Confluences, a market-entry facilitator in Cambodia, and YCP, an Asia-focused strategy consulting firm with offices in over 20 countries, have jointly-published a white paper on “The Declining Profitability Trend in Cambodia’s Banks: The Impact of Rising Costs and NPLs”.
A launch event for the white paper was held on October 23, 2024, at TRIBE Phnom Penh Post Office Square, where two YCP representatives also delivered presentations focused on non-performing loans (NPLs) and cost transformation. We detail some of the key takeaways from this latest publication.
The report largely focuses its analysis on the top five banks in Cambodia by asset ownership – Advanced Bank of Asia Ltd. (ABA), ACLEDA Bank Plc. (ACLEDA), Canadia Bank Plc. (Canadia), KB Prasac, and Sathapana Bank – as they hold close to 50 per cent of the country’s total assets and thus provide a representative snapshot of the sector.
Declining Profitability Among Cambodia’s Top Banks
Rapid growth and transformation has been evident in Cambodia’s banking sector over the past decade, however, the sector is currently experiencing a significant decline in profitability and operational efficiency.
The report notes that the top five banks have seen a median decline in Return on Assets (ROA), from 2.3 per cent to 1.2 per cent, and in their Net Profit Margins (NPM), from 26.6 per cent to 16.5 per cent, between 2019 and 2023
Even among the remaining 54 banks, median ROA declined from 1.5 per cent to 0.3 per cent, and NPM from 27.2 per cent to 6.2 per cent, in the same period.
What Caused The Decline In Profitability?
The decline is attributed to a number of contextual factors from recent years, both within Cambodia and across the globe, that caused a spike in loan provisions, namely the unique conditions brought on by the COVID-19 pandemic:
- Borrowing conditions during the pandemic were very favourable in Cambodia, due to banks offering lower borrowing rates (resulting from Cambodia’s high dollarisation and the U.S. Federal Reserve lowering interest rates) and the National Bank of Cambodia (NBC) implementing moratorium policies to ease debt payments – This initially led to higher profit margins for banks, however, as the situation of the pandemic softened, it became clear that the recovery process was going to be slower than expected, and many struggled with repayments after accumulating excessive debt.
- Cambodians heavily invested in real estate, a major pillar of the economy that was seeing a major boom in the years prior, but saw a significant downturn in the aftermath of the pandemic – many had to draw from their income to repay their real estate debts, which increased the risk of loan defaults, putting further pressure on banks.
Overhead Cost Analysis
The report also looks into banks’ overhead costs and operational efficiency to better understand internal causes for the decrease in profitability. The top five banks have largely had an unchanged overhead ratio (OHR) over the past five years. However, when dividing operating expenses into two main categories – discretionary costs and committed costs – the report found that the proportion of discretionary costs (non-essential expenses like marketing, advertising, repairs) has been increasing across all top banks since 2021.
Correspondingly, the report suggests that up to 50 per cent of discretionary costs are classified as ‘addressable’ and can be optimised or reduced through strategic management.
The Non-Performing Loan (NPL) Situation In Cambodia’s Banking Sector
A major point of focus in the report is on the growing issue of provisions (funds set aside as assets to pay for anticipated future losses) and NPLs, which have a considerable impact on the financial stability of the banking sector.
Provisions at the two largest banks in Cambodia – ABA and ACLEDA – alone increased threefold since 2021, according to the report, resulting from the conditions detailed in the prior section.
“Right now, NPL is rising on average, among 60+ banks in Cambodia, at around 5 per cent,” shared Gary Murakami, Associate at YCP, during an interview with B2B Cambodia. “In the past, just until 2019, it was around 2 per cent. The three point increase means a lot, because this will not end at just 5 per cent, but will rise even up to 7 to 8 per cent.”
This implies that 5 per cent of bank loans are basically unmoving stock, which will affect the efficiency of the business, so they have to do something to get rid of it.
Watch a snippet of our interview with Gary Murakami, Associate at YCP:
Aside from increasing provisions, another reason given for the spike in NPLs, particularly in 2023, was the delay in loan reclassification. Regulators afforded banks more flexibility in how NPLs were classified during the pandemic, thus “the true extent of credit issues” was briefly concealed and only came to light when the NBC’s moratorium policies phased out and banks had to acknowledge their deferred problem loans.
The report also suggests that the rising proportion of personal loan portfolios across the banking sector may have contributed to the recent spike in NPLs. In 2012, the top five banks with larger personal loan portfolios had relatively lower NPL rates, which encouraged all banks to expand their portfolios in this area. The situation shifted significantly by 2023, with the top banks with substantial personal loan portfolios facing higher NPL rates.
Important to note, however, is the recent transformation of KB Prasac and Sathapana into commercial banks from microfinance institutions, which had an impact on how this factor of personal loans is understood. Both KB Prasac and Sathapana have the highest proportion of personal loans among the top five banks, which is not a big surprise as microfinance institutions tend to exhibit higher risk-tolerance in their loan approval strategies. As a result, even now as commercial banks, they are left with more high-risk personal and small-sized loans compared to their peers, thus spiking their NPLs.
The situation of the two former microfinance institutions is contrasted with Canadia Bank, which did not experience a significant spike in its NPL ratio between 2019 and 2023, despite also increasing its personal loan portion from 7 per cent in 2012 to 20 per cent in 2023. The report, thus, concludes that personal loans can still be viable for Cambodian banks, as long as they implement more rigorous risk assessments, and if microfinance institutions transitioning into commercial banks consider accepting lower returns to reduce risks.
_20241031_121859.jpg)
Addressing NPL Challenges And Cost Optimisation – Recommendations For Cambodian Banks
Murakami told B2B Cambodia about a few ways NPL challenges can be addressed in Cambodia.
“One way is to basically restructure loans, so in simple terms, giving more favourable terms for borrowers so that borrowers can repay smaller amounts, or at a lower interest rate, to banks, so that banks still make losses but can still recover some money,” he proposed.
“Another way is to get rid of NPL by selling it to someone else. This is common in some developed markets, but in Southeast Asia, it's not, and in Cambodia, I would say it's still extremely rare or illiquid.
There's no one who wants to buy NPL (in Cambodia), but we (YCP) have been one of the market makers in Malaysia, which was also in a similar situation around five or six years ago. Now the NPL sale market is getting more active by having players like us who support finding buyers and sellers, to assist sellers in divesting part of their loan portfolios. This is something that we want to propose to Cambodian banks and audiences today.
In terms of cost optimisation, the report broadly advises banks to adopt comprehensive procurement and supply chain strategies.
Understanding that taking these recommended steps can be complicated, the report advises banks to find the right industry partners who can help. Since YCP was involved in the authoring of this white paper, the solutions proposed largely surround the company’s proprietary AI tool, BluMor, which the report states can help to design “a more effective NPL divestiture strategy”, and YCP’s other consultancy services for cost-optimisation, which promises a “guaranteed cost savings of 4 per cent on addressable costs".
“I think it's a bit too late to talk about prevention, so I want to share solutions to make the situation better from here,” Murakami asserted. “Definitely, one way is to introduce AI machine learning (ML) tools to make portfolio analysis better, so that [banks] can know and make decisions on what loans they have to restructure at an optimal price to recover some of the money, and if it’s determined not recoverable, they have to sell it.”
“For those banks who are still doing this manually, or do not have access to machine learning AI software, it will be difficult for them to make decisions. So what authorities like the NBC can do is to facilitate smaller banks to introduce more technology, mainly big data analytics,” he concluded.