Agricultural Finance in Uganda

Agricultural Finance in UgandaThe Way Forward

Richard L. MeyerRichard RobertsAdam Mugume

FSD Series No 13

c Financial Systmes Development (FSD) Programme 2004

Responsible:

Peter Rhode

Publisher:

German Technical Co-operation (gtz)

Swedish International Development Agency (Sida)

Financial Systems Development (FSD) Programme

37/43 Kampala Road

P.O. Box 27650

Kampala, Uganda

Email:[email protected]

Layout / Cover design:

Acha Graphics

P.O. Box 23363

Kampala, Uganda

Email: [email protected]

Printer:

Quick Color Print

PO Box 3015 Kampala, Uganda

Email:[email protected]

Table of Contents

Table of Contents

List of Tables

List of Figures

Abbreviations and Acronyms

Executive Summary

Chapter 1 Introduction1.1 Background1.2 Objectives of the Study1.3 Approach and Organization of the Study1.3 Structure of the Report

Chapter 2 Macroeconomic Issues and Financial Sector Performance2.1 General Description2.2 Policies and Challenges in the Financial Sector2.3 The Suppliers of Agricultural and Rural Financial Services2.4 Using Land as Loan Collateral2.5 Conclusions

Chapter 3 The Demand for Financial Services3.1 Overview3.2 The Demand – Input and Output Trading Markets3.3 The Demand – Production Stage (Farmers)3.4 Summary of Main Points on Demand

Chapter 4 Supplying Financial Services to Agriculture and Rural Areas4.1 Introduction4.2 The Suppliers of Agricultural and Rural Financial Services4.3 Expanding the Frontier of Formal Finance4.4 Summary of Main Points About the Supply of Financial Services

Chapter 5 Conclusions and Recommendations5.1 Introduction to Conclusions and Recommendations5.2 Cluster One: Long-Term Strategic Plan for Financial Services to the Agricultural

Sector, and Related Issues5.3 Cluster Two: Issues for Attention by Legislators, Government Ministries and the

BoU5.4 Cluster Three: Unfinished Business

References

Annexes

I

II

III

IV

VII

11112

3359

1212

1515162023

2525252835

373737

40

42

43

46

I

Agricultural Finance in Uganda - The Way Forward

List of Tables

Table 2.1 The Structure of the Banking Industry (as of 31 Dec. 2002)

Table 2.2 Suppliers of Financial Services and their Rural Clientele

Table 3.1 Numbers of Farmers and Traders by Commodity

Table 3.2 Comparative Fertilizer Use in Uganda and in Neighboring Countries(Kg fertilizer per cultivated ha per annum)

Table 3.3 Cost of Delivered Fertilizer

Table 3.4 Traders’ Demands for Financial Services

Table 3.5 Some Indicative Returns to Investment in Crops

Table 3.6 Farmers’ Demands for Financial Services

Table 4.1 Loan Sizes, Interest Rates, and Operating Costs by Category of Sup-plier

6

11

16

17

17

17

21

21

21

29

II


List of Figures

Figure 2.1 Loans and Advances of Commercial Banks to Economic Sec-tors (percentage)

Figure 2.2 Key Financial Sector Indicators, 1993-2002

Figure 2.3 Credit, TBs, Excess Reserves, Intermediation Margin and In-flation, 1993-2002

Figure 2.4 Structure of Interest Rates, December 1994 - September 2003

Figure 2.5 Structure of Commercial Bank Income, 1997-2002

5

7

8

8

9

III


ABBREVIATIONS AND ACRONYMS

ACDI/VOCA Agricultural Cooperation Development International/Voluntary OverseasCooperative Assistance

ADB Africa Development Bank

AFMIN African Microfinance Network

AFRACA Africa Rural and Agricultural Finance Association

AMFIU Association of Microfinance Institutions in Uganda

ASCA Accumulating Savings and Credit Associations

BoU Bank of Uganda

CBA Community Business Advisor

CBO Community Based Organization

CDO Cotton Development Organization

CERUDEB Centenary Rural Development Bank

COMESA Common Market for East and Southern Africa

CREAM Consultancy for Rural Enterprise Activities and Management Ltd

DANIDA Danish International Development Agency

DCA Development Credit Authority

DFCU Development Finance Company of Uganda

DFD Development Finance Department of the Bank of Uganda

DFID Department for International Development

EIB European Investment Bank

EPTD Environment and Production Technology Division of IFPRI

EU European Union

FAO Food and Agriculture Organization

FINCA Foundation for International and Community Assistance

FSA Financial Services Association

FSAIU Financial Services Association International Uganda Ltd

FSD Financial System Development Program

GoU Government of Uganda

GTZ German Technical Cooperation

HIPC Heavily Indebted Poor Countries Initiative

ICRC International Committee of the Red Cross

IFAD International Fund for Agricultural Development

IFPRI International Food Policy Research Institute

IITA International Institute of Tropical Agriculture

JENGA Joint Encouragement of New Gainful Activities (CARE project, West Africa)

IV


KfW German Development Bank

MAAIF Ministry of Agriculture, Animal Industry and Fisheries

MCC Microfinance Competence Centre

MDI Microfinance Deposit-taking Institution

MFPED Ministry of Finance, Planning and Economic Development

MFI Microfinance Institution

MMD Mata Masu Dubara (program of CARE in Niger)

MSCL MicroSupport Centre Ltd

MTCS Medium Term Competitiveness Strategy

NAADS National Agricultural Advisory Services

NARO National Agricultural Research Organizations

NPA Non-Performing Assets

PMA Plan for Modernisation of Agriculture

PMT Performance Monitoring Tool

PEAP Poverty Eradication Action Plan

RMFSP Rural Microfinance Support Program

ROSCA Rotating Savings and Credit Association

SACCO Savings and Credit Cooperative

Sida Swedish International Development Agency

SLA Savings and Loan Association

SME Small and Medium Enterprise

SOE State-Owned Enterprise

SPEED Support for Private Enterprise Expansion and Development Project

SUFFICE Support to Feasible Financial Institutions and Capacity-BuildingProgram(EU)

TB Treasury Bill

UCA Uganda Cooperative Alliance

UCB Uganda Commercial Bank

UCCA Uganda Change Agents Association

UCDA Uganda Coffee Development Authority

UCSCU Uganda Cooperative Savings and Credit Union

UGT Uganda Grain Traders

UIB Uganda Institute of Bankers

UMU Uganda Microfinance Union

UPE Universal Primary Education

V


UNDP United Nations Development Program

USAID United States Agency for International Development

UWFT Uganda Women’s Finance Trust

WFP World Food Program

WOCCU World Council of Credit Unions

VI


Executive SummaryThis report presents the findings of a study commis-sioned by the Bank of Uganda (BoU)/GTZ/Sida Fi-nancial System Development Program and KfW thatwas designed to investigate the development of self-sustainable agricultural finance in Uganda. The ob-jective of the study is to identify the major bottle-necks and draft a medium-term strategy for the sup-port of agricultural finance. It was undertaken againstthe backdrop of success that the government hasachieved, working in conjunction with several inter-national donors, in strengthening microfinance ser-vices for the poor.

Macroeconomic and Financial Policies and Per-formance

Since 1987, Uganda has been undertaking majorpolicy reforms designed to create a more liberalmarket-oriented economy and reverse the previousinward-looking, import substitution development strat-egy. Major policy measures have been taken todevelop an effective, efficient and competitive finan-cial system. The government has reduced its rolesas owner of financial institutions and allocator offinancial resources. The BoU (Bank of Uganda) hasbeen given the mandate and the tools to play a moreeffective role in overseeing the development of thefinancial system, and to regulate and supervise themajor financial institutions. The country is amongthe world’s leaders in working through the complexissues of developing and regulating microfinance.

The economy responded well to the changes in de-velopment strategy during the 1990s when compara-tively high levels of economic growth were recorded,inflationary pressures were contained, and goodprogress was made in reducing poverty. The countrybecame an international showcase for economicreform and its efforts were recognized when it wasselected as the first developing country to qualify fordebt relief under the HIPC initiative in 1998. Concernshave emerged, however, that perhaps the relativelyeasy task of restoring economic growth has run itscourse and the more difficult task of developinginstitutions necessary to support a market-orientedeconomy must now be faced.

Some basic underlying structural problems can beseen in the financial system. In spite of several bankclosures and the licensing of many new banks, fi-nancial sector deepening has not yet recovered toits mid-1970s level. A quarter of the commercial bankshave been closed due to fraud and mismanagement,most having been registered between 1992 and 2002.

The ratio of customers to bank branches has risensharply as the number of bank branches has beensubstantially reduced. Attractive rates paid ontreasury bills and the underlying weakness of thebanks to successfully screen clients and enforce loancontracts have led to high levels of excess reservesbeing held by banks and in banks heavily investingin risk-free assets rather than advancing loans. Realinterest rates on loans are high so demand is limitedto lightly leveraged firms realizing high rates of re-turns on investments. The four largest commercialbanks are foreign-owned. They compete and engagein inter-bank transactions amongst themselves, arethe market leaders and hold 70 percent of total com-mercial bank assets. The remaining smaller com-mercial banks, also mostly foreign-owned, competefor the remaining market niches. The commercialbanks limit their exposure to agriculture and ruralareas by making loans to the larger processing andexport firms, some input supply companies and afew large farmers.

The emergence of microfinance has been a morepositive development in the financial sector, espe-cially for those concerned about access to formalfinancial services by small firms and households,which comprise most of the economy. Even here,however, agriculture and the rural economy have beenlargely unaffected up to now because mostmicrofinance institutions (MFIs) have focused theiroperations in urban and peri-urban areas, their loanasset portfolios being heavily concentrated in short-term working capital loans for trading and commer-cial enterprises with frequent loan installments thatare best suited to such enterprises. Member-ownedSACCOs (Savings and Credit Cooperative Associa-tions) and informal finance still largely serve the ru-ral economy. Increased competition between com-mercial banks and MFIs has led both to experimentwith new products and to attempt to serve new typesof clients. This is seen most clearly in the competi-tion for salary based loans. This development offerssome hope that previously neglected small and mi-cro businesses, small farmers, and rural areas mayeventually be offered a better supply of more attrac-tive financial products.

Agriculture and Rural Areas – The Emerging De-mand for Formal Financial Services

Uganda’s economic reforms have provided fertileground for private sector responses to economicopportunities in agricultural and fisheries production

VII


and other associated downstream value-added ac-tivities. Indeed, success in these developments iscrucial to the effectiveness of the Plan for Modern-ization of Agriculture (PAM), itself an important con-tributor to the aims of the Poverty Eradication ActionPlan (PEAP).

The formal financial system is currently meeting someof the demand for financial services from theagricultural production and trading sectors, but ac-cess is generally limited to larger clients, both farm-ers and traders. Moreover, even for larger clients,there is unmet demand for less traditional financialproducts, such as term loans and price bufferingmechanisms.

Demand – Input Supply and Post Harvest Traders

Of primary importance are the demand signals fromdestination markets (for exported commodities) andterminal markets (for other produce). The effective-ness by which the marketing chain can meet thesemarket demands is dependent to some extent on theability of actors in the chain to purchase volumes ofcommodities sufficiently large to achieve economiesof scale in handling, processing and transport.Moreover, at some stages in the chain, a criticalminimum volume is needed in order to attract buyerswhose business would lead to advantageous sales.

Handling large volumes of commodities requiresworking capital. Only the largest traders currentlybenefit from bank advances secured by warehousereceipts. There is scope to improve the efficiencyand lower the cost of managing stored products ascollateral, so as to enable more traders to take ad-vantage of the mechanism and the improved borrow-ing terms that result. Efficient trading also needsequipment, storage facilities and transport appropri-ate for larger volumes. The resulting benefits, in awell-informed chain, ultimately feed through to thefarmer-producer, through formal market informationservices and informal signals passed along withinthe commodity chain. These requirements for out-put traders are mirrored in input markets, such asthose for fertilizers, which are often served by thesame traders.

Apart from conventional loans, there is clearly ademand in Uganda for improved marketing/financialmechanisms in order to reduce downside price risks.These mechanisms, for crops such as maize, wouldmake a positive impact throughout the system, rightdown to the farmer producer, as well as to thesuppliers of financial services. Possible strategicinterventions include measures that will facilitatecontract farming (which would convey price stabil-ity benefits for producers), and encouragement offorward selling to regular buyers. The mission hasidentified these interventions as warranting additional

study.

Along with the expansion in trading enterprises, fu-ture development in rural areas will include a naturalgrowth in part-time farming and migration out offarming completely. This will spawn other non-farmenterprises in rural areas, which in turn will createan additional demand for rural financial services.

Demand – At the Farm Level

The agricultural sector is not homogenous. The PMArecognizes three broad groups of farmers (i.e. sub-sistence, semi-commercial and commercial). Be-cause of substantial differences in the circumstancesof these groups, their demand for financial servicesis outlined separately below.

Commercial Farmers:

There are an estimated 60,000 farmers and fisher-men who operate on a commercial scale in Uganda.Some already enjoy access to short-term loans fromcommercial banks, MFIs and business firms that buyand/or process crops such as sugar cotton and to-bacco. Term finance is much less common. Yet it isterm finance for machinery, equipment and majorfarm improvements, such as livestock, that this grouprequires if a greater supply response to expandingmarket opportunities is to be engendered throughproductivity increases. Indeed, to date, access toterm finance has been confined to a few borrowerswho have benefited from special lines of credit forrelatively large outlays for items, such as oil press-ing machinery and cotton gins. In addition, someMFIs have made a few loans to rural individuals formachinery such as hammer mills and maize shellers.

There is a market for lease arrangements as demon-strated by several enterprises and individuals whocurrently lease machinery such as tractors and trucks.Demand for leasing is likely to expand, since about athird of current lessees receive tax benefits under leasearrangements and this proportion is expected toincrease. Finally, a largely unexplored financialproduct for this group is life insurance, especiallywhen linked to term loans as a way of mitigating therisks faced by lenders.

Semi-commercial Farmers:

The demand for financial services from this group offarmers is similar to that for commercial farmers withany difference being mainly one of scale. Somefarmers in this category are linked to nucleus estateswhere there is significant management, input supplyand product marketing support. Although many such

VIII


outgrower schemes include production loansextended by the central processor/buyer, there aremany situations where a local MFI or other financialintermediary could provide better all-round service tothe outgrowers. In addition, expanded financialservices from financial institutions would help mitigatesome of the exploitative tendencies that are inherentin financial dealings that see nucleus estates provideoutgrowers with financial as well as other services.

Subsistence Farmers:

Subsistence farmers are not only the most numerous(more than 3 million households), but by far the mostchallenging for the suppliers of financial services.Clearly it is vital to disaggregate the demand forservices within this group. An important distinctionneeds to be made between “villagers” who do notactively strive to produce marketable surpluses, and“farmers” who set out to produce for the market, albeiton a small scale. If policy makers base policyformulation and support initiatives on the assump-tion that villagers will automatically respond to thesame production incentives as farmers, then this willmean diversion (even waste) of effort and financialresources (e.g. under the Outreach Plan) from moreproductive and promising, but still poor, segments ofthe rural population.

It can be expected that a large number of villagersdemand savings, deposit and money transfer ser-vices. Beyond this group, there are emergent sub-sistence farmers who actively try to earn a signifi-cant part of their livelihood from farming. They areoriented to serving the market, even though most inthis category still use traditional farming technolo-gies. There will only be a few in this group who canuse loans for farming purposes effectively. Thereforefinancial intermediaries need efficient screeningtechniques to identify creditworthy borrowers ofseasonal finance.

Lenders must identify suitable creditworthy borrow-ers by selecting only those who already have provenabilities to manage improved technologies or newcrop/livestock enterprises by using their own finan-cial resources. Loans can then be advanced to en-able these proven entrepreneurs to expand the scaleof their operations. A similar approach is needed forfishermen.

Supplying Financial Services to Agriculture andRural Areas

Supplying financial services to rural areas is morechallenging than urban areas because of the highercosts and risks involved. Most of the savings and

loan transactions are fairly small with the result thatfinancial institutions face high operating costs. Cen-tenary Bank is the only commercial bank that hasmade a special effort to design a loan product andlending methodology for use in making individualloans to small commercial farmers. Its experiencedemonstrates both the promise and pitfalls of serv-ing this clientele group.

The emergence of NGOs as specialized microfinanceinstitutions and the new legislation authorizing someMFIs, the so-called Micro Deposit-taking Institutions(MDIs) to intermediate the public’s savings, meansthat eventually there will be more regulated financialinstitutions committed to serving those in the lowerincome segment of the market. Increasingcompetition among the banks may also mean thatsome will actively search for new market niches inrural areas. Several banks have begun to offerunsecured salary loans and to use ATM machinesto reduce the cost of handling small savingstransactions. Some banks lend to NGOs, therebyindirectly serving the lower income market segments.

Hundreds of SACCOs and other member-owned fi-nancial organizations are the most important sourceof financial services for thousands of rural and farmhouseholds. However, they are among the weakestand least sustainable of the financial institutions. Thisis because SACCOs face inherent problems in hav-ing weaker governance structures compared to mostother regulated financial institutions. The SACCOsector’s lack of strong regulatory and supervisorymechanisms, compared to banks, contributes to itsweakness. This situation is unfortunate becausemember-owned organizations have the potential tointermediate member savings in remote areas wherecommercial banks may find it too costly to establishbranches. Moreover, member-owned organizationsoften engage in smaller size transactions that aredesired by lower income people.

Expanding the Frontier of Formal Finance

All financial institutions face constraints in trying topush the formal financial frontier deeper into ruralareas. Commercial banks are best suited to makelarge term loans for agricultural transformation, butthe current system of land titling, registration, andsecurity of land tenure prevents the widespread useof land as collateral for loans. The lack of long-termsavings also limits the supply of stable funds neededto make term loans. The reforms underway in theJustice, Law and Order Sector will be important forfinancial institutions as they will strengthen the le-gitimacy of written contracts and contract enforce-ment measures through the legal system.

IX


The MDIs that will be licensed under the new law willface two major constraints in serving agriculture. Oneis the lack of resources (capital) and trained staff forexpanding their branch networks. The other is a lackof appropriate rural savings and loan products giventhat these institutions have largely in the past servedan urban and peri-urban clientele with loans andcompulsory savings products. In addition, theremaining NGOs that will not be licensed to takedeposits under the MDI bill will face constraints inaccessing loanable funds, as donor funding for on-lending gradually declines. Moreover, many cannotbe expected to be financially viable for some time tocome to be able to access commercial bank loans.

The member-owned organizations face the greatesthurdles. Not only do they tend to be weak, they lacka strong regulatory framework that is so important forcommercial banks. However, unlike some NGOs, evensome of the best SACCOs have not been able tosignificantly improve their financial position in spite ofheavy donor support. Thus, while some are now beingreorganized as a condition for receiving additionalexternal support, their prospects for efficientlymanaging such support remains weak. In addition,such external support can undermine incentivesfor self-help and thereby damage the SACCOs’most important attribute, namely their ability tointermediate local savings.

All financial institutions face common crosscuttingproblems. One is that neither they nor farmers haveaccess to good sources of information about thenature of profitable investment opportunities in themarket. Second, they all suffer because of the lowlevel of profitability inherent in farming, which is fur-ther exacerbated by deficient infrastructure andmarkets, and by the low level of human capital foundin agriculture. Third, trained bank staff is scarce andexpensive. Fourth, it is costly to establish and oper-ate bank branches in remote areas. Fifth, there arestill gaps in donor coordination such that projectsand activities undertaken by different donors are notalways geared towards a coherent strategy of finan-cial sector development.

Recommendations

The Recommendations of the Mission are annotatedin more detail in Chapter 5 in this report. They ad-dress direct and indirect ways in which the economictransformation of the rural sector can be encouragedthrough strengthening the financial system. TheRecommendations are arranged in three clusters:

? Cluster One: Long Term Strategic Plan for Fi-nancial Services to the Agricultural Sector, andRelated Issues

? Cluster Two: Issues for Attention by Legislators,Government Ministries and the BoU

? Cluster Three: Unfinished Business

Cluster One: Long Term Strategic Plan for Finan-cial Services to the Agricultural Sector and Re-lated Issues

The issues concerning the improvement of financialservices to the agricultural sector warrant specialefforts to develop an overall ongoing strategy, whichwould provide guidance for policy development, andfor the design and coordination of support programsand projects. The Mission proposes that a long-termstrategic plan should be developed through dialoguebetween all concerned parties. Such a plan shouldinclude inputs from a range of experienced and re-sourceful stakeholders, including those from thecommercial and trading sectors.

A High Level Workshop that would detail a work planfor the ongoing strategy on agricultural finance wouldinitiate the Plan. The Mission believes that such aworkshop could be held in the near future, contin-gent on the issuance of a policy paper that wouldfocus deliberations, and on efforts to ensure thatsuitable participants attend the workshop and anyfollow-up workshops and/or deliberations. It is cru-cial for donors to be fully engaged in the workshopand contribute to the design of the long-term strategyso as to incorporate the workshop’s outcome into theirbilateral and multilateral programs of assistance toUganda.

Particular issues to be dealt with under the Work-shop and the Plan would include:

? Ongoing support for MFIs and the ‘newly to belicensed’ MDIs involved with the agricultural sec-tor.

? Measures to strengthen business arrangementsbetween the agricultural sector and the financialsector – for example in the area of contract farm-ing.

? Specific attention to member-owned financialorganizations, including:

? Support measures other than the provision offunds for on-lending;

? Separation of financial from other areas ofbusiness;

? Rationalization of the roles of apex bodies; andidentification and strengthening of the morepromising governance models. Developing astandardized performance monitoringsystem would assist policy making for themember-owned bodies.

X


? Adequate finance of the marketing chain, and fullincorporation of the interests of these businessesin policy-making on agricultural finance.

? Identification of measures to increase farm gateprice stability.1 Measures could include facilita-tion of forward sale and forward contracting (in-cluding the possible use of put options); improvedsetting and enforcement of grading standards.Closely connected is the need to improve price/demand forecasting for key regional crops, suchas maize, where Uganda has significant naturaladvantages as a producer in the Eastern/South-ern Africa regions (bi-modal rainy season, highreliability of rainfall). It is the opinion of the Mis-sion that there may also be an opportunity inUganda to introduce a limited degree of pricebuffering through a price guarantee arrangementoperating at the terminal market level. However,this would depend on improved levels of price/demand forecasting. The Mission stresses thatthis runs counter to what most observers wouldconsider possible, but still feels it is at least worthinvestigating, given the special circumstancesand advantages in Uganda - notably the bi-modalcropping pattern and existing excellent marketinformation mechanism. (See also Cluster Threebelow.)

? Provision of both seasonal and term finance foragricultural producers is currently meager, andmeasures to improve this situation should forma major part of the strategic plan for agriculturalfinance in Uganda. Given the diversity of intentand capability to productively use purchased in-puts by Ugandan farmers, lenders must developand implement careful procedures for seasonalloans. Information on investment opportunities inthe sector needs to be collected, analyzed andmade widely available in order to facilitate termlending (see Agricultural Enterprise Watchlist,paragraph 11 below). The special challenges in-volved in developing term finance, especially thelimited supply of long-term savings, need to beaddressed. The results of the European Invest-ment Bank Apex Private Sector Loan Schemeshould be evaluated to determine if and how itaffected agricultural lending. There may be anopportunity for increased donor support for termlending, if such support can address underlyingproblems rather than simply supplying long-termfunds to substitute for missing domestic savings.

Cluster Two: Issues for Attention by Legislators,

Government Ministries and the BoU

? It is vital to implement macroeconomic and otherreforms that will reduce Treasury bill interestrates.

? A major effort is needed to unlock the real wealththat lies in the rural areas by addressing the landtenure issue. To begin with; a review of the cur-rent land records could be undertaken to estab-lish those who have legitimate claims over landwhilst weeding out those with illegitimate claims.A longer-term project could involve a more ex-tensive evaluation of the magnitude of rural landconflicts, their impact on agricultural production,and the efficacy of the new land legislation andadministrative procedures in minimizing and/ormitigating these problems. It goes without say-ing that several inter-related issues are at theheart of improving the security of land tenure andthe ability of land users to mortgage such landas collateral for long-term loans.

? Closely connected is the need to improve legalcontract enforcement in regional and local courts.Specific warehouse receipt legislation, currentlyunder consideration, is a step in the right direc-tion, and clearly deserves serious attention bylegislators.

? Scope exists to forge linkages (through insur-ance product design) between life insurers andlenders, in order to improve the security of termloans. Donors could assist in the design of suchproducts. On the other hand, MFIs will need as-sistance in developing the necessary businessarrangements with insurers and in linking insur-ance products with loans.

? Several fields of information management requireattention. Firstly, policy makers need informationon the performance (in a broad sense) of thoseproviding financial services, in order to make andmonitor supportive policies. Secondly, NAADSshould start an Agricultural Enterprise Watchlist,giving information on investment opportunities.Thirdly, it is vital that the market informationservice (Foodnet) continues to be sufficiently wellfunded by government, given that it is a valuablepublic good.

? Education is vital in many areas of financial ser-vices for agriculture, including improving thegovernance of member-owned institutions, andspecialized knowledge and skills for bank andMFI staff, and for borrowers. Systems of knowl-edge management (incorporating presentationand dissemination of key material) are also re-quired.

1 This will require the commissioning of specific studies

XI


Cluster 3: Unfinished Business

? Carry out a more detailed investigation of pos-sible strategic interventions by government toincrease the level of stability of farm-gate pricesfor key crops such as maize.

? Prepare an Issues Paper as preparation for aHigh Level Policy Workshop on Agricultural Fi-nance in Uganda.

? Collect and analyze information on the struc-ture and performance of member-owned organi-zations in rural areas, with a view to facilitatingstakeholder deliberations leading to the devel-opment of a long-term strategy for these organi-zations in the area of Agricultural Finance inUganda.

? Conduct a detailed analysis of the factors thatimpede or facilitate the expansion of bankbranches in rural areas.

? Prepare a support project to improve land titling,registration and security of tenure, and to facili-tate and streamline the process of using land ascollateral for agricultural lending.

XII


Chapter 1Introduction1.1 Background

The Financial System Development Programme (FSD)of the Bank of Uganda (BoU)/ GTZ/KfW/Sida has beenimplementing a programme to develop and deepenthe financial sector in Uganda. The overriding goal ofthe program is to contribute to the Ugandan PovertyEradication Action Plan (PEAP) by enhancingeconomic growth. The aim is to increase the efficiencyof the financial sector and the utilization of financialservices by micro, small and medium enterprises, andlow-income households.

One field of cooperation vital for financial sectordeepening in Uganda is agricultural finance. In April2002, the FSD Programme organized a dialogueseminar on agricultural finance in Uganda, whichprovided a forum for stakeholders to raise and dis-cuss the key and pertinent issues of agricultural fi-nance. The discussions stressed the need for anoverall agricultural finance policy to contribute towardsan enabling environment for self-sustainable financein Uganda. In subsequent discussions, the Ministryof Finance, Planning and Economic Development(MFPED) and the BoU welcomed the suggestion bythe FSD Programme to kick-start a policy initiativeon agricultural finance via a study to identify the majorbottlenecks. To this end, GTZ, KfW and Sida jointlysupported the BoU in conducting such a study. Thefindings of this exercise are set out in this report.

1.2 Objectives of the Study

The study aims to identify the major bottlenecks forthe emergence of sustainable agricultural finance inUganda’s current policy environment and to draft amedium-term strategy for the support of agriculturalfinance in Uganda. The results of the study shouldform a basis for future discussions with national andinternational stakeholders, including the assignmentof roles and responsibilities for further action on theway forward for agricultural finance in Uganda.

The fieldwork for the study was undertaken in Novem-ber 2003 by two international consultants, Richard L.Meyer and Richard Roberts, and one nationalconsultant, Adam Mugume. They were assisted andadvised by the able GTZ Program staff, among whom,Gabriela Braun provided general leadership andoversight, while Joseph Wasswa-Matovu contributedAnnex 3, and advised on presentation and editing.

1.3 Approach and Organization of the Study

The study team recognized that a long-term strategywould be required to develop a sustainable systemfor agricultural finance. The team also recognized thatfinancial services are needed for the entire ruraleconomy, and as such it would be inappropriate toanalyze finance for agriculture without consideringhow the demands for financial services by rural non-farm households and businesses might evolve alongwith the agricultural sector. To guide its thinking andanalysis, the team approached the task by posingthe question “How will Ugandan agriculture changeover the long term, and how will these changesinfluence the demand for financial services?”

The agricultural sector assumes a dominant role inUganda’s economy in terms of numbers employed1.Thus, it accounts for over 80 percent of all employ-ment and supports the livelihoods of the majority ofrural inhabitants who constitute 85 percent of Uganda’spopulation. Agriculture also accounts for 85 per centof Uganda’s export earnings.

More importantly, agriculture has the potential to actas a base for the improvement of the livelihoods ofboth rural and urban populations. In rural areas suchimprovement would be achieved by enhancing pro-ductivity at the primary, i.e. production level. In ruraltowns and urban areas agricultural products consti-tute the base for the creation and expansion of value-adding processing industries catering to domestic andregional markets, and for packaging/marketingoperations, both for domestic and export markets.

As part of its Poverty Eradication Action Plan, theGovernment of Uganda’s Plan for the Modernizationof Agriculture includes among its priority areas foraction, measures that have direct relevance to thisreport. The first is research and the second isextension. There is much to be accomplished in theseareas, however, before these measures will effectivelyraise agricultural and pastoral productivity in Uganda.For the vast bulk of Uganda’s farmers and ranchers,the level of use of improved technology is very low,with concomitant low levels of investment.

Against this demand scenario, a number of challengesface all those involved in supplying financial services.

1 GoU (2000), “Plan for the Modernization of Agriculture”Ministry of Agriculture, Animal Industry and Fisheries; Ministryof Finance, Planning and Economic Development, Entebbe/Kampala, August, 2000


1

It is widely recognized that supplying financial servicesin rural areas is usually more challenging than inurban areas for a number of reasons (see below).These reasons help explain the limited penetration ofcommercial banks into rural areas. While thesereasons to a large measure exhibit the challengesfinancial institutions face in serving full-time farmers,many also apply in cases where financial institutionshave to serve part-time farmers, rural traders and ruralnon-farm enterprises2. These reasons include:

? Dispersed Clients: Population density is lowerin rural areas than in urban or peri-urban areas.Coupled with the greater distances and poorertransportation and communications facilitiesfound in rural areas, dramatic increases in thecosts for both financial institutions and their cli-ents can be expected.

? Poverty: Farmers and rural people tend to bepoorer than urban people, and have fewer as-sets to offer as loan collateral and to liquidatein the event of emergencies.

? Seasonality and Loan Demand: Farmers tend tohave similar seasonal patterns of cash deficitsand surpluses. Such a pattern of cash flow ishowever not suited to agricultural loans, whichgenerally are larger, stay outstanding for longerperiods, and need to be repaid in one or only afew installments.

