About building efficient credit markets

Since the average annual savings of adult Ugandans is less than Shs 5,000, many of us will have to deal with credit at some point in our lives. This becomes more likely when it comes to running a business. Credit is an essential part of the day-to-day operations and survival of any business because few (especially micro, small and medium-sized enterprises) have sufficient business savings to meet their working and long-term capital needs.

Unfortunately, few Ugandans or their businesses have access to credit from formal financial institutions such as banks. The most recent national surveys on the demand for financial services put this figure at around two in 10 adults in Uganda. The other eight rely on family and friends, informal financial institutions and money lenders to meet their credit needs. In fact, many Ugandans do not even want to access credit from formal financial institutions. This is partly explained by past experiences where their property or that of relatives has been liquidated by banks for non-repayment of their loans.

From high interest rates due to risky businesses and non-performing loans to onerous collateral requirements, the state of credit markets in Uganda is informal, opaque and makes capital extremely expensive. It is not an environment conducive to business growth and keeps individuals and businesses in a perpetual cycle of debt.

Fortunately, this narrative is set to change with the amended Credit Reference Bureau regulations issued by the Bank of Uganda on September 9, 2022. Credit Reference Bureaus ensure that transparency prevails in credit markets by tracking credit history of all borrowers to let lenders know how they are repaying their loans. This allows financial institutions to adequately assess and minimize the risk of default by providing credit and guarantees commensurate with the risks of the borrower. Until recent amendments, this service was only available to the formal banking sector which covers Tiers 1-3 (Commercial Banks, Credit Institutions and Finance Companies and Microfinance Depository Institutions) of the Ugandan financial system.

The amended regulations now extend this service economy-wide to cover both formal and informal credit providers. It also expands the scope of credit to include financial and non-financial credit.
This will significantly improve the transparency of the entire credit market, allowing providers and consumers in this market to have a more comprehensive credit risk score. The new regulations will also help level the playing field for small and large lenders.

The hope is that this increased transparency will reward more disciplined borrowers with increased access to credit at affordable interest rates. The other expected benefit is more appropriate collateral requirements as credit reports will become their ‘reputation collateral’.
Credit reporting by credit reference bureaus requires the digitization of consumer and SME financing, which presents a great opportunity to expand access to financing to unserved and underserved market segments. As the provision of digital financial services expands beyond traditional banks, expanding access to data from multiple financial institutions, from traditional to less formal, is more critical than ever, making this amendment timely.

The amended Credit Reference Bureau Regulations also pave the way for discussion on the role the Uganda Credit Reference Bureau Association registered in 2021 can play in credit reporting, a relatively new concept for the majority of players in the financial sector while ensuring financial inclusion.
From setting industry standards for credit reporting to educating borrowers and lenders on credit reporting, the to-do list for the association is endless. The need to put in place structures for less sophisticated financial institutions and measures to protect borrowers from excessive risk and their data prove that there is still much to be done to improve the state of Uganda’s credit market.

To tackle this daunting task, Financial Sector Deepening Uganda is keen to play a convening role for key credit reporting stakeholders to discuss and agree on how to create an effective credit market in Uganda that includes unserved and underserved market segments.

The author, Mr. Joseph Sanjula Lutwama, is Director of Programs at Financial Sector Deepening Uganda.