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Chapter 4. Cambodia’s Banking Sector: Are More Banks Always Better?

Olaf Unteroberdoerster
Published Date:
February 2014
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Information about Asia and the Pacific Asia y el Pacífico
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Faisal Ahmed and Phurichai Rungcharoenkitkul 

Cambodia has witnessed a rapid increase in the number of banks in recent years. This chapter explores whether Cambodia is “overbanked” from a cross-country perspective.1 It also discusses how such a proliferation of banks could adversely affect competition and financial stability given the ownership structure and fragmentation in the banking system, highlighting the need for putting a moratorium on new bank licenses and further improving supervision.

Cambodia is overbanked compared with its developmental peers and neighbors, including even countries with significantly higher income levels and much larger and better developed financial systems. An overbanked financial system implies a less than optimal balance between competitiveness and soundness in the banking system; indeed, a proliferation of banks can weaken financial stability including by encouraging banks in excessive risk taking, limiting the scope for business diversification, and overburdening the banking system’s supervisory capacity (Claessens and Laeven, 2004). Unlike other industries, in a banking system competition is related less to the number of institutions and more to the quality of supervision and transparency. Furthermore, excessive competition to capture an already saturated market can pose risks to the health of the banking system.

The risks to financial stability in Cambodia could increase owing to a confluence of Cambodia-specific structural factors: (i) a high level of dollarization (Chapter 3), limiting the role of the central bank as a lender of last resort; (ii) the absence of an interbank market, constraining risk sharing and liquidity management; (iii) limited fiscal buffers and foreign exchange reserves to support the banking system in times of stress; (iv) regulatory and supervisory constraints from overbanking; and (v) still fragile confidence in the banking system given Cambodia’s history of civil war.

Although foreign-owned entrants to the banking system can serve as conduits for international best practices and newer sources of funding, financial stability risks could easily emerge, because excessive bank flows can amplify macroeconomic and financial sector vulnerabilities. The latter problem was witnessed in emerging Europe during the most recent financial crisis and, in earlier decades, in East Asia and Latin America. The shifting funding structure of the banking system—an increasing reliance on external sources—warrants closer monitoring. It also highlights the need for exploring options for managing externally funded credit growth to complement the reserve requirement.

Stylized Features of the Cambodian Banking System

Reversing the consolidation of and subsequent stability in the number of banks until about 2005, since then Cambodia’s banking system has become increasingly crowded, with the number of banks more than doubling to 39 (Figure 4.1). Many of the new entrants are foreign banks with operations that, although clustered in select urban centers such as Phnom Penh, intermediate a sizable amount of loans.

Figure 4.1Cambodia: Rapidly Increasing Number of Banks

Source: National Bank of Cambodia.

Cambodia’s banking system is both highly liberalized and highly dollarized,2 and foreign banks have a relatively large presence in it as compared with other countries in the region. More than two-thirds of the banks, which account for half the total deposits, are foreign-owned (Figure 4.2). Most of the foreign banks originate in neighboring countries and display significant variation in size and scope of operations (Figure 4.3).3

Figure 4.2Ownership Structure of Banks in Cambodia: Domestic versus Foreign

Source: National Bank of Cambodia.

Note: Defined as the residency of majority ownership. “Other foreign” includes banks from Australia (ANZ Royal), China, India, Japan, Kazakhstan, Taiwan Province of China, Thailand, and the United States.

Figure 4.3Cambodia: Banking System Structure—Size Distribution of Banks, December 2011

Source: National Bank of Cambodia.

The banking system is relatively concentrated but populated by a large cluster of small banks, with 25 (out of 39) banks accounting for less than 10 percent of total deposits.4 Some of the smaller banks have attempted to rapidly increase their portfolios in recent years, albeit from a small base. Some of the recent entrants have captured a sizable market share within a short period. Although some of the larger banks have their preferred market segments, overall competition for market share has increased sharply in the last two years as demonstrated by the substantial decline in interest rate spreads over the same period.

A Concentrated Banking System

The banking system in Cambodia is characterized by “a missing middle”—that is, there are a few large banks and a large number of small banks. Although this concentration has eased somewhat, when compared to Vietnam, a neighbor with a higher per capita income and larger financial system, the concentration appears to be more acute in Cambodia. The large banks individually are also more dominant in Cambodia (Figure 4.4).

Figure 4.4Comparing Bank Concentration: Cambodia and Vietnam

(Distribution in percent of total deposits from largest to smallest banks, 2010 or latest)

Sources: Bankscope; the National Bank of Cambodia, and IMF staff estimates.

