An extract from The Banking Regulation Review, 11th Edition
Prudential regulationi Relationship with the prudential regulator
The NBC acts both as the regulatory and supervisory authority of the banking and financial sector in Cambodia. It has gradually changed its supervisory approach by shifting from compliance-based supervision to risk-based and forward-looking supervision (deploying stress tests and simulations) to focus on certain specific high-risk areas such as credit risk, liquidity risk, market risk and operational risk. The NBC has also issued prudential regulations to strengthen good governance, policy compliance, customer protection and transparency, and the enhancement of financial education among all relevant parties. Thus, its supervisory work is carried out through both off-site examinations and on-site visits.
Banking institutions are required to comply with a series of disclosure obligations, namely periodical reports (including daily, weekly, monthly, quarterly and annual reports), as well as internal control reports, reserve requirement reports and audited annual financial reports. In addition, the NBC also has the power to require covered entities to provide ad hoc reports whenever necessary. The NBC is developing its supervisory report template, which aims at harmonising the content of the reports and improving the capture of information. The report submission process has been greatly improved, as their filing can now be done online.
The transparency of BFIs is generally much more significant compared to companies operating in other financial sectors in Cambodia. Every bank is required to publish its annual audited financial report no later than 30 June of the following year, and such report is available to the public.ii Management of banks
The management of BFIs is organised pursuant to the Regulation on Corporate Governance of Banking and Financial Institutions dated 25 November 2008 (the Regulation on Corporate Governance), which also defines key good governance principles to be adhered to. Their usual structure consists of a board of directors (except foreign bank branches) and compulsory committees, namely audit and risk committees, as well as other specialised committees as needed or required by the NBC.
The independent director is an important feature of the management of BFIs. The board of directors of commercial banks shall be composed of at least two independent directors, while at least one-third of the total number of board members of specialised banks and microfinance institutions shall be independent directors. The audit committee and compensation committee, if any, shall each be chaired by an independent director.
The relevant regulation requires the strong autonomy of the boards of directors and management of all locally incorporated banks, including foreign subsidiaries. All decision-making, including credit approval, shall be made locally. Such requirements have not been fully implemented by some foreign subsidiary banks, which have long depended on their headquarters due to the lack of adequate resources on the ground.
While a branch of a foreign bank in Cambodia does not have a separate board of directors, it is still required to adopt good governance policies and procedures aimed at complying with the principles set forth in the Regulation on Corporate Governance, including the strength of local governance through the enhancement of management autonomy granted by foreign headquarters to local executives.
All BFIs are required to have internal audit and compliance officers. In the case of outsourcing, which is permitted under the current regime, the internal audit cannot be performed by the same firm as the one in charge of the external audit.
Any designation, dismissal, removal or resignation of the head of internal audit and compliance must be reported to the NBC. The NBC has issued a new Regulation on Customer Complaint Settlement of Banking and Financial Institutions. The Regulation requires all BFIs to set up a new section or unit for the management of customer complaints, which is to be monitored by a senior customer relations officer who is a senior manager appointed by the board of directors to oversee the implementation of this new measure.
With respect to remuneration policies, the board of directors is allowed to determine the company's compensation policies and practices as long as they are consistent with the institution's corporate culture, long-term objectives and strategy, and control environment. In other words, there is no specific restriction on the remuneration package, except that the NBC has the authority to recommend institutions to review decisions that are considered not to be aligned with the above-mentioned principles. The NBC's current focus is on the financial situation of each institution.iii Regulatory capital and liquidity
Cambodian regulatory capital standards are not fully in compliance with Basel II, but the current standards are seen as a mixture of elements found in Basel I, Basel II and Basel III. The compliance process is progressing from a banking supervision technical standpoint, but a number of new regulations still need to be introduced. The process is time-consuming, as the full implementation of the new standards requires sufficient resources, including a number of qualified personnel within the entire banking sector.
All regulatory capital requirements described below apply equally, without discrimination, to all banks operating in the country whether they are locally incorporated or branches of foreign banks.Net worth calculation
The NBC has amended its method of calculation of net worth to be in line with Basel III. The sum of paid-in capital and net worth must at least be equal to or larger than the minimum capital. Net worth is composed of two components: Tier 1 capital (core capital) and Tier 2 capital (supplementary capital).
