W ith the first new banking licenses in over two years just granted, and other regional

players eying up the market, Robert Lang sizes up the state of the banking

sector.

THE National Bank of Cambodia (NBC), the Kingdom's central bank, recently granted

four new bank licenses -the first licenses granted since May 1994. This brings the

total number of banks to 33.

At first glance, the entrance of four additional banks appears to signal that the

economy is on the cusp of significant growth. "When investors come, banks come,"

said Niev Chanthana, Banking Supervision Advisor at NBC. In addition, banks from

Taiwan and South Korea are also reportedly applying for licenses, and several banks

from Japan are conducting market research.

However, many industry executives believe that 33 banks is too many for a country

where banks do not play a major role in financing economic growth, the citizenry

does not trust banks, and central bank supervisory capabilities exist on paper but

not in reality.

The IMF recommended, as early as 1993, that Cambodia reduce the number of banks or

at least cease issuing new bank licenses, except for well-known international banks.

Officials believed that 25-30 banks were more than enough, especially given the central

bank's weak supervisory capabilities. Moreover, the quality and activities of the

banks had become a matter of concern.

Before the new licenses, there were 6 foreign banks branches, and 22 locally incorporated

banks.

The four new licenses were issued to Lippo Bank of Indonesia, Advanced Bank of Asia

(ABA), Cambodia Agriculture Industrial Merchant Bank (CAIM), and Khmer Bank. Although

its management is South Korean, ABA is locally incorporated. It doesn't have any

branches in South Korea, and is planning to get involved with financing business

from South Korea.

Lippo Bank, part of the US$6 billion dollar Lippo Group which earns significant income

from banking and other financial operations in Indonesia, Hong Kong, and China, applied

for a banking license in 1994. In Cambodia, Lippo Bank plans to lend to its customers

from Hong Kong, China, and Taiwan, according to observers familiar with the bank's

operations. Lippo would particularly like to tap into investment from China since

that is a sector with little competition.

Lippo is optimistic about Cambodia's future and expects that in coming years Taiwan

and China will commit substantial investment in the economy, particularly in the

purchase of land and development projects in Kompong Som, said the observer.

Although Lippo Bank doesn't expect to earn a profit for several years, setting up

a branch in Cambodia fits into its long-term regional growth strategy. Moreover,

as part of the Lippo Group, it can afford to absorb losses from its Cambodian operations

for several years.

Lippo's characteristics and its likely strategy point to the appeal of strong regional

banks for the Cambodian economy. The IMF had excepted well-known foreign banks in

its 1993 recommendation to cease issuing new bank licenses because of their strength

and because they bring with them a full array of professional banking activities.

The Cambodian government would like Standard Chartered to upgrade its representative

office, established in 1992, to a branch office. "The head office is still thinking

about this," said Pamela Huy, Manager of Customer Services.

Losses Guaranteed

Industry executives were nearly unanimous in expressing optimism about the future

of Cambodia's economy. Profits for banks, however, are only expected 3-5 years down

the road.

In the meantime, most banks - foreign and locally owned - operate in the red, according

to observers. Expect 5 years to make a profit, said several bank executives.

The Cambodian market is challenging because there is not a significant amount of

loan activity taking place. Most foreign banks do not extend loans to local companies;

most project financing occurs offshore.

Foreign banks earn revenues from fees and commissions, which includes fees for transferring

money, remittances, and letters of credit. "A bank cannot make money on wire

transfers," said one bank executive. "Fee income is insufficient to cover

operating costs."

Most foreign banks established branches in Cambodia in order to service their existing

customers who have set up business here. For example, Thai Farmers Bank extends 75%

of its total loans to Thai customers, according to Terawat Singtong, Manager. Its

most well-known customer is CP Cambodia, a subsidiary of Thailand's largest conglomerate

CP Group.

Cambodian-owned banks extend loans and earn fee-based income, but they, too, find

profits elusive. Part of the reason is the widespread mistrust of banks.

Creative Marketing Required

Many Cambodians don't save their money in banks, primarily because they don't have

experience with banks. Instead, they buy gold, consumer goods -TVs, a home, a car

- or invest in the informal economy.

To educate consumers and build confidence, banks must be creative in how they market

their services. "We don't want to be high class," said Pung Kheav Se, General

Manager of Canadia Bank. "Our employees don't wear uniforms. Our lobby is very

simple. We want to make the customer feel comfortable when they come into our bank."

"A lot of customers don't know how to use our bank services," said Teng

Danee, Managing Director of Pacific Commercial Bank. "The younger ones don't

know, and the old ones know but they are afraid."

Pacific Commercial sends employees cold calling on residents to try to pique their

interest in the bank services.

"There's been a change from the days when customers used to take off their shoes

before they entered the lobby," said Bob Yap, General Manager of Singapore Banking

Corp (SBC), a locally incorporated bank. "People are beginning to save more,

but it's still not much."

This means that the national savings rate is very low, and underscores the as-yet

negligible role that banks play in mobilizing savings and fostering economic development.

This phenomena - mistrust, education, and growing trust - is partly the natural growth

process that banking sectors of other Southeast Asian countries have gone through.

However, part of the blame, observers say, lies with the government for not enacting

confidence-building measures in the sector. Possible policies include increasing

the efficiency of the banks' intermediary process and encouraging the use of banks

and checks among government employees.

"It is not enough to increase the number of banks," said another observer,

"the government needs to instill trust in the riel, the economy, and the country."

Absence of a Security Law Hinders Loans

One positive step would be the passage of a security law. Currently, there are no

legal provisions that detail collateral conditions, several executives complained,

which impedes the rate of loan growth. The Ministry of Commerce is reportedly drafting

a contact law which, among other things, would cover the security issue, but it will

most likely not become law for several years.