? Heterogeneity of Farm-Level Activities: Farm-households have diverse farming and non-farm-ing activities and produce a variety of products.This reduces their production and marketingrisks, but complicates the task of loan officerswho need to understand their cash flows andpredict their loan repayment capacity.

? Risk of Lending: Farmers face many production,yield, marketing and price risks that can causeactual cash flows to deviate substantially fromthose projected at the time the loans are issued.

? A Poor Debt Repayment Culture: Past efforts toprovide loans to farmers were in a sense grantsin disguise. These schemes and grants have lefta poor debt repayment culture among farmerswho have had access to cheap agricultural fi-nance in the past.

? Price Instability: Instability in the price regimesof agricultural products in both domestic and in-ternational markets can cause actual income todiffer greatly from that that was originally pro-jected.

For these reasons, formal financial institutions tend

to shy away from serving the agricultural and ruralsectors as the low volume of agricultural loans inthe financial institutions’ asset portfolios show. Whenthey lend to agriculture, financial institutions tendto make short-term seasonal loans that are securedby stringent collateral requirements, with the clientshouldering the bulk of the interest rate risk in theform of variable interest rates. Where term loansare advanced to farmers, they are generally limitedto those funded through donor programs.

1.4 Structure of the Report

Apart from the Executive Summary, this report isorganized into five chapters. The annexes that ac-company the body of the main report provide greaterdetails on key issues in the main report. Chapter 2describes the evolution of macroeconomic and fi-nancial policies and how this evolution has affectedthe structure and performance of the financial sys-tem and its ability to serve the agricultural and ruralsectors. Chapter 3 analyzes demand conditions forfinancial services that will emerge as Uganda’seconomy undergoes structural transformation overthe next twenty years. Chapter 4 contains an analy-sis of the structure of Uganda’s current financial sys-tem, its products, and the segments of the agricul-tural and rural economy it currently serves. Thischapter also analyzes the constraints that are likelyto impede the financial system’s ability to meet thedemands that are expected to emerge, along withrecommendations for improvements; including therecommendation for the development of a long-termstrategy to develop financial services for the agri-cultural and rural sectors. Finally, Chapter 5 knitstogether the arguments in the preceding chapters intoan annotated list of recommendations.

2 A more detailed discussion of this topic can be found in BrigitteKlein, et.al., Better Practices in Agricultural Lending, AgriculturalFinance Revisited No. 3, FAO and GTZ, FAO, Rome, 1999.


2

This chapter briefly discusses the performance ofthe Ugandan economy, with special reference to theformal financial system. Section 2.1 gives a briefdescription of Uganda’s economy in relation to itspast poor performance and the policy reforms imple-mented to address past poor performance. In Sec-tion 2.2, we summarize current financial sector poli-cies and identify some outstanding challenges fac-ing the sector. Section 2.3 includes an analysis ofthe suppliers of financial services to the agriculturalsector and to rural areas. Section 2.4 explains whyland as loan collateral is an important issue thatdemands our attention. The current state of the bank-ing sector and the supply of rural financial servicesare summarized in the last section.

2.1 General Description

The policy framework in Uganda until 1987 was aninward-looking economic development strategy,which emphasized the role of the state in economicdevelopment. It appeared self evident that an activestate, pursuing interventionist economic policies inline with clearly articulated development plans, couldwithin a short period of time eradicate poverty andunderdevelopment, and ensure national control overstrategic sectors of the economy. As a result of thisthinking, the state undertook a major role in devel-opment by investing heavily in sectors seen asstrategically important and by providing generousincentives (including interest rate and credit subsi-dies) to state-owned enterprises (SOEs), includingagricultural marketing boards, and to private inves-tors in priority sectors. Cognizant of vulnerabilitiesinherent in agriculture coupled with its elevated po-sition in Uganda’s economy ensured that governmentalways underwrote the agricultural sector, more thanany other sector, with highly subsidized loans.

In addition, the state made use of a complex sys-tem of trade and exchange controls to protect infantindustries. However, this development strategy re-sulted, inter-alia, in the building up of a large andinefficient public enterprise sector, which later be-came a heavy burden on the treasury.

Consistent with these policies, the key function as-signed to the financial sector was to collect savingsat low cost and channel them to the government and

to identified priority sectors. Accordingly, the stateheld a dominant stake in the financial sector, whichit tightly regulated through administered interest ratesand directed credit. The role of market mechanismswas substantially limited. Under this policy regime3,private banks were part of the firms that were affectedas the government took a majority stake andconsequently gained exclusive control over theallocation of funds in the economy. This meant thatthe financial sector’s key role in the economy; thatof facilitating the mobilization and intermediation ofsavings was gradually undermined. In the early 1980s,as part of a proactive policy to improve financialdepth, the government through the UgandaCommercial Bank (UCB) and the Cooperative Bankexpanded the national branch network withoutconsideration for whether the branches were profitableor not, or whether the branch managers had risk man-agement know how. This consequently contributedto inadequate banking discipline and to insolvencyfor the two banks and further eroded publicconfidence in the financial system.

In a nutshell, consequent to government involvementin the financial sector, the balance sheets of thefinancial institutions deteriorated as their capitalbases eroded in the face of large loan losses. More-over, these policies had redistributive effects as theymade subsidized credit available to politically fa-vored classes. As a result the scope of financial in-stitutions remained severely restricted, which in turnled to the concentration of financial services in thehands of a few commercial banks, the largest beingthe government-owned Uganda Commercial Bank(UCB).

This meant a vicious circle existed between the fi-nancial sector and the macro-economy whereby theinsolvent financial system undermined confidence inthe financial sector, resulting in a low savings rate,inflation hedges, and a lack of monetary depth. Inturn, the lack of monetary depth and other inefficien-cies in the financial system contributed to macro-

Chapter 2Macroeconomic Issues and Financial SectorPerformance

3 This policy regime began in 1970 when the government soughta 60 percent participation in a number of private industrial,commercial, and financial undertakings. The military regimeinitially partially reversed this policy by reducing governmentparticipation to 49 percent. However, the nationalization drivewas revived during the “Economic war” of 1972.


3

economic instability. This period also saw thepoliticization of commercial life and an underminingof professional and ethical standards. The result wasthat the credibility of financial institutions was severelyimpaired4. It was against this background that in 1987the government, under the auspices of the BrettonWoods institutions, adopted its Economic RecoveryProgramme (ERP) with three reform pillars, namely;fiscal austerity, privatization, and market liberalization.These measures have helped to establish a truly liberalmarket economy in Uganda.

Since the adoption of the ERP in 1987, great ad-vances have been recorded in the major macroeco-nomic indicators. Growth has been dramatic andaveraged 6.5 percent over the last 15 years in spiteof a difficult international environment with deterio-rating terms of trade. Inflation has also been curbedand has averaged about five percent per year overthe last decade. The solvency, transparency and li-quidity of the banking sector have also all signifi-cantly improved. Thus, the ratio of non-performingassets to total assets that in the early 1990s stoodat about 40 percent had fallen to about 3.5 percentin 2002, an impressive achievement even as such arate is still high by international standards. Savingsand time deposits that amounted to Ushs102.8 bil-lions in 1993, stood at impressive Ushs 517.7 bil-lions in 2002; an increase of over 400 percent. Therate of HIV/AIDS infection, which in the early 1990swas estimated at 25 percent, also fell to 6.1 percentin 2002 (Republic of Uganda, 2002). More impor-tantly, solid growth has been accompanied by a sub-stantial reduction in poverty, which has lifted morethan 4 million people out of poverty in a decade.Thus, the percentage of individuals in absolute pov-erty, which in the late 1980s stood at about 56 per-cent, was reduced to about 35 percent in 20025.

However, these aggregate data mask vast regionaldisparities. The central and western regions of thecountry have grown more rapidly than regions in thenorth and east. Thus, taking a clue from the PovertyEradication Action Plan (PEAP), the right policyframework is needed to ensure that all citizens, par-ticularly the poorest members of the community,

benefit from economic growth. High economic growthand poverty eradication, in the context of continuedmacroeconomic stability, which is underpinned byappropriate fiscal, monetary, and structural policies,will thus continue to be the government’s principaleconomic and social policy framework. Thegovernment is committing its own and donor fundsto increase public expenditures on growth-orientedand antipoverty programs and accelerate theimplementation of the PEAP.

To summarize, most of the potential for rapid im-provements in economic growth and poverty reduc-tion through macroeconomic reforms has now beenexhausted. Impetus for further growth will requiresdeeper reforms to create an enabling environmentfor the private sector if growth rates of about 7 per-cent and government and millennium goals (e.g., ofreducing poverty to 10 percent by 2017) are to beachieved. However, the private sector continues toraise a number of concerns. These range from cor-ruption to inadequate infrastructure, poor public ser-vice provision, and limited access to financial ser-vices. This environment is also heightened by politi-cal uncertainty and insurgency in northern Uganda.

The demand for financial services by the agriculturaland rural sectors is discussed at length in Chapter3. Suffice to note that the policy support mecha-nism for meeting this demand needs to be well in-formed about the current situation, as discussed inChapter 4. Regarding credit, there are no reliableobjective standards of credit adequacy, but one fea-ture evident in Figure 2.1 is that in the post financialsector reform period, a change in the compositionof private sector credit from formal financial institu-tions is observable. An important feature to note isthat two sectors, manufacturing and trade and otherservices, dominate credit allocation even as the shareof credit going to agriculture has shrank. Theagricultural sector that currently dominates theeconomy6 receives only about 10 percent of all credit.The dependence on rain-fed agricultural productioncontributes to the general perception of formal lend-ers that agriculture based clients are high-risk. More-over, the volatility of agricultural incomes implieshigher transaction, enforcement, and supervisioncosts.

4 The IMF studied the banking crises that occurred in Ugandaand nine other Sub-Saharan African countries in the 1985-95period and found they shared similar problems related to;government interference, poor banking supervisions andregulation, and shortcomings in management. See RolandDaumont, Francoise Le Gall, and Francois Leroux, “Banking inSub-Saharan Africa: What Went Wrong?” IMF Working PaperWP/04/55, Washington, DC, April 2004.

5 According to the latest PEAP review, poverty was estimated tohave increased to 38 percent between 2000 and 2003.

6 Agriculture had a 41 percent share of GDP in 2001/02,employed about 80 percent of the labor force and generatedalmost all of the country’s exports


4

2.2 Policies and Challenges in the FinancialSector

The liberalization of the financial sector in Ugandawas part of the wide-ranging adjustment programsembarked upon in 1987. The key elements of finan-cial sector reforms that were implemented are trace-able to the Bank of Uganda Act of 1993 and theFinancial Act amendment of 1993 and include:

? The establishment of a legal basis for the inde-pendence of the BoU. This legal basis erodedthe discretion of politicians in monetizing fiscaldeficits and also restrained fiscal dominance incredit extension to the government.

? The conferring to the BoU of wide-ranging pow-ers over the financial sector with overall respon-sibility for supervising financial institutions andto serve as the sole monetary authority.

? Institutional reforms, including new laws andregulations governing the financial sector,

? Elimination of government intervention in thedetermination of interest rates,

? Removal of the barriers to competition in thefinancial sector,

? The scaling back of government ownership offinancial institutions,

? Allowing new financial products to appear,thereby increasing the diversity of financial ser-vices, reliability and efficiency,

? Limiting excessive taxation of banks, (e.g. reserveratios were substantially reduced to a maximumof 7 and 8 percent on time and saving deposits

and demand deposits, respectively, down from 10percent in both cases), and

? Complementary reforms like opening the capitalmarket, reducing the corporate tax rate, legaliz-ing foreign exchange deposits, etc.

The ultimate goal has been to enhance the develop-ment of an effective, efficient, and competitivefinancial system. More significantly, since 1987 thegovernment has committed itself to pursuing appro-priate domestic financial policies, to strengtheningfinancial institutions, and to enhancing the mobiliza-tion of domestic financial resources and their effi-cient allocation. Monetary growth targets, as one ofthe means to control the inflation rate, have sincereplaced direct controls. With the approach of set-ting growth targets for M2 (currency plus demand,savings and time deposits), the monetary authori-ties have presumably been able to lower the inflationrate more than would have been possible using otherapproaches.

2.2.1 The Current Structure of the FormalFinancial Sector

By the early 1990s, the banking sector consistedmainly of five foreign banks (Standard, Stanbic,Barclays, Libyan Arab Bank and Baroda), and twolarge locally owned banks (UCB and Cooperative)that together controlled 70 percent of all bank as-sets and liabilities even though they were insolvent.By the end of 2002, the system had substantiallygrown. The formal sector encompassed the CentralBank, 15 commercial banks, 8 credit institutions,about 18 insurance companies, 67 forex bureaux, 2

Figure 2.1: Loans and Advances of Commercial Banks to Economic Sectors (percentage)


5

development banks and the stock exchange.

However, in recent years, the building societies thatmushroomed in 1980s and early 1990s have disap-peared while the commercial bank branch networkhas contracted from 290 offices in 1972, to 146 in1996, and to 126 currently. This has resulted in arapid deterioration in the ratio of customers per bankbranch from 34,000 in 1972 to 80,000 and 100,000in the 1980s and 1990s, respectively, and to about190,000 in 2002. This compares very poorly with theaverage of 7,000 customers per bank branch for theCOMESA region.7 Uganda’s ratio of M2 to GDP of15 percent, in comparison to Kenya and Tanzaniawhose broad-money to GDP ratios, respectively,stand at 40 and 35 percent, suggests that the finan-cial sector is still underdeveloped, although it hasgreatly improved compared to the situation in the1980s. Consequently, only a limited number of fi-nancial instruments are available for savings mobili-zation, diversification of risk, and management ofliquidity. The formal financial system is largely bank-centred and supplies mainly short-term working capi-tal loans going to the non-agricultural sectors withless credit going to agriculture despite its dominantrole in the economy. Also the rural banking presencehas decreased because of branch closures.

2.2.2 Structure and Competitiveness of theBanking Sector

Uganda’s financial sector has undergone consider-able reforms to strengthen, broaden, and deepen thesystem and to encourage competition. A debateexists now about whether the few large internationalbanks have an advantage, because of the scope oftheir business and their recourse to head office ser-vices, relative to new small banks that must set upsuch services. Table 2.1 below seems to suggestthey do because the four major global internationalbanks hold more than 70 percent of total bank as-sets. However, this position could be explained inpart by the closure of the banks that used to domi-nate the market, which could have engendered a runon the remaining weaker banks and therefore resultingin the shifting of deposits to these safer global banks.

When international financial institutions dominate acountry, they may enjoy competitive advantages thatallow them to increase their market share relative tolocal smaller and weaker banks and attract deposi-tors away from them. However, because internationalfinancial institutions have a larger propensity to makeloans to large corporations, they are less likely tobecome a sustainable and reliable direct source ofcredit and other financial services for farmers or smallbusinesses engaged in agriculture. With this marketstructure, new and small bank entrants cannot easilyfind a market niche and, at best, are market followers.In light of this, the BoU has placed a moratorium onlicensing new banks based on the argument that theeconomy is over-banked and that new entrants couldfurther weaken the small banks unless they providenew products. Moreover, it is possible to speculatethat these few dominant banks took over the price-setting function when the government relinquishedit.

2.2.3 Loan Portfolio Management

Since the mid 1990s, financial sector policies havefocused on strengthening the system, increasing li-quidity ratios, and tightening risk exposure. The BoUinstituted a framework for more effective supervisionand enforcement of prudential regulations thatincluded increasing minimum capital requirements.This indeed has contributed to reducing the rate ofnon-performing assets (NPA) as well as enhancingthe profitability of the sector as is evident in Figure2.2.

7 Mpuga, P., “Credit Demand and Small Scale IndustrialDevelopment in Uganda”, Paper presented at 1st

Industrialisation Workshop, 12th -13th August, Centre for BasicResearch, Kampala, Uganda, 2003

Table 2.1: The Structure of the Banking Industry(as of 31 Dec. 2002)

Source: BOU


6

Bank Ownership TotalAssets

(billions)

Sharein the

Market

No. ofBranches

StanbicStandardBarclaysCity BankBarodaCERUDEBCraneDFCUOrientNileAlliedTropicalCairoDiamondNational Bankof Commerce

ForeignForeignForeignForeignForeignLocalLocalForeignLocalForeignForeignForeignForeignForeignLocal

766.1606.8228.4186.7122.8116.2108.182.1368.348403620.316.110

31.2 %24.7 %9.3 %7.6 %5 %4.7 %4.4 %3.3 %2.8 %2 %1.6 %1.5 %0.8 %0.7 %0.4 %

68621618246333112

However, the dramatic decline in the NPA may notentirely suggest an improvement in the risk-returnassessment on the part of commercial banks.Rather, it is largely due to the closure of theCooperative and Greenland Banks and therestructuring of the UCB. The UCB and theCooperative Bank were an important part of theinward-oriented economic policies of the pre-reformperiod and their existence could have hampered thedevelopment of the financial sector because otherlenders could not compete with the subsidized termsthey offered. Furthermore, they undermined the loanrepayment ethic since loans advanced to importantindividuals in Uganda by these banks were generallynever paid back. In addition, since the bulk of the loansthese banks offered were agricultural, their closuremeant that less total lending was available for the ag-ricultural sector.

2.2.4 Financial Sector Policy Challenges

Financial sector development is instrumental in notonly fostering investment and growth, but also inmobilizing resources. Underdeveloped financialmarkets limit the efficient reallocation of resourcesespecially in those sectors and enterprises that areless well linked to the financial system. That said,the government has credibly exhibited its commit-ment to stay the course of financial sector reformand to this end, some positive results have beenrecorded. Nevertheless, the financial sector still facesa number of challenges and problems whose mitiga-tion goes beyond simple solutions.

As shown in Figure 2.3, under liberalization, creditextension has remained static despite the accumu-lation of excess reserves and minimal decline in in-termediation costs. Instead, the commercial bankshave concentrated their assets in Treasury Bills

(TBs). Large intermediation costs impede the expan-sion and development of financial intermediationbecause they discourage potential savers who facelow returns paid on deposits. This limits the resourcesavailable to potential borrowers and constrains thegrowth of the economy.

High interest rates may impede the growth of fledg-ing enterprises. In particular, farmers find that theyhave to pay higher interest, making it more difficultfor them to invest in more productive ventures, suchas improved crop varieties necessary to improveagricultural productivity and raise incomes abovesubsistence for farmers. The necessary capital formore rapid growth becomes simply too costly. More-over, World Bank surveys point to the cost, inad-equacy and short-term nature of bank lending as majorconstraints in investment expansion.8

Several factors contribute to the high costs of inter-mediation. They include:

? Deficiencies in the system of commercial law forenforcing collateral liquidation in cases of loandefault9;

? Adverse selection due to politically well-connectedborrowers who in the past were responsible for alarge number of non-performing loans.

Figure 2.2: Key Financial Sector Indicators, 1993-2002

Source: BOU

8 Reinikka, R., and J. Svensson, 2001, “Investment Responseto Structural Reforms and Remaining Constraints: Firm SurveyEvidence from Uganda”, in Ritva Reinikka and Paul Collier, (eds.)Uganda’s Recovery: The Role of Farms, Firms and Government,The World Bank, Washington D.C., 2001.9 The difficulties faced by financial institutions in liquidatingcollateral in the case of non-performing loans and advances aregradually being resolved with the recent strengthening of theCommercial Division of the High Court. Banks have been able toenforce recovery of bad debts with minimum difficulties. Inaddition, a Credit Reference Bureau is soon to be established;something that should reduce the risks financial institutions wouldface when advancing loans to their clients and in promoting abetter loan repayment culture.


7

? Weak capacity of banks to assess commercialrisks, especially of new entrepreneurs, hencetheir perception of new entrepreneurs as high riskand thus their reluctance to lend to them.

? Sterilization measures through issuance of high-return treasury bills. High interest rates paid onTBs mean that banks can be assured of highand safe returns by simply investing a large pro-portion of their assets in TBs. Banks then havevery little incentive to issue loans and advancesto sectors such as agriculture where returns arelow and investments risky. Moreover, as shownin Figure 2.4, there is high variability in the TBrates, which creates uncertainties for banks aboutfuture investments. This subsequently, could in-crease the option value for waiting and hence abuild up of excess reserves.

Figures 2.3 and 2.5 show clearly that treasury billshave become a lucrative form of investment for thecommercial banks. Banks in the main have shiftedtheir assets and loan portfolios into TBs and short-term loans. This suggests that even creditworthycustomers will have limited access to the formal fi-nancial sector. Moreover, agricultural based enter-prises have been limited in their ability to borrow byhigh collateral requirements imposed by the banksand the fact that most land, particularly outside ofgreater Kampala, is unacceptable as collateral or isaccepted only after being highly discounted.

Figure 2.3: Credit, TBs, Excess Reserves, Intermediation Margin and Inflation, 1993-2002

Source: BOU

Figure 2.4. Structure of Interest Rates, December 1994 - September 2003


8

2. 3 The Suppliers of Agricultural and RuralFinancial Services

The structure of the current supply of rural financialservices has evolved out of the interplay of sponta-neous developments in the economy and responsesto the policy changes discussed above. The mainfeatures of the rural financial system are outlined inthis section. More detailed information together withan analysis of the implications of weaknesses in thecurrent structure for the provision of improved ser-vices to the agricultural sector is presented in Chap-ter 4.

It is difficult to develop a clear understanding of thetotal volume and types of financial services availableto and actually used by rural firms and households inUganda. On the one hand as noted above, there is ageneral perception that the country is severely underbanked relative to its neighbors. This is reflected in asavings ratio of only 4.9 percent of GDP compared tothe African average of 17.7 percent. In addition, only77 percent of total GDP is supposedly monetized,and the ratio of broad money (M2) to GDP is only 10percent compared to 40 and 35 percent in Kenyaand Tanzania, respectively (PMA, p. 63). This view isbolstered by household survey data that suggeststhat banks provide only 2.4 percent of the total creditreported and that severe credit rationing exists10.

On the other hand, field surveys conducted in 107communities during 1999 to 2001 give a somewhatdifferent impression.11 Over 95 percent of the house-holds interviewed reported access to credit; about

one quarter reported access to formal credit in thevillage, and more than two thirds reported access toinformal credit in the village. The average amount offormal credit reported as borrowed in cash wasUshs179,000 compared to Ushs129,000 from infor-mal credit sources.

A related study analyzed the activities of NGOs (NonGovernmental Organizations) and CBOs (Commu-nity Based Organizations) and found that relativelyfew communities reported a program in the villagespecifically related to credit, but over 40 percent ofthe households reported participating in such orga-nizations.12 The first number may be an underesti-mation considering that the persons interviewedmight not have perceived that locally organizedSavings and Cooperative Credit Organizations(SACCOs) were to be considered as organizations.Not surprisingly, the research found that the NGOsand CBOs tended to be located in areas with highpopulation density and good market access, whilegovernment programs were more widely distributed.

The implications of improving access to financialservices are likewise debatable. The PMA makes thelogical argument that farmers need credit to managethe seasonality of their cash flows, to make

Figure 2.5. Structure of Commercial Bank Income, 1997-2002

Source: BOU, Bank Supervision

10 Mpuga, P., “Credit Demand and Small Scale IndustrialDevelopment in Uganda”, Paper presented at 1st IndustrialisationWorkshop, 12th -13th August, Centre for Basic Research,Kampala, Uganda, 2003.

11 Ephraim Nkonya, John Pender, Pamela Jagger, DickSserunkuuma, Crammer Kaizzi, and Henry Ssali, “Strategies forSustainable Rural Development in Uganda,” Research ReportManuscript, International Food Policy Research Institute,Washington, DC, November 2003.12 Pamela Jagger and John Pender, “Impacts of Programs andOrganizations on the Adoption of Sustainable Land ManagementTechnologies in Uganda,” EPTD Discussion Paper No. 101,International Food Policy Research Institute, Washington, DC,March 2003.


9

investments, and to cope with the vulnerabilities offarm production. Therefore, the establishment of aviable and sustainable rural financial system is con-sidered to be one of the key interventions for thesustainable development of the agricultural sector(PMA, pp. 62-63). The measured impact of accessto credit on production and productivity is ambigu-ous, however, as demonstrated by results from the1999/2000 national household survey. The surveyfound that only 15 percent of the loans received byfarmers in 1999 were used to purchase inputs, 7percent were used for investments in land and live-stock, and the largest share was used to establishnon-agricultural enterprises, and for health and edu-cation expenditures.13 These results suggest that theissue of profitability of investments must be evalu-ated relative to a farm-household’s total financialdemands. It will be argued in Chapter 3 that the de-mand for farm investment finance per se would comefrom just a portion of the farming community that isable to manage relatively larger and more complexenterprises.

The fragmentary data quoted above suggests thatevidence concerning access to finance in rural ar-eas varies with the definition of type of financial ser-vice, specific geographic location, and source of in-formation. As in most countries, it is logical to expectthat access to the formal financial system will berestricted to larger rural towns and cities, while themost distant and remote farming communities will beserved mostly by informal sources and occasionallyby NGOs. In addition, MFIs are also contributing tothe expansion of financial services into the ruralhinterland.

Notwithstanding the widespread perception of creditconstraints, many types of formal and informal finan-cial arrangements exist in rural areas. The system ofsuppliers of these services can be viewed as a trianglewith a small number of formal financial institutions atthe top, many MFIs serving the middle segment ofthe market, and numerous informal groups,moneylenders, and other informal arrangementsserving the majority of the poor in rural areas.

The top segment corresponds to Tier 1 and 2 full-service regulated and supervised banks and creditinstitutions.14 The MFIs can be divided into a fewTier 3 regulated microfinance deposit-taking institu-tions (MDIs) expected to be licensed under the newlegislation15, and a large number of Tier 4 unregu-lated NGO – MFIs, SACCOs, CBOs, and other infor-

mal sources that do not qualify as Tiers 1, 2 or 3.This finance triangle corresponds to a triangle repre-senting farm sizes that consists of a few large farm-ers and agribusinesses at the top and millions of sub-sistence farmers at the bottom.

Table 2.2 presents a stylized description of thesources of financial services and the respective seg-ment of the market that each serves. It is an attemptto piece together fragmented information obtained frominterviews and documents. It is impossible to quantifythe total volume of transactions involved and it ispossible that the number of firms and householdsthat potentially have access to financial services ishigher than those that choose to use them at anyone time, i.e. actually participate in financial trans-actions by taking loans or savings. The table showsthat at the top, formal financial institutions serve largefarms and agribusinesses. Chapter 4 presents adiscussion of each of the major categories of suppliersand the segments of the market they serve.

The supply of financial services is not stagnant orunchanging. Competition is increasing among thefinancial institutions, especially in the greater metro-politan area of Kampala. The pressures of competi-tion, plus the successful experience of marketleaders, have prompted institutions to look “downmarket” for new sources of business and revenue.For example, 20 banks, non-bank financial institu-tions and MFIs now make unsecured salary loans tolow-income workers. Banks are working to improvetheir standard of service to clients. Many now offerthe use of ATM machines. With its acquisition of UCBbranches, Stanbic Bank may be in the best positionto expand services into new retail markets withpotentially important benefits for the agricultural andrural sectors.16.

The competitive pressures between banks and NGO-MFIs have led to two important changes for NGO-MFIs that mirror those in Bolivia and Bangladesh,two countries at the forefront in microfinance. First,in locations where NGOs are heavily concentrated,the market is becoming saturated so they are forcedto search for new market niches. Second, when giventhe opportunity, most customers choose individualrather than group liability loans. This preference isforcing some NGOs to rethink their lending technolo-gies. Competition means that some NGOs will haveto become more receptive to serving agriculture andrural areas if they are to survive. Yet the current loan

13 Klaus Deininger and John Okidi, “Rural Households: Incomes,Productivity, and Nonfarm Enterprises,” in Ritva Reinikka andPaul Collier, (eds.), Uganda’s Recovery: The Role of Farms,Firms, and Government, World Bank, Washington, DC, 2001.14 Tier 1 institutions are commercial banks while Tier 2institutions are credit institutions. Both Tier 1 and 2 institutionsare licensed under the Financial Institutions Statute 1993.

15 Micro Deposit-Taking Institutions Act, 2002.16 A recent report discusses the competition that is emerging inmicrofinance, the challenges it presents for financial serviceproviders, and the benefits that may emerge for customers. SeeGraham A. N. Wright and Paul Rippey, “The CompetitiveEnvironment in Uganda: Implications for Microfinance Institutionsand their Clients,” MicroSave-Africa, Nairobi, September 2003.


10

products of most NGOs are not ideally suited forfarming enterprises. Moreover, it is unclear how manyfarm and non-farm rural clients will be able to paythe high interest rates and fees required to coverthe high operating costs of MFIs in rural areas.Nonetheless, with appropriate product developmentand cost containment, the new MDIs are likely toprovide stiff competition for commercial banks in ruralareas, and may become the leading players in thekey semi-commercial farmer and trader niches ofthe rural market. A key characteristic of SACCOs and other member-

owned financial organizations is that theoretically theyare member controlled and this fact introduces somegovernance issues that are not shared or shared to aless extent, by banks or NGOs.17 Partly due toshortcomings in governance, most are assumed tobe weak and poorly managed. Even among thestronger SACCOs, serious problems are to beencountered as reported in Annex 2. This situationis unfortunate because many of these organizationsare located outside of Kampala, some in remote lo-cations, and are the only type of financial institutionthat can serve sparsely populated areas where it isuneconomic for banks and the future MDIs to locatebranches.

Unlike the banks, member-owned financial institutionslack a strong support system to nurture, regulate andsupervise the sector. The Uganda Cooperative Alliance(UCA) Ltd., the Uganda Co-operative Savings andCredit Union (UCSCU) Ltd., and AMFIU (Associationof Microfinance Institutions of Uganda) all providesupport to the sector, although AMFIU has only a fewSACCO members. However, all three are too weakand lack the mandate and resources to be significantsources of strength, let alone be the agents oftransformation necessary to achieve the goal ofeffectively providing financial services to smallsubsistence farmers and the rural poor. Moreover, inthe case of AMFIU, a conflict of interest would emergewhere it to nurture and regulate its membersconcurrently.

There are many other unregulated informal financialinstitutions and arrangements that apparently providea huge volume of financial services for participatinghouseholds. The more geographically isolated thelocation, the more likely it will be that these sourcesoffer the only financial services available. This categoryincludes processing firms, traders and nucleusestates that make in-kind loans to farmers andothers in the production/marketing chain. A numberof informal group financial arrangements seem tohave emerged mostly in the past ten years. Thereare Rotating Savings and Credit Associations

Table 2.2: Suppliers of Financial Servicesand their Rural Clientele

17 A governance system can be defined as the interactionsamong shareholders, managers, boards of directors, andoutside auditors, together with laws, regulations, andinstitutions that govern their interaction.


11

Suppliers Financial Services Supplied

Moneylenders ? Any rural or urban firm or householdneeding quickly disbursed,emergency or business loans.

Money keepers ? Hold small amounts of savings forothers.

