Man versus microcredit: An endless battle for equity in the microfinance sector

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Source: National Bank of Cambodia

As credit in the microfinance sector expands, borrowers and lenders aim for a win-win outcome, though often that is not the case. Even more so now with the pandemic pushing people into a debt trap

Truth be told, the microcredit sector has a hand in raising the living standards of Cambodians, pushing them above the poverty level since its presence in the 1990s by financing household needs, business ventures and agricultural development.

Based on its prolific presence in the countryside, microfinance institutions (MFIs) and microfinance deposit-taking institutions (MDIs) have been a boon to a largely provincial population where nearly 80 per cent of Cambodia resides.

Even so, the boon puts paid to the economy which stays stimulated on the back of increased lending activities, especially crucial in the current landscape.

Last year, National Bank of Cambodia (NBC) said MFIs’ credit growth rose to 32.5 per cent from 30.7 per cent in 2018 while MDIs posted a 34.8 per cent growth compared to 25.8 per cent a year ago, largely due to loans to households, followed by financing to service and trades.

The central bank alluded that the increased access to finance offered by MFIs and MDIs meant that people relied less on informal lending that charged higher interest rates and shorter loan durations.

To give an idea, the share borrowing from informal sources fell to six per cent in 2016 from 32 per cent in 2004, NBC said.

As of December 31, 2019, there were 82 registered MFIs and MDIs in Cambodia and 245 rural credit institutions.

The substantial number of microcredit firms indicates the lucrative earnings from the sector despite the small pool of borrowers, seeing that Cambodia’s population is about 16 million.

Last year, the return on assets for MFIs was 2.2 per cent and 2.9 per cent for MDIs but in comparison, MDIs generated sustained profits which were partially due to better internal cost management.

Between 2009 and 2017, microfinance borrowers more than doubled to 1.8 million, three times the growth of commercial bank borrowers, World Bank’s report on the sector stated last year.

Interestingly, it noted that the MDIs, now six compared to seven in 2017, hosted more than 85 per cent of the total customers and loan volume.

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Source: National Bank of Cambodia

Unfortunately, this quick yet fuss-free credit supply, and collateralised for some, has created a burgeoning credit situation where the total loan portfolio ballooned to over $10 billion with 2.6 million borrowers, as of now.

MFI outstanding balance came in around $6.3 billion, said Oeur Sothearoath, CEO of the Credit Bureau of Cambodia, an agency set up under a sub-decree in 2012.

Accordingly, credit-to-GDP ratio rose to 92 per cent as of December 31, 2019, NBC data stated.

“This growth is along the economic growth in Cambodia,” he opined.

Kaing Tongngy, head of communications for Cambodia Microfinance Association (CMA) justified the value saying that there is a strong need for cash to fuel the Kingdom’s fast pace growth.

He assured that the association constantly monitors the sector’s performance to prevent potential risks.

For economist Dr Chheng Kimlong, though the $10 billion loan portfolio is not a major concern, he finds that a multitude of consequences emerging from it such as the sale of land and assets due to income loss, and misuse and ineffective use of loans, were more detrimental.

“In fact, rising debt level can force a number of people to slip and become trapped in poverty,” said Kimlong, who is the director for independent think tank Asian Vision Institute’s Centre for Governance Innovation and Democracy,

The crises of microcredit

Meanwhile, Associate Prof Samreth Sovannroeun, an economics lecturer with Saitama University in Japan, acknowledged that MFIs helped to enhance financial inclusion which saw credit rise rapidly over the last 30 years.

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Source: National Bank of Cambodia

But he advised that there should be more caution on lending to extremely poor households which include Level 1 IDPoor cardholders as many of them might borrow for urgent needs that might not be productive.

“It can increase their debt burden, especially if their financial literacy is low. Extremely poor households should be mainly supported by social welfare schemes, not by accessing to loans,” he said.

Current circumstances though do not indemnify borrowers where cost of credit and increased exposure to risk and debt levels might affect household welfare.

Citing the introduction of the 18 per cent interest rate cap for MFIs in April 2017 which caused a dip in average borrowing cost, World Bank alleged that MFIs partially offset that drop by raising fees charged to borrowers.

Additionally, evidence indicated that some MFIs which provided loans at rates below the cap had converged to the top end of the interest rate, which could push up the cost for some borrowers.

This alone creates disdain over the microfinance sector, often accused of producing a highly leveraged lower income society in Cambodia.

French economists Isabelle Guérin and Jean-Michel Servet, and Belgian management academic Marc Labie, in a collection of essays titled The Crises of Microcredit, which they edited, said the sector was conceived as a social welfare-oriented mission.

Over the years, the mission might have blurred when it was conjoined with financial institutions, strapped with a profit-making motivation.

The trio made this assumption based on the literature in 2016, which highlighted interviews and adverse incidents in the sector in Tamil Nadu (India), Dominican Republic and Senegal.

London-based Financial Times, which reviewed their work, quoted them as saying that the profit-oriented approach of microcredit had led to a frantic search for clients.

“[It also caused] the concentration of funds into small areas to minimise costs and considerable pressure on loan officers with profitability targets foisted on them, which in turn affected customers,” Guérin, Servet and Labie said.

