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Logo of Phnom Penh Post newspaper Phnom Penh Post - Interest rate cap will hurt rural families

People drive by a branch of microfinance company Vision Fund in Phnom Penh.
People drive by a branch of microfinance company Vision Fund in Phnom Penh. Sreng Meng Srun

Interest rate cap will hurt rural families

On March 13, the National Bank of Cambodia announced a major new policy. Starting April 1, all microfinance institution operating in Cambodia will be required to lend at interest rates no higher than 18 percent per year. This is a deeply misguided regulation that will undo over a decade’s worth of successful financial policies.

At the dawn of this century, Cambodia’s financial sector was largely nonexistent. There were no ATMs, few bank branches, and equally few customers. In rural areas, there were no banks at all, and moneylenders held a monopoly on lending.

How times have changed!

Today’s village household has far greater control over its finances and is deeply connected to Cambodia’s growing economy. A farmer can borrow from a microfinance lender to buy seeds and fertiliser and set aside savings to help pay for his kids’ school fees. He can finance a solar panel to charge the phone that lets the family stay in touch with older children in the city, who themselves can send money home to the parents cheaply and reliably. None of this even requires the three-hour trip to town – a loan officer from a microfinance institution visits the village each week, while the village shopkeeper doubles as a microfinance agent who can send and receive payments. This picture is repeated in house after house, village after village, from the outskirts of Phnom Penh to the remotest corners of Cambodia. Today, in rural areas alone, half a million clients hold savings at microfinance institutions, and over a million borrow from them.

The new regulation puts all that under threat.

Interest rate caps are a type of price control. Like all price controls, they have a predictable effect – if something can’t be sold at a profit, it won’t be sold at all. If there’s any doubt, just take a look at the empty store shelves in Venezuela, where price controls have created a major food shortage. After all, even the most socially oriented business has to cover its costs.

The results in Cambodia won’t be empty shelves, but it will mean fewer and more costly financial services for the very people the law is intended to help – the rural poor. To understand why, consider two loans: one for $500 and one for $5,000.

In Cambodia, $500 loans are typical for rural households. The loan officers of rural microfinance institutions travel by bike to the countryside, through unpaved roads and footbridges, to meet with villagers and evaluate their borrowing needs and household finances. All that costs money – in staff time, transportation, communication. Making such a loan costs about $75, or 15 percent of the loan amount. Technology helps keep costs as low as possible, but it cannot replace the last-mile human contact.

Meanwhile, a typical $5,000 loan is more likely to be lent in the city, to a higher-income client. Loan officers there need not go far, but at the same time, rental costs for the branch are higher, and the staff command higher salaries. Making such a loan costs about $300, or four times the cost of the smaller loan. Even so, that represents only 6 percent of the loan amount, compared to 15 percent for the $500 loan – a cost difference of 9 percent.

In rural Cambodia, there is another major cost factor. Because savers demand higher interest rates for riel deposits than for US dollar ones, lending in Khmer riel (KHR) comes with higher funding costs. The interest rate for one-year KHR deposits at banks currently stands around 7.00 percent, compared with 4.75 percent for USD. And foreign funding is more costly still, due to a special tax on foreign debt and the cost of hedging the risk of currency fluctuations.

Most clients in rural areas are too poor to borrow $5,000 and typically do not receive incomes in dollars. But the higher cost of making small loans in riel means that lenders must also charge higher interest rates. That is why small KHR loans typically come with interest rates of around 30 percent, while larger USD loans have rates near 20 percent. Yet the new 18 percent cap is applied equally to both.

Implementing the cap will consign rural Cambodia to the empty-shelves syndrome, but instead of groceries, it will be financial services that will vanish. With rural microfinance institutions forced to refocus on wealthier households, poor village families will be left to manage their finances informally. Loans will still be available from moneylenders, but at rates that often exceed 120 percent per year. The same with informal savings and payments, which are not just expensive but also unreliable. All the while, the regulation will have the perverse effect of further deepening the country’s reliance on dollars.

