by Junho Phue
An in depth look into the controversial move by the Cambodian Central Bank, and whether it will better or worsen the conditions for rural entrepreneurs in Cambodia.
An article from the Phnom Penh Post called Interest Rate Cap Will Hurt Rural Families by Daniel Rozas, called to attention a policy capping interest rates of 18% annually on all microfinance institutions starting April 1st. There are a growing number of Cambodians that are struggling to pay off their loans from microfinance institutions. To alleviate the struggle, prime minister Hun Sen issued the Cambodian Central bank to put an interest rate cap of 18% annually on all loans given out by MFIs (microfinance institutions). The premise of this controversial measure is the notion that MFIs have transitioned to for profit organizations and are charging rural working borrowers a substantial interest rate of 30% for the prime reason of making excess profits.
FOR PROFIT VS. NON PROFIT MFIs
Over the years in Cambodia, Microfinance organizations have transitioned from being nonprofits to for profits organizations. A prime example of this would be Hattha Kaksekar Limited, the fourth largest microfinance institution which has been acquired by Thailand’s Bank of Ayudhya. The question remains, are microfinance institutions’ purpose of serving loans to rural poor borrowers clouded by the fact that they have transitioned to being for profits?
To see whether for profit Microfinance institutions have deviated away from the social purpose of strengthening the rural workers, Kenneth Downey and Stephen J. Conroy of the University of San Diego conducted a study. They tested to see if for profits and non-profits MFIs were different in regards to the expectation that one is trying to make profits while the other is trying to serve a social purpose. They put to test 6 hypotheses in their respective order: nonprofit MFIs have a higher proportion of women borrower, non- profit MFIs make many small loans compared to for-profit, non- profits have lower margins, nonprofit MFIs have higher expenses, nonprofit MFIs charge a lower interest rate, and nonprofit MFIs have a higher proportion of risky loans. Using 460 microfinance institutions from around the world, they regressed their data and rejected all 6 of their hypothesis. This conveys the fact that there was no significant difference between for profits and for non-profit institution.
Figure 1: Comparison of Differences in For Profit and Non Profit MFIs. Graph from Kenneth Downey and Stephen J. Conroy, Microfinance: The Impact of Nonprofit and For-Profit Status on Financial Performance and Outreach
From table 2 of the study, the percentage of women who had earned loans from both institutions were relatively the same. It is also conveyed that while non-profits gave out more small loans and smaller loan sizes, there were no statistical significance amongst the two to suggest that they were vastly different.
Interest rates vary in price, and they do so to serve an important purpose. The purpose of doing so is so that microfinance institutions can cover costs of lending to risky and safe borrowers. In Cambodia, lenders can typically differentiate the safe and risky buyers through geography. In the geographical rural areas, loans are more expensive due to the cost it takes to monitor borrowers and the greater risk these projects entail.
Daniel Rozas in his article Interest Rate Cap Will Hurt Rural Families, provides a great example of the cost of lending to rural and urban borrowers. In rural areas, lenders must travel certain distances to monitor borrowers. Typical opportunity cost of lenders is 75 dollars, and on top of that rural borrowers typically borrow $500. It costs about 15% of the loan for the lender to monitor that rural borrower. Rural borrowers tend to have a higher chance of default, because most Cambodians use those loans to finance capital to help with their crop yield. Farms are susceptible to natural disaster, and if one farm fails all farms fail as well.
Most rural borrowers in the agricultural fields are lent money individually therefore farmers often offer collateral on their farms. Group lending isn’t feasible for rural farmers since they all have a high chance of default, if one farm fails then all other farms fail as well. Individual lending requires frequent checkups and calls as well. Lenders must be well versed in the agricultural fields to know how to lend to farmers, this increases the cost of lending. In group lending, borrowers have a sense of the types of borrowers they are grouped in. Therefore, the lender does not need to keep monitoring the group. Group lenders also have social collateral, therefore if one member fails to pay, he is likely to be ostracized. Risky borrowers tend to borrow with risky borrowers in groups, and since the returns are higher amongst risky borrowers are reliable in the sense that they can pay off the loans that other members can’t pay.
