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Banking on an economic crisis

Banking on an economic crisis

While Cambodia was not directly hit by the domino effect that caused financial institutions like Lehman Brothers to crumble, a domestic crisis has exposed the undeveloped banking sector


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Money changers offer foreign currency Thursday in Phnom Penh. Dollarisation of the Cambodian economy means the central bank has been limited in its ability to control money supply in response to the economic crisis.

EXACTLY one year after the subprime mortgage crisis first hit in the United States in July 2007, Cambodia's central bank took measures to reduce liquidity in its undeveloped financial system by doubling reserve requirements from 8 percent to 16 percent.

This move showed Phnom Penh was clearly out of sync with the world's major financial centres and impervious to the credit crunch that had forced New York, London, Paris and Tokyo into unprecedented crisis.

In a clear sign of Cambodia's lack of integration into the global financial community, the National Bank of Cambodia (NBC) was taking measures to rein in a rapidly increasing money supply even as much of the developed world was trying desperately to increase liquidity.

Although Cambodia's financial sector had escaped direct impact from the financial crisis - which hurt developed Asian economies such as South Korea - it was exposed to threats.

"Cambodia's banks are not exposed directly to the fallout from the build-up of toxic assets in Western banks," said the Economist Intelligence Unit (EIU) in its April outlook for Cambodia. "But they are vulnerable to domestic problems, including the recent bursting of the property bubble and the general downturn in the economy owing to the global slowdown."

It was not the first time vulnerabilities had been pointed out. Following IMF consultations with Minister of Economy and Finance Keat Chhon and National Bank of Cambodia Governor Chea Chanto in Phnom Penh from late October to early November last year, the International Monetary Fund noted that the global crisis "has exposed vulnerabilities among Cambodia's banks and is beginning to affect their financial soundness".

THE lack of openness is clearly worrying.

When the financial crisis began to spread across the globe, Cambodian banks had continued to operate in their own world.

As lending continued to increase, in large part driven by heady returns in a booming property market, loans began to catch up with the strong deposit growth of recent years.
Lending overstretched

The IMF warned that the loan-to-deposit ratio had reached 100 percent in October, up from just 68 percent a year earlier with "a move toward more risky lending activities".

Suddenly, South Korean construction companies, scared off by the worsening economic situation, withdrew their money and left, the IMF said, even as mortgage lending and consumer loans were expanding.

Non-performing loans (NPLs) were also being under reported: "Mid-year audits by the National Bank of Cambodia revealed NPLs [as a share of loans] higher by two percentage points than previously reported by banks," the IMF said in February.

At the end of 2008, the EIU noted that outstanding stock of credit to the private sector had increased 54 percent over the year to 9.9 trillion riels (US$2.4 billion).

It has awarded Cambodia's banking sector a CCC credit rating, which Fitch Ratings classifies as "a current perceived possibility of default". At this level of risk Cambodia's banking sector is considered to have a high level of outstanding credit given that other CCC-rated countries saw a median increase in credit over the year of just 23.8 percent, or less than half the rate of growth in Cambodia, the EIU said.

In its February report outlining these underlying problems, the World Bank noted that "two large banks" were threatened by NPLs while the IMF went further shortly afterwards, noting that "several large [banks] could face a large deterioration in credit quality and a need for recapitalisation".

Both organisations have repeatedly refused to identify the banks in question, with International Monetary Fund resident representative John Nelmes reiterating that the IMF "does not discuss or speculate about individual banks".

What is certain is that borrowing growth has fallen and NPL rates are up. Canadia Bank saw NPLs rise to 2.35 percent last year from less than half a percent the year before, according to bank data. The microfinance sector at the end of the first quarter said bad loans would rise to more than 1 percent this year.

"According to official data, the ratio of NPLs to total outstanding loans edged up slightly in 2008, to stand at 3.7 percent at the end of year," the EIU said last month. "Non-performing loans will rise in 2009-10, although official data may not reveal the true extent of the problem."

Cambodia's high exposure coupled with a perceived lack of openness meant the financial system was beginning to attract negative attention, adding to underlying weaknesses.

"Confidence is obviously a key issue, and banks will be reluctant to reveal the true extent of non-performing loans if the situation is bad/worse than previously thought," the EIU's Cambodia analyst Danny Richards said in an email Wednesday. "However, an opaque banking system is also a breeding ground for rumour and negative speculation."

The EIU has slowly increased its risk rating for Cambodia, from 68 out of 100 in December to 69 in January and up to 70 last month, the highest level in the past two quarters.

With loan-to-deposit ratios narrowing, banks are now looking to increase deposits, offering high rates to attract customers - the fixed deposit 12-month rate on dollars at Advanced Bank of Asia was 8 percent this week, ACLEDA was offering 7 percent, and May Bank, the lowest on the market, was offering 3.75 percent.