For commercial bank, specialised banks and microfinance deposit-taking institutions:
- Tier 1 capital must include:
- paid-in capital;
- share premium;
- audited net profit for the previous financial year;
- profits as recorded on intermediate dates (subject to the NBC's approval); and
- retained earnings limited to 20 per cent Tier 1 capital;
- Tier 1 capital must deduct:
- own shares held by the bank;
- accumulated losses;
- intangible assets;
- loans to related parties; and
- losses determined on dates other than regular year-ends; and
- Tier 2 capital, which must not exceed 100 per cent of Tier 1 capital, must include:
- re-evaluation reserves;
- provisions for general banking risks;
- subordinated debt instruments not exceeding 50 per cent of Tier 1 capital;
- a general provision of 1 per cent foreseen; and
- other items with prior approval of the NBC.
Deducted items include equity participation in banking or financial institutions, and other items including deferred charges.
The Tier 1 capital of microfinance institutions is composed of an almost identical structure to that applicable to commercial banks, specialised banks and microfinance deposit-taking institutions, except that there is no restriction on the retained earnings, and a provision for general banking risks is included (with the prior agreement of the NBC).
Unlike the structure of Tier 2 capital applicable to commercial and specialised banks and microfinance deposit-taking institutions, the Tier 2 capital of microfinance institutions must include:
- re-evaluation reserves;
- provisions for general banking risks (with the prior agreement of the NBC);
- subordinated debt instruments not exceeding 100 per cent of base net worth and with prior agreement of the NBC; and
- other items with prior agreement of the NBC.
In February 2018, the NBC introduced another prudential regulation to determine the capital buffer, which includes the capital conversation buffer and the countercyclical capital buffer, to increase the resilience of banks and microfinance deposit-taking institutions.Capital conservation buffer
The capital conservation buffer is designed to ensure that banks and microfinance deposit-taking institutions build up capital buffers under normal financial situations that can be drawn down when losses occur. The requirements are as follows: the capital conversation buffer must be equal to 2.5 per cent of the risk-weighted assets; and the sum of the Tier 1 capital ratio (7.5 per cent) plus the capital conservation buffer (2.5 per cent) must not be less than 10 per cent of the risk-weighted assets. Amid the covid-19 pandemic, the NBC has decided to delay the requirement for BFIs to meet the capital conservation buffer of 50 per cent.Countercyclical capital buffer
A countercyclical capital buffer is designed to ensure that banks and microfinance deposit-taking institutions have sufficient capital to bear losses where the NBC has found that credit has excessively grown in a manner that would lead to systematic risk. The NBC may consider the setting of the countercyclical buffer requirement at a level of between zero and 2.5 per cent of the risk-weighted assets. Based on Circular No. B7-018-001 on the implementation of the regulation of capital buffers, this countercyclical capital buffer ratio is currently set at zero per cent.
Regarding the implementation of capital conservation buffers, banks and microfinance deposit-taking institutions must have implemented at least 50 per cent of the conservation buffer by 1 January 2019 and been fully compliant by 1 January 2020. The implementation of countercyclical capital buffers will be determined by a particular circular to be issued by the NBC.Solvency ratio (capital adequacy ratio)
Banks and microfinance deposit-taking institutions must not let their solvency ratio slip below 15 per cent. Prior to December 2004, the solvency ratio was 20 per cent, and one of the main reasons for scaling down the solvency ratio was to boost credit transactions. The minimum solvency ratio of microfinance institutions is also 15 per cent.
The numerator of the ratio is the net worth, and the denominator of the ratio consists of the aggregate of assets and off-balance-sheet items. Assets are subject to a weighting system according to their risks. So far, Cambodia's risk-weighting system takes into account only credit risks, while Basel II requires two additional factors: market risks and operational risks.
The weighting system includes the following:
- zero per cent: cash, gold, claims on the NBC, assets collateralised by deposits 100 per cent lodged with a bank, and claims on or guaranteed by sovereigns rated AAA to AA-
- 20 per cent: claims on or guaranteed by sovereigns rated A+ to A-, and claims on or guaranteed by banks rated AAA to AA-;
- 50 per cent: claims on or guaranteed by sovereigns rated BBB+ to BBB-, and claims on or guaranteed by banks rated A+ to A-;
- 120 per cent: traded securities; and
- 100 per cent: all other assets.
Off-balance sheet items applicable to microfinance institutions are treated with full risk (100 per cent). However, off-balance-sheet items applicable to commercial and specialised banks are classified into the following categories: 100 per cent of their value if they carry full risk; 50 per cent of their value if they carry medium risk; and 20 per cent of their value if they carry moderate risk. Items carrying low risk are not taken into account.