Family and friends ? Loans for emergencies and start-upof business activities.

CommercialBanks

NGO - MFIs

? Small loans and savings services forfarmers, rural traders, and non-farmfirms and households in rural townsand villages.

? Participation in pooling financial re-sources for purchasing lumpy assets(e.g. vehicles) or financing group in-vestments.

SACCOs,ROSCAs,CBOs, andother member-ownedfinancialorganizations

Suppliers

? Large loans for commodity processingfirms, trading companies, nucleus es-tates.

? Letters of credit for importers and ex-porters.

? A few loans for individual large farmers,horticultural and flower growers/export-ers.

? Use of warehouse receipts, bondedwarehouses, chattel and real estatemortgages, third party guarantees.

? Leasing of vehicles and equipment.

? Checking, savings and deposit servicesfor firms and households in rural towns.

? Savings services for savings groupsand richer farm households in closeproximity to bank branches.

? Remittance and money transfer services.

? Banking services for MFIs and SACCOs.

? Small group-guaranteed and individualloans largely granted to small-scaletraders in urban and peri-urban areas.

? Probably some lending for garden plotsin peri-urban areas.

? Compulsory savings for borrowers.

? Experimental insurance linked to loansand remittance services.

? Some financial services linked withother developmental activitiespromoted by NGOs.

? In-kind loans and suppliers’ credits forbuyers, sellers and farmersthroughout the production/marketingchain.

Processingcompanies,traders, inputsuppliers,nuclear estates

Financial Services Supplied

(ROSCAs) that are completely self-organized andautonomous that intermediate funds among theirmembers. All members get loans during one full rota-tion. Accumulating Savings and Credit Associations(ASCAs) have also emerged that operate like savingsclubs in which not everyone borrows and interest isexplicitly paid to savers. Many moneylenders makeshort-term, quickly disbursed, usually high interest,emergency or business loans. Loans are also madeamong family members and friends at zero or lowinterest rates for emergencies and business start-ups.Businessmen and elderly relatives act as money-keepers by holding money for people who do not feelsecure or disciplined enough to keep it themselves.

Finally, the Entandikwa Credit Scheme best repre-sents the issue of failed government supported creditdriven agricultural and rural finance schemes. Thisscheme was introduced in 1995 and sought to tar-get that section of the population that could not ob-tain credit through traditional commercial lending.The Scheme was to benefit individuals and/or groupsof the rural and urban poor, artisans, women, thedisabled and the youth. Extension officers were sup-posed to offer routine technical services to the ben-eficiaries regarding the development and manage-ment of their micro-enterprises, and to monitor theutilization of the loan funds and advise on loan re-payment. Although neither formal documentation norevaluations are available, it is widely recognized thatthe scheme was a failure. In fact, the scheme wassubject to massive rent seeking behavior as localelites received the lion’s share of funds disbursed.In addition, the scheme’s inauguration coincided withthe 1996 presidential elections something that sentwrong signals to beneficiaries that loans under thescheme were essentially political grants. Conse-quently only about 40 percent of the loans were everrecovered and the ‘revolving funds’ nature of thescheme was seriously compromised.

2.4 Using Land as Loan Collateral

An especially difficult problem in Uganda relates toland titling, registration, transfer, security of tenure,and operations of the land market. This problemexists in urban and peri-urban areas but is espe-cially serious for agriculture because land is com-monly used everywhere as collateral for agriculturallending. This requires record keeping and legal sys-tems to identify the boundaries of properties, regis-ter the interests of claimants in a property (such aswho holds a mortgage on it), and facilitate the sei-zure and liquidation of land pledged as collateral forloans. Although community or traditionally ownedland can provide a degree of security of tenure so itwill be used efficiently in the short term for farming,two problems can emerge in the long term.18 First,

the users of such land may be discouraged frommaking investments in it because they may not havelong-term use in order to enjoy the benefits fromsuch investments. Second, lenders may refuse toaccept it as collateral given fears that they would beunable to foreclose in the event of default. Thus,where lenders accept land as collateral, they havetended to demand a high ratio of land value relativeto the loan to be advanced.

Annex 3 of this report contains a summary of keylegal provisions concerning land in Uganda. Althoughthe Land Act of 1998 is forward looking in the senseof recognizing the interests of both occupants andowners in land, the mechanisms that preserve andtransfer these rights in the newly decentralized ad-ministrative system call into question the ability ofpeople to effectively use their interests (in reality aform of equity) as collateral for loans. A completeanalysis of this issue is beyond the scope of thisstudy. However, as discussed in Annex 3, the poten-tial problems seem serious from the perspective offinancial contracts, and are especially serious out-side of Buganda. They will likely prevent the full useof land as loan collateral for the foreseeable future.

If so, this is a critical problem that will constrain theability of the formal financial system to make long-term loans for land acquisition and improvementssince formal institutions normally rely on mortgagedland as collateral for these types of loans. This couldlead MFIs and other financial institutions to look forcollateral substitutes, and to secure their loansthrough multiple sources of collateral; a situation thatshould crowd out a number of potential borrowerswith few alternative assets to present as collateral.Resolving the land issue is going to require a long-term and expensive commitment, but is necessaryif land is to act as collateral and underpin the avail-ability of sustainable amounts of term finance thatare necessary to fundamentally transform the agri-cultural and rural sectors.

2.5 Conclusions

To summarize, the liberalization of Uganda’s finan-cial sector has been part of the success story of thewhole economy. Much as financial reforms shouldbe applauded for a gradual increase in the deepen-

18 There is evidence of substantial insecurity in tenurearrangements. For example, a 2001 survey of peri-urban andrural households revealed that about a quarter of therespondents had plots involved in conflicts and that about athird have lost land through conflicts since 1994. In addition,productivity was found to be significantly affected on plotsinvolved in conflict. See Klaus Deininger and RaffaellaCastagnini, “Incidence and Impact of Land Conflict in Uganda,”Policy Research Working Paper 3248, World Bank,Washington, DC, March 2004.


12

ing of financial intermediation, it is fair to concludethat financial deepening and development of the sectorleaves much to be desired, particularly in relation tothe flows and costs of credit to the agricultural sector.

Given the depth to which the financial sector had sunkby the mid 1980s, a more rapid rebound was expectedwhen the reforms were implemented. Perhaps thereformers grossly underestimated the possibility thatendogenous constraints, such as imperfect andincomplete credit markets, could be significantbarriers to efficient and improved credit allocation toagriculture. Apart from these imperfections, the policyalso disregarded peculiar structural features ofUganda’s financial system, such as the dominanceof a collusive commercial banking system and non-existent equity markets, and the problems that thesepose for efficient credit market operation. Whilstexperience has shown that imperfect government isnot good at picking viable investments, there is littleto suggest that a banking sector working under aninappropriate financial market structure would do anybetter. This situation has important implications forthe possibility of developing viable rural financialmarkets that will contribute to pro-poor growth and toa dynamic rural economy.

The challenge is not just to create banks that do notlose money because of bad loans, but also to createsound banks that provide credit for growth, and morefinancial services to agriculture, which underpins thisgrowth. In particular, whenever information is im-perfect and markets incomplete, the invisible handof the market works most imperfectly. Significantly,the development of appropriate institutional struc-tures to reduce transaction and information costs,which inhibit financial sector development, have tobe pioneered by active government programs and,in line with this, there is need to reconsider all ele-ments of monetary and banking policies.

The current state of the banking sector and the sup-ply of rural financial services can be characterizedas follows:

? Commercial banks: The commercial banking sec-tor is dominated by a small number of foreign-owned banks, as locally-owned commercial banksaccount for little more than 12 percent of total bankassets. Banks are important in financing majorexport and import operations. They also provideservices to major farm production units (i.e. largefarms and estates), major fishing entities,processors and marketers. With the exception ofthe largest bank, the commercial bank branchesare based in major urban centers, with a heavyconcentration in the Kampala/Jinja/Entebbe area.Their direct relevance to small and dispersedagricultural production and marketing entities is

likely to continue to be very minor in theforeseeable future.

? Two financial institutions, Centenary and DFCUGroup, provide some financial services to farmersas discussed in more detail in Chapter 4. Theyhave been heavily donor-driven and/or geared tolarger operators. Both have demonstrated thatsuccess can be achieved in rural areas, but alsosustainable operations require a stronggovernance system that maintains constantvigilance and assures adherence to sound bankingpractices. They remain potentially important forsome segments of the agricultural sector.

? Uganda has a vibrant microfinance sector, espe-cially in urban and peri-urban areas. This develop-ment has blossomed under the liberalizedeconomic policy environment of recent years.However, the relevance of microfinance for arural clientele remains unclear in the minds ofpolicy-makers who appear more concerned withraising objections to the high interest rates MFIscharge clients than to the issues of financial andoperational self sustainability that underpin goodpractices in microfinance. Thus, where MFIsemploy good practices and charge cost cover-ing interest rates, such rates can prove unsuit-able for the lower rates of return expected formost types of investments in the agriculturalsector.

? The member-owned financial institutions, largelycomprised of SACCOs, are in a very unsatisfac-tory situation for continued, effective operations,let alone for growth, to realize their potential forexpansion in rural areas. The SACCO segment ofthe financial sector has also seen numerous adhoc measure of assistance implemented with littlesuccess. Thus, confusion and ambivalent on thepart of policy-makers and SACCOs apex/supportbodies, as to how to push SACCOs forward isstill pervasive. Despite these problems, theSACCO sector cannot be ignored in futureplanning, since it offers a potential means ofaccess to financial services for many who cannothave access to formal financial institutions.SACCOs come closest to being grass-rootsinstitutions; something that presents them withboth great advantages and disadvantages (seeChapter 4 for more details). An important stepforward in improving the sustainability of farmergroups and member-based SACCOs would be toseparate their financial and non financialoperations.

? Competition is increasing among banks and be-tween banks and MFIs. This is resulting in someexperimentation with new products and attemptsto discover and serve new markets. This is a


13

hopeful sign that should herald more and betterservices for the agricultural and rural sectors.

? No single type of institution can be identified ashaving a clear competitive advantage and therebyhold the key to improved financial services for theagricultural sector. Each type can play a role inthe financial system, while the policy environmentneeds to recognize the need for variedexpectations of the main institutional types, aswell as distinct approaches to supporting policiesand project/program initiatives.

? The problems of land titling, registration, transfer,insecurity of tenure, and the operations of the landmarket pose significant constraints for thedevelopment of the rural financial system,especially for term lending to finance invest-ments in agriculture. The effects of the recentlegislation need to be evaluated and the timemay be ripe to launch a fundamental review ofthe entire land issue.

? The government and donors should work towardsthe development of a long-term strategic plan fordeveloping the rural financial system rather thanimplement isolated reforms and programs. Thecoordination and planning activities thatsuccessfully paved the way for developing themicrofinance sector are a good precedence, butthis effort will need to be more ambitious andwill require the involvement of a broader rangeof stakeholders. The need for a strategic plan isdiscussed in more detail in Chapter 4


14

3.1 Overview

As noted in Chapter 1, the agricultural sector pro-vides a base for the improvement of the livelihoodsof both rural and urban populations. In rural areasthis is achieved through the enhancement of pro-ductivity at the primary, i.e. production, level. In ru-ral towns and urban areas agricultural products con-stitute the base for the creation and expansion ofvalue-adding processing industries for domestic andregional markets, and for packaging/marketing op-erations for both domestic and export markets. Aspart of the Government’s Poverty Eradication Ac-tion Plan, the Plan for the Modernization of Agricul-ture (PMA) includes, among its priorities, areas foraction that have direct relevance to this report. Thefirst is research, through NARO (National Agricul-tural Research Organization). The second is exten-sion, through NAADS (National Agricultural AdvisoryService). Both organizations face stiff challenges.For the vast bulk of Uganda’s farmers, the level ofuse of improved farming technology is very low, with93 percent dependent on the hand hoe for cultiva-tion, less than 30 percent use improved seeds, lessthan 10 percent use any form of plant protection,and the use of chemical fertilizers by subsistencefarmers is negligible (GoU 2000, page 47).

Financial services are essential at all stages in or-der to optimise the rate at which more efficient op-erations and adoption of improved technology cantake place. This section of the report examines thenature of the demand for these services, startingwith the premise that market-oriented financial ser-vices will follow genuine demand from clients. Fi-nancial services and products, especially loans,should not be used as tools to attempt to lead eco-nomic activity, as has been convincingly demon-strated in the disappointments with supply-led andtargeted agricultural credit programs in many coun-tries over the last 30 years. Rather, promising eco-nomic activities should lead to demand for such ser-vices.

In this brief look at the demand for financial ser-vices, a longer-term perspective has been taken.This time horizon is considered appropriate. The vastmajority of farmers operate on a very small scale,which means that the bulk of the population of thecountry currently achieves very low productivity.Realism suggests that increases will come slowly in

this sector. Moreover, the major developments, whichcan be prompted by government and donor action,are generally those that take several years to im-pact positively on the economic well being of ruralpopulations. Examples are initiatives in the fields ofeducation, health, infrastructure improvements andinstitution building.

Naturally, as education and other developments pro-ceed, increasing numbers of rural people will moveaway from total dependence on the land and thelakes for their livelihoods. The resulting migration –permanent, partial (part-time), seasonal – will in turncreate demand for financial services in small townsand other rural centres. Much of this demand will befor services for which the MFI industry is alreadywell equipped to supply in terms of technologies.However, a physical presence in rural centres, andstaff to man these offices/branches, will be needed,together with the necessary internal information sys-tems for supervision and control. Coupled with thiswill be a need for improvements in banking systemsand technologies so that rural branches can be prof-itable.

This report takes the position that the Ugandan agri-cultural sector can only develop soundly if key ac-tors receive signals concerning demand for prod-ucts of the sector, and the likely profitability of meet-ing such demand. Such signals are generated indestination markets (for exported commodities andproducts) and in terminal markets – effectivelyKampala (for other commodities and products). Theprocess requires suitable information transmissionmechanisms (see also Annex 4 Information Man-agement). Meaningful marketing messages can thenbe effectively fed back along the marketing chain tothe primary producer, and to the input suppliers uponwhom he/she depends. In this connection it is inter-esting to note that in his report to Parliament for2002/3, the Minister of Agriculture notes that

Chapter 3The Demand for Financial Services

19 Parliament: The Republic of Uganda. “Report of theSessional Committee on Agriculture, Animal Industry andFisheries (MAAIF) on the Ministerial Budget Policy Statementfor MAAIF for FY 2002/2003,” Kampala. (Section 5, MajorConstraints Facing the Ministry as a Whole).


15

“Uncertainty of market availability foragricultural produce negatively affectedfarmers’ drive to increase production”19.

The case of cotton constitutes a useful example ofinformation transfer. In Uganda the Cotton Devel-opment Organization (CDO) conveys a powerfulmessage to growers, traders and ginners, and to theirfinanciers, regarding the forward market for this com-modity, by the pre-planting publishing of an indica-tive price for seed cotton at the gin. This action hasother benefits, which are covered below in the sec-tion on price buffering.

The availability and efficiency of financial servicesimpact on the agricultural sector through severalphases of economic activity. For convenience theseare differentiated below into the input/output mar-ket, and on-farm production stages. Some aspectsof the likely demand for financial services for theproduction/processing/marketing chain for agricul-tural products and produce, in a longer-term per-spective, are now examined. The discussion is di-vided into: first, the trading component, comprisingthe input and the output markets20, and second, theon-farm production component, i.e. farmers.

3.2 The Demand – Input and Output TradingMarkets

3.2.1 The Issue of Scale

The effectiveness by which the marketing chain canmeet market demands is dependent to some extenton the ability of actors in the chain to purchase quan-tities of commodities in sufficiently large volumes toachieve economies of scale in handling, processingand transport. Moreover, at some stages in the chain,a critical minimum volume is required in order toattract those sellers (in the case of inputs) and buy-ers (in the case of outputs) whose business wouldlead to advantageous sales.

Given this need for scale, it is ironic that perhapsthe biggest single impediment to improving the effi-ciency of both input and output markets is the small-scale nature of transactions, which characterizesdealings in the Ugandan agricultural sector. Thenumbers of traders operating is large, due at least inpart to the lack of adequate road infrastructure, andthe consequent use of the bicycle as a major meansof transport. The bicycle often has a four gallon con-tainer (formerly for kerosene, the “debe”) strappedon to the bicycle carrier. The debe acts both as ameasure and as a transport container, hence onename for the small-scale traders, “debe boys”. Thenext step up the ladder from the bicycle-user is apetty trader who can transport a greater volume

through the use of a “boda”. This is a light, usually50cc, motorcycle, which represents a significant in-crease in investment and running costs over a stan-dard pedal bicycle.

Table 3.1 sets out some estimates for the numbersof farmers and traders involved in various enterprisetypes. It illustrates the size of the potential pool ofclients from among whom demand will be gener-ated for financial services, as some actors increasetheir scale of operations. Anecdotal evidence sug-gests that the current net incomes of the majority oftraders operating in rural areas are within the rangeUshs1,000 (US$0.50) to Ushs3,000 (US$1.50) perday. This income level is comparable with the dailypay of laborers in construction in Kampala, whichtypically ranges from Ushs3,000 to Ushs4,000.

Given these low levels of remuneration from trade,coupled with the uncertainty of trade-related income;there is only a weak incentive for operatives to re-main in the activity as and when other opportunitiesarise. Thus the numbers of debe boys and other pettytraders will diminish over time, allowing the moreefficient (or better funded) operators to expand. Asecond consequence of the low remuneration earnedfrom trading is that any borrowing by petty tradersfor their business activities, initially, at least, wouldperforce be on a very small scale. One notes thatthis implies high costs for lenders, and consequentlyhigh interest rates.

20 For many crops, e.g. coffee, tea, cotton, vanilla, as well asfor fish, there is a strong element of processing undertakenwithin the marketing chain.

Table 3.1: Numbers of Farmers and Tradersby Commodity *


16

Commodity Typicalnumber of

tradingsteps, ortransac-

tions (smallscale

producers)

Estimatednumber ofproducers

Numberof

exporters

Numberof in-

countrytraders

CoffeeRobusta/Arabica

Up to 5 500,00010% oftheseArabica

22 400processors400“merchants”4000localtraders100,000bicycletraders(debeboys)

Cotton 3 or 4 500,000 1 major(UGT)

6-7,000“buyers”,1,200agents

Maize,Sorghum,Beans

3 or 5 2,500,000 56ginneries

1,500ruralbuyers

Matoke 3 or 4 > 2 m NA ** > 500,000

Fertilizer affords a good example of current scaledifficulties in the inputs market. Annual consump-tion is just less than 20,000 tonnes, and large orhighly intensive farming enterprises such as tea es-tates and flower farms directly import a third of thisamount. The rest of the farming community has anextremely low rate of use of chemical fertilizer, asshown in Table 3.2. One notes that some growth inusage has been registered over the last two decades,albeit from a very low base.

ters. A quick comparison of the landed cost in someselected cities of Uganda, Kenya and the UnitedStates is given in Table 3.3 below. The results showthe very much higher cost faced by Ugandan farm-ers.

Notes:*A variety of sources have been used in constructing this table.Most numbers are broad estimates and the table must beregarded as incomplete.** Not applicable, though there is undoubtedly some minor bordertrade with immediate neighbors, especially to the south and west.

Table 3.2: Comparative Fertilizer Use inUganda and in NeighbouringCountries (Kg fertilizer per culti-vated ha per annum)

Source: Compiled from FAO/AgriStat. data

Efforts to increase fertilizer use, which recent IFPRIstudies have shown to be essential for some of themore intensively farmed parts of the country, musttackle the vicious circle of low demand/inefficientinputs markets/high prices. The cost of inputs isclearly a factor in Uganda’s low rate of utilization,and this is particularly marked in the case of a highweight-to-value commodity like fertilizer, where thehigh transport costs experienced in the country im-pact heavily on the cost in the main and rural cen-

Table 3.3: Cost of Delivered Fertilizer

Source: Omano, Stephen “Fertilizer Trade and Marketing inUganda” International Food Policy Research Institute, Kampala,Uganda, 2000.

Scale as an issue is also indicated by the currentpractice in Uganda of using the 50 kg. bag as theunit of sale at the wholesale level. Retailers com-monly break down these units into 5kg. and eveninto 1kg. bags. There are few markets in the worldin which the demand is focused on such small units.

Efficient trading also needs equipment, storage fa-cilities and transport appropriate for larger volumes.These requirements for input traders, such as thosedealing in fertilizer, are mirrored in output markets.Indeed, the same traders often serve the two mar-kets. Table 3.4 below summarizes the possible ef-fective demand for financial services that is under-stood to exist in the trading community, which dealsdirectly with the agricultural sector. Product-by-prod-uct notes follow the table.

Notes:*”Effective demand” means that the user of the service can haveproductive and profitable use for it, and would be expected to be ina position to meet obligations accordingly. The time periodenvisaged is still 20 years, but the judgements on which this tableare based are largely subjective


17

Commodity Typicalnumber of

tradingsteps, ortransac-

tions(smallscale

producers)

Estimatednumber ofproducers

Numberof

exporters

Numberof in-

countrytraders

Vanilla 3 40,000 18 (15registered)

70traders,unknownnumbersof pettytraders

Fish 3 250,000 11packingplants

750,000processors/ retailers,unknownno. ofcollectors,unknownno. of icesellers

Country/Region 1980 - 1989 1990-1995 1996 - 2000

Uganda 0.07 0.19 0.41Kenya 21.39 23.24 31.58Tanzania 8.42 9.02 6.13Africa (South of Sahara) 7.54 8.14 7.92

Delivered (CIF) to: Cost of DAP per ton, US$

Kampala, Uganda 325Nairobi, Kenya 265Tampa, USA 165

Table 3.4: Traders’ Demands for FinancialServices

TraderGroup

Moneytrans-

fer

De-posits

Shorttermloans

Ware-house

Re-ceipts

PriceBuffer-

ingArrange-ments

Termloans

Financial Services -Possible Effective Demand

Rural Traders-debe boys

Yes Yes Some No NoSome

Rural Traders- agents

Yes Yes Yes Some SomeYes

Transporters Yes Yes Yes Some NoYes

Terminalmarketoperators /inputwholesalers

Yes Yes Yes Yes YesYes

Exporter/Importers

Yes Yes Yes Yes YesYes

3.2.2 Money Transfer & Deposits

The demand for these financial services by tradersat all levels will grow as scale increases. The chal-lenge, which is addressed in the supply section ofthis report, is to manage the problem of cost in serv-ing large numbers of small traders, who currentlymainly work on a cash basis and far from any bankor MFI branches.

3.2.3 Seasonal Loans

Addressing the issue of scale of transactions for bothinputs and outputs is first and foremost an issue ofthe availability of working capital, both on-farm (forthe inputs market) and in the trading sector (for bothinputs and outputs markets). Handling larger volumesof commodities requires working capital, the demandfor which will be determined in large part by devel-opments in the road infrastructure, by the introduc-tion and acceptance of grading standards, by thewider availability and use of market information andgenerally by the growing commercialisation of farm-ers themselves. Most traders (in terms of numbers)are used to working purely on a cash basis, or withtrade credit. Access to institutional borrowing wouldenhance the ability of the more efficient traders toexpand their scale of operations through giving themaccess to larger volumes of working capital.

3.2.4 Term Loans

Since trading operations invariably involve storage,and sometimes also processing such as drying,washing, re-packaging etc., significant investmentsneed to be made in buildings and equipment for anyscale of operation other than the most basic. Someterm lending in the sector, for items such as oil-press-ing machinery, and cotton gins, is already being un-dertaken. There is understood to be scope for moreinvestments in plant and equipment, especially inorder to meet market demand for higher quality orvalue-added produce.

Robusta coffee provides a good example in this re-gard. Currently the destination market prices for stan-dard Robusta coffee are at a 30-year low, with nolikelihood of a significant improvement in the nearfuture. The Uganda Coffee Development Authority(UCDA) has identified a market opportunity for higherquality Robusta, which results from careful gradingcombined with wet processing. The higher qualityproduct can be expected to fetch a significantlyhigher price. The industry (through the UCDA) claimsthat it needs to increase the number of wet-process-ing plants from the current 16 to a total of 800 if it isto fully exploit the market opportunities wet pro-cessed robusta coffee present. However, each wet

processing plant costs US$50,000. The potential newinvestment required is then close to US$40m. Thisexample indicates the type and scale of potentialdemand for term finance in Uganda’s agriculturalsector, even when one considers just one (albeitmajor) crop. In addition, the assumption is that pricesin destination markets will be such that investmentsof this type continue to yield positive return.

3.2.5 Warehouse Receipts

Only the largest traders currently receive bank ad-vances secured by warehouse receipts. There isscope to improve the efficiency and lower the costof managing stored products as collateral, so as toenable more traders to take advantage of the mecha-nism and the improved borrowing terms that thismode of collateral provides. These improved termscommonly mean a saving in interest charges of somethree percent over loans secured with conventionalcollateral.21 This differential is due to the greater easewith which such receipts can act as collateral. Againstthis saving there is the cost of collateral manage-ment, which is typically US$2,000-US$3,000 perwarehouse per season. Clearly the greater the vol-ume being secured, the lower will be the unit cost ofusing warehouse receipts as collateral.

Currently nearly half of all cotton and coffee is se-cured at some stage before leaving Uganda, bywarehouse receipts. Under such arrangements ex-porters obtain funding that is secured by warehousereceipts from commercial banks with a quality con-trol firm acting as collateral manager. At the level ofcharges quoted in the previous paragraph, the ser-vices of the collateral manager would be too expen-sive for all but larger warehoused volumes. Theremay also be an opportunity here for competition inthe provision of warehouse management, competi-tion that could result in lowered costs of collateralmanagement.

Affordable warehouse receipt arrangements needstandardized and readily implemented grading sys-tems, so that commodities (notably grain) can bebulk handled, and ownership determined merely byweight and grade, rather than by organizing individu-ally identified lots. Attention is needed to improvegrading systems for many commodities. A start isbeing made with maize, with the introduction from2004 of two grades, top grade (the only grade cur-rently traded by major firms in the terminal market)and a lower grade for animal feed. Provided that thegrading “message” is conveyed to farmers, and thereis every reason to believe that this will happen, thenew grading system will result in lower reject vol-

21 Private communication from a major commercial bank inKampala.


18

umes in the terminal market (Kampala) and overall abetter appreciation by farmers of the importance ofproducing a quality product in order to realise a betterprice. It should also help expand the scope for theuse of warehouse receipts.

It is understood that consideration is currently beinggiven to improving the legislative framework forwarehouse receipt operations, on the grounds thatthese involve three parties in a business relation-ship (i.e., the owner of the commodity, the financierand the collateral manager). Existing contract law isdrafted with the more normal two party contracts inmind. It is understood that there is indeed a strongcase for new legislation, given the expanded rolethat warehouse receipts can play in facilitating fi-nancing of trade in agricultural products. The cur-rent stalled position of the legislative proposals needsto be addressed.

3.2.6 Price Buffering/Marketing Measures

Apart from conventional loans, there is clearly ademand at this stage of Uganda’s agricultural de-velopment for measures to bring an element of sta-bility to farm gate prices. This demand is expectedto grow as more producers become more depen-dent on income from crop sales. The difficulties ofbuffering prices are considerable. Indeed, this maybe an area in which the GoU and its partners coulddo further work in order to design specific measures,which could eventually include strategic governmentinterventions. This report sets out some approachesthat might be considered.

The first of these is not a financial product, but ratherimproved price forecasting. Moreover, an examplealready operates in Uganda. Although not con-structed as such, the Cotton DevelopmentOrganization’s indicative price mechanism has someof the effect of a price-buffering instrument. The at-the-gin seed cotton indicative price is based on fu-tures prices in overseas markets for trades forLiverpool A grade lint. This indicative price is care-fully and conservatively determined. It effectivelyacts as a psychological (though not actual) floor pricefor the commodity. As a reliable indicator22 of priceexpectations, it provides an element of price cer-tainty to growers, traders, ginners and their finan-ciers. It is suggested here that there is a need tobring some of the benefits of this element of marketcertainty into the production and trading actions forother major crops in Uganda. While not directly re-ducing downside price risks, the indicative price doestend to set a benchmark, at least for cotton, where

the challenges of accurate forecasting are apparentlybeing met with some success.

If a similar system would work in the maize market,then it would make a positive impact throughout theproduction/marketing chain. Those benefiting wouldinclude not only traders and farmers, but also thesuppliers of financial services. It is further suggestedthat the feasibility of designing and implementingan indicative price for maize should be a subject offurther investigation. Information used in determin-ing the pre-planting maize price forecast would in-clude:

? Likely purchases of the forthcoming crop by theWorld Food Program (WFP) and the InternationalCommittee of the Red Cross (ICRC);

? Stocks and forecasts of production compared withmarket demand in neighboring countries,especially Kenya; and

? The growth of the intensive livestock industry inUganda (which is likely to continue to grow sub-stantially, a trend which the introduction of acheap livestock-feed grade for maize may wellencourage).

The key opportunity for Uganda in this area is thatthe bi-modal rainfall pattern permits two maize cropsper year, as opposed to a single crop in most of themaize producing areas of southern Africa. Thismakes the forecasting horizon shorter. If a shortfallis projected in countries such as Zambia, Zimba-bwe or South Africa, Ugandan producers have timeto respond by increasing the area planted for thenext crop.

The second suggestion is also a marketing mecha-nism. Already mentioned is the fact that significantpurchases of Ugandan maize are made by interna-tional relief agencies, notably by the WFP and theICRC. Currently the destinations for this grain areunderstood to include: Congo, Ethiopia, Eritrea,Southern Sudan and Northern Uganda. Given thatfood shortages in these areas are likely to continuefor the foreseeable future, forward purchasing con-tracts are an option which may convey benefits bothfor Kampala-based traders (giving security of returnfrom sales of a future crop) and for the relief agency(providing security of supply – a policy which at leastone of these agencies has already started to imple-ment).

For the Ugandan farmer and rural trader, a greaterdegree of forward purchasing by these agencieswould have a price stabilizing effect down the chain.Since two crops per year are possible in Uganda,such forward selling/purchasing is more feasible thanin other markets, as the time and demand-forecast-ing horizon is shortened for both buyers and sellers.

22 For the last two seasons it has proved conservativelyreliable (personal communication from the CDO); earlierexperience is unknown.


19

It is suggested that the feasibility of this mechanismbe further explored, together with identification ofany necessary actions by the financial sector in or-der to both accommodate this type of arrangementsand, more importantly, take advantage of the im-proved price security in the maize chain (such asthrough bank-issued letters of credit, bonded ware-house receipts, and other types of guarantee).

