Microfinance in Cambodia

Lessons Learned for the Future

— Alia Yusuf

In 2020, microfinance institutions (MFIs) undoubtedly felt the impact of the Covid-19 pandemic as millions of people lost their jobs and became unable to repay their loans. In Southeast Asia, this is particularly apparent in Cambodia, where many of its workers collectively owe approximately US$10 billion in microfinance debt, or almost a third of its GDP (Lindsay, 2020). Cambodia’s situation contradicts the image that is often celebrated by the microfinance industry; a one-stop solution to reduce poverty and inequality, two of the UN’s SDGs. The lessons learned from Cambodia’s microfinance industry is crucial as it highlights the need for change in the industry.

The Asian Development Bank defines microfinance as ‘the provision of a broad range of financial services such as deposits, loans, payment services, money transfers, and insurance to poor and low-income households and their microenterprises’ (ADB, 2000, p. 2). This could come from a range of institutions, from formal ones such as NGOs, rural banks and cooperatives, to more informal sources such as money lenders and shopkeepers (ibid).

While there are various models of MFIs, essentially they provide low-income households with access to credit either by sharing the risks among members in a community or even without any collateral. By providing households with capital to start businesses, microfinance could, in theory, help us achieve at least three SDGs — (1) No Poverty, (4) Decent Work and Economic Growth Gender and (10) Reduced Inequalities. With income inequality still being a pervasive issue in Southeast Asia, the use of MFIs can potentially uplift the poor and open up social mobility.

What happened in Cambodia?

In Southeast Asia, the use of microfinance is widespread in countries such as Indonesia, Philippines and Vietnam to varying degrees of success. Yet, the adverse impact of the microfinance industry has recently been under the spotlight in Cambodia. This is a direct result of several contributing factors. First, the government’s financial sector reforms over the past 20 years have led to the commercialisation of the microfinance industry, encouraging self-regulation to further expand the sector (Green, 2020).

Second, the introduction of an 18% interest rate cap on microfinance loans in 2017 has resulted in higher borrowing fees and late penalties to offset the loss of profit from declining interest rates. The cap meant that MFIs have shifted their focus on larger loans in order for them to make a profit, and since its introduction, the number of loans below US$500 have declined by 48% (IBRD, 2019). On top of the US$10 billion in microfinance debt, the debt crisis has ultimately led to distress land sales, migration, as well as human rights abuses such as child labour (LICADHO, 2020).

At its core, MFIs’ business models have to balance two objectives: financial sustainability and achieving their social objectives.

However, in the process of striving for operational effectiveness and financial sustainability, there is a possibility that these MFIs may lose sight of their social objectives. On a regional level, this is supported by a recent study in which 172 MFIs in the ASEAN-5 countries (Philippines, Indonesia, Malaysia, Cambodia and Thailand) achieved a low social efficiency score relative to the financial efficiency from 2012-2018 (Zainal et al, 2020).

Additionally, the study also finds that with an increase in banking restrictions, the MFIs’ efficiency in attaining their social objectives also decreases (ibid). These findings highlight the need to take precautionary steps to ensure that what happened in Cambodia does not also occur in other countries.

Lessons Learned

Even prior to the Covid-19 pandemic, scholars have often questioned the link between microfinance and the reduction of poverty and inequality. On one hand, there are claims that on a macro level, microfinance does not bring a net positive impact as the majority spend the borrowed money on consumption, whether it be on food, education, or other aspects. This may lead to evergrowing vicious cycles of debt (Hickel, 2015).

Alleviating poverty instead requires more structural solutions by creating jobs and increasing workers’ productivity (Karnani, 2007). On the other hand, microfinance does grant individuals more opportunities for upward social mobility. We also need to consider the forms of non-financial support that MFIs can give beyond lending money. These days some MFIs also provide other services, from financial education to incentives and assistance to help environmental causes, such as UNCDF’s CleanStart Initiative (Mia et al, 2018).

