The Failures of Microcredit in Cambodia

August 2022 saw the release of a new report into the troubled state of Cambodia’s microfinance sector – one that did not make for encouraging reading.

Carried out by the Institute for Development and Peace (INEF) at the University of Duisburg-Essen, the study added empirical heft to the growing evidence that micro-loans, intended as a market-friendly panacea for development challenges and poverty reduction in Cambodia (as in many other parts of the so-called developing world) has led to widespread over-indebtedness and growing inequality.

Since at least 2006, when Muhammad Yunus was awarded the Nobel Peace Prize for founding the Grameen Bank in Bangladesh, microfinance has become a common part of efforts to reduce poverty and stimulate economic growth. According to its boosters, microfinance would financially empower villagers, long excluded from the formal banking system, and enable them to invest in local businesses and haul themselves – and their countries as a whole – out of poverty.

In Cambodia, however, it has been clear for some time that the reality has diverged significantly from this narrative. The expansion of the microcredit sector has led to rising debt levels, which have burdened hundreds of thousands of mostly rural families with crushing and sometimes insurmountable financial burdens.

In a landmark 2019 report, the human rights group LICADHO and the urban rights NGO Sahmakum Teang Tnaut (STT) documented how skyrocketing debt levels had generated a range of human rights abuses, “including coerced land sales, child labor, debt-driven migration, and bonded labor.” In May 2022, the watchdog of the International Finance Corporation (IFC), the World Bank’s private lending arm, announced that it would review a complaint filed by LICADHO and STT alleging that it has caused “grave harm” by funding and supporting microfinance lenders in Cambodia.

The German government-funded INEF report was intended to supplement the anecdotal, qualitative nature of the existing studies into Cambodia’s microfinance sector, such as the 2019 LICADHO/STT report, and to create an empirical assessment of “the overall picture of the debt problem.”

In addition to discussions with villagers and local authorities in 24 Cambodian villages, the statistical core of the study was a large household survey, involving 1,388 randomly selected households. Of these, 770 households (or 55.5 percent) currently had outstanding micro-loans. This is in itself a fairly telling statistic on the saturation of the microcredit market in Cambodia, where even small district towns sometimes boast numerous microfinance branches.

The INEF report begins by noting the rapid growth in the microcredit sector in Cambodia in recent years. The country now boasts 81 registered microfinance institutions (MFIs), 47 commercial banks, 12 specialist banks, and 246 rural credit institutions, in addition to the galaxy of informal money lenders. This is both cause and effect of a boom in the country’s microfinance sector. In a report published in March 2020, the Microfinance Index of Market Outreach and Saturation (MIMOSA) found that Cambodia’s rate of credit saturation was the highest among the 11 countries it studied.

According to the INEF study, the saturation of the lending market has created intense competition, which in turn has encouraged “questionable and ethically dubious business practices, especially in loan acquisition.” These include “aggressive door-to-door solicitation” and unstinting efforts to get poor borrowers to take out new loans or increase the value of existing ones. Among MFIs, banks, and other credit institutions, the rhetoric of poverty reduction, once foregrounded in their public communications, has long given way to “the goal of expansion, of increasing turnover as well as profits.”

In many cases, the report finds, debt “serves investment purposes and the majority achieves its purpose, be it the expansion of income-generating measures, investment in housing or the acquisition of higher-value consumer goods.” But it also notes that a considerable chunk of outstanding microfinance loans are taken out to service basic living costs, which “should not be the case with responsible financing and inevitably leads to over-indebtedness.”

The INEF study notes that the average value of MFI loans among those surveyed was $5,183, a figure considerably higher than what has traditionally been considered a “micro” loan. The report said that “an exceptionally high proportion” of respondents – just under half of those with outstanding loans – reported having difficulties with meeting repayments.

This has created a number of hardships for Cambodian households, including, as a final resort, the sale of land in order to meet loan repayments, the impacts of which cannot be ignored in a nation where land continues to be a source of livelihood for a majority of the population.

According to the report, Cambodia has recorded “alarmingly high” and “unacceptable” number of distressed land sales. Of the 964 interviewed households with credit experience in the last five years, 61 (6.2 percent) had to sell a piece of land to repay a loan. “If this figure is extrapolated to all borrowers in Cambodia,” the report concludes, “then possibly 167,400 individuals or households were forced to sell land due to over-indebtedness in the last five years.”

The report notes that MFIs and banks “try by all means to prevent expropriation of land titles by the courts,” at least in part to avoid the growing public criticism over the loss of land by defaulting creditors. At the same time, it notes that the intense competition in the sector has made it tempting to accept land titles as collateral in order to sign up customers to larger and more profitable loans.

While the report said that child labor and labor migration as a result of over-indebtedness were generally rare, participants in the group discussions stated that children are taken out of school in order to work to repay loans. The study also found that reduction of food consumption was “a frequently used method to save in order to repay debts.”

On the whole, the report is relatively measured on the causes of the crisis in Cambodia’s microfinance sector. It points out that a “number of the ultimately problematic loans are by no means the result of persuasion by MFIs or banks alone, but are the result of bad investments, unfortunate coincidences, or even risky speculation.” External shocks like the COVID-19 pandemic have also played a key role in the difficulties many households face in repaying loans, as they have in other parts of the world.

Moreover, in some cases, borrowers “deliberately concealed their inadequate repayment capacity when applying for a loan or even took out several loans at the same time,” something that newly empowered government regulators might find it difficult, if not impossible, to detect.

But the report’s balance ensures that its conclusions land especially hard. The study pointed not just to the proximate failures of microcredit in Cambodia, which have been legion in absence of effective regulatory capacity. It also suggests that the promises of microfinance, as a market-friendly intervention that would sidestep more direct state welfare interventions, may have been considerably oversold.