The third mechanism relates to the purchase of putoptions, which convey a right (but not an obligation– it is an option, not a forward contract) to sell aspecified quantity of a commodity, at a certain price,to a pre-identified buyer. Such an arrangement ismade prior to or during the growing season. This iscurrently the subject of some attention internation-ally by a multi-agency group led by the World Bank.The mechanism has some attractions, but it is feltby the mission and by many other observers thatgiven the present depressed state of the world cof-fee market, it would be inappropriate at this time torecommend adoption of this mechanism for achiev-ing an element of price stability for coffee

The fourth possibility is to exploit the high potentialfor the contract growing of crops such as maize, and/or similar supply-based contracts by traders of maizegrain. One current constraint to contract arrange-ments in rural areas is weakness in the ability ofdistrict courts to handle any subsequent contractualdisputes, though the Kampala Commercial Court iswell placed to handle larger cases. This weaknessin the districts clearly needs to be addressed.

Apart from this, there are other strategic interven-tions by the government, which would facilitate con-tracting of this type. These could include, firstly, sup-port for the more widespread use of grading stan-dards. Secondly, work could be carried out on thedesign of financial instruments to assist maize chainactors to obtain finance, possibly using linkages toprice projections derived from improved price fore-casting. One such instrument could take the form ofa guarantee to cover loans (to producers and mar-keters) in the event of a price slump to a level belowthat agreed for any forward contracts. A guaranteewould be useful in maintaining the financial sound-ness of the commercial entities involved, becausewhen the spot market price falls below an agreedindicative price, the value of the warehoused grainheld in the terminal market would be less than whatUGT (or other terminal market traders) would haveto pay their contracted suppliers (big maize grow-ers, and traders handling the grain from smaller pro-ducers).

The mission recognizes that there are importantdesign issues in this difficult area of work. It is equallyrecognized that interventions of this type give theimpression of running counter to free-market poli-

cies, and would therefore need to be presented in sucha manner as to demonstrate their commercial worth.For both of these reasons a detailed investigation isneeded.

Such an investigation, say for maize, would exam-ine the likely production response from varying farm-gate price levels, the extent to which forward con-tracting could be enhanced in the Ugandan and re-gional context, and the financial implications of in-troducing a guarantee arrangement, together withthe options for meeting the costs involved. This ex-ercise is beyond the scope of the present study, butthe mission strongly recommends that it be care-fully undertaken before decision makers can be ex-pected to give any consideration to interventions ofthis type.

3.3 The Demand – Production Stage (Farm-ers)

The benefits of improved efficiency in the inputs andoutputs markets can be expected to feed down tothe farmer. Some of the required information ondemand for products, and prices in various marketsis currently available through the GoU/Foodnet Mar-ket Information Service, which recently started op-erations and is expanding its area of outreach acrossthe country. The National Agricultural Advisory Ser-vice (NAADS) also conveys market demand infor-mation, along with technical, production advice tofarmers. Other channels for transmitting demandinformation to farmers are the buyers of agriculturalproducts and produce (see also Annex 4 Informa-tion Management). It is a matter of mutual interestthat farmers and buyers have their sights set on themost profitable products, and on the most favorablepresentation and timing of their entry into the mar-keting chain, in order to optimize their gains frommarket interactions.

The productivity of capital in farming is of funda-mental importance to farmers and to their financiers.Whereas farmers can be expected to act rationallyin investing in their operations when using their ownfunds, a history of easy credit may have blurred thefocus of many to the key issues of the productivityand profitability of loan-financed use of purchasedinputs and other farming investments. This has im-portant policy and operational implications for finan-cial institutions making farming loans (see below).

In terms of empirically determined returns to invest-ment in farming, little information was available tothe mission. Nonetheless, the results of one studyundertaken on behalf of the Bank of Uganda shownin Table 3.5 shed some light on the issue. The ‘ben-efit ratios’ quoted in the table must be regarded astentative, and are in any case highly sensitive to thecrop prices obtained on sale. Perhaps the most ac-


20

curate position on the returns to farming investmentis that they can be substantial, but that they are sub-ject to wide swings, and include seasons in whichlosses are made. The reality is that in contrast tonon-agricultural investments, farm production facesa different and usually more potent set of risks anduncertainties – the weather, commodity price fluc-tuations (often determined in far-off export markets),input supply difficulties, transport problems, poorroads, and praedial larceny (this was experiencedin 2003 by some vanilla growers in Uganda, whoreportedly lost substantial volumes of mature ornearly mature vanilla pods to thieves).

The agricultural sector is not homogenous, and the

** If agricultural insurance were to be available, then there wouldbe some effective demand from very large, heavily indebtedfarmers, for this service. This applies especially to mortality coverfor livestock. Crop insurance is not likely to be available in Ugandawithin the long term horizon covered in this report, with thepossible exception of specifically designed and brokered coversfor intensive, high value crops, e.g. roses.

Table 3.5: Some Indicative Returns to Invest-ment in Crops

Source: Bank of Uganda

recognized three tiers of farmers outlined in the PMAprovide a useful basis for suggesting differentialapproaches by providers of financial services. Thesedifferences will form the basis for policies that aresuggested below for the various groups. Firstly asummary is given in Table 3.6 of the likely effectivedemand for financial services, again using a longterm time horizon.

Table 3.6: Farmers’ Demands for FinancialServices

Notes:* “Effective demand” means that the user of the service can haveproductive and profitable use for it, and would be expected to be ina position to meet obligations accordingly.

3.3.1 Commercial Farmers

There are an estimated 60,000 farmers and fisher-men operating on a commercial scale in this group.Many if not most commercial farmers and fisher-men will doubtless already enjoy access to moneytransfer, deposit services and short-term loans.Some of these short-term advances will be fromcommercial banks; others will be from MFIs (espe-cially for those commercial farmers who are urbanor per-urban), while some financial services are ob-tained by farmers or fishermen as outgrowers orsuppliers to a processing plant, e.g. a cotton gin, atobacco curer, a sugar processing factory or a fishpacking plant. For cotton, input supplies are com-monly provided, in kind, through ginneries. Thereare reportedly 56 ginneries in the country, and onaverage each processes cotton from some 10,000growers. Input costs are deducted from paymentsfor seed cotton delivered. Cotton seed is handledby the Cotton Development Organization (CDO),which also imposes upon gins a levy of two percenton the ex-ginnery value of cotton lint. This levy cov-ers the cost of the operations of the CDO, includingthe cost of processing and delivering seed at no fur-ther charge to farmers.

Tobacco is in a similar situation in that the mainbuyer, British American Tobacco, provides some in-puts to growers under similar arrangements to thoseoperated by some cotton gins. Sugar is another cropthat lends itself to closed marketing arrangements –due to the high weight-to-value characteristics ofharvested cane, and the need for processing to takeplace quickly after harvest. These inter-linked trans-actions carry advantages and disadvantages forfarmers and processors. For the farmer/growersthere is one big advantage. They are assured of asupply of the inputs in situations where input mar-kets are unreliable because business volumes arelow and demand uncertain. The processors alsobenefit as they are assured of a steady supply offarm output. Both parties also benefit from lowertransaction costs.

On the other hand, there are disadvantages to inter-linked transactions of the type mentioned above.Although many of these arrangements include ad-vances for production expenses, the involvementof a local MFI or other financial intermediary wouldprovide a better all-round service to outgrowers/es-tate farmers, giving them also a degree of indepen-


21

Crop Input costsUshs/ha

Coffee, improved 4.38

Benefitratio

310,000Coffee, clonal 2.98409,000

Tea, outgrowers 1.32193,000Maize, using improved seeds 3.5557,000Beans 1.1242,500

EconomicGroup

Moneytransfer

Depos-its

Sea-sonalloans

Insur-ance

Life/Agric.

Termloans

Financial Services -Possible Effective Demand *

Subsistancevillagers

Yes Yes No NoNo

Subsistancefarmers

Yes Yes Some LifeNo

Semi-commer-cial farmers

Yes Yes Yes LifeSome

Commercialfarmers

Yes Yes Life **YesYes

dence from the estate system. This independencecould be useful in negotiating better business ar-rangements with the estate/buyer/processor. Thereis some anecdotal evidence in Uganda of exploita-tion of farmers in nucleus estate situations23.

Therefore independence in selecting partners for fi-nancial intermediation should be regarded as politi-cally and socially desirable. For processors, there isa risk that farmers indebted to them will engage inextra-contractual marketing (‘side selling’) in orderto evade repayment obligations; so these systemstend to work best when there is the reality of mutualbenefit in developing a close working business rela-tionship, and where fairness in dealing prevails. Thisrequires good information flows and constant vigi-lance.

Much less common than access to seasonal finance,for the bulk of commercial farmers, is successfulexperience in obtaining term finance. To date themajor agricultural term finance users have beenthose benefiting from the EIB line of credit throughparticipating banks. These borrowers are generallylarge enterprises, and the loans, which in any caseare very limited in number, have, in the main, beenfor processing equipment and similar purposes. Yetit is term finance that will be needed on commercialas well as on semi-commercial farms, in order topermit the expansion of cropped areas and/or largerlivestock units. Much scope exists for developmentwork on financing methodologies for such invest-ments – including expansion of current leasing ar-rangements.

Encouragement for many types of term investmentin farming would be given by greater certainty ofland tenure. This applies particularly to various landimprovement investments, such as fencing, watersupplies, irrigation, and forestry. (See Annex 3 for adetailed discussion of land tenure issues that influ-ence the demand for investments and access to fi-nance.)

In effecting arrangements for term borrowing andinvestments, linkages between life insurance andterm loans will be desirable in many instances sincethe productivity of the investment may dependgreatly on one key individual (usually the familyhead). Health cover will also be in demand if premi-ums and benefits can be made sufficiently attrac-tive. Insurance on farm assets such as farm build-ings is already available in Uganda, and demandfor this is expected to grow. Mortality cover for high

value livestock while no longer available in Ugandamay well be offered again. Certainly there would bea demand for insurance for livestock enterprises,especially if such cover were to be made a condi-tion of bank loans. Less likely over the foreseeableplanning horizon is effective demand and indeedsupply of crop insurance, though for highly inten-sive enterprises, such as flower production, somecover may be possible. (See Annex 5, Insurance asa Financial Service.)

3.3.2 Semi-Commercial Farmers

Because by definition semi-commercial farmershave progressed in the scale of their operations anduse of technology, most in this category will havealready demonstrated an ability to manage improvedtechnology and/or larger enterprises. To this extentthey are similar to farmers in the commercial farm-ing category. It is also likely that many will be part-time farmers, perhaps working in rural towns, oroperating small businesses, including trading in ag-ricultural products and inputs. Many in this groupwould be candidates for client status with a localbank or MFI. This would also apply to those who arein outgrower situations with nucleus estates or otherprocessors/buyers.

As with commercial farmers, as expansion of acre-age becomes possible either because more landbecomes available or management ability improves,investments in machinery/equipment and/or perma-nent improvements such as fencing, water supply,irrigation, storage become viable and lead to a de-mand for funding. Also as with commercial farmers,over the foreseeable time horizon there will be agrowing market for life insurance (and in some in-stances health insurance) for this group. MFIs thatlend significant sums as term loans may developloan products that include a link to an insurancepolicy on the life of the borrower.

3.3.3 Subsistence Group: Villagers and Farm-ers

In Table 3.6 a distinction is made between ‘subsis-tence villagers’ and ‘subsistence farmers’. This dif-ferentiation is important for financiers as well as forgovernment policy makers. It is based on the ob-servation that in rural areas there are persons, andindeed families, who do not actively strive to pro-duce a saleable surplus from their farming activi-ties. Indeed, they are the true subsistence cultiva-tors, with their farming activities being in the natureof home gardening rather than a commercial activ-ity. Therefore they are labeled as villagers ratherthan farmers.

23 Eaton, Charles and Andrew Shepherd, Contract Farming:Partnerships for Growth, FAO, Rome 2001 (p. 14) list thefollowing as among the disadvantages for farmers of inter-linkedtransactions, “manipulation of quotas and quality specifications;corruption; domination; indebtedness and over-reliance onadvances”.


22

If policy makers base policy formulation and supportinitiatives on the assumption that villagers areautomatically susceptible to the same incentives forproduction as farmers, then this carries the risk ofdiversion of human and financial resources frommore productive and promising sections of the ruralpopulation. This has important implications for ini-tiatives such as the Outreach Plan, if financial insti-tutions supported by the Plan eventually make loansto the rural poor. Since villagers have no intentionof farming for profit, any external funding of theirproduction decisions runs a considerable risk of fail-ure. This is because this group lacks an orientationto farming as a commercial activity. Altering villag-ers’ attitudes towards commercial farming cannotsimply be achieved by making farming loans, or evengrants, suddenly available to them. This situationwould apply no matter the sources of funding, e.g.MFIs and/or other financial intermediaries.

Nevertheless, a large number of villagers have aneffective demand for savings deposit and moneytransfer services. Financial intermediaries might beable to offer these services on a cost-covering ba-sis, as an important part of their product range atthe grassroots level. At present it is estimated thatless than ten percent of the population in this cat-egory have access to formal savings facilities.24

Given this situation it is hardly surprising that thereis a very poor knowledge interface between the fi-nancial sector and the agricultural/fisheries sectors(see Annex 4 Information Management).

Emergent subsistence farmers, the farmers in thedistinction made above, are a slightly different cat-egory. By contrast with villagers, those in this groupactively try to earn a significant part of their incomefrom farming. They are oriented to meeting marketopportunities, even though most in this category stilluse traditional farming technology. The transitionfrom the use of traditional farming technology to theuse of improved technology involves an increase inmanagement task. This can best be illustrated bythe following simple equation.

menting control measures – optimizing harvest tim-ing in relation to the market, processing/ packagingneeds, etc.

These are demanding requirements and carry im-plications for financiers, since the effect of introduc-ing credit, if indeed it is used for farming, is to in-crease either complexity or size or both. It is impor-tant for lenders to be able to distinguish betweenthose farmers who can use loans effectively fromthose who cannot do so. The most straightforwarddifferentiating technique is to only consider for loansthose who have already proven their ability to man-age improved technology, or new crop/livestock en-terprises, using their own financial resources. Loanscan then be used to supplement savings in order toenable these proven operators to expand the scaleof their operations.

Similar approaches are applicable for fishermen. Thosewanting to upgrade their equipment using credit shouldfirst have shown their ability to manage improvedtechnology and be integrated into a reliable marketingoutlet for their catch, before a lender should considertheir loan applications.

For the whole of the subsistence group, savings,deposit and money transfer facilities are important,both as valued services in their own right, and, inthe case of deposits, as a means whereby the finan-cial intermediary can develop a relationship as thebasis for further business, in particular for meetinggenuine, effective demand for loans.

3.4 Summary of Main Points on Demand

? Uganda has highly favorable natural conditions foragriculture and fisheries. However, production mustbe demand driven in order to realize optimum factorreturns and, therefore, attractive profit levels fromcredit-financed investments.

? Effective transmission of demand signals is vital;fortunately in Uganda the rapidly developingFoodNet market information service performsthis function for many agricultural products. Fi-nancial institutions working with the agriculturalsector (farmers and/or traders) should be awareof and utilize this service, while the GoU anddonors should ensure that it continues as animportant public-good tool in the commercial-ization of agriculture.

? As out-migration from rural areas proceeds, thedemand for term finance and the ability to servicesuch finance should increase. Currently suchfinance is focused on the largest commercialfarmers. Financial institutions need to designsuitable products and procedures in order to profitfrom this business opportunity with smaller farmers24 Estimate made by the mission, based on anecdotal

evidence.

T = f (C,S)Where:T = management riskC = complexityS = size of operations

It is evident that an increase in either C or S willincrease the task of management, which involves:market-led enterprise planning, understanding thetechnology in relation to agro-climatic factors, orga-nizing labor (the farmer’s own, that of his family, andhired help), timing agricultural operations, recogniz-ing pests and diseases and deciding on and imple-


23

and fishermen.

? Use of improved farming technology and/or pro-ducing on a larger scale requires a concomitantincrease in managerial ability. Lenders need todistinguish between farmers who have provedthat they have this ability, and those who do not.This is a particularly important issue for initia-tives such as the Outreach Plan, which are in-tended to benefit the poorest among the ruralpopulation.

? Currently the small volumes bought, sold andtransported characterize the trading sector ser-vicing agriculture. Rationalization of this sectorwill require investment in storage facilities andmeans of transport, and in some cases accessto working and investment capital on the part oftraders in agricultural produce, both those basedin rural centers, and those in cities.

? Much scope exists for improving marketing pro-cedures, especially those which help reduce priceuncertainty for both producers and traders. A startcan be made by giving further attention to price/demand forecasting, and to the encouragementof forward purchases by large buyers, includinginternational relief agencies. Other approachescould include facilitation of contract farmingarrangements. Mechanisms for buffering pricesfor key crops, such as maize, could be consideredin the light of the favourable situation in Uganda(notably the bi-modal cropping season, reliabilityof precipitation, coupled with the soundgroundwork in forecasting by the Foodnet project).Some strategic interventions by government wouldbe required for actual price buffering in the form oflimited guarantees. The Mission is of the view thatmore developmental work is warranted in this areain order to provide a sound basis for considerationof possible interventions by decision-makers.

? Development of insurance as a financial serviceto agriculture and fisheries will be chiefly and mostusefully confined over the foreseeable planninghorizon to the coverage of equipment, buildingsand harvested crops, together with life cover. Thelatter type of product, if combined with term loans,could become a growth area for insurance andbanking institutions (including MFIs). Cropinsurance is not seen as becoming importantwithin the next decade or two because of thelikely low level of demand (at the high premiumlevels which would be required) in relation to theheavy cost of designing suitable products, andtraining and maintaining the specialist staff re-quired to operate such programs. However, therewill be growing demand (through loan conditions)for mortality cover on valuable, credit-financedlivestock.

? The information interface between the financial ser-vices sector on the one hand, and the agriculturaland fisheries sectors on the other, in Uganda, isweak. Attention by all parties to improvedinformation acquisition and management shouldassist in ensuring optimal mutual support, to thebenefit of financiers, farmers and fishermen, andtraders operating in these sectors.


24

Chapter 4Supplying Financial Services to Agriculture and Ru-ral Areas4.1 Introduction

The previous chapter presented an analysis of howthe demand for financial services in agriculture andthe rural economy may evolve over the next severalyears. One of the characteristics of the economicdevelopment process in all countries is the relativedecline of agriculture as per capita income rises.Therefore, it is likely that the proportion of the country’spopulation living on farms and in rural areas (currently85 percent) will decline sharply over the next decade.As economic growth occurs, some people will moveoff farms and migrate to rural towns and cities, andmany will become engaged in economic activities withbackward and forward linkages to agriculture. Somewill continue to live on farms, but earn larger amountsof household income from non-farm enterprises. Somewill specialize more in farming and utilize the land leftbehind by migrants to increase their farm sizes byemploying animal and machine power. Some willbecome specialized in producing for nucleus estates.

The formal financial system is currently servicing afairly small proportion of farmers and selected marketniches within the rural economy. Economic transfor-mation will increase the demand for financial servicesby farms and by households and firms in villages andrural towns. If some of the constraints identified inthis chapter can be reduced or eliminated, the financialsystem will be able to respond better to theseemerging opportunities and contribute more to theeconomic transformation process than it is doing today.

This chapter has three purposes: to summarize howthe financial system is currently serving the ruraleconomy, to identify how the supply of financial ser-vices will likely evolve in response to new demandsfor services, and to identify constraints that may af-fect its performance. The chapter ends with a listingof the key actions proposed to be taken to improvethe likelihood that the financial system will contributeto and accompany the economic transformation ratherthan impede it.

4.2 The Suppliers of Agricultural and RuralFinancial Services

Agriculture and rural areas are supplied financialservices by formal financial institutions, NGO-MFIs,member-owned organizations, and informal sources.An overview of the sources, their products and the

clients served was presented in Chapter 2. Thissection provides important additional information aboutthe suppliers and their services.

4.2.1 Tier 1 and 2 Financial Institutions

Tier 1 and 2 financial institutions include 15 commer-cial banks and 8 credit institutions. About 10 percentof the total volume of loans and advances made bycommercial banks reportedly go to agriculture. Theycould offer more financial services for agriculture andin rural areas but their limited branch networks, amongother factors, constrain their outreach. They primarilymake large short-term loans to commodity processingfirms, trading companies, nucleus estates, and a fewindividual farmers, especially in the export sector. Withdonor support in the form of guarantees and incentives,some banks have started lending to MFIs so theyindirectly finance rural firms and households. Somebank loans are undoubtedly made directly to smallerfirms located in rural towns and cities. Bank loanstypically are made for less than a year at prime ratesof interest (currently about 15 percent) plus additionalpercentage points based on the perceived risk of theborrower. The banks offer a wide variety of otherproducts and services to any firm, group or house-hold that meets their requirements, and is locatedclose enough to travel to their branches. However, thehigh minimum balances required and the formalitiesinvolved prevent most poor people from usingcommercial bank savings and deposit services.

Term loans are largely limited to those made by eightbanks that participate in the European InvestmentBank Apex Private Sector Loan Scheme. This schemeprovides financing for loans of 5 to 12 years, with aone-year grace period. Loans can be made in eitherUshs or foreign currency at below market rates and,unlike most short-term loans, the borrowers canchoose fixed interest rate loans. Apparently, less than20 percent of the 100 or so term loans granted underthis Apex scheme have gone to agriculture.

Many banks have failed due to poor management andimprudent lending but, except for the CooperativeBank, there is little evidence that agricultural lendinghas been the primary reason for failure. It is generallyassumed that the granting of loans to people who werewell-connected and refused to repay was the primary


25

cause for the Cooperative Bank’s failure, not theinherent risk and cost of agricultural lending.25

Two financial institutions merit specific comment. TheCentenary Rural Development Bank is recognized asbeing the pioneer bank in the country that beganmaking individual loans to farmers in 1998 in its Mbalebranch. It began this lending using a lendingtechnology that analyzed the farm household’sexpected cash flow. Loans were made for 6-10 monthsat an interest rate of 1.8 percent per month plus othercharges. The loans were collateralized and often carrieda grace period followed by 3-4 monthly payments.Interest was charged at 1.8 percent per month on thedeclining balance, and an application fee of Ushs 5,000(about $3) was charged along with a monthly inspectionfee of two percent, which was reduced to 0.5 percentfor the fourth loan if the borrower made on-timepayments for the previous three loans. As additionalcollateral, a special loan current account was alsoopened for the borrowers and post-dated checks weredrawn against it for the loan installments.

The experience in the Mbale branch clearly showsthat by employing an appropriate lending technology,using well-trained and motivated loan officers, andfollowing prudent lending practices, many of whichare similar to those successfully used in microfinance,it is possible to successfully serve agriculture.However, Centenary’s high initial loan recoverydeteriorated when it rapidly expanded agriculturallending into other branches in conjunction with a loanguarantee program. Recently it has been trying tocollect from the guarantee an amount roughly equalto 29 percent of the loans guaranteed. It is unclear ifits agricultural loan portfolio is as large today as itwas in the peak guarantee period. This experienceshows that government and donor incentives caninduce financial institutions to imprudently expand intonew markets where they have little experience, and/or when they have insufficient numbers of staff trainedfor new markets, coupled with insufficient control andmonitoring by senior management.

The second financial institution is the DFCU Groupthat includes the DFCU Bank, DFCU Leasing, DFCULimited (long-term lending), Housing Finance Com-pany, and Rwenzori Properties. The Group reportedthat over eight percent of its loans and advances weremade to agriculture and agro-processing at the end of2002. The Leasing Company controls over 85 percentof the country’s leasing market, with 16 percent of itsnet lease investments outstanding at the end of 2002going to agriculture and agribusiness.26 The transportsector represents about 40 percent of the total. Byretaining ownership of the assets leased, it is expected

that leasing will be less risky than lending.

The agricultural items leased include new and usedtractors, maize mills, coffee and millet processingequipment, and milk coolers. Under a DFID ChallengeFund Grant, a pilot beehive-leasing scheme is nowoperating in which the Uganda Honey Company isproviding training and buys the honey. The bulk of thefunding for all lease operations is borrowed fromInternational Financial Institutions at an average costof approximately 12 percent. Most leases are madefor Ushs50 to 500 million, for 2 to 5 years, at leasinginterest rates from 16 to 26 percent with an average of18 percent. About 60 percent of the items leased aresecond hand when leased, which reduces the cost tolessees. Cash down payments of 10 to 15 percentare required, and the lessee can opt to purchase theequipment at the end of the lease for up to five percentof the value. To minimize default, lessees are requiredto prepare post-dated checks for the gross rentalsover the lease period. It has opened four rural LeasingCenters with a grant from the SPEED Project thatsubsidized the start-up costs and training. This willbroaden its geographic spread and facilitate more ruraloperations. The Leasing Company is an example of afinancial institution that successfully participated indonor-funded schemes, but has not lost its commit-ment to efficiency and sustainable operations.

4.2.2 NGO-MFIs

Nongovernmental organizations that specialize infinance number in the hundreds, but the exact num-ber is unknown as neither the NGO Board nor theRegistrar of Companies keep records of registeredMFIs. Most are assumed to be quite weak; however,about a dozen are recognized as market leaders. Nineparticipate in the SPEED Project27 designed tostrengthen them for conversion into Tier 3 licenseddeposit-taking MDIs. Even though they are amongthe best, it is likely that only 3 or 4 will be included inthe first round of NGOs that apply for MDI licenses.

Most NGOs serve clients drawn from urban and peri-urban areas. The Uganda Microfinance Union isunique as it started in 1997 in a rural location andeventually opened urban branches. Some are “homegrown” while others mimic international MFIs, suchas the Grameen Bank or FINCA. Most make fairly

25 Some delinquencies have been reported in agricultural loansguaranteed by the USAID/SPEED (Support for Private EnterpriseExpansion and Development) Project.

26 Much of this material was extracted from Juma Kisaame,“Case Study of DFCU Leasing Company– Uganda,” Paperpresented at the Paving the Way Forward for Rural FinanceInternational Conference Sponsored by the Agency forInternational Development, Washington, DC, June 2-4, 2003.27 The mission is especially grateful for the assistance of severalSPEED project staff members who so graciously provided theirtime, data and facilities during our work. Any misinterpretations ofthese data are our responsibility and the SPEED project staff maynot share the conclusions presented here.


26

short-term loans, often with group guarantees andfrequent payment schedules. These types of arrange-ments are better suited to trading enterprises withhigh turnover than to farming enterprises with moreirregular and seasonal cash flows. The interest ratesand fees charged for small loans can total the equiva-lent of a 50-100 percent nominal interest rate calcu-lated on an annual basis, in order to cover high oper-ating costs.

Some MFIs experience rapid growth and high loanrecovery rates. For example, six MFIs in the SpeedProject grew from serving a total of 42,000 clients in1998 to over 150,000 by 2002 with over Ushs32 billionin loans outstanding. Moreover by 2002, the numberof savers exceeded 227,000, surpassing the numberof borrowers by more than 50,000, and the total volumeof savings was Ushs15 billion, roughly half the loansoutstanding. This demonstrates the demand forsavings that exists among poor people. Their portfolioat risk (defined as loans more than 30 days overdue)ranged from a low of zero to a high of 8.4 percent.Four of the six had an index of financial self-sufficiencyabove 100 percent indicating they could cover alloperating and financial costs.

The NGO sector receives considerable assistance.Some comes through donor projects, like SPEED,that target one or a few NGOs for large amounts ofassistance. The EU provides broader support to thesector through SUFFICE (Support to Feasible Finan-cial Institutions and Capacity-Building Efforts). Itprovides credit lines, bank guarantees, matchinggrants for MFIs and providers of capacity buildingservices, and research and field-testing of new prod-ucts. Other donors support AMFIU that was estab-lished to serve as an advocate and capacity builder ofthe sector. Still other NGOs obtain assistance directlyfrom network organizations, such as the links betweenFINCA Uganda and FINCA International and betweenthe Uganda Women’s Finance Trust and Women’sWorld Banking. Both of these NGOs are activelyworking towards transformation into MDIs. Animportant development has been the growth ofcommercial bank lending to NGOs now totaling severalbillions Ushs in outstanding loans. The interest rateson some of these loans are strictly commercial whileothers are subsidized directly by donors and indirectlyby loan guarantees. These wholesale-retailrelationships permit the banks to utilize theircomparative advantage in mobilizing savings, whilethe NGOs utilize their comparative advantage inmaking loans to lower income customers.

4.2.3 Member-Owned and Managed Organiza-tions

The number of cooperatives and other member-ownedorganizations supplying financial services is even largerthan the number of NGO-MFIs. As of October 2002,6,580 cooperatives were registered with the Registrarof Cooperatives, of which 680 were SACCOs.28 It wasestimated that at least 60 percent of Tier 4 MFIs,excluding moneylenders, are SACCOs. It is aheterogeneous group that includes credit unions,community based village banks, Financial ServiceAssociations (FSAs)29 and Savings and LoanAssociations (SLAs)30. Some are savings-first self-help oriented organizations, but many groups orSACCOs are reportedly being created in rural areasbecause of the expectation they will receive externalassistance.31

Member-owned financial institutions generally facegovernance problems because they are membercontrolled. Partly due to shortcomings in governance,most are assumed to be weak and poorly managed.Even the WOCCU-assisted SACCOs that wereexpected to be stronger face serious problems asreported in Annex 2. Unlike banks, this marketsegment suffers due to the lack of a strong supportsystem to nurture, regulate and supervise it. This isunfortunate because they may be the only type offinancial institution that can economically servesparsely populated remote areas where it is too costlyfor banks and the future MDIs to locate branches.

Member-owned organizations normally provide onlysavings services and loans. Credit unions and FSAscollect member shares as the primary source of loancapital and are weak in mobilizing savings. Membersoften save just the minimum required to get loans, asoccurs in many NGOs. Loans are made in varioussizes and terms and, except for SLAs, loandelinquencies are often high. Poor lending and col-lection practices, aggravated by a bad debt repay-ment culture and numerous supply-led governmentcredit schemes in the past, have caused this prob-lem. Poor loan recovery and limited savings mobili-

28 Stefan Staschen, Possible Mechanism to Regulate Tier 4MFIs in Uganda, Financial System Development Program,GTZ, Kampala, May 2003.29 A financial service association (FSA) is a small locally managedmicrofinance institution providing savings and loan services to itsshareholders. The model was developed by Ahmad Jazayeri whois organizing them in Uganda and Tanzania as a means to providefinancial services to low-income people. A total of 31 FSAs areoperating in Kampala and southern Uganda and, as of September30, 2003, they reported a total of 13,079 shareholders.30 CARE has created almost 600 SLAs, each with about 22members, in the West Nile with a total membership close to13,000 members.31 See Leonard K. Mutesasia and Nthenya R. Mule, “Understand-ing the West Nile SLAs and Charting a Path for the Future,” FinalDraft Report presented to the DFID Financial Sector DeepeningProject, Kampala, October 2003.


27

zation produce liquidity problems, which discouragegrowth in membership and loan repayment, asborrowers fear they will not get new loans if they payoff current ones. Some SLAs operate as savings clubsand make loans to nonmembers, and others makeloans to members for group enterprises.

