek to

be regulated (or not to be regulated) as deposit taking institutions. From the analysis, it can be

concluded that, the fact that a good number of sampled MFIs were considering, and had began

taking actionable steps towards entry or transformation to regulated deposit taking MFI, is a

great and bold step towards enhancing financial inclusion in the EAC, where as indicated in

Chapter 1, majority of the adult population is unbanked and poverty is widespread.

Part C: Licensing requirements

Microfinance licensing requirements and processes can be viewed as a gateway as the play a

crucial role in either enabling or impeding the entry and transformation of MFIs into regulated

deposit taking status. This subsection of the paper focuses on the specific licensing provisions in

the EAC microfinance legislations and the relative ease or difficulty in meeting those

requirements. The requirements are broadly categorised into three as follows: Ownership,

capitalisation and other requirements. Ownership requirements cover the entities’ ability to meet

shareholding limits and requirements stipulated by their regulatory authority; capitalisation

requirements define the minimum capital required for regulated entities; and other requirements

cover the diverse requirements including corporate governance structures (directors,

management), management information systems (MIS), places of business (premises, and

policies and manuals. These sections following will therefore discuss the findings of the study in

this regard.

74

 

5.7 OWNERSHIP AND SHAREHOLDING REQUIREMENTS

5.7.1 Breakdown of ownership and shareholding requirements

An analysis of the breakdown of ownership and shareholding requirements revealed that four of

the respondent MFIs, representing 28.6% of respondents, were wholly owned (100%) by

corporate owners. The rest of the MFI respondents, each representing 7.1% of respondents, had

varied ownership and shareholding percentages. Out of these, majority were largely owned by

corporate owners, with the largest two corporate shareholding percentages of 97.5% and 95% of

total shares. In a few entities, major shareholding was held by individual shareholders; the largest

two individual shareholding amounts being 60% and 25% of total shares. One of the MFI

respondent almost equally balanced its shareholding between corporate owners at 41.24% and

development finance financing at 58.76%. These details are tabulated in Table 5.10 below:

Table 5.10: Breakdown of current shareholding/ownership structure

Individual

Owners

Corporate

Owners

Development

Finance

Partners

Government

owned

Board of

Governors

Frequency Percent

60.0% 40% 0% 0% 0% 1 7.1

17.7% 82.3% 0% 0% 0% 1 7.1

0% 100.0% 0% 0% 0% 4 28.6

25.0% 75.0% 0% 0% 0% 1 7.1

6.0% 94.0% 0% 0% 0% 1 7.1

2.5% 97.5% 0% 0% 0% 1 7.1

15% 85.0% 0% 0% 0% 1 7.1

0% 41.24% 58.76% 0% 0% 1 7.1

0% Max 20% Max 20% 0% 0% 1 7.1

0% 0% 0% 100% 0% 1 7.1

0% 0% 0% 0% 100% 1 7.1 Source: Research study findings, 2012

5.7.2 Existence of shareholders/owners exceeding stipulated limits

Cases of existence of shareholders/owners exceeding the stipulated limits are common among

unregulated MFIs in developing countries, particularly NGO MFIs. However, analysis from the

75

 

research study revealed that 57% of the respondents did not have shareholders owning more than

the stipulated minimum shareholding amounts for licensed and regulated deposit taking MFIs as

required by their respective Central Bank; although 14% of the respondents did. 29% of the MFI

respondents did not provide a response to this question (Figure 5.3). The findings suggest that,

although ownership is indicated as one of the key challenges to entry or transformation into

regulated status [section 2.3.4.(i)], it appears that more than half of the MFI respondents in the

EAC would not be faced by this challenge if they were to seek entry or to transform to regulated

status as a deposit taking MFIs.

Figure 5.3: Shareholders exceeding stipulated minimum shareholding limits

Source: Research study findings, 2012

5.7.3 Ease of effecting the necessary changes

The flexibility within which MFIs are able to institute certain changes to meet certain minimum

stipulated requirements is key to the ease of entry or transformation into a regulated deposit

taking regime. For those MFI respondents that would have to restructure their ownership and

shareholding structures to meet the required minimum shareholding limits for regulated deposit

taking MFIs in the respective EAC member countries, the study sought to establish the ease or

difficult in doing so. Figure 5.4 (below) reveals that 35.7% indicated that it would be moderately

easy to effect the necessary changes, 14.3% indicated it would be extremely difficult while 7.1%

indicated it would be easy to effect the necessary changes. The reasons given were as follows: (i)

76

 

it was difficult to source shareholders that would embrace the vision, mission and objectives the

MFI stood for, (ii) ownership control would be eroded as inviting external investors would

probably lead to mission drift given the difficulty in getting like-minded strategic investors: and

(iii) although the process was moderately easy; it would be an intricate process given that not

only would they need buy in from the members of their non-profit mother association but they

would have to carefully consider the choice of shareholders to safeguard the mission of the

institution.

Figure 5.4: Ease of effecting the necessary changes

0

10

20

30

40

50

Easy to effect

Moderately easy to effect

Extremely difficult to

effect

No Response

Per

cent

age

Ease of effecting the necessary changes

Source: Research study findings, 2012

5.7.4 Challenges regarding minimum ownership and shareholding requirements

Finally, regarding shareholding and ownership requirements, the MFA and MFI respondent

groups provided qualitative responses regarding perceived and real challenges faced in meeting

the minimum ownership and shareholding requirements and limits. In Kenya, the MFA and MFI

respondents were in agreement that changing the ownership structure (especially for

international NGOs) and sourcing for suitable likeminded investors were key challenges. Further

concerns were raised including (i) ensuring congruence of shareholders to guard against mission

drift (ii) difficulty in relinquishing ownership to others to co-own the institution; and (iii)

possible burdensome conditionality’s by new shareholders, for example, expectations of quick

and possibly high returns. Respondents from Uganda and Burundi also shared the same opinion

indicating that sourcing of suitable shareholders had proven to be quite a challenge, to the extent

77

 

that it often led to delays in the licensing process in Uganda. In addition, Ugandan respondents

raised concern that bringing on board business people who did not observe or share the primary

objectives of microfinance could derail the MFI from its core mission. In Rwanda and Tanzania,

raising capital from local investors was indicated as the greatest challenge. In Tanzania, other

challenges noted included the possible clash of interest caused by inviting shareholders who did

not share the same vision with current organisation and the threat of loss of the identity, brand

and culture that made MFIs unique. In addition, pre-existing institutions were not provided with

a transformation plan, with grace period for divestiture, which made divestiture of shares rather

difficult.

