Information about Asia and the Pacific Asia y el Pacífico
Journal Issue

Cambodia: Selected Issues and Statistical Appendix

International Monetary Fund
Published Date:
March 2003
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Information about Asia and the Pacific Asia y el Pacífico
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IV. Banking Sector Reform and Financial Intermediation25

82. The size of the banking system in Cambodia, in terms of deposit base, grew from 4 percent of GDP in the early 1990s to 12 percent by the end of the decade. But, financial intermediation by banks played only a limited role in facilitating economic development. The recent bank restructuring process, whereby the number of banks was reduced from 31 to 17 and capital positions strengthened, improved public confidence in the banking sector. Nevertheless, lending activities of banks continue to stagnate. This chapter first discusses the historical background and developments of the banking sector during the 1990s. Section B reviews the progress under the current PRGF program. In section C, the remaining agenda for improving financial intermediation in Cambodia is discussed, followed by a conclusion in section D.

A. Developments in the Banking Sector in the 1990s

Banking sector before the 1990s

83. The weak public confidence in the banking sector and its limited role as a financial intermediary are the legacy of political turmoil and civil strife of the past three decades. After gaining independence in 1953, Cambodia’s economy performed relatively well for about a decade until interventionist policies gained influence and banking, along with foreign trade, were nationalized in 1963. Increasing strife in the region also led to internal political turmoil, and hopes for economic revival were quashed as the civil war escalated in the early 1970s and Khmer Rouge eventually took over the country. The Khmer Rouge (1975-79), with a view to creating an agrarian moneyless society, launched a radical economic experiment, whereby private property was denied and money, banks and markets were abolished.

84. In the 1980s, a banking system was reintroduced by the successor government After the fall of the Khmer Rouge, the new regime established the National Bank of Cambodia (NBC) in 1980, a state-owned monobank whose role included central, commercial, and development banking activities, according to the socialist economic model. In 1989, however, as a part of an effort to restructure the economy along a market-based system, several reforms were initiated through government decrees, whereby the commercial bank functions were separated from the NBC, and establishment of private commercial banks were allowed as limited liability companies. The banking sector was opened up to competition from foreign banks, which were encouraged to establish their presence in Cambodia, frequently in joint venture arrangements with the National Bank.

Developments in the 1990s

85. After the first private commercial bank was established as a joint venture between NBC and a foreign bank in 1991, the number of banks increased rapidly reaching 30 by the end of 1994. This development arose in part due to the relaxation of requirements for obtaining a license, which was limited essentially to meeting a low minimum capital requirement condition. The proliferation of banks put heavy strain on NBC’s regulatory and supervisory capacity, and the authorities imposed a moratorium on new licenses in 1994 despite continued strong demand by a wide range of investors. The National Bank resumed granting licenses only in June of 1996, following some strengthening of prudential regulations, which included more stringent reporting requirements, and conducting on-site inspections using international audit firms. In 1996, a new central bank law was promulgated, establishing NBC as the central bank. The NBC gradually divested its interest in all commercial banks except the Foreign Trade Bank (FTB).

86. The proliferation of banks during this period left Cambodia with an excessively large number of banks relative to its size and development. Not enough business opportunities were available, leaving many banks with marginal, and sometime questionable, banking activities. These problems first became evident when one of the smaller banks was found to have lost most of its capital through speculation in the overseas commodity market, and another bank closed voluntarily due to lack of business, in the mid-1990s. In addition, the Asian crisis caused difficulties for some of the foreign-owned banks to meet the minimum capital requirements which were increased somewhat in 1997, as these banks were under financial pressure in their respective home countries. In light of a serious lack of lending opportunities, reflecting unstable economic conditions and high credit risk of the potential borrowers, the NBC opened dollar-denominated accounts for commercial banks in 1998, remunerated at seven-eights of SIBOR. Due to the weak business and regulatory environment, public confidence in the banking system, as well as mutual confidence among banks, remained very low, and financial intermediation by the banking sector continued to be marginal.

B. Progress under the PRGF

87. The policies under the PRGF-supported program aimed at rebuilding the banking sector so that only viable banks with sound banking activities would operate under a strengthened regulatory environment. Accordingly, the banking sector policy consisted of three pillars: (i) re-licensing of commercial banks under the newly promulgated Banking and Financial Institutions Law; (ii) strengthening bank supervision; and (iii) reforming and eventually privatizing the state-owned FTB to further reduce direct involvement by the state in the financial sector.

