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Author: Sanjay Sinha. Introduction to the social investors’ “playground” Relatively light and supportive regulation of microfinance, systematic and graded requirements for deposit taking, and a positive approach to foreign private investors make Cambodia a very popular destination for international social investors.  Not surprisingly, over the past decade, Cambodian microfinance has gone from a largely NGO domain to a haven of commercial microfinance where international NGOs remain but mostly (now) as commercial investors gradually cashing in on their grant investments of the late 1990s and early 2000s.  International NGOs, international private investors and DFIs between them own 87% of the shares of the largest 15 MFIs (excluding ACLEDA which is a bank).  During the past decade, the size of the microfinance industry has grown more than four-fold and nearly 40 fold in terms of portfolio, largely enabled by this inflow of foreign capital.   The motivation for this international investment is undoubtedly mixed.  The liberal investment environment is, presumably, a reason in itself but Cambodia is also a country with great potential for financial inclusion: It is one of the poorest countries in Asia with Bangladesh and Nepal being the only significant countries that are poorer; yet, its average per capita GDP growth rate has been 8.5% per annum over the past five years providing significant possibilities for savvy investors. Financial inclusion through banks is so low it approaches negligible levels. According to the Global Findex survey, the poorest income quintile in Cambodia has virtually no financial inclusion compared to 25% for all developing economies.  Investing in Cambodian microfinance is, therefore, a logical step for social investors; it brings significant benefits to low income families at the same time as producing good returns on investment.  Thus, 19% of adults had originated a new loan from a “formal financial institution” (read MFI) during the period covered by Findex. Thus, by end-2012 credit outstanding from MFIs was a high 17.7% of the $4.75 billion of credit provided in Cambodia by the banking sector.  Including ACLEDA increases this contribution to an impressive 45.5%.  These figures are very high by the standards of other countries; even MFI-intensive Bangladesh has an equivalent contribution of just over 8% while Nepal and India have significantly lower levels.   In this context, the impact of the growth of the microfinance sector on financial inclusion bears examination.  In most countries, microfinance institutions have made a virtue of focusing on low income clients projecting themselves as purveyors of services to the poor, enabling both investment and consumption smoothening for families clustered just above and just below the poverty line.  However, this has resulted in the emergence of a “missing middle” where small entrepreneurs in the second quintile (from above) – often the largest providers of employment per unit of investment – have found themselves excluded from loan capital by the restrictive practices of the banking sector at one end of the spectrum and by those of the MFIs at the other.  This note examines the effect of the practice of microfinance in Cambodia on financial inclusion in the country. The average loan balance rises as a proportion of GDP – is the mission drifting? Figure 1 shows the trend in Cambodian microfinance over the past 9 years – the period since the microfinance sector became significant in that country.  The ratio of the average loan balance (at the end of each year) to the per capita GDP (at constant prices) has risen from 23% in 2003 to over 70% in 2012.  The 2012 proportion compares with average balances of 11% in India, 45% in Nepal and 11% in the Philippines at roughly the same time.  In Nepal this proportion has been broadly constant over the years while in India and in the Philippines it has fallen from 17% and 19% respectively in 2003.  The apparent implication of this is that while in other countries MFIs have focused on their traditional client base of families in the third to fourth income quintiles (from the top), in Cambodia much better off clients (with a need for larger loan sizes) are now being served. Developmentally this is an apparently negative result for a low income country. But more and more borrowers at the lower income levels are being served Figure 2 provides a more balanced picture of the shift in the distribution of Cambodian MFIs relative to the economic status of the population during the 2003-12 period.  In 2003, 9 of the 11 largest MFIs in Cambodia provided loans of a size that averaged less than 42% of per capita GDP.  By 2012, there had been a substantive shift with just 4 of 15 MFIs averaging loan size less than 42% of per capita GDP; the other 11 were spread up the spectrum to nearly twice the per capita income per person.  [In this analysis, $113 in 2003 is equivalent to $200 in 2012 at constant prices.  