So, what can be done to improve the system? First and foremost, more well-placed government support is vital to the effectiveness of MFIs. The interest rate cap has brought negative consequences, leading some Cambodians to borrow from more informal sources, which often encourages predatory lending (Chandran, 2019). Therefore, although ambitious, the government should pursue reforms of the financial system in the long-run for stability.

Cambodia has shown the risks of overreliance on microfinance and the importance of having a cohesive national social assistance program. Currently, Cambodia’s social assistance program for health and education is still in its early stages with low coverage (OECD, 2017), partly explaining the widespread use of microfinance. By ensuring that basic needs are met through the social safety net, it may potentially reduce the proportion of loans made for consumption-based needs and reallocate them for business-creating activities.

Moreover, there is a need for stronger laws and regulations for consumer protection.

This can be done by creating counterparts to the Cambodia Microfinance Association, which represents lenders and was originally formed by merging the seven largest Cambodian microfinance firms before its expansion (Zhou, 2015). The creation of such organisations can act as a representative body for borrowers to address concerns of the practices in the existing system with state authorities and support individuals with potential legal disputes.

Cambodia’s microfinance debt crisis serves as a powerful reminder of the need for better governmental support and a stronger regulatory framework to protect consumers. It is not an easy problem to solve, requiring massive financial resources and political support to resolve. Nevertheless, it is time for change. These key lessons can help inform the wider region as to how we can pursue economic growth without forsaking financial inclusion.

References

ADB, 2000. Finance For The Poor: Microfinance Development Strategy. Asian Development Bank. https://www.adb.org/sites/default/files/institutionaldocument/32094/financepolicy.pdf Green, W., 2020. Regulating Over‐indebtedness: Local State Power in Cambodia's Microfinance Market. Development and Change, 51(6), pp.1429-1453. Hickel, J., 2015. The Microfinance Delusion: Who Really Wins?. The Guardian. https://www.theguardian.com/global-developmentprofessionals-network/2015/jun/10/the-microfinancedelusion-who-really-wins IBRD, 2019. Microfinance And Household Welfare. World Bank. http://documents1.worldbank.org/curated/en/144661552916 327946/pdf/128266-REVISED-WP-PUBLIC-Nota-MFI-web.pdf Karnani, A., 2007. Microfinance Misses Its Mark. SSIR. https://ssir.org/articles/entry/microfinance _ misses _ its _ m ark LICADHO, 2020. Worked To Debt: Over-Indebtedness In Cambodia's Garment Sector.LICADHO. https://www.licadho cambodia.org/reports/files/230Worked%20to%20Debt%20Jo int%20Briefing%20Paper _ ENG _ 30062020.pdf Lindsay, S., 2020. Cambodian Workers Owe Billion In Microfinance Debt As COVID-19 Wipes Out Incomes | ASEAN Today. ASEAN Today. https://www.aseantoday.com/2020/04/cambodianworkers-owe-10-billion-in-microfinance-debt-as-covid-19wipes-out-incomes/ Mia, M., Zhang, M., Zhang, C. and Kim, Y., 2018. Are microfinance institutions in South-East Asia pursuing objectives of greening the environment?. Journal of the Asia Pacific Economy, 23(2), pp.229-245.OECD, 2017. Social Protection System Review Of Cambodia. OECD.https://www.oecd.org/countries/cambodia/SPSR _ Ca mbodia _ ebook.pdf Zainal, N., Md Nassir, A., Kamarudin, F. and Law, S., 2020. Does bank regulation and supervision impede the efficiency of microfinance institutions to eradicate poverty? Evidence from ASEAN-5 countries. Studies in Economics and Finance, aheadof-print(ahead-of-print).Zhou, A., 2015. A Comparison Of Microfinance Regulation And Social Protectionism In Argentina And Cambodia. University of Pennsylvania. http://repository.upenn.edu/sire/40