Bank Restructuring under the new Banking and Financial Institutions Law

88. The Banking and Financial Institutions Law was promulgated in November 1999, three years after its submission to the National Assembly. The new law provided a fundamental framework for banks’ operations and the NBC’s supervisory functions, which included: (i) the definition of banks and the scope of banking operations; (ii) the supervisory and regulatory power of the NBC, including the NBC’s ability to impose disciplinary sanctions and penalties against noncompliant banks; (iii) requirements for the integrity of bank management; and (iv) bank liquidation procedures.

89. Under the new law, all private commercial banks were required to be re-licensed by the NBC. At end-1999, the Cambodian banking system consisted of 31 banks, comprising two state-owned banks, seven foreign bank branches, and 22 privately-owned commercial banks. The NBC used this opportunity to scrutinize the viability of existing commercial banks, and classified them into three categories: (i) viable and fully capitalized banks without need for restructuring; (ii) potentially viable banks requiring some corrective measures; and (iii) nonviable banks. Banks falling into the second category were asked to submit a memorandum of understanding to the NBC describing the details of their restructuring plan, including the timetable for capital increase to meet the new minimum capital requirement set at US$ 13 million. Banks falling into the third category were liquidated.

90. The re-licensing process was completed in April, 2002. During the process, the NBC closed 15 banks that were either insolvent or not in compliance with the law. Fourteen banks were awarded full banking licenses, and four banks were granted licenses to operate as specialized banks with restrictions on the scope of their banking operations. In addition, two international banks with world-wide operations recently closed their branches in Cambodia as a result of a global strategic review of their operations by their respective headquarters. At the same time, a new local bank was granted a banking license and started operations in November, 2002. As a consequence, Cambodia’s banking system currently consists of 17 banks, comprising one state-owned bank, three foreign bank branches, nine locally incorporated commercial banks and four specialized banks.

91. The liquidation of nonviable banks is well under way, with 10 banks already completed. For the remaining five insolvent banks, four banks are under the liquidation process by the court, and one is being liquidated outside the court.

Strengthening bank supervision

92. Bank supervision is being strengthened on two fronts: (i) improving various prudential regulations; and (ii) strengthening bank supervision capacity of the NBC. The Central Bank Law of 1996 and the Banking and Financial Institutions Law of 1999 provided an adequate legal framework for bank supervision. These laws were supplemented by a series of regulations issued in early 2000, setting out in greater detail prudential requirements such as capital adequacy requirements, minimum capital, liquidity requirements, limit on large exposures, loan classification and provisioning. Subsequently, these regulations were expanded to cover additional issues such as restrictions on related party lending and acquisition of fixed assets. In February 2002, the prudential regulations were extended to micro-financing institutions (MFIs), and those institutions with operations exceeding certain amounts were required to obtain a license or register at the NBC, and were made subject to liquidity requirements and reserve requirements. More recently, regulations on prompt corrective action, spelling out procedures and disciplinary actions by the NBC against undercapitalized banks have been issued, along with a regulation on standardized procedures for off-site surveillance and on-site inspections, supplemented by detailed manuals for these operations.

93. The supervision capacity at the Bank Supervision Department (BSD) of the NBC is gradually improving. The number of staff has been increased from about 40 to 60 in the last two years. In the past, the BSD had relied on international audit firms for conducting on-site inspections of banks to compensate for their limited experience and capacity. With technical assistance from the Asian Development Bank, the NBC is in the process of developing the capacity for off-site and on-site surveillance activities, and has already started to conduct on-site inspections on a limited scale. With the completion of the bank re-licensing process, the NBC is now shifting its emphasis and resources to enhancing supervisory activities.

Restructuring of the Foreign Trade Bank

94. The FTB was a remnant of the monobank system in the 1980. It had operated commercial banking functions as a department of the NBC without a banking license and without an independent capital base. To establish a banking system operating on modern principles of good practice, the separation of the FTB from the NBC and the restructuring of the FTB as a fully independent state-owned financial institution operating on commercial basis were seen as essential. The reform of FTB’s operation was also critical for its eventual privatization, to complete the transition toward eliminating state involvement in the banking sector.

95. The FTB was legally separated from the NBC in August 2000, and a Board of Directors was established to provide operational independence. It completed an external audit (which was substantially qualified given the poor state of the accounts), and received its banking license in December 2000. However, during the transition period, the FTB was still under the NBC ownership who also provided physical assets to satisfy the initial minimum capital requirement of CR10 billion. In June 2001, the NBC issued a central bank note for a full recapitalization of FTB to CR50 billion (US$13 million). To complete the separation of the regulatory function of the NBC and the commercial bank function of the FTB, the Ministry of Economy and Finance issued a recapitalization bond (CR40 billion) to replace the capital provided by the NBC and became the majority shareholder in April 2002. In January 2003, the FTB publicly announced its intention to privatize and to seek out strategic investors with international banking experience willing to run the operation of the FTB in a manner consistent with the broader objectives of financial market development in Cambodia.

