A recent report has found that the majority of Cambodia’s nearly 40 commercial banks lack the scale and efficiency required to generate a healthy return on investment for their shareholders, with many not even able to cover their own operating costs.
Phnom Penh-based investment firm Mekong Strategic Partners (MSP) said in a performance review last month of Cambodia’s banking sector that despite an impressive run of revenue and profit growth, banks have made little headway in curbing expenses. It noted that while bank revenues have grown by an average of 22 percent a year during the past decade, and revenues by 19 percent a year, expenses have matched this level of growth and sapped the underlying profitability of banks.
“As a consequence of this stagnant underlying profitability, the return on equity for Cambodian banks has remained stuck between 11 percent and 12 percent, which is well below the cost of capital for these banks,” the report said.
MSP estimates that the actual cost of capital for bank operations in Cambodia is at least 15 percent, and likely as high as 18 percent, resulting in negative returns for many bank shareholders.
The report follows up on research MSP published three years ago which posited that the majority of the Kingdom’s banks were underperforming, with just five banks posting a return on equity (RoE) greater than 15 percent in 2013 and the industry average at a dismal six percent.
“If these banks do not improve their RoE, they will not be able to fund the level of credit growth we expect in Cambodia going forward – 15 percent to 20 percent [per year] – without asking shareholders for additional capital,” MSP said at the time. “This will either lock them into a downward spiral in market share, becoming increasingly irrelevant, or will increase the pain for shareholders who have to come up with ever increasing amounts of capital.”
In its latest report, MSP did not break down RoE by bank, but noted that apart from a few strong performers such as Acleda, ABA and Canadia, “overall returns are being dragged down by smaller banks who need a radical change in strategy to achieve an acceptable return.”
While MSP has identified a number of reasons for the low performance, such as poor management and increased competition, chief among them is that the individual banks lack sufficient scale.
“Most banks operating in Cambodia lack scale, and this will be exacerbated by new minimum capital requirements,” the report said.
The National Bank of Cambodia has given commercial banks until March 2018 to raise their paid-up capital to at least $75 million, double the previous requirement. The new minimum capital threshold for subsidiaries of investment-grade foreign banks was set slightly lower at $50 million.
Whereas MSP previously estimated that banks would need a loan book of at least $150 million to generate enough profit to achieve a positive return for their shareholders, with the higher capital requirements, as well as lower interest margins and higher staff costs, it now estimates banks will need more than double this amount.
“At this level of capital, banks will need a loan book of at least $350 million, and more likely $400 million, to generate sufficient profits to achieve an RoE of 15 percent or more,” the report said. “Banks with a loan portfolio below this will struggle to generate an acceptable return.”
Only about a third of banks in Cambodia currently have a loan-book larger than $350 million, and many of the smaller banks suffer from a “lazy balance sheet” with low gearing, the report noted.
The average gearing in the banking sector, a measure of assets divided by equity, is just five times, while banks “generating a healthy RoE typically have a gearing level of seven or eight times,” it added.