NB Financial Health
‘Like Using a Wall to Stop a Runaway Bus’: Cambodian Microcredit is Overheated, But Rate Caps Aren’t the Answer
There is nothing so convenient as arguing against a straw man. You dress it up in whatever way you want, then tear it down, feeling great about the accomplishment.
That’s what Milford Bateman does in his recent NextBillion article, “Don’t Fear the Rate Cap: Why Cambodia’s Microcredit Regulations Aren’t Such a Bad Thing.” He starts with the rather startling – and entirely unsupported – assertion that the rate cap announced in Cambodia is an effort to “to avert an otherwise inevitable and destructive meltdown.” He then proceeds to raise an entire army of strawmen in the form of arguments I apparently made in my article in the Phnom Penh Post, none of which are there.
Did I “steer blame away from those responsible for the current crisis in Cambodia”? Where did I write that “the supply of microcredit will completely dry up as a result of government intervention”? Did I write “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”?
It may work in today’s political environment, but for a credentialed academic, such license with truth and facts is simply not acceptable. The trouble is that this approach pervades the entire article.
The irony is that much of Bateman’s argument about Cambodia’s saturated microcredit market is one I have been making myself for two years now. Yes, the market has grown fast – too fast. Yes, high profits are a problem. Yes, over-indebtedness is a real and pressing concern. I have written about this, and argued the point with social investors, Cambodian MFIs, and the Cambodian central bank. But what Bateman seems to miss here is the most basic point that the interest rate caps are an utterly nonsensical way to address the problem of rapid growth. It’s like using a wall to stop a runaway bus. It might get the job done, but brakes would be better at protecting the passengers. (Note: The author is currently consulting on two projects that involve Cambodia – Mimosa and the CMA Lender Guidelines to develop self-regulations to improve market sustainability and avoid over-indebtedness.)
Indeed, the cap, by creating a clear preference for some types of lending – larger loans to urban, wealthier clients, over smaller ones to rural, poorer households – could well heighten the risk of the bubble. It wouldn’t be at all surprising to see current rural lenders refocus their attention toward cities, and thus further deepen competition with lenders already serving that sector.
Bateman also indirectly references the noted economist Hyman Minsky, suggesting that Cambodian microcredit is at “the final ‘edge of the cliff’ Ponzi stage of microcredit.” The trouble is, evidence doesn’t back up the claim (Bateman cites none). This stage relies on continuous growth to feed repayments, and the simple decrease in that growth would trigger a market unraveling – exactly as we saw in the early months of 2007 in the U.S., when money stopped flowing into subprime mortgages. As it happens, during mid-2016, MFIs in Cambodia had a period of some six months of minimal and even negative growth which offered a perfect opportunity to test the extent of the market’s reliance on growth. An advanced Ponzi stage would’ve predicted a rapid run-up in delinquencies, as borrowers reliant on new credit to repay their existing loans were no longer able to make those repayments. That didn’t happen.
It’s one thing to argue that Cambodia may be at the Ponzi stage of credit, as defined by Minsky. It’s another thing to assert that it is already at that stage. Bateman’s certainty is unsupported by the evidence.
Yes, there are individual borrowers in Cambodia who meet the “Ponzi finance” state defined by Minsky. I have personally spoken to several of them. But the sector hasn’t yet reached the point where their number is large enough to make crisis inevitable, as would be the case at the true Ponzi finance stage. That’s the reason I’ve personally focused a great deal of effort over the past year to work with many stakeholders in Cambodia to develop real, enforceable mechanisms to slow runaway lending.
Despite the focus on growth and saturation, the strangest part of Bateman’s argument is how little he discusses the premise of the article itself – the impact of interest rates. The one defense he proffers is a World Bank paper, which according to Bateman, suggests 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.” As with Bateman’s strawmen, the paper says no such thing. The closest evidence to Bateman’s excessively liberal paraphrasing is the finding that “in WAEMU (West African Economic and Monetary Union) countries, the imposition of interest rate caps on microfinance loans caused microfinance institutions to withdraw from poor and more remote areas and to increase the average loan size.” Doesn’t seem marginal to me.
