Abstract
This Selected Issues paper analyzes the potential impact of oil on economic growth and policy for Cambodia. It shows that a hypothetical moderately sized oil sector would have a significant, but not overwhelming, impact on macroeconomic prospects; but reaping the benefits while avoiding economic problems would depend, in particular, on sound fiscal policies. The paper looks at the role of wage and employment policies within the broader civil service reform agenda. It also analyzes wage bill developments since the 1990s and proposes steps to accelerate pay and civil service reforms.
IV. Monetary Growth and Banking Sector Risk1
1. The recent rapid monetary growth in Cambodia is not currently a macro-economic policy concern. Rapid increases in broad money and credit to the private sector are not only to be expected at this stage in Cambodia’s development but are essential for the modernization of the economy. There is no readily available international benchmark for acceptable rates of growth for either macroeconomic or prudential reasons; the nature of the growth and the soundness of the institutions that are facilitating the growth have to be assessed on a case-by-case basis. In Cambodia, the growth does not yet appear to be inducing inflationary pressures and the rate of increase in the share of GDP of monetary aggregates is not out of line with episodes of sustainable credit growth in other countries. 2
2. There are, however, significant risks on the prudential side, which have the potential to undermine macroeconomic prospects. These concerns are the focus of this chapter. The main data source is the National Bank of Cambodia (NBC)’s annual bank supervision report which provides detailed data derived from the off-site monitoring system, developed with IMF technical assistance. 3 Section A sets the context by providing an overview of the banking system; section B analyses the determinants of the deposit growth that is providing the funding for rapid increases in lending, the characteristics of which are analyzed in section C. Section D brings the analysis together by identifying the key balance sheet risks to commercial banks and identifies policy and supervisory priorities for NBC.
A. The Cambodian Banking System
3. Commercial banking was established in the early 1990s but growth was slow until reforms in the early 2000s. 4 Following the abolition of money and banking by the Khmer Rouge in the late 1970s, banking remerged in the 1980s under a Soviet-style monobank (the NBC). In 1989, commercial bank functions were separated from NBC and private commercial bank licenses began to be granted in 1991. By 1994, there were 30 banks operating, many in joint ventures with NBC. In 1996 a modern central banking law was established and the NBC began divesting its interest in commercial banks except the Foreign Trade Bank (FTB). It then embarked on a reform process, with IMF support, which resulted in the closure of 15 banks and a tightening of prudential regulations. At the end of 2006, the system consisted of 15 fully licensed commercial banks, of which 5 were majority Cambodian owned, 5 specialized banks and 16 microfinance institutions. 5 With the sale of FTB to a consortium led by the market-leading Canadia Bank in late-2005, only one state owned bank remains—the Rural Development Bank. Two more, foreign-owned, banks are expected to begin operation in the second half of 2007.
Banking Sector Deposits and Credit 1999-2006
(Millions of riel)
Citation: IMF Staff Country Reports 2007, 291; 10.5089/9781451821857.002.A004
The banking sector remains small, concentrated and highly dollarized
Although deposits and credit have grown rapidly, they remain small in proportion to GDP. The growth in deposits reflects a growth in the formal sector, balance of payment flows and dollar cash savings being brought into the banking system. 6 The growth may also reflect to a certain extent increases in private sector credit—although as lending remains well below deposits, money creation is minimal.
Deposits and loans are almost entirely (over 95 percent) in U.S. dollars, with riel deposits concentrated in FTB.
The broader economy remains cash based, with transactions in local currency occurring almost completely outside the formal banking system, including through money changers that are licensed but not supervised by NBC.
Credit and Deposits as a share of GDP
Citation: IMF Staff Country Reports 2007, 291; 10.5089/9781451821857.002.A004
Concentration of Commercial Bank Deposits
(by bank size in 2006)
Citation: IMF Staff Country Reports 2007, 291; 10.5089/9781451821857.002.A004
Source: NBC 2006 Banking Supervision Annual ReportUntil recently the banking market was dominated by two Cambodian banks, Canadia and FTB, which held almost half of all deposits. 7 Other banks were small and generally associated with specific sectors or nationalities. With the entrance to the market of ANZ Royal (in late-2005), competitive pressure began to build as more modern banking services became available. The concentration of deposits in Canadia and FTB—now with the same owner—decreased markedly, as the rapid growth in deposits flowed disproportionately to ANZ Royal, ACLEDA—the bank with the largest rural presence—and Cambodian Public Bank, a subsidiary of a major Malaysian bank.