5.8 CAPITAL REQUIREMENTS

5.8.1 Ease or difficulty in meeting minimum capital requirements

In exploring the ease or difficulty for new or transforming entities in meeting the minimum

capital requirements, the study revealed that majority of the EAC respondents found it relatively

easy to meet the minimum capital requirements stipulated for regulated deposit taking MFIs in

their respective countries (Table 5.11). MFAs in Kenya, Burundi and Rwanda indicated that this

requirement was easy to meet in agreement with the MFIs in the same countries (apart from

Kenya whose MFI respondents slightly differed, indicating that the minimum capital

requirements were moderately easy to meet). For Uganda, although the MFA indicated that the

requirement was extremely difficult to meet; MFIs in the country differed, indicating that the

requirement was moderately easy to meet. In Tanzania, although the responses were not quite

similar, the most common collective response was that the requirements were moderately easy to

meet. Across all countries, 28.6 percent of the respondents felt that the capital requirements for

the MFIs to transform were easy to meet while 71.4 percent felt they were moderately easy to

meet. From these results, it appears that in the EAC, meeting the minimum capital requirements

is not an impediment to the entry or transformation of unregulated entities into regulated status in

agreement with section 2.3.4 (ii) which calls for regulators to set minimum capitalisation levels

that are low enough to enable entities to enter into regulated space yet without attracting unviable

candidates (BCBS 2010).

Table 5.11: Ease or difficulty in meeting the minimum capital requirements

ASSOCIATIONS

78

 

Limit Kenya Uganda Burundi Rwanda Tanzania Total Percent

Easy to meet 1 0 1 1 0 3 42.9

Moderately easy 0 0 0 0 1 1 14.3

Extremely difficult 0 1 0 1 1 3 42.9

Impossible to meet 0 0 0 0 0 0 0.0

Total 7 100.0

MFIs

Limit Kenya Uganda Burundi Rwanda Tanzania Total Percent

Easy to meet 0 0 1 2 1 4 28.6

Moderately easy 4 3 0 2 1 10 71.4

Extremely difficult 0 0 0 0 0 0 0.0

Impossible 0 0 0 0 0 0 0.0

Total 14 100.0

Source: Research study findings, 2012

5.8.1.1 Challenges faced in meeting minimum capital requirements

Regardless of the fact that it appeared that meeting the minimum capital requirements for

regulated deposit taking MFIs did not pose any threats to entities seeking to enter or transform

into regulated status, the challenges in meeting this requirement were explored nevertheless. The

responses from the various countries were varied. The two common challenges that were

identified by majority of the respondents were (i) ability to meet the minimum capital

requirements; and (ii) ability to source suitable deep pocketed investors who would not erode the

mission of the MFI. The key specific responses are indicated as follows: In Burundi MFIs

indicated that identifying and mobilizing the right investors to join the organization was a

meticulous and lengthy process which took some time (approximately 6 months). In Rwanda, the

greatest challenge was raising the required capital because there were not enough potential

investors to invest in microfinance. In Kenya, Uganda and Tanzania, raising and maintaining the

minimum requirements; getting deep pocketed investors that were driven by the social mission

of microfinance; identifying and getting suitable shareholders with required capital resources,

and having the right and relevant mix of shareholders in respect of their key competencies were

the critical issues that were identified as challenges to raising minimum capital requirements. It

79

 

is clear that there is a strong linkage between the shareholding and capitalisation requirements.

Respondents in the EAC appear to be very passionate about ensuring that the mission of the MFI

is protected. In this regard, the choice of shareholders, who tend to be potential inventors and

equity partners, is something that they do not take lightly regardless of the delays it poses to the

licensing process.

5.9 OTHER LICENSING REQUIREMENTS

5.9.1 Constituting a Board of Directors

As indicated in section 2.3.4 (iii), ensuring that regulated deposit taking MFIs have good

corporate governance structures must never be compromised. It is in light of this that the EAC

member countries have benchmark corporate governance requirements for regulated deposit

taking MFIs (section 4.2.1). MFIs are, therefore, expected to have in place a competent Board of

Directors and management staff. Constituting good Board of Directors and management teams

differ from country to country. According to the study findings, the MFAs in Burundi and

Rwanda, indicated that constituting a Board of Directors with the required composition, size and

competencies as per the Central Bank’s requirements was extremely easy to meet; in Kenya, it

was reasonably easy to meet while Uganda and Tanzania conceded that it was extremely difficult

to meet. For MFIs themselves, the responses were different. Majority of the respondents in

Kenya indicated that it was slightly difficult to meet the requirements; while in Uganda and

Rwanda, majority found the requirements easy to meet. The experiences in Burundi and

Tanzania were varied. All in all, the collective summation of responses indicated that in the

EAC, constituting a Board of Directors is relatively uncomplicated as indicated by a total of 60

percent who felt that it was extremely easy to meet and reasonably easy to meet (Table 5.12).

Table 5.12: Constituting a Board of Directors

ASSOCIATIONS

Likely

experiences

Kenya Uganda Burundi Rwanda Tanzania Total Percent

Extremely easy

to meet

0 0 1 1 0 2 40.0

Reasonably

easy to meet

1 0 0 0 0 1 20.0

Slightly 0 0 0 0 0 0 0.0

80

 

difficult to meet

Extremely

difficult to meet

0 1 0 0 1 2 40.0

Impossible to

meet

0 0 0 0 0 0 0.0

Total 5 100.0

MFIs

Likely

experiences

Kenya Uganda Burundi Rwanda Tanzania Total Percent

Extremely easy to

meet

0 2 1 2 0 5 35.7

Reasonably easy

to meet

1 0 1 1 1 4 28.6

Slightly difficult

to meet

3 1 0 0 1 5 35.7

Extremely

difficult to meet

0 0 0 0 0 0 0.0

Impossible to

meet

0 0 0 0 0 0 0.0

Total 14 100.0 Source: Research study findings, 2012

5.9.2 Recruiting qualified management team

With regard to the ease or difficulty in recruiting qualified management teams that meet the

regulatory authority’s requirements, responses varied. While majority of the MFA respondents

indicated that the requirement was easy to meet, majority of the MFI respondents indicated that

this was a slightly difficult requirement (42.9 percent). Given the findings (Table 5.13) it would

be prudent to conclude that the process of recruiting qualified management teams as required is

not an easy process. This most likely has to do with the resources incurred with regards to cost

and time of hiring and (re) training teams to be able to fulfill their mandates effectively and

efficiently.

