THE 18TH JOSEPH MUBIRU MEMORIAL LECTURE, Central Bank of Kenya A presentation by PROF. NJUGUNA NDUNG’U GOVERNOR, CENTRAL BANK OF KENYA at THE 18TH JOSEPH MUBIRU MEMORIAL LECTURE, Speke Resort, Commonwealth Resort, Munyonyo FINANCIAL INCLUSION TO DEEPEN AND DEVELOP FINANCIAL MARKETS IN THE EAST AFRICAN COMMUNITY(EAC) 26th November 2010

Financial Inclusion Central banks should develop a comprehensive financial inclusion package Financial inclusion has benefits: Poverty reduction through savings and credit → financial access Monetary policy transmission → Mechanism improves Developing and deepening the financial markets In honor of Governor Joseph Mubiru, this is what he started and this is what we need to accomplish for all EAC countries We have lived with policy mistakes; it is time to look for sustainable solutions: Some examples:- Monetary policy cannot work effectively when a large proportion of the population is excluded from the market Financial inclusion for the poor will solve the poverty problem sustainably Failure to build strong institutions to support the markets Build capacity for future growth through finance The regulator in Joseph Mubiru would have advised today:- Be an Advisor to the market Cultivate partnership with the market. (PPP is not a new phenomenon, you can see) Develop the market and its supporting institutions and initiatives Regulate the market for easy entry and orderly exit; liberalization of the financial markets is within some predefined beacons So, for this memorial lecture, I would wish that we fulfill these four but important pillars to grow our financial markets

Financial Inclusion and Poverty Reduction Increased access to financial services to the poor can:- Provide a safe haven for their meagre savings - some are target savers – have investments to make at a pre- determined time in future Widen their economic opportunities Increase their asset base through increased savings and access to credit Reduce their vulnerability to external shocks: Savings for consumption smoothing Savings-investments cycles are important for sustainable growth and economic wellbeing. This is where capacity for growth is enhanced

Status of Financial Inclusion in EAC Countries Access Strands Kenya Uganda Tanzania Rwanda Burundi* Population (millions) 38.6 2009 Census 32.3 2010 est.** 41 10.7 9.5 Adult Population (millions) 18.7 13.2 22.3 3.7 4 Formal 22.6% 18% 12.4% 14% N/A Formal other 17.9% 3% 4.3% 7% Informal 26.8% 17% 27.3% 26% Excluded 32.7% 62% 56% 52% Sources: FinAccess 2009, FinScope 2007- 2009 * No data available, however, Burundi is planning for a FinScope study to be carried out soon. ** Source: www.cia.gov/library/publications/the world. factbook

Status of Financial Inclusion in EAC Countries--- Low access to formal financial services by the adult populace in the EAC Broadly, access to informal financial services is relatively high Access is skewed towards males Females tend to utilise informal financial services Exclusion levels are higher in rural areas than in urban areas More than half of the adult population in the region is excluded from any financial service – Kenya’s position is relatively better This does not reflect a good picture for EAC economies and their future capacity to grow This is why the theme of this lecture is important

Financial Inclusion has Challenges in the Region Supply-side barriers - Entry conditions and minimum balances, high transaction costs, lack of proper risk assessment criteria and information asymmetry, lack of appropriate products/ institutions Fear of loss - especially with bank failure histories Demand-side barriers - Low income base, chronic unemployment, lack of permanent income flows or employment, inhibiting cultural values, low levels of education and financial literacy Physical distances to the financial markets - banks and non-bank financial institutions

Available Solutions Commercial banks branch networks: Let us make them easier to operate and open Mobile phone financial services: leverage on technology for cost effective financial services: Presents an opportunity to increase the level of financial inclusion through the use of mobile telephones Prevalence of mobile telephones has been recorded to be three times the number of bank account holders Mobile money transfer service is currently offered in almost all the EAC countries

Available Solutions… Deposit Taking Microfinance Institutions Focus on rural and peri-urban areas where financial inclusion is lowest Make them conduits to reach the remote and disadvantaged areas with lower investment costs Credit Reference Bureaus Reduced information asymmetry Build information capital – That should change the collateral technology in use in EAC countries Solution to Non-Performing Loans problem? – That is credit risks Deposit Protection Insurance Re-examine the structures of the deposit insurance schemes Unified deposit insurance scheme or ‘silo’ schemes? This provides protection and confidence in the market and financial inclusion is sustainable