4. On the surface, banks appear adequately capitalized, profitable and highly liquid (Table 1). Profitability is to be expected in a rapidly growing credit market, where staff costs are low and interest spreads are very high—the difference between lending and deposit rates was around 14 percent at the end of 2006.
Comparative Financial Soundness Indicators
Comparative Financial Soundness Indicators
| 2002 | 2003 | 2004 | 2005 | 2006 | ||
|---|---|---|---|---|---|---|
| NPL Ratio | ||||||
| Cambodia | 14.8 | 13.9 | 10.3 | 7.8 | 9.9 | |
| Low Income Asia | 10.3 | 9.2 | 8.1 | 7.1 | 6.3 | |
| Return on assets | ||||||
| Cambodia | 1.1 | 0.9 | 1.2 | 1.8 | 2.8 | |
| Low Income Asia | 2.5 | 3.0 | 2.8 | 3.1 | 3.0 | |
| Return on equity | ||||||
| Cambodia | 3.9 | 3.8 | 5.7 | 7.9 | 14.2 | |
| Low Income Asia | 14.5 | 23.5 | 22.9 | 32.0 | 29.5 | |
| Capital adequacy ratio | ||||||
| Cambodia | 49.0 | 41.0 | 34.0 | 32.0 | 26.5 | |
| Low Income Asia | 19.4 | 20.3 | 20.2 | 19.1 | 18.3 | |
Comparative Financial Soundness Indicators
| 2002 | 2003 | 2004 | 2005 | 2006 | ||
|---|---|---|---|---|---|---|
| NPL Ratio | ||||||
| Cambodia | 14.8 | 13.9 | 10.3 | 7.8 | 9.9 | |
| Low Income Asia | 10.3 | 9.2 | 8.1 | 7.1 | 6.3 | |
| Return on assets | ||||||
| Cambodia | 1.1 | 0.9 | 1.2 | 1.8 | 2.8 | |
| Low Income Asia | 2.5 | 3.0 | 2.8 | 3.1 | 3.0 | |
| Return on equity | ||||||
| Cambodia | 3.9 | 3.8 | 5.7 | 7.9 | 14.2 | |
| Low Income Asia | 14.5 | 23.5 | 22.9 | 32.0 | 29.5 | |
| Capital adequacy ratio | ||||||
| Cambodia | 49.0 | 41.0 | 34.0 | 32.0 | 26.5 | |
| Low Income Asia | 19.4 | 20.3 | 20.2 | 19.1 | 18.3 | |
5. However, consistent lack of compliance with technical and prudential regulations gives rise to doubts over the underlying health of the banking system. On-site inspections have discovered major balance sheet problems in a number of banks that had previously been unreported. While NBC has enforced some prudential regulations firmly, others have been honored only in the breach and banks do not feel that enforcement is always even-handed. Adherence to large exposure and related party lending regulations has been a particular problem, indicating that there may be considerable underlying concentration of risk in the banking sector.
B. Liabilities
6. Although the number of depositors has grown rapidly, the growth in total deposits is mainly due to an increase in the size of very large deposits. The number of depositors grew by above 35 percent in 2005 and 2006, while the increases in total value of 16 percent in 2005 and 40 percent in 2006 were mostly attributable to increases in the number and value of deposits above US$20,000. These deposits make up only 5 percent of total accounts and account for 80 percent of total deposits in the banking system. Individual and businesses account for around two thirds of total deposits. Given data limitations, however, it is hard to accurately distinguish between commercial and private accounts within this broad category.