4.2.4 Informal Finance32

There are many other unregulated informal financialinstitutions and arrangements that provide a hugevolume of financial services for participating house-holds. They are often the only source of financialservices in the most geographically isolated locations.These informal arrangements are built on trust, socialand family relations, and reciprocity rather than writtencontracts. They exist among people who know eachother and this knowledge is used to screen thetransactions that are undertaken and to enforce infor-mal agreements. They have stood the test of time, soexpanding the formal financial frontier into rural areaswill likely involve harnessing these traditional practicesrather than trying to replace them. There are, however,some disquieting reports about these traditionalmechanisms. For example, it was reported thattrustworthiness is declining in rural areas leading to areduction in informal lending and an increase incollateral requirements. A decline in levels of trust-worthiness would signal the need to introduce moreformal systems, while retaining the advantages of thetraditional practices. A worsening of economicconditions, considerable rural unrest and insecurity,and deaths due to HIV/AIDS could all contribute to abreakdown in these traditional financial methods ofcoping with problems and obtaining financial servicesin areas located far from formal finance.

4.3 Expanding the Frontier of Formal Fi-nance

We now turn to the question of how to push the fron-tier of formal finance deeper into agriculture and ruralareas. What policies, programs, initiatives, and in-vestments should be implemented so the supply offinancial services expands to meet the changes infuture demand identified in Chapter 3?

4.3.1 Objectives of the Financial System

There are three important objectives that the Ugan-dan formal financial system should strive to achievein its efforts to serve more agricultural and rural cli-ents in the future.

? Outreach – The financial system should attemptto reach as many households and firms as pos-sible, including many of the poor, but not neces-sarily the poorest most indigent members of therural society whose serious needs cannot be metsolely by financial services. A larger variety ofservices are preferred to a fewer number, andmaking services available on a continuous andrepeated basis is preferable to a one-time eventsuch as providing someone a grant.

? Sustainability – The financial system should besustainable so it can continue to offer its servicesover time without interruption and be self-financingso the financial institutions generate the revenuesnecessary to cover their costs. In this way theywill be less dependent on the whims and prioritiesof the government and donors for subsidies.

? Efficiency – The financial system should consumeas few of the nation’s resources as possible toproduce products and services and offer them toclients as cheaply as possible. Competition shouldbe encouraged as an important driver of efficiency.

If the financial system meets these objectives, it willmake a significant impact on the country by assist-ing the largest possible number of people realize theirdirect economic objectives of increased employmentand income, and reduced poverty. Other indirectbenefits such as improved consumption, nutrition,empowerment and welfare may also follow.

Several ways to assist the financial system meetthese objectives are outlined in this section. Some ofthem are crosscutting in that they affect all segmentsof the market, while others are specific to particulartypes of financial institutions.

Key topics to be considered in this analysis include:

? General environment. Financial institutions oper-ate within a framework of policies and institutionsthat condition their activities, and facilitate orconstrain them in meeting their objectives.

? Supply of resources. All financial institutionsconsume financial and human resources and alllenders must have access to funds to lend.

? Internal operations. All financial institutions em-ploy resources and technologies to produce theirfinancial products and services. Some are mar-ket leaders in discovering and introducing innova-tions, while others lag behind and eventually followthe leaders.

? Governance system. The internal and external“rules of the game” and the interplay among agents(boards of directors, managers, staff) determinehow well an institution performs. Some types offinancial institutions tend to have stronger

32 A description of informal financial services in rural areascan be found in Grace Sebageni, Steven Kaagwa, andLeonard Mutesisira, “Where There is No Banker: FinancialSystems in Remote Rural Uganda,” MicroSave Africa, Nairobi,February - May, 2002.


28

governance systems than others.

? Comparative advantage. Some types of financialinstitutions may have a comparative advantage insupplying certain products and services in somemarket segments compared to others.

? External support. Providers of financial servicesvary in their dependence upon and ability to effec-tively use external support without damaging theirfinancial discipline.

4.3.2 Matching Demand and Supply: At WhatPrice?

The task of efficiently producing financial services ischallenging. Table 4.1 provides some sketchy datacompiled from documents and interviews to demon-strate some features of the current supply of loans. Itlists categories of suppliers, estimates of loan sizes,and ranges of nominal interest rates that have beenreported. This is a crude approximation since it isnecessary to analyze all fees, compensatory savingsbalance requirements, and other transaction costs toaccurately determine the full cost of borrowing. Thelast column reports the level of operating costs fortwo sources which provide some clues about the costof supplying loans. Of course, estimating full costsrequires a careful analysis of the cost of funds includingreserve requirements, loan losses, and many otherdetailed accounting issues.

As expected, large banks make the largest loans atthe lowest explicit interest rates often set at the primerate plus a margin depending on type of loan andperceived riskiness of the borrower. The size of theDFCU leases can also be quite large with implicitinterest rates roughly in the same range. The operat-ing costs of these two categories are unknown butclearly personnel and facility costs must be relativelyhigh. They mobilize funds at a rather low interest ratefrom savers or at mildly subsidized rates frominternational financial institutions. Centenary Bankmakes much smaller loans to individual farmers,although some small DFCU equipment leases maybe granted to a similar class of customer. Centenary’sinterest rates are roughly in the same range as thebanks, but it also charges several other types of feesthat raise total borrowing costs. It raises funds fromthe public and has also received large amounts ofdonor funds in the past.

The NGO-MFIs and credit unions tend to serve adifferent market segment compared to banks. Loansizes are much smaller on average and interest ratesare significantly higher. Thanks to the efforts of sup-porting institutions, estimates of operating costs areavailable, and they tend to be very high because ofsmall loan sizes and other reasons. On the one hand,

the cost of funds for NGOs is high because some

Table 4.1: Loan Sizes, Interest Rates, andOperating Costs by Category ofSupplier

Notes: * Operating costs are defined as operating expenses/average assets.

borrow from banks. On the other hand, some alsoreceive concessional funds. Credit unions tend to havelower operating costs because their salaries are oftenlower, sometimes their facilities are subsidized, andmembers donate labor for management andgovernance. The FSAs serve a similar market segmentwith interest rates that are significantly higher. However,they are still in an experimental phase so it is unclearwhat rates they might charge in the future. Theiroperating costs are unknown.

The SLAs appear to serve yet another market seg-ment. They represent the most rural of all categoriesas they operate in a region where few other financialinstitutions are located. Their loan sizes are muchsmaller. Interest rates are surprisingly high perhapsbecause the members use moneylender rates as theirreference and assume that is the competition “to beat.”It may also be the case that they want to compensatethemselves for the savings they put at risk and for thetime spent in governance. By comparison, the creditunions in the WOCCU project pay two to eight percentper annum on savings and no profits are paid on sharesowned.

How will the rural financial markets evolve, what willbe the probable costs of advancing small rural loans,and what levels of interest rates will prevail in the future?First, although the nominal interest rates reportedabove appear very high, they are less so whenadjusted for inflation. For example, farmers indeveloped countries today pay between 6 to 10 per-cent annual interest rates on seasonal farm loans but


29

Suppliers Interest Rate(%)

Large banks Unknown

OperatingCosts* (%)

Prime (15)plusX % annual

Loan size(Ushs)

Millions

DFCULeasing

Unknown16 - 26 %annual

50 - 500million

CentenaryBank

Unknown2 % per monthdeclining

Ave. 300,000

NGO-MFIs 40 - 85 %2-3% permonth flat or4% decliningbalance

50,000 - 4million

Credit Unions 4 - 45 %20 - 48 %annual

50,000 - 4million

FSAs Unknown8 % per monthdeclining

50,000 - 2million

SLAs Unknown5 - 20 %monthly flat

5 - 50,000

Rural moneylenders

Unknown5 - 20 %monthly flat

50,000 andabove

their current inflation rates may be only 2-3 percentcompared to 5-10 percent in Uganda. The more strikingdifference is that developed country farmers face lessinterest rate risk as they can also obtain fixed interestrate term loans at roughly the same rate as seasonalloans. Even for seasonal loans, most bank loans inUganda are made at variable rates. Therefore, theUgandan agricultural sector is at a comparativedisadvantage in using borrowed funds to financelonger-term investments.

Treasury bill rates establish a floor for the interestrates charged by banks, and influence the ratescharged by other lenders that borrow from them.Therefore, the interest rates charged borrowers bymany lenders must be several percentage pointsabove the T-bill rate. For this reason, the single mostimportant action that Uganda can take to lower inter-est rates for all borrowers, including those in agricul-ture and rural areas, is to implement macroeconomicand other reforms that will stabilize and reduce theTreasury bill rate.

Second, the future cost of funds for the MDIs will beinfluenced by their success in mobilizing savings anddeposits from their borrowers and the general public.They will probably have to pay savings rates at leastas high as those offered by banks, and their cost ofadministering such savings may be high in the earlystages until they attain economies of scale. Therefore,the future interest rates for MDI loans may bedetermined as much by their efficiency in savingsmobilization as by their efficiency in lending.

Third, the future rates that non-deposit-taking NGOswill have to charge for loans will be determined partlyby their access to subsidized sources of funds, butthere is evidence that such funds are drying up ex-cept for social investors who target the strongest andmost sustainable MFIs. Most NGOs have little expe-rience in serving agriculture and rural areas so it isdifficult to estimate their future operating costs andinterest rates if they expanded more aggressively intothis market.

Fourth, the member-owned organizations have thegreatest ability to offer lower rates for loans. They relyheavily on member savings and shares thatsometimes can be mobilized at low cost. Some usesubsidized facilities and donated time from membersfor governance purposes. They also tend to pay lowersalaries. Despite these advantages, many, if not most,SACCOs are extremely weak. Moreover, since theirloan recovery is frequently poor, they need to chargehigh interest rates to cover loan losses even if theymobilize cheap savings. Since many SACCOs andother types of member-owned organizations areunsustainable, it is unclear what their costs andinterest rates would be if they were sustainable entities.The problems of the SACCOs, coupled with the failure

of the Cooperative Bank, suggest that the old paradigmfor developing the cooperative sector has been andwill likely continue to be a failure.

Fifth, although moneylender rates are reportedly highin rural areas, it is not clear how much their rateswould fall if sustainable MFIs attempted to serve theirclients with the same size loans for the same pur-poses.

Sixth, the rural economy is heterogeneous. For ex-ample, large banks are needed to serve large pro-cessing firms, but they are too costly and don’t havethe appropriate lending technology to make small loansto individual farmers. Small and medium size banksand MDIs may be ideal to serve small and mediumbusinesses in rural towns.

There does not appear to be strong evidence thatshows that a particular type of supplier has a clearcomparative advantage in efficiently mobilizing sav-ings, making and recovering loans, and supplying otherservices for the heterogeneous demands of rural areas.This being the case, the most prudent governmentpolicy will be to encourage a competitive environmentin which all types can experiment, evolve, andcompete with each other over time.

4.3.3 The Future for Commercial Banks

The increasing competition that is observed amongthe commercial banks will have important conse-quences for both microfinance and rural finance. First,there may be further restructuring of the banking sectorthrough acquisitions and mergers. Although thecountry may be under banked in terms of branchesoutside of Kampala, it is possible that it is over bankedin terms of number of different financial institutionsappropriate for the existing market. If true, thelicensing of MDIs will exacerbate the situation. Thebanks and MDIs that survive will be the ones that adaptand find profitable new markets.

Second, when Treasury bills cease to be so attrac-tive, banks will have to look for new sources of rev-enue. Those currently servicing large agribusinesseswill be able to grow along with the successes real-ized by their clients. The magnitude of the financialresources involved and associated risks mean thatonly the biggest banks have the capacity to serve thelargest businesses. Those banks with the largestbranch networks will be in the best position to serveemerging business opportunities in rural towns andtowns. The first NGOs that successfully complete thetransformation process into MDIs and become adeptat mobilizing savings and deposits will be obviouscandidates to expand their branch networks into underbanked regions.

Third, some banks may decide to increase their farm


30

lending, while others may specialize in retail bank-ing. Some may even create specialized agriculturaldepartments. Centenary Bank may return to its origi-nal prudent individual farm-lending model and slowlyextend it into new areas. Other smaller banks mayfollow the Centenary example and make the institu-tional commitment needed to serve this market. It islogical to expect that favorable geographic areas willbe reached first, where farmers have the bestproduction possibilities and access to the best mar-kets.33

As the banks learn from their experiences in lendingto MFIs, more wholesale-retail relationships maydevelop. Banks may use their comparative advantagein mobilizing savings, and lend to MDIs and NGOs,while these entities utilize their comparative advantagein on-lending to the agricultural and low-income marketsegment.

Four sets of constraints will influence the future per-formance of commercial banks in agriculture.

? First, commercial banks are best suited to maketerm loans because of their capacity to transformshort-term savings into long-term loans. However,as noted in Annex 3, there are many impedimentsin the current landholding system that will preventthe widespread use of land as collateral for long-term loans in the near future.

? Second, the absence of long-term savings in thecountry will impede the ability of financial institu-tions to make substantial numbers of loans withmaturities longer than a few years.

? Third, unlike MFIs, commercial banks depend onwritten contracts and contract enforcementthrough the legal system. The reforms under wayin the Justice Law and Order Sector will be cru-cial for streamlining the procedures used to en-force loan contracts, resolve disputes and reduceintermediation costs.

? Fourth, financial intermediation is an information-intensive activity. As noted in Chapter 3, there areno good easily accessible sources of informationabout economic opportunities in agriculture for useby either farmers or bankers. This problem willhave to be rectified through the reforms underwayin NARO and NAADS if farmers are to discoverand respond to market opportunities, and if bankersare going to correctly assess the creditworthinessof potential borrowers. Eventually, the volume of

credit transactions in the economy will require thecreation of a credit reference bureau system tofacilitate the exchange of information and reducethe cost of information sharing among creditors.

4.3.4 The Future for MDIs and NGOs

The Micro Finance Deposit-Taking Institutions Actrepresents an important step forward in resolving theproblem of how to legally mobilize deposits from thepublic for use in making small loans tomicroenterprises. Now it is up to the NGOs to meetthe minimum capital and other requirements speci-fied for Tier 3 status as deposit-taking MDIs, and forthe BoU to develop the capacity to efficiently license,regulate and supervise them. Experience in othercountries suggests that NGO transformation is not asimple task. The SPEED Project is discovering someof the costs and difficulties that MFIs face in thisprocess. Even if the first few MFIs smoothly trans-form themselves into MDIs, there will be a need foradditional resources to screen and assist the nextround of potential candidates for transformation. Moreimportantly, the new MDIs will need considerableassistance in designing savings instruments thatappeal to the general public, not just the poor whohave been their traditional clientele. Also, if they aregoing to penetrate rural markets, they will need addi-tional capital and staff to expand their branch net-works. Their existing lending technologies will likelybe appropriate for use in lending to small businessesrural towns, but they will need to develop new loanproducts for crop and livestock enterprises.

The remaining Tier 4 non-deposit-taking NGOs willface problems as they will be limited to taking com-pulsory savings as a kind of loan insurance from theirclients, but they will not be allowed to on-lend theseresources. Therefore, they will have to rely ondonations and concessional funds from donors, orbecome strong and credible enough to borrow fromother financial institutions, or expand slowly throughretained earnings from grant-based lending. The bestoption for some may be to try to develop long-termwholesale-retail partnerships with banks. In any case,they will have to develop more transparent accountingsystems that reflect their true financial health, andgood lending technologies to efficiently make andrecover loans.

4.3.5 The Future for Member-Owned FinancialOrganizations

The future role of member-owned and managed finan-cial institutions is the most problematic segment ofthe financial system. Much additional thought andanalysis is needed to design a comprehensive strat-

33 There is some evidence indicating that better access toinfrastructure is also associated with lower levels of civil strife.This in turn can be expected to influence where financialinstitutions choose to locate. See Klaus Deininger, “Causes andConsequences of Civil Strife: Micro-Level Evidence fromUganda.” Policy Research Working Paper 3045, World Bank,Washington, DC, May 2003.


31

egy for these organizations. On the one hand, theypresent the best potential solution for reaching poorhouseholds in the remotest locations. On the other,they tend to be the weakest in achieving long-termsustainability. This segment of the market seems mostsusceptible to manipulation by politicians and localelites eager for votes and influence. Moreover,member-owned institutions have been particularlyvulnerable to having their financial discipline under-mined with external funding.

The failure of the Cooperative Bank with the loss ofmillions in donor funds, the weaknesses that persistin some of the best SACCOs even after months ofassistance from the WOCCU project, and the lack ofan effective national support and regulatory system,even after considerable donor assistance, are evidenceof the fundamental problems of this entire sector andthe great challenge in finding effective ways to developit. Therefore, although member-owned organizationsnumber in the hundreds and provide limited financialservices to thousands of members, there is no clearway forward for developing them into a dynamicsustainable segment of the financial sector. Theexperiments underway with community-based villagebanks and the creation of FSAs and SLAs, togetherwith the WOCCU attempt to strengthen a fewSACCOs, may eventually reveal strategies toovercome the weaknesses inherent in theseorganizations.

The experiences of the recent past clearly suggestwhat not to do. First, the government and donorsshould not distort the internal incentive and governancesystems of member-owned organizations by providingthem with funds for on-lending. This tends to destroytheir most important strength – intermediation ofmember savings. Frequently, external funds providedto revolving funds tend to get disbursed, but not repaidso they revolve only once or twice then collapse. Onlyfinancial organizations with strong governancestructures can avoid the temptations for malfeasancethat such funds produce. The mission stronglysupports the current thinking of the Outreach Plan tonot provide funds for on-lending to SACCOs, andbelieves that this should be the policy for all governmentand donor programs.

Second, new SACCOs should not be promoted withthe promise that this is the way for the members toobtain outside financial assistance. The muddledmessage now being delivered to people in some ruralareas must be clarified. This represents a delicateproblem because the delivery of information andtechnology is done most cheaply through groups, soit is logical that the reforms of the research andextension systems include promoting the creation ofgroups. Moreover, local self-help groups are one ofthe traditional ways to solve problems at the village

level. However, the frequent poor management andgovernance in SACCOs makes them most vulnerablewhen they attempt to manage external resources. Themission strongly believes it is essential that acommitment be made at the highest levels to developa clear message regarding the separation of financialactivities from other functions that farmer groups areencouraged to undertake. A similar explicit separationof the functions of the apex organizations, UCA andUCSU, should be explored.

Several things should be done by the government,donors and the member-owned organizations them-selves that will contribute to the formulation of a much-needed long-term strategic development strategy. Inthis regard:

? Basic information is needed. The development ofa strategy requires a better understanding ofseveral basic issues than exists today. Basic datacollection and some field survey work are neededto answer questions such as: How many SACCOsare registered? How many are effective membersof UCA and UCSCU? How many names andaddresses of members can actually be retrieved?How many SACCOs are really functioning? Howmany provide financial services? How good aretheir financial records? How many have thecapacity to maintain accurate accounts andrecords? How many are lending outsideresources? How many are essentially defunctbecause of unrecovered loans? How many activemembers are there? How many are active savers?How many members have lost savings? What arethe characteristics of the most successfulSACCOs?

? Strategic planning is needed concerning the ap-propriate support structure. Some questions hereinclude: What legal, regulatory and supervisoryframework is needed for the sector? Are therelogical reasons to support three separate organi-zations – UCA, UCSCU, and AMFIU? Whatshould be their respective roles and responsibili-ties? What powers should each have? What roleshould the BoU have relative to the threeorganizations? What about the Registrar of Co-operatives? How much of this framework can beself-financed? Are there public goods componentsof the system that justify public support and canbe clearly identified and appropriately funded? Arethere any proposals for changes in organizationand legislation? Are they comprehensive andinclusive in their approach? Is a temporaryadministrative system needed to provide leadershipand guide the development of this entire supportframework? Should this framework be set in placebefore additional resources are spent in developinggrassroots organizations?


32

? A better understanding is required concerning theimpacts of the past support that was provided tothis sector and the lessons to be learned from it.For example, what are the primary factors thatcontributed to the collapse of the CooperativeBank? Why has the support provided to UCA andUCSCU not produced stronger organizations?Why have some of the SACCOs supported bythe WOCCU project performed better than others?Is support more effective when it is targeted atjust a few SACCOs rather using a broad sector-wide approach? Have some SACCOs been ableto efficiently manage external resources? Whatare their characteristics? Are most successfulSACCOs utilizing only their own resources? Cana set of best practices be established to guidethe support provided to the sector? Whatperformance standards should be established fororganizations receiving support?

Several decisions might come out of a strategic plan-ning exercise. For example, it might be concludedthat it is a waste of resources to assist SACCOs atthe grassroots until the support system is overhauled.Several legislative and organizational changes mightbe proposed. Powers and responsibilities might begiven to an organization to close poorly performingSACCOs. Perhaps a few could be identified that wouldbenefit from a low-budget intensive strengtheningprogram with the objective of converting them intoregulated financial institutions that collect savings fromnonmembers. Some type of self-regulatoryorganization might be created for smaller SACCOswith powers delegated to it by the BoU. SmallSACCOs might be trained to use a set of simplestandardized accounts. Another category of simpleorganizations, such as MMDs,34 might be nurtured tooperate on self-auditing principles that are highlytransparent and understandable for the members.Strong educational programs on governance might bedesigned for all levels in the sector. Most importantly,strong commitments might be made at the highestlevels in the public administration to not use theseorganizations as conduits to disburse public funds.

If most of this is accomplished, it is possible to envi-sion sustainable SACCOs of various sizes offeringcompetitive services at the local level to intermediatemember savings. Larger ones might evolve in townsand cities and effectively compete as regulated full-service financial institutions. Others might be formedto offer services for paid employees in commodity

processing plants, while others might offer servicesto producers for nucleus estates. A strong regulatorysystem would likely be developed, and a second tierfederation might be created eventually to intermediatesavings among member SACCOs and to manageemergency and savings insurance funds.

If a systematic approach is not taken, it is likely thatadditional resources will be spent in this sector butmost SACCOs will continue to be weak, vulnerable topolitical promises of bailouts and cheap money,lethargic in mobilizing savings, and uncompetitive inlocations served by banks, MDIs, and dynamic NGOs.The support institutions will provide few services ofreal value to their members and will be more active inadvocacy than in genuine development of the sector.For this reason, the mission recommends that thegovernment and donors agree to support thedevelopment of a comprehensive long-term strategicplan for this sector rather than implement isolatedreforms and programs.

4.3.6 The Future for Informal Finance

The informal financial system will continue to providefinancial services in the foreseeable future. Sometimesit has a comparative advantage compared to formalfinance. For example, the trading sector and nucleusestates acquire information about the traders andfarmers with whom they do business. This informationis useful in screening potential clients for in-kind loansand these interlinked transactions give them goodopportunities to recover loans. However, contractenforcement is more difficult for some commodities,such as cotton, where farmer-borrowers can engagein side selling to traders other than the ones fromwhom they borrow. Once trading patterns becomemore settled, these problems may be self-correcting.Traders may begin to realize that if they want theircontracts respected, they must respect the contractsof their competitors, and farmers may learn they willbe denied access to future loans if they fail to repaycurrent obligations.

Moneylenders often thrive even where formal financialservices exist because they offer quick, low transac-tion-cost loans for any purpose. By necessity, formalfinancial suppliers follow procedures that require moretime, and they prefer to lend for productive activitiesthat are expected to increase borrower income.

As noted in Chapter 3, interlinked contracts can beexploitative, and so can moneylenders. This situationsometimes leads decision-makers to propose controlsto avoid these abuses. Usually these controls areineffective so the expansion of formal finance tends tobe the most effective way to reduce this problembecause it provides alternatives to the informalsources. Moreover, the expansion of formal finance

34 The Mata Masu Dubara (MMD) Program was pioneered byCARE in Niger. The MMDs consist of a small group of savers,some of whom also borrow, that are organized into groups with anexplicit termination date at which time the interest earnings aredistributed to the savers. The original model used no writtenaccounts, but relied entirely on the members to recall whocontributed what, who owed what, and what amount of funds arestored in the group’s moneybox at any time.


33

may reduce the costs of informal finance and permitthe users to avoid the reciprocal obligations thataccompany borrowing from friends and relatives. Themission believes that expansion of the formal financialsystem is the most effective way to control abusesthat may occur with informal finance rather than tryingto mitigate abuses through rules and regulations thatare effectively unenforceable.

4.3.7 Crosscutting Issues

There are five crosscutting issues that affect most orall segments of the rural financial system, which willhave a crucial influence on its future performance. Theyinclude:

? Access to information. This topic was introducedin Chapter 3 and discussed in detail in Annex 4.Suffice to emphasize here that all agents in theagricultural sector - farmers, traders, and proces-sors – need information about profitable produc-tion and marketing opportunities to serve domesticand foreign markets. Entrepreneurs often do nothave sufficient resources to bear the cost ofacquiring good information. Moreover, they maynot be able to recover the costs through returnson investments because innovators tend to quicklylose their competitive advantage when others learnfrom their example. Financial institutions need thissame type of information in order to evaluateapplications for loans. They also help to dissemi-nate information to their clients. Eventually a creditbureau may be useful to facilitate the sharing ofinformation. Some types of information generationactivities, such as agricultural extension, havestrong public goods features that justify the useof public funds.

? Human capital in rural areas. The limited mana-gerial capability of subsistence farmers is wellknown. This affects their ability to efficiently oper-ate their enterprises and the member-ownedorganizations in which they participate. This is aparticularly serious problem for women who makeup a large share of the rural workforce and do muchof the farming. Public investments in improvinghuman capital will contribute to improvedagricultural productivity, to creating clients forfinancial institutions who are better prepared touse their products and services, and to rural peoplebetter prepared to manage their member-ownedorganizations.

? Trained banking employees. Financial institutionsneed personnel trained in agriculture, finance,accounting, management information systemsand other fields. These skills are scarce and salarylevels are high in Uganda compared to the size ofsmall loans that are best suited to poor people.

This situation contributes to high interest rateson loans. Moreover, it is expensive for financialinstitutions to handle the small savings anddeposit accounts of poor people. It would be usefulto analyze the future demand for bank personnelby skill level and evaluate if the projected evolutionin supply will be adequate, or if special programsshould be created to train the needed personnel.The financial sector also needs an informationsystem to search for and disseminate informationabout training materials and opportunities, suchas those identified in Annex 4.

? Establishing branches of financial institutions .Increasing rural outreach will depend importantlyon the ability of financial institutions to profitablyexpand their branch networks. Careful analysisis needed to identify barriers that impedebranching and make it expensive. For example,these might include banking regulations that aremore appropriate to urban than to rural operations.The poor quality of rural infrastructure and theinsecurity and civil strife that occur outside themajor cities represent additional problems. Recentmajor improvements in the cellular phone systemmay pave the way for cost-reducing innovationsin transferring information and data betweenbranches and head offices, thus permittingimproved managerial oversight. One importantbenefit that this would convey is the possibility oflowering the costs of operating rural branches,since good communication permits these officesto be staffed by more junior staff.

? Donor support and coordination. Donor coordina-tion in supporting microfinance has been outstand-ing in the Microfinance Forum, in the creation ofAMFIU, and in the development and adoption ofthe Performance Monitoring Tool (PMT). A similarapproach is needed for rural finance, but a moreambitious effort encompassing a broader range ofstakeholders is needed compared to thoseinvolved in the current coordination mechanisms.One achievement of microfinance coordination isthat a remarkable consensus has emerged tosupport a market-oriented approach to developingthe financial system. However, there is anincomplete flow of information about individualprojects so that all stakeholders can learn fromsuccesses and failures. The mission foundreluctance by some organizations to shareinformation and this attitude slows the speed oflearning within the sector. There are obviousincentives for donors to implement individualprojects and pursue objectives that don’tnecessarily add up to a coherent strategy. Thisis evident in the long history of support to anindividual institution, such as the Centenary Bank,and in the multiple projects that have supported


34

financial development in rural areas. Further effortsare needed to develop a coherent framework sothat individual activities make a greater contributionto an overall strategy. Greater consensus inneeded about what works and what doesn’t work,what should be done and what shouldn’t be done.

4.4 Summary of Main Points About the Sup-ply of Financial Services

This section presents a summary of the main pointsdiscussed in this chapter and the recommendationsthat logically flow from them and from Chapters 2 and3. It concludes with a discussion about the need fordeveloping a long-term strategy for creating a dynamicand sustainable rural financial system.

4.4.1 Main Ideas Discussed and Actions Re-quired

? Implement macroeconomic and other reforms tostabilize and reduce the interest rates on Trea-sury bills.

? Begin to build a data base of information on finan-cial service providers, the nature of services theyprovide and the costs they incur in supplying theservices.

? Conduct analysis to develop a better understand-ing about the number and distribution of smallerNGOs and SACCOs that currently supply finan-cial services, their strengths and weaknesses, andtheir potential for expanding sustainable servicesinto rural areas.

? Conduct analysis to determine the mix of formaland informal financial services used by rural farmand non-farm households and firms.

? Evaluate the adequacy of financial services to thetrading sector, especially with a view to identifica-tion of strategic interventions to increase pricecertainty.

? Conduct an in-depth study of the possibilities ofoffering new financial services in rural areas,especially insurance as noted in Chapter 3.

? Adopt policies that will stimulate the expansionof different types of formal financial service suppli-ers and encourage competition between formaland informal finance.

? Develop a policy for the government and donorsto support the suppliers of financial services inways other than providing funds for on-lending.

? Evaluate the adequacy of the sources of informa-tion available to entrepreneurs and the financialsystem regarding economic opportunities, and

identify possible areas for publicly fundinginformation generation and dissemination.

? Support policies and programs to raise the levelof human capital in rural areas and especially ofpeople engaged in farming.

? Project the future demand for trained manpowerby financial institutions, and determine how toimprove the supply if that is needed.

? Develop a long-term strategic plan for expandingthe formal financial system that involves all majorstakeholders so there is a greater probability thatindividual future projects and programs willcontribute to it.

4.4.2 A Process for Developing a Long-TermStrategic Plan for Developing an Agricul-tural and Rural Financial System

A long-term perspective is required when thinking aboutan agricultural and rural finance system, and adevelopment strategy for the entire rural financialsystem is needed to guide specific activities. Thisstrategy will need to involve many public and privateorganizations. It will require a better understandingthan is available today of the services currentlyprovided by each segment of the market and the usersof these services. Much more empirically basedinformation is needed so good decisions can be made.

A framework involving analysis and discussion amongstakeholders is needed to guide the process ofdeveloping this strategy. It will have to include anadministrative mechanism to provide leadership, toidentify key issues to be analyzed, to set a timetablefor activities, to develop a budget to finance prepara-tory work, and to develop procedures for consulta-tions, discussions, and the exchange of ideas. Onealternative would be to identify a future date for a two-three day conference at which presentations wouldbe made on predetermined topics. Another alternativewould be to organize a series of half-day seminarsspread over a year, each one to cover a specific topic.For the latter, a relatively small group of representativesfrom the relevant constituencies could be organizedas a working group to provide leadership over the lifeof the process. It would generate information; critiqueresearch, documents and presentations prepared forit; and prepare a draft strategy. The whole processwould need to be given a mandate from the highestlevel (perhaps the office of the President or the BoU).This would allow it to command respect and besuccessful in obtaining access to information and data.The objective would be to produce a plan with specificproposals for actions, policies, legislation, andinvestments for pushing out the frontier of the formalfinancial system.


