Interest Rate Cap Rattles Cambodia's Microfinance Industry

Mar 2017
Cambodia, March, 24 2017 - A recent decision by the National Bank of Cambodia to impose an interest rate cap on loans provided by microfinance lenders has prompted fears that low-income Cambodians, who often depend on small borrowings to stay afloat, will be hit hard.

The central bank on March 14 said microfinance institutions can charge a maximum 18% annual interest rate, compared with 20-30% before. The change took effect immediately and has drawn widespread criticism from industry experts.

"This is, frankly, a really terrible, misguided policy," said Daniel Rozas, a microfinance consultant and co-founder of the MIMOSA project, which researches market saturation in the industry.

The interest cap is expected to lead to a reduction in the number of loans provided by microfinance institutions to low-income Cambodians, analysts say, since higher rates are essential to offset the risks of lending to poorer people.

"We're talking about a million or so clients who'll no longer be able to borrow from MFIs [microfinance institutions], and that cannot but help to affect other parts of the rural economy, including bank lending there," said Rozas.

He added that low-income Cambodians are now likely to turn to illegal loan sharks. Also, microfinance institutions will probably see lower profits, which will almost certainly prompt an industrywide downturn and perhaps a contraction of the sector.

"The NBC has failed to consider the most basic math here, which makes me think that this isn't coming from the NBC at all, but is rather the result of a political agenda for the government -- to look like it's doing something on behalf of the rural poor," said Rozas.

Several commentators have described the government's intervention as a populist move, given that a vitally important commune election is only three months away. Nonetheless, most agree that the decision will have the opposite of the intended effect.

On March 13, Cambodian Defense Minister Tea Banh said in a speech to members of the ruling Cambodian People's Party that Prime Minister Hun Sen had ordered the central bank to impose the interest cap, a policy the premier had suggested in November.

The limit was imposed by the NBC the following day, despite its own report in November that said any such limit on interest rates would be bad policy and lead to lenders "refusing to provide credit to the poor."

Microfinance institutions have been ordered in recent months to change their logos to keep people from confusing them with those of state agencies, sparking rumors the government was concerned it would face a backlash when these lenders call in debts.

No consultation

Huot Ieng Tong, chairman of the Cambodia Microfinance Association, which represents 84 institutions, said the government did not consult the industry about the cap and only informed lenders the ruling had been signed.

The association has suggested a number of ways around the interest rate ceiling, including tax exemptions and cheap loans from the central bank to ensure financial stability for the industry, which is worth an estimated $4 billion, including all loans and savings.

However, the proposal to have the central bank lend money to microfinance institutions is a "nonstarter," because Cambodia is highly dollarized and the NBC lacks control over the dollar economy, according to Miguel Chanco, lead ASEAN analyst for the Economist Intelligence Unit. The country uses both local currency and dollars, and much of the capital of banks and MFIs is in dollars.

Chanco also said the restrictions on microfinance institutions will hurt the wider banking sector. "As long as the [interest] cap remains, there will be a slow-burning process where credit dries up and the financial system is put under constraint."

But others question whether high-interest microfinance is actually helping the economy and the livelihoods of Cambodians.

A report published in early March in the international Journal of Development Studies examined whether Cambodian households were made better off by microfinance loans.

The study's author, Seng Kimty, argues the loans trap low-income borrowers in a cycle of high-interest indebtedness. This is because the majority of loans surveyed were used for things that did not enhance the borrower's productivity, such as purchasing vehicles or household necessities, rather than generating income that would help them repay the debt.

Many experts agree that there is a microfinance bubble in Cambodia, although they differ as to how serious it is and whether and when it will burst.

As of the end of 2016, there were around 1.9 million microfinance clients who borrowed a combined total of almost $3 billion, making the average loan roughly $1,500, according the NBC's latest annual report. The latest World Bank study of gross national income per capita, conducted in 2015, put the average at about $1,070. Cambodia raised the minimum wage of garment workers this year to $153 per month.


Some think the industry has taken advantage of the poor. Microfinance was a "noble idea but has become a grand scheme to try to make as much money as possible, from the greatest number of people possible," said Ou Virak, head of the Phnom Penh-based Future Forum think tank.

He added that the industry has allowed some lenders to "make big returns with little accountability," and question whether loans should have been given in the first place. "Without regulations and enforcement ... microfinance is a formalized scheme for loan sharks."

Despite this, Ou Virak saw a number of problems with the recent decision to cap interest rates. Such rules should have been enacted long ago, while the recent limits should have been eased in over a period of at least three years, he said.

Comparisons have been drawn between the immediacy of the interest rate cap on microlenders and the NBC's decision last year to raise capital requirements on Cambodia's banking institutions, including microfinance institutions.

The policy implemented in March 2016 requires deposit-taking microfinance lenders to increase their minimum capital from $2.5 million to $20 million by 2018. The same deadline was placed on those not licensed to take deposits, which must increase their minimum capital from $62,500 to $1.5 million.

This move was "sound in principle" said Chanco, adding that it was important for the central bank to set an achievable deadline.

However, along with the increase in capital requirements, the interest rate cap is likely to cause panic in the microfinance industry and force the institutions to look for alternative ways of raising capital to avoid going bust.

Chanco speculated that there will be an increasing number of mergers and acquisitions in the coming months. Indeed, Hong Kong's Bank of East Asia, and Sri Lanka's LOLC Finance jointly agreed in mid-March to purchase a majority stake in Prasac Microfinance, Cambodia's largest MFI by assets.

While this might be good news for Prasac Microfinance, such a big acquisition is unlikely to be on the table for all of Cambodia's MFIs, some of which are likely to go under as a result of the interest cap, analysts warn.

Although the cap is meant to slow the expansion of MFIs, analysts believe there were better way to achieve that goal. "The rate cap slows growth in the way that a wall slows a speeding bus," Rozas said. "I suppose it works, but brakes could still get the job done and [are] a lot safer for the passengers on board."


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