Uganda takes a tiered approach to the regulation and supervision of its financial institutions (Table 1). Banks and credit institutions such as housing lenders, which are highly regulated and supervised by the Bank of Uganda, occupy the first two tiers. The third tier, composed of so-called Micro Deposit-taking Institutions (MDIs), was created by a 2003 act designed to allow the largest microfinance institutions to submit themselves to full supervision in exchange for the ability to accept and on-lend deposits from the general public. Despite much enthusiasm for the act, which many thought would create a large supervised microfinance sector, few MFIs proved interested in undergoing the transformation necessary to change tiers; by 2005, only four had completed the process, at an average cost of one million dollars per institution.Footnote 21 The 2003 Act, noted the Assistant Commissioner in charge of microfinance in the Ministry of Finance, “didn’t work out as expected.”Footnote 22
The fourth tier of the framework is a residual category that includes all other forms of lenders, including all MFIs that did not transform into MDIs. Tier 4 lenders are formally beyond supervision by the Bank of Uganda—and are, for all intents and purposes, beyond any effective government regulation. Leaving tier 4 institutions unregulated was an intentional effort by the government only “to regulate what it could supervise” and to “avoid overly burdensome regulations” that might have a chilling effect on the growth of the microfinance sector.Footnote 23 Although tier 4 institutions are formally required to register with the government, they can do so as moneylenders, companies, NGOs, or savings and credit cooperatives (SACCOs), each falling under a different regulatory purview. In practice, virtually anyone can become a “microfinance institution.”
The government’s efforts to promote unbridled entry and competition were extremely effective. In 2001, some analysts estimated that Uganda had the most competitive microfinance sector in Africa; by 2006, nearly three quarters of all of the microfinance institutions in the country said that they were in direct competition with at least one other institution.Footnote 24 In the same year, a census of MFIs suggested that there were just over 800 institutions and 1200 outlets (including branches) providing small loans, most of them clustered in urban and peri-urban areas.Footnote 25
The first ever census of Ugandan MFIs, done in 2006, illustrated how little the government knew about the sector and how frequently MFIs were entering and exiting the market. While initial estimates based on registration figures suggested that 3360 tier 4 MFIs were active in the country, census agents crisscrossing the country with global positioning devices found that only 779 of these institutions were, in fact, operating. The gap between the number of registered institutions and those actually in operation was particularly dramatic in the case of savings and credit cooperatives (SACCOs): nearly half of the 1274 institutions with current registrations were no longer operating; of the ones that were operating, nearly 20 % had been open for 1 year or less.Footnote 26 A similar census conducted in 2010 showed that 60 % of all active institutions in the country had opened in the previous 4 years.Footnote 27
In 2006, the modal MFI in Uganda was small, locally run, and operated by a relatively inexperienced Ugandan staff. Most had four or fewer employees and were making fewer than 100 loans per year.Footnote 28 Nearly two thirds of the directors of these institutions had fewer than 5 years of experience in microfinance, and almost a quarter reported that they had only a secondary school education (or less)—a figure that had hardly changed in 2010.Footnote 29 More than 90 % of loan officers reported that they had worked in the industry for less than a year. The vast majority of these institutions kept their accounts by hand; three quarters had their accounts audited by their directors or not at all; and 16 % of all of the registered MFIs in the country did business out of the director’s house.Footnote 30 In contrast to the high repayment rates associated with international microfinance institutions, delinquency rates among these local institutions were high: tier 4 institutions reported that they had made 354,000 loans in 2005, of which 273,000 (77 %) were outstanding.Footnote 31
Multiple borrowing became a serious problem, and Ugandan MFIs sought new ways to protect themselves from default.Footnote 32 Many abandoned or minimized group-based lending, focusing instead on making loans to individuals secured on chattel, money, and titled property. Individual loans began to dominate: by 2006, nearly all MFIs in Uganda offered individual loans, and more than a third relied exclusively on this model.Footnote 33 In the same year, about 85 % of clients borrowing from MFIs reported that they had individual loans.Footnote 34
The practice of using money as collateral created a number of opportunities for malfeasance. Deposits taken as collateral were not regulated by the Bank of Uganda as long as they did not bear interest and were not used to make loans. These deposits typically came in the form of forced savings, requiring the borrower to deposit a percentage of the principal with the institution before receiving the loan. If the borrower failed to repay, then the institution would reimburse itself from these deposited funds; if he repaid as agreed, then he would be free to withdraw the money. By 2003, more than 80 % of borrowers reported that they had been required to make such a deposit to secure a loan, and nearly two thirds of MFIs reported that they collateralized loans on this type of savings.Footnote 35
Fraud and Theft by Ugandan MFIs
These lending models allowed organizations operating as microfinance institutions to engage in frank fraud and theft, taking advantage of the fluidity of the microfinance sector and the pervasive practice of requiring forced savings to steal from borrowers before disappearing. In some cases, institutions operating as MFIs stole money from borrowers without making any loans. The prevalence of this type of fraud underscores the ways that microfinance enables opportunism by lenders, while the government’s difficulties in mitigating these problems demonstrate some of the unique challenges associated with regulating a sector that is so strongly associated with benevolent ambitions.
