Cambodia Investment Review
The Cambodian financial sector demonstrated resilience in 2022, delivering a reasonable performance despite challenging global conditions. The year was marked by strong balance sheet growth, offset by higher expenses and credit costs, a trend expected to continue into 2023 according to the latest report by the Mekong Strategic Capital titled Scale: Measuring What Matters.
Cambodia’s financial sector performed commendably well in 2022, given the onset of an inflationary economic environment. Revenue saw an increase of 16%, reaching $4.10 billion, up from $3.53 billion. However, profits were down by 6% from the previous year, settling at $1.22 billion, a decrease from $1.27 billion. This deterioration in the bottom line was largely attributed to increased credit costs and expenses.
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The sector’s total loan book stood at $53.2 billion, with commercial banks and microfinance deposit-taking institutions (MDIs) holding 97% of this amount. The remaining 3% was represented by 9 specialized banks and 82 microfinance institutions (MFIs).
Growth and Challenges in the Sector
Sector loan growth continued to outpace deposit growth, with a 17% increase in loans compared to an 8% increase in deposits year-over-year (YoY). This tightening of liquidity led to a sharp increase in interest rates and a deterioration in the loan to deposit ratio (LDR), which stood at 127%.
The return on equity (ROE) dropped to 8.4% from 10.2% in 2021, with the top 20 institutions returning an average ROE of 10.6%, while other institutions averaged just 2%. Other industry operational indicators included a strong solvency ratio of 31.3% and a return on assets (ROA) of 1.7%.
The Real Estate sector, which makes up approximately 33% of total system loans, has grown significantly over the past 10 years. Banks with larger distribution networks emerged as winners, driven by the rapid growth of the mass-market segment over the past decade. This segment, composed of growing middle-income and Small & Medium Enterprises (SMEs), has led to a shift in market dynamics.
Prospects for the Top 5 Banks in 2030
Banks that traditionally focused on low-yield MNCs and HNW customers and did not expand to service the mass market lost out to those that did. The system’s liquidity tightened in 2022, driving up funding costs, a trend expected to persist into 2023.
Looking ahead to 2030, the Cambodian banking sector is expected to consolidate into 4-5 large banks, with other banks reduced to small niche players. Two near-certain candidates for a Top 5 position are ABA and Acleda, with the remaining three positions up for grabs.
ABA’s strengths lie in its strong transaction banking capability and ideal size distribution network. Acleda’s advantages include the biggest physical distribution and high levels of trust among the Cambodian population. Challenges for these banks include improving efficiency, strengthening corporate banking capabilities, and building out digital capabilities.
Scale Drives Returns: A Deep Dive into the Cambodian Financial Sector in 2022
In the Cambodian financial landscape, scale has emerged as a defining factor in determining success. Banks that have invested in both digital and physical distribution channels have reaped the rewards, while those focusing solely on the top end of the market have found themselves left behind.
Larger banks have seen growth in profits, while smaller banks have generally witnessed a decline in earnings. The most successful institutions have supported Small & Medium Enterprises (SMEs) and the mass market, recognizing the importance of a diversified approach.
Evolution of Top Leaders with ABA’s Rise to the Top
ABA Bank’s growth story is a testament to the power of strategic investments in both physical and digital distribution channels. Growing from just a 2% market share to the #1 position within eight years, ABA now holds the largest revenue share of any financial institution in Cambodia at 14%.
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Key milestones in ABA’s growth include the launch of their mobile app in 2015, the introduction of the PayWay e-commerce gateway in 2017, and the initiation of QR payments in 2018. These innovations have positioned ABA as a leader in transactional banking, with the bank continuing to invest in physical infrastructure.
ABA’s success has been marked by a consistent investment in both physical distribution and digital channels. The bank added an average of seven branches per year over the last decade and saw exponential growth in its Point of Sale (POS) count, adding over 2,500 POS in the last year alone.
The rise of the “Bakong” system provides a significant opportunity for other banks to compete against ABA in the payments space. The COVID-19 pandemic has further accelerated online payments, with 1 billion online transactions totaling $273 billion.
Physical Distribution and Revenue Is a Crucial Connection
Branches play a vital role in both loan and deposit origination. Financial Institutions with a larger number of branches, ATMs, and POS have become top incumbents, owning larger loan/deposit books and generating higher incomes.