96. Meanwhile, in an effort to introduce a market-oriented business culture, the first outside director with commercial banking experience was appointed to the FTB Executive Board in June 2001. At the same time, the FTB worked closely with its external auditors to eliminate long-standing problems in their accounts by reconciling outstanding discrepancies and provisioning against unrecoverable bad loans. Although the external audit of their end-2001 accounts remained qualified due to technical reasons, it received an unqualified opinion on a special audit of their financial position at end-March, 2002. With technical assistance being provided by Australia, progress is also under way to modernize the FTB’s operations by improving the management information system, developing procedure manuals for key areas such as credit processes and internal audit, computerizing operations, and establishing various training programs for the staff.

Other developments

97. Progress has also been made in the area of payments system reform. A clearinghouse for checks denominated in riels has been in operation since 1995. However, there were no such facilities for US dollars, raising concern among banks about the safety of the settlement of their dollar transactions, and posing a serious threat to the development of a sound financial system under the highly dollarized economy.26 In response, the NBC established a second clearinghouse for checks denominated in US dollars in January 2001, which soon exceeded the first clearinghouse in terms of volume. Both clearing houses operate under strict solvency rules, and the NBC does not assume any risk associated with their operations.

98. The Law on Negotiable Instruments and Payments Transactions was drafted based on technical assistance provided by the IMF, The draft law covers all types of payment transactions, and is intended to eliminate legal uncertainties to reduce payment system risk, thereby providing a firm foundation for a modem payment system in Cambodia. The draft law was submitted to the Council of Ministers in June 2002, and is expected to be sent to the National Assembly in 2003.

99. Cambodia did not have a uniform chart of bank accounts. As a result, commercial banks were using different accounting standards, hampering effective bank supervision and enforcement of prudential regulations. A draft uniform chart of accounts, compatible with International Accounting Standards, was prepared by the NBC with technical assistance funded by the Asian Development Bank. Commercial banks were asked to provide their comments, and it is now finalized, for a full implementation by July 2003.

C. Remaining Agenda

100. The bank re-licensing program has been successful in terms of improving the financial soundness of the banking sector. In this process, nonviable banks were closed, and the size of the banking system was downsized to a level more in line with the size of the Cambodian economy and the supervisory capacity of the NBC. In response, public confidence in the banking system appears to be gradually improving, as reflected in the 22 percent increase in the deposit base during the first 10 months of the year. The lending activities, however, continue to stagnate. Growth in private sector credit has been virtually non-existent in the past two years, showing serious signs that improving the financial health of the banking sector by itself will not be enough to promote increased financial intermediation.

Current state of the banking system

101. The Cambodian Banking System is well capitalized and highly liquid. Due to the increased minimum capital requirement (US$13 million), banks are well capitalized with average capital adequacy ratios reaching 50 percent. Banks are also very liquid as they carry large amounts of vault cash and keep huge excess reserves at the NBC. The liquid asset ratio (liquid assets to total assets) is close to 60 percent. However, due to the fact that a large proportion of bank assets is held in low-yielding liquid assets, the profitability of the banking sector is low. The return on assets and return on equity are about one percent and three percent, respectively, at end-2001. Although the asset quality of banks’ loan portfolio is generally poor, the volume of nonperforming loans stands at a manageable level with the rate of nonperforming loans to total loans declining from around 18 percent in the first quarter of 2000 to 12 percent in September 2002.

Selected Financial Indicators(In percent)
Dec.Dec.Sep. 3/
Capital adequacy ratio 1/48.659.753.4
Liquid asset ratio 2/57.158.959.6
Return on assets0.91.01.5
Return on equity2.83.24.4
Source: Data provided by the National Bank of Cambodia.

Capital (net worth) / risk weighted assets.

Liquid assets / total assets.

Data based on banks’ monthly report to the NBC.

Source: Data provided by the National Bank of Cambodia.

Capital (net worth) / risk weighted assets.

Liquid assets / total assets.

Data based on banks’ monthly report to the NBC.