One example of this type of fraud involved an MFI named Caring for Orphans, Widows, and the Elderly (COWE). This organization initially appeared to be an unremarkable NGO working in microfinance and health insurance for vulnerable populations in several areas of rural Uganda. Its model seemed quite standard: individuals paid a membership fee, a fee to enroll in the healthcare program, and a forced savings deposit into a collateral account held by the institution, in anticipation of receiving a loan. COWE duly registered with the NGO Registration Board of the Ministry of Internal Affairs in 2001, and its employees worked through local officials and community leaders in each of the areas where it had offices. By 2002, local papers were noting that the organization would provide microfinance loans that “will enable the beneficiaries to engage in productive work and reduce poverty.”Footnote 36
In April 2002, there were widespread allegations that COWE’s directors had been engaged in fraud. The institution was accused of failing to provide services as promised and illegally seizing its members’ deposits, and four executives of the organization were accused of embezzling more than 200 million Uganda shillings (approximately $100,000), largely from impoverished borrowers.Footnote 37 Investigations revealed that COWE was operating in 15 districts, even though it was only licensed to operate in three. The Ugandan NGO board froze the bank accounts of the organization’s directors and suspended its license. Yet, the COWE directors protested that the NGO board had acted without a hearing, and that the board had based its action on slanderous and vengeful allegations leveled by competing microfinance institutions and a former director who had been refused a large loan.Footnote 38 COWE won re-registration in a High Court appeal.Footnote 39
Less than 6 months after COWE was allowed to resume its operations, newspapers once again began to report complaints of fraud. COWE members in several parts of the country complained that the organization had shut its doors and taken their deposits without ever giving them loans. Officials estimated that more than five billion Ugandan shillings ($2.7 million) was lost across the country, with more than 700 million shillings (approximately $390,000) taken from widows and orphans in a single district.Footnote 40 A local paper quoted a 75-year-old widow who complained that the COWE directors should “either kill us or they bring back our money. I sold all my six pigs and gave the money to the officials of COWE who promised to give me a big loan and free medical service but I have got nothing since. They have closed all their offices.”Footnote 41
Despite these well-publicized allegations, COWE continued to operate—and defraud clients—for years. In 2007, 5 years after the organization had first had its registration suspended and reinstated, COWE was accused of having defrauded a new tranche of borrowers across the country. As these new allegations came to light, the Minister for Internal Affairs noted that “if organizations are registered as NGOs, it is very difficult to pursue them.”Footnote 42 His ministry had, he claimed, de-registered COWE, but the organization had simply re-registered as a different type of tier 4 lender with no problem.