Contribution to Growth by Account Size (US$)
Contribution to Growth by Account Size (US$)
| >$20,000 | $10-20,000 | $1-10,000 | <$1,000 | Total | |
|---|---|---|---|---|---|
| Growth in number of deposit accounts | |||||
| 2005 | 0.7 | 0.5 | 3.4 | 33.5 | 38.1 |
| 2006 | 1.1 | 0.8 | 4.4 | 32.1 | 38.4 |
| Growth in value of deposit accounts | |||||
| 2005 | 12.3 | 1.3 | 2.3 | 0.3 | 16.3 |
| 2006 | 38.1 | 2.4 | 3.4 | 0.5 | 44.5 |
Contribution to Growth by Account Size (US$)
| >$20,000 | $10-20,000 | $1-10,000 | <$1,000 | Total | |
|---|---|---|---|---|---|
| Growth in number of deposit accounts | |||||
| 2005 | 0.7 | 0.5 | 3.4 | 33.5 | 38.1 |
| 2006 | 1.1 | 0.8 | 4.4 | 32.1 | 38.4 |
| Growth in value of deposit accounts | |||||
| 2005 | 12.3 | 1.3 | 2.3 | 0.3 | 16.3 |
| 2006 | 38.1 | 2.4 | 3.4 | 0.5 | 44.5 |
7. Deposits are mostly short term and interest rates are low. Although the maturity structure varies by bank, most deposits are in current or short term savings accounts that attract low rates of interest. In 6 large banks, the average maturity of deposits is less than 4 months, with over two-thirds of deposits having a maturity of one month or less. 8 Deposit interest rates are low—reported system wide average rates were 1.9 percent in 2006. The average effective interest rate for the 15 commercial banks was 2.1 percent, with individual banks’ rates ranging from 6¾ to ¼ percent. 9
8. Other non-equity liabilities are negligible. Borrowed funds account for only 4 percent of non-equity liabilities, mainly reflecting equity stakes taken by bilateral donors and international organizations in 3 banks. Banks’ funding costs are therefore quite low, although their relatively undeveloped systems and the low level of banking sector infrastructure means that transactions costs can be high.
C. Assets
9. Loans to customers represent only around half of commercial banks’ assets. The growth in credit to the private sector in 2006 accounted for 50 percent of total asset growth. Banks, however, remain highly liquid—liquid asset ratios average 30 percent with ratios for some banks exceeding 50 percent. This is due to the difficulty in identifying sufficient lending opportunities and the lack of other investment opportunities. Banks are therefore forced to keep excess liquidity either in cash or in NBC (remunerated well below Singapore overnight rates). Although deposits taken in Cambodia are not meant to be taken offshore, substantial balances are held in foreign bank accounts, apparently to clear transactions made between residents and non-residents. A significant fee (0.15 percent) is levied by NBC on all funds entering or exiting Cambodia.
Commercial Bank Assets
(billion riels)
Citation: IMF Staff Country Reports 2007, 291; 10.5089/9781451821857.002.A004
10. Lending is mostly short-term and secured against real estate. Credit mainly takes the form of loans, with around a third in the form of overdrafts; the average credit maturity for large banks is around 8 months. 10 Some lenders are beginning to offer longer maturities, including mortgages, but this type of credit remains a very small part of the overall portfolio. Around 90 percent of loans are secured, almost entirely against real estate although the pattern differs by banks with some having most loans unsecured. Banks state that collateral levels are cautious (collateral is generally capped at less than 50 percent of market value). However, they acknowledge that accessing collateral could be problematic in the current Cambodian legal environment.
11. Interest rates for credit are very high but with new banks entering the market there are pressures for some moderation. Lending rates have declined, from 18 percent in 2004 to 16 percent at the end of 2006. If non-performing loans are excluded from the credit stock, the effective interest rate in 2006 would be 18 percent. Effective lending rates in individual banks vary between 5½ and 25½ percent reflecting the fact that some banks, including one large bank, engage in microfinance-type lending, which is generally at higher interest rates. Lending in the informal sector is reported to be at even higher rates.
12. Individual banks tend to concentrate lending in specific sectors. In aggregate, credit is mainly directed to the services and retail sectors—accounting for over 50 percent of outstanding credit in 2006. Many banks are heavily exposed to a particular sector, with 12 of the 15 commercial banks having over 30 percent of their credit in one sector and 4 with more than 80 percent.
Total Credits Classified by Type of Business, 2006
Citation: IMF Staff Country Reports 2007, 291; 10.5089/9781451821857.002.A004
13. It is likely that a considerable portion of credit is directed towards investment in construction and real estate. Information is not available on the precise uses being made of credit but discussions with banks and the private sector suggest that the primary uses of credit are financing real estate purchase and construction and also working capital. With construction growing at over 20 percent in real terms in each of the last two years and focused on manufacturing and service industries, it is reasonable to assume that around 40-60 percent of credit could be related to real estate or construction.
14. Credit is also concentrated in a relatively small number of large customers. Large exposures, defined as credit to a single customer exceeding the prudential norm of 20 percent of the net worth of the lending institution, grew rapidly until 2005, peaking at 90 percent of the banking sector’s net worth and around one-quarter of total credit. During 2006, NBC discontinued granting exemptions to the prudential regulation, mainly based on assurances from international banks’ parent companies. The value of large exposures then steadied, leading to a decline in their ratio to net worth to less than 50 percent. Loans to related parties were also substantial (15-20 percent of net worth) until 2006, when they were reduced substantially to around 1 percent, following supervisory actions by NBC.
