Is microfinance still fulfilling its promise, or has it veered off course, creating more challenges than opportunities for the communities it was meant to uplift? In Cambodia, where the microfinance sector has rapidly grown to become a significant driver of financial inclusion, questions are being raised about the effectiveness of current practices and their impact on borrowers. While initially seen as a powerful tool to alleviate poverty, microfinance in Cambodia now faces a credibility challenge. As over-indebtedness rises, it is becoming clear that existing client protection standards, which were once deemed credible parameters of consumer protection within microfinance institutions, are no longer enough to manage the risks inherent in this market.

Cambodia’s Microfinance Landscape: A System Under Strain

Microfinance has played a pivotal role in Cambodia’s economic development, offering much-needed access to credit for those traditionally excluded from formal banking. Since its modest beginnings in the 1990s, the microfinance sector grew exponentially, with a loan portfolio reaching $9.4 billion by the end of 2022 and nearly 2 million borrowers across the country. This growth, however, has come with significant risks.

Cambodia now holds the world’s highest number of microfinance loans per capita. What began as a way to provide small, manageable loans to low-income households has evolved into a system where borrowers take on increasingly large loans—often exceeding their repayment capacities. Over the last decade, the average loan size has grown to more than $4,000, nearly three times the average household income. Rather than fostering sustainable income generation, many borrowers use these loans for urgent needs such as medical expenses or repaying previous debts.

The result? Over-indebtedness has surged. A 2023 report by two leading Cambodian human rights groups, Licadho and Equitable Cambodia, highlighted alarming trends: a significant portion of borrowers have been forced to sell land or assets to repay loans, and an increasing number of households are resorting to new loans simply to stay current on old ones. This cycle of debt is unsustainable and points to a larger systemic issue that current client protection frameworks are not adequately addressing.

Client Protection Standards: Falling Short of Today’s Realities

Microfinance institutions (MFIs) have long adhered to client protection standards designed to promote transparency, responsible lending, and borrower education. Yet, as the Cambodian market has evolved, these protections have proven insufficient. For example, while repayment rates remain high—a key metric often cited to demonstrate sector health—many borrowers are juggling multiple debts, including loans from informal lenders, to maintain these payments. This creates a misleading picture of stability, while the underlying debt burdens on households continue to grow.

Additionally, while most institutions comply with existing regulations, practices such as using land as collateral for microloans, particularly in vulnerable communities, have led to widespread land dispossession. These challenges have prompted international scrutiny and multiple complaints to various ombudsman.

Recent Interventions:

Recognizing these challenges, Cambodian and international institutions have initiated and continued important dialogues in 2024. In July, the National Bank of Cambodia (NBC) and the United Nations (UN) convened a multi-stakeholder consultation process, which brought together over 100 groups and institutions. This effort resulted in an ambitious reform agenda focused on five key areas: regulation, borrower support, technical enhancements, informal lending controls, and agricultural insurance.

Key actions from the consultation include:

1. Immediate Regulation and Supervision: Enforce the implementation of the Code of Conduct and lending guidelines for all microfinance institutions. Prohibit the use of ID Poor cards as collateral to prevent further exploitation of vulnerable groups.
2. Borrower Support Initiatives: Strengthen complaint mechanisms to allow borrowers a safe way to report abuses and seek resolution. Create an independent debt counseling and mediation mechanism to provide borrowers with impartial advice and guidance. Develop financial literacy programs aimed at educating borrowers on debt management, with a focus on vulnerable populations.
3. Technical Enhancements and Data Collection: Implement a consolidated data-sharing system across financial institutions to track borrower indebtedness. Develop targeted regulations on loan restructuring and refinancing to assist borrowers in financial distress.
4. Addressing Informal Lending Practices: Enforce laws against informal lending practices, particularly those involving illegal moneylenders and online loans. Prohibit local authorities from certifying Indigenous Communal Land Titles (ICLT) or other vulnerable assets as collateral for loans.
5. Agricultural Insurance Schemes: Pilot a crop insurance program under modern agricultural cooperatives to protect rural borrowers from climate risks. Set up a working group to support the development of agricultural cooperatives for indigenous communities, offering alternative access to credit.

ABC and CMA: New 2024 Regulations for Responsible Banking

In August 2024, the Association of Banks in Cambodia (ABC) and Cambodia Microfinance Association (CMA) introduced additional reforms aimed at bolstering responsible practices within Cambodia’s banking and financial sectors. These measures focus on:

1. Land Collateral Restrictions: Immediate prohibition on using collectively-owned or indigenous lands as collateral for new loans. Ethical handling of existing collateral by prohibiting coercive sales methods and ensuring titles are returned upon repayment.
2. Protection of Personal Identification Documents: Strict regulations forbidding the use of personal identification documents like ID Poor cards or passports as collateral, safeguarding the rights and dignity of borrowers.
3. Thorough Assessment of Borrowers’ Financial Capacity: Banks and financial institutions are now required to conduct comprehensive assessments of borrowers’ repayment capacities, particularly for vulnerable groups, to prevent over-indebtedness.
4. Promotion of Financial Inclusion: Encourage unsecured lending approaches to vulnerable communities to reduce dependence on traditional collateral.

Learning from Global Best Practices: Pathways to Reform

Cambodia is not alone in facing challenges with its microfinance sector. Several countries have faced similar issues and offer valuable lessons for reform.

• Sri Lanka: The government provided debt relief to over 75,000 women in drought-stricken regions who had become over-indebted. While not a complete solution, this intervention gave borrowers crucial breathing space while longer-term reforms were implemented.
• Mexico: Mexico introduced stricter regulations on microfinance practices and launched financial literacy campaigns to help borrowers better understand loan terms and avoid over-indebtedness.

These examples underscore the importance of immediate and targeted relief measures in Cambodia. Exploring debt restructuring or relief for vulnerable borrowers, particularly those with Indigenous Communal Land Titles, could prevent further land loss and ensure a fairer, more inclusive financial system.

Furthermore, the microfinance sector must shift its focus back to supporting income-generating activities. Encouraging MFIs to prioritize loans for business creation and sustainable livelihoods will help align the sector with its original mission—lifting people out of poverty rather than driving them into debt cycles.

A Call for Immediate Action

Cambodia stands at a crossroads, and the stakes couldn’t be higher. The calls for reforms initiated by the NBC, UN, ABC, and CMA signal a clear acknowledgment of the microfinance crisis in Cambodia, but they are only the beginning. Without urgent and bold systemic changes, the sector risks perpetuating harm rather than delivering on its promise of financial inclusion.

For social investors and stakeholders, this is a pivotal moment to advocate for meaningful reforms. Strengthening regulatory oversight, ensuring transparent lending practices, and prioritizing borrower well-being are crucial to keeping Cambodia’s microfinance sector both profitable and socially responsible. Investors should not only back these initiatives but also demand accountability from the institutions they fund. With coordinated efforts, the sector can regain stability and become a positive force. Decisive action can restore microfinance to its true purpose: a tool for empowerment, not exploitation.