Table 5.13: Recruiting qualified management team

81

 

ASSOCIATIONS

Likely

experiences

Kenya Uganda Burundi Rwanda Tanzania Total Percent

Extremely easy

to meet

0 0 1 1 0 2 40.0

Reasonably

easy to meet

1 0 0 0 0 1 20.0

Slightly

difficult to meet

0 0 0 0 0 0 0.0

Extremely

difficult to meet

0 1 0 0 1 2 40.0

Impossible to

meet

0 0 0 0 0 0 0.0

Total 5 100.0

MFIs

Likely

experiences

Kenya Uganda Burundi Rwanda Tanzania Total Percent

Extremely easy

to meet

0 2 1 1 0

4 28.6

Reasonably easy

to meet

1 0 0 1 0

2 14.3

Slightly difficult

to meet

2 1 1 1 1

6 42.9

Extremely

difficult to meet

1 0 0 0 1

2 14.3

Impossible to

meet

0 0 0 0 0

0 0.0

Total 14.0 100.0Source: Research study findings, 2012

5.9.3 Raising funds for entry or transformation into regulated status

The study also sought to establish the ease or difficulties for MFIs in raising funds for entry or

transformation into regulated status as a deposit taking MFI. This was with regards to funds

82

 

needed for setting up branches, management information systems, and recruiting staff among

other capital intensive requirements. The MFAs in the EAC had varied responses, with Uganda

and Tanzania citing that these requirements were extremely difficult to meet, Kenya and Burundi

indicating they were slightly difficult to meet and Rwanda indicating they were reasonably easy

to meet. For the MFIs themselves, majority of the Kenyan respondents, in agreement with the

Association indicated this was a slightly difficult requirement to meet. The rest of the EAC

respondents had varied responses. Responses from MFA respondents indicated that raising funds

for entry or transformation into regulated status was either slightly or extremely difficult to meet

as indicated by 40 percent of the respondents, respectively. Only 20 percent indicated that raising

funds was reasonably easy to meet. With regard to MFIs, 50 percent indicated that raising funds

was slightly difficult to meet while 28.6 percent indicated it was extremely difficult to meet. The

analysis is presented in Table 5.14 below.

Table 5. 14: Raising funds for entry or transformation into regulated status

ASSOCIATIONS

Likely

experiences

Kenya Uganda Burundi Rwanda Tanzania Total Percent

Extremely easy to

meet

0 0 0 0 0 0 0

Reasonably easy

to meet

0 0 0 1 0 1 20

Slightly difficult

to meet

1 0 1 0 0 2 40

Extremely

difficult to meet

0 1 0 0 1 2 40

Impossible to

meet

0 0 0 0 0 0 0

Total                5 100

MFIs

Likely

experiences

Kenya Uganda Burundi Rwanda Tanzania Total Percent

Extremely easy to

meet

0 0 1 1 0 2 14.3

83

 

Reasonably easy

to meet

0 1 0 0 0 1 7.1

Slightly difficult

to meet

3 1 1 1 1 7 50.0

Extremely difficult

to meet

1 1 0 1 1 4 28.6

Impossible to meet 0 0 0 0 0 0 0.0

Total                14 100.0 Source: Research study findings, 2012

5.9.4 Preparing Feasibility Study or Business Plan

The study revealed that while MFAs in Uganda, Burundi and Rwanda indicated that it was

reasonably easy for MFIs to develop feasibility plans and business plans, Kenya and Tanzania

MFA respondents indicated that this requirement was slightly difficult to meet. With regards to

MFI respondents, majority in Kenya were in agreement with the responses from the Association.

In Uganda, majority indicated that it was extremely easy. In Rwanda, the MFIs indicated it was

reasonably easy to meet, while in Burundi and Tanzania, the responses were varied. The varied

responses have to do with the resources used in preparing the feasibility study and business

plans. Some institutions rely on external consultants, of which their input is relatively minimal,

whilst others assign dedicated staff members to do this task, which can be quite an involving and

rigorous process. On average, it is reasonably easy to meet requirements to prepare feasibility

studies or business plans (60 percent) while only 40 percent responded that it was slightly

difficult. The results are presented in Table 5.15 below.

Table 5.15: Preparing Feasibility Study or Business Plan

ASSOCIATIONS

Likely

experiences

Kenya Uganda Burundi Rwanda Tanzania Total Percent

Extremely easy to

meet

0 0 0 0 0 0 0.0

Reasonably easy

to meet

0 1 1 1 0 3 60.0

Slightly difficult

to meet

1 0 0 0 1 2 40.0

84

 

Extremely

difficult to meet

0 0 0 0 0 0 0.0

Impossible to

meet

0 0 0 0 0 0 0.0

Total 5 100.0

MFIs

Likely

experiences

Kenya Uganda Burundi Rwanda Tanzania Total Percent

Extremely easy to

meet

0 2 1 0 0 3 21.4

Reasonably easy

to meet

1 0 0 2 1 4 28.6

Slightly difficult

to meet

2 1 0 0 1 4 28.6

Extremely difficult

to meet

1 0 1 1 0 3 21.4

Impossible to meet 0 0 0 0 0 0 0.0

Total 14 100.0 Source: Research study findings, 2012

5.9.5 Setting up requisite premises

While the responses varied, the study revealed that majority of the MFA and MFI respondents

indicated that setting up of premises was either slightly or extremely difficult to meet (Table

5.16). This is due to the fact that setting up the requisite places of business as per the Central

Banks’ standards is quite costly in terms of monetary and other resources, and is time consuming

and laborious [Section 2.3.4 (iv)]. About 40 percent of the respondents felt that setting up

requisite premises was slightly difficulty while 20 percent found it extremely difficult.

Table 5.16: Setting up requisite premises (including branches and other stipulated places of

business) as required by the Central Bank

ASSOCIATIONS

Likely

experiences

Kenya Uganda Burundi Rwanda Tanzania Total Percent

85

 

Extremely easy

to meet

0 0 0 0 0 0 0.0

Reasonably easy

to meet

0 0 1 0 0 1 20.0

Slightly difficult

to meet

0 1 0 1 0 2 40.0

Extremely

difficult to meet

1 0 0 0 0 1 20.0

Impossible to

meet

0 0 0 0 1 1 20.0

Total 5 100.0

MFIs

Likely

experiences

Kenya Uganda Burundi Rwanda Tanzania Total Percent

Extremely easy to

meet

0 0 1 1 0 2 14.3

Reasonably easy

to meet

1 1 0 0 0 2 14.3

Slightly difficult

to meet

1 1 1 2 0 5 35.7

Extremely

difficult to meet

2 1 0 0 2 5 35.7

Impossible to

meet

0 0 0 0 0 0 0.0

Total 14 100.0 Source: Research study findings, 2012

5.9.6 Developing a suitable MIS and reporting system

The study also sought to establish the ease or difficulties for MFIs in developing a suitable

Management Information System (MIS) and reporting system that met the requirements of the

respective country Central Banks. The Associations in Kenya, Rwanda and Tanzania indicated

that it was extremely difficult for MFIs to meet this requirement; however in Uganda and

Burundi the Associations indicated that this requirement was reasonably easy to meet and

86

 

extremely easy to meet, respectively. On average 60 percent, of the MFAs indicated that it was

extremely difficult to develop a suitable MIS and reporting system compared to 20 percent who

indicated it was extremely easy and reasonably easy to meet this requirement, respectively. With

regards to MFI respondents, all respondents in Kenya, Rwanda and Tanzania indicated that this

requirement was slightly difficult to meet while in Uganda all respondents indicated that the

requirement was reasonably easy to meet. Responses in Burundi were varied. All in all, majority

of the MFI respondent indicated that this requirement was extremely difficult to meet (50

percent) while 28.6 percent indicated that it was slightly difficult to meet requirement of

developing a suitable MIS and reporting system. This is due to the heavy investments in

technology needed to ensure the MFI has a robust information technology (IT) system. The

results are presented in Table 5.17 below.

