PHNOM PENH (Khmer Times) – At least $1 billion in surplus liquidity is sitting idle in Cambodia’s banking system and could be unlocked if the central bank implemented a more effective interbank lending mechanism, experts say.
“Banks in Cambodia have over $1 billion tied up in unused deposits, not including $890 million in physical cash and $760 million held on deposit with other banks,” said Stephen Higgins, Managing Partner at investment firm Mekong Strategic Partners. “If banks could deploy a sensible interbank mechanism, it would [free up] liquidity and generate at least $100 million in additional revenue.”
Interbank lending is where banks lend capital to one another for a specified term. Most of these loans are for maturities of less than a week, often overnight. The access to funds helps banks overcome temporary liquidity shortages while maintaining the central bank’s minimum capital and reserve requirements.
The National Bank of Cambodia, the Kingdom’s central bank, has set a minimum capital requirement of $37.5 million for commercial banks, $7.5 million for specialized banks, and $2.5 million for microfinance institutions (MFIs). It also requires all lending institutions hold 12.5 percent of their deposits either as vault cash or on deposit in the central bank as a liquidity buffer in the event of a financial crisis.
The capital restrictions can squeeze banks, particularly smaller lenders, during bank runs and periods of heavy lending activity.
“The interbank market is hugely important,” said Mr. Higgins. “Banks need to keep a big buffer of liquidity. With a functioning interbank market, they can easily go out and get money for 30 or 90 days, or even overnight, so they can operate a lot more efficiently.”
Lack of Interest
In 2013, the National Bank of Cambodia introduced negotiable certificates of deposit (NCDs) in an effort to establish a formal interbank market and provide an alternative to the high-risk informal lending system that had developed between banks in its absence. The tradable certificates state that a specific amount of money has been deposited in the central bank and will be redeemed with interest at maturity.
NBC director-general Chea Serey explained during a recent business luncheon that NCDs allow banks to borrow large amounts of money on short notice to cover unexpected cash outflows. She said the NBC-backed certificates reduce banks’ reliance on informal interbank lending and provide an interest rate benchmark.
“If the central bank charges 0.1 percent [on NCDs] then the other banks would also want to charge that interest rate,” she said. “They cannot charge any higher, because if they charge much higher then banks would just go to the central reserve.”
It is puzzling then, that even with a secure financial tool in place, the country’s formal interbank market has failed to take off, Ms. Serey observed. “There is some primary market [activity], but we have not seen a secondary market,” she said.
Banking experts that Khmer Times spoke to said banks, like consumers, are looking to deposit their extra cash in a place that offers the highest possible return with the least possible risk. Backed by the central bank, NCDs are virtually risk-free, but this is reflected in their low returns.
“If banks lend to each other the risk weighting is 100 percent…and they need approval from head office, whereas to buy a note from the NBC, they can just do it,” explained Mr. Higgins. “But no one wants to buy the certificates from the NBC because the rates are too low.”
Risk vs. Reward
Interest rates on US-dollar NCDs average 0.11 percent on certificates with maturities under two weeks, and 0.33 percent on those with tenors of six months, according to NBC data. Khmer riel certificates fetch 1.27 percent on a two-week tenor, while those with a one-year maturity receive 2.99 percent.
“As a consumer, I can go to a commercial bank and get 4-5 percent interest, while when banks lend to each other [the rate] tends to be less than 100 basis points, which is under 1 percent,” said Mr. Higgins.
According to Lawrance Liang, chairman of Cathay United Bank (Cambodia), the interbank market’s low interest rates discourage banks from depositing their surplus capital in the central bank.
“As commercial banks, we need to maximize our profitability by best utilizing our cash or liquidity position,” he said. “So we comply with the central bank’s reserve requirements, but if we have any excess liquidity we’ll either issue loans of make investments – which give higher yields than the interest rate of NCDs.”
Toward More Efficiency
Mr. Higgins said a simple solution is at hand – one that would enhance the functioning of the interbank market and allow liquidity to move more easily between banks.
He said the central bank should mandate that all banks maintain a portion of their 12.5-percent deposit reserve requirement as NCDs. Under his proposal, the NBC would reduce the reserve requirement to its historical 8 percent level while requiring that banks hold the remaining 4.5 percent in the form of certificates of deposit.
By making the certificates mandatory, the central bank would discourage banks from hoarding liquidity. A secure and flexible mechanism would allow banks with liquidity shortages to sell their certificates to other banks in return for cash, less the discount rate. The banks would return the cash by buying back the NCDs at a set time. If still short of liquidity, the bank could enter into the same transaction with another bank.
“This model would free up liquidity and increase the efficiency of the financial sector,” said Mr. Higgins.
Importantly, he added, it would give the central bank a flexible monetary tool to adjust the sector’s liquidity without risking the solvency of individual banks.