Raymond Sia
There has been growing public interest in recent times in how commercial banks in Cambodia actually operate. That interest has only increased with news of banks being liquidated; the Kingdom has seen five commercial banks wound up in the past seven months.
So; what exactly happens to the savings and deposits we keep in a bank?
Banks Produce Profit With Our Money.
Banks are not charitable organisations.
Banks are accountable and responsible to their shareholders; and to their customers.
When a bank accepts deposits from customers (after conducting their customary due diligence), it must then set aside part of the deposit to meet certain regulatory requirements. One of these is placing a percentage of those deposits with the central bank as a Statutory Reserve Requirement (“SRR”). The National Bank of Cambodia currently imposes a 7% SRR for both US Dollar and Khmer Riel deposits.
The SRR ensures banks hold a buffer of liquidity to meet unexpected demands for withdrawals. This requirement protects depositors and helps maintain the stability and integrity of the financial system.
From a bank’s perspective, however, these reserves come at a cost: funds held in reserve earn little or no interest and cannot be lent out or otherwise put to profitable use. SRR therefore have a wide-ranging impact, shaping a bank’s ability to create credit / loans, manage liquidity, and respond to changing economic conditions.
Once the SRR has been set aside, banks are free to lend the remainder to customers or to other banks.
The risk assessment involved for customers and other bank counterparties is broadly similar in both cases, and centers on a few key questions: what interest rate is appropriate given the risk-reward options and how does the bank mitigate the risk of non-repayment?
The gap between what a bank earns on loans and what it pays out on deposits is known as its Net Interest Margin (“NIM”) — one of the clearest measures of how profitably a bank is putting our money to work.
Assuming a bank gather deposits at 3% and lends at 8%; its NIM is at 5%. We can gauge a bank’s profit using the size of its loan book and NIM; and deducting other capital & operational expenses and delinquent loan provisions.
Cambodia banking industry’s financial performance today relies heavily on lending activities. The slowdown of lending activities along with the higher provisioning for non-performing loans will have a negative impact on earnings and profitability.
Banks Manage Our Money.
This point may surprise many people, and it is admittedly a technical one.
The reality is that when we place our deposits or savings with a bank, we are effectively granting that bank a mandate; under the terms of the deposit account agreement to manage our funds.
Whether one is a regular savings customer or a premier or private banking client, and whether the money sits in a current account or a fixed or term deposit, the exact terms of engagement may differ. But the underlying principle is the same; the bank is managing our money on our behalf.
For the funds in current or savings accounts, customers have immediate access to the funds while those in fixed / term deposits, funds can only be withdrawn upon maturity or there will be penalties for withdrawal such as zero or reduced interest payments.
Most banks offer deposit tenors of no longer than 12 months. In Cambodia, however, a handful of banks offer terms ranging from 24 months up to 60 months. Both these banks and their customers are taking on interest rate risk by locking in a rate over such a long period; a bet that can work for or against either party depending on how interest rates move.
Banks will constantly review their liquidity position and seek a balance on certain financial parameters such as the “Maturity Gap” between its deposits and its loans or the difference between the maturity of its assets (namely loans) and liabilities (namely deposits).
Most banks would be naturally faced with Negative Maturity Gap i.e. more liabilities mature earlier than assets as deposit tenors tend to be shorter (up to 36 months – 60 months) than loan tenors; which can be up to 5 years to 10 years for business loans and 15 years to 20 years for housing loans.
A large Negative Maturity Gap for banks who do not have contingency funding such as interbank lending limits may result in liquidity pressure if majority of depositors withdraw their funds.
Banks are also watchful of their Loan-to-Deposit Ratio (“LDR”) – calculated by dividing a bank’s total loans by its total deposits and expressed as a percentage. LDR measures the proportion of a bank’s deposits that have been lent out, indicating liquidity and lending efficiency.
Banks would often maintain a liquidity buffer for unforeseen circumstances such as a wave of large withdrawals; short of an outright bank run. There is no single perfect formula for the right LDR, but industry practitioners often use 80% – 90% as a rough benchmark.
We should not be too fixated about this figure, but it remains a useful yardstick. A percentage above 100% will often raise concerns should tightening of liquidity occurs and a percentage lower than 70% is often deemed as a “lazy & not optimal balance sheet”.
The prudent and compliant approach is simple: banks must ensure at all times they maintain adequate liquidity to repay depositors should withdrawals occur.
Banks Give It Away.
To be crystal clear and not to worry, what banks “give away” is a portion of the profits they make – not the deposits that customers place with them. These acts of charity are often funded by the NIM which we spoke about in No.1 above or from the shareholders’ personal contribution.
These contributions for Corporate Social Responsibility (“CSR”) activities; drawn from profits; support many good initiatives, and it is heartening to see the generosity of Cambodian banks and their shareholders on this matter.
I strongly believe that improving and strengthening financial literacy should be a key CSR activity for all banks. It is encouraging to see both National Bank of Cambodia and Association of Banks in Cambodia placing emphasis on this important agenda.
All banks and bankers need to practice Responsible Banking which involves all parts of banking activities from deposit taking to lending.
Customers need to have the right & proper foundation on financial literacy before banks provide them financial access. Customer protection is important and every bank has a role to play in building this trust with its customers.
Raymond Sia currently serves as the Managing Director of Canadia Investment Holding Plc and Board Director for Canadia Bank and Credit Bureau Cambodia. He believes all banks & bankers should practice Responsible Banking which covers both lending & deposit gathering activities. Raymond is also the author of the “Right Angle – The Collection Volume One” which is now available for sale. The views expressed above are strictly the author’s personal opinion and do not represent the organizations & institutions he is attached with or represents.
