High interest rates and a lack of checks and balances mean the poverty-alleviating promise of microfinance loans has not been delivered in Cambodia. And while the government’s recent intervention to cap interest rates may offer short-term solutions, don’t bank on a long-term fix, writes Kimty Seng.
Microfinance is widely touted for its great potential to alleviate poverty in the developing world while at the same time providing financial sustainability and, in some cases, profit for borrowers.
Its main element is the lending of small amounts of money – microcredit – to the poor, helping them take control of their lives by bankrolling micro-businesses, and boosting household income and consumption. It empowers women, reduces financial constraints on needy households, and allows them to acquire assets and deal with unexpected expenditure.
Nevertheless, there are concerns that microfinance institutions (MFI) are drifting away from their original social mission to alleviate poverty – particularly in Cambodia.
My recent study suggests that in Cambodia high interest rates and non-productive use of microcredit are trapping poverty-stricken borrowers into a cycle of debt. This is especially the case when earnings are too low to cover credit costs. Consequently, the expansion of microcredit has the potential to impose a heavy debt burden on borrowers, plunging the needy into a poverty trap.
The study also shows that Cambodia’s debt-to-income ratio, which is an indicator of over-indebtedness at the macro level, has increased remarkably. The ratio went from approximately 32 per cent in 2005 to 92 per cent in 2011. From 2012 to 2014, the ratio grew at rates higher than 100 per cent (from 107 per cent to 162 per cent respectively), revealing that microfinance borrowers were more likely to already be over-indebted.
In Cambodia, microloans are often used for nonproductive activities, such as purchasing vehicles or household items, rather than generating earnings that would help borrowers repay debts. However, MFIs claim that the majority of loans were handed out for income-generating activities. This may be so; borrowers are likely to commit to using finance in productive ways in order to take out the loans. They may, however, not use the loans for these income-generating activities once they have the finance. Borrowers’ limited financial knowledge and lack of any proper monitoring procedures or guidance for the productive use of loans only makes matters worse.
Moreover, the fact that borrowers are required to put up their assets as collateral may give financial institutions incentive to offer loans without caring how the loans are to be used. Consequently, indebtedness is one of the major causes of rural land loss in Cambodia, impoverishing low-income borrowers and widening the disparity between the haves and the have-nots. In these cases, the poverty-reducing mission of microfinance turns into a nightmare.
At the beginning of March, The National Bank of Cambodia (NBC) capped annual interest rates on MFI microloans at 18 per cent to help the growing number of disadvantaged borrowers struggling with over-indebtedness. Before the intervention, which came into effect on 1 April, the average interest rate for microfinance loans was approximately 30 per cent.
According to Daniel Roza and Stephen Higgins, the government’s restriction limits the scope of MFIs’ operations, with the market facing a lack of credit supply. This potentially means needy households are very likely to lose again – being denied opportunities to receive finance from formal credit sources and instead turning to informal financial sources out of desperation.
Microfinance markets are sustainable only if they work for both lenders and borrowers. The success of borrowers is the MFIs’ success. Nonetheless, in the development of microfinance in Cambodia, the MFIs have become more commercial, growing at the expense of needy households, and becoming extractive institutions.
This is epitomised by the lack of transparency when it comes to the actual price of microfinance loans. Borrowers, in particular, those with limited education, are usually unaware of all the charges imposed on them or overall costs of credit.
This, of course, limits their abilities to make informed choices. The micro-lending institutions should be more transparent so that the poor can make borrowing decisions more efficiently.
Some commentators welcome the NBC’s 18 per cent interest rate cap. However, while lightening poor borrowers’ debt burden in the short-term, the interest rate cap will do little to help borrowers in the long run if loans are not used for productive purposes. An appropriate ceiling should only be applied to microloans that are used to fund productive activities, with a specific basis on which the ceiling is to be calculated.