In the early 1990s, the microcredit model pioneered in Bangladesh by Dr. Muhammad Yunus came to Cambodia.
Today, Cambodia possesses one of the world’s largest and most profitable microcredit sectors. Recently, however, it has faced serious criticism for high levels of individual over-indebtedness, steep interest rates and high profits made by the largest microcredit institutions, many of which are now owned by foreign investment houses and commercial banks.
Indeed, thanks to the extent of over-indebtedness and microcredit (also known as micro- finance) market saturation, fears are growing that there may be a repeat in Cambodia of the disastrous “microcredit meltdown” that took place in Andhra Pradesh state in India in 2010.
There is therefore an urgent need for the Cambodian government to do something. Various measures have indeed been taken of late, notably the imposition of an interest rate cap of 18 percent on all new microloans. But it is also useful if we first come clean about what has gone wrong, why, and who is mainly responsible.
There are several fundamental flaws inherent to the basic micro- credit model. The first problem starts from the fact that Cambodia’s communities have for many years been pretty well served by the informal microenterprise sector. Most things the rural poor need to survive, they can very easily access—if they have the cash to do so.
Yet microcredit is supposed to work by encouraging many more of the poor to get into the business of supplying simple items and services to their neighbors, even if their neighbors don’t have any extra cash with which to purchase these additional items and services. The inevitable result is that new microenterprises mainly end up taking clients and demand away from existing, al- ready struggling microenterprises in a process that economists term “displacement.”
Importantly, because any additional jobs created in one new microenterprise are generally matched by employees dismissed in other microenterprises, the net number of jobs created in the community over the longer-term is typically much less than predicted.
Furthermore, even when some additional jobs are created, the added competition that results puts immediate downward pressure on local prices, which means that both new and existing microenterprises will suffer from reduced profits and wages. Ultra-competitive “pure” local markets, which microcredit helps create, are generally always associated with self-employment profits and wages pushed down to the very bare minimum of survival.
A second, longer-term problem in Cambodia is that informal microenterprises simply do not drive forward sustainable development. The surface appearance of frenetic entrepreneurial activity, very often misreported as evidence of great dynamism and innovation, belies the fact that informal microenterprises do not stimulate growth and development in the local economy. Very few informal microenterprises typically graduate into formal small or medium-sized enterprises (SMEs). Above all, the problem is that Cambodia’s scarce financial resources have been wasted on creating many more “here today, but gone tomorrow” informal microenterprises, while far more productive and development-enhancing formal SMEs have historically been ignored since they are too risky and cannot pay high interest rates. This adverse form of financial intermediation has driven many local economies in Cambodia into a poverty trap.
Third, almost right from the start in Cambodia, its microcredit institutions were unwilling to advance a microloan without some form of physical collateral, typically land. Many poor individuals and families handed over their land certificate to a microcredit institution as collateral, but then lost it later on when their microenterprise went sour and they were unable to repay their microloan.
The inevitable result has been the gradual dispossession of land from the poor, many of whom were forced to migrate. Their land ended up in the hands of the microcredit institutions and then, usually for a large profit, passed on to plantation farmers, developers and other well-connected people and institutions. Estimates vary as to how significant this process has been—and few people wish to talk about it—but some knowledgeable analysts have said that as much as 10 to 15 percent of Cambodia’s land once owned by the poor has been lost in this way.
The long-term consequences of this process simply cannot be overstated. Landlessness is often seen by economists as the defining feature of a household that has plunged into irretrievable poverty. If we recall that Dr. Yunus’s famous Grameen Bank in Bangladesh was founded as an institution primarily to help the very poorest—its landless—it is disturbing to find that the micro- credit sector in Cambodia is help- ing drive its poor into landlessness.
The sour reality is that Cambodia’s microcredit sector has largely frustrated the effort to address poverty. Cramming more and more informal microenterprises into the local economy as a way of “resolving poverty” is simply economic nonsense.
Even worse, Cambodia’s largest microcredit institutions have evolved from their nongovernmental roots into Wall Street-style institutional structures that now exist mainly to advance the financial interests of the small elite that own and control them. And just like on Wall Street, the reckless lending strategies that were adopted in Cambodia to pursue this narrow goal have created the situation today where the entire financial system is in jeopardy.
What the Cambodian government does now remains to be seen. But it is to be hoped that any action will be based on the need to establish a local financial system that is genuinely assisting Cambodia’s poor to escape their plight, and not simply pretending to.