Other size classes have also been converted accordingly]. In terms of numbers of borrowers, this translates to virtually all the 256,000 MFI borrowers in 2003 being served by institutions with average loan size less than 21% of per capita GDP.  By 2012, most of the MFIs had moved above the lowest size class but 48% of borrowers were still served by MFIs with average loan sizes less than $400 (42% of per capita GDP).  By 2012 this number had increased to more than twice the 2003 level.  Far from abandoning borrowers at the lower end of the spectrum, Cambodian MFIs had actually increased the numbers covered at that level.   …while there is an effort by some MFIs to cover borrowers with larger loan requirements   The remaining 52% of borrowers in 2012 were covered by the 11 MFIs spread up the spectrum in terms of loan size as presented in Figure 2 .  The figures shows a relatively good spread of average loan sizes including those suited to small and micro-entrepreneurs in the second and third income quintiles.  The deposit service is becoming more important, increasing overall outreach of microfinance services to around one million families, and other financial services are also gradually being offered Of the 15 MFIs covered by this analysis, 7 are licensed microfinance deposit-taking institutions (MDIs) with the first two MFI deposit licences having been provided in 2009.   The total deposits of the MFIs amounted to $274 million, 33% of outstanding loans at end-December 2012 and 27% of total MFI funds on that date.  The 620,000 depositors at MFIs were 49% of the total number of borrowers and the average size of deposits ($441) was a significant 66% of the average outstanding loan of $660.  Observation at a couple of Cambodian MFIs indicates that many MFI depositors are not MFI borrowers.  More recently, these MFIs have also started to offer money transfer services  and to experiment with micro-insurance in collaboration with foreign insurance companies.  A number of MFIs are conducting micro-insurance pilots in Cambodia and have also recently introduced money transfer services.  The outreach of both these services is expected to grow strongly over the next few years. Based on this discussion, the outreach of Cambodian MFIs could far exceed the 1.25 million who are MFI borrowers and can be estimated at around 1.5 million adults.  Adding ACLEDA would take this number to nearly 2 million.  But, there is a significant degree of overlap of clients amongst MFIs in Cambodia.  Thus, the total number of families served by microfinance is probably closer to one million than 2 million.  Nevertheless, in a country of under 15 million people, a total of ~3 million households  (average household size, 5.1 persons in 2004), approximately 1 million households served by MFIs constitutes a substantial contribution to financial inclusion .  …and the geographical distribution of services is considerable The inclusive effect of microfinance could be limited if services were extraordinarily concentrated in the more populous parts of the country.  In practice, Cambodian MFIs started with a concentration of offices in central and southern Cambodia but quickly spread to the north and, in recent years, have taken criticism of geographical concentration to heart and started to work in the underdeveloped north-east as well.  Data from the 15 leading MFIs shows that they operate in all of the 24 provinces in Cambodia through 741 branch offices.  This distribution applies not only to MFIs offering loans at the top or bottom ends of the scale but broadly to all average loan size classes.  In addition ACLEDA Bank has 238 branches in the 24 provinces resulting in widespread availability of microfinance services in the country. To conclude , while international investors may have gone to Cambodia attracted by the liberal regulatory framework and approach of the government and the National Bank,  the net effect of the inflow of foreign capital into the microfinance sector has been a growing and already impressive contribution to financial inclusion .  With the expansion of financial services like money transfers and micro-insurance, this contribution is only likely to grow further.  Microfinance in Cambodia may be an investors’ playground, but it is a force for financial inclusion as well . About the author: Sanjay Sinha is Managing Director of M-CRIL, a company that undertakes financial and social ratings of microfinance institutions and provides research and other services designed to facilitate microfinance. He has knowledge and experience of over two dozen countries and over 35 years of economic and development research experience. He has specialized in the analysis of value chains of relevance to the livelihoods of low income families and micro-enterprise promotion in addition to microfinance. Sanjay has an M.Phil in Economics from Oxford University, UK. He was a UN Advisor on Inclusive Financial Sectors during the Advisor Group's tenure, 2006-2008.