"Real or personal property is the only collateral," explains one industry

observer, "and it is uncertain [in the event of default] whether the bank can

collect on that collateral." The amount of a loan is based on 50-100% of the

value of the borrower's property. In other words, the owner of a house valued at

US$100,000 is eligible, depending on the particular policy of the bank, to receive

a loan of US$50,000-100,000.

Locally incorporated banks try to minimize the risk created by the absence of a security

law by taking possession of the title deed. Foreign banks prefer to lend to customers

with whom they have an ongoing relationship in their originating country, thereby

obviating the need to seek recourse in Cambodian courts.

The absence of a security law increases the risk of lending but it is not what hampers

loan growth or the entrance of additional foreign banks, according to some observers.

Rather, foreign banks are reluctant to set up operations in the Kingdom because the

market is too small: there is not enough banking activity to justify the presence

of additional banks. This observation underscores the difficulty in explaining why

NBC recently approved the new licenses.

Revenues from Interest on Loans

The picture may not be completely bleak, however. Several Cambodian-owned banks claim

to be making money from loan activity. One of the problems of extending loans is

that many companies don't use financial or cash flow statements. Most banks don't

base their decision on a financial statement due to creative accounting practices

in the Kingdom. "[Granting loans] is a very informal process," explained

SBC's Yap.

Most locally incorporated banks interviewed claimed that nearly all of their loans

go to local trading companies. Nearly all loans are short-term, usually 6 months,

with an annual interest rate of 15-20%. For instance, Canadia Bank charges an annual

rate of 18%. It pays depositors 8.5-9.5%.

Similarly, Pacific Commercial Bank - partly owned by Vice Chairman of the Cambodian

Chamber of Commerce Kong Triv - primarily extends small and medium-sized loans to

trading companies. It prefers 3-month term loans for new customers, with an annual

interest rate of 19.8%. The bank pays 9% annual interest on deposits.

Revenues From Speculative Activities

High deposit rates found at locally incorporated banks raise concern about how the

bank can afford to pay the high rates. (Most foreign banks don't pay interest on

deposits.)

Most of the assets - both foreign and local banks - are held overseas. This not only

means that the vast majority of assets are not circulated back into Cambodia's economy,

but also opens up questions about how these deposits are used. Several observers

were concerned that deposits are used in unsafe ways, if not involved in risky speculative

activity.

In May 1995, Credit Bank of Cambodia closed after failing to meet the minimum capital

requirement. It lost US$1.5 million on the Chicago futures market. Amid allegations

that NBC handled the case with serious improprieties, the bank's license has been

removed and the case is still pending in court.

The extent that deposits are used in unsafe ways is unknown. NBC does not have the

structure or the capability to monitor the use of deposits.

Indeed, as the bankruptcy of Barings and Sumitomo Corp's estimated US$2.6 billion

losses in copper futures attest, it is difficult to monitor the use of derivatives

even in countries with a more stringent regulatory system.

Most bank observers agree that Cambodia's banking supervisory skills are in disarray.

Part of the problem is the dearth of trained supervisory personnel. "They don't

have the manpower," explained one executive. "So banks are rarely, if ever,

audited. Plus, [central bank] officials don't know what they are looking for and

we have to show them. The bank could easily hide any information they want to."

Moreover, when NBC does locate a irregularity, it lacks the teeth or political will

to implement the law. Shortly after the closure of the Credit Bank of Cambodia, central

bank auditors were met by armed guards who refused them entrance to review the books.

Since the central bank must be aware of its weaknesses, why has it added to its burden

by recently increasing the number of banks?

Revenues From Illicit Activities

The potential to earn profits from illicit activities at least partially explains

the appeal of some banks to establish operations in Cambodia, particularly in an

environment where it is difficult to make money from legitimate banking activity.

Cambodia has many of the factors conducive for laundering money, such as a weak legal

system, the absence of central bank supervision, and the unrestricted movement of

capital. Illicit activities not only include laundering drug money but also revenues

from prostitution, illegal gambling, tax evasion, logging, robberies, and kidnapping.

While all 33 banks technically have the authority to operate normal banking facilities,

roughly a dozen are truly legitimate banks, according to several bank executives.

"How do you know if a bank is legitimate?" asked an executive. "Stand

outside and look at how many customers come in. Try to make a deposit, exchange money,

or even get change for a $100 bill."

Allegations of money laundering are extremely difficult to prove, despite the seemingly

infinite supply of circumstantial evidence. Indeed some observers claim that these

allegations are misplaced and overstated in Cambodia's cash economy. It is not unusual,

they say, for legitimate bank customers to make deposits or withdrawals of US$100,000

in the same week. Plus, cash substitutes -credit cards, checks, even cashier checks

- are virtually unknown among customers and merchants. Therefore, it is nearly impossible

for NBC to differentiate between cash transactions of legitimate and non-legitimate

purposes.

The Business of Regulating Banks

One observer claimed that NBC has a powerful incentive to issue additional licenses:

money. After abruptly notifying a bank that it has been granted a license and setting

an arbitrary deadline, NBC charges nearly US$2000 for each day it is late in establishing

operations. NBC requires that at least 60% of the incoming bank's employees come

from its employment roster. Plus, there are numerous other fees and expensive license

renewals.

Perhaps this last factor most adequately explains why NBC recently granted four new

bank licenses. If accurate, it points to the need to add competence and teeth to

the bank supervisory capabilities as well as to adopt a transparent and standardized

process of granting licenses.