Reliance on loan sharks

In Cambodia, the struggle of meeting loan obligations, more stark in the lower income class, has been well documented by the media and non-governmental organisations.

Most of these stories hark back to the loss of jobs and depressed income due to the pandemic which slayed efforts to service loans, often averaging between two and three.

Solutions commonly involve restructuring loans including securing a stay on interest payments or a revision on interest rates, but the short-term reprieve is no answer to ongoing dilemmas.

Others resort to selling farm land, cattle or their own dwelling to raise loan fees or remortgage homes to release funds, which might have pushed them further into a debt trap.

More worrying is the reliance on loan sharks for urgent cash outlays, making them vulnerable to unscrupulous lending tactics including high interest rates of over 20 per cent.

“About 30 years ago, it was as high as 40 per cent but there are no more loan sharks now as NBC worked on shutting them down,” remarked Kimlong.

Financial inclusion has been a key element to achieving socio-economic development as per the Fourth Rectangular Strategy and National Strategic Development Plan.

“But progress towards streamlining the management of the financial sector, particularly on the part of loan arrangements by non-registered MFIs and moneylenders, comprising loan sharks, as we know, has been met with challenges,” he said.

Indebtedness has also risen, partly due to the loan use and management of loans by the bottom 40 per cent (B40) of the income classes in Cambodia.

“Low and limited financial literacy, low business skills and unexpected sources of expenses within households have forced loan defaults, and thus indebtedness,” he said.

In Channy, chairman of the Association of Banks in Cambodia, suggested the avoidance of the word indebtedness as it gives the idea that customers have no ability to repay because the latter continue `to do good business’ and meet their loan repayments regularly.

His bank, Acleda Bank Plc, where he holds the president and group managing director posts, and which has its roots in micro credit, as well as Japanese-owned Sathapana Bank Plc are the only two commercial banks that offer micro loans, apart from MFIs and MDIs.

MFIs are not different from financial institutions as they are licensed by the NBC and are subjected to prudential rules and regulations, Channy said.

So, while MFIs push for growth they thoroughly consider the asset quality (loans), which makes customer selection crucial.

No fissure in MFI sector

Different from its foreign counterparts, MFIs in the Kingdom provide loans to families of about five people where over three are income earners.

“[So] gross domestic product [GDP] per capita of $1,643 would translate to about $4,929,” said CMA’s Tongngy.

Accordingly, MFIs need to adhere to rules and regulations including the sector’s self-regulation rules known as lending guidelines which limit MFIs from approving high risk loans.

The sector assigns limits, particularly for refinancing, of not more than five per cent for high risk loans and 15 per cent for medium risk loans.

“Any MFI which breaches the limit will [receive] a warning or have their licence revoked. We monitor this limit regularly. The whole sector’s performance is below this limit.

“Non-performing loan [NPL] stood at 2.7 per cent in August but it is considered healthy by global standard,” he said.

He dismissed the notion of a fissure in the sector on the back of a ballooning loan portfolio and outstanding loans.

For now, the liquidity of six MDIs which cover 85 per cent of the entire sector remains `stronger than ever’, he stressed, adding that there has been an increase in deposit since June this year.

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Source: Cambodia Microfinance Association (Annual Report 2017)

The 32 per cent year-on-year drop in new loan disbursement in August after a steady dip since April further strengthened liquidity.

“Based on our data and observation, the MFI sector is still very strong and the possibility of a collapse is near zero per cent. It has been well-prepared for the economic downturn,” Tongngy said.

As for the inability to pay back loans, he commented that MFIs have their own policy for them, without going into details.

He claimed that no court case has been taken during the Covid-19 period, and that it is possible for the sector to write off certain loans.

“But in such cases, MFIs would not inform clients or public as it could potentially spoil credit disciplines,” Tongngy said.

Debt service burden stress

As the effects of the pandemic linger, unemployment and poverty levels are likely to come under stress.

In the mix, a large fraction of Cambodians, and especially those in the B40 would stay highly leveraged and could resort to trading properties for cash, a move which could impact the economy in the long run.

Kuala Lumpur-based economist Lee Heng Guie said high household debt, whether bottom and middle-income households help to boost consumption and GDP growth in the short run.

“But it tends to lower growth in the long run due to higher debt service payment constraints spending [particularly] if income does not rise higher to cover the debt service burden,” said Lee, executive director of independent think tank Socio-economic Research Centre.

The negative long-run effects on consumption tend to intensify as the household debt-to-GDP ratio exceeds a threshold of 60 per cent.

To reduce the impact on the lower income segment, the government should consider targeted cash transfers or assistance and implement effective public policies on education, employment, micro-entrepreneurship housing, healthcare and public transportation.

“This will help the B40 households gradually move out of from a low-income trap,” Lee said.

However, he added, MFIs can step up by providing technical advice with business loans, and monitor and manage their loan books to avoid suffering a loss.

Kimlong agreed, adding that financial literacy is key along with enhanced business and investment climate, a reliable regulatory framework, social justice to alleviate poverty and ensure inclusive growth.