35

A list of the potential topics to be addressed shouldinclude:

? Macroeconomic and financial policies and theireffect on the level and volatility of interest rates.

? A review of the legal issues concerning land, landtitling, and land transfers and possibilities forreforms to facilitate the granting of long-terminvestment loans using land as collateral.

? The comparative advantage of Ugandan agricul-ture and projected rates of return for rural on-farmand off-farm investments.

? The future demand for loans, savings, insuranceand other financial services in rural areas.

? The current outreach (geographic distribution,types of clients) of the supply of financial servicesby the formal financial system (including themicrofinance system).

? The operating and financial costs for different typesof financial institutions supplying financialservices.

? Experiences with alternative designs and modelsfor delivering products and services for agriculturaland rural clients.

? The financial status and performance of NGO-MFIsand SACCOs.

? The status of the existing support system formember-owned organizations and alternativesways to organize apex bodies to support suchorganizations.

? Opportunities for and pitfalls in the use of ware-house receipts, loan guarantees, matching grants,subsidies and other methods to augment thesupply of rural financial services.

? Changes in the financial infrastructure needed toenhance financial transactions, such as a creditreference bureau, a collateral registration system,and changes in legislation affecting borrower andcreditor rights.


36

5.1 Introduction to Conclusions and Recom-mendations

This report has been commissioned by the Bank ofUganda. Accordingly the conclusions and recom-mendations it contains are directed primarily to thecentral bank. Many of the actions discussed, par-ticularly with respect to issues directly connected withmember-owned organizations, fall outside of theresponsibilities of the BoU. Nevertheless, the mis-sion considers that the BoU is in a good position toensure appropriate consideration of the issues iden-tified, and is similarly well-placed to prompt or tosuggest action, as required.

Most of the Recommendations which follow are di-rected, at least in part, to policy makers. And mostwill involve more than one ministry or institution. Theissues surrounding financial services for agriculturenecessitate a multi-agency approach to policy mak-ing in this area. For this reason, the major recom-mendation of the Mission concerns development ofa Long Term Strategic Plan for Agricultural Finance.

More detail is given below on this Plan, and theWorkshop which it is suggested should be held inthe near future, as a means of ensuring participa-tion in the Plan of key ministries, public and privatesector entities, and donors. All of these can andshould contribute to policy-making for improving fi-nancial services to the agricultural sector.

For convenience, the material which follows hasbeen arranged in clusters which reflect the prioritysequencing and responsibilities as seen by the Mis-sion.

5.2 Cluster One: Long-Term Strategic Planfor Financial Services to the AgriculturalSector, and Related Issues

5.2.1 Long-Term Rural and Agricultural Fi-nance Strategy/High Level Policy Work-shop

A clear long-term strategy for expanding the formalfinancial system into rural areas would convey manybenefits. It would need to be broadly based, with allkey stakeholders involved in the overall objective of

contributing ideas and resources. Such a strategyshould provide a favourable environment for im-proved financial services to the agricultural sectorand the rural economy. It would facilitate mutualsupport between individual projects and programs,and also assist in ensuring that the necessary publicgood inputs, such as policy direction, education, train-ing and information dissemination, are optimallydesigned and implemented.

The strategy would need to be dynamic, adjustingto changing needs and circumstances. It would,therefore, require an operational base, with a workplan, and the resources to implement the work plan.The Mission envisions it in terms of an ongoing Plan,and suggests that the responsibility for steering thisinitiative would be determined through a dialogue ofall concerned parties. This dialogue would also beresponsible for allocating responsibility for implemen-tation. An ongoing working group would give conti-nuity to this dialogue. Such a working group wouldbe drawn from farming and marketing firms and or-ganizations, government ministries and donors. Thisworking group would effectively be an expanded (i.e.more broadly-based) version of the existing RuralFinance Group under the PMA.

Careful attention would need to be given to the ini-tiation of the Plan, in order to avoid problems, whicharise so easily with multi-sector and multi-agencyexercises of this sort. The Mission believes that theappropriate mechanism to start the initiative wouldbe a High-Level Policy Workshop. This would bespecifically designed to introduce the concept of thePlan, to highlight the required components, to en-courage maximum participation by stakeholders, andto identify future responsibilities. The outputs of thisworkshop would lay a good foundation for ongoingpolicy-making and support efforts, for all businessesinterfacing with the agricultural sector; this wouldinclude SACCOs and other member-owned organi-zations, as well as other financial and marketing/supply entities operating in the market.

The mission further believes that future operationsof the Plan could be conducted through a project, orbetter, a program encompassing multiple projects.Such a program could, inter alia, consider imple-menting many of the recommendations set out inthe present report.

Chapter 5Conclusions and Recommendations


37

finance on terms that facilitate investment. Much hoperests in the idea that MDIs will be licensed and will beable to efficiently mobilize savings deposits, and thatthis will increase the supply of funds for small-scalelending (including rural lending) and also lower thecost of such funds. As stated in Chapter 4, in thefuture, interest rates for MDI loans may be determinedas much by their efficiency in savings mobilization asby their efficiency in lending. Therefore:

Non-deposit-taking NGOs, in general, have little

IInputs for the Policy Workshop would include:

? A specially commissioned report which wouldassess past government and donor efforts (tech-nical assistance, matching grants, funds for on-lending, etc.) and projects, together with opera-tions of current lenders focusing on theirstrengths and weaknesses in strengthening fi-nancial services provision in rural areas; and

? An Issues Paper that would provide the basis forfocused discussion and decision-making duringthe Workshop.

The outputs of the Workshop would be guided by theIssues Paper and should include:

? An agreed work plan for establishing and operat-ing the Long-Term Rural and Agricultural FinanceStrategic Plan. This would focus on policyformulation and project design to guide futureefforts to strengthen the provision of financialservices in rural areas, for farmers and for otherentrepreneurs; and focus government and do-nor attention on activities that contribute system-atically to the overall strategy.

? An agreed mechanism for monitoring the effec-tiveness of financial sector business linkages withthe agricultural sector (including input and outputmarketing entities), and the manner by which theresults can be fed back to policy-makers on anongoing basis.

5.2.2 Institutional Changes MFIs - MDIs: Needfor Support and Action

As with other sectors of the economy, servicing theagricultural sector sustainably is a matter of control-ling financial risks and costs, in order to offer loan

experience in serving agriculture and rural areas. Ifthey are to make significant inroads into the sector,then other NGO-MFIs will need support in areas suchas financial product design, and assistance with in-formation management and communication systemsin order to provide the basis for effective and effi-cient operations.

5.2.3 Informal Finance - MFI Interface

The mission believes that expansion of the formalfinancial system is the most effective way to controlabuses that may occur with informal finance, ratherthan trying to control the latter through unenforce-able rules and regulations. This applies both to in-formal transactions among relatives and friends, aswell as to moneylenders, traders, and the more for-mal interlinked transactions of the type used in con-tract farming arrangements. In the case of interlinkedtransactions, financial institution development isneeded in order to provide the necessary competi-tion and the ability to compare costs of loans andother services being provided by sugar mills, cottongins and other crop buyers.


38

Thus, concerned ministries, financialinstitutions, marketing bodies and commodityorganizations should combine efforts to initiateand develop an ongoing Long-Term StrategicPlan for the Provision of Financial Services tothe Agricultural Sector. To ensure optimum ef-fectiveness, three requirements would need tobe met. First, it would require management bya prominent organ in the public sector in orderto facilitate information gathering and analysis.Second, it would need to enjoy a high degreeof independence, so that the outputs of its workwould command respect, and carry weight fora large number of stakeholders. Third, it wouldneed to be triggered by a carefully preparedHigh-Level Policy Workshop.

Much support, including from donors, will needto be continued for these MDIs to take fulladvantage of their new status.

Financial service provision in the context ofother business arrangements with the agricul-tural sector works best when it operates in acompetitive context. The existence of contractfarming and/or other interlinked transactionsinvolving loans should be an encouragementto the establishment of specialized institutionalarrangements. It should not be a deterrent tosuch efforts.

5.2.4 Member-owned Organizations

Nearly every aspect of the situation of member-owned organizations is muddled. This includes theway in which they are promoted in rural areas, intheir status and operational procedures in rural com-munities, the manner in which they interact with otherfinancial intermediaries, and even their interface withthe apex bodies which are meant to support them.A number of problem areas contribute to this situa-tion.

Firstly, although member-owned organizations havethe greatest ability among financial intermediariesto offer lower rates for loans, they are highly vulner-able to manipulation by individuals and/or small-group interests. Until the general level of educationis raised in rural areas, the scope for SACCOs andother member-owned organizations to realize thepotential of this institutional model will be limited. Itis understood that a few SACCOs have managed toimprove their governance/management situation andsurvive as intermediaries working for the benefit oftheir broader memberships.

Four further points relating to SACCOs and othermember-owned organizations are already clear.

Secondly, SACCOs have received much attentionin some political and development circles becauseof the large numbers of people they are believed torepresent. This has led to many projects and pro-grams designed to assist them. But even with thebest of intentions these efforts are doomed to fail-ure because of the scarcity of solid data on theSACCO movement and its performance. Withoutsuch data (more detail as to requirements is givenin Chapter 4), it is not possible to formulate the policychanges that are needed, let alone deliver the policy-based outcomes which are desired, nor is it feasibleto design and implement effective support projectsand other initiatives.

5.2.5 The Key Role of Marketing in FinancingAgricultural Production

Adequate financing of the marketing chain will fa-cilitate individual operators to handle larger volumes,and permit investments leading to a reduction in post-harvest losses. Both of these help build efficiencyand lower marketing margins.

Access to suitable financial products can also havea positive feedback effect on farm gate prices,through forward selling, “put” options, contract grow-ing and other marketing mechanisms which providesome price security to those in the commodity chainwho assume ownership of farm produce – all theway back to the farmer/producer. (See Chapter 3for more details.)


39

Donor support may help those SACCOscommitted to reform by graduating them intoa stronger financial model, perhaps by assist-ing them to develop suitable governance struc-tures, coupled to specific training efforts.

A performance monitoring system isneeded for the SACCO sector. This wouldfocus firstly on the collection of data onthe structure and performance of theseorganizations, identifying, among otherthings, the more promising types of gover-nance structure.

Apart from efforts to increase the use of themarketing methods mentioned above, the areaof farm product price buffering is one wherethe mission feels valuable developmental workcould be done on possible strategicinterventions by the public sector, interventionswhich would reinforce and build on forwardselling and the other means to stabilize pricelevels (see Section 5.4.1 below).

Firstly, the mission strongly supports thecurrent thinking of the Outreach Plan to notprovide funds for on-lending to SACCOs, andbelieves that this should be the policy for allother government and donor programs.

Secondly, the mission strongly believes it isessential that a commitment be made at thehighest levels to develop a clear messageregarding the separation of financial activitiesfrom other functions that farmer groups areencouraged to undertake.

Thirdly, the mission believes that the separa-tion of financial activities from other areas ofbusiness should be reflected in the policiesand support actions of all apex bodies

Finally, the respective roles and responsi-bilities of the various apex bodies needs tobe clarified, so that their scope of opera-tions is clear for their memberships and fordonors from whom they receive support.

5.2.6 Term Finance

Increasing labor productivity in farming – the key toimproving rural incomes – depends on increasedcapital investments and eventually on the availabil-ity of term finance. Uganda has a long way to go inthis field. Many constraints exist, including the issueof land tenure, but it is already clear that further in-vestigative and developmental work is warranted toexplore ways of improving term finance availability,even within the current environment (see Chapter3). On the supply side, commercial banks will bethe main providers, and the requirement for donorinvolvement has been highlighted above in Chap-ters 3 and 4. MFIs and even MDIs are likely to havevery limited ability to enter this market, especially toserve commercial farmers, who in the main consti-tute the main source of effective demand for thistype of finance. Nevertheless, demand for term in-vestment finance is bound to grow from smaller farm-ers, who will generally need to demonstrate success-ful experience with seasonal loans in order to ac-cess term loans.

sale of surplus products (i.e. villagers). This is animportant issue for programs intended to benefit thepoorest among the rural population (see Chapter 3where villagers are distinguished from farmers).

5.2.7 Seasonal Production Finance

The use of improved farming technology and/or pro-ducing on a larger scale requires a concomitant in-crease in the managerial abilities of farmers. Lend-ers need to distinguish between farmers who haveproved that they have this ability, and those whohave not. A second requirement is that lenders ex-tend production finance only to those cultivators whodeliberatively strive to earn cash income from farm-ing activity (i.e. farmers) rather than those whosefocus is subsistence production with the occasional

5.2.8 Donor Support and Coordination.

Systems of coordination are required not only be-tween ministries and local financial institutions. Theyare also required within the donor community, wherethe current score card may well read, “Good, butcould do better” (see Chapter 4). Further efforts areneeded to develop a coherent approach to financialsector development so that individual activities andprojects make a greater contribution to an overallstrategy. Greater consensus is needed as to whatworks and what does not work, what should be doneand what should not be done. Thought should alsobe given to establishing a suitable, ongoing forumfor the exchange of information, with the focus onministries rather than donors, but with donor partici-pation.

5.3 Cluster Two: Issues for Attention by Leg-islators, Government Ministries and theBoU

5.3.1 Macro-economic Management: TreasuryBills

The Treasury bill rates establish a floor for the inter-est rates charged by banks. In the interests of in-creased investment, every avenue should be ex-plored to lower the high cost of borrowed funds for


40

The mission believes that better informationabout investment opportunities in theagricultural sector is needed, in the first in-stance, if banks are to make significant in-roads into this area of lending. The Agricul-tural Enterprise Watchlist, suggested in An-nex 4, would be a useful support measure (seealso 5.3.4 below). The special challengesinvolved in developing term finance, especiallythe limited supply of long-term savings, needto be addressed. The results of the EuropeanInvestment Bank Apex Private Sector LoanScheme should be evaluated to determine ifand how it affected agricultural lending. Theremay be an opportunity for increased donorsupport for term lending, if such support canaddress underlying problems rather thansimply supplying long-term funds to substitutefor the missing domestic savings.

Lenders should identify the twin triggers ofeligibility for seasonal borrowing by smallfarmers: first the intention to produce for themarket; second the managerial ability to copewith the increased managerial task that theuse of production finance and purchased in-puts involves.

The mission has suggested several initiativeswhere consultation is the key to effectiveplanning and implementation. The High LevelPolicy Workshop provides the first of suchexercises, one that should lead to bettercoordination between key ministries, otherconcerned public and private sector entities,and donors. It is crucial for donors to be fullyengaged in the Workshop so they contributeto the design of a long-term strategy andincorporate the outcome into their bilateral andmultilateral programs of assistance to Uganda.

the benefit of all borrowers, including those in agricul-ture and rural areas. Accordingly…

5.3.2 Legislative Issues: Land and ContractEnforcement

An important impediment to the greater involvementof lenders, especially longer term lenders in agricul-ture, is the current landholding and tenure system,which in most areas of the country does not facili-tate the use of land as collateral, despite the legisla-tive attempt to clarify the situation by providing Cer-tificates of Occupancy for customary tenants (seeAnnex 3). The mission recognizes that tackling thisissue is a potential minefield for any government,but wishes to make two observations. First, there islittle doubt that this situation, common in Africa, is amajor constraint to rural development, and will there-fore have to be addressed at some stage in the fu-ture. Issues of short-term conflict reduction as wellas long-term rural development are involved. Sec-ond, given the momentum behind Uganda’s eco-nomic reform efforts and the public support thesereforms have garnered, this might be a good time toaccelerate efforts to fundamentally address the landissue in its several dimensions.

The current situation for settling smaller legal issuesin the commercial sector is unsatisfactory, and is adeterrent, especially for transactions of commercialbanks. The reforms under way in the Justice Lawand Order Sector will be crucial for streamlining theprocedures used to enforce loan contracts, resolvedisputes and reduce intermediation costs.

As a special field of contract law, financing in themarketing chain will be facilitated by greater clarityin the legal status of warehouse receipts. In this re-gard……

5.3.3 Insurance as a Financial Service for theAgricultural Sector

Insurance products for the agricultural sector overthe 20-year horizon will be confined to cover forequipment, buildings and harvested crops, togetherwith life cover. Crop insurance is not seen as be-coming important within this time period. However,there will be a growing demand (through loan condi-tions) for mortality cover on valuable, credit-financedlivestock. MFIs and other lenders may similarly re-quire cover on the life of a borrower for term loans(see Chapter 3 and Annex 5). Thus there is somepotential for designing useful insurance products,especially to support term finance, by assisting bothlenders and borrowers in managing risk.

5.3.4 Information Management

The information interface between the financial ser-vices sector, on the one hand, and the agriculturaland fisheries sectors, on the other, is weak inUganda. Attention by all parties to improved infor-mation management should assist in ensuring opti-mal mutual support, to the benefit of financiers, farm-ers and fishermen, and traders operating in thesesectors (see Chapters 3 and 4, and Annex 4).

A two-way flow of information is needed. Financialinstitutions need information on enterprise opportu-nities in Uganda such as could be provided by theAgricultural Enterprise Watchlist suggested in An-nex 4. Such a Watchlist could be a means of out-reach for NAADS, while at the same time constitut-ing a useful interface point between the government


41

specific warehouse receipt legislation, currentlyunder consideration, is a step in the rightdirection, and clearly deserves attention bylegislators.

it is vital to implement macroeconomic andother reforms that will stabilize and reducethe Treasury bill interest rates.

The mission is bound to join those who seethe land tenure issue as being an area forurgent and bold attention, at the highestlevels. A practical start could be arenewed push to clean up the existing landrecords, and the system by which these arecreated and stored. This could then leadto more fundamental changes, permittinggreater security/certainty of ownership,thus facilitating investment and unlockingthe real wealth that exists in the land inthe country.

Product design assistance for insurers maybe required here, while MFIs may needassistance in developing the necessary busi-ness arrangements with insurers and linkagesbetween insurance products and loans.

Policy makers need information on theperformance (in a broad sense) of those pro-viding financial services, in order to make andmonitor supportive policies. An institutionalmechanism should be established in order toeffect this.

More resources may have to be identifiedand committed to introduce reforms in andstreamline the procedures of district courts.

extension services and the banking sector. It wouldinclude information on typical rates of return for in-vestments in the agricultural production sector, anddownstream in the processing/marketing chain.

Agricultural production must be demand driven inorder to realize optimum factor returns, and there-fore produce attractive profits from credit-financedinvestments in the sector. Uganda’s excellent mar-ket information system, Foodnet, needs to be morewidely used by the production sector, and to be morewidely known by the financial sector. It is a basicdecision-making tool for producers and those in themarketing chain.

5.3.5 Education and Training

Education has already been noted as an essentialrequirement for improving the key governance is-sue for member-owned institutions in Uganda. Otherareas are within financial intermediaries, as well asamong borrowers themselves (see Chapter 4). Butit is not only general education and skills trainingthat are important. Systems of knowledge manage-ment (incorporating presentation and disseminationof key material) are also required. International at-tention in rural finance circles is now beginning tofocus on this potentially fruitful field, and Ugandacould be well placed to benefit. (See Annex 4; ap-proaches for information and assistance could alsobe made to the FAO-coordinated, multi-donor initia-tive, Rural Finance Learning Centre – [email protected] or [email protected])

5.4 ClusterThree: Unfinished Business

5.4.1 Further Actions and Developments

The present mission has been unable to completework in areas where it is clear that further efforts areneeded. Among the more pressing are the follow-ing:

? Carry out a more detailed investigation of possiblestrategic interventions by government to reducethe magnitude of farm-gate price-level uncertaintyfor key crops, e.g. maize (see Chapter 3).

? Prepare an Issues Paper as preparation for a HighLevel Policy Workshop (see Chapter 4).

? Collect and analyze information on the structureand performance of member-owned organizationsin rural areas, with a view to facilitating stakeholderdeliberations leading to development of a long-termstrategy for this sector (see Chapter 4).

? Conduct a detailed analysis of the factors thatimpede and facilitate the expansion of branchesof financial institutions into rural areas. Thisshould include an analysis of banking regula-tions, the impact of poor rural infrastructure andinsecurity outside of major urban centers, andthe efficacy of incentives, such as matchinggrants, in encouraging more branching. It shouldalso include information on business opportuni-ties for financial intermediaries in the rural non-farm economy.

? Preparation of a support project to improve landtitling and security of tenure (see Chapter 2 andRecommendation 5.3.2 above). Long-term is-sues surrounding land titling, registration, trans-fer, and its use as loan collateral require carefulstudy.


42

NAADS should start an Agricultural EnterpriseWatchlist, possibly as a collaborative exercisewith the DFD Department of the BoU and/orthe Uganda Institute of Bankers.

It is vital that the market information service(Foodnet) continues to be sufficiently well-funded, as a valuable public good.

Information on the support for improved trainingcurrently and potentially available deserves tobe more widely known so that managers infinancial institutions can draw on the resourcesas an important part of building capacityamong their staff and their clientele.

References

African Development Bank, Appraisal Report, “Na-tional Livestock Productivity ImplementationProject”, Kampala, Uganda, Oct. 2002.

Alan, Newlyn R., “The Ugandan Financial system:Its Evolution and Current Problems”, Republic ofUganda Policy Framework Paper, International Bankfor Reconstruction and Development, Washington,DC, 1990.

Apex Sub Committee of the Uganda MicrofinanceForum, “UCAP, The Uganda Micro Finance Capac-ity Building Framework,” Kampala, Uganda, Revised27 August, 2001.

Collier, Paul, and Ritva Reinikka, “Reconstructionand Liberalization: An Overview,” in Ritva Reinikkaand Paul Collier, (eds.) Uganda’s Recovery: The Roleof Farms, Firms and Government, The World Bank,Washington D.C, 2001.

Daumont, Roland, Francoise Le Gall, and FrancoisLeroux, “Banking in Sub-Saharan Africa: What WentWrong?” IMF Working Paper WP/04/55, Washing-ton, DC, April 2004.

Deininger, Klaus and John Okidi, “Rural Households:Incomes, Productivity, and Nonfarm Enterprises,” inRitva Reinikka and Paul Collier, (eds.), Uganda’sRecovery: The Role of Farms, Firms, and Govern-ment, World Bank, Washington, DC, 2001.

Deininger, Klaus and Raffaella Castagnini, “Inci-dence and Impact of Land Conflict in Uganda,” PolicyResearch Working Paper 3248, World Bank, Wash-ington, DC, March 2004.

Deininger, Klaus, “Causes and Consequences ofCivil Strife: Micro-Level Evidence from Uganda.”Policy Research Working Paper 3045, World Bank,Washington, DC, May 2003.

Eaton, Charles and Andrew Shepherd, ContractFarming: Partnerships for Growth, FAO, Rome,2001.

Ferris, R.S.B., A.K. Muganga, P. Robbins andS.Kolign “New Approaches to Market Information toEnhancing Agricultural Competitiveness in EasternAfrica”, Kampala, mimeo, 2003.

Final Evaluation, Rehabilitation of Productive En-terprises Project, USAID/Kampala, June 1994.

Financial System Development Project,Microfinance in Uganda, Lessons from Finca, FSDSeries No. 4, Financial System DevelopmentProject, Bank of Uganda and German TechnicalCooperation, Kampala, 2000.

Food and Agriculture Organization, The State ofWorld Fisheries and Aquaculture 2000, FAO, Rome,2000.

Glenn D. Westley and Brian Branch, (eds.), SafeMoney: Building Effective Credit Unions in LatinAmerica, InterAmerican Development Bank, Wash-ington, DC, 2000.

Government of Uganda, “Plan for the Moderniza-tion of Agriculture,” Ministry of Agriculture, AnimalIndustry and Fisheries, Kampala, Uganda, 2000.

Grimpe, Barbara, Rural Microfinance Clients inUganda: Finca Client Analysis, FSD Series No. 6,Financial System Development Project, Bank ofUganda and German Technical Cooperation,Kampala, 2002.

Hannig, Alfred and Edward Katimbo-Mugwanya(eds.), How to Regulate and SuperviseMicrofinance? Key Issues in an International Per-spective, FSD Series No. 1, Financial System De-velopment Project, Bank of Uganda and GermanTechnical Cooperation, Kampala, 2000.

Hannig, Alfred, Peter van Dijk, and ThomasSchuppius (eds.), Agriculture Finance in Uganda –A Debate on the Way Forward: Proceedings of the5th FSD Annual Dialogue Seminar, FSD Series No.9, Financial System Development Project, Bank ofUganda and German Technical Cooperation,Kampala, 2002.

Heney, Jennifer A., “Enhancing Farmers’ FinancialManagement Skills,” FAO/GTZ, Rome andEschborn, 2000.

International Fund for Agricultural Development,“Rural Marketing Diagnostic Study Report,” Rome,August 2003.

Jagger, Pamela and John Pender, “Impacts of Pro-grams and Organizations on the Adoption of Sus-tainable Land Management Technologies inUganda,” EPTD Discussion Paper No. 101, Interna-tional Food Policy Research Institute, Washington,DC, March 2003.

Kalyango, David L. and Fiona Musana (eds.), AnInsight into Microfinance Practice in India and Indo-nesia, FSD Series No. 8, Financial System Devel-opment Project, Bank of Uganda and German Tech-nical Cooperation, Kampala, 2002.

Kasekende, L., and M. Atingi-Ego, “Financial Liber-alization and its Implications for the Domestic Fi-nancial System: The Case of Uganda, AERC Re-search Paper 128, Nairobi, Kenya, 2003.

Kisaame, Juma, “Case Study of DFCU Leasing Com-pany – Uganda,” Paper presented at the Paving theWay Forward for Rural Finance International Con-ference Sponsored by the Agency for InternationalDevelopment, Washington, DC, June 2-4, 2003.


43

Klein, Brigitte, et.al., Better Practices in AgriculturalLending, Agricultural Finance Revisited No. 3, FAOand GTZ, FAO, Rome, 1999.

Land Act Implementation Study, Draft Report, Kampala,August, 1999.

Ledgerwood, Joanna, Deborah Burand, and GabrielaBraun (eds.), The Micro Deposit-Taking InstitutionsBill 2002: Summary of Workshops and InformationExchange Events, SPEED-USAID and FinancialSystem Development Project, Bank of Uganda andGerman Technical Cooperation, Kampala, Novem-ber 2002.

MAAIF/FAO “Towards a National Policy and Strat-egy for Marketing, Processing and Storage of Agri-cultural Commodities in Uganda,” PMA Secretariat,Kampala, May 2002.

Microfinance Forum, Apex Subcommittee on RuralFinance, “Strategic Plan for Expanding the Outreachand Capacity of Sustainable Microfinance inUganda,” Kampala, Uganda, April, 2002.

Ministry of Agriculture, Animal Industry and Fisher-ies (MAAIF), “Meat Production Master Plan”,Entebbe, Uganda, October, 1998.

Ministry of Agriculture, Animal Industry and Fisher-ies (MAAIF), “The National Meat Policy”, Entebbe,Uganda, July 2003.

Ministry of Agriculture, Animal Industry and Fisher-ies and Ministry of Finance, Planning and EconomicDevelopment, Plan for Modernisation of Agriculture,Eradicating Poverty in Uganda: Government Strat-egy and Operational Framework, Kampala, Uganda,2000.

Ministry of Finance and Economic Planning,“Entandikwa Credit Scheme, Operational Guide-lines,” Kampala, Uganda, 1995.

Ministry of Finance, Planning and Economic Devel-opment, Poverty Eradication Action Plan, Volume3, Building Partnerships to Implement the PEAP,Kampala, Uganda, December, 2001.

Ministry of Finance, Planning and Economic Devel-opment, Poverty Eradication Action Plan, PEAP, ASummary Version, Kampala, Uganda, May 2000

Ministry of Water, Land and Environment, “LandSector Strategic Plan, 2001-2011: Utilising Uganda’sLand Resource for Sustainable Development,”Kampala, Uganda, (date unknown).

Mpuga, P., “Credit Demand and Small Scale Indus-trial Development in Uganda”, Paper presented at1st Industrialisation Workshop, 12th -13 th August,Centre for Basic Research, Kampala, Uganda, 2003.

Mutesasia, Leonard K. and Nthenya R. Mule, “Un-

derstanding the West Nile SLAs and Charting a Pathfor the Future,” Final Draft Report presented to theDFID Financial Sector Deepening Project, Kampala,October 2003.

Nkonya, Ephraim, John Pender, Pamela Jagger, DickSserunkuuma, Crammer Kaizzi and Henry Ssali,“Strategies for Sustainable Land Management inUganda,” Research Report Manuscript, Submittedto the IFPRI Publications Review Committee, IFPRI,Washington, DC, July 2003.

Nkonya, Ephraim, John Pender, Pamela Jagger, DickSserunkuuma, Crammer Kaizzi, and Henry Ssali,“Strategies for Sustainable Rural Development inUganda,” Research Report Manuscript, InternationalFood Policy Research Institute, Washington, DC,November 2003.

Okoth-Ogendo, H. W. O., “Legislating Land Rightsfor the Poor: A Preliminary Assessment of theUganda Land Act 1998.” Uganda Land AllianceStrategic Planning Workshop, Mukono, Uganda,1998.

Omano, Stephen “Fertilizer Trade and Marketingin Uganda” International Food Policy ResearchInstitute, Kampala, Uganda, 2000.

Pender, John, Ephraim Nkonya, Pamela Jagger,Dick Sserunkuuma, and Henry Ssali, “Strategiesto Increase Agricultural Productivity and ReduceLand Degradation: Evidence for Uganda,” Contrib-uted Paper Presented at the 25th International Con-ference of Agricultural Economists, August 16-22,2003, Durban, South Africa.

Reinikka, R., and J. Svensson, “Investment Re-sponse to Structural Reforms and Remaining Con-straints: Firm Survey Evidence from Uganda”, inRitva Reinikka and Paul Collier, (eds.) Uganda’sRecovery: The Role of Farms, Firms and Govern-ment, The World Bank, Washington DC, 2001.

Republic of Uganda, “Background to the Budget,”Ministry of Finance, Planning and Economic De-velopment, Kampala, Uganda, 2001.

Republic of Uganda, “Background to the Budget,”Ministry of Finance, Planning and Economic De-velopment, Kampala, Uganda, 2002.

Ribot, J. C., “Decentralization, Participation andAccountability in the Sahelian Forestry: Legal In-struments of Political-Administrative Control,” Af-rica 69(1): 23-65, 1999.

Roberts, Richard and William Dick (eds.), Strate-gies for Crop Insurance Planning, FAO, Rome,1991.

Sebageni, Grace, Steven Kaagwa, and LeonardMutesisira, “Where There is No Banker: Financial


44

Systems in Remote Rural Uganda,” MicroSave Africa,Nairobi, February - May, 2002.