A review is being conducted to harmonise the standard of loan classification and provisioning to comply with the anticipated implementation of the International Financial Reporting Standards applicable to financial institutions.Capital guarantee
Cambodia has yet to establish any deposit insurance scheme, but to help protect depositors the NBC has imposed a capital guarantee on BFIs. Commercial banks and specialised banks must permanently deposit 10 per cent of their registered capital with the NBC as a capital guarantee. This amount was increased in 2001 from 5 per cent.
Deposits made in riel by commercial banks and specialised banks bear interest at half of the six-month refinancing rate set by the NBC, whereas deposits in foreign currencies will bear interest at one-quarter of the six-month London Interbank Offered Rate (LIBOR).
Microfinance institutions and financial lease companies are required to permanently deposit 5 per cent of their registered capital. Deposits made in riel by microfinance institutions bear interest at half of the six-month refinancing rate set by the NBC, whereas deposits in foreign currencies will bear interest at three-eighths of the six-month LIBOR. However, deposits made by financial lease companies either in riel or in foreign currencies bear no interest. Payment service institutions and rural credit institutions are also required to deposit 5 per cent of their registered capital with the NBC as a capital guarantee. A depositing institution may get a refund of its capital guarantee after its liquidation and the settlement of all liabilities.Reserve requirement
Under one of the monetary tools available to it, the NBC demands commercial banks to maintain with the NBC reserve requirements against deposits and borrowings at a daily average balance equal to 8 per cent in riel and 12.5 per cent in foreign currencies. The reserve requirements had previously been increased to 16 per cent to curb booming credit activities and to limit lending to real estate-related transactions.
The reserve requirements are 5 per cent for microfinance institutions and 8 per cent for microfinance deposit-taking institutions.
The NBC additionally imposes reserve requirements against borrowing funds. Such reserve requirements are 8 and 12.5 per cent applicable on borrowing funds derived from local and foreign currencies, respectively. However, amid the covid-19 pandemic, the NBC has reduced the reserve requirements against deposits and borrowings to 7 per cent for both local and foreign currencies.
Due to the pandemic, the NBC has requested that BFIs pay particular attention to their customers in the worst-affected sectors, such as tourism (e.g., hotel, guesthouse and restaurant owners), garment manufacturing, construction, and transportation and logistics, and permit these customers to restructure their loans. Loan restructuring will not be granted to any business that has defaulted on payments for more than 90 days but to those experiencing temporary financial and repayment difficulties, with terms of agreement to 31 December 2020.Large exposure and related-party transactions
Large exposure refers to gross exposure larger than 10 per cent of BFIs' net worth. A BFI's total credit exposure to a single beneficiary is limited to 20 per cent of its net worth. BFIs are required to maintain a maximum ratio of 300 per cent between total large exposure and net worth.
As for the purpose of identifying the beneficiary of large credit exposure, two or more individuals or legal entities will be considered as a single beneficiary if:
- one of them exercises control over the other, whether directly or indirectly;
- they are subsidiaries of the same parent company;
- they are under the same de facto management; or
- one of them holds an equity interest of more than 10 per cent of the other and they have a special business relationship.
In the event a large exposure is guaranteed by another bank or international financial institution, with the prior approval of the NBC, the exposure will be reduced to half when calculating the solvency ratio. Furthermore, the NBC may increase the large exposure ratio to up to 35 per cent of the net worth upon request from the bank, if the NBC finds that the BFI is satisfactory in terms of the NBC's internal rating, or benefits from an investment grade rating by an international rating agency, and provided that the borrower's financial health is strong (the latter includes good business perspectives, solvency, profitability and management).
Recently, the NBC extended its control over large exposure not only on individual and legal entities, but also over sectoral concentration, to capture the overall risk and keep up with developments in the banking sector.
