The Economic Roundtable Central Bank of Kenya A presentation by PROF. NJUGUNA NDUNG’U GOVERNOR CENTRAL BANK OF KENYA at The Economic Roundtable Financial Inclusion is Fixing the Economic Growth Engine for Kenya 5th November, 2010

Preamble Fixing Kenya’s growth engine with Financial Inclusion Growth in Kenya is driven by investments: Financial inclusion solves the supply side of financing investments Increased deposits in the banking sector may work to affect the pricing structure: supply creates its own demand Financial inclusion is about access to financial markets; for the poor it allows them to build their assets through savings and affordable credit At the end: it is to boost savings and to strength savings -investment cycles in the economy Financial inclusion provides us with a win-win outcome 2

Financial Access for the Poor Increased access to financial services to the poor can:- Provide a safe haven for their meagre savings - some are target savers Widen their economic opportunities Increase their asset base through increased savings and affordable credit Reduce their vulnerability to external shocks: Savings for consumption smoothing Kenya’s National FinAccess Survey, 2009 revealed that 32.7% of Kenya’s bankable population is totally excluded from both formal and informal financial services If 46% are poor and 32.7% are excluded - then most of the excluded are the poor Strategies to enhance financial inclusion therefore are a critical component for reducing poverty and uplifting the poor But also provides the liquidity in the market for banks to on-lend

The Changing Landscape for Financial Inclusion Kenya’s financial sector has undergone significant transformation in the last few years In the last 6 or so years, we have seen:- Significant decline of barriers to entry to the financial sector via removal of minimum balances Significant decline in cost of maintaining micro accounts - via ledger fees The introduction of new instruments targeting lower segments of the population But physical distances remain obstacles - that is where innovation is required

Instruments to Support Financial Inclusion Working Solutions Mobile Financial Services - Use of mobile phones for person to person, person to business, business to person and ATM payment transfers Licensing of Deposit Taking Microfinance (DTM) Institutions - Nationwide and Community MFIs. 2 nationwide DTMs licensed so far with 31 branches across country Closer reach to low income segments. Outreach to be enhanced through use of agents and easing branch requirements/specifications Deposit Protection Fund - Covers up to Ksh.100,000 (US$1,250) Future Solutions Agent Banking – Turning non-bank outlets into financial services providers - So far 5,892 agents approved, leveraging on mobile phone agents also. Agents to push forward financial inclusion frontiers Expansion of Branch Network of Commercial Banks Increase from 534 in 2005 to 1030 end of September 2010. Growth driven mainly by competition and declining barriers to entry 140% growth in rural branches compared to 68% growth in urban areas Consumer Protection - The missing link in financial inclusion Consumer protection rights entrenched in Kenya’s New Constitution

Instruments to Support Financial Inclusion... Macro-level Support Credit Reference Bureaus - Extending credit based on financial identity Rolled out in August 2010 and in two months, banks have accessed over 100,000 credit reports Currency Centres - Reducing Cash in Transit costs for banks and their branch networks across regions:- First Centre already operational from end 2009/early 2010 in Central Kenya serving 88 bank branches The Centre is already processing on average 9% of the total national currency transactions processed by CBK

Outcomes – Mobile Phone Financial Services - M-Pesa Flows, Volumes & Values 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 US$29m Average value per transaction Ksh.2,391 equivalent to US$29.6 per transaction Transaction Cost at Ksh.30-35 or US$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. 7

Transition from Money Transfer to Banking for the Micro Savers For the last three years, millions of Kenyans have been able to use mobile phone platforms to make payments and send remittances In 2009 mobile phone platforms began being integrated with banking platforms One of the criticisms then was that mobile phone money transfers did not seem to affect financial intermediation significantly In May 2010, Equity Bank partnered with Safaricom to launch M-Kesho account that goes beyond transfers to micro-savings, micro-credit and micro-insurance Since the launch, over 700,000 M-Kesho accounts have been opened with over US$5 million mobilised. Other banking products that leverage on mobile phone technology include KCB Bank Connect and Family Bank’s Pesa Pap. Other mobile phone operators have also launched their mobile money products – Zain (Zap) and Essar (Yu Cash)

Outcomes - Expanding Financial Services: Branch Networks, MFIs Exponential growth of bank branches from 534 end of 2005 to 1030 end of September 2010 Number of rural branches has grown by 140% compared to 68% in urban areas Two Deposit Taking Microfinance Institutions have opened 31 branches since 2009 (16 in rural areas) Increased outreach programme by Kenyan banks and DTMs reaching rural unbanked and under banked Kenyans

Outcomes - Growth of Kenyan Banking Sector and Deposit Protection Fund (DPF) - Deposit Accounts Number of deposit accounts has increased from 2.55m in 2005 to nearly 12 million at end of September 2010 Number of micro accounts has increased by 425% from about 2.14 million accounts in 2005 to about 11.25 million accounts at end of September 2010 Growth attributable to reduced costs of maintaining micro accounts and introduction of innovative instruments But also increased branch outlets that solve the physical distance Barriers of entry have been significantly reduced

Outcomes - Macro Level Support

Outcomes - Macro Level Support...

will have to give way: the price of credit 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 13

Outcomes - Macro Level Support... Declining velocity - an indication of financial depth Rising multiplier - an indication of financial innovation These two then portend a challenge to the current monetary targeting framework: Velocity movements may imply unstable money demand The relationship between reserve money and broad money is unstable and unpredictable, so reserve money cannot be an intermediate target Excess liquidity in the banking sector is a new phenomenon – supply of liquidity is good for the growth engine – investments – but also its pricing structure must change Currency outside the banking sector as a ratio of Broad Money has declined - a signal for less money being held in ‘’unsafe’’ places Monetary policy transmission will change for the better; so will monetary policy making

Paradigm Shift: A Structural Change has taken place Structural shift of the economy should also reflect the changing tools of monetary policy MP framework: Using RM as an immediate target for M3 has two defects: It over-tightens money supply-since innovations affect broad money – this may kill growth by raising interest rates It is totally ineffective since the assumed stability of m=M3/RM is destroyed. A rising multiplier may erroneously reflect the Central Bank losing the supply process whereas it is financial innovation taking place Excess liquidity in banks and in the system: financial inclusion increases deposits - the supply side. This may affect the price structure in the market as well as provide space for any surge in demand We need to chart a new direction of monetary policy management as well as monetary policy framework This has to be supported by investment in analytical skills 15

Key Lessons There is a potentially huge market of the unbanked waiting to be tapped. There are 43 banks: some have the technology to manage micro accounts - others should follow. This will drive financial inclusion further The structural change should inform policy and also develop new tools to manage this change as well as new policy framework The Regulator should act as an agent of change and an agent to develop the market:- Give confidence to drive credibility Provide an analytical direction to drive change and the pricing structure of financial products Provide space for innovators to work Protect the deposits as they enter the market - via the Deposit Insurance Fund But more importantly how to manage this change with new tools We can now start to talk about monetary policy transmission mechanism to the economy with comfort

Key Lessons... But risk of ‘’too big to fail’’ or ‘’too big to save’’ syndromes when micro accounts are involved. One bank holds 46% of the accounts – minimised by DPF and increasing core capital Move policy frameworks in line with dynamic developments: - if we get it right it will serve EAC. We need an anchor for inflation expectation given the excess liquidity in the market which is not being lent out