Staschen, Stefan, Possible Mechanism to RegulateTier 4 MFIs in Uganda, Financial System Develop-ment Program, GTZ, Kampala, Uganda, May 2003.

Uganda Commercial Bank (UCB), 22nd Annual Re-port, Kampala, Uganda, 1987.

USAID “Final Evaluation, Rehabilitation of Produc-tive Enterprises Project,”USAID/Kampala, June1994.

Wright, Graham A. N. and Paul Rippey, “The Com-petitive Environment in Uganda: Implications forMicrofinance Institutions and their Clients,”MicroSave-Africa, Nairobi, September 2003.


45

Annex 1


Terms of ReferenceBackground

The overriding goal of both the Ugandan/Germanand the Ugandan/Swedish co-operation is to con-tribute to the Ugandan Poverty Eradication ActionPlan by enhancing economic growth. It aims to in-crease the efficiency of the financial sector and theutilisation of financial services by micro, small andmedium enterprises and low-income households.Both co operations systematically support the Bankof Uganda and other partners in important fields ofthe deepening of the financial system such as bank-ing supervision, development of the payment sys-tem, promotion of innovative financial products,capital market development etc.

The development and deepening of the financialsystem is one of the key areas of co-operation be-tween the Governments of Uganda (GoU), Germanyand Sweden. Therefore, the German/Swedish sup-port is not only limited to the current fields of inter-vention but constantly strives to identify areas forpossible further co-operation.

One of the fields which are vital for financial sectordeepening in Uganda is Agricultural Finance. In April2002, the German/Swedish Financial System De-velopment Programme (FSD) organised the dialogueseminar on “Agricultural Finance in Uganda – aDebate on the Way Forward” which provided a fo-rum for discussion on the pertinent issues in agricul-tural finance. The participants of the widely-attendedseminar came up with the following conclusions:

? The market alone will not ensure the emergenceof Agricultural Finance

? Government has a role to play in providing incen-tives for the development of an agricultural financemarket

? There are market opportunities proving that apositive combination of increased outreach andfinancial sustainability of financial services pro-viders interested in agricultural finance is fea-sible

? Setting the right policies is an essential pre-con-dition for the development of an agricultural financemarket

? Building up an agricultural finance system can bea fragile and long-term process

? The Central Bank in charge of regulating andsupervising financial institutions, the overall sta-bility of the financial system and the protectionof the interests of depositors, has a direct inter-est in the deepening of the financial sector whichincludes the expansion of financial services tothe rural population.

? External incentives, including well-designed spe-cific subsidies, can help to correct market fail-ures without distorting the private sector-ledmarket development process

? An agricultural finance Apex body, a “bank foragricultural banks and agricultural finance institu-tions” as well as a capacity builder and policyadvocate, appears to be an interesting optionfor supporting the complex, gradual and time-consuming process of building up self-sustain-able agricultural finance providers that are fullyintegrated in the national financial sector

The discussions held at the seminar stressed theneed for an overall agricultural finance policy to con-tribute towards an enabling environment for self-sustainable agricultural finance in Uganda. Duringthe following discussions, MFPED (Ministry of Fi-nance, Planning and Economic Development) andBoU (Bank of Uganda) welcomed the suggestion byFSD to kick-start a policy initiative on agriculturalfinance via a study to identify the major pertinentbottlenecks.

It is to that effect, that GTZ, KfW and Sida are jointlysupporting the BoU in conducting the present study.

1 The Policy Framework

In Uganda, a comprehensive political frameworkwhich provides the basic principles for designing amore specific framework for agricultural finance isalready in place. The Poverty Eradication Action Plan(PEAP) outlines the government’s strategy to trans-form the country into a modern economy whereagents in all sectors can participate in economicgrowth. The pre-requisites for this include themodernisation of agriculture and the developmentof industries, which build on demand and supply link-


46

ages from agriculture. One of the fields of interventionmentioned as strategic area for promotion of economicgrowth and transformation is “financial sector reform”.

In May 2001 GoU launched the Plan for Modernisationof Agriculture (PMA) as a strategic framework toeradicate poverty by improving the natural resource-based livelihoods of the rural poor in a sustainablemanner. It lays out a set of principles and prescribesthe role of GoU in assisting the development of therural sector. It also describes the new institutionalframework by which sustainable rural livelihood willbe promoted. The PMA includes the development of aviable and sustainable rural financial system as animportant element for the development of theagricultural sector.

As a response to the need of the low-income popula-tion especially in rural areas the Cabinet recentlypassed the Outreach Plan, which was developedunder the auspices of the PMA and the MicrofinanceForum (MFF). The Outreach Plan seeks to furtherstrengthen the outreach of microfinance institutionsto rural areas. However, empirical evidence showsthat many of the obstacles to the delivery of sus-tainable financial services lie in the real sector (e.g.deficient infrastructure, lack of support services forfarmers and non-availability of efficient markets) andcannot be overcome by strengthening financial in-stitutions alone. Further, the microfinance sector inUganda still has limitations given that only few insti-tutions achieve large number of clients in a sustain-able manner, whereas most of the institutions re-main weak. The expansion of financial services es-pecially when supported by external donors and con-cessionary funds hold risks for reaching self-sustainability in a market environment. The OutreachPlan shows that it is widely recognised thatmicrofinance can play a vital role in expanding out-reach and alleviating poverty. However, microfinancealone cannot address the challenge of agriculturalfinance. A consistent and comprehensive policyframework as a basis for strengthening financial in-stitutions as well as for addressing the real sectorproblems is needed.

In Uganda, the design and implementation of sucha policy framework by all stakeholders involved re-main a major challenge on the agenda of the Ugan-dan government. Setting appropriate policies andguiding the development of an agricultural financemarket are imperative for Uganda, where 80% ofthe population depends on agriculture.

2 Objective of the Study

The study aims at the identification of the majorbottlenecks in the current policy framework and thedraft of a medium-term strategy for the support of

agricultural finance in Uganda. The results of the studywill provide the basis for further discussions with thenational and international stakeholders including theassignment of roles and responsibilities for furtheraction to be taken.

3. Specific tasks of the Consultants

Specifically the consultants will carry out the follow-ing tasks:

? Review past policy initiatives on agricultural financeand their impact and sustainability.

? Review the policies and strategies on financialsector development and on rural/agriculturaldevelopment outlined in the PEAP and the PMA.To effectively do this, the consultants will makethe necessary consultations with all relevantorganisations and stakeholders and establish thecurrent position on all issues contained in thestrategy document.

? Undertake consultations with public, private andcivil society sector representatives on past agri-cultural finance initiatives and their relative im-pact on the agricultural sector. Define stakehold-ers, group them and identify representatives (fo-cal groups) of the groupings for discussions. Thisactivity should include consultations with GoUofficials.

? Suggest criteria for classification of agriculturalproducers (e.g. export orientation, commercialfarming, subsistence production) and identify themayor bottlenecks for agricultural finance foreach class of producers. The analysis shouldinclude constraints found in the real sector (e.g.roads, irrigation, markets, agricultural researchand extension, taxation, agricultural trade policyand development of product prices).

? Review the supply side of agricultural finance(Bank of Uganda – Development Finance Depart-ment, commercial banks, development financeinstitutions, micro finance institutions, informalproviders of loans and different government, NGOand donor programmes). The review of the supplyside shall include the financial products currentlyoffered to farmers of the different sub-groupsfocusing on terms and conditions. The study shallalso provide an overview on typical contractualarrangements in crop deals such as interlinkedtransactions and briefly discuss their strengthsand weaknesses.

? Availability and design of crop insurance schemes.

? Review the state of implementation and the activi-ties of the Outreach Plan and make an assess-ment of its potential to expand the provision of


47

financial services to small farmers.

? Identify the major bottlenecks of the current policyframework for agricultural finance.

? Formulate proposals for a medium-term strategyfor the support for agricultural finance in Ugandaincluding potential roles of national stakeholdersand international donor agencies. The proposalsshall build on the existing policy framework suchas the financial sector policy, the PEAP, the PMAand the Outreach Plan.

? Discuss the proposals with all relevant stakehold-ers in a seminar that will take place in the lastweek of the mission.

4. Team of Consultants

The team of consultants comprises two internationalexperts with a strong background in agricultural fi-nance and a local consultant experienced in the topic.The mission will be sponsored by KfW and the FSDProgramme.

5. Timing

The assignment will be carried out between and .In the last week of their assignment a seminar willbe held where the consultants present their propos-als to the stakeholders. The recommendations of theconsultants will include the discussions of the semi-nar.

6. Output

Based on the seminar and the findings of the mis-sion, the consultants will draft and submit a compre-hensive draft report within 14 days of completion ofthe onsite visit to Uganda. The final report shall besubmitted to KfW and FSD by 11 th of July.


48

Annex 2

Savings and Credit Cooperative Societies (SACCOs)

One of the potentially most important types of finan-cial institutions for serving rural areas are member-owned and managed SACCOs. By volunteering theirtime to govern the organization and sometimes to staffday-to-day operations, the members can reduceoperating costs and supply financial services to someremote and sparely populated areas that would betoo costly for branches of banks or MFIs using paidstaff.

As of October 2002, 6,580 cooperatives were re-portedly registered with the Registrar of Coopera-tives, of which 680 were supposedly SACCOs.1

Relatively little systematic information is availableabout them. It is generally believed that most areweak and many exist in name only. The Commis-sioner of Cooperatives has the responsibility for reg-istering cooperatives but has little capacity to regu-late or supervise them. The Uganda CooperativeAlliance (UCA) Ltd. is an apex institution with re-sponsibilities to promote and defend the entire co-operative sector, but it also has little capacity to ei-ther strengthen or regulate it. The Uganda Co-op-erative Savings and Credit Union (UCSCU) Ltd. isthe federation or league with SACCOs as members.It claims to have 300 members but for a recent train-ing activity was able to produce names and ad-dresses for only a small fraction of this number.Rather surprisingly, the UCA rather than UCSCU isimplementing a project funded by the Swedish Co-operative Center and the Canadian Co-operative As-sociation to create and strengthen so-called villagebanks, which are community-based SACCOs.2

1 The USAID/WOCCU Project

The World Council of Credit Unions (WOCCU) hasimplemented several projects in developing coun-tries to rehabilitate credit unions. Its approach in-volves improving human resources, introducing dis-

cipline in the management of financial resources, andimproving governance by introducing modernmanagement tools and programs that generate in-formation needed by managers, boards of directorsand members to understand the performance of theirorganizations. For managers and members who arecommitted to reforms, the adoption of this approachhas succeeded in ing many moribund credit unionsinto dynamic competitive financial institutions. 3

WOCCU had an USAID-financed SACCO rehabili-tation project in Uganda that made some progress,but failed to meet performance standards so wasterminated early at the end of 2003. The goal of theproject was to build strong financial discipline, intro-duce transparent accounting systems, reform poli-cies, and develop competitive products. The projectworked initially with 19 SACCOs but five weredropped because of failure to implement the project’stechnical advice, high delinquency of board mem-bers, dishonesty, financial insolvency and inappro-priate financial practices. The project provided tech-nical advisors, paid the salaries for some credit unionmanagers, conducted training, introduced manage-ment and computer systems, and supported the costof stationery, furniture, renovations, and other op-erational expenses of the participating SACCOs. Italso attempted to strengthen UCSCU and recentlyhelped to overhaul its bylaws.

The data in the table below present some compara-tive statistics for the 14 SACCOs remaining in theproject as of September 30, 2003. At that time, mostof them had been participating in the project for 30months. They were selected to participate becausethey were considered to be among the largest andbest in the country and, therefore, were expected tobenefit from this type of assistance. They were con-centrated in the central part of the country. Threewere classified as urban, one as peri-urban and therest were rural. The rural ones include some farmermembers. Ten are open to anyone in the commu-nity while the others are tied to a particular place ortype of employment. The data provide insights into1 Stefan Staschen, Possible Mechanisms to Regulate Tier 4

MFIs in Uganda, Financial System Development Programme,GTZ, Kampala, May 2003.2 The use of the term village banks is a bit confusing herebecause in most countries that term is used for some type offinance programs patterned after FINCA International that iscredited with coining the term. However, these village banks donot seem to be created to follow an explicit FINCA model.

3 A description of the methodology and the results obtained inrehabilitation projects can be found in Glenn D. Westley and BrianBranch, (eds.), Safe Money: Building Effective Credit Unions inLatin America, InterAmerican Development Bank, Washington,DC, 2000.


49

the nature and severity of the problems faced by thissegment of the financial markets.

The 14 SACCOs have a total membership of over18,000 but they are heterogeneous in many charac-teristics. The smallest has only 259 members whilethe largest has over 4,500 members. Total consoli-dated savings were Ushs4.0 billion (over US$2.0million) with an average of almost Ushs220,000 permember (US$110). The largest (I) reported overUshs1.2 billion (about US$600,000) in savings, about30 percent of all savings reported. In addition, the14 reported over Ushs547 million (US$280,000) inconsolidated share capital. The largest amount ofaverage savings per member was reported by thefairly small SACCO labeled as M with close toUshs1.8 million (US$900). There are exceptions,but some of the largest amounts of average savingsper member are found in SACCOs with the fewestmembers.

Credit unions have a strong history of mobilizingsavings and as a group these 14 are net savers.

Total savinhs2.4 billion (US$1.3 million), orUshs133,544 (US$68) per member. The largestSACCO, I, also has the largest amount of total loansoutstanding of Ushs626 million, but the largestamount outstanding per member is found in thesmallest (G) with only 259 members, each owing anaverage of Ushs805,710 (over US$400). On theone hand, some SACCOs are fairly cautious in lend-ing. For example, the amount of loans outstandingin B is equal to only 17 percent of its savings, and ithas 57 percent of its total assets in financial assets,much of it in T bills. On the other hand, others aremore aggressive. For example, the amount of loansoutstanding in D was 125 percent of savings and ithas the largest external debt amounting to one thirdof total assets.

All of these SACCOs have bank accounts and somehave deposits in other SACCOs and in UCSCU. Twohave made investments in T bills. The minimum sizeof loan made is usually Ushs50,000 and the maxi-mum of Ushs1 to 8 million. The annual nominalinterest rates on loans range from about 18 to 48

Membership and Performance of 14 SACCOs, as of September 30, 2003

Notes: *For reasons of confidentiality, the names of the SACCOs are suppressed.Source: WOCCU


50

SACCO Number Total Average Total Average Portfolio Operatingof Savings Savings Loan Loan at Risk ExpenseMembers (000 Ushs) per Outstanding Outstanding (% Over Ratio (%)

Member(s) (000 Ushs) per member 30 days)

A 1,450 48,342 33,339 55,927 38,570 58.2 11.0

B 1,033 403,821 390,920 68,214 180,853 26.9 12.2

C 691 18,273 26,444 18,539 26,829 58.0 23.8

D 580 49,819 85,895 62,535 107,819 62.8 23.6

E 789 56,949 72,179 26,230 33,245 14.8 44.9

F 1,380 183,839 133,217 167,712 121,530 30.6 92.8

G 259 190,248 734,548 208,679 805,710 25.4 27.1

H 755 64,514 85,449 52,658 69,746 62.0 45.2

I 4,549 1,207,853 265,521 626,600 137,745 60.1 23.0

J 1,408 126,404 89,776 113,129 80,347 57.3 13.8

K 3,212 106,921 33,288 94,914 29,550 51.5 41.9

L 787 670,362 851,794 609,373 787,005 5.6 1.1

M 491 873,927 1,779,892 326,545 665,061 76.1 4.2

N 973 22,069 22,681 10,424 10,713 63.3 20.2

Conso- 18,357 4,023,341 219,172 2,451,479 133,544 41.7 9.8lidated

percent. They tend to link loan sizes to existing sharecapital rather than to an analysis of the member’sdebt repayment capacity. The nominal annual in-terest rate paid on savings ranges from 2 to 8 per-cent.

Lack of financial discipline and inability to cover costsare two of the biggest problems faced by theseSACCOs. For example, only one (L) had single digitlevels of portfolio at risk that are similar to the stron-gest NGO – MFIs. Nine had 50 percent or more oftheir portfolio in arrears 30 days or more and theoverall average was over 40 percent. This high rateof arrears can be attributed to poor lending prac-tices and collection policies. If a significant amountof these loans are never repaid, member savingswill be lost.

Operating cost ratios are highly variable among theseSACCOs. They range from a low of 1.1 percent to ahigh of 92.8 percent, but this latter figure is distortedbecause of accounting adjustments. Eleven of the14 fall in the 10-45 percent range, which is lowerthan the best MFIs. The s of the staff members paidby WOCCU are included in these cost estimates,which elevates the numbers. Even so, these costsseem high. Credit union operating costs frequentlyare relatively low because the members, who areoften poor, resist paying what they perceive to behigh salaries to managers and other employees. Thiscontributes to low operating costs, but often themanagers and employees do not have strong finan-cial and management skills.

The project discovered several long-term manage-ment problems in these SACCOs. Often there wasa lack of commitment on the part of boards and/ormangers to make necessary changes. The data pre-sented in the form of averages above mask someof the problems that emerge with closer examina-tion. Many loans have been delinquent for a longtime, and there is a resistance to adopt adequateloan loss provisioning because of the damage thatwould do to reported earnings. As a result, the ac-tual provisioning is only about 40 percent of recom-mended levels. The reported profits, therefore, tendto be exaggerated. The proportion of non-earningassets is high because of these nonperforming loansand large investments in fixed assets. This saps theirliquidity so they frequently don’t have the fundsneeded to make new loans. This problem, in turn,has a negative impact on willingness to repay be-cause the borrowers fear they will not be able toaccess new loans if they pay existing ones. Thelack of profits means the SACCOs cannot pay divi-dends on share capital, stunts the growth in newmembers, and prevents the accumulation of reservesneeded for future investments, modernization andgrowth.

2. Termination of the Project

The decision to end the project was made becauseof its failure to achieve performance targets agreedto with USAID. The SACCOs were slow to improveand there was a reluctance to adopt modern bylawsand management techniques, design new products,follow prudent policies, elect responsible board mem-bers and hold them accountable, and hire compe-tent staff. If this is the situation for some of the bestSACCOs in the country, one can only guess at thesorry state of most others.

The problems encountered with these SACCOs,coupled with the millions of dollars in donor and gov-ernment funds lost in the failed effort to develop theCooperative Bank, suggest that the cooperative ormember-owned and managed segment of the finan-cial markets has experienced grave difficulties, al-beit for different reasons. This segment seems tohave great difficulty in modernizing and followingsound policies and practices required for sustain-able and dynamic financial intermediaries. There-fore, it seems clear that it would a mistake to chan-nel more funds into SACCOs until fundamentalchanges are made starting at the highest levels. Anappropriate legislative, regulatory, and supervisoryframework is essential before money can be pru-dently spent on strengthening the sector at thegrassroots level. There appear to be too many in-centives and opportunities for members and lead-ers to engage in opportunistic behavior, and notenough effective controls to stop it, a situation thatfrequently leads to undesirable outcomes and wastedresources. The sector lacks a strong commitment toimplement reforms needed to improve governance.Therefore, its ability to be an effective leader in thesearch for ways to push out the frontier of formalfinance is seriously constrained.


51

Annex 3

A Note on the Use of Land as Collateral for Agricul-tural Lending in Uganda

Land is the most commonly used asset as collateralfor agricultural lending in most countries. However,for land to effectively act as collateral for agricul-tural loans, a system of public recordkeeping is re-quired that identifies and outlines the dimensionsand/or boundaries of individual properties, registersclaimants’ interests in land (such as who holds amortgage on it, which mortgages have been paidoff, who owns the mineral rights, etc), establishesthe value of land, and contains clear legal proce-dures that specify creditor and debtor rights, proce-dures for foreclosure, seizure and liquidation of prop-erty pledged as collateral for a loan, etc., has to ex-ist. For Uganda the question is whether such a sys-tem exits, which would allow and facilitate using landas collateral for loans advanced to the agriculturalsector.

The Ugandan Constitution vests land in the people.The Land Act of 1998 (LA98) operationalises thisconstitutional provision and stipulates the Act’s imple-mentation modalities in the context of a decentral-ized public administration and politics consistent withthe Local Government Act 1997. Government posi-tion papers link the LA98 with increased productiv-ity and development. Thus, in the government’s view:

to use it as collateral for loans for a variety of purposesincluding making improvements to the land. But whatexactly does the Act offer to individuals with a claimto land that can permit it to be used as acceptablecollateral for agricultural loans?

In Uganda, the first expression of de jure land lawwas the 1900 Agreement. It imported to the countrythe customary law of England in the form of free-hold, for a select group, and customary tenure onwhat was now ‘Crown Land’, for the majority. Sub-sequent land legislation of1928, 1962, 1969, and1975 altered the legal expression of land arrange-ments and relations between the owners (state andtitle holders), on the one hand, and occupants(bibanja holders, leaseholders and customary ten-ants), on the other. Moreover, the whole realm ofextra-legal social, cultural and political-economicrelations in which these laws operated shaped theireffects and meanings and, thus, the de-facto modesavailable to individuals to access and secure land.(Ribot, 1999: 26).

The Ugandan legal system recognizes four types ofland tenure: customary, mailo, leasehold and free-hold (see table below). In addition, the sub-tenure ofoccupancy is recognized under specific legal condi-tions. Two other sub-tenures, known as renting andborrowing, operate widely but without legal recogni-tion.

Unlike earlier land laws vested land to the State andabolished freehold and mailo tenures; the 1995 Con-stitution restores freehold and mailo tenures andvests land in the people of Uganda. Under the newconstitution, provisions were made to enable cus-tomary tenants on public land to become freeholdowners. Lawful and bonafide occupants on registeredland (i.e., freehold and mailo land) were recognizedand the constitution stipulated that within two yearsof its promulgation, a law (i.e., the LA98) to regulatethe relationship between the ‘occupants’ and the‘owners’ of land would be enacted. Finally, the Con-stitution anticipated that land management would bedecentralized to the districts.

The LA98 provides for certificates of ownership forcustomary tenants on what was formerly public land.On mailo land, the LA98 attempts to resolve conflictsbetween owners and occupants (i.e., lawful and

A key objective of the LA98 is individualization of landthrough certificates of occupation, certificates ofcustomary ownership, and registerable interests thatcan be bought and sold. Underlying this view is theidea that identifiable land rights provide for security oftenure. In turn, identifiable land rights lead to thedevelopment of efficient land markets that enhancelandowners’ access to finance and credit markets andto investments in land and land improvements. In asense, the LA98 should nurture a progressive outlookthat allows one to individually own land and to be able


52

A good land tenure system should supportagricultural development and overall economicdevelopment through the functioning of a landmarket, which permits those who have rightsin land to voluntarily sell their land and forproducers and investors to gain access to land(Position Paper of Department of Lands,Housing and Physical Planning, 1997).

bonafide) through the provision of certificates ofownership and occupancy. However, the LA98 doesnot vest absolute land rights in the hands of eithergroup. Rather, it has enforced ‘bundles of rights’ forowners and occupiers respectively. Thus, the LA98leaves ample room for conflicts over the allocationof rights.

Overall, it appears that the LA98 establishes a regu-lated relationship between lawful and bonafide oc-cupants and mailo registered owners that to someextent provides security of tenure to all the partiesconcerned. Thus, the LA98 restores the mailo ten-ure but subjects registered owners to the rights oflawful and bona fide occupants. Section 30 describesa ‘lawful occupant’ as:

(a) a person occupying land by virtue of the re-pealed

(i) Busuulu and Envujjo Law of 1928;

(ii) Toro Landlord and Tenant Act of 1937;

(iii) Ankole Landlord and Tenant Law of 1937; or

(b) a person who entered the land with the con-sent of the registered owner, and includes a pur-chaser;

(c) a person who had occupied land as a custom-ary tenant but whose tenancy was not disclosed or

compensated for by the registered owner at the timeof acquiring the leasehold certificate of title.

Under the LA98, lawful occupants or ‘tenants by oc-cupancy’ can be issued a Certificate of Occupancyafter verification of the claim and the boundaries ofthe land. With this Certificate and the owner’s con-sent, the tenant may assign/sell, sub-let, pledge orbequeath his/her right of occupancy.

To the extent that a Certificate of Occupancy legiti-mizes a tenant’s occupancy, it constitutes an impor-tant document that lenders could consider as collat-eral in extending seasonal loans to tenants. For ex-ample, such a certificate could serve as evidencethat a standing crop really belonged to the person(s)who claimed to be the tenant(s) and offered it ascollateral for a short-term loan. However, becausethe process of issuing Certificates of Occupancy isin its infancy and is presently being undertaken un-der the Land Sector Strategic Plan (LSSP) only on apilot basis in some districts, it is expected that Cer-tificates of Occupancy will only become crediblecollateral on a wide scale in the distant future.

Section 30 (b) of the LA98 recognizes the land rightsof people that gained occupancy with the consent ofthe registered owner, but it is silent on whether thosewho gained occupancy with the consent of the oc-cupant (bibanja holder) can also claim to be lawfuloccupants. In other words, Section 30 (a) (i) does not

Types of Land Tenure, Features and Incidence

Source: Land Sector Strategic Plan, 2001-2011


53

Tenure

Customary

Leasehold

Freehold

Mailo

Occupancy

Renting

Borrowing

Key features

“Traditional” land tenure, varying in differentareas. More individualized in south and west;more communal in north and east.

49 or 99 year leases, with developmentconditions. Land rent and premium payable.Leasehold title issued.

Registered ownership in perpetuity. Freeholdtitle issued.

Limited form of freehold, which recognizestenants’ rights. Mailo title issued.

Right to occupy land under specificconditions based on occupation prior to 1983.

Use rights to land for a defined period subjectto payment of rent

Use rights to land for a defined period subjectto payment of part harvest

Geographical incidence

Countrywide

Countrywide, especially inurban areas

Predominantly in south andwest

Central region

Countrywide on any registeredland

Varies countrywide

Various countrywide

appear to cover all those who occupy the land by virtueof arrangements with the bibanja holder. Yet this isan important question as a large number oftransactions involving usufruct rights have occurredsince 1975, particularly in Kampala District. However,it is generally held that occupants that purchased landfrom a bibanja holder (now considered the lawfuloccupant) are ‘lawful occupants’ under the Act. Anyinterpretation of Section 30, therefore, ought tolegitimize transactions that have occurred in theinformal land use market. Consequently, under theLA98 the bibanja holder and anyone acquiring userights from the bibanja holder through purchase orother means can be deemed to have security of tenure.Less fortunate and secure are those who occupiedland through license, rental, borrowing, or leasingarrangements, since these arrangements are not‘regulated’ by law.

Section 30 (2) defines a bonafide occupant as aperson who before the coming into force of the Con-stitution:

(a) Had occupied and utilized or developed anyland unchallenged by the registered owner or agentof the registered owner for twelve years or more;or

(b) Had been settled on the land by the Govern-ment.

The twelve-year period specified above is referredto in the Limitation Act. This Act provides that noaction for the recovery of land shall be brought aftertwelve years from the time such right of action arose.Further, Article 30 (5) states: any person who haspurchased or otherwise acquired the interest of theperson qualified to be a bona fide occupant shall betaken to be a bona fide occupant. This means thatland transacted by squatters (before the Act madethem bona fide occupants) will be honored. It is un-clear whether or not the twelve-year qualifying pe-riod applies to those who acquired land interests fromthe person qualified to be a bona fide occupant.Section 31 states that a person who has occupiedland unchallenged by the registered owner for lessthan twelve years does not qualify to be a bona fideoccupant. The provision for squatters to becomebona fide occupants is controversial because, bygranting squatters inheritable occupancy on regis-tered land, the LA98 effectively deprives registeredowners interest in their land.

The Government’s position on these issues is thatthe Constitution both guarantees a qualified right toown property and provides for security of occupancy.These arrangements suggest a potential impassebetween owners who, on the one hand ‘own’ but donot ‘control’ the land and lawful and bona fide occu-pants, on the other hand, exercise control by virtue ofoccupancy. Legal title is further denied its economic

content by the provision that all tenants by occupancyare required to pay Ushs1000 (currently about US$1)per year in rent to the owner, regardless of the size orlocation of the land. It seem to be more reasonableto apply a different rent on urban land, compared torural land, because of the wider range of commercialactivities and land values that urban lands command.Moreover, it would be expected that there would be acorrelation between the plot sizes of rural land andrental charges, especially where commercial farmingis practiced.

Government expects that the outcome that mayemerge will be commercial, that is, it hopes thatowners and occupants will sort out any land owner-ship disputes commercially. Under this line of think-ing, freehold and/or mailo landlords would sell theirrights to tenants thereby allowing the latter to enjoyfull use of the land. However, far from making itpossible for the parties to sort things out commer-cially, Section 32 (9) stipulates that the security oftenure of a lawful or bona fide occupant is not preju-diced by reason that he or she does not possess acertificate of occupancy. In other words, occupantsdo not have to acquire a certificate of occupancy, astheir security of tenure exists with or without this for-mality. Needless to say, this ambiguity would ap-pear to complicate occupants’ land ownership claimsor rights vis-à-vis lenders. Lenders might be morewilling to extend seasonal and short-term credit tooccupants with Certificates of Occupancy comparedto those without.

In a nutshell, the LA98 does not create absolute rightsin land, comparable to western notions of privateproperty. What it does is to legitimize ‘bundles ofrights’ for owners and occupiers. This can be seenas an attempt to incorporate or formalize land trans-actions that occurred alongside (but not outside) theofficially sanctioned registered land market. How-ever, rather than exclusively defining these ‘bundlesof rights’ in a way that would allow the owner of a‘bundle’ to exclude others, the Act leaves ample roomfor conflicts over the allocation of rights. This im-plies that it would be almost impossible to expectthat land titles held by land owners or Certificates ofOccupancy could act as credible forms of collateralacceptable to lenders in the agricultural sector.

The difficulty of this situation can be recognized whenone considers what would have to occur if an occu-pant wished to have a Certificate of Occupancy,which would require him/her to apply to the owner.The owner would inform the Parish Land Commit-tee and a date would be set to verify and adjudicatethe boundaries. The Committee’s determinationwould be sent to both parties and, as long as thereare no rental arrears, the owner must grant consentin the prescribed form to the occupant(s). The Re-


54

corder could then issue the Certificate of Occupancy.The Recorder would also notify the District Registrarof Titles who would note the Certificate as anencumbrance on the title of the land. While the ownerpossesses the ‘right’ to sell the land title, it is anencumbered title and will only be bought by some-one willing to accept the encumbrance(s). In factSection 37 requires that an owner ‘who wishes tosell the reversionary interest in the land’ must givethe first option of purchase to the occupant. Like-wise an occupant, who “wishes to assign the ten-ancy” must give the first option to the owner of theland.