Smaller banks will find it challenging to scale up without acquisition, as branded distribution builds trust and helps larger players build strong market share of deposits.
Out of 74 banks and MDIs, only 12 operate 60 or more branches, and 10 of them rank among the Top 20 by loan size. There is a clear correlation between network distribution and profitability, with those having more than 60 branches earning an average Return on Equity (ROE) of 14.2%, compared to 8.7% for those with fewer branches.
Cambodia’s Big-4 has 55% of the sector’s Net Profit After Tax (NPAT), while 52 smaller institutions saw profits shrink by 34%, accounting for just 27% of the total sector.
Challenges of Smaller Banks with Efficiency and ROE
The proliferation of smaller, sub-scale banks has reduced sector efficiency, driving down sector ROE. The Top 10 banks based on revenue averaged 13.8% ROE, compared to 7.3% of the total sector average. Banks outside of the Top 10 averaged only 2.3% ROE.
The decline in ROE over the past decade is largely driven by inefficient smaller banks, with the average Cost-to-income of new entrant banks in the past 10 years at 59%, against 43% for the Top 10 incumbents.
Lending Growth Continues in Cambodian Financial Sector: An In-Depth Analysis of 2022
The Cambodian financial sector witnessed a 17% increase in loan growth in 2022, a trend that is expected to slow down to single digits in 2023 before rebounding to double-digit growth in 2024. The Big 4 banks, with well-established branch networks, continue to outpace the remaining institutions in loan growth, holding 42% of the sector’s loan book.
Approximately one-third of the sector’s loan book is related to real estate, which grew the most in the last five years, adding nearly $16 billion of loans. However, Non-Performing Loans (NPLs) have increased by 1% to 3.1% in 2022, with the real estate segment accounting for approximately 26% of this increase.
In the last five years, Real Estate and Retail Trade loans grew by nearly $16 billion, constituting more than 52% of total sector loan growth. The Real Estate sector’s loan growth mainly supported landed property developments, construction, and consumer home loans, with most banks not having material exposure to high-rise commercial or residential developments.
Increase in NPLs as Covid-19 Loan Restructuring Moratorium Ends
More than one-third of banking loans were concentrated in real estate in 2022, indicating a sizable exposure to the asset class. This concentration has a limiting effect on a bank’s appetite to continue supporting the sector at current growth rates. The Top 10 Financial Institutions hold 55% of the total Real Estate sector loan book but are otherwise relatively well diversified.
The Real Estate sector has the highest volume of NPLs in 2022, with a reasonable NPL ratio of 2.9%, given that the sector makes up over one-third of total system loans. The Retail Trade sector, being the second-largest growth sector, has an NPL ratio of 3.4%, indicating that exposure to the two largest asset classes is being well maintained.
The hotels and restaurants sector, affected by travel restrictions and lockdowns during Covid-19, reported the highest sector NPL at 10.7%. With the National Bank of Cambodia’s (NBC) end to restructured loans as of June 2022, provisioning has increased as loans are reclassified. NPLs are expected to exceed 5% by the end of 2023, before declining in 2024.
A Balanced View of Growth and Risks
The Cambodian financial sector’s lending growth in 2022 paints a picture of continued expansion, particularly in the Real Estate and Retail Trade sectors. The Big 4 banks continue to dominate, reflecting the importance of well-established branch networks.
However, the increase in NPLs and the sizable exposure to the real estate sector present challenges that must be carefully managed. The end of the Covid-19 loan restructuring moratorium and the expected increase in NPLs in the coming years underline the need for prudent risk management.
The implementation of CIFRS 9 in 2019 as a reporting standard, aligning with international banks, is a positive step towards greater transparency and accountability.
As the Cambodian financial sector navigates the complex landscape of growth opportunities and potential risks, a balanced approach that combines aggressive growth strategies with robust risk management will be key to sustainable success.
Liquidity Tightens in Cambodian Financial Sector: A Comprehensive Analysis of 2022
In the Cambodian financial sector, loan growth has been consistently outpacing deposit growth for the last five years, creating an approximately $11 billion funding gap. This has put pressure on banks to find wholesale borrowings to support loan growth, leading to a sharp rise in interest rates.
