The Government of Uganda and other stakeholders in the industry (donors, practitioners, and consultants) collaborated in creating the rules and regulations for the microfinance industry from around 2000 to 2004 under the auspices of the Micro Finance Forum. These collaborative efforts culminated into the passing of the MDI Act in 2003 and its associated Regulations # 61 to 65 of 2004 in October 2004. The MDI Act created a new category (Tier 3) of financial institutions: the Micro Finance Deposit-Taking Institution (MDI) to be regulated and supervised by Bank of Uganda. Under this act, MDIs are permitted to collect savings from the public and intermediate them i.e. use them to make loans. In this sense, they perform one of the traditional roles of a commercial bank. However other activities of MDIs are significantly restricted (Sections 18 - 20 of the MDI Act 2003) compared to those of a commercial bank (as laid out in the Financial Institutions Statute, 2004).

Options
The process of converting from a non-regulated (Tier 4) to a regulated and supervised financial institution is referred to as transformation. The laws in Uganda provide various options of regulated financial institutions: (Tier 1) Commercial Banks under the FIS 2004, (Tier 2) Credit Institutions under the FIS 2004, and (Tier 3) MDIs. The trend has been for Tier 4s to work towards attaining Tier 3 Status but the possibility of an application to BOU for a Tier 1 or 2 license by a Tier 4 institution can not be ruled out in future. In a recent Regulatory Impact Assessment Study commissioned by the Transformation Steering Committee, MDIs were considering the possibility of converting to Tier 1 status to overcome the stringent restrictions under the MDI Act 2003.

Who has transformed?
Four MDIs were licensed by BOU and these are: FINCA Uganda Limited (25th October 2004), PRIDE Microfinance Limited (30th June 2005), Uganda Microfinance Limited (30th June 2005), and Uganda Finance Trust Limited (12th October 2005). Faulu Uganda Limited completed its preparations and planned to submit its license application to BOU for a Tier 2 licence in the last quarter of 2007. The next batch of potential transforming institutions has not gained critical mass in terms of business volumes but may include: UGAFODE, Pearl Microfinance Limited, HOFOKAM, and MED-Net…

Support for Transformation
DFID’s Financial Sector Deepening Project Uganda (FSDU) together with other donors (SUFFICE, SPEED, GTZ/FSD)supported transforming institutions to comply with the requirements of the Act. FSDU provided direct support to Uganda Microfinance Limited, Uganda Finance Trust Limited, Faulu Uganda Limited in this area. FSDU also hired a Transformation and Consolidation consultant to provide free advice to MDIs and other transforming institutions in Uganda. This consultant also served as the Secretary to the Transformation Steering Committee that coordinated donor support for transformation and post-transformation activities. The TSC, was a committee (discontinued in August 2007) comprising of major donors to the microfinance sector and other key stakeholders in the transformation of microfinance institutions in Uganda.

Challenges
After about 2 years of operation as regulated financial institutions, MDIs are faced with a host of challenges including: slow rate of growth of savings deposits, coping with high operating expenses, expanding outreach outside the urban and peri-urban areas, lowering interest rates to cope with adverse political and media publicity, and positioning themselves in light of Government’s microfinance policy shift to rural member-based institutions (preferably SACCOs at sub-county level).  The next transforming MFIs will not enjoy the same level of funding as no donor who has committed significant funding or mainstreamed transformation as a core activity.

Study on the Effects of MDI Regulation
After more than four years since the MDI Act was promulgated in 2003 and two years after the first microfinance deposit-taking institution (MDI) was licensed in October 2004, The Transformation Steering Committee (TSC) commissioned a study to assess the effects of the MDI Regulation in Uganda  This study was undertaken by Friends Consult Limited and completed in August 2007 under funding from DFID Financial Sector Deepening Uganda Project (FSDU) . This study is intended to assess the impact of the MDI Act on the various microfinance (MF) stakeholders i.e. Government, donors, microfinance institutions, clients, and the regulated institutions, among others. Findings of this study will go a long way in informing the process of review and implementation of microfinance regulatory frameworks in Uganda and elsewhere.