It’s difficult to imagine that this is the intent. If concern is over excessive profits from microfinance lending, why not address that directly? The government could levy a higher tax on profits that exceed 3 percent return on assets, allocating the revenue to pro-poor programs. This would not only raise the costs for profiteers, but would also give the money right back to the poor.

That’s just one option among several. But one thing is certain: if the new regulation isn’t changed, the result will not only fail to protect poor rural families, it will unravel their financial independence and ability to share in the fruits of Cambodia’s growing economy. What took a decade to build, will take just months to erase.

Daniel Rozas is an independent microfinance consultant based in Brussels.

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Milford Bateman's picture

I very much share Mr Rozas’s worries about the microcredit sector in Cambodia. Its collapse, if it comes, would be very bad for Cambodia’s financial system and for its poor. However, in so many respects Mr Rozas has provided only a deceptively partial account of what has gone wrong and why.

He first talks about ‘over a decade’s worth of successful financial policies’. This is nonsense: we are where we are today - in very deep trouble - because of an unsuccessful financial policy! Promoting microcredit as a for-profit business has brought us to the very edge of the cliff and whether we go over or not is one important question, but understanding how we got to this point is the key to avoiding such disasters in future, and in Cambodia now. And the key driver in Cambodia, as in virtually all of the many previous microcredit crises (India, Bosnia, South Africa, etc), narrowly-averted crises (Bangladesh) and oncoming crises (Mexico? Peru?), is the conversion of most microcredit institutions into for-profit commercial bodies and the accompanying ‘light touch’ regulatory framework in which they are expected to operate and ‘stay on mission’. What this commercialization has done everywhere it has been tried out, in fact, has been to provide Wall Street-style incentives for the CEOs and senior managers to recklessly expand the supply of microcredit to quite ridiculous levels, just as we see in Cambodia. This is done, principally, because this is the way such individuals will become rich as private individuals through hiked up salaries, bonus payments, cashed-in share options, etc. Key shareholders will also, of course, add additional pressure to recklessly expand in order to maximise their own dividends and eventual capital gains. The eventual consequences to the poor of such reckless lending and narrow financial gains are, sadly, but a minor consideration.

Second, yes, of course, the poor need a range of financial services – ATMs, savings, credit, mobile phone payment systems, etc – but that is NOT the same as saying they need the huge quantities of microcredit that have been directed their way since the early 2010s, which is why we have a potential disaster on our hands right now. Conflating all these important services together, however, is the conventional deception that the microcredit industry uses to downplay the damage brought about by the reckless lending by the main microcredit institutions – you either take the enormous quantities of microcredit being pushed out into the community, they say, or you go entirely without all sorts of services and go without any form of credit too. This is a false choice, of course. An even sillier argument is also deployed by Mr Rozas, which is that the poor will fall en masse into the hands of the local loan shark if the supply of microcredit is curbed in any serious way. There is simply no evidence from anywhere that I can find to suggest that the huge quantities of microcredit that have swamped poor communities everywhere in the global south in recent years, including in Cambodia, will still be required from local loan sharks when the current destructive fad for microcredit is finally over.

Moreover, if the main for-profit microcredit institutions now choose to cut down on the supply of microcredit, this will be no bad thing. The dangerously high level of over-indebtedness that currently exists in Cambodia may fall to a manageable level. The levels of profit will be reduced too, another not such a bad thing, not least since much of this profit is channeled abroad to wealthy shareholders and so lost as demand to Cambodia. CEO and senior manager salaries, many involving foreign experts and advisors, will fall too, which is also not such a bad thing.

Finally, lost in all this discussion about how to avert a meltdown is the actual impact on the poor in Cambodia arising from the spectacular quantities of microcredit that they have absorbed in recent years. And the sad fact which Mr Rozas skips over is that there remains no evidence whatsoever that this amount of microcredit has helped to reduce poverty on average, and, as I will argue in Phnom Penh in May at a conference looking into the role and impact of social enterprises, microcredit has actually made things much worse for Cambodia's poor in so many ways. This, surely, is the ultimate insult.