Table 5.17: Developing a suitable MIS and reporting system

ASSOCIATIONS

Likely

experiences

Kenya Uganda Burundi Rwanda Tanzania Total Percent

Extremely easy to

meet

0 0 1 0 0 1 20.0

Reasonably easy

to meet

0 1 0 0 0 1 20.0

Slightly difficult

to meet

0 0 0 0 0 0 0.0

Extremely

difficult to meet

1 0 0 1 1 3 60.0

Impossible to

meet

0 0 0 0 0 0 0.0

Total 5 100.0

MFIs

Likely experiences Kenya Uganda Burundi Rwanda Tanzania Total Percent

Extremely easy to

meet

0 0 1 1 0 2 14.3

Reasonably easy to

meet

0 1 0 0 0 1 7.1

Slightly difficult to 2 1 0 1 0 4 28.6

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meet

Extremely difficult

to meet

2 1 1 1 2 7 50.0

Impossible to meet 0 0 0 0 0 0 0.0

Total 14 100.0 Source: Research study findings, 2012

5.9.7 Length of the licensing process

The length of the licensing process has fundamental implications for entry or transformation of

MFIs into regulated deposit taking institutions. The question on thoughts regarding the length of

the licensing process was posed to respondents. Majority of the MFI respondents indicated that

the length of their licensing processes were moderate (69.2 percent) while 30 percent felt that the

licensing process was too long and therefore affecting entry or transformation of MFIs. On the

other hand, 44 percent of the MFAs felt that the licensing process was too long and the same

applied to those who recorded the length of licensing as moderate. Regarding specific country

responses, respondents in Uganda and Rwanda indicated that the licensing timeframe was

moderate. Respondents in Burundi. Kenya and Tanzania had mixed responses; where in Kenya

respondents indicated that the process was moderate and long respectively; while in Tanzania,

respondents indicated that the licensing process was quite short and too long, respectively. In

Burundi, while the MFA indicated the process was quite short, sampled MFIs felt it was

moderate.

Table 5.18: Length of the licensing process

ASSOCIATIONS

Thoughts Kenya Uganda Burundi Rwanda Tanzania Total Percent

Quite short 0 0 1 0 0 1 11.1

Moderate 1 1 0 1 0 4 44.4

Too long 0 0 0 0 1 4 44.4

Total 9 100.0

MFIs

Thoughts Kenya Uganda Burundi Rwanda Tanzania Total Percent

Quite short 0 0 0 0 0 0 0.0

Moderate 2 3 1 2 1 9 69.2

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Too long 2 0 0 1 1 4 30.8

Total 13 100.0Source: Research study findings, 2012

While the MFA in Burundi thought the length of the licensing process was quite short, the MFI

respondent indicated it was moderate. The respondents indicated that the process depended on

the nature of the case suggesting that if the application packet contained all required elements,

then the analysis of the licence application would be quicker. One of the respondents provided

highlights of the licensing process indicating that it took about a month after the licensing

request had been submitted to the Central Bank, for the Bank to notify the MFI that they have

received all the documents they needed to analyze their request. It then took up to the 3 months

for the Central Bank to grant or deny the MFI approval to work as a deposit taking MFI.

In Kenya, the respondents indicated that although 3-6 months would be ideal, it took 12 months

and sometimes longer for a licence application to be finalised. The MFA noted that it had been

challenging for MFIs to meet the transformation requirements hence delays in being licensed.

One year, in the respondents’ opinion, was too long for licensing, especially for new entities that

needed to commence business immediately. One MFI respondent indicated that business

opportunities were lost during the vetting and application process. This translated to

transformation being a very expensive process for entities, especially for new ones, which were

not able to conduct any business while still waiting to complete the process. This situation

caused anxiety to the staff and stakeholders of the institution. In addition, a MFI respondent

indicated that if the licensing process was too long, then the sense of commitment and focus of

stakeholders would be lost.

In Rwanda, the respondents indicated that it took 4-6 months to acquire a licence; although 6

months was too long. One respondent added that during that period, the MFIs equity was held at

the Central Bank without earning any interest which was unfair for a company which expends

without generating revenue. Another respondent indicated that the licensing requirements and

conditions were not clarified in a structured manner; with new conditions being introduced as the

licensing process progressed.

Respondents from Tanzania indicated that the licensing process was lengthy because the

requirements were expensive, shareholding structures took time to negotiate and expertise in

microfinance was not vastly available in the local market. Respondents from Uganda, on the

other hand, indicated that it took an average of 6 months to obtain a response from the Central

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Bank. One respondent even expressed satisfaction that BOU was cooperative and ‘openly willing

to bring as many institutions as possible’.

5.9.8 Ideal time frame and process in obtaining a licence from the Central Bank

The study sought to get views from the respondents’ on what an ideal time frame (Table 5.19)

and licensing process would be to them. The different respondents shared diverse opinions;

however, majority (60 percent) indicated that 3 months was ideal for an applicant to obtain a

licence to conduct deposit taking business from the point of application. In addition, the MFA

respondent in Burundi indicated that the current licensing process was rigorous and meticulous,

which was quite appropriate and ideal for the industry. One MFI respondent indicated that

‘taking into consideration the Central Bank’s expertise in the assessment of the quality of MFIs

seeking licensing, and in light of the volume of work involved in the analysis of a licence

request, 3 months presents an ample timeframe to evaluate a request, conduct the appropriate

follow-up and issue the licence’

The Kenyan MFA indicated that 9 months was an ideal timeframe; however, new institutions

could take less time than existing ones that were transforming to regulated status. The MFI

respondents on the other hand, indicated that the licensing process was too lengthy and suggested

a period between 6 to 12 months. They also suggested that (i) once all licensing requirements

have been met, licensing should be immediate (ii) an interim licence should be given within 6

months upon application and the applicant given a timeframe of up to one year within which to

comply with the outstanding issues before it can receive a licence; and (iii) thereafter if the

institution did not comply, then the interim licence would be revoked with no further extension.