Regulatory Impact Assessment of MDI Regulations in Uganda

CONSOLIDATION & RESTRUCTURING IN THE MICROFINANCE INDUSTRY

There are over 1,000 financial institutions of various types (commercial banks, credit institutions, MDIs, and Tier 4 institutions such as  SACCOs) providing microfinance services in Uganda. Competition is becoming very intense especially in the urban and peri-urban areas such as Kampala, Mbarara, Jinja and Mbale. Financial institutions in these areas are striving to increase their portfolios and client numbers. Commercial banks are scaling down and spreading tentacles into market niches previously served by microfinance institutions. Barclays Bank will complete integration of Nile Bank Limited (a local bank) by the end of this year, to finalise the acquisition. Barclays Bank, through the acquisition of Nile Bank Limited,  aims at creating a stronger bank with a retail network spanning across various market segments. Bank of Africa completed its acquisition of Allied Bank in…..  Competition will intensify further as several Kenyan banks are reportedly prospecting entry into Uganda (Lead Story, Business Week :Volume 3, Issue 15, Sept 

10 16/2007) and as Housing Finance Company of Uganda prospects converting from a Tier 2 to a Tier 1 license by the end of 2007.

 DFID’s Financial Sector Deepening Uganda Project (FSDU) believes that consolidation is the way-forward for weaker institution as they are faced with the challenge of competing for the same clients with larger and more efficient financial institutions. Consolidation provides smaller institutions with a graceful exit option by combining a small, unsustainable programme with a stronger partner to sustain delivery of financial services to the deserving communities. Allowing weak institutions to fail comes with undesirable consequences to the sector. The placement of FOCCAS under receivership in July 2006 caused a lot of damage to the sector in form of: negative media and political publicity, client unrest and suspicion, financial losses to social investors and wholesale lenders (commercial banks and others). In the right circumstances, consolidation can provide a way out, before an institution fails, to the benefit its clients and the industry as a whole.

Linkage banking is a strategic alliance, in which two or more entities operating in the same market (or locality) cooperate in the delivery of financial services. Typically, the arrangement involves a regulated financial institution and one or more Tier IV microfinance institutions. FSDU has adopted the approach of supporting eligible regulated financial institutions, termed Linkage Implementers (LI), to set up linkage structures targeted at serving Tier 4 institutions and their clients. The linkages allow the clients of Tier 4 institutions to access services such as secure savings, training, IT support, refinance facilities, money transfers, mobile banking, capacity building, and back-office services from the LI.  The LI is able to access, directly or indirectly, a client base which it could not otherwise profitably serve and turn its competitors into partners in the delivery of financial services. FSDU co-financed aikan (a consulting firm), to undertake pre-feasibility studies for Centenary Bank in the Central Region, and Deloitte & Touche to undertake a similar assignment for PostBank in Northern Uganda.  Centenary Bank and PostBank are expected to take this to the next level of undertaking full blown feasibility studies for preferred linkage options and the recommended linkage partners.  

FSDU established the Consolidation and Restructuring Challenge Fund (CRCF) to facilitate consolidation and linkages in the financial sector. The fund was open to groups of two or more partners interested in exploring various consolidation options by co-funding activities such as: feasibility studies, asset valuations, legal reviews, market studies, e.t.c. The fund sought to encourage institutions to “think outside the box” win-win approaches to consolidation including, but not limited to: mergers, acquisitions, and linkage Banking arrangements. FSDU only completed the HOFOKAM merger i.e. merger of the microfinance program under the Catholic Dioceses of Hoima, Fort-Portal, and Kasese.

Effective July 2005, FSDU revised the matching requirements under the CRCF to provide a generous grant of up to 80% of the costs of agreed studies and consultancies i.e. the FSDU paid up to 80% while the benefiting financial institution paid 20%. Full details on the fund application criterion were provided on this link Consolidation & Restructuring Challenge Fund.

Related Documentation Book Review - Tying the Knot Case Studies of Mergers in Micro Finance Legal Aspects of MFI Mergers & Affiliations Linkage Banking Presentation Linkage Banking Flyer Commercialization & Mission Drift	Related Documentation Linkage Banking Pre-feasibility study - Centenary Bank [Presentation] Linkage Banking Pre-feasibility Study - PostBank [Presentation]