3 RD EAC ANNUAL SECRETARY GENERAL’S FORUM September 2014 Enhancing the competitiveness of the East Africa Community Access to Affordable financing in relation to the Economic Growth in the East Africa

Outline of the Presentation 1.Distinction between Access to Finance and Financial Inclusion 2.Access to Finance and Growth in East Africa 3.Financial Inclusion Landscape in East Africa Access to Financial Services by Individuals Access to Financing by Enterprises 4. Conclusion and policy issues for discussions

3 Access to finance: Supply or availability of financial services; is broad term including users of financial services and non-users. Some people may have access to financial services at affordable prices but choose not to use certain financial services, while others may lack access in the sense that the cost of these services are prohibitively high or services are simply unavailable due to regulatory barriers etc. Financial inclusion is the use of financial services by individuals and firms Financial inclusion allows individuals and firms to take advantage of business opportunities, invest in education save for retirement and insure against See diagram for illustration Distinction between Access to finance and Financial Inclusion

Figure1: Use and Access of Financial Services Population users of financial services PrudentialNon-PrudentalRegisterdInformal Non users of formal financial services Voluntary exclusion 1. No Need for financial services 2.Cultural, religious reasons, indirect access Involuntary exclusion 3. Insuffienct income, high risk 4. Discrimination

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* Access to finance is critical for inclusive economic growth. Access to credit is critical element for firms growth and individual development. * There is substantial and conclusive empirical evidence that access to financial services matters for Economic development. * The Economic boom in Asian Countries is highly linked to financing to SMEs that have lifted hundreds of millions out of poverty and created tens of millions of new middle class consumers (Tanzer, 2015). * SMEs are responsible for driving innovations and competition in many economies. In India for example SMEs account for 39% of manufacturing and 33% of total exports. * The growth of firms is important for production of goods and services, income generation, employment creation and consequently alleviation of poverty. It is estimated that in Africa private sector contributes about 80% of GDP and creates about 90% of all jobs. SMEs create between 67-80% of jobs and contribute between 30-35% of GDP. Access to Finance and Growth in East Africa

* Access to finance by enterprises has been perceived as one of the main obstacles for doing business in Africa and development of SMEs. It is the greater obstacle for SMEs than for large firms, particularly in developing world. * Firm’s access to line of credit in East Africa is very low at an average of less than 30% and only about 15% of firms use credit to finance investment. Access to finance adversely affect the growth of enterprises particularly SMEs leading to low income levels, unemployment and poor quality of life. * Financial exclusion has adverse effects on economic growth, exacerbates poverty and income inequalities. * Improving Access to finance is critical to unlocking East Africa’s great growth potential and ensure economic growth is enjoyed by all. * There is a great need to address barriers for financial inclusion at individual and firms level if East Africa is to achieve faster economic growth and social economic transformation toward inclusive growth that will alleviate more than 76 million of East African people who are trapped in poverty and create a substantive middle class. Access to Finance and Growth in East Africa

* Understanding of financial inclusion landscape is crucial to provide evidence based identification of constraints and design of appropriate policy strategies, reforms and delivery channels. * 3 Dimension Framework below is useful for our analysis Financial Inclusion Landscape in East Africa 1. Access Availability of formal, regulated financial services: Physical proximity, Affordability 2. Usage Actual usage of financial services and products: Regularity Frequency and Duration of time 3. Quality Products are well tailored to client needs Appropriate segmentation to develop products for all income levels

* Financial inclusion is improving over time * Adult population with access to financial services was 76%(2013) on average against 57%(2009). Informal access to finance decreased by 10% in East Africa. Adults relying on formal service has increase by 29% from Figure 3: Financial Inclusion in East Africa Access to Financial Services for Individuals

* This translate to an average of 19% increase in adults with access to financial services or 19% reduction in the people excluded from any form of financial services. * On average only 24% of the people in East Africa are excluded from any form of financial services by 2013 down from 43% in * The significant use of financial services is attributed mainly to increase in use of mobile phone financial services. For some countries the use of mobile phone financial services has more than doubled for example in Kenya from 28%(2009) to 62%(2013). * Demographic gains have been made over the years but disparities across by gender, age residence (urban/rural) and income exists -61% of male adults have access to formal financial services against 50% female adults. 23% and 18% of women and men respectively engage in informal financing Close to 70% of adults living in urban areas have access to financial services as compared to 48% in rural area. -The population with higher education levels has more access to financial services as compared to those with low education. E.g.Kenya those with tertiary education have close to 98.2% inclusion rate as compared to exclusion rate of 60.7% for those with no education. Access to Financial Services for Individuals

* The uptake of financial services has improved overtime with time. but * Limited population of adults in East Africa use wide range of financial services ranging from having an account with commercial banks, using of savings, credit, insurance products and remittance mechanism(See Table below). Table 2: Use of Financial Services Use of Financial Services and Products BurundiKenyaRwandaTanzaniaUganda Adults with formal saving products(%) Adults with no saving Use of credit products/services (both formal and informal) Adults using mobile money services (%) Note Burundi mobile penetration rate is only 28% and1% is for use of mobile phone for transaction; 2.9 uptake of credit does not include informal sector