In urban areas of Cambodia, such as the capital Phnom Penh, interest rates are lower. The typical loan given to people from urban Cambodia is around $5000 dollars, in which there is a steep cost of $300 for the lenders to make that loan, but it only comes to about 6% of the loan. If we compare the cost of the rural and urban borrowers we can see that it costs more to lend out money to the rural borrowers. Therefore, higher interest rates are necessary for rural borrowers so that the lenders can cover the cost of gathering information on the borrower, as well as to price risk.
Higher interest rates given to rural farmers and people in rural areas are justified. The high cost to monitor these loans drive up the interest rates. Without pricing the interest rate higher in rural areas, microfinance institutions may not be able to cover the cost of lending, and can stop lending altogether to rural workers and entrepreneurs.
The solution thrown out by the Central Bank of Cambodia is not viable because in short it will drive out microfinance institutions from giving out loans to rural borrowers, thus deepening the divide between wealth amongst rural and urban borrowers. The question remains, what can be done to reduce the number of people struggling to pay off their debts? One method would be to reduce the costs of lending for the MFIs through improving social capital amongst rural areas. This will insure a lower interest rate as lenders won’t have to charge higher interest rates to cover their costs of lending. Another solution comes from Daniel Rozas, in which he stated that by taxing excessive profits made by MFIs, the taxes could be used towards social capital in rural areas. Thus, reducing the cost of transportation for lenders.
Cambodia has an ever-expanding economy, putting an interest rate cap will only curb this growth. To cover costs MFIs may have potential fees and prices will drive up the costs of loans at microfinance institution, or they may altogether not give out loans to rural borrowers at all. This will greatly impact the potential capital and money that these borrowers can borrow. Putting an interest rate cap will only worsen the economy for Cambodia, to truly combat the growing interest rates, governments should combat the costs it takes for lenders to give out loans.
Conroy, Stephen J., and Kenneth Downey. “Microfinance: The Impact of Nonprofit and For-Profit Status on Financial Preformance and Outreach.” Microfinance: The Impact of Nonprofit and For-Profit Status on Financial Performance and Outreach (n.d.): n. pag. 2010. Web. <https://www.econ-jobs.com/research/35795-Microfinance–The-Impact-of-Nonprofit-and-For-Profit-Status-on-Financial-Performance-and-Outreach.pdf>.
Editorial, Sea Globe. “Cambodia’s Microfinance Shakeup: In Whose Interest?” Southeast Asia Globe Magazine. N.p., 10 Apr. 2017. Web. 16 Apr. 2017. <http://sea-globe.com/cambodia-microfinance/>.
Rozas, Daniel. “Interest Rate Cap Will Hurt Rural Families.” Phnom Penh Post. Post Media Co Ltd 888 Building H, 8th Floor, Phnom Penh Center Corner Sothearos & Sihanouk Blvd Sangkat Tonle Bassac120101 Phnom Penh Cambodia, 21 Mar. 2017. Web. 15 Apr. 2017. <http://www.phnompenhpost.com/analysis-and-op-ed/interest-rate-cap-will-hurt-rural-families>.
Rozas, Daniel. “Interest Rate Cap Will Hurt Rural Families.” Phnom Penh Post. Post Media Co Ltd 888 Building H, 8th Floor, Phnom Penh Center Corner Sothearos & Sihanouk Blvd Sangkat Tonle Bassac120101 Phnom Penh Cambodia, 21 Mar. 2017. Web. 18 Apr. 2017. <http://www.phnompenhpost.com/analysis-and-op-ed/interest-rate-cap-will-hurt-rural-families>.
Vichea, Pang. “Microfinance and Poverty.” Phnom Penh Post. Post Media Co Ltd 888 Building H, 8th Floor, Phnom Penh Center Corner Sothearos & Sihanouk Blvd Sangkat Tonle Bassac120101 Phnom Penh Cambodia, 04 Apr. 2017. Web. 16 Apr. 2017. <http://www.phnompenhpost.com/analysis-and-op-ed/microfinance-and-poverty>.