Street vendors – like these ones, seen on Phnom Penh – often access microloans to launch their businesses, while some members of the public use the capital to gamble or speculate. Yousos Apdoulrashim
In recent years, the stories of low-income Cambodians trapped in a vicious cycle of debt by microfinance have gained considerable attention.
Featured in Bloomberg and DW (Deutsche Welle), these anecdotes paint a grim picture of microfinance not as a lifesaver but as a shark, leading people to wonder whether microfinance is a lifeline for the poor.
To better understand its impacts, I first discuss its roots, followed by its development, causes and effects in Cambodia. Finally, I will explore some measures to mitigate its dark side.
The root of microfinance
The financial system plays a key role in an economy by channelling funds from savers to borrowers. As a vital part of this system, banks traditionally deal with people with wealth and proven earning abilities, leaving a sizable portion of the world’s population excluded from this important system.
However, in 1974, Dr. Mahammad Yunus found a way to bring this marginalised group into the system. While looking for ways to alleviate poverty, he met farmers in Jobra village, Bangladesh, whose small businesses were financed by banks at higher rates.
Through compassion, Yunus helped those poor farmers obtain lower rates by using a group of women as co-guarantors. This way of practice proved so successful that by the 2000s, microfinance institutions (MFIs) offering similar services proliferated across Asia, Africa and Latin America. Cambodia is one of the many countries flooded with micro-loans.
The evolution of microfinance in Cambodia
In the 1980s, after devastated by internal conflicts and the genocide, Cambodia desperately needed human resources, financial capital and technology to develop.
In 1990, GRET (Group de Recherches et d’Echanges Technologies) launched the first significant MFI to assist the poor, rural population. In 2005, there were 16 licensed MFIs and about 83 non-profit microfinance organisations.
By the end of 2023, the microfinance sector had expanded significantly, with 87 MFIs and 114 rural credit institutions, based on the National Bank of Cambodia (NBC)’s 2005 and 2023 Supervision Annual Reports.
Micro-loan volumes skyrocketed from just a few million USD in 1995 to $431 million in 2010 and reached a peak of $9.5 billion in 2022. What caused such staggering growth?
The causes of the micro-loan glut in Cambodian
Two market forces — supply and demand — drove this sharp rise. On the supply side, a lucrative return rate is one of the key drivers.
In 2018, the return on equity of LOLC Cambodia and PRASAC, for instance, was around 28%, three times the average return for commercial banks in Cambodia.
This attracted numerous local and international investors into the market, making it so competitive that borrowers find it easier and cheaper to obtain loans.
On the demand side, people’s demand for micro-credits rose for several factors. First, people felt wealthier than before. The country’s average annual income increased by around 7% per annum in recent decades, and there were an increasing number of people receiving money sent by relatives working overseas (e.g., in Thailand, Malaysia, Korea and Japan.). Remittances rose notably from just under 1% of the country’s GDP in 1993 to 9% in 2022.
Another is people’s tendency to imitate each other. When their neighbours, for example, have a car or a new smartphone, they wish for the same.
This can be seen through astronomically rising micro-loans for household consumption from just $4.3 million in 2010 to around $3.2 billion in 2022.
Additionally, many people, rich and poor alike, engaged in speculation during the real estate boom, which substantially inflated people’s wealth from properties.
These market forces led to a rising tide of debt. The average loan balance of LOLC Cambodia customers, for example, surged from around $250 in 2009 to roughly $2,500 in 2018. This growing debt has both positive and negative effects on society.
The effects on borrowers
Since the effects of micro-loans at a micro-level are more dramatic and easily quantified than those at a macro-level (e.g., inflation, employment and economic development), I primarily discuss the former.
For individuals, debt is like a double-edged sword, either improving or ruining their lives.
Generally, if borrowers use a loan responsibly and as intended, it is more likely to benefit them and society, because it loosens their financial constraints and releases their creativity. There exist numerous success stories of low-income women using tiny loans to build successful businesses.
If they use a loan, however, in an unproductive way, like gambling or for speculative purposes, they tend to become over-indebted and unable to pay back their debt.
What’s more, since most borrowers rely on agriculture and remittances from their children working either in garment factories or overseas, their abilities to pay are easily impacted.
All of these factors, along with high interest rates of micro-loans, can plunge borrowers into a debt trap, in which borrowers might be forced to liquidate their land and homes or migrate for jobs as far away as overseas, where they are even more susceptible to exploitation, as documented by WD.
These dramatic anecdotes have urged many people to ask, “Who is to blame–borrowers, lenders, regulators? And what has been done about it?”
Who is to blame?
The question of blame should be evaluated based on a case-by-case basis. Many MFIs act responsibly, creating value for their investors, clients and wider society. If not, they would not be able to survive and thrive so long in this competitive market.
Others might even be predators hunting their prey ruthlessly. Because land, for example, was so valuable, some lenders might forget all about sound lending principles (e.g., affordability) as long as borrowers pledged their land.
Since most borrowers are not well-educated, they are vulnerable to predatory lending. It is fair to note that some borrowers behave unethically as well, taking loans, for example, from multiple lenders until they are too indebted to repay.
What has been done?
What has been done to protect the vulnerable in particular? If the microfinance market is left to adjust itself by weeding out bad actors, it is highly unlikely to work because predators lurk at every corner, and there exists a huge gap between borrowers and lenders in terms of financial literacy — the ability to assess information and use funds wisely. Studies in both advanced and developing countries show that low financial literacy is associated with over-indebtedness.
Therefore, the microfinance market, just like the banking segment, needs intervention from benevolent policymakers.
Recently, the National Bank of Cambodia (NBC), the Cambodia Microfinance Association, the UN and other relevant stakeholders have collaborated to strengthen the sector with guidelines, such as prohibiting the use of Indigenous Communal Land Titles, expanding financial literacy programmes, and enhancing sound lending practices.
Whether these policies are effective remains to be seen.
Ultimately, people are mainly responsible for their own livelihoods. Yet, given the poor’s limited resources and knowledge, they require assistance to break free of their undesirable conditions.
Micro-loans are supposed to be one of the ideal helping hands, if employed with a social responsibility mindset. Unfortunately, when it comes to business, people extract profits as much as possible if left unchecked, which is why the NBC has capped an interest rate at 18%. Can this ceiling be even lower or comparable to the banks’ average charge?
Dr Veasna Kheng has a PhD in Economics from Monash University, Australia. The views and opinions expressed are his own.