* Increasingly over the years, more people use variety of financial products and services from both formal and informal sectors to meet their needs. * The level of financial sector development determines the level of formality and behaviors. In Tanzania for example Banks are used mostly for savings, non-bank formal (usually mobile) is used for remittances and informal sector is preferred for credit. Similar pattern may exist for other countries in East Africa. * Alternatives to Formal Accounts: Mobile Money payments- “branchless banking” * Increasing number of people are using new alternatives to banking made possible by the rapid spread of mobile phones. This has allowed millions of people who are otherwise excluded from formal financial system to perform financial transactions relatively cheap, securely and reliably. The average use of mobile money service in East Africa is around 35% (note 68% in Kenya-MPESA) as compared to Sub-Saharan average of 16%. In Rwanda mobile money accounts for 43.8% of all money transfers & Uganda about 68%. * The informal sector played a significant role in terms of increasing access to savings and credit product, the most important impact being in terms of providing access to credit. Rwanda for example adults who claim to have used credit products increase from 12% (2008) to 52% (2012). In Burundi approximately 40% of population would prefer to borrow from a friend, neighbor or relative mainly due to exclusion from the financial sector due to lack of collateral and high interest rates. Use of Financial Services and Products

The observed low levels of access to finance is mainly due to underdeveloped financial systems and limited outreach. The main reasons for low financial inclusion are highlighted below: Barriers to Banking The Percent of Unbanked adults cited the following as main reasons for not using banking services: * Insufficient income to justify opening an account * Cost of operation account is too high - cannot maintain minimum balance * Distance from the Bank & required documentation * Do not understand how the account works Adults who do not use credit from Banks cited the following as main reasons: * Fear debt: - worried would not be able to pay * Loans are expensive * Lack of security to offer Barriers to saving * Information asymmetry: Poor understanding on what is saving: * Lack of money to save: Uganda(44%) Adults do not use mobile Money due to the following reasons * Lack of cell phone * Lack of income * Limited information on how it works or where to get it Barriers to Access Financial Services

* Lack of access to finance which include problems in both availability and cost of financing represents the biggest constraint for firm’s growth. Globally it is ranked as the 6 th major obstacles faced by firms. The other obstacles include macroeconomic stability, tax rates, electricity, corruption and political stability|(IFC 2004). * The share of Bank financing in Africa is 8% (compared to an average of 11% in other developing countries). Share of equity financing in Africa is less than 2% as compared to 8% in developing economies. * Africa: firms are more dependent on internal funds and are more credit constrained in term of accessing external formal financing * Sub-Sahara Africa: Only 22% of enterprises have a loan or a line of credit. 45% of firms in Sub-Sahara Africa cite access to finance as major constraint to growth. * East Africa: Only about 28% of firms have a loan from Bank against 34% in developing economies and 51% in developed economies. 15% of firms use the Banks to finance investment. Access to Financing by Enterprises

Percent of firms with BurundiKenyaRwandaTanzaniaUganda Checking and savings account (%) Loan/Line of Credit (%) Facility to finance investment Facility to finance working capital Table 4: Firm’s financial inclusion in East Africa

Access to Financing by Enterprises(contd.) * Young firms and start-ups are particularly credit constrained because of principal-agent problem. They have not been in the market for long and there is little information on their performance or creditworthiness. Survey show younger firms rely on informal financing (from family and friends) Firms that need loans but did not apply for one cited the following barriers * Complex application procedures * High interest rates * Lack of required guarantee * High collateral requirements

Conclusion and Policy Issues for Discussion * A large percent of firms and individuals are still excluded from access to formal financial services. Barriers faced by firms and households tend to decline as per capita GDP rises, and in countries with more competitive, open, market oriented and will regulated financial systems with more competitive open finance. Policy and strategy for financial inclusion * Prudent Macroeconomic policies: Reduction of fiscal deficit & domestic borrowing to free resource to private sector. * Government to share credit markets risk through mechanism like Partial Credit guarantees (PCGs) combined with technical assistance. * Government to set standards for disclosure and transparency, regulating aspects of business conduct, and overseeing effective recourse mechanisms to protect consumers. * Encourage competition as part of consumer protection because it creates a mechanism that rewards better performers and increases the power that consumers can exert in the marketplace.

Conclusion and Policy Issues for Discussion * Improvements in financial sector infrastructure can enhance financial inclusion. Movable collateral frameworks and registries as well as information systems can boost lending to SMEs by overcome information problems * Need to address market distortions e.g. information asymmetry or abuse of power. * Promote technological advances: Innovations in technology, such as mobile banking, mobile payments, and the biometric identification of individuals, help reduce transaction costs.