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The banking sector’s post-Covid challenges

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The National Bank of Cambodia (NBC). As the country reopened, the NBC has to start normalising accommodative policy measures amid elevated credit risk while remaining a contributor to economic recovery. Hean Rangsey

The banking sector’s post-Covid challenges

These past two years saw the Covid-19 pandemic affect Cambodia’s businesses and households’ income and led to losses in the banking sector. The National Bank of Cambodia (NBC) had departed from her mandate to reduce burdens of banking institutions and households while also supporting economic recovery.

As the country reopened, the NBC has to start normalising accommodative policy measures amid elevated credit risk while remaining a contributor to economic recovery. The question is how the authority could achieve these objectives. Three aspects could be considered: First, status of credit risk and overall health of the banking sector. Second, how to contain credit risk while maintaining the banking sector’s stability. And third, how to unwind the accommodative measures while continuing to support economic recovery.

Status of credit risk and overall health of the banking sector

Credit growth has been subdued since mid-2020 due to slow economic recovery while banks were facing loan restructurings. As such, the overall banking system’s Non-Performing Loan (NPLs) remained low and capital adequacy remained solid, as of the first half of 2021. This reflects that overall credit risk is not at alarming level and the overall banking sector’s health remains sound.

Although economic activities remain passive, consumptions and unproductive investments continue and might be absorbing liquidity surplus from the banking sector. According to NBC semester report 2021, bank credits to individual, mortgage, real estate service, and construction constitutes a big proportion of total loan. Therefore, credit risks could be building up due to over leverage in unproductive sector and at the individual banking institution level.

Recently, the authority has tightened the loan restructuring measure. While this could be the first step towards unwinding its accommodative policies, higher NPLs in some banking institutions is expected, which could elevate credit risk. However, it cannot be judged as to what degree credit risk would be at as it is conditional on economic performance.

Containing credit risk and maintaining stability

While loan restructuring has been tightened, more loan losses are expected in some banks. If capital positions of those banks remain strong, they would be able to endure longer over the next months. However, supportive measure such as requiring retained-earnings and dividends to make up for loan-loss provisions could be an option. Assuming that economic recovery continues uninterruptedly, banks could expect lower provisioning and restored capital position overtime.

Although system-wide credit risk remains low and overall banking sector’s health remains sound, policies should targets reducing banks and households’ leverage into unproductive usage such as borrowings for consumption, construction and real estate. In the meantime, the authority should encourage banks to strengthen transparent reporting, self-risk assessment, internal control and preparation of corrective actions.

To be more pre-emptive, the authority should further increase monitoring of the banking sector’s health and performance along with continued enhanced supervision. In addition, the authority should continue to maintain the provision of liquidity in the banking system at a sufficient level against risk materialisation.

Unwinding while supporting economic recovery

The measures the authority has introduced so far comprises both monetary policy measures (a/ Lower interest rates for Negotiable Certificate of Deposits - NCD and Liquidity Providing Collateralised Operation – LPCO; b/ Lower reserve requirement rate) and banking policy measures; (c/ Delay of full implementation of the capital conservation buffer; and d/ Guidance for loan restructuring and regulatory forbearance).

As economic activities improve, these banking policy measures should also be reversed back to their normal course. As noted earlier, the authority has already started to phase out loan restructuring, although not completely. Therefore, the authority could already be on track to setting good timings for implementing a step-by-step phasing out of those measures. Nonetheless, the authority should provide clear communication to the market on the timing and sequences of phasing out so the market can price in possible impacts and properly prepare accordingly.

Having dealt with prudential requirements, the authority should remain supportive for banking institutions facing liquidity shortage and for economic recovery. One is to extend lower reserve requirement rate for sometimes to provide banking system sufficient liquidity to maintain ongoing supports for economic recovery. However, careful monitoring of liquidity level is crucial to avoid over surplus which provide incentives for more leverage into unproductive sector.

Similarly, continuous favourable interest rate on NCD and LPCO should be prolonged to maintain supports for only individual banking institutions facing liquidity shortage. Again, the authority should clearly communicate its policy steps so as to guide the economy and banking sector towards safe transition to normalisation.

As an implication for the future, it is necessary to have a liquid interbank and money market in Cambodia as it could improve liquidity mobilisation among domestic banking institutions, reduce reliance on foreign funding as well as vulnerability to transmission of foreign economic and financial shocks, and strengthen macroeconomic policy autonomy.

Cheng Oudom is an economist at the National Bank of Cambodia (NBC). The views expressed are entirely his own.

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