Interest Rate Cap: Who Wins?

by Beatrice Dominique de la Fuente

Interest Rate Cap: Who Wins?

The microfinance industry has been booming in Cambodia in recent years, helping to provide low-income citizens with access to finance, and with the ultimate objective being poverty alleviation. This cause, however, has been met with some criticism. At the National Summit on the Development of the Microfinance Sector in Cambodia last year, Cambodia’s Prime Minister Hun Sen called out microfinance institutions (MFIs), stating that “It seems that these MFIs have a plan to take advantage of the people”. He further questioned, “Why haven’t we taken action?”. About a year later, it seems that the government finally has.

On the 1st of April 2017, the National Bank of Cambodia imposed an interest rate cap of 18% on all loans provided my MFIs. Prior to this loans would average approximately 20 – 30%. In theory, this move by the government is beneficial for poor Cambodians because it increases affordability and protects them from the higher interest rates. This is purported to provide a ripple effect in society in which the rural poor can improve livelihoods through increased access to finance. At the same time, it should leave less room for MFIs to act deceitfully.

Many claim this decision is underpinned by a political motive. With the upcoming Cambodian elections in June, the Prime Minister “has been eager to be perceived as a champion of the poor to earn votes.

Unfortunately, the result will probably be the opposite of the intended effect.

Interest rates averaged around 20 – 30% to offset the risks of lending to low-income Cambodians. It is also justified in that it is relatively expensive to set up operations in remote areas of Cambodia. By capping the interest rate at 18%, MFIs will, more often than not, now be making losses from their loans. This is expected to lead to a reduction in the number of loans provided to the rural poor. As such, low-income Cambodians – the targeted beneficiaries of this arguably political move – are actually being disadvantaged by this interest cap.

On the other end, MFIs will have to rethink their options. Should they offset their losses by charging higher fees on, for example, services and administration? Would it be better to close down? One of the biggest MFIs in Cambodia – PRASAC Microfinance Institution – is now hoping to diversify and transform into a commercial bank.

However, it is also contended that regulation is necessary due to the unsustainable growth rate of the microfinance industry. By ordering this ceiling, it deters more competitors from entering the arguably saturated market.

Undoubtedly, this has stirred the microfinance industry in Cambodia. The introduction of the interest rate cap: was it a positive or negative move?