NB Financial Innovation
Don’t Fear the Rate Cap: Why Cambodia’s Microcredit Regulations Aren’t Such a Bad Thing
Cambodia’s microcredit sector is in an existential crisis. An astonishingly rapid and manifestly unsustainable increase in the supply of microcredit since 2010 has given rise to a number of serious risks as well as exacerbating ongoing negative impacts and trends. The Cambodian government has, finally, been forced to react in order to avert an otherwise inevitable and destructive meltdown. The first important measure last year was to increase the capital reserve requirements in the microcredit sector.
Most recently, the National Bank of Cambodia announced an interest rate cap of 18 percent that will essentially halve the interest rates applied to most new microloans. The hope is that the explosive growth of Cambodia’s microcredit sector can be tempered somewhat.
Predictably, sympathetic microcredit advocates and analysts have come out to defend Cambodia’s microcredit sector. One of the most active of these is microfinance consultant Daniel Rozas, who penned a piece in the Phnom Penh Post opposing what he sees as unwarranted government interference into Cambodia’s supposedly successful microcredit sector.
However, I think Rozas is very seriously wrong here, not least because he tries to steer blame away from those responsible for the current crisis in Cambodia.
First, let’s try to understand why this crisis has emerged. Cambodia’s microfinance sector today is one of the largest and most profitable in the world. It attained this position thanks to the extensive commercialization and deregulation of the microcredit sector that began in the early-2000s, which enabled the initially non-governmental microcredit institutions to convert into fully for-profit, market-driven business entities. Crucially, this change provided the CEOs, senior management and core shareholders in the microcredit sector with very powerful Wall Street-style incentives to grow the supply of microcredit as rapidly as possible. Doing this, however, was not meant to benefit Cambodia’s poor so much as generate the revenues that could be used to hike CEO and senior management rewards to elite status, as well as generate the high level of dividends and eventual capital gains expected by shareholders that include the World Bank’s IFC arm and private wealth management and investment funds (probably the most notably successful example involved Jardine Matheson Holdings which in 2009 paid US $34 million for a 12.25 percent stake in ACLEDA and sold it in 2015 for US $166 million to register an astonishing five-fold financial gain).
Just as on Wall Street in the 1990s, however, Cambodia’s microcredit institutions found that the best, if not only, way to achieve the required rapid growth was by indulging in a spurt of reckless lending, defined as the situation where a lender pumps out as many loans as possible with limited reserves, without regard for the quality of the loans advanced, and with little interest in the eventual consequences of client over-indebtedness. A local and expatriate elite played an initial part in the over-lending frenzy that transpired in Cambodia, but we must also look to the foreign banks and investment houses that began to buy into Cambodia’s microcredit sector after 2010. This started with Jardine Matheson Holdings’ investment in ACLEDA in 2009, and continued right up to the full acquisition in 2016 of Cambodia’s largest dedicated microcredit institution, PRASAC, by a Sri Lankan conglomerate. All of these investments had no other aim but to make a lot of money at the expense of poor individuals in Cambodia languishing at the bottom of the pyramid.
So it is quite wrong for Rozas to say that Cambodia has enjoyed “over a decade’s worth of successful financial policies,” a period of success that risks being broken by the Cambodian government’s recent interventions. On the contrary, the country is where it is today – in very deep trouble – because of a manifestly unsuccessful financial policy that has directly given rise to a hugely destructive episode of reckless lending, an episode that transpired mainly in order to satisfy the purely private enrichment goals of the narrow elite that now manages and owns Cambodia’s microcredit sector.
Second, let’s now turn to the more immediate issue of the impact of interest rate caps. The common scare tactic deployed by analysts like Rozas, that the supply of microcredit will completely dry up as a result of government intervention, is simply not borne out by the evidence to date. This shows that most microcredit institutions react to interest rate caps by only marginally reducing the volume of microcredit they pump out to some high-cost geographical areas or market sectors. But since this is actually what we want them to do in the current oversupply context, then that’s perfectly OK. Ideally, one might say, an interest rate cap will help the poor to liberate themselves from their crushing burden of microdebt.
Rozas also trots out another well-worn scare tactic related to this supply issue, which is the theory that if the microcredit sector is constrained in some way or its growth halted, the poor will flock to the local money-lender to satisfy their huge thirst for microcredit. This argument is both weak and morally suspect. Pointedly, Rozas does not provide, and I am not aware of, any example where this outcome has transpired other than at the margin. Moreover, let’s remember that the modern microcredit movement only came recently into the lives of the global poor, and it actually required a massive, and arguably unethical, sensitizing and marketing effort to get the poor to willingly go into such crazily high levels of debt, and also to stay there in perpetuity (in Bangladesh they call this “topping-up”). This effort then had to be re-doubled when it became clear to the poor that microcredit was not actually creating the promised exit from poverty that they, and others, were told it would accomplish. So take away the aggressive marketing and the constant pressure on the poor to keep borrowing ad infinitum and they might well cut back on debt of their own volition, which would also mean they would have no real reason to flock to the local money-lender.