The media may be partly to blame for the fact that individuals failed to avoid COWE, even after it had received so much bad press. As late as 2007, the largest newspaper in the country (which had previously covered the various allegations against the organization in great detail), described the organization as “a charity that supports orphans and the elderly” without additional comment.Footnote 43 Even in 2008—after the directors of the organization had finally been arrested and the President had called for them to be punished—the same paper reported the organization’s involvement in an unrelated lawsuit by describing COWE as an “NGO, which cares for orphans and widows,” making no mention of any of the allegations or charges against it.Footnote 44
In a 2014 interview, the Director of the Bank of Uganda’s Non-Bank Financial Institutions Department was confident that some of the people who had been involved in COWE were continuing to defraud vulnerable borrowers.Footnote 45 He noted, ruefully, that his department had no authority to supervise or investigate tier 4 lenders such as COWE, but could only enforce restrictions such as forcing unregulated organizations to stop using the word “bank” in their names. When victims of fraud wrote letters of complaint to the Bank of Uganda, he explained, his office was forced to advise them to seek remedy in the courts.
Crisis in Ugandan Microfinance
Although COWE was the most remarkable case of widespread theft, it was far from the only one that received attention. In 2007, COWE and several other tier 4 MFIs—including Dutch International, and Together Everybody Achieves More (TEAM)—were accused of embezzling more than 11 billion shillings (approximately $6 million) from clients, much of it deposits associated with loans.Footnote 46 As public fear and anger reached a fever pitch, the Bank of Uganda issued a statement cautioning borrowers to avoid depositing money with unsupervised institutions: “BoU will not protect any person who deposits money with a person who is not licensed to take deposits or who aids and abets crime and the perpetuation of fraud in the Ugandan financial sector.”Footnote 47
Several months later, the police began to investigate MFIs across the country. Lending institutions with names like Development Scheme Microfinance Ltd., Support Organization of Micro Enterprises Development, Key Business Microfinance, and others were shuttered.Footnote 48 Newspapers reported that institutions had given their clients “the run-around” and refused to give them access to deposits that they had a right to withdraw, while other clients complained that the institutions’ records underreported their deposits.Footnote 49
Panic precipitated mob actions against a number of lending institutions. In Kampala, as many as 800 clients attacked a large MFI, forcing the police to intervene and provide an armed escort for the institution’s staff. “We want our money back,” one member of the crowd said: “these people keep on tossing us by shifting the dates when we are to get our money, but even Bank of Uganda passed a statement saying the unlicensed institutions were not recognized by them, so it means we can’t get our money back.”Footnote 50 Rumors that the MFI was under investigation by the police were dismissed by the lender’s Chief Executive Officer as being “just” the result “of our competitors’ malice.”Footnote 51
The Bank of Uganda responded to the crisis by reiterating its advice to use only supervised institutions. A local paper pointed out that the Bank’s response “effectively implies that the hundreds of MFIs that operate throughout the country can literally disappear with depositors’ money with little worry of punitive action from anyone.”Footnote 52 Many observers complained that the Bank’s actions were insufficient. Under the headline “Quack MFIs May Throw Economy Into Chaos,” the main independent newspaper editorialized that the central bank “should have gone beyond mere warning and directed for closure of unlicensed microfinance institutions.”Footnote 53
While the immediate crisis subsided, the general issues of fraud did not. Papers carried reports of new pyramid schemes masquerading as MFIs, asking “how could so many people be duped so quickly?” and noting that one had “won the public over by marking itself as a non-profit making, philanthropic organization ‘designed to assist marginalized and disadvantaged groups in society.’”Footnote 54 Another lender opened under the name Visa Finance, using radio advertisements to attract clients who were required to pay a number of application fees and deposit 25 % of the value of the loan for which they were applying. The proprietors of this institution absconded in the middle of the night; a police investigation was obstructed by the fact that they had used only their first names on official documents and had turned off the only cell phone they provided as a contact.Footnote 55 Several MFIs were closed for fraud in 2009, including one whose regional offices continued to operate for more than a month after its Kampala office had been shuttered.Footnote 56
Both logistics and politics contributed to this supervisory failure. The Bank of Uganda was not authorized to supervise or regulate microfinance institutions, and local officials and police did not systematically ensure that unregulated MFIs were not breaking the law. Fraud was, as a result, often uncovered only when large numbers of borrowers began to complain to local media—and, even then, little seems to have been done in most cases. Efforts to stem fraud were also complicated by the concurrent expansion of a government lending program administered through SACCOs. New institutions sprang up to take advantage of this money, and the number of SACCOs in the country trebled in 4 years.Footnote 57 These institutions continued to be wholly unregulated even while operating under this government umbrella; complaints of fraud persisted, and newspapers periodically printed stories about the arrest of SACCO directors.Footnote 58
The government had long been working on legislation that would bring all tier 4 MFIs under regulation. Prior to 2008, legislators had imagined that the new law would be SACCO-specific; after the crisis, however, they realized that this type of targeted regulation would be “inadequate,” since it would leave NGOs, moneylenders, and others outside of the regulated sphere.Footnote 59 By 2014, it was proposing a combination of regulatory authorities that would manage the prudential and non-prudential regulation of the entire sector, using access to lending from a development fund as an incentive to submit to regulation. Yet supervising—and even designing regulation for—tier 4 institutions is, as one government official put it, “an enormous task.”Footnote 60 Indeed, at the beginning of 2015, nearly 7 years after the government announced that it was at work on the measure, the bill had still not been presented to the legislature.
