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.