Pointedly, when the microcredit sector in Bosnia hit a similar crisis in 2008-09, the over-indebted were provided with a debt advisory service that counseled them on how to avoid going into such serious debt in the future, while the World Bank assisted the microcredit sector to contract to a “sustainable” level (which was set at less than half the supply of microcredit reached at the peak level of 2008). As far as I could ascertain from my industry connections and regular travels there, the local money-lenders saw no real uptick in business. Similar measures could be used to resolve the crisis in Cambodia today.
And it surely tells you something that in those countries with no appreciable microcredit sector or over-indebtedness issue, for their part the local money-lenders have not reacted to such an obvious “business opportunity” by pushing the poor into excessive debt. There certainly do not appear to be as many money-lender-driven meltdowns as there are microcredit-driven meltdowns. One reason perhaps is that the local money-lenders would not wish to essentially set out to destroy the very same villages that they and their families also reside in.
Finally, there is the argument that microcredit has clearly been beneficial to the poor in Cambodia, and it is for this important reason that Rozas and others are doing all they can to ensure that it is saved. In fact, there is an argument to be made that, as virtually everywhere else in the global south, the microcredit sector is responsible for frustrating the goals of poverty reduction and sustainable development in Cambodia. There is the high and growing level of individual debt, most of which has been used for unproductive and short-lived informal businesses, or else for consumption spending, and which has trapped many poor individuals into regular interest payments that are now beginning to exceed what they spend on basic items such as food. Worse, an increasing number of new microloans (albeit from a low base) are now being accessed simply to repay installments due on existing microloans, a clear indication that the final “edge of the cliff” Ponzi stage of microcredit has now been reached.
There is also the hugely important issue of land loss. A significant proportion of the microloans disbursed in Cambodia since the early 2000s have been collateralised by the poor using their land certificate. Their subsequent inability to repay their microloans – for example, because the businesses financed went bust – has meant the gradual loss of this land. As is well known to development economists, loss of land is probably the most important factor explaining why the poor fall into irretrievable and chronic poverty. Estimates are that up to 15 percent of the land lost by the poor in Cambodia in recent years has been through this microcredit-assisted route, which, if accurate, represents a simply huge negative impact arising from the microcredit model. If we recall that the Grameen Bank in Bangladesh was founded to primarily help the very poorest – the landless – it is disturbing to find that the microcredit sector in Cambodia is increasingly helping drive the poor into landlessness.
Perhaps the most important impact issue that has been carefully hidden under the carpet here is the longer-term “anti-developmental” impact of Cambodia’s microcredit sector. It is well-known that Cambodia’s financial sector is probably the world’s most microcredit-oriented, with as much as 45 percent of credit provided by the banking sector intermediated by microcredit institutions. What this astonishing figure actually reflects is the construction of a deeply inefficient financial intermediation structure, one that ensures the most unproductive enterprises imaginable – tiny, informal microenterprises and self-employment ventures – are massively supported. Meanwhile, far more productive formal SMEs are offered but a fraction of the capital they desperately need to invest, train employees, retool and re-equip with the latest technology, and so, hopefully, be in a position to grow to their fullest potential. Compare this to neighbouring Vietnam, where the local government-supported financial system has, since the 1990s, played a major role in supporting the growth of formal technology-based SMEs and semi-commercial family farms, a development that has very much driven forward the country’s rapid growth from the “bottom up.” In contrast, Cambodia’s microcredit-dominated financial sector has effectively served to undermine and block a similar dynamic upgrading process from emerging there.
The events playing out in Cambodia right now represent a clear turning point both for Cambodia’s bloated microcredit sector and perhaps for the global microcredit movement, which is faced with the messy, yet entirely predictable, collapse of yet another of its role models.
Milford Bateman is a Visiting Professor of Economics, Juraj Dobrila at Pula University Croatia and Adjunct Professor of Development Studies, St Mary’s University, Canada. He is the author of “Cambodia: The next domino to fall?”, a chapter in the forthcoming book “The Rise and Fall of Global Microcredit: Development, Debt and Disillusion.” A preliminary conference paper based on this book chapter is available here.
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