BANKING SYSTEM IN CAMBODIA

by

Yuthea Em

CONTRACT: Tel +85517241777

Email: emyuthea@yahoo.com/emyuthea@gmail.com

A paper research submitted and presented in partial fulfilment of the requirement of the University of Hertfordshire for the degree of Doctor of Philosophy

January 2006
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Abstract The pages that you are going to read will provide you some general understanding of banking system in National Bank of Cambodia as a whole. They contain information about bank practices, industry environmental conditions, viewpoints, law and regulation in supervising banks and financial institutions. The National Bank of Cambodia-kingdom's central bank-has liberalized the financial markets as for the reform years ago. The system consists of foreign bank branches, local banks and NBC's provincial branches, which are now being privatized and the number will be cut down. Commercial banks have been given the rights in setting their own interest rates for deposits, which shall remain above the minimum rate determined by the NBC. Operating license has 3-year maturity, which bank shall have to renew for the next term operation. They are under the supervision by the central banks. We do not have investment banks or savings banks or community banking etc. yet. Today banking mainly serves business and investment sectors. The practices are flexible and adaptive to customers. Application of law is less severe in now context, so both local and foreign investors might find it easy and attractive in considering an investment. Loan, in most cases, is given based on the collateral. There must be house or land or building in exchange for the loan. Unlike other banking system where we can have inventory, accounts receivable, negotiable instruments or commercial papers as collateral pledged for loan, Cambodian banking situation does not allow that to happen yet. It is transparent that Cambodia is using cash as a dominant means of payment. Though check usage is common to some foreigners or companies or organizations, it would not appeal much to Cambodian merchants. They would prefer cash to check, as it is straightforward, fast and real. We do not have the retail payment system like payment at the terminal, payment via electronic machines or credit cards or any substitute means of cash yet. There is card for encashment and payment of bill but it is not widely and generally available as a form of payment either. The major obstruction for the national bank to implement a policy or a strategy is the fact that dollars are spreading over the country and they are outvalued than the national currency (Riel). Any better implementation of a plan or a regulation can occur as long as the NBC gets rid of dollar by which meant "dedollarization". This is a great burden, which the NBC and the government bear to do, and which may not by regulation but a creation of a trustworthy and beneficent condition.
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I. Rational Cambodias banking system was re-established in 1980 in form of a mono-banking system, under which the central bank and its provincial branches performed both the central and commercial banking functions. Reforms were initiated in 1989 to establish a two-tier banking system that led to establishment of commercial banks. The Law on the Organization and Conduct of the National Bank of Cambodia (NBC) was adopted in 1996. It defines an independent role of the central bank in the conduct of monetary policy and places a clear limit on bank credit to the government. Commercial banks are now operating under a framework of the Law on Banking and Financial Institutions enacted in 1999 and the current works to improve commercial banking services are based on this law. Law on Foreign Exchange enacted in 1997 stipulates relatively free foreign exchange transactions between Cambodian residents and the rest of the world. As part of continued efforts to strengthen banking system, NBC introduced a bank-restructuring program in 2000 that required all commercial banks to increase their capital base and to comply with new prudential regulations. Banks that met these requirements have been re-licensed; banks that failed to improve their capital base were closed or placed under restructuring program. A blueprint for further reforms of banking system was adopted in 2001 1. NBC is working to strengthen the legal framework to promote banking activities by initiating and participating in the preparation of law on financial contracts, commercial laws including secured transactions and bankruptcy laws. The draft law on the negotiable instruments and payment transactions is awaiting adoption by the National Assembly. Even banking system have reformed and operated under a framework of the Law on Banking and Financial Institutions that led to establishment of commercial banks but Cambodia is still using cash as a dominant means of payment. Though check usage is common to some foreigners or companies or organizations, it would not appeal much to Cambodian merchants. They would prefer cash to check, as it is straightforward, fast and real. We do not have the retail payment system like payment at the terminal, payment via electronic machines or credit cards or any substitute means of cash yet. There is card for encashment and payment of bill but it is not widely and generally available as a form of payment either.