Indeed, what the paper states quite emphatically is that the effects of caps differ greatly. And a major part of that difference stems from how and at what level the cap is set. If the Cambodian government had sought to emulate neighboring Thailand and cap microfinance loans at 36 percent, it might arguably even have done some good, by differentiating MFIs from truly high-cost lenders. The problem is that at 18 percent, the cap is economically untenable for lending to poor households in rural areas. There is simply no way to get around this inconvenient detail. Bateman welcomes a reduction of lending in high-cost areas and market sectors (read: poor, rural households) as a means of deflating a saturated market. But eliminating lending in one area and increasing it in another is no way to tackle bubbles. The types of caps matter, but apparently not to Bateman.
Even more strangely, in welcoming the demise of rural microfinance, Bateman ignores the actual needs of poor rural households in Cambodia. He says nothing whatsoever about the very predicable loss of access to deposits provided by those same rural MFIs whose departure he cheers. Even more bizarrely, Bateman suggests that these households are better off when their only access to credit is from money-lenders. He argues that “in those countries with no appreciable microcredit sector … 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.”
Bateman is correct in pointing to the absence of informal credit crises in the historical record. It’s a point I’ve made myself. The reason is that informal credit, composed of thousands of small-time lenders, is inherently non-systemic, and thus is unlikely to create systemic risks that result in a “meltdown.” However, as an argument in favor of client protection, this is downright bizarre. Money-lenders have repeatedly demonstrated not only the ability to over-indebt individual clients, but to do so to far greater depths than MFIs. Is Bateman arguing that money-lender credit in Cambodia, at interest rates often exceeding 100 percent, is somehow more affordable? That money-lenders who abide by no regulations, reporting requirements, or any oversight whatsoever are somehow more socially responsible? How many examples does Bateman need of money-lenders pushing borrowers to sell organs, or their children into bondage and outright slavery? By arguing that informal money-lenders are somehow more attuned to client protection than MFIs, Bateman is descending into looking-glass territory.
Indeed, with his strawman arguments, misrepresentation of others’ research, and fallacious arguments in favor of rate caps, Bateman simply betrays his personal bias, for the cap achieves the one thing he craves – it harms the sector he’s been battling for years.
The Cambodian microfinance sector faces real challenges, including over-indebtedness. The Cambodian authorities have done far too little on this front. When I met with the staff at the Cambodian central bank last summer, I implored them to take real measures to slow growth. There’s much they could do. They could put limits on risky practices, such as multiple lending or aggressive refinancing. They could set higher provisioning requirements for certain types of loans. The Cambodian government could even tax high profits, as a way to reduce incentives for high growth – a response that few investors would welcome, but one that would actually address a key driver behind the problem.
The new regulation on interest rates is a deeply flawed law, failing to define what it means by “interest rate” (a major omission, given the many and complex ways rates can be expressed), and its sloppy drafting is easily apparent. (The law manages to contradict itself in whether it applies only to MFIs or banks also.) Just last November, the Cambodian central bank had itself carried out a detailed study of interest rate caps and their likely impact on the market, finding that implementing them would be harmful. It’s clear that the rate cap is not the result of well-considered regulations aimed at protecting clients. However, the cap may well score political points for one of the world’s longest-serving heads of state, Hun Sen (32 years and counting), whose party faces elections in June.
In a country with a strong judiciary, such a law would be quickly stricken down, as we’ve seen with similarly poorly drafted executive orders coming out of the current White House occupant. But Cambodia has no such backstop. If enforced, the cap will inevitably hurt the very people it ostensibly seeks to protect. By becoming its apologist, Bateman betrays his utter lack of concern for the actual MFI clients themselves. Like communist apologists from decades past, Bateman is instead happy to burnish his reputation as a leftist crusader, with the sole difference being that instead of raging against capitalism, Bateman rages against the neoliberal order. And as is so often the case with ideological crusaders, Bateman is perfectly happy to write off the impact on the lives of actual people as simply the cost of the struggle.
Daniel Rozas is a senior microfinance expert at the European Microfinance Platform.
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