The traditional indicators of concentration (e.g., a Herfindahl index of the share of bank deposits or credit in the top banks) also point to a relatively concentrated banking sector in Cambodia, further highlighting the need for improving supervision and corporate governance to increase contestability and efficiency in the banking system (Figure 4.4).

Is Cambodia “Overbanked”?

To answer this question, we use four indicators of bank density: (i) number of banks per unit of credit; (ii) number of banks per unit of output; (iii) number of banks for a given size of population; and (iv) number of banks for a given number of the “banked” population (defined as population adjusted for financial penetration). We then compare bank density across Cambodia’s developmental peers and neighbors.

By all four indicators, Cambodia appears overbanked, standing out as an outlier compared with developmental peers and neighboring countries (Figure 4.5). Even compared with Vietnam, which has the second highest number of banks in the region (91, second to Indonesia with 121 banks) and is facing elevated financial stability risks, the number of banks in Cambodia, measured per unit of credit, is 10 times higher, and measured relative to GDP (output) it is three times higher.

Figure 4.5How “Overbanked” Is Cambodia?

(Indicators of bank “density”)

Sources: Central banks; Moody’s; CGAP and World Bank Group, Financial Access Database 2010; and IMF staff estimates.

1 “Banked population” is calculated as population adjusted for financial penetration ratio.

The degree of overbanking in Cambodia, therefore, appears to be pronounced, especially in light of the country’s low level of financial access (see World Bank, 2010 and Figure 4.5). It should be noted that, in terms of providing financial access to a large segment of the population, microfinance institutions are playing a key role and some of the commercial banks are considering increasing their presence in this business segment.

How Overbanking Affects Financial Stability

Given the banking structure in Cambodia—a few large banks along with a large cluster of small banks—one question naturally arises: What are the likely effects of the proliferation of banks on competition and financial stability (see also Box 4.1)?5

An overcrowded banking sector implies reduced market power and profit and thus a lower buffer against adverse shocks for a given level and quality of bank capitalization (Allen and Gale, 2004). A reduced scope for profit also incentivizes small banks to pursue more aggressive risk-taking behavior, increasing overall systemic risk (Vives, 2001). Any excessive competition to capture market share in a small and saturated market can pose further risks to banks’ long-term profitability and soundness.

In Cambodia, many of the small banks operate in niche markets, limiting the scope for diversification in their portfolios.6 In addition, small banks often do not have the requisite size to benefit from economies of scale (e.g., internal risk management and credit quality control) (Beck, Demirgüc¸-Kunt, and Levine, 2006). This again tends to lower profits and increase incentives for risk taking.

Box 4.1Nexus Between Competition and Financial Stability

The relationship between competition and financial stability is complex; competition does not necessarily lead to financial stability, and excessive competition can lead to financial fragility, supporting the notion of an optimal level of competition for a given level of financial development and structure.

Vives (2001) argues that different countries may have different optimal levels of competition intensity; countries with a strong regulatory structure and relatively low social costs of failure (e.g., few government bailouts, low unemployment) will benefit from intense rivalry. On the other hand, developing countries with a weak institutional structure and high social costs of failure should moderate the intensity of competition and focus on improving regulation and supervision. Although in advanced economies competition can foster financial stability, Berger, Klapper, and Turk-Ariss (2009) find that excessive competition in developing countries weakens financial stability, in line with the competition-fragility nexus argued in Allen and Gale (2004).

The presence of a large number of small banks can complicate the already weak monetary transmission channel in Cambodia, as is common in many developing countries. Since small banks have been observed to be more vulnerable to liquidity shocks, the conduct of monetary policy or imposition of stronger capital adequacy standards can become more challenging, as has been witnessed in Vietnam (see Box 4.2).

Overbanking, coupled with the ownership structure, can amplify the buildup of financial stability risks. For example, domestic liquidity and bank flows through foreign banks at low interest rates can accelerate the race to capture market share and result in the lowering of credit standards. In fact, cheaper foreign funding and ample domestic liquidity in Cambodia have resulted in a significant decline in lending interest rates; the interest rate spread was compressed by around 150–200 basis points over the 12 months up to December 2012, raising questions about the adequate pricing of risks and the downward pressure on bank profitability as measured by the return on assets.7

Box 4.2Vietnam’s Experience with Small Banks

Amid an optimistic investor assessment following its integration into the World Trade Organization, Vietnam received a large number of applications from new banks. During 2007–08, nine new banks were given licenses and another nine banks were authorized to change from a limited rural scope to unrestricted urban operations, leading to a significant increase in the number of banks and increasing competition for deposits and scarce human resources.