Expansion of Branch Network of Commercial Banks: Some Outcomes Number of Bank Branches – Kenya, Tanzania and Uganda The growth is evident But more needs to be done

Number of Bank Branches in: Kenyan Banks Expansion to the EAC Region Name of Bank Number of Bank Branches in: Kenya Tanzania Uganda Rwanda Burundi Kenya Commercial Bank (KCB) 169 11 13 9 - Equity Bank 116 43 Diamond Trust Bank 32 10 15 2 Fina Bank 5 NIC Bank 16 3 Commercial Bank of Africa (CBA) 19 I&M Bank [1] KCB has another 11 branches in Southern Sudan [2] Equity Bank has 3 branches in Southern Sudan [3] I&M Bank has 14 branches in Mauritius through its subsidiary Bank One Limited The region should develop strong indigenous banks to serve the region in totality They will support and facilitate trade in the region

But we Need to Continue Searching for More Solutions Increase of core capital of commercial banks Need for strong and well capitalised players Capital base to provide buffer to withstand shocks Agent Banking Reduced costs - fixed and operational for establishing bank branches No compromise in quality-But reach/easy and cost effective access is important Consumer Protection adequate disclosure of information, efficient dispute resolution mechanisms, comparability of offers, data protection and effective delivery security, Public-private sector financial literacy initiatives.

Financial Inclusion Has Had Some Successes Growth in Mobile Money Transfers - Kenya As at September 2010 M-Pesa transferred Ksh 68.02 billion equivalent to US$ 841 million with 28.45 million transactions Per day transactions-Ksh.2.3 bn or USD 29m Average value per transaction Ksh 2,391 equivalent to US$ 29.6 per transaction Transaction Cost at Ksh. 30-35 or USD 0.38-0.44 per transaction. M-Pesa remains a low value payment system: targets the bottom population This seems to be corroborated with other two pieces of evidence in the same period:- Accounts in the banking sector have increased Currency outside banks as a ratio of broad money has declined

Financial Inclusion Successes… Growth in Deposits, Loans & Advances

Financial Inclusion has Macroeconomic Implications: Kenyan Case (1)

Financial Inclusion has Macroeconomic Implications: Kenyan Case (2)

Financial Inclusion has Macroeconomic Implications: Kenyan Case (3)

Financial Inclusion has Macroeconomic Implications: Kenyan Case (4) Excess liquidity in the banking system is a new phenomenon and without any monetary overhang This is an outcome of financial inclusion mostly driven by micro accounts A structural transformation seems to be emerging in the financial system This excess liquidity has implications on its pricing structure as well as room to finance investment If excess liquidity is increasing and inflation is stable and declining; something will have to give way: the price of credit But also excess liquidity means that the capacity for banks to increase credit to private sector has increased

Implications for Monetary Policy (1) Declining velocity - an indication of financial depth Rising multiplier - an indication of financial innovation Currency outside the banking sector as a ratio of Broad Money has declined - a signal for less money being held in “unsafe” places These outcomes then portend a challenge to the current monetary policy framework: Velocity movements may imply unstable money demand The relationship between reserve money and broad money is unstable and unpredictable – multiplier unstable Excess liquidity in the banking sector is a new phenomenon Monetary policy framework; Target broad money via reserve money as an intermediate target – Totally inadequate

Implications for Monetary Policy (2) Structural transformations in EAC Implementation of the Common Market Protocol. Establishment of an East African Community Monetary Union (EAMU). Significant innovation uptake Financial institutions are also rapidly branching out into many economies in the region There is need to consider the conduct of monetary policy given these developments Financial innovations have implications on monetary policy transmission

Conclusion What Joseph Mubiru would have wanted to see for Uganda and the EAC is welfare benefits of financial inclusion Financial access is a sure way of sustainable poverty reduction Financial infrastructure has changed and we now have to use a combination of financial inclusion solutions for immediate results The central banks should be the agents of this change; the structural transformation; but we need to manage it to deepen and diversify the financial markets in EAC - as Governor Joseph Mubiru would have wished This way we can meaningfully say that financial development will support economic development and will finance investments for economic development

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