Higher NPL, Loan Provisioning Forecast this Year

Credit risk in the economy is allegedly “extremely high”, S&P Global states in its latest report. Following the end of NBC’s regulatory forbearance measures last June, non-performing loans and loan loss provisioning are expected to trend upwards this year, impacting earnings. Still, local bankers are confident that Cambodia’s banking sector is well-capitalised to withstand these post-pandemic challenges
People buy vegetables at a market in Phnom Penh. Kiripost/Sam
People buy vegetables at a market in Phnom Penh. Kiripost/Sam

A recent banking industry credit risk assessment (BICRA) on Asia Pacific banks by S&P Global, which measures key risks and risk trends, rated Cambodia nine out of 10 in the first quarter of 2023, placing it among the “highest risk group”, along with Vietnam, Bangladesh and Mongolia.

Among its risk indicators categorised under economic risk trend and industry risk trend, credit risk in the economy and institutional framework were marked “extremely high” while economic resilience and systemwide funding were assessed as “very high”.

Despite the mark down, S&P Global adjudged the economic and industry risk trend segments in Cambodia as being stable.

Amid rising funding costs and a contagion risk from the collapse of two banks in the US, the ratings firm believes that Asia-Pacific banks are able to withstand higher funding costs and other knock-on effects from the volatility in some global banking markets.

“We remain cautious, however, as previous banking crises indicate that the effects of banking sector contagion effects can take some time to fully play out,” it said in the April 19 report.

Back home, the possible growth of bad loans following the end of the regulatory forbearance by the National Bank of Cambodia (NBC) has been flagged by analysts and economists.

Last December, an ASEAN+3 Macroeconomic Research Office (AMRO) blog post stated that Cambodian banks have “some room for improvement” regarding the level of loan provisioning, where funds are allocated to account for future losses of loans.

At the time, it said the absence of additional provisions for restructured loans resulted in decline of provision-to-non performing loan (NPL) ratio.

“Therefore, the amount of provisions might not be sufficient to cover future losses, considering the masked NPL ratio,” associate economist Chunyu Yang wrote.

Broader NPL classification

This dates back to 2021 when NBC introduced new classification and provisioning requirements for restructured loans to treat loans “deemed performing as viable”, classifying them as “special mention” with three percent provisioning of the gross amount.

Prior to the pandemic, loans that were restructured to cater to the ability of borrowers during difficult times were classified as non-performing loans, though they were being paid off, albeit at a slower rate.

Due to the massive impact on businesses and livelihoods during the pandemic, NBC’s forbearance regulatory measures focussing on classification instructed that restructured loans need not be classified as NPLs.

Therefore, loans that were restructured would continue to be normal performing loans, as long as they continue to meet the new arrangements of repaying the newly agreed sum per annum.

However, some restructured loans may have included “repayment holidays”, which are “ending now”, so those loans might “struggle”, banking expert Stephen Higgins co-founder and managing partner of Mekong Strategic Capital explained.

“This was very sensible by the NBC [as] it protected the economy and the banking system during a very abnormal economic situation,” he said via email.

The outcome was that a large share of loans were deemed viable, nearly 63 percent in 2021, suggesting that a majority of the restructured loans were considered viable.

In its 2021 Financial Supervision Report, NBC mentioned that the “broader classification of NPLs” suggested that the impact from the pandemic on “banks’ assets was contained”.

With the circular no longer in application now, a customer who is not able to meet their repayments could still have their loan restructured, but the bank would book it as an NPL, Higgins said.

“NPLs will continue to increase due to the challenges that the economy is facing before an expected improvement later this year,” he added.

A similar concern was highlighted by S&P Global primary credit analyst Ruchika Malhotra last November, who projected higher credit losses with rising NPL recognition.

Banks would be “forced to increasingly recognise NPLs”, possibly rising to 3.6 percent in 2023 from a 2.9 percent forecast last year, thereby reflecting “increased asset quality recognition post forbearance amid brisk credit growth, thus masking the recognition”.

While she acknowledged the aggressive growth of banks' balance sheets over the years, Malhotra sees high underlying credit risks even as brisk credit growth continues.

High level of indebtedness

Paris-listed Coface associate economist Eve Barre told Kiripost that the current environment is challenging for the banking sector, although the Cambodian economy is set to be robust this year, with continued support from the recovery in tourism.