Many of the new (and small) banks started to compete aggressively for funding (deposits and/or interbank credit) and participated in connected lending, contributing to the buildup of the credit boom and exacerbating Vietnam’s current financial sector vulnerabilities. Many of the small banks were undercapitalized, poorly managed, and exposed to excessive risks. Reportedly, during 2007 and afterward, in these banks credit growth was extremely fast, the funding costs to this growth were high, and exposures to the stock market and real estate bubbles were elevated. Furthermore, the governance structure of many of these small banks weakened their credit allocation process and thus their credit quality. Some of these banks aggressively expanded their portfolios, often into illiquid assets such as real estate.

The financial stability risks and liquidity concerns of the small banks complicated the implementation of regulatory and supervisory measures (e.g., resulting in repeated delays in enforcing the minimum capital requirements). Furthermore, the liquidity risks of the small banks complicated monetary policy. The loose monetary conditions also accelerated the buildup of macro-financial vulnerability. The banking system in Vietnam is now undergoing consolidation.

Compounding the above financial stability risks is the fact that a crowded banking system is more difficult to monitor, in turn burdening the generally constrained supervisory capacity common in developing countries (diseconomies of scale in supervision). In Cambodia, this capacity, while improving in recent years, may be stretched because of the growing number of banks (see Chapter 9 for a detailed discussion).

All of the channels discussed above appear to be relevant for Cambodia and warrant continued vigilance by supervisors. Moreover, given that most of the small banks operate in urban centers (mostly in Phnom Penh) and offer a narrow set of products and services, the scope for diversification remains limited. The banks’ small size puts an additional constraint on their ability to optimize risk management practices that benefit from economies of scale.

How Foreign Ownership Affects Macro-Financial Stability

Although foreign banks can contribute positively to the efficiency of the banking system, including through the implementation of international best practices, better risk management, and product innovation, they are not risk-free and do not necessarily offset the consequent financial-stability risks from overbanking. In fact, cheaper funding through foreign banks can easily trigger a credit boom and lower credit standards in a small domestic market. These risks are important given the large degree of foreign ownership in the Cambodian banking system.

Empirical studies of foreign bank behavior show that large foreign ownership increases the likelihood of importing the home countries’ macroeconomic and policy volatilities (Clark and others, 2003). Bank flows are generally short term, procyclical, and more volatile in times of crisis. Since many of the foreign-owned banks in Cambodia are from parts of Asia that have attracted global capital flows (reflecting improved regional growth prospects), Cambodian policymakers need to be mindful of the consequences of capital inflows through the banking system.

Indications are that some of the banks in Cambodia have already started sourcing cheaper funds from abroad to finance domestic lending. Net foreign assets fell steadily during 2012, driven by rising foreign liabilities (Figure 4.6). The diverging pattern in 2012 of net foreign assets and net domestic assets was similar to the pattern observed during the 2007–08 credit boom, indicating a rising risk appetite in the domestic credit market.

Figure 4.6Cambodia: Net Foreign and Domestic Assets in Deposit Money Banks

(In percent of GDP)

Source: National Bank of Cambodia; and IMF staff estimates.

Structurally, since 2011 credit growth has been outpacing deposit growth, and it is now being aided by a marked increase in cross-border bank flows (both nonresident deposits and other foreign liabilities), which tend to be more volatile than other forms of capital flow. Bank-level diagnostics show credit growth in Cambodia has been higher in smaller banks and has accelerated with the entry of foreign banks, which accounted for more than two-thirds of the 2012 credit flows, increasing the sensitivity of the banking system to external funding shocks. These risks are now structurally pronounced given that credit growth in Cambodia is clearly breaking away from its long-term pace of financial deepening (see Chapter 5).

Studies on emerging Europe (which shares the Cambodian feature of large foreign ownership of the banking system and reliance on external funding) suggest that foreign bank behavior can be procyclical, aggravating macroeconomic and financial stability risks (Box 4.3). De Haas and Van Horen (2011) showed that foreign bank subsidiaries in emerging Europe reduced their lending earlier and faster than domestic banks during the 2008–09 global financial crisis.8

In Cambodia, the influx of mostly foreign banks highlights the importance of ratcheting up bank supervision as well as the critical need for better coordination, cooperation, and information exchange among cross-border supervisors to anticipate and minimize financial stability risks. To improve bank supervision, therefore, it is important to prevent the banking system from overcrowding, including by instituting a moratorium on new bank licenses.9

Box 4.3Possible Banking Lessons for Cambodia from Emerging Europe

The expansion of Western European banks to emerging Europe fueled a credit boom before the global financial crisis. These banks provided direct cross-border lending and financed much of the credit increase in emerging Europe through interbank deposits and capital injections to their local subsidiaries. With low interest margins in Western Europe, they became increasingly interested in expanding in emerging Europe and came to dominate much of the latter region’s banking systems.