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The system’s Loan-to-Deposit ratio (LDR) increased to 129% in 2022, a figure that needs to decline in the coming years. From a system health perspective, Cambodian banks remain some of the most well-capitalized in the region, boasting an average Capital Adequacy Ratio (CAR) of over 22%.
Tightening Liquidity and Rising Interest Rates
The widening gap between deposits and loans is putting pressure on banks, leading to increased competition for deposits and higher Cost of Funds (COF). This has resulted in a switch from transaction accounts to term deposit accounts, further increasing banks’ cost of funds.
Banks are increasingly looking at offshore borrowings to cover the growing gap between loan growth and deposits. Environmental, Social, and Governance (ESG) factors are becoming increasingly relevant as international banks and investors assess sustainability. The liquidity crunch is expected to contribute to the slowdown of the sector’s loan growth.
The tightening sector liquidity has led to a shift from Transaction/Savings to Term Deposits, resulting in higher average funding costs. Funding costs have gone up nearly 100 basis points, or 39%, over the past 12 months. One-third of this increase is due to the change in the mix from transaction/savings to term deposits, and two-thirds are due to rising deposit rates.
Shift from Transaction/Savings to Term Deposits
Due to the tightening of liquidity, banks are fighting harder for deposits, with some offering up to 10% on term deposits. This trend is expected to continue as the sector grapples with the challenges of balancing loan growth with deposit growth.
The finance sector’s LDR grew from 118% to 129% in 2022, equating to a borrowing need of approximately $11 billion. This ratio was traditionally around 100%, and it is expected to revert towards those levels in the coming years.
Despite the tightening liquidity, the finance sector remains very well capitalized, mainly consisting of high-quality tier 1 capital. This positions the sector well to absorb an economic slowdown, reflecting the robustness of the Cambodian financial system.
A Challenging Landscape with Opportunities for Prudent Management
The liquidity situation in the Cambodian financial sector presents both challenges and opportunities. The tightening liquidity and rising interest rates require careful management and strategic planning.
Banks must navigate the complex landscape of loan growth, deposit growth, and interest rates, balancing the need for expansion with the imperative of maintaining financial stability.
Read more: Leader Talks: Stephen Higgins on Cambodias post-COVID financial sector outlook
The well-capitalized nature of the sector provides a solid foundation, but the dynamics of liquidity management will be a key determinant of success in the coming years. As the Cambodian financial sector continues to evolve, the ability to adapt to changing liquidity conditions will be a critical factor in sustaining growth and maintaining the confidence of both domestic and international stakeholders.
Stephen Higgins, Managing Director of Mekong Strategic Capital offered his insights into the recent report, highlighting some critical trends and challenges facing the sector. On the success of banks serving the mass market, Higgins emphasized the importance of scale. “Banks serving the mass market at scale are winning,” he stated. “Niche banks are only becoming ‘more niche,’ and will increasingly lose relevance. The ability to reach a broad audience has proven to be a decisive factor in the current financial climate.”
Significant Rise in Funding Costs Will Undoubtedly Crimp Bank Profits
The report’s findings on tightening liquidity and rising funding costs were a particular concern for Higgins. He noted a 40% increase in funding costs in June 2023 over June 2022. “This significant rise in funding costs will undoubtedly crimp bank profits in 2023,” Higgins warned. “There will need to be a much bigger focus on cutting operational expenses. Efficiency and prudent management will be key to navigating this challenging environment.”
Real estate-related loans, which make up a third of total loans and have dominated growth over the past decade, were another focal point of Higgins’ reflections. “The dominance of real estate-related loans in the loan portfolio is a trend that has shaped the sector over the past decade,” he observed. “It’s a dynamic that reflects broader economic trends but also poses specific risks and opportunities for banks.”
Finally, Higgins expressed confidence in the overall stability of the Cambodian banking system. “The bank system remains very well capitalized, arguably too well capitalized,” he said. “This strong capital position is a testament to the resilience of the sector, but it also raises questions about how capital is being deployed and where opportunities for growth may lie.”
Mekong Strategic Capital is an Investment and Advisory firm headquartered in Cambodia and operating across the Greater Mekong region.Read the full report here.