Slower inflation after a spike to 5.6 percent on average in 2022 should also benefit private consumption, Barre said.

However, she anticipates NPLs to increase as loan restructuring efforts ended last July, asserting that it is “all the more” likely now given the “high level of indebtedness of the Cambodian private sector”, mimicking International Monetary Fund assessment last December.

“[Private sector debt] has traditionally been high and increased further with the pandemic to reach 180 percent of gross domestic product by the end of 2022,” Barre said.

Against this backdrop, local bankers stressed that the banking sector is steady, with NBC assuring that the NPL rate would be manageable this year despite external headwinds, including high funding costs.

In Channy, president and group managing director of public-listed ACLEDA Bank Plc agrees, explaining that the increase in cost of funds was anticipated in advance which was why the bank had been offering high term deposits.

On this basis, he does not think the NPL rate would be impacted by high funding costs.

“The rise or drop in NPL is more related to the [challenges] in the business sectors and issues faced by the customers and the assessment of their business plans.”

NBC did not respond to questions.

‘Only natural’

Last year, NBC noted that the NPL ratio for commercial banks was 3.2 percent, up from 2.4 percent in December 2021, Raymond Sia, chairman for the Association of Banks in Cambodia said.

This increase, however, was “not unexpected”, he pointed out, given that the industry exited from Covid-19 loan restructuring forbearance alongside negative impacts from global slowdown and demand.

The NPL ratio changes in tandem with loan quality and overall loan size, as well as other external factors which have bearings on the ratio, such as overall economic and customers’ business conditions. “It is not a simple task to project NPL rates moving forward.”

Sharing that capital and solvency remain stable in the sector, Sia said banks have put in place prudent internal control after taking cognisance of the headwinds, including the rise in interest rates by the US Federal Reserve.

These controls include liquidity management by taking into consideration ratios like loans to deposits, liquidity coverage ratio and net stable funding.

“We are confident that the banking sector is well capitalised based on the regulatory prudential ratios and supervision and guidance provided by NBC,” he reiterated.

The economic outlook for Cambodia remains positive with GDP growth projected at 5.5 percent for 2023 by Asian Development Bank.

“A growing economy will overall have a positive impact on business activities and increase demand for its goods and services, which will also have a similar positive effect on foreign direct investments, which has a positive correlation on bank deposits, and demand for loans,” he said.

While high credit risk might weigh down on the banking industry in Cambodia as raised by some analysts, Sia opined that it was only natural for delinquent loans and ratios to rise after a period of forbearance.

“This is also a similar phenomenon in other markets. The key focus is on cashflow sustainability and repayment capacity.

“This requires banks to take a pragmatic stance to see how customers can be assisted in their ‘time of need’ by considering options such as restructuring their loans by making adjustments on the parameters of the loans such as tenor or instalment amounts,” he said.

Impact on earnings

Though Channy of ACLEDA does not expect much impact from loan provisioning, Sia and Higgins forecast a slight drop in net earnings.

Like in most markets around the world, Higgins said, there is a likelihood of higher provisioning this year, on account of “much tighter” liquidity and rising rates, a softer than expected economy and changes around loan restructuring requirements.

“Combined with lower loan growth, this higher provisioning will probably result in lower earnings this year, but that’s coming from a pretty good base. The sector will still be profitable and well capitalised.”

In that, he added, the strong capitalisation, owing to NBC’s conservative capital requirements, and position which Cambodian banks find themselves in also ensure the absorption of higher credit losses stemming from increased loan provisioning.

A number of factors impact banks’ earnings, Sia said, citing loan loss provisioning (for NPLs), rising cost caused from general operations, and rising cost of funding or deposits, as some of them.

“Should these costs persist to remain at elevated levels, there will be some impact on earnings moving forward,” he said.

However, despite this, the banking sector is well positioned with opportunities, hence the continuous strong interest seen with new players entering the market.

It would appear that the microfinance sector is also on stable grounds when it comes to NPL rate.

According to Kaing Tongngy, Cambodia Microfinance Association spokesman, the sector has so far maintained a “one percent rate” below the industry average.

Comparatively, the NPL rate for the overall banking and finance sector climbed to 3.6 percent this February from two percent last year.

But the NPL rate for the microfinance sector is likely to increase due to current global challenges but at a “manageable level”, Tongngy said.

And, he added, any spike in NPL or interest rates is bound to impact the earnings of microfinance institutions.