15. Loan quality, while ostensibly reasonable, is hard to assess due to doubts over the quality of classification by banks. System-wide non-performing loans (NPLs) stood at less than 10 percent at end-2006. The steady decline in the ratio in recent years represents the impact of rapid increases in new lending—the stock of reported non-performing loans barely increased between mid-2003 and mid-2006. The ratio rose sharply at the end of 2006, after a reclassification of loans in a large bank following an NBC on-site inspection—an indication of broader reporting problems. NPL ratios vary widely by bank, with 40 percent of banks reporting zero non-performing loans and one bank with a ratio in excess of 60 percent. Provisions are generally not made to cover non-performing loans but general provisions are made by a number of banks, but these covered only 12 percent of NPLs at the end of 2006.
Non Performing Loans
(billion riel)
Citation: IMF Staff Country Reports 2007, 291; 10.5089/9781451821857.002.A004
Source: NBC.D. Banking System Risks and Policy Priorities
16. The banking sector performs reasonably well in terms of some conventional financial soundness indicators. The extraordinarily high level of dollarization means that there is little problem of currency mismatches in the overall banking system or in most banks—although FTB, which holds most riel deposits, is exposed somewhat to abrupt movements in the exchange rate. Maturity mismatches are also well within acceptable levels. Levels of non-performing loans are not out of line with similar economies (see Table 1), but doubts over classification continue to cloud the picture.
17. However, significant vulnerabilities remain, particularly through the concentration of both deposits and credit. The concentration of the banking sector reflects the narrow base of economic growth and small formal sector, it also reflects an immature banking sector, where banks fiercely protect their customer bases and do not cooperate in sharing risk. Similarly, the weak institutional and governance environment is reflected in, and is a source of potential risk for, the banking system. While the banking sector is not likely to be a barrier to continued rapid economic growth, it is vulnerable to, and could intensify, an economic downturn. The main risks are:
Individual banks are heavily exposed to individual sectors and customers. Information is not available on the exposure of banks to individual depositors, although the dominance of large value accounts suggests that the withdrawal of a few large depositors could significantly undermine the deposit base. Greater risk exists on the credit side. Approaching half of all credit being extended to individual customers exceeds 10 percent of the lending bank’s net worth and with banks tending to concentrate in specific sectors, they are heavily exposed to changes in the fortunes of a particular industry.
Adverse developments in the real estate market could rapidly affect the banking system. There are indications that recent rapid increases in land prices, particularly in Phnom Penh where real estate prices have risen rapidly recently, are not sustainable. Rental prices are relatively low compared to asset values and occupancy rates in some sectors are softening. It appears likely that up to half of banks’ lending portfolios depend on the continued profitability of the real estate and construction sectors. Should there be a bursting of the possible land price bubble there could be a rapid downturn in asset performance, with consequent implications for profitability. This is particularly troubling given the difficulties in accessing collateral in the difficult legal and judicial environment.
The profitability of the more inefficient banks is likely to become increasingly threatened as competition drives down interest spreads. If these banks cannot attract deposits they may turn to borrowing to finance their lending activities. Experience in other emerging economies suggests that credit growth financed by borrowing from overseas, which is much more expensive and would be more exposed to currency movements, creates much larger prudential risks (Enoch and, Ötker-Robe, 2007).
Confidence in the banking system, while gaining momentum, is still fragile. Despite recent rapid growth in monetization, Cambodia remains mainly unbanked, with much of the population still hesitant to entrust their savings to the banking sector. A high-profile bank failure or a downturn in economic prospects could rapidly erode recent gains in confidence, leading to reversals in growth and a rapid decline in credit opportunities.
Liquidity injections would be reliant on NBC’s international reserves. In the event of a banking crisis sparked by any of the above events, NBC would have to draw on its international reserves to provide liquidity to the almost completely dollarized banking system. At present, reserves are equivalent to around 90 percent of uncovered dollar deposits in the banking system. There is no clear benchmark for what constitutes adequate reserve cover for monetary aggregates. While current coverage percent appears adequate, reserves are growing much slower than deposits and are at least in part reliant on banks’ dollar deposits (through the required reserves ratio).
18. Preventing macroeconomic risks emanating from the banking sector requires NBC to improve adherence to prudential regulations. The culture of non-compliance with certain regulations that has developed is unhealthy for the banking system and undermines NBC’s credibility as a regulator. Continuing recent stronger enforcement, in particular of the systemically important banks, will be important in signaling that regulations are no longer negotiable. While the current set of regulations is broadly appropriate for the Cambodian banking system, it is not sacrosanct. 11 Future strategy should combine tailoring of regulations to reflect better current risks and market constraints with rigorous even-handed enforcement.
