1. 3 RD EAC ANNUAL SECRETARY GENERAL’S FORUM 12-13 September 2014 Enhancing the competitiveness of the East Africa Community Access to Affordable financing in relation to the Economic Growth in East Africa

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

3. 3 Access to finance: Supply or availability of financial services; is a broad term including users of financial services and non-users. Financial inclusion is the use of financial services by individuals and firms; is a narrow term. See diagram for illustration Distinction between Access to finance and Financial Inclusion

4. 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 Classification of the access strand.docx 4. Discrimination

5. 5

6. * Access to finance is critical for inclusive economic growth. Access to credit is critical element for firms growth and individual development. Empirical evidence * 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 drive innovations and competition in many economies. e.g. India: 39% of manufacturing & 33% of total exports. * Africa: Private sector contributes 80% of GDP; creates 90% of all jobs. SMEs create 67-80% of jobs ; contribute 30-35% of GDP. Conclusion: The growth of firms, SMES is important for -production of goods and services -employment creation -income generation alleviation of poverty. Access to Finance and Growth in East Africa (contd)

7. * Access to finance by enterprises is the main obstacles for doing business. More so for SMEs. It affect the growth of enterprises particularly SMEs leading to low income levels, unemployment and poor quality of life & income inequalities. * EA: LoC < 30% of firms: only 15% of firms use credit to finance investment; majority use LoC to finance working capital. * Improving Access to finance is critical to unlocking EA’s growth potential and ensure economic growth is enjoyed by all. * There is a great need to address barriers for financial inclusion if EA Africa is to achieve faster economic growth and social economic transformation towards inclusive growth i.e. alleviate more than 76 million of East African people who are trapped in poverty and create a substantive middle class. This will Make the EAC a lovely home and a places to do business. Access to Finance and Growth in East Africa (contd)

8. * 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

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

10. * 19% increase in adults with access to financial services or 19% reduction in the people excluded from any form of financial services. * 24%(2013) of the people in EA are excluded from any form of financial services by down from 43% in 2009. * Key driver: increase in use of mobile phone financial services e.g. Kenya from 28%(2009) to 62%(2013). * Demographic gains have been made over the years but disparities across gender, age, residence (urban/rural) and income exists: Access to financial services: Formal: Men:61%; Women: 50% Informal: Men 23%; Women 18% Urban 70%; Rural 48% People with higher education levels have high inclusion rate than those with no/low education e.g. Kenya: those with tertiary education: 98.2% inclusion rate; No education: 60.7% exclusion rate Access to Financial Services for Individuals (contd)

11. * The uptake of financial services has improved over time. But still: * A limited population of adults in East Africa use wide range of financial services & products Table 2: Use of Financial Services Use of Financial Services and Products BurundiKenyaRwandaTanzaniaUganda Adults with formal saving products(%)1263.33634.425 Adults with no saving3725.625.829.629 Use of credit products/services (both formal and informal)2.928.6522535 Adults using mobile money services (%)1507.349.934 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

12. * 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. E.g TZ: banks are used mostly for savings, non-bank formal (usually mobile) is used for remittances and informal sector is preferred for credit. Use of mobile money service is increasing: East Africa: 35% (note 68% in Kenya-MPESA) Sub-Saharan: 16%. Rwanda mobile money accounts for 43.8% of all money transfers & Uganda about 68%. * Alternatives to Formal Accounts: Mobile Money payments- “Branchless banking” is game changer ; future of banking (banks in partnership with phone cos) * informal sector increasingly play significant role in terms of fostering access to savings and credit product. e.g.Rwanda: use of credit products increase from 12% (2008) to 52% (2012). In Burundi: 40% prefer to borrow from a friend/neighbor/ relative mainly due to exclusion from the financial sector due to lack of collateral and high interest rates. Use of Financial Services and Products (contd)

13. 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

14. * Lack of access to finance (due to availability and cost of financing) represents the biggest constraint for firm’s growth. The other obstacles include macroeconomic stability, tax rates, electricity, corruption and political stability(IFC 2004). * Access to finance is ranked as the 6 th major obstacles faced by firms globally. 45% of firms in Sub-Sahara Africa cite access to finance as major constraint to growth. * Share of Bank financing in Africa is very low Percent of Enterprises with LoC Sub-Sahara Africa: 22%. East Africa: 28% Other developing economies: 34% Developed economies 51% in. Conclusion: Firms are more dependent on internal funds and are more credit constrained in term of accessing external formal financing. (See Table 4) Access to Financing by Enterprises

15. Percent of firms with BurundiKenyaRwandaTanzaniaUganda Checking and savings account (%)90.589.171.686.285.8 Loan/Line of Credit (%)35.325.446.316.317.2 Facility to finance investment12.322.924.26.87.7 Facility to finance working capital25.52644.517.314 Table 4: Firm’s financial inclusion in East Africa

16. 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. * Young 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

17. 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.

18. 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.