One year period, in their opinion, gave a strong indicative timeline to gather resources and

develop systems, as well as assess/evaluate whether the strategy was workable or working. The

respondents also suggested that the timeframe should not be too short in order to enable the

regulator to carry out thorough due diligence.

For Rwanda, the MFI respondents suggested 3-6 months as ideal as the ‘period is long enough

for the Central Bank to process the dossier, conduct due diligence and respond to the MFI; and

for the MFI to start the deposit taking business. One MFI respondent went to the extent of

providing a licensing procedures’ checklist including timeframes for all stages of the process of

up to 6 months.’ To assist this process, one MFI respondent suggested that if the conditions for

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qualification were clearly stated on the onset, then it would be easy for any MFI to prepare

documentation and other licensing requirements even before making the application.

The respondents from Tanzania suggested that the licensing process should be differentiated for

existing institutions seeking to transform from new institutions entering the market. For Uganda,

respondents conceded that 6 months as required in Section 7(3) of the MDI Act 2003 was

enough time for the Central Bank to conduct due diligence and verify the applicants’ capabilities

and planned strategies. Specific responses with proposed licensing processes were also submitted

providing suggestions that the Central Bank conduct thorough due diligence and issue licences

upon the applicants’ satisfactory fulfillment of licensing requirements. Overall, 50 percent and

35.7 percent of all MFIs that responded felt that the ideal time to obtain a license was 3 months

and six months respectively. This is a very critical factor given that some applications take up to

12 months or more to be processed as indicated in Kenya in section 5.9.7. The results are

presented in Table 5.19.

Table 5.19: Ideal time frame to obtain a license from the Central bank

ASSOCIATIONS

Ideal time Kenya Uganda Burundi Rwanda Tanzania Total Percent

3 months 0 0 1 1 1 3 60

6 months 0 1 0 0 0 1 20

9 months 1 0 0 0 0 1 20

12 months 0 0 0 0 0 0 0

Total 5 100

MFIs

Ideal time Kenya Uganda Burundi Rwanda Tanzania Total Percent

3 months 2 0 1 3 1 7 50.0

6 months 1 2 0 1 1 5 35.7

9 months 0 0 0 0 0 0 0.0

12 months 1 1 0 0 0 2 14.3

Total 14 100.0Source: Research study findings, 2012

Part D: Non-licensing and regulatory requirements and considerations

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5.9.9 Impeding non licensing requirements

The study sought to establish what non-licensing requirements of the microfinance legislation in

the respective EAC countries would deter an institution/entity from entry or transformation into a

regulated deposit taking MFI. The qualitative responses from the different EAC member

countries varied. The MFA in Burundi indicated that some deterrents would include stringent

prudential standards, monitoring and control of regulated MFIs and penalties for offenders. In

Kenya, the MFI respondents indicated that strict lending limits that stunt the potential growth of

the institution, stringent risk classification and provisioning requirements, implications on the

breach of the law and misplaced fear that the activities, performances and results of the

institution would be under scrutiny and under specific reporting requirements set by the regulator

were the greatest deterrents. The MFA in Tanzania also indicated that the risk classification and

provisioning criteria was too stringent for MFIs. In addition, the MFA and MFI respondents in

Tanzania indicated that the limits on lending using deposits (lending not exceed 60% of deposits)

and reporting requirement were too stringent. The Rwanda MFI respondents indicated the

deterrents were limits on financial resources and limits on service delivery; and in Uganda,

respondents indicated that the limits on lending, limits on undertaking certain operations, too

many regulatory requirements and too much supervision by the regulator were the key deterrents.

5.9.10 Impeding non-regulatory considerations

The study also sought to establish what non-regulatory considerations would deter an entity from

entry or transformation into a regulated deposit taking MFI. The qualitative responses from the

different EAC member countries varied. The respondents from Burundi and Rwanda indicated

that the strategic objectives of an institution played a key role in determining whether an entity

would enter or transform into regulated status. To explain this point, a respondent added that, in

Burundi, most MFIs that are deposit taking did not serve the poorest of the poor, which is one of

the core missions of an MFI. ‘Most tend to follow the trend of commercial banks with regards to

their client focus. Part of the explanation for the shift in customer focus is the higher cost of

operation associated with deposit taking MFIs. They have bigger infrastructure, often times a

larger number of staff, both of which raise costs and require more income. Serving the very poor,

therefore, does not generate enough revenue to cover the costs.’ An MFI respondent from

Burundi also indicated that the lack of organizational competencies, skills and background in

microfinance were possible deterrents to an institution’s entry or transformation into a deposit

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taking MFI. Another respondent indicated that an MFI choosing to remain faithful to this lowlier

market segment may opt to remain a credit-only institution.

For Kenya, the MFA indicated that the high cost of transformation and competition with non

regulated MFIs was a key deterrent and MFIs opted not to seek regulation to avoid these costs.

Responses raised by the MFI responses had to do with the operational capacity and capabilities

(or lack thereof) to conduct deposit taking business in terms of infrastructure, systems, staff,

processes and procedures. In Tanzania, the state of organizational competencies and capacities

were also a factor. Finally for Uganda, the MFA respondent indicated that the high costs of

investment in operations, infrastructure and staffing which increased costs were likely deterrents

to entry or transformation into regulated status.

5.10 DISCUSSIONS AND INTEPRETATIONS

This subsection of the paper provides further discussions and interpretation of the results. Based

on the responses from the respondents in the study, specific underlying themes were identified to

summarise the findings of the study. These themes are discussed in this subsection as follows (i)

Motivation and benefits of transformation, (ii) Regulatory challenges and impediments to

transformation (iii) Licensing and regulatory requirements and considerations, and (iv) Non

licensing and regulatory requirements and considerations.

5.10.1 Motivations and Benefits of Transformation

Section 2.3.2 of the research paper discussed the motivations for transformation based on studies

and surveys conducted in several developing nations in Latin America, Asia and Africa. The

discussions revealed that the key reasons for transformation of NGOs into regulated deposit

taking MFIs are interrelated. The primary reason as indicated in the literature was to reduce

donor dependency and enhance the financial sustainability of institutions in order to reach

significant scale and enhance outreach. Regulated deposit taking MFIs are allowed to mobilise

public deposits, can attract diverse avenues of financing and can serve clients with diversified

financial services and products to fund growth and outreach. Another critical reason advanced in

the literature for transformation was for unregulated entities to comply with legal requirements.