Where NBC considers regulations to be inappropriate to the current Cambodian context it should phase in or amend the regulation rather than granting ad hoc exemptions and waivers. An example of this approach was the recent (November 2006) amendment to the large exposure regulation. Until mid-2006 NBC regularly granted exemptions, in the presence of informal guarantees, believing that the regulation unduly constrained credit to the still small formal sector. Acknowledging this practice’s detrimental reputational effect, NBC amended the regulation so that exposure limits reflected the financial strength of both lender and borrower and to be more stringent on the guarantees that would be acceptable from parent banks. The result has been some loosening of the formal exposure limits, but with a reduction in prudential risk and an increase in compliance.
Where the regulation is considered fundamental, for instance capital adequacy, strong sanctions for those banks that transgress are essential. In order to provide explicit high-level backing to the banking supervision department, sanctions could be imposed on their recommendation by a high level committee in NBC.
19. Rigorous on-site supervision is needed for all banks. Although, given the limited resources of the banking supervision department, the frequency will have to vary according to banks’ size and importance. While data obtained through off-site supervision forms an excellent basis for monitoring banking sector risks, the quality of reporting needs much improvement. For instance, there are clear problems in NPL classification that can only be properly addressed by substantive on-site inspections by NBC teams. Inspections could also be used to develop a better picture of what uses are being made of banks’ credit, in particular gathering information on the levels of exposure to land price speculation and construction.
20. Banking sector risk should decline with the development of more modern infrastructure. The authorities’ financial sector blueprint—prepared with the support of the Asian Development Bank, is an ambitious strategy that contains a number of important initiatives that will assist in the addressing the risks apparent in the banking sector. These include the development of a credit information system and developing securities markets. Interbank mechanisms that allow participants to both compete and collaborate in credit markets will be crucial in spreading risks more evenly through the system. The presence of international banks will also tend to create pressure to modernize—as the entry of ANZ in 2005 showed. NBC should welcome the interest being shown in the Cambodian market by other international banks and not resist the consolidating pressures that they may bring. There is still a large number of banks relative to the size of the Cambodian market.
21. The informal market is likely to continue to be a major part of the financial sector in the short term. The money changers appear to play an important role in the financial sector, primarily in foreign exchange trading but also acting as intermediaries for private sector tax payments and for transferring money within the country. However, information on the scale of their operations and the extent to which they also take on the role of financial intermediation is scarce. Documenting the size and scope of the informal sector would enable NBC to develop a more comprehensive financial sector strategy.
References
De Zamaroczy, Mario and Sophana Sa, Economic Policy in a Highly Dollarized Economy: The Case of Cambodia., IMF Occasional Paper 219 (Washington: International Monetary Fund).
Enoch, Charles, and Ínci Ötker-Robe, eds., 2007, Rapid Credit Growth in Central and Eastern Europe: Endless Boom or Early Warning (Washington: International Monetary Fund).
International Monetary Fund, 2003, Cambodia: Selected Issues and Statistical Appendix, Country Report No. 03/59 (Washington).
National Bank of Cambodia, 2007, Annual Report 2006, Banking Supervision Department (Phnom Penh).
Prepared by Matt Davies.
See, for example, Enoch and Ötker-Robe (2007) for analysis of rapid credit growth in Central and Eastern Europe in the early 2000s.
Available at: http://www.nbc.org.kh/sup-reports.asp
See IMF (2003) for a more detailed description of the development of the banking system.
See Table 13 of the Statistical Appendix for details.
There is little information on the amount of dollars held outside the banking system. De Zamaroczy and Sa (2004) estimated that $2.9 billion were in circulation in 2001–this reflected the effects of UNTAC, international aid flows, return of Cambodians abroad and large scale investment in the garment industry.
FTB was sold to a consortium led by Canadia Bank in late-2005.
Data taken from the 2005 and 2006 annual reports of Canadia, ANZ, Cambodia Public, ACELDA, Union Commercial and Cambodian Commercial banks.
Effective interest rates are calculated by dividing interest expenses/income by the average stock of deposits/loans.
Staff calculations based on lending maturities data taken from the 2005 and 2006 annual reports of Canadia, ANZ, Cambodia Public, ACELDA, Union Commercial and Cambodian Commercial banks.
See Table 17 in the Statistical Appendix for details on current prudential regulations.