Self-Exclusion by Borrowers in the Aftermath of the Crisis
It is impossible to know how much money has been stolen as a result of fraud by Ugandan MFIs or by how many institutions. There are no systematic data on thefts, complaints, or closures, and the newspaper and police reports that exist are closely associated with moments of widespread panic. The number of people directly affected may well not have been large: in 2009, fewer than one percent of survey respondents reported that they had lost money to theft or fraud by an outside party or committee member of a financial institution.Footnote 61 In 2013, 10 % of respondents responded affirmatively to the question: “Have you ever been dissatisfied with a financial service provider (e.g., because you were treated unfairly, you lost your money)?”Footnote 62 While it is impossible, from this question, to know how many people lost money and how many felt unfairly treated or otherwise dissatisfied, the overall proportion of dissatisfied clients remains small.
Yet simple calculations of the amounts of money lost may fail to capture broader losses of trust in the financial sector as a whole. By this standard—the erosion of trust in financial institutions—malfeasance by unregulated microfinance institutions may have contributed to a remarkable negative shift in public perception of the sector. In 2006, before malfeasance in the microfinance industry had come to light, 57 % of survey respondents agreed with the statement “I trust formal commercial banks,” and 45 % reported that they trusted SACCOs (Fig. 1). Seven years later, in 2013, more than three quarters of respondents said that they did not trust commercial banks, and more than 80 % reported that they distrusted SACCOs. In just 4 years, between 2009 and 2013, the number of people reporting that they trusted commercial banks declined from more than 50 % to less than 25 %.Footnote 63
In fact, in 2013 Ugandans reported comparatively low levels of trust in all types of financial institutions (Fig. 2). It is, perhaps, not surprising that Ugandans might be distrustful of MFIs, moneylenders, and SACCOs in light of the pervasive—and well-publicized—misdeeds within this essentially unregulated portion of the lending sector. Indeed, the Bank of Uganda’s statements during the crisis were designed to buttress trust in regulated institutions and direct borrowers away from unregulated ones. Yet, respondents report an overwhelming distrust of every single category of financial institution, including commercial banks and micro-deposit-taking institutions (MDIs), both of which are well-regulated and well-supervised. If malfeasance in the microfinance sector did, indeed, contribute to these remarkable changes in public opinion, then it may be that trust in Uganda’s entire financial sector has suffered from the exploits of a relatively small number of con artists.
One must be somewhat cautious in this interpretation: among other things, there is a lag between the most serious reports of malfeasance and the largest change in public opinion. While there is relatively little change in trust for financial institutions between 2006 and 2009, which spanned the height of the microfinance crisis in Uganda, there is a substantial shift between 2009 and 2013. Yet, such a lag might be explained by the fact that Ugandans—and, particularly, the poor and illiterate—rely heavily on word-of-mouth (rather than newspaper or radio reports) in assessing financial institutions.Footnote 64 It is not implausible that it could take a year or more after such a crisis for word to spread and Ugandans to render judgment.
