Cambodia’s banking sector, traditionally known for its rapid growth and dynamic transformation, is facing a significant decline in profitability, with banks in the country experiencing a decline in return on asset (ROA) and net profit margin (NPM), a new paper by YCP and Confluences says.
This decline is attributed to pressure on profit margins from overhead costs, an increase in provisions for doubtful debts, and a sharp rise in non-performing loans (NPLs).
The report analyzes Cambodia’s banking sector, highlighting the ongoing challenges faced by the industry.
According to the report, the Cambodian banking sector is facing financial stains, a situation that can be seen through the significant decline in key profitability metrics.
Between 2019 and 2023, the top five banks in the country experienced a median decline in ROA from 2.3% to 1.2% and NPM from 26.6% to 16.5%. A similar trend was observed across 54 smaller banks, with median ROA falling from 1.5% to 0.3% and NPM from 27.2% to 6.2%, pointing to widespread challenges within Cambodia’s banking sector.
Overhead costs put pressure on profit margins
To understand the cause of this decline, the report examines overhead costs, a critical factor for operational efficiency.
Operational efficiency is measured using the overhead ratio (OHR), which divides operating expenses by operating income.
For the top five banks, the OHR has remained largely unchanged over the past five years, although some banks have improved their efficiency. Though OHR has not deteriorated, its stagnation puts pressure on profit margins, the report says.
Looking more deeply at operating expenses, the report notes that discretionary costs, which include expenses for marketing, advertising, repairs, and maintenance, stood at an average of 16.6% of total operating expenses for the top five banks in 2023.
These costs have been rising since 2021, reflecting increased investments in areas such as advertising, and infrastructure maintenance, aimed at enhancing physical distribution and market presence.
For instance, ABA increased its marketing and advertising spending by over 300% and its repairs and maintenance spending by more than 50% between 2021 and 2023, revealing an effort to expand visibility and operations.
Discrepancy costs, which are flexible, should optimized and more effectively managed, the report says, especially during a period of declining profitability. Within the category, up to 50% of these costs are considered addressable, meaning that they can be reduced through strategic initiatives and improved operational efficiency.
Rising NPLs
Another challenge highlighted in the report is the rapid increase in provisions for doubtful debts. This trend, which has been ongoing since 2019, is particularly prominent at ABA and ACLEDA, where provisions have tripled since 2021. This increase underscores the financial burden faced by banks to withstand and absorb risks.
This increase is driven by several factors, the report says, including a slow economic recovery leading to higher credit losses and elevated debt levels.
During COVID-19, regulators allowed banks more flexibility in classifying NPLs, which temporarily concealed the true extent of credit issues and delayed the financial impact on banks.
However, once this period ended, banks were required to acknowledge these deferred problem loans, resulting in a surge of NPLs in 2023. Furthermore, the rise in interest rates offered by Cambodian banks increased borrowers’ difficulties in servicing their debts, which necessitated higher provisions to cover potential losses.
Consequently, the rising provisioning contributed significantly to the profitability decline in the top five banks between 2019 and 2023, the report says.
Furthermore, the top five banks in Cambodia have significantly increased their personal loan portfolios in the last decade, showcasing growing risk tolerance to drive loan expansion.
This increased focus on personal loans, however, has led to a sharp rise in their NPLs. The report advises banks to develop more effective consumer credit risk assessment strategies to balance expected returns with risk, and ultimately maximize their potential profits.
Featured image credit: edited from freepik
