A lot of ink has been devoted in the press about the rapid growth of the microfinance sector in Cambodia. Unfortunately, too rarely the focus has been on shining a light on the positive financial and welfare impacts for households by giving more Cambodians access to reliable financial services.
The country comes from a long road of recovery. Cambodia had to reintroduce a banking system to support economic activities after the fall of the Khmer Rouge regime. The financial system was in its infancy, with limited access to formal financial services. Microfinance institutions played a crucial role in promoting financial inclusion in Cambodia. The expansion of the microfinance sector has provided access to formal credit for a large segment of borrowers who previously depended on informal sources.
Based on research and our own experiences at Incofin we answer for you the eight most pressing questions.
1. How confident are we that Incofin is financing responsible microfinance institutions in Cambodia?
Incofin has encouraged responsible lending in Cambodia since 2012 through financing market research and through its investment strategy. Three safeguards give us assurance that we only work with responsible financial institutions:
1. RESPONSIBLE LENDING GUIDELINES
Incofin only works with financial institutions that comply with the Responsible Lending Guidelines to prevent over-indebtedness and excessively risky refinancing. Thanks to the dashboard produced monthly by the Credit Bureau of Cambodia, all financial institutions can track and monitor their high-risk refinancing. The tool also allows the regulator to sanction institutions guilty of aggressive refinancing practices.
2. CLIENT PROTECTION PRINCIPLES PATHWAY CERTIFICATION (CPP CERTIFICATION)
All Incofin’s partner institutions in Cambodia have received the highest gold level CPP certification. To obtain this, institutions must conduct an independent 3rd-party audit on their customer protection principles. Currently, seven microfinance institutions in Cambodia are gold certification recipients. The principles are there to protect the rights and interests of the end customer and encompass transparent and responsible pricing, a fair and respectful treatment of clients and collection practice, and mechanisms to prevent over-indebtedness amongst others.
3. SOLID ON-SITE DUE DILIGENCE
All our partners in Cambodia are required to go through Incofin’s social and financial due diligence process, which is conducted on-site every year by our investment team in Phnom Penh. Responsible lending practices are crucial to avoid over-indebtedness. Our partner financial institutions identify all sources of income and expenses, including existing loan repayments, of their customers and family members living in the same house before granting credit.
Inofin was amongst the very first investors that decided to work only with investees in compliance with those standards, even though it led to a reduced market share. All four financial institutions that Incofin works with in Cambodia have passed Incofin’s social and financial due diligence process, adhere to the Responsible Lending Guidelines and agree to conduct independent 3rd -party audits on customer protection principles (e.g. CPP certification).
2. Is there too much lending in Cambodia?
Looking at all formal and informal credit supply, we tend to answer with yes to this question. While it is true that Cambodia private debt to GDP ratio is alarmingly high, we need to remember that the majority of such private debt is concentrated in the corporate sector and resides with commercial banks, frequently financing real estate. The risk for overheating the market is however not microfinance – microfinance institutions represent only 17% of all outstanding credit in Cambodia.
Many Cambodians, especially in rural areas, still rely on informal credit and private lenders. Some of them combine a loan from a formal institution with credit from an informal source. People who borrow informally are often more susceptible to mistreatment by their lenders in case of repayment difficulties. Informal loans entail higher interest rates and less protection for the borrower. This is the very reason why we shall fight against the irresponsible credit suppliers.
The risk of overheating should also rather be sought in the real estate sector and the price trends in the sector over the past years. Land purchasers with deep pockets fuel speculation that can culminate in a real estate bubble bursting.
That is why at Incofin, we analyse closely the share of housing loans of our microfinance partners in Cambodia. We do not lend to institutions that grant loans for speculative real estate and we check whether the housing loans are truly intended to finance a household’s house purchase or home improvement project and whether there is enough repayment capacity.
3. Does microfinance really benefit low-income populations in Cambodia?
Cambodia has become one of the world’s leaders in poverty reduction: poverty rate dropped from 53% in 2004 to 10% in 2018. Among the many improvements that took place in the country and contributed to this success, financial inclusion played a role. Two leading research studies confirm the positive impact of microfinance in Cambodia.
- 60 Decibels interviewed over 18,000 microfinance clients worldwide, including in Cambodia. 80% of the Cambodian borrowers reported that their quality of life improved thanks to microfinance.
- The Dr. Bliss-study from 2022 concluding that most of the microfinance loans in Cambodia have a positive impact on the livelihood of the borrower, improving the sources of income.
At Incofin, we collect social performance data on a quarterly basis from all our institutions.
4. Are microloans in Cambodia always used for productive or business purpose?
We estimate that 60% of microloans are being used undoubtedly for productive purposes, such as setting up or expanding a small business. 30% of the microloans go to non-productive activities (including consumer goods, health, education, and housing improvements). A further 10% is used for refinancing or debt management.