Moreover, the pattern of the change does not provide compelling support for several plausible alternate explanations. For example, it is possible that the global financial crisis, which occurred during roughly the same period as the Ugandan microfinance crisis, precipitated a diminution of trust in banks around the world. One could also imagine that tightened credit as a result of the global crisis might have led to a loss of confidence in local institutions. Yet, in either case one would not expect all categories of financial institution to suffer the same loss of trust. If the shift was the result of the actions of financial institutions in the USA and elsewhere, then we might expect Ugandans to increase (or, at least, not lose) their levels of trust in indigenous institutions like MDIs and village savings and loans. In addition, the Ugandan government was lending extensively through SACCOs during this period. Thus, if credit restrictions or interest rates were driving the change, then we might expect to see SACCOs suffer much less than other institutions—and, perhaps, even enjoy a reputational benefit from their access to government capital. Finally, Uganda’s financial sector, which saw a series of bank failures in the late 1990s and early 2000s, weathered the global financial crisis quite well. Indeed, a review of Ugandan newspapers during this period suggests few explanations for this shift in trust apart from the malfeasance and dysfunction in the microfinance sector. Rather, local news highlights the degree to which observers and reporters continue to return to examples of malfeasance of the microfinance crisis, both in the immediate wake of the crisis and in more recent reporting about the sector.Footnote 65
This shift is not limited to reports of trust in financial institutions: Ugandans also appear to have changed their borrowing behavior. Between 2006 and 2009, the proportion of survey respondents reporting loans from “informal” lenders, a category that here included all MFIs except SACCOs, increased from 25 to 32 %.Footnote 66 Yet, in the following 4 years, that percentage decreased to only 18 %—lower than it had been 7 years earlier (Fig. 3). This change does not primarily reflect a shift toward borrowing from other sources: while slightly more respondents reported borrowing from banks and cooperatives between 2009 and 2013, the largest shift is an increase in the number of respondents who report that they are not borrowing from any source—those who were “excluded” from borrowing. Indeed, after a marked reduction in 2009, by 2013 the number of excluded respondents had returned to essentially its 2006 level. Ugandans were not only declining to take loans from informal sources including MFIs, but many were not borrowing at all. Whether or not this trend away from informal finance and toward exclusion is attributable to the microfinance crisis, it is certainly not one that proponents of microfinance hoped to produce.
In recent years, Ugandan MFIs have moved away from forced savings and toward other forms of collateral. In 2003, 80 % of borrowers reported that they had been required to make a forced savings deposit to get a loan; 10 years later, a minority of borrowers reported that they had taken loans secured against anything other than titled land, chattel, or livestock (Table 2).Footnote 67 Non-SACCO MFIs were the least likely to rely on this “other,” intangible security, including forced savings, salary assignment, group lending, or other forms of guarantee. Although this shift is not surprising, given the trend away from group liability and the crisis associated with forced savings, it threatens to undermine many of the goals of the microfinance movement. If one is interested in expanding access to credit, then the fact that nearly 50 % of non-SACCO microfinance loans are secured against some form of land title is disheartening. Uganda’s microfinance market appears to be becoming more exclusionary across several dimensions.
Finally, attitudes toward borrowing among the general public underscore the problematic state of Uganda’s lending sector. In 2013, 79 % of survey respondents agreed with the statement “I often think that I would like to start my own business, but I can’t get enough money”—making them, presumably, potential candidates for microfinance loans. Yet, among the group who agreed with that statement, 61 % also agreed with the statement that “Borrowing is a risky business,” and 69 % agreed that “I try to avoid taking loans as much as possible.”Footnote 68 Nearly all of those who said they could not get enough money to start their own businesses agreed with both other statements. More than a decade after Uganda was hailed as having one of the most competitive and least onerously regulated microfinance sectors in Africa, some of the very people who seem most likely to be candidates for microfinance loans appear to be avoiding them. After many years of empowering lenders in an effort to mitigate problems of credit rationing, a key challenge for Ugandan microfinance may now be to empower borrowers to overcome their avoidance of borrowing.