102. Lending activities of the banking sector are quite limited relative to the size of the economy, as well as the size of their deposit base. Credit to the private sector is 7 percent of GDP, significantly lower than other Asian countries at a comparable stage of development. The size of the loan portfolio is less than a third of their total assets and less than half of their deposit base. The remaining assets consist primarily of cash balances, deposits at overseas banks and placements at the NBC. Loans are mostly short-term, mainly providing import/export financing and working capital to the trade (wholesale, retail) and the service sectors (tourism, hotels). The interest rates charged on these loans are usually very high, with an average spread of 13 to 14 percentage points over the interest rates paid on deposits.

Cambodia: Interest Rates, 1997-2002 1/(Percent per annum)
Deposit rates
Riel savings deposits7.
Foreign currency savings deposits2.
Foreign currency term deposits3.
Lending rates 2/
Foreign currency loans: rates charged to private enterprises18.417.717.317.417.117.015.515.
Source: Data provided by the National Bank of Cambodia.

Simple averages of rates reported by the ten commercial banks with the largest deposits.

Virtually all loans to the private sector in Cambodia are denominated in foreign currencies. The recent rise reflects the closing of some banks offering lower lending rates.

Source: Data provided by the National Bank of Cambodia.

Simple averages of rates reported by the ten commercial banks with the largest deposits.

Virtually all loans to the private sector in Cambodia are denominated in foreign currencies. The recent rise reflects the closing of some banks offering lower lending rates.

103. Demand for credit by high quality borrowers, such as multinational corporations, is limited, owing to their limited presence in Cambodia and their reliance on internal funds. This has caused some prominent foreign banks to pull out of Cambodia in response to higher minimum capital requirement. On the other hand, demand in the lower segment, consisting mainly of local small- and medium-sized enterprises (SMEs), seems to be relatively strong.

104. Most banks are foreign-owned and many of them have limited interest in meeting local financial needs. Their focus are on providing financial services to their home country customers in Cambodia. Banks are concentrated in the urban areas, and only a few banks have branch offices outside the major cities, leaving most of the rural population with no access to financial services provided by banks.

Improving financial intermediation

105. There are various issues that the authorities have to address in the coming years to improve financial intermediation. These include:

  • Strengthening legal infrastructure to support the enforceability of financial contracts. Cambodia still lacks key legislation pertaining to commercial activities that are indispensable to providing stability in financial transactions. Commercial Contract Law, Secured Transactions Law, and Commercial Arbitration Law are still in their drafting stage, and are expected to be approved by the Council of Ministers by early 2003. The absence of legal basis for secured transactions makes the present collateral registration system unreliable, thus making it difficult for banks to provide collateral-based lending. Lack of a proper collateral valuation system and cumbersome registration procedures are also inhibiting factors. The weak and inefficient judicial system also raises significant concerns about the fair enforcement of financial contracts and regulations. Banks usually chose not to go to court when they have disputes with borrowers, as it is likely to be more time-consuming, costly and unpredictable. The government must move forcefully with judiciary reform as an integral part of the Governance Action Plan.

  • Improving availability of reliable borrower information and enhancing cost effectiveness. Few firms produce financial statements, and no common accounting standards are in place, making cash-flow based lending difficult. Some of the local banks assist their clients in keeping records and producing financial statements before making loans. This practice, although beneficial to both parties, increases the administrative cost substantially, and together with the small size of loans, lead to high spreads, which not many small businesses can afford. Recently, the government made substantial progress by passing the Law on Accounting. Although the law is yet to be fully implemented, it requires all firms above a certain size to file a full set of accounts based on the new Cambodian Accounting Standards that are consistent with a subset of International Accounting Standards. It also provides for the establishment of National Accounting Council to be responsible for the oversight of accounting in Cambodia. These promising developments, however, must be accompanied by an effort to substantially increase the number of trained accountants that are so scarce currently.

  • Improving availability of financial services in the rural area. The rudimentary banking system cannot address the nature of demand from the rural poor mostly engaged in agriculture. To fill the gap, various NGOs, many supported by foreign donors, are operating as MFIs delivering credit and mobilizing savings in the rural area. As of June 2002, the aggregate outstanding microcredit was close to US$42 million (1.2 percent of GDP), and savings mobilized were US$5.6 million. However, the government estimates the total need for microcredit at around US$125 million, indicating that there are still large potential financial needs. The Rural Development Bank (RDB) was established in 1998, with foreign assistance, as a wholesale bank mobilizing funds from the international donor community to be channeled to the MFIs. RDB has a capital base of US$5 million, and negotiated several special financing arrangements with international donors amounting to more than US$20 million. Disbursements, however, are slow, and the total amount of loans outstanding is only US$2.5 million, reflecting the weak capacity of both the RDB and the MFIs. Thus, strengthening the capacity of these institutions is imperative to the promotion of financial development in the rural area. Non-licensed MFIs should be encouraged to convert to licensed MFIs, enabling them to expand their scope of activities and gain access to additional donor funds. Although capacity building through gaining experience in the field will inevitably take time, the RDB, with the financial and technical support from the donor community, can assist the MFIs by providing training facilities or assistance with computerization and record keeping, which are the areas where many MFIs are weak. To complement the limited donor funds, the MFIs should strengthen their deposit taking activities to mobilize savings in rural areas. This, in turn, will require further strengthening of prudential supervision of the MFIs, posing a major challenge for the NBC.