"The kicker is, higher deposit rates ultimately lead to high loan rates, which become a ‘tax' on businesses and consumers," James Lowry, ANZ Royal Bank's head of corporate and institutional banking, said Thursday. "If borrowers' capacity to service loans is impinged by higher interest rates, then people tend to borrow less or be restricted in how much banks will lend them, thus impacting lending activity."

Cambodia found itself caught between a rock and a hard place. At the same time as banks faced narrowing loan-to-deposit ratios and mounting exposure to bad loans, domestic firms, and developers in particular, were crying out for financing as the economy teetered on the edge of recession. Where banks were willing to lend at all, money was not going cheap.

Many other countries have seen interest rates plummet - the US benchmark rate has been lowered to below 0.25 percent, Thailand's rate has been slashed four times since December, and the Eurozone rate was predicted to be lowered to 1 percent this week, AFP reported.

In Cambodia, this has not been possible. Where other countries had been able to adjust interest rates to calibrate a response to the unprecedented failings of the global financial system, Cambodia's dollarised economy meant that the NBC did not have the same tools at its disposal.

"The NBC lacks most of the conventional monetary instruments that other central banks have. Currently they use reserve requirements and intervention as their main monetary policy tools," Nelmes told the Post in March.

Central bank response

As it became clear that Cambodia's economic growth was beginning to decline, the NBC reacted in January by widening money supply, lowering the reserve requirement by 4 percentage points to 12 percent to boost liquidity. This time, it also introduced measures to improve oversight of loan quality, drawing praise from the IMF for its handling of the complex problems facing the financial sector.

A decrease in the reserve rate, a new temporary overdraft facility for banks suffering from dangerously low liquidity, increased supervision and improvements to the lending provisions system mean the central bank "deserves to be commended for strengthened efforts at managing the risks", Nelmes said Thursday.

"A next step will be to introduce reforms that help to build an inter-bank market, so that banks can more easily trade liquidity among themselves to manage their liquidity needs."

The question remains whether these measures will be sufficient to stave off the worst of the impact of the crisis on the domestic banking system.

A spate of balance sheets for 2008 released last month by Cambodia's private banks showed nothing untoward, but it may not be until 2009's results are released next year that we see the true impact of the crisis given the largely hidden nature of the underlying problems thus far.

"The lack of openness is clearly worrying - potentially storing up greater problems in the future in terms of taking action to clean up balance sheets," said Richards.



The future is uncertain for Cambodia’s financial institutions. Their health depends more on what happens in the real domestic economy than the global financial sector. The third and final part of this series next Friday will look at what Cambodia needs to do to broaden its economy to ensure better protection.


December 2008

At the end of the year, non-performing loans (NPLs) in Cambodia increase slightly on the previous year, up to 3.7 percent, official data shows. Some analysts voice concerns that the true rate of NPLs could be higher after the banking sector was found to have under-reported the extent of bad loans by two percentage points following a midyear audit by the National Bank of Cambodia, as reported by the International Monetary Fund. Still, NPLs had decreased compared to a rate of nearly 10 percent in 2002.

January 2009

The National Bank of Cambodia lowers the reserve requirement for private banks from 16 percent to 12 percent in a bid to free up liquidity in the economy in place of interest-rate adjustment, as seen in non-dollarised economies. The move comes after the central bank had doubled the reserve requirement from 8 percent to 16 percent in July on the back of a drastic increase in lending and money supply that threatened to overheat Cambodia’s surging economy, which had posted repeatedly high levels of GDP growth.

February 2009

Concern mounts that the Cambodian financial system has come under increasing strain and banks may be under threat when the World Bank, followed by the International Monetary Fund, release reports saying that private banks are at risk from bad debt and a subsequent lack of liquidity. Neither organisation is prepared to identify the banks in question as rumours spread as to the identities of the “two large banks” mentioned by the World Bank as being at greatest risk from the ensuing crisis.

March 2009

With the warning signs increasing across the Cambodian financial sector, microfinance organisations report that NPLs are on the rise. Having recorded an NPL rate of just 0.67 percent in 2008, the sector predicts that the rate will move above 1 percent in 2009, the Post reports. The Cambodian Microfinance Association says that total lending was set to increase this year as people look to borrow from decreasing supplies of available credit, prompting fears of a rise in the seizure of property used as collateral.

April 2009

The London-based Economist Intelligence Unit [EIU] raises its banking sector risk score to 70 out of 100, the highest level since the economic crisis hits Cambodia. The rating – equal to CCC, or a “current perceived possibility of default” – has climbed steadily from 68 percent in October to 69 percent in January. “Some banks have been experiencing liquidity shortages in recent months, forcing them to draw on their excess reserves,” the EIU says in its monthly economic outlook for Cambodia released in April.


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