In addition, under the LA98, an occupant may “as-sign, sub-let, or pledge, create third party rights in,sub-divide and undertake any lawful transaction inthe respect of the occupancy.” Before doing so, how-ever, the occupant must have the owner’s consentto the transaction. The owner may grant consent,grant consent with conditions, or refuse consent. Inthe case of the latter two responses, the occupantmay appeal the decision to the District Land Tribu-nal. A copy of every consent form is sent to the Re-corder. No transaction ‘to pass any interest in land’will be ‘valid and effective’ without consent. Thusthe decisions and actions of owners and occupiersare inextricably linked. Their respective ‘bundles ofrights’ cannot be exercised without the acquiescenceof both parties. This has led some to argue that theprovisions relating to the tenant by occupancy mayhave rendered registered land totally unmarketablein perpetuity (e.g. Okoth-Ogendo, 1998:9)

The Land Act provides for the institutional articula-tion of the rights highlighted above in a decentral-ized environment. However, since its enactment,implementation of the Land Act has proven to bedifficult. Donors and many in government blame thison a shortage of financial and human resources tocreate the necessary decentralized administrativestructures. Moreover, decentralization increases thenumber of sites of formal adjudication of rights andexposes the adjudication process to local predispo-sitions. In Buganda, the complex “bundles of rights”that can be applied to the same piece of land furtheramplify points of conflict.

A major hurdle of implementation is setting up thedecentralized structures specified in the Act. Admin-istration of the Act implies a large bureaucracy. LandCommittees will be established in each Parish, eachgazetted urban area and each division in the caseof a city, to determine, verify and adjudicate theboundaries to land and provide this advice to theDistrict Land Boards. Each District shall have a Dis-trict Land Board of a minimum number of five people.In addition each Sub-county, each gazetted urban areaand each division in the case of a city will have a

Recorder responsible for keeping records relating tocertificates of customary ownership and certificatesof occupancy. Each District shall have a District LandTribunal to determine disputes of higher value and ineach Sub county there shall be a Land Tribunal tojudge disputes of a lesser nature.

The Act also expects each District to create andmaintain a District Land Office to perform registra-tion, surveying, valuation and planning functions.Clearly these demands place financial and manage-ment pressures on institutions in an early stage oftheir development. Equally daunting are the costsof maintaining the structures for decentralized landadministration. In short, it would be an incredibleachievement for one statute to successfully ‘vest landin the people’, resolve the competing interests oflandowners and occupants, and create a system ofcompetent and consistent recording and monitoringat local and central levels.

Fortunately, the Land Act does not stand alone be-cause there are multi-strands of legislation that sup-port decentralizing land administration. The LocalResistance Councils Act 1993, the Local Govern-ment Act 1997, and the Constitution of 1995 trans-fer real powers to local governments and therebyappear to provide important supports for decentrali-zation. Recently, however, inconsistencies betweenthe governance statutes and the Land Act have beenrevealed. For example, on the question of financ-ing:

Local governments are desperately short of funds andit is highly unlikely that they can raise resources tofinance the institutions specified in the Act.


55

The Land Act provides that all expenses of theDistrict Land Boards and Parish LandCommittees shall be charged on the DistrictAdministration funds. However, two sectionsin the Local Governments Act 1997 could beread as being in conflict with this. Section 81specifies that any extra obligation transferredto a Local Government by the Government shallbe fully financed by the Government, yet theLand Act makes no such provision. Section83 reinforces this by stating that no financialobligation shall be placed on local Governmentby the Government after the enactment of theAppropriation Act without provision of funds(Land Act Implementation Study, Annex 7:Institutional and Capacity Building AppraisalDraft Report, August 1999: 4-5).

Ambiguity is also evident in land policy. The Constitu-tion states that land matters fall exclusively under thejurisdiction of the central government. District LandBoards are given land administration functions suchas allocation, registration, and attendance to landissues in accordance with the laws made byParliament. The Local Governments Act is consis-tent with the Constitution on this matter. The LandAct, however, suggests that Districts have a landpolicy role. This ambiguity notwithstanding, if Dis-tricts are empowered to make land policy and inter-pret the Land Act in accordance with local circum-stances, then it is possible that decentralization ofland management to the parish level will democra-tize land management systems and bring servicesnearer to the people. On the other hand, without acentral government monitoring and supervisoryframework to keep the Act “nationally intact and lo-cally articulated” in a consistent way, local imple-mentation and discretion will likely lead to manifold,unanticipated outcomes.

It is obvious, therefore, that although land administra-tion and adjudication is to be implemented within adecentralized environment, financial and otherlogistical constraints make it unlikely that landown-ers and occupiers will be able to expeditiously ob-tain a formal certification of ownership or a certifi-cate of occupancy with which to mortgage land ascollateral for agricultural loans. This problem repre-sents an important constraint to the establishmentof a market-oriented formal financial system to serveagriculture and rural areas.


56

1. Introduction

The interface between the financial services sector,on the one hand, and the agricultural and fisheriessectors, on the other, is weak in Uganda. It is weakin terms of numbers from these primary productionsectors who are clients of financial institutions; it isweak in terms of the mechanisms in place for keyinformation generation, transfer and sharing; and witha few exceptions it is weak in terms of the knowl-edge that financial institutions have of the agricul-tural and fisheries sectors.

This annex explores some relevant informationfields, and suggests initiatives, through which theinformation interface could be strengthened, to thebenefit of producers, traders and financiers.

Three broad information fields are relevant.

a.Information clients have about financial serviceavailability and conditions, about managementof their own financial affairs, and informationneeded for them to adopt or expand the use ofimproved farming technology;

b.Information financial institutions have about theagricultural and fisheries sectors;

c.Information, especially for policy makers, aboutthe performance of financial service support forthe agricultural and fisheries sectors.

These are discussed, in turn, below.

2. Information Available to Clients

2.1 Financial Management Skills

Much is written about the skills required by the staffof financial institutions. A recently published book4

explores the other side: the skills required by farmerclients of banks and other financial institutions, andhow these skills can be improved through actionstaken by governments, not least through adjustmentsto general education in schools. There is every rea-son to believe that clients’ financial managementskills are no less important in Uganda than else-

where, and are therefore worthy of attention. Theneeds of small-scale traders in this connectionclosely parallel those of farmer clients of financialinstitutions.

What are the practical implications of this objective?Heney (2000, page 75), when discussing ways bywhich farmers’ financial skills can be improved, liststhe following as important: “better literacy, betteranalytical skills, better understanding of enterprises,better awareness of goals, better budgeting, bettermanagement of savings, better knowledge of finan-cial services”.

The last of these targets financial institutions directly.Indirectly, through product design, financial institu-tions can impact on several other goals in Heney’slist. Government policies and outreach programmescan impact many of these requirements. However,there are some that financial institutions can target.The last in the list, “better knowledge of financialservices”, is a matter for awareness building andmarketing. Others, especially “better understand-ing of enterprises, better awareness of goals, betterbudgeting, better management of savings” are allobjectives which careful product design can address,albeit indirectly.

The implications for support efforts to improve prod-uct design for institutions expanding into rural areasare clear, i.e. products should be designed in sucha way as to contribute to the understanding clientshave of financial services, and how they can behelped by using them. For example, school savingsschemes have a strong, early childhood, educationalvalue; loan application methods can be designed toincorporate simple financial analysis and budgeting(including whole household budgeting, where appro-priate), the use of which involves a learning pro-cess5.

2.2 Market Opportunities

It is clear that the Ugandan agricultural and fisher-ies sectors can only develop soundly if signals con-cerning demand for products are received by keyactors. Such signals are generated in destination

Annex 4

Information Management

4 Heney, J.A., Enhancing Farmers’ Financial ManagementSkills, FAO/GTZ, Rome & Eschborn, 2000 5 Heney, op.cit. p.81


57

markets (for exported commodities and products) andin terminal markets – effectively Kampala (for othercommodities and products). This process requiressuitable information transmission mechanisms so thatmeaningful marketing messages can be effectively fedback along the marketing chain to the primaryproducers, and to the input suppliers on whom theydepend.

In Uganda the formal demand transmission mecha-nism for farmers is provided by the regional FoodnetService, supported by USAID and the IITA (Interna-tional Institute of Tropical Agriculture). Some of theclients of this service pay for up-to-date market in-formation, sent by email (currently 100 traders sub-scribe to this service6);others have access to priceinformation conveyed by SMS messages on cellphone networks (for which there is a charge); freeaccess is available over local FM radios throughoutmuch of Uganda, where an effort is also made tobroadcast in local languages. Clearly the last ofthese transmission mechanisms is the one of mostrelevance to small-scale farmers.

The information from Foodnet includes prices for27 commodities, in 3 markets in Kampala (based ondaily collection of price information), and from 16markets in rural (district) centres, derived fromweekly price collection in these markets. There isalso an important regional component, as Foodnetoperates also in Congo, Ethiopia, Eritrea, Kenya,Madagascar, Rwanda, Sudan and Tanzania, in otherwords, in all the important regional markets for Ugan-dan produce (chiefly maize and beans). A monthlybulletin is produced which is a regional trade over-view, noting production levels and shortages, andcurrent trade patterns – including estimates of cur-rent, informal, cross-border trade. By noting localiseddemand situations for particular products, informa-tion is also conveyed about new product possibili-ties and new markets.

Foodnet is an impressive achievement, and de-serves ongoing support by the GoU so that the mar-ket information provided, and on which the agricul-tural sector increasingly depends, can continue tobe available7.Some users (e.g. traders) can pay forthe service. However, for the bulk of the farmingcommunity, whose price information needs are lesstime-sensitive, market information is readily ac-cessed from broadcasts over local FM radio stations.

The latter ought to be regarded by government as apublic good, and fully funded accordingly.

2.3 Improved Farming Technology

Market information provides the base for farm pro-duction to be market led, supported by research andextension services, which in Uganda also aim to besensitive to market conditions. Technical materialis an important part of the information flow neededin rural areas. To meet this need the Government’sNAADS (National Agricultural Advisory Service) ini-tiative is now getting established. For crops such ascoffee, other support networks, such as the UgandaCoffee Development Authority are also important.The NAADS services are provided free of charge tothe farmer, as are services from commodity-spe-cific bodies: however in the latter case the overallcosts are met by the industry itself.

Specific donor-funded projects, such as SPEED andIDEA, have also had an important technology trans-fer role. As projects such as these come to an end, itis understood that NAADS will take over the associ-ated responsibilities.

Financial institutions can utilize such services assources of information leading to better lending (seefollowing section).

3 Information Flow to Financial Institu-tions

3.1 The Use of Information

Financial institutions can use information about theagricultural and fisheries sectors in order to increasetheir efficiency in all phases of banking, i.e. productdesign (savings products and loans) and, for creditoperations: loan assessment, loan supervision, loancollection and arrears control, realization of collat-eral. There are also senior level tasks that require agood knowledge of these sectors, including ensur-ing portfolio balance, asset-liability management,liquidity management, loan-asset portfolio manage-ment. The risk associated with sectors exposed tothe vagaries of climate, disease, price fluctuations,isolation and transport difficulties all mean that thevery best information mechanisms must be in placefor effective lending to these sectors.

3.2 Personnel

Any financial institution including the agriculturalsector in its forward business plans would need tohave some specialist knowledge in-house, perhapsin a specifically-designated unit.

6 Personal communication from Dr. Shaun Ferris, Coordinatorof the Foodnet Project.7 There are many examples in the developing world of marketinformation services that have been started by donor-fundedprojects. Few of these have become sustainable. The usualreason for their demise has been the unwillingness of govern-ments to pay the costs involved, especially for collection of pricedata on a regular basis, so that the information disseminated istimely and therefore optimally useful to growers and traders.


58

Some of the information will be gained in-house throughrecruitment of suitable staff. Clearly this is the short-cut route to a financial institution gaining the requiredexpertise. It is not known to the mission how effectivelycurrent university training in Uganda prepares studentsfor possible employment in banks and MFIs servingthe agricultural sector. However, given the Cinderellastatus of agriculture among many younger people, itwould be surprising if there were to be the sort of livelydemand that would prompt university departments toinclude relevant learning modules in their courses.This is an area that may warrant investigation, andpossible remedial action.

Uganda is far from being alone in this situation. Manycountries currently face shortages of suitably trainedmanpower for financial intermediation in rural areas,and require assistance in remedying this situation.This has been recognized by a number of donorsand development organizations. As a result themulti-donor Rural Finance Learning Centre (RFLC)8

has recently been established. The objective of theRFLC is to be a source of information of direct useto universities and other organizations that are in-volved in training for rural banking activity. Theneeds for in-house training are also relevant here.Assistance in the form of on-line lessons for self-study, course materials for trainers, as well as asearchable database of resources can also be pro-vided by the RFLC

3.3 Ongoing Information Flow

Financial institutions that may have only basic knowl-edge about agriculture need to develop ongoing link-ages with the major commodity organizations, suchas the CDO (cotton) and the UCDA (coffee). Thiswill assist in keeping up-to-date with opportunitiesfor new product lines. Banks and MFIs may also pre-pare to respond to the growing demand for financialservices, especially for loans, by using an Agricul-tural Enterprise Watchlist. A sample of such awatchlist is given in the draft in Section 3.4 below.The intention of this draft watchlist is not to stand inits own right as a finished product. Rather it is in-tended to prompt thinking on the part of financiersas to new areas of business in the agricultural andfisheries sectors, coupled with staff capacity-build-ing requirements, which would need attention inpreparation for increased business with these sec-tors.

3.4 Agricultural Enterprise Watchlist

An examination of the item-by-item demand forsome selected items of Uganda’s agricultural andfisheries products reveals opportunities for the fu-ture, together with a few areas of concern. The draftlist below attempts to capture some of the points ofrelevance to banks and other financiers. It servesto illustrate in a summary, introductory form the sortof information to which banks need access in orderto build a sound agricultural loan portfolio. Special-ist agriculturalist loan officers need to maintain on-going databases about these product sub-sectors.These databases would essentially be expansionsof the material that follows.

Coffee

The dismal outlook for standard grade Robusta hasalready been mentioned in this report. As a meansof adding value, a start has been made in upgradingto wet-processing technology, in order to produce ahigher quality product. This start, to date, has beensmall, involving some 2 percent of the crop. An even-tual investment of $40m in wet-processing technol-ogy is envisaged in the current plans of the UgandaCoffee Development Authority. Even though themarket indications for superior Robusta are currentlyfavourable it would be important to harmonize therate of this development with the growth of the spe-ciality-coffee market, especially if an appellationcontrolé 9 market labeling approach is taken for apart of the crop. It is understood that the appellationcontrolé approach to attempting to build value in themarket is the current objective, with a start havingbeen made by identifying four such zones10. Onenotes that this marketing strategy will doubtless needa great deal of promotion, with equal certainty thatthere will be stiff competition from other producingcountries. However, it is in harmony with the trendfor information on the origin of products that is in-creasingly demanded by the consuming markets inthe EU and US.

Again on the production side, efforts are being madeto replace aging and often virus-affected coffee treeswith newly developed strains of robusta, resultingfrom plant breeding in Uganda.

The situation with Arabica, which accounts for just10 percent of Uganda’s coffee production, is lessserious, as established markets continue to providedemand for the Ugandan crop.

8 Information available from the Chief, AGSF, AGS Division,FAO Rome (email [email protected]) or email direct [email protected]

9 An appellation controlé system is analogous to that used inthe French wine industry. It is a marketing strategy in whichthe geographical origin of the product is stated on thepackage, in a system which has controls exerted by anauthority which itself is subject to impartial monitoring.10 “Uganda Competitive Private Enterprise and Trade ExpansionProject (COMPETE), Final Report,” Kampala, May 2002, SectionB3


59

Cotton

Cotton was first grown on a commercial scale inUganda in 1903, so the industry is well established,with a great deal of local expertise developed in pro-duction, trading, processing and marketing. AlthoughUgandan cotton, being handpicked and roller-ginned,is higher quality than much of the cotton in the mar-ket, it is still very vulnerable to market downturns,often caused by over-production in those countriesproviding a heavy subsidy to producers.

Recent project activity in Uganda has demonstratedthe benefits to be gained through the use of improvedon-farm production technology, involving the use ofpurchased inputs. It is likely that as the benefits ofthis technology become apparent to farmers, thendemand will increase for seasonal production loans.Semi-commercial and commercial farmers are thosemost likely to be involved in this trend11.

Fish

It is estimated that one million persons are involvedin the fish trade in the country. Some 80 percent ofthese work in the domestic market, in processingand (small-scale) marketing ends of the industry.Approximately 75 percent of the total production isconsumed domestically or in the immediate region,mostly for human food, but some as a protein-richingredient in livestock feed.

Fish exports have been a relatively recent area ofbusiness, and returns are impressive for species suchas Nile perch. Local processing facilities for exportedproducts consist of some 11 plants, with a substan-tial over-capacity at present levels of permissiblecatch.

Since the capture fisheries resources are limited,attention is being given to the following measures:

a) reducing the proportion of fish caught but re-jected due to incorrect or below-standard post-catch and pre-processing handling;

b) investigating the requirements and developingthe technology for cage production of Nile perchor an introduced species such as Barramundi(Australian origin);

c) further developing pond aquaculture of Nile tila-pia and mirror carp.

All of the above measures require a mix of publicfunding (information in the main) and private invest-ment, with a likely heavy demand for loan financing

Currently aquaculture in Uganda accounts for only1 percent of total national production of fish, well

below the global proportion of 26 percent by weight(FAO, 2000). The global trend is one of continuedexpansion, especially in developing countries, withtotal farmed fish production, by weight, likely to sur-pass total global beef production in 2011. The ex-tent to which Uganda participates in this trend is atpresent unclear, but financiers should be aware ofthe potential in this industry12. They should be equallyaware of the uncertainties involved, particularly interms of disease and algal bloom outbreaks that havebeen responsible for incidents of heavy mortality offarmed fish in many countries, from New Zealand toNorway, with banks experiencing losses as a result.The lesson in this is that financiers should obtainthe very best technical advice available, while be-ing wary of rapid expansion of intensive fish farm-ing enterprises.

Coarse grains

The principal coarse grain in Uganda is maize (corn)with the coarse grain crops more suited to drier con-ditions (sorghum and finger millet) grown chiefly inthe north of the country. Although maize is currentlythe chief cereal crop and is likely to be so in theimmediate future, there is likely to be increasingdemand for sorghum, for brewing. Purchases ofUgandan maize by international relief agencies havebeen important outlets, and there is no sign that thistrade will diminish in the next few years. However,it is the Kenyan market that is likely to generate themajor future sustained demand. Important too willbe the demand for maize as an ingredient of feedsproduced for the growing Ugandan livestock indus-try.

As with cotton, maize responds well to investmentin seasonal inputs (hybrid seed, fertilizer and, in someareas, pesticides), once the benefits to labour andland productivities have been realized through at-tention to planting in rows (which greatly reducesthe labor requirement for adequate weed control),and correct plant spacing/ plant population.

Maize occupies an unusual place in Ugandan agri-culture, because unlike the case of manyneighbouring countries, it is not the chief staple ce-real. This position is held by plantain banana(matoke). Maize is therefore more in the nature of acash crop. One feature of this status is that there isno cultural or traditional imperative for it to be culti-vated, allowing the perception of market demand toprovide the incentive for it to be grown. This high-lights the potential role for new maize marketing strat-

11 Information from the Cotton Development Organization

12 One substantial scheme, the Bunamwaya Fish FarmingScheme, plans some 70 ponds, each of 1800 m3, with totalproduction by the end of 2004 of some 2000 tonne of tilapia (NewVision, 19 Nov. 2003).


60

egies to play a role in improving livelihoods of farmersin maize-growing areas.

The potential for maize exports has already beennoted. A recent study13 has noted (PSFU 2003 pagexvii) “Pre-processing maize exports in the form ofstorage, cleaning and re-drying are important for thepreservation and stabilization of maize grain inpreparation for export. Re-drying and storage willencourage long-term stocking of excess maize. Thiswill provide an all year round market to maize farm-ers and stabilize prices. As a result, farmers will gainconfidence in the crop, increase production and gen-erate adequate and predictable excesses for export.Cleaning and sorting will help to improve the qualityand consistence of the grain, making it more readilyacceptable on the export markets. However, tech-nology and investment in these important operationsis still lacking.” The same publication addressespossible future demand for investment funds, interalia, for post-harvest equipment, which would include“dryers, shellers, storage. At an estimated cost ofUS$25,000 per unit, an investment of US$1,000,000would cater for at least 40 rural-based farmer groups.Simple and effective storage, re-drying and clean-ing systems for grain should be initiated and encour-aged to ensure preservation of harvested grain.”

Vanilla14

No one expects the current high prices to continue,yet Uganda is well-suited to vanilla production froman agro-climatic point of view, and its high value-to-weight ratio puts it in a better position to sustain hightransport cost than is the case with crops such ascotton and maize. Assuming that the current (veryhigh) price levels do not drop too dramatically, thenthere is likely to be a continuation of the significantprivate investment in this industry.

Roses15

From a small beginning a significant export tradehas grown (worth some $30m in 2002), though itsimpact on the vast bulk of the population has beeninsignificant. Production is intensive, and the mar-ket is closely tied to the Dutch international flowertrade. Future developments are likely to be an ex-pansion along the model already developed, i.e.capital intensive, tightly controlled, and in the handsof a small number of operators. It is likely that theroses industry could expand to be worth some $80mper annum over the next few years.

Livestock and Poultry16

Given the usual trend for demand for livestock prod-ucts to increase faster than demand for crop prod-ucts as urban incomes increase, demand will growin Uganda for dairy products, beef, pig meat andproducts, and poultry products.

The financing requirements, especially for intensivelivestock production can be substantial for a smallfarmer/entrepreneur. Typically for a modest 500-bird broiler unit the capital investment needed isUshs1.5m ($750), with a further Ushs1.7m in oper-ating capital required per batch of birds. Whereas todate there has been little borrowing in the broilerindustry, as units have grown from small beginnings,this may change if demand picks up. Borrowing de-mand will also grow from existing, proven operatorswishing to expand their enterprises.

Investment in dairy enterprises, especially those uti-lizing Friesan/Ankole cross cows (which are valuedat Ushs1.2-1.5m each), is very much larger again.Currently there is apparent over-production in thedairy industry, but given very low per capita con-sumption levels, this situation may well changequickly.

Beef cattle are well suited to large tracts of the coun-try, but most cattle ranches are not currently pro-ducing optimally, and many require considerableinvestment in breed improvement and facilities suchas water supply.

Pig production, based on the Cambrough (Landrace/Large White cross) has a bright future, as demandis good and growing, returns are attractive and anumber of support initiatives by the GoU and do-nors are underway. Pigs units potentially have asignificant benefit/cost advantage over broiler chick-ens in that their feed cost per unit of live weight gainis lower, due to their lower requirement for protein(which is costly) in the feed.

4. Information about the Performance of Fi-nancial Service Support for the Agricul-tural Sector

4.1 Policy Generation and Delivery - Require-ments

The objective of sustainable, effective and efficientprovision of financial services in rural Uganda re-quires substantial attention to achieving a support-ive policy environment. Since the policy mix which

13 PSFU (2003) “Identifying Improvement Opportunities andDiagnosing Prospects in Uganda’s Maize Supply Chains” PrivateSector Foundation of Uganda (PSFU), Kampala, 2003.14 Personal communication from IDEA Project staff.15 Information provided by IDEA Project.

16 Much of the information in this section was provided ininterviews with senior officials of the Livestock Division of MAAIF,Entebbe.


61

is relevant depends on several government ministries,there is need for two basic information sets.

First, information on the current delivery of financialservices, rural deposits, farming loans, fisheriesadvances, repayment rates, delinquency, and useof collateral.

Second, common information on the respective,current policy foci of all relevant ministries – MAAIF,Finance Planning and Economic Development,Commerce, Lands, as they impact on financial ser-vices to agriculture.

4.2 Information

The first information set requires commitment to anongoing mechanism whereby information more de-tailed than that collected by the BoU is collected,analyzed and presented to policy makers in an opti-mally useful format. The objective is to facilitate theidentification of remedial and improvement mea-sures through informed, timely policy adjustments.

4.3 Coordination

The second information set involves establishing asuitable forum for the exchange of information, withthe focus on ministries rather than donors, but withdonor participation. Indeed, there is growing recog-nition of the need for an appropriate mechanism forcontinuous exchange, apart from the immediateneeds of donors. Several initiatives are relevant here,and the Mission has recommended an overall Plan,which would encompass the interests of all stake-holders and provide a basis for consistent policymaking and project design. An important part of theoperations of the Plan would be information ex-change.


62

Annex 5

Insurance as a Financial Service

1. Management of Risk

The management of risk using the financial mecha-nism of insurance is a fundamental part of a mod-ern economy. Risk impacts all stages of the produc-tion/ marketing/ processing/ storage/ export/ retailchain. Within this chain investments are made inshort-term items such as on-farm inputs, producebuying, and other working capital needs. Investmentsof a longer-term nature are also involved, includingon-farm storage and machinery, transport vehicles,warehouses, processing and packaging equipment.Risks to some of these items are commonly insured,with property, machinery breakdown and vehicle in-surance policies being prominent in Uganda. Insur-ance shares with other financial services the needto control costs and risk. Managing risk is both thebusiness of insurance and a challenge, in that insur-ers confront the special problems involved in thebusiness, especially those of moral hazard and ad-verse selection. Designing and marketing insuranceproducts for large numbers of widely scattered farm-ers throw these issues into very sharp focus17.

Potentially, other types of insurance products relatedto agriculture and to farmers are:

? Livestock insurance

? Growing crop insurance

? Life insurance, including for lower income persons

? Health insurance

2. Livestock Insurance

Livestock insurance has been available in the pastin Uganda. The policy was a mortality cover, andonly cross-bred cattle (not indigenous breeds) couldbe insured. The product was offered by the largestinsurer, the National Insurance Corporation Ltd.(NICL), which is 100 percent owned by the govern-ment. Although this insurance product was profit-able for NICL, it has been discontinued due to lowdemand. In turn this low demand was probably aresult of very stringent conditions incorporated in the

policy. These related in particular to the requiredproximity of veterinary care and separation of theinsured cattle from local animals. The future for live-stock mortality cover is uncertain, but given the lowhistoric loss ratio (reported to be just 12 percent)experienced on the discontinued product, it is likelythat cover could be obtained again, if there wereindications that the market would be sufficientlylarge18.

3. Crop Insurance

Growing crop insurance is currently not available inUganda, although there is some demand (noted butnot quantified by the mission) for protection on thepart of investors who have a significant investmentin growing crops19. There is a considerable researchcost involved in establishing a crop insurance capa-bility. Moreover, standard crop insurance productsrequire individual loss assessment in the event of aclaim. This essentially means that only very largeenterprises (especially intensive, highly capitalisedflower production units) could be included, becausethe costs of loss assessment are not in a linear rela-tionship with either the magnitude of the claimedloss, or of the insured amount.

If large numbers of small farms were to be insured,then one approach to the problem of loss assess-ment cost is to carry out the procedure on an arearather than individual farm or field basis. This is done,for example, in India.

However, because the size of the potential marketin Uganda is very limited, and because most insur-ers have little or no experience with agricultural in-surance, it is unlikely that this type of risk manage-ment mechanism will become common in Ugandain the next 20 years. The only exception to this couldbe large nucleus estates, as and when these be-come more common. Here there is scope for econo-mies of scale in marketing policies, in assessinglosses and in settling claims. For example, insurance

17 For a detailed discussion of these and related points, seeRoberts and Dick (eds.), Strategies for Crop Insurance Planning,1991, FAO, Rome

18 Personal communication, Chief Manager, Marketing, NationalInsurance Corporation Ltd.19 Personal communication from a major insurer, relating enquiriesfrom clients.


63

cover can be designed so that it is automatic for allgrowers linked to a given nucleus estate. Thiseliminates nearly all marketing costs, while thenucleus estate recording system for areas plantedand harvested provides a useful reference point foran insurer, and a low cost means to obtaining theinformation required. Economies of this type canpermit insurance operations to be undertaken as asustainable business activity, as for example in thesugar industry in Mauritius.

Again it is possible that a new type of crop insur-ance in the form of index or coupon cover may havesome relevance in Uganda in the future. This uses aclimate index as the trigger for qualifying a couponholder, the insured, for an indemnity payment. Thistype of product is suited to addressing risk from asingle peril of infrequent occurrence. To this end itmay have a place in Uganda for the very infrequentperil of drought. However, much investigative workwould need to be carried out before this possibilitycould be developed to the extent that it could bediscussed at a political and/or farmer’s level. To datethe only working examples of this type of crop insur-ance product have been in Canada and the UnitedStates. However, insurance of this type is currentlyunder consideration in Morocco, following some pre-paratory design work by the World Bank and KfW.

4. Life Insurance

Life insurance for lower income persons is a prod-uct that probably has a future in Uganda. This islargely because of the existence of the MFIs.MicroFinance Institutions already have close con-tact with their clientele, which affords an insurer aready-made contact point. This reduces the trans-action costs of marketing policies and handlingclaims. Moreover a lender has an interest in seeingthat a loan is covered in the event of the death ofthe borrower.

What is uncertain is the size of the demand. At thetime of writing, life policies written in Uganda ex-clude death from HIV/Aids as an insurable risk. How-ever, as such deaths become less common then itis expected that this exclusion will no longer apply;indeed one major insurer has already commissionedactuarial work in preparation for the introduction ofpolicies that will cover death from HIV/Aids.20

Since linking a loan to life insurance on the life ofthe borrower would reduce risk, some MFIs mightoffer this type of arrangement as a product, with aprice that reflects the costs/benefits to both parties.Indeed, both commercial banks and MFIs that de-sign and market term loan products for the purchase

of equipment, vehicles, water supply etc., could wellmake insurance of the borrower a condition of the loan.At first sight the lack in Uganda of a national identitycard might suggest that identification difficulties mightoccur in the event of a claim. However, a majorinsurance company maintains that this is not a majorarea of difficulty. MFIs could readily negotiate withinsurers to market their policies, in return for a modestcommission. In effect, in doing so, the MFIs wouldact as specialised brokers.

5. Health Insurance

Health insurance is being tried in some African coun-tries, including Uganda, where at least two schemes,Microcare (Kampala and S.W. Uganda) and KitovuPatients’ Prepayment Scheme (Masaka) operate. Inthe latter case the medical treatment is limited tothat currently offered at Kitovu Hospital, a missionestablishment. Here too the obvious problem forhealth insurers relating to the lack of a National Iden-tity Card has been overcome by the Scheme issu-ing a photo ID card for participants. At Kitovu Hospi-tal there has been a close link to the local MFI,FINCA, since the Scheme requires group participa-tion, with at least 60% of any given group enrolling,and a minimum of four persons in each enrolled fam-ily. The current status of the Kitovu Scheme is thatthe cost of treatment plus the cost of administrationof the scheme is roughly double the premium in-come, so sustainability is dependent on donor fund-ing at the present stage.

Given the paucity of experience to date with thisinsurance product for lower income persons, coupledwith the fact that it was not examined in any greatdetail during the present exercise, no firm conclu-sions can be drawn as to the future potential forhealth insurance.

20 Personal communication from a major insurer.


64

Agricultural Finance in Uganda

Documents

Transcript of Agricultural Finance in Uganda