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Experts warn against interest rate cap

A woman receives money from a finance officer at a Phnom Penh branch of Prasac Microfinance Institution, the country’s largest MFI.
A woman receives money from a finance officer at a Phnom Penh branch of Prasac Microfinance Institution, the country’s largest MFI. Hong Menea

Experts warn against interest rate cap

With the ongoing debate over whether the government should take interventionist measures to impose an interest rate cap on Cambodian lending institutions, an economic researcher at the central bank has concluded that any manipulation of current free market practices would have broad negative consequences.

“As experiences from other countries around the world show, an interest rate cap is not a good policy to tackle high interest rates in the long run,” Leng Soklong, an economic researcher for the National Bank of Cambodia (NBC), said yesterday. “[Instead,] improving competition and efficiency in the sector would be the best measure.”

In a presentation during the NBC’s third annual macroeconomic conference last Friday, Soklong showed that while interest rate caps were used in 62 of 152 World Bank member countries, it was typically employed as a blunt instrument with mixed results.

Citing such countries as Greece, Spain and Portugal that have used it to protect consumers from predatory lending, he juxtaposed the tool against countries like Germany, Japan and Nicaragua, where it has produced adverse results such as the closures of microfinance institutions (MFIs), a rise in illegal lending and diminished access to credit in rural and vulnerable areas.

Soklong indicated that if Cambodia adopted interest rate caps – a populist measure that Prime Minister Hun Sen called on last week to help those in the struggling rice sector – it would cause loan sizes to grow, diminishing the ability of MFIs to lend.

Additionally, he noted in his presentation that interest rates offered by Cambodian MFIs have fallen organically by almost 30 percent over the last decade to an average in 2015 of 20.3 percent per annum – well below the global average of 27 percent.

“Based on the data, the decline of interest rates in this sector was a result of cost saving and efficient operation in the sector,” he told the Post. “Moreover, competition, with many players coming in, contributes to this improvement.”

In Channy, president of Acleda Bank, also agreed that compared to previous years, Cambodian interest rates had dropped impressively. “The government has licensed more regulated MFIs, and more financial institutions operating in Cambodia means that competition will naturally lower interest rates,” he explained.

He said that on average bank interest rates had already fallen to a little over 8 percent, from 9 percent just two years ago. As for MFIs, he said the 2014 rates of 26 to 30 percent per annum had already fallen to around 25 percent this year.

“In a free market, there are no interest rate cuts and the rates are dependent on supply and demand,” he said, adding that despite the prime minister’s announcements, he did not expect regulators would accept a cap on interest rates.

Pressure on the poor

While borrowers and critics have claimed that Cambodian lenders have unreasonably high interest rates, Channy claimed that little could be done as foreign lenders injecting cash into Cambodia must factor in the “high-risk” nature of the country that can lose its international credit rating on political and economic instability.

“If you look at Cambodia, until we develop into a stable middle-income country, foreign lenders have to add higher lending rates,” he said.

Citing the London Interbank Offered Rate (LIBOR), a European benchmark rate, he said foreign lenders have to tag on an additional 4 percent when lending to Cambodia, whereas for more developed economies such as Thailand and Vietnam they add just 2 percent. The risk-adjusted rate means Cambodia financial institutions are borrowing at 5.2 percent even before taxes and overhead costs are factored in.

“At 8 percent for commercial loans it means we [banks] are already lending with low margins,” Channy said, adding that it was unfair for the government to single out the MFI sector.

Stephen Higgins, managing partner of the local investment firm Mekong Strategic Partners, said that the NBC should never consider imposing an interest rate cap because it was simply a “bad policy”.

He said an interest rate cap would result in a net loss to the Cambodian economy and increase financial pressure on the poor.

“There is a mistaken belief that they help reduce the cost of credit to low-income clients, however all they achieve is to reduce the availability of credit, and force clients to go to unofficial sources of credit which are invariably more costly,” he explained.

Channy expressed a similar view, arguing that an interest rate would cause MFI credit to dry up, pushing borrowers to unlicensed lenders who usually offer much higher rates.

“If interest rate caps stop MFIs from issuing small loans and shifting to larger loans, many borrowers would have to go to illegal lenders for credit,” he said.

However, Bun Mony, CEO of Sathapana Bank, doubted that the central bank would ever take such drastic measures to reduce interest rates. “The problem in Cambodia is that you have other ministries that do not understand the financial markets and try to pressure the government,” he said.

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