One must not lose sight of the fact that non-productive purposes are also essential for low-income households. Using a microloan to manage an emergency or health issue is not in itself a negative phenomenon.
Rather than focusing solely on the stated purpose of the loan, we call for constant and rigorous examination of the credit underwriting quality conducted by the microfinance institution involved.
5. Should we be concerned about the microloans that are used for debt management or refinancing?
Not necessarily. It is important to make a distinction between lower-risk and higher-risk refinancing. There is a lower risk in case a borrower whose loan is about to reach maturity, asks to close early and to refinance it through a larger loan to match enlarged business needs because he or she won a new contract.
In that respect, Cambodia can be considered as a market leader in terms of transparency of its credit system data. Lending institutions are obliged to conduct a credit bureau check before considering disbursing a loan. Secondly, the Lending Guidelines Dashboard allows financial institutions to track and monitor their high-risk refinancing practices.
How does Incofin prevent higher-risk linked to loan refinancing? First, we only work with microfinance institutions with high-risk refinancing <5% according to the Lending Guidelines. Secondly, during our due diligence, our investment team visits the branches of financial institutions and engages with their loan officers to analyse and assess their refinancing practices.
6. From time to time, stories surface about dubious collection practices, such as borrowers being forced to sell their land to repay their debt. How serious is this problem?
Incofin strongly condemns any practice whereby people would be forced to sell their land or irresponsibly pushed further into debt to pay off previous debts.
While we unfortunately observe some deceptive collection practices, it is important to note that recent rigorously led impact surveys such as the one of Dr Bliss, concluded that such cases are a minority or even anecdotal (less than 1% of cases). The report states that the reason vulnerable families fall into a situation of repayment issues is not the loan amount in itself, but an external shock (loss of job, reduction of income-generating work) that happens after repayment capacity was determined.
At Incofin, we make sure that our microfinance institution partners have formal collection procedures in place, and that all steps are clearly outlined in the collection procedures. During our due diligences, we verify that the organisations have operational and governance mechanisms in place to ensure the highest level of ethical behaviour when it comes to dealing with delinquent clients, collecting repayments and controlling collecting practices.
Foreclosure of collateral is only allowed when all other alternatives have been exhausted: this ranges from granting a waiver of repayment for a few instalments to completely rescheduling the loan. In line with the guidelines of the Client Protection Principles, forced collection practices will not be tolerated.
7. Is there an excessive focus on micro-credit in Cambodia as opposed to savings?
There is a need for more savings products that help grow the resilience of especially more vulnerable populations. Less than 7% of Cambodia’s population saves with a financial institution. The recovery of the economic and banking system after the fall of the Khmer Rouge takes time. And it takes even more time to regain people’s confidence to take money out of their homes and place it into the banking system. Microfinance institutions can help restore that trust and advocate with people the importance of rebuilding the resilience and safety nets lost during the Covid crisis.
Savings is just one product. Microfinance institutions should take the lead in supporting the further development of financial products, such as savings, but also remittances, microinsurance, agricultural insurance, and services for SMEs.
8. What is the future path for microfinance in Cambodia?
Cambodia does not need less microfinance, but more responsible microfinance. All parties involved have a role here to play. Together, we must protect the original aim and positive impact intentions of financial inclusion.
The shareholders of microfinance institutions should revise their expectations on growth and profits and have a deep discussion on a fair split of the profits between shareholders, employee and end clients (through interest rate reductions).
Meanwhile, lenders, both local and international, both impact and mainstream, must stop lending to microfinance institutions which are not Client Protection Pathway-certified or which are not adhering to the Responsible Lending Guidelines. This is the only way to send a strong signal to the sector that there is zero tolerance for irresponsible lending practices.
Regulators should continue efforts to ensure compliance with applicable client protection regulations, including direct complaint lines and on-site audits. Regulators should also pursue the fight against the informal credit sector.
Borrowers need to be protected and empowered to optimise their financial decision-making. We welcome the efforts of the NBC and the Ministry of Education to include financial literacy in the national curriculum.
Cambodia’s rapid digital transformation, especially through mobile banking, will only further promote formal financial inclusion and reduce reliance on the informal sector. Internet banking and mobile apps in particular empower people in the lower income segment of the population by giving them access to user-friendly financial services at lower costs.
For example, mobile banking solutions have helped digitise account opening and accessing, allowing rural Cambodians to access services without having to travel to a branch. We welcome the development, but call on all stakeholders to be vigilant in creating a secure financial ecosystem.
By acting collectively at all these levels, the “bad” players in the industry will be easily identified and pushed out of the market. We will be able to discern between those institutions that “walk the talk” in terms of responsible finance and those that betray the original impact intent of microfinance.