Capital inflows through these banks fueled a domestic credit boom in emerging Europe, which led not only to rapid GDP growth but also to sharply wider current account deficits and overheating pressures. Capital inflows increasingly went to the nontradable sectors (financial services, real estate, and construction) and growth became unbalanced and vulnerable to a sudden reversal of capital flows. Moreover, since the majority of loans were foreign-currency-denominated in much of the region, an exchange rate depreciation resulting from a slowdown of capital flows would have had powerful adverse balance sheet effects and could have undermined financial stability. Because much of the external debt was owed by banks, financial stability was potentially also at risk from this perspective.

In the fall of 2008, the large capital flows from banks in advanced economies to emerging Europe declined suddenly. In the global financial turmoil, global risk aversion increased sharply, stock markets fell precipitously, and interbank markets dried up. Banks in advanced economies, which were confronted with liquidity and capital shortages, came under severe liquidity pressures, which forced them to stop new lending or even to deleverage. In a change of strategy, they advised their subsidiaries that new funding would henceforth need to come from increasing local deposits. Other capital inflows to the region declined as well, further exacerbating the economic downturn.

The regulatory response to the banks’ problems in the home markets in Western Europe risked aggravating the reversal of credit flows. Starting in the fall of 2008, parent banks faced mounting liquidity and solvency problems in their domestic markets, and most of the banks needed to avail themselves of some form of state aid in their home countries. In a number of cases, home regulators pressed for deleveraging from investments in Eastern Europe. In the end, although some of the Western banks played a stabilizing role, banking systems in several emerging European countries could not avoid crises (e.g., the Baltic countries, Hungary, and Ukraine).

The experience of emerging Europe highlights how bank flows, including even those that pass through the prudently managed foreign banks, can contribute to a rapid buildup of financial stability risk and create policy challenges as external financial conditions change. The existing tools for managing credit growth (i.e., reserve requirements on deposits) cannot directly alter the pace of foreign-funded intermediation. Given Cambodia’s open capital account and dollarization, the pace of risk buildup therefore needs to be closely managed and supervised.

Sources: International Monetary Fund, 2010; and Purfield and Rosenberg, 2010.


Cambodia appears to be “overbanked” when compared with its developmental peers and neighboring countries. An overbanked financial system does not necessarily imply an optimal balance between competitiveness and soundness in the banking system. In fact, it can accelerate risk buildup, including through excessive risk-taking behavior by the banks, limiting the scope for diversification and overburdening supervisory capacity. Given Cambodia’s open capital account, high level of dollarization, and limited monetary policy tools, the financial stability risks from a crowded banking system need to be closely monitored and supervised, especially when credit growth results from increasingly volatile foreign bank flows.


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1The notion of “overbanking” does not refer to financial penetration, that is, financial access, which is currently low in Cambodia at 10 percent of the population. Rather, it refers to the density of banks (i.e., the number of banks for a given level of credit, economic activity, or population, as used in the literature; see Claessens and Laeven, 2004).
2As of December 2012, over 95 percent of deposits and lending was in U.S. dollars.
3Five of the top 10 largest banks are foreign-owned (Figure 4.3).
4A few of the specialized banks are restricted from taking domestic deposits.
5Claessens and Laeven (2004) refer to evidence in the industrial organization literature, which underscores that measures of market structure, such as the number of institutions, are not necessarily related to the level of competitiveness in an industry.
6It should be noted that large banks in developing countries also are not immune to concentration risks and connected lending due to challenges with corporate governance and bank supervision. As seen during the recent global financial crisis, banks in advanced economies are also exposed to a large set of risks, including high leverage.
7Although most of the traditional financial soundness indicators, such as nonperforming loans or sectoral loan classification data, do not point toward any immediate vulnerabilities, it should be noted that those indicators are often backward looking and may not adequately capture the medium-term risks at the early stage of the credit cycle.
8Japanese banks during the Asian crisis and North American banks during the Argentine crisis also sharply reduced their lending.
9Entrants are reported to be attracted to the Cambodian market because of its growth potential. Some of the foreign banks from neighboring countries (e.g., Vietnam) are reportedly influenced by both pull factors (e.g., growth potential in the host market) and push factors (saturated home market).

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