Related parties are any individual or legal entities who directly or indirectly hold 10 per cent of capital or voting rights, or any person who participates in the administration, direction, management or internal control; and the external auditor. Outstanding loans granted to related parties cannot exceed 10 per cent of the net worth of the banks and microfinance institutions, and 3 per cent of the net worth for microfinance deposit-taking institutions. Even though, in accordance with the existing applicable regulation, banks shall submit reports on related parties' loans on a quarterly basis, in practice the NBC requires that a report is made on a monthly basis. Recently, the NBC also extended its supervision coverage on the basis of entire transactions conducted between related parties instead of on the basis of loan transactions.Liquidity coverage ratio
The NBC has previously imposed a minimum liquidity ratio of 50 per cent on commercial banks, specialised banks and microfinance deposit-taking institutions. Banks can satisfy such minimum liquidity ratio requirement but have a shortfall of maturing assets over maturing liabilities in the next 30 days. The International Monetary Fund (IMF) has opined that although a large portion of banks' balance sheets are invested in liquid assets, they may face short-term liquidity risks. Taking into consideration this liquidity risk, the NBC has increased the minimum liquidity ratio imposed on all deposit-taking banks and financial institutions from 50 to 100 per cent. The minimum liquidity coverage ratio (LCR) of 100 per cent should have been fulfilled and maintained within institutions by 1 January 2020. The NBC required all institutions to comply with the minimum LCR within the following timelines:
- minimum LCR of 60 per cent from 1 September 2016;
- minimum LCR of 70 per cent from 1 September 2017;
- minimum LCR of 80 per cent from 1 September 2018;
- minimum LCR of 90 per cent from 1 June 2019; and
- minimum LCR of 100 per cent from 1 January 2020.
Each BFI may hold up to 15 per cent of its net worth in each equity participation, provided that the maximum total equity participation is restricted to 60 per cent of their own net worth. Under the Cambodian banking regime, equity participation is defined as holding at least 10 per cent of the capital or voting rights of another company.Securities trading
All BFIs, with the exception of microfinance institutions and financial lease companies, are permitted to trade and hold the securities listed on the securities exchange. Based on daily mark-to-market positions held, each institution can hold securities equalling up to 20 per cent of the institution's net worth. The tradable securities positions held by the institutions are marked-to-market on a daily basis and determined by using the official closing prices shown by the securities exchange. The NBC has also launched negotiable certificates of deposit (NCDs), a new securities product, to enable banks to convert surplus deposits into securities. This mechanism allows banks to utilise those securities as collateral for interbank loans. The NCD is designed to help the banks maintain their liquidity in times of economic crisis. It also facilitates the work of banks with deposit shortages by allowing them to borrow funds from other banks with short-term surpluses.Credit risk grading and provisioning on impairment
In the past, the NBC imposed a different measure for asset classification and provisioning of bank and microfinance institution, as banks' assets are classified into five categories:
- normal: with provisioning of 3 per cent for banks and zero per cent for microfinance institutions;
- special mention (not applicable for microfinance institutions): with provisioning of 3 per cent for banks;
- substandard: with provisioning of 20 per cent for banks and 10 per cent for microfinance institutions;
- doubtful: with provisioning of 50 per cent for banks and 30 per cent for microfinance institutions; and
- loss: with provisioning of 100 per cent for both banks and microfinance institutions.
However, since 1 December 2017, all banks and financial institutions are required to maintain the same credit risk grading and classification. Credit risk grading and classification are divided into five categories, and vary depending on the duration of the facilities:
- facilities with an initial term exceeding one year:
- normal: the facilities are duly repaid on time and there is no suspicion regarding the future repayment capacity;
- special mention: the repayment is overdue by 30 days or more;
- sub-standard: the repayment is overdue by 90 days or more;
- doubtful: the repayment is overdue by 180 days or more; and
- loss: the repayment is overdue by 360 days or more; and
- facilities with an initial term below or equal to one year:
- normal: the facilities are duly repaid on time;
- special mention: the repayment is overdue by no more than 30 days;
- sub-standard: the repayment is overdue by no more than 60 days;
- doubtful: the repayment is overdue by no more than 90 days; and
- loss: the repayment is overdue by no more than 180 days.
The provisioning of the above classifications are 1 per cent (normal), 3 per cent (special mention), 20 per cent (substandard), 50 per cent (doubtful) and 100 per cent (loss), respectively.iv Recovery and resolution
There are currently no specific regulations or measures in place requiring banks to draw up recovery and resolution plans, or living wills. BFIs are, however, advised to make their own necessary arrangements.
As part of the crisis prevention and resolution initiative, the authorities are developing a legal framework to empower the NBC and other relevant authorities to take action against failed banks. Pending the adoption of such regulations, any liquidation of failed banks must follow the provisions of the Law on Insolvency, and the NBC is entrusted to oversee the process.