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Small banks ‘underperform’ in thriving sector

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Investment firm MSP has called on the National Bank of Cambodia (NBC) to increase the minimum capital requirement for commercial banks to $150 million from the current $75 million. Supplied

Small banks ‘underperform’ in thriving sector

As the Kingdom’s energetic banking sector rockets at an average annual rate of 28 per cent and teems with an ever-increasing number of new players vying for a slice of the market, smaller banks have been left in the dust.

This is according to a report compiled by investment and advisory firm Mekong Strategic Partners Co Ltd (MSP) and entitled Cambodian Banks: 2020 Financial Review “Time for Consolidation”.

The banking sector enjoyed a remarkably strong year last year with revenue up 23 per cent and profits up 46 per cent, MSP said.

Loan growth remained “unsustainably high” at 24 per cent and deposits rose 15 per cent, while total loans for the overall financial sectors – including microfinance institutions (MFIs) – climbed to $32 billion, it said.

Despite the growth, it said, the return on equity (RoE) in the sector remained relatively subdued at 11.7 per cent.

Though there are currently 12 banks that deliver returns of more than 15 per cent, up from seven in 2016, returns in the sector are dragged down by an excessive number of small, underperforming banks – 60 at the end of last year, which it said, was “unsustainable”.

MSP said: “Over the past decade, bank earnings have grown an average of 28 per cent per annum, although growth was slightly lower at an average of 20 per cent over the last five years.

“We believe that this would be one of the fastest rates of growth globally, and has contributed to the high demand for banking licences in Cambodia.

“An unfortunate side effect of this is that there are now too many small, underperforming banks in Cambodia, and there is a growing need for consolidation in the sector.”

MSP managing partner Stephen Higgins told The Post that at current capital levels, most banks would need a loan book of at least $400 million to generate an acceptable RoE, stressing that only 16 banks had a loan book that high as of last year’s end.

Though $400 million might seem like a lot, Higgins noted that the figure represents a market share of just 1.5 per cent, which will soon be one per cent.

He said: “So we’ve got a lot of really small banks that will need to start merging or buying other players if they want to become meaningful.

“If you strip out the four big banks, the average RoE for the sector falls to just eight per cent. At that rate, you’re almost better off taking your capital and investing it into a term deposit.”

MSP suggested the National Bank of Cambodia (NBC) to increase the minimum capital requirement for commercial banks as they did in 2016, doubling from $37.5 million to $75 million, and allowing two years for banks to comply.

A typical bank with the $75 million minimum in capital could only build a maximum loan book size of approximately $400 million, which it said, is a 1.5 per cent share of overall financial sector loans last year.

It said: “This will fall to less than a one per cent share by 2023, which would call into question the viability and relevance of banks of this size.

“We believe that the NBC should again consider an increase in minimum capital to $150 million by 2023-2025.

“This would be in line with their previous approach of doubling capital about every eight years. It would strengthen the overall health of the banking sector, and encourage much needed consolidation to reduce the number of banks below 60.”

Less than 20 per cent of Cambodian banks have capital of $150 million or more, MSP said, adding that it believes that a third of banks could achieve that level organically by 2024.

“Under the expected increase in capital requirement to $150 million, banks will find it hard to generate a decent return for the shareholders in this competitive landscape.

“And, a bank would require a loan book between $670 million to $750 million to generate an RoE of 15 per cent,” it said.

Higgins said the NBC’s decision to double minimum capital levels in 2016 after last increasing them eight years prior was “a very sensible, and much needed move”.

He said: “We expect another eight years to pass before they increase them again, so maybe around 2024 to 2025 we’ll see another big increase in capital requirements, ideally to around $150 million.

“We estimate that at least a third of banks would be at this level anyway, and the remainder would need to merge or seek additional capital from their shareholders.

“If banks don’t have $150 million of capital, then they’re guaranteeing that they’ll have less than a one per cent market share, which basically makes them irrelevant.”

MSP added that smaller banks require a shift in business strategies – through market consolidation – such as mergers and acquisitions, productivity boosts, increased investment in technology and talents, as well as optimisation of capital structure.

Additional measures suggested are product development that places a strategic focus on the unbanked “missing middle” in the small and medium-sized enterprise (SME) segment, and investment in a digital strategy, it said, stressing that network expansion does not merely entail more branches or ATMs.

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