The real (experienced) or perceived (anticipated) benefits of transformation were discussed in the

literature as well as based on the respondents’ feedback. These benefits are quite similar to, and

are the likely reasons that fuel, the motivation for new or transforming entities to desire or seek

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to enter or transform as regulated deposit taking MFIs. Lessons from the literature (Sections 1.2;

2.3.2 and 2.3.3) indicated that reduced donor dependency, greater access to, diverse sources of

funds; enhanced outreach and service to more low-income consumers; improved internal

processes and professionalism; enhanced range of products; and legitimacy in the financial sector

were some of the benefits of transformation.

The responses from both MFA and MFI respondents in this particular research study

corroborated the fact that the motivations for, and benefits of, transformation in the EAC actually

do not differ from those in the other developing nations across the globe. The three top reasons

shared by the respondents were (i) ability to mobilize public savings, (ii) credibility or perceived

stability due to regulation by the Central Bank, and (iii) diversification of product range. The

reasons still link to the ultimate goal of enhancing financial inclusion as increased savings

mobilisation increases the prospects of increasing on lending; credibility or perceived stability

due to regulation accords the MFI visibility and attracts additional private investors aimed at

expanding business operations; while the diversification of product ranges allows MFI to offer

more services to more clients. Ultimately, regardless of the form, the motivations for, and

benefits of, transforming NGOs into regulated deposit taking MFIs leads to the ultimate goal of

expanding outreach sustainably.

5.10.2 Licensing and regulatory requirements and considerations

The study revealed that 64 % of the MFI respondents had considered, or were currently in the

process of, entering or transforming into regulated deposit taking MFIs. Out of these, over half of

the respondents (57.1%) intended to get licensed and regulated as a deposit taking MFI over the

next 3 years. One institution indicated that it planned to set up a separate deposit taking

microfinance institution instead of converting the existing one; although the time frame was not

provided. It was therefore important to understand what the considerations or challenges were

posed when determining these time frames. The following are some of the factors that the study

identified that impeded or provided challenges to the entry or transformation into regulated

status: cost of transformation, inhibitive regulatory requirements, ownership and shareholding

requirements and capitalisation requirements.

5.10.3 Cost of Transformation.

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The cost to transformation is one of the areas that cannot be overlooked in the entry or

transformation of entities into regulated deposit taking MFIs. Section 2.3.4(iv) of the study

indicated that the cost of transformation was one of the biggest challenges for transforming

entities. Averaging over USD 1 million dollars in some cases, these costs tend to be heavy and

prohibitive and cannot be afforded by most MFIs. Costs incurred during the transformation

process cover investments to develop policies, processes and infrastructure including

management information systems, recruitment and training staff, preparing of premises. To

support this fact, both MFA and MFI respondents indicated that one of the greatest challenges

that led MFIs not to consider being licensed and regulated as deposit taking MFIs were the costs

of entry or transformation in regulated status as deposit taking MFIs (Section 5.2.3). Majority of

the respondents indicated that the costs of setting up MFIs was considered too high in terms of

setting up of the corporate governance structures, information technology platforms and

processes, physical branch infrastructure, staffing, developing and meeting reporting

requirements, among other transformation costs. Beside the cost of transformation in monetary

terms, MFAs and MFIs in the EAC indicated that the licensing process for both new and existing

entities was relatively long and arduous. While they recommended that the ideal time should be

between 3-12 months, some of the respondents indicated that the licensing process sometimes

takes over a year to complete. It was indicated that the licensing process was lengthy because the

requirements were expansive and often too expensive.

5.10.4 Inhibitive regulatory requirements

The questions on what regulatory requirements inhibit entry or transformation of MFIs into

regulated deposit taking entities was extensively analyzed. Respondents in the study indicated

that some of the provisions in the microfinance regulatory regime, to a large extent, played a role

in impeding entry or transformation into regulated status. While some respondents indicated that

a number of the licensing, regulatory, supervisory and reporting requirements were too stringent

or onerous, other respondents indicated that the microfinance laws were not easy to understand.

In addition, to this, it appeared that regulatory arbitrage was playing a big role in dissuading

applicants from seeking to be licensed as regulated deposit taking MFIs. One MFA respondent

even indicated that leaving some MFIs outside of a legal framework (unregulated) weakened the

desire to transform. In agreement with these findings, section 2.3.3, noted that transformation can

be made more difficult where legislation and regulations are inappropriate and rigid (Rosengard

2000; Christen et al. 2011). Legislation and regulations whose provisions, requirements and

standards are not adapted appropriately to the microfinance industry are likely to present

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regulatory obstacles that inhibit the entry and participation of new or transforming entities in the

regulatory space (Gallardo 2002).

5.10.5 Ownership and shareholding requirements

Although only 14% of the EAC MFI respondents indicated that their shareholding was not

within the required limits of their respective regulators, the respondents in the different EAC

countries had different opinions regarding the ownership requirements in their respective

countries. While respondents in Kenya and Tanzania indicated that it was extremely difficult for

new or transforming entities to meet the required shareholding requirements and limits, for

Uganda and Burundi it was relatively easy. The greatest concerns regarding ownership that were

raised have to do with the sourcing of suitable likeminded strategic investors and equity partners.

The major concerns raised are whether new shareholders would be able to uphold the vision,

mission and values of an existing MFI in order to safeguard the MFIs identity, brand, culture and

client focus of the institution. Majority of the respondents who were concerned about diluting

shareholding to external investors expressed concern that devolving shareholding to external

investors would reduce the NGO or original MFIs ownership to the extent that mission drift

would be eminent. The study revealed that challenge of identifying suitable investors was quite

difficult for many institutions in the EAC leading to delays in the licensing process.

Indeed as highlighted in section 2.3.4 (iv), the dilution of ownership to external investors may

result in loss of control or influence of original shareholders over the direction or mission of an

MFIs business (Christen et al. 2011). Where investors recruited are more profit driven rather than

social mission driven, an MFI may face increased risk of drifting from its social mission. Further,

very stringent shareholding and ownership limits are perceived to be unattractive and may inhibit

entry by promoters or applicants seeking licences to establish deposit taking MFIs (Gallardo

2002). However, as regulators, ensuring that good corporate governance practices are upheld by

all deposit taking institutions, including deposit taking MFIs, is paramount in ensuring the

protection of depositors and financial sector stability. The fundamental issue to address would be

how to ensure good corporate governance without compromising the mission and very existence

of the deposit taking MFIs. 

 

5.10.6 Capital Requirements

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While the respondents in the EAC did not express fundamental difficulties in meeting the

minimum capital to operate regulated deposit taking MFIs, they related the ability to meet capital

requirements with the ability to get suitable investors to inject capital into the institution, and

once again reiterated the challenge of lack of suitable deep pocketed yet likeminded investors

who were driven by the social mission and not the commercial benefit of the organisation. For

Tanzania, respondents indicated that the regulator had already taken steps to address this issue.

The capital for deposit taking MFIs was rather high initially and had to be reduced by the Central

Bank to enable more institutions to join.