  • Streamlining prudential regulations. Some of the quantitative prudential regulations such as capital adequacy requirements (20 percent) are set at a high level compared to international standards, constraining, to a varying degree, the lending activities of some of the active banks. Therefore, there is scope to somewhat relax these regulations once supervisory capacity of the NBC is sufficiently upgraded and more effective and targeted supervision is put in place by strengthening off-site and on-site surveillance activities.

Reform of the FTB

106. The FTB has the potential to become a major player in the Cambodian financial market due to its size and its uniqueness in providing financial services in local currency. Given the limited interest by the majority of the foreign banks in providing financial services in local currency, the business plan to be formulated by the FTB during its reform process as well as its eventual privatization could have a significant implication to the future development of the banking sector. Identifying a competent manager who is willing to run the FTB in a way conducive to the financial development of Cambodia will be a major challenge.

Strengthening banking supervision

107. Strengthening the NBC’s supervision capacity will become increasingly important as private credit picks up. Detecting imprudent lending activities and preventing deterioration of the quality of banks’ assets will be all the more important given the NBC’s limited capacity to serve as a lender-of-last-resort due to the high degree of dollarization in the banking sector. Early introduction and full implementation of the standard chart of accounts by the banks will contribute to increased transparency of banks’ operation and should be one of the top priorities. Emphasis should be given to strengthening on-site inspection and enough resources should be allocated to that end. Quality of off-site surveillance activities should be strengthened by improving the analysis of various reports received from the banks, and both the on-site and the off-site team should exchange their information systematically to improve the effectiveness of the supervisory activities.

Other issues

108. The NBC should start designing the appropriate structure of deposit insurance system (DIS) for possible introduction in the future. Although it is not a matter of immediate concern, the lack of a deposit insurance system could potentially force banks to hold large amounts of vault cash to prepare for a possible bank run, hindering effective allocation of funds. A well designed and sufficiently funded DIS will promote the use of the banking system and encourage the monctization of the economy. It can also contribute to gradual de-dollarization by introducing different modalities of insurance coverage between domestic and foreign currency deposits.

109. Providing effective means for banks to manage their liquidity is also one of the issues that should be addressed in the medium term. The lack of an interbank market, together with the inability of the NBC to provide liquidity to banks to meet temporary liquidity shortages, results in banks maintaining an unusually high level of liquidity. Increasing transparency of banks’ operations will contribute to building up mutual confidence among banks and should help establish an interbank market. Although the Central Bank Law provides the legal basis for the NBC to provide rediscount facilities, it cannot do so due to lack of eligible negotiable instruments such as bills of exchange and promissory notes. The Law on Payment Transactions, expected to be adopted in 2003, will provide the legal basis for the development of such financial instruments. This, in turn, could lead to the establishment of an interbank repo market.

D. Conclusion

110. The restructuring of the banking system under the PRGF program was broadly successful. The financial health of the banks has improved, and public confidence in the banking system is recovering. Lending activities, however, continue to stagnate. Improving financial intermediation by creating an environment conducive to the promotion of financial transactions should be the focus of bank regulators in the coming years. Legal infrastructure needs to be strengthened to improve enforceability of financial contracts. Availability of accurate borrower information must be improved by strengthening various accounting regulations; access to financial services in the rural area has to be improved to promote nation-wide economic development, improving the livelihood of the poor. The regulatory and supervisory capacity of the NBC should continue to be strengthened in line with the increasing activities of the banks to ensure sound development of the financial sector. All these will inevitably take time to fully implement, but they are essential to achieving a sustainable economic growth led by the private sector.

Prepared by Toshinori Doi (ext. 39701).

The banking system continues to be highly dollarized, with 94 percent of the deposits and 96 percent of the loans denominated in the US dollars. Only a few banks take riel deposits, and the FTB dominates the market with a share of 84 percent. The high degree of dollarization poses a significant challenge for bank supervision, as the lender-of-Iast-resort function of the NBC will be severely impaired.

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