The explosive growth of bank lending in Cambodia has industry insiders concerned that the Kingdom’s credit market is overheating, with some urging the central bank to tighten its reins on lending institutions in order to cool lending and protect the country’s financial sector from potential shocks and downturns.
The loan portfolio of the Kingdom’s commercial banks grew 30 per cent in 2014 to reach $9.7 billion by the end of the year, according to the National Bank of Cambodia (NBC). Credit growth ballooned even faster among the nearly 40 microfinance institutions (MFIs) under its purview, with their loan portfolio soaring 56 per cent during the year to surpass the $2 billion mark.
The rapid pace of credit growth, which the International Monetary Fund (IMF) forecasts will accelerate over the next three years, led the UN agency to recommend that Cambodia implement prudential measures that increase capital buffers and tame lending.
“The priority is to address growing financial stability risks by stabilising and moderating the pace of credit growth to more reasonable levels, while closely monitoring the effect on growth,” the IMF said in a report on its latest Article IV consultation.
Stephen Higgins, managing partner of investment firm Mekong Strategic Partners, said the IMF’s concern is justified given the rate of credit expansion.
“They are rightly concerned about credit growth, which is just too high, and probably double what it should be,” he said.
In a study last year, his firm concluded that Cambodia’s credit market would swell to $30 billion by 2020. But with no sign of lending slowing in 2015, he now thinks it is on pace to reach $50 million, or about 150 per cent of the GDP.
“The IMF’s [latest] forecasts for credit are even higher than ours, so I reckon the $30 billion by 2020 is in the bag, even though everyone thought we were exceptionally optimistic at the time,” Higgins said.
International ratings agency Standard & Poor has also expressed concern, labelling the country’s banking sector as “high risk” due to its surge in lending and “too many banks [competing] in a small economy.” In a report released in February, it warned that Cambodia’s financial sector was overexposed, while the central bank lacked the capacity to bail out underperforming banks in a crisis.
The ballooning credit has not gone unnoticed at the NBC, which has a toolbox of prudential regulations it periodically tweaks to spur or rein in credit growth and to ensure that financial institutions maintain sound capital structure.
Lawrance Liang, chairman of Cathay United Bank (Cambodia), the local banking arm of a Taiwanese financial group with over $200 billion in assets, said the measures are essential given the small size of Cambodia’s economy, which makes it particularly sensitive to large movements of foreign capital.
“It’s especially important for NBC to monitor closely weak capitalised banks and MFIs since their thin capital and concentration of risks make them more vulnerable than healthy ones to weather the impact of potential economic shocks and downturns,” he said.
One of these tools is the minimum capital requirement, which aims to ensure that banks and MFIs have sufficient capital to cover their liabilities without putting their deposits at risk.
The central bank last adjusted the threshold rate in 2008, raising the minimum capital requirement to $37.5 million for commercial banks, $7.5 million for specialised banks, and $2.5 million for deposit-taking MFIs.
But with bank credit growing about 30 per cent a year, and even faster for MFIs, this fixed rate has not kept up with bank expansion.
Banking experts have called for doubling, or even tripling the minimum capital requirement. Some including the IMF have also argued that as the country’s eight deposit-taking MFIs have grown larger than some mid-cap banks – and are competing directly with them – they should be subjected to the same regulations.
“Similar minimum capital requirements as commercial banks should be established for MFIs, though maybe a bit looser given their overall weaker capitalisation nature,” said Liang.
In Channy, president and group managing director of Acleda Bank, said he was comfortable with the current level of the minimum capital requirement, and raising it would slow the influx of new banks and MFIs into the Kingdom, though not necessarily curb lending growth.
For that, he said, the central bank has three essential tools at its disposal: the capital adequacy and liquidity ratios, and the reserve requirement.
“The regulator can tighten growth by adjusting these two ratios, as well as adjusting the reserve requirement,” he said.
Under the current regime, the NBC requires banks to have capital adequacy ratio of at least 15 per cent and liquidity ratio of over 50 per cent.
“In order to have more solvency, NBC can increase the capital adequacy ratio, and to have more liquidity, it can increase the liquidity ratio,” Channy said.
The NBC’s reserve requirement – a specified proportion of banking deposits that must be held in cash or near-cash assets – is 12.5 per cent for banks and 8 per cent for MFIs. Raising the requirement is more of a blunt-instrument approach, which bankers say would reduce the capital available to be loaned out, but discouraging lending would also decrease investment and economic growth.
Whether this is necessary is debatable. The central bank’s capital adequacy ratio is nearly double the 8 per cent required under Basel I, a global regulatory standard on bank risk management and liquidity, and still a notch above the more stringent framework of Basel III, which was developed in response to the 2007-08 global financial crisis.
The liquidity ratio, a measure of the liquid assets that a financial institution can use to cover its short-term liabilities, is a comfortable 80 per cent and 161 per cent for banks and MFIs, respectively, according to NBC data.
The IMF, however, noted that while Cambodian banks satisfy the minimum liquidity requirement, they have a “shortfall of maturing assets over maturing liabilities in the next 30 days” and in a pinch, could face a short-term liquidity risk. It therefore recommended that the central bank impose a secondary reserve of liquid assets to cover expected short-term cash outflows.
According to Grant Knuckey, CEO of ANZ Royal Bank, the central bank is looking to introduce this liquidity coverage ratio (LCR), which is a Basel III ratio common to many jurisdictions. This would not just slow lending; it would make it more secure.
“One very clear effect of introducing the LCR will be a lessening of credit growth, as well as ensuring that growth is coming from banks that have the right liquidity capacity,” he said.
Knuckey said he expects the NBC to roll out this prudential requirement “imminently,” possibly alongside capital measures, to curb lending and increase the resilience of Cambodia’s banking sector.
“I expect 2016 to look very different to 2015 from a credit growth perspective,” he said.
Cathay United’s Liang said while he supports prudential measures aimed at slowing credit growth, particularly in the “overheated” real estate sector, he recommends a gradual phase-in over several years to give financial institutions time to adjust.
“I also suggest the NBC consider establishing a clear exit mechanism for those financial institutions that fail to comply with [any increased] minimum capital and reserve requirements,” he said.