5.11 NON-LICENSING AND REGULATORY REQUIREMENTS AND

CONSIDERATIONS

The qualitative responses from the different EAC member countries regarding the non-licensing

and non regulatory requirements that were likely to deter an entity from entry or transformation

into a regulated deposit taking MFIs varied. Some of the common non-licensing regulatory

requirements that were cited included: strict prudential standards including lending limits, risk

classification and provisioning, and reporting requirements which respondents in the EAC felt

were rather stringent. The risk classification and provisioning as well as reporting requirements

were of particular concern to Kenyan and Tanzanian respondents. Rwanda and Uganda indicated

that limits on service delivery and certain operations were quite a deterrent. Overall, the EAC

respondents indicated that too many regulatory requirements and too much supervision by the

regulator were the deterrents to entry into regulated status.

Regarding non regulatory impediments, the following were cited as common to the EAC

respondents. Majority of the respondents indicated that the strategic objectives or orientation of

an institution could impact the decision on whether or not to enter or transform into regulated

status. This includes the organisational missions and visions and strategic objectives. On one

hand, when an institution does not see any profit in serving poor clients on a large scale, it may

chose not to transform. On the other hand, some entities consider transformation a deterrent in

itself that prevents them from serving the poorest clients because of the cost of transformation

and institutional change that follows the process. This point is supported in section 2.3.2 which

highlights the fact that in spite of the gains, transformation does not apply to all unregulated

entities as the process of transformation is rather difficult. Only strong and sustainable

institutions with a good financial record should strive to transform (Robinson 2004). Other

common non regulatory impediments indicated were (i) lack of organizational competencies,

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capacities, skills and background in the microfinance skills. Finally the high cost of

transformation for investment in operations, infrastructure and staffing came up several times as

a concern and deterrent to transformation or entry into regulated status.

5.12 CONCLUSIONS

The study set out to assess regulatory barriers impeding the entry or transformation of

unregulated microfinance entities into regulated status under the specific microfinance

legislations and regulations in the EAC. A detailed and in depth literature review was conducted

in chapter two to develop a solid theoretical framework for the research. This in tandem with the

chronological guidance in chapter three on the research methodology formed fertile ground for

data collection and analysis as outlined in chapter five. The analysis confirmed that indeed the

East African economic landscape is littered with barriers that impede entry or transformation of

unregulated microfinance entities into regulated status. These include; cost of compliance, long

and rigorous licensing processes, stringent/fallible reporting requirements, legal framework and a

general averse attitude towards regulation underpinned a lack of understanding of the regulation

framework/benefits. Based on this we conclude that indeed barriers exist which require a policy

and legal environment review to spur increased appetite for entry into regulated status.

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CHAPTER SIX: CONCLUSION AND POLICY RECOMMENDATIONS

6.1 CONCLUSION  

This paper has extensively looked at barriers that impede entry or transformation of MFI into

regulated deposit taking institutions in developing countries and within the EAC. The findings of

the research study and literature review based on studies and surveys conducted in several

developing nations in Latin America, Asia and Africa indicate that indeed there are motivations

and benefits of entry and transforming into regulated deposit taking. Entities seek to transform

into licensed and regulated financial institutions in order to access diversified commercial

sources of funds, including voluntary savings, to fund growth and outreach; provide a wider

range of services, including savings; comply with legal requirements and ultimately increase

long-term development impact (Rhyne 2002; Robinson 2004; Basel Committee on Banking

Supervision (BCBS) 2010; Christen et al. 2011). Essentially, the regulation and supervision of

deposit taking microfinance leads to the ultimate goal of expanding outreach sustainably.

The study has also identified that there are impediments that deter or slow entities from seeking

entry or transformation into regulated status, including the cost of transformation, inhibitive

regulatory requirements and ownership and shareholding requirements, among others. To

continue to enable the entry or transformation of entities and address the impediments and

barriers of entry or transformation into regulated status, the following policy recommendations

are proposed.

6.2 ENABLING LEGAL AND REGULATORY FRAMEWORKS

The first key recommendation that can be made from this research concerns the enabling legal

and regulatory framework. Proactive regulators, who have embraced the additional mandate of

expanding financial inclusion, must be cognisant of the catalysts that enable entities, and

impediments that deter entities from, entering or transforming into regulated deposit taking

MFIs. The entry or transformation of entities into regulated status can be made difficult where

legislation and regulations are inappropriate and rigid. Legislation and regulations whose

provisions, requirements and standards are not adapted appropriately to the microfinance

industry are thus likely to present regulatory obstacles that inhibit the entry and participation of

new or transforming entities in the regulatory space. As indicated in section 2.3.4, regulators

must work in partnership with microfinance industry stakeholders to create an enabling

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environment that facilitates the entry of new entities and the transformation of unregulated

entities into licensed and regulated deposit taking institutions without compromising the safety of

depositors’ funds and stability of the financial system (Rosengard 2000; Gallardo 2002; Christen

et al. 2011).

Policy proposal: There is need for EAC regulators to continually adjust existing, or formulate

clear and appropriate microfinance legislation to provide appropriate and relevant provisions that

create an enabling environment for ease of entry and transformation. This may be done through

sharing of experiences and lessons together, and particularly sharing of regulatory and

supervisory practices that work well. The EAC member states must seek to do this in order to

enable the MFIs in the respective countries to grow in size and scale as the EAC moves to

implement policies towards the realisation of a monetary union. EAC member countries

6.3 APPROPRIATE LEGAL AND REGULATORY FRAMEWORKS

Regulators in the EAC, as well as in other developing nations, must remain cognisant that in as

much as the regulation and supervision of deposit taking MFIs plays a critical role in enhancing

financial inclusion, not all entities qualify or desire to be deposit taking MFIs. Further, not all

MFIs must be prudentially regulated and supervised. Regulators must, therefore, develop

appropriate regulatory environments for those seeking to be regulated as deposit taking MFIs as

well as those who do not wish to. As indicated in section 2.4.5 there are five broad approaches of

regulating MFIs as follows: no regulation, self-regulation, hybrid regulation, regulation by

existing banking laws and the regulation by special MFI laws.

Policy proposal: There is need for regulators within the EAC to understand and carefully

consider the distinct features and characteristics of MFIs and their clients as well as the various

institutional types or forms of MFIs in the specific microfinance sectors when determining the

most appropriate approach to use in their regulation and supervision. Where regulatory arbitrage

is rife because of lack of regulation in some areas of the microfinance industry, EAC member

countries should implement appropriate regulatory approaches, for instance self regulation or

hybrid regulation, to provide a safe regulatory platform to encourage growth and innovation in

the microfinance industry.

