Analysts say the central bank’s unprecedented decision to slash and cap microfinance interest rates at 18 percent a year, allegedly on the orders of Prime Minister Hun Sen himself, could bankrupt dozens of microfinance institutions (MFIs) while drying up credit channels to the poor – the very people the populist measure aims to help.
Ngeth Chou, senior consultant at Emerging Markets Consulting (EMC), projected that only the Kingdom’s largest microfinance providers would weather the sudden and drastic interest rate cut, which is slated to come into effect on April 1.
“In general, there would be a few like Prasac, Sathapana and HKL that may survive,” he said. “The rest will be unsustainable.”
Cambodia had 54 licensed MFIs and seven microfinance deposit-taking institutions (MDIs) as of end-2016, with a total 1.9 million clients and a combined loan portfolio of $3 billion, according to the National Bank of Cambodia (NBC). In addition, several prominent banks, such as Acleda Bank and Sathapana Bank, provide a large volume of microfinance loans to farmers, small businesses and consumers.
Chou said the NBC’s decision to cap annual microfinance interest at 18 percent – nearly half the prevalent rate charged by most MFIs – will turn microlending into a loss-making activity.
He said MFIs that focus on small group lending will be hit the hardest as they must lend at rates between 23 to 25 percent to cover basic operating costs and the high cost of source funds.
Moreover, he speculated that a collapse of the microfinance sector would have severe consequences on the rural poor, cutting off their access to credit.
“As MFIs close, rural clients will not have access to the same services that were once provided to them that are used to cover immediate financial needs,” he said.
According to EMC’s research, 37 percent of clients borrow money for food consumption and over a quarter borrow for health care expenses.
“Previous clients will have to turn to private money lenders that generally charge from 5 percent to 10 percent per month, which is far more expensive than what have been charged by MFIs,” he added.
Stephen Higgins, managing partner of local investment firm Mekong Strategic Partners, said he expects the NBC’s cap on microfinance interest rates to drive the Kingdom’s seven MDIs previously profitable businesses deep into the red.
“Basically, it is a loss of revenue of at least $122 million, compared to a profit of $119 million for the MDIs,” he said, having calculated the impact an 18 percent interest rate cap would have on net profit based on their 2016 annual financial statements.
He added that financial institutions, even well-managed ones, that rely on small-scale loans will not be able to survive in the new environment unless they make up for the lower interest rate with higher fees.
“If you take AMK for example, it has a big focus on serving the poorest members of the community, and as a result it has the lowest average loan size of the MDIs,” he explained. “Despite being well run and efficient, it needs to charge an interest rate of about 30 percent just to break even.”
Higgins said the people most impacted by the interest rate cap will be those who can only afford small loans, such as smallholder farmers looking to purchase seed and fertiliser.
“They simply will not be able to get a loan from the formal financial system, and some will be pushed into the arms of loan sharks.”
Sim Senacheert, general manager of Prasac, the country’s largest microfinance institution by assets, said the NBC’s announcement came as a surprise with no prior consultation.
“This regulation was not expected to happen,” he said. “It is difficult to understand why this regulation is needed when free-market competition has already decreased the average lending rates from 50 percent five years ago to around 20 percent today.”
He pointed out that Cambodia had one of the best track records for microfinance lending in the world with a low non-performing loan (NPL) ratio and a negligible level of defaults. He said the organic growth of the free market obviated the need for government intervention.
“The reason that lending rates have naturally fallen is because the number of clients has increased to nearly 2 million people with a $3 billion loan portfolio,” he said. “When there is a cap there will be nothing but challenges.”
Top Sok Samphea, chief operating officer of VisionFund (Cambodia), said the interest rate cap could force the MFI to eventually stop lending amounts below $5,000 – which would be a huge blow to an institution dedicated to serving the poor.
She explained that the vast majority of VisionFund’s $150 million loan portfolio comprised of loans between $700 and $1,000. For these loans, the MFI had to charge 25 percent interest to cover operating costs.
“We are studying how to reduce operating costs so that we can stay with our clients, because we don’t have any intention to walk away from people in rural areas,” she said. “We just worry that sooner or later, we will have to force ourselves to not provide small loans because we can’t afford it.”
Samphea said that if the government is going to hold firm on the regulation, it should support MFIs by reducing profit taxes, lowering licensing fees and delaying the deadline on minimum capital requirements. She also advocated that the interest rate ceiling should not be imposed overnight, but rather through a slow rollout.
“If the interest rate cap could be applied step by step, for example 25 percent in 2017, 23 percent in 2018 and 19 percent in 2019, that would be a better solution,” she said.
Scott Osheroff, regional analyst for Asia Frontier Capital, said that while a ceiling on interest rates would certainly ripple the market in the short term due to the rapidly growing pool of consumer debt, it “would likely benefit the average Cambodian in the medium term”.
“The capping of interest rates and increased capital requirements will likely drive consolidation among MFIs,” he said. “However, this is largely a good thing as there are too many in the sector, many of which have been struggling for some time.”
However, Higgins said that the regulation would hurt investor confidence – which could be a devastating blow given the sector’s dependence on overseas capital for expansion and to meet the revised minimum capital requirements.
“Those capital providers will obviously be very nervous about continuing to support the industry here,” he said.