6.4 LICENSING AND REGULATORY REQUIREMENTS

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One important aspect in regulation and supervision of MFIs has to do with licensing and

regulatory requirements. The literature in this study indicated that the transformation process can

be difficult and time-consuming and may present some threats or challenges that may

compromise the same goals for transforming, for instance mission drift. The study specifically

identified the cost of transformation (in terms of money and time), inhibitive regulatory

requirements and long and rigorous licensing processes as some of the factors that impeded or

provided challenges to the entry or transformation into regulated status.

Policy proposal: There is need for EAC regulators to revise the microfinance licensing

procedures and other inhibitive regulatory requirements in order to increase entry and

transformation of MFIs into the deposit taking regulated environment. This will improve their

operations and enable them to reach out to more of the unbanked population in the EAC. There is

also need for regulators within the EAC to learn from one another, particularly from those with

relatively appropriate regulations to help one another improve the regulatory and supervisory

environment.

6.4.1 Cost sharing mechanisms

As was revealed in the study, the cost of transformation is one of the most common impediments

to entry or transformation into regulated status. Costs incurred during the transformation process

cover investments to develop policies, processes and infrastructure including management

information systems (MIS), recruiting and training staff and preparing of premises. These costs

tend to be heavy and prohibitive and may not be afforded by most MFIs (Robinson 2004).

Policy proposal: Regulators in the EAC should embrace financial innovations that make it

possible to reduce costs of setting up business for regulated deposit taking MFI. Enabling the use

of alternative places of business and allowing the sharing of the MIS and other infrastructure are

some of the avenues that may be explored by regulators to reduce costs of transformation for

MFIs. One example is the use of the agency model in Kenya, where financial institutions namely

commercial banks and deposit taking MFIs are allowed to contract and use third party retail

outlets to conduct specified deposit taking business on their behalf. This model would enable

deposit taking institutions MFIs to expand reach significantly and cost effectively.

6.4.2 Inhibitive regulatory requirements.

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Stringent regulatory requirements can, to a large extent, deter or inhibit entities from entering or

transforming into regulated status. Regulators may consider applying ‘risk based licensing’

which applies rigor where risk is more prevalent in the different stages of the licensing process.

This does not mean that some entities will be vetted more harshly or less harshly than others; but

it would mean that consideration be put mostly to where more risks are evident in the different

stages of the licensing process.

Policy proposal: There is need for EAC regulators to interrogate the potential risks that are posed

by entities seeking to be regulated as deposit taking MFIs and carefully consider which risks

every licensing requirement seeks to mitigate. If there is less risk in a particular area, then the

licensing and regulatory requirements should not be too stringent and time consuming.

6.4.3 Ownership and shareholding requirements

Indeed, it is acknowledged that placing ownership and shareholding limits for single, group or

related shareholders in deposit taking MFIs is a key principle of good corporate governance

However, very stringent shareholding and ownership limits may be perceived as unattractive and

inhibit entry by promoters or applicants seeking licences to establish deposit taking MFIs. In

some EAC countries, ownership was not an impediment to entry or transformation while in

others, it was one of the challenges cited by respondents. It is therefore worth mentioning that

regulators therefore provide clear standards for ownership that are applicable and realistic while

at the same time ensuring that good corporate governance practices are observed (BCBS 2010).

For example, EAC regulators may provide transforming entities which are financially sound and

which have met all other licensing requirements with a transitional grace period to divest their

shareholding over a specified period of time while they continue to operate under the supervision

of the Central Bank. This would be a condition to the licence which would be closely monitored

by the Regulator to ensure compliance and prevent breach of the licensing condition. This

transitional grace period would provide the entities with adequate time and opportunity to

comply with the ownership and shareholding limits and attract suitable likeminded investors in

order to avert the risks of mission drift.

Policy proposal: Regulators within the EAC region would need to provide clear standards for

ownership that are applicable and realistic while at the same time ensuring that good corporate

governance practices are observed.

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6.5 NON-LICENSING AND REGULATORY REQUIREMENTS AND

CONSIDERATIONS

6.5.1 Non-licensing requirements and considerations

Regarding non-licensing requirements and considerations, regulators must note that not every

regulation and supervisory approach is appropriate for the different types of MFIs. Regulators

must therefore strive to understand the MFIs and the environment they operate under in order to

come up with appropriate legislation and regulations whose provisions, requirements and

standards are appropriate for the microfinance industry. They must always be cognisant that

repressive and inappropriate regulation may be worse than no regulation at all (Gonzalez-Vega

2002).

Policy proposal: All regulators within the EAC must work in consultation with the respective

microfinance industry players to amend or create regulations that are appropriate to the

microfinance industries.

6.5.2 Non-regulatory requirements and considerations

Regarding non-regulatory requirements and considerations, the regulators ought to work with the

respective MFAs to educate and provide microfinance players with a clear understanding of the

roles and processes of regulation and supervision. It is also important to provide consumer

education to allay various misconceptions about regulation and supervision of microfinance that

may play a role in deterring entities from seeking to be licensed and regulated as deposit taking

MFIs.

Policy proposal: Regulators within the EAC region ought to work with the respective MFAs to

educate and provide microfinance industry players with a clear understanding of the roles and

processes of regulation and supervision with regard to non-regulatory requirements and

considerations.

6.5.3 Peer Learning Mechanisms

Peer learning is a fundamental factor to improving the microfinance regulatory regimes in the

EAC. Towards this, regulators as well as the MFAs in the EAC must seek to develop knowledge

103

 

sharing mechanisms to facilitate peer-to-peer exchanges, amongst themselves. This may be done

through workshops, knowledge exchange visits, attachments and joint inspection programs

which are already ongoing in different arenas of the financial sector. The aim of these

interactions is to learn from peers as well as to set standards of best practice. Specifically, in the

EAC, these mechanisms would be useful in identifying areas of convergence and divergence in

the microfinance legal and regulatory frameworks in order to identify and harmonise provisions

in the microfinance laws that work best in the different EAC countries.

Policy proposal: Regulators, as well as the MFAs, in the EAC must seek to develop knowledge

sharing mechanisms to facilitate peer-to-peer exchanges amongst themselves. This can be

achieved through workshops, knowledge exchange visits, attachments and joint inspection

programs which are already ongoing in different arenas of the financial sector.

Ultimately, regulators in the EAC and in developing nations must strive to create enabling

policy, legal and regulatory environments that support the development of microfinance and by

extension, the enhancement of financial inclusion. Towards this, regulators must continually seek

to understand the dynamism in the EAC microfinance subsectors as well as the inherent risks in

the individual MFIs. This understanding will guide them in developing suitable policy, legal and

regulatory environments that are able to appropriately assess and mitigate the risks MFIs present

to the financial system while encouraging innovations to spur growth and development of MFIs

and enhance financial inclusion.

104

 

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