The National Bank of Cambodia 2002 Annual Report, 2004 1

II. General aspects of the National Bank of Cambodia The National Bank of Cambodia is Cambodia's central bank and is charged with the responsibility of supervising and regulating financial institutions in Cambodia. It has the power to manage money transaction, credit, domestic and international settlement and foreign exchange, precious metal and stone 2. Central Bank is defined as a country's leading bank which acts as banker to the government and the banking system and acts as the authority responsible for implementing the government's monetary policy. Central banks such as the Bank of England in the UK handle the government's financial accounts in conjunction with the Treasury, taking in receipts from taxation and the sale of government assets, and making disbursements to the various government departments to fund their activities. The central bank acts as the government's broker in its borrowing and lending operations, issuing and dealing in government bonds and treasury bills to underpin its year to year budgetary position and management of the country's national debt. The Bank of England and its satellite, the Royal Mint, are responsible for issuing the country's basic stock of money-legal tender consisting of bank notes and coins. The central bank occupies a key role in the management of the money supply, influencing the level of bank deposits and credit creation by the financial institutions, particularly in commercial banks, as well as the structure of interest rate in economy, through buying and selling operations in the market for short- and long-dated financial securities. Central bank is also responsible for managing the country's exchange rate and holding the country's stock of international reserves to be used in the financing of balance of payment deficits. The Bank of England operates an "Exchange Equalization Account" which it uses to intervene in the foreign exchange market, buying and selling currencies to "fix" the exchange rate at a particular level or ensure that it falls (depreciates) or rises (appreciates) in an "orderly" manner.

2.1. Background During the period of 1975-1979, in contrast to the rest of the world, the Cambodian Banking System (CBS) was completely abolished by the Khmer Rouge Administration. Money and means of payment were abandoned. There were no bookkeeping or monetary accounts; data were not available from that period. After the liberation day January 7th, 1979,
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Bulletin term 01 # 03, National Bank of Cambodia, 2002 2

the fiscal system in Cambodia has its origins in the framework of central planning. Other sectors of the Cambodian economy had to be constructed and operated according to that central planning economy. The People's National Bank of Kampuchea, now the National Bank of Cambodia (NBC), also acted as commercial bank by granting loans and accepted deposit and had its 20 provincial bank branches, a Municipal Bank and Foreign Trade Bank. Five months later, the Riel (Cambodian Currency) was issued in March 1980 to serve the revival of the nation 3. After the gradual reformation starting in mid-1989 from central planning economy to market economy, the NBC was ranked as a Ministry and was chartered by the Council of Ministers. The NBC was empowered to monitor the circulation of currency and the growth of credit within the limits of the economic and financial policy of the nation. The NBC then began to carry out all the operations normally conducted by other central banks. 2.2. Cambodian banking system reform As a first step in establishing a modern financial sector, Cambodian financial system has been transformed from a mono-bank in which National Bank played a role as both central bank and commercial bank into a system that distinguishes these two layers. The Government initiated a breakup of the mono-bank and intended to close or privatize the provincial branches of the NBC while transferring their treasury functions to the Ministry of Finance (which will leave the NBC exclusively in charge of central banking activities). In addition, the Government has opened up the banking sector to competition from foreign banks, which have been encouraged to establish their presence in Cambodia. The majority of markets have been liberalized, most prices have been freed, and the scope of official subsidiaries has been significantly reduced. To create a Cambodian Banking System consistent with a market economy guided by the new economic policy of the government, the Cambodian banking system has begun to reorganize after fifteen years of operation.

The new system, a two-tier system, is recently composed of the NBC, its Foreign Trade Subsidiary (Foreign Trade Bank of Cambodia), its twenty provincial branches, the Municipal Bank in Phnom Penh and 29 commercial banks of which 5 are joint venture banks, 6 foreign bank branches, 17 privately owned banks and 1 representative office 4.

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Law on the organization and conduct of National Bank of Cambodia, National Bank of Cambodia, 1996 The National Bank of Cambodia Report, 1994 3

The two-tier system is a modern banking system that has two layers with distinguish of functions and duties between central bank and commercial bank. To strengthen the banking system, NBC recently conducted a bank relicensing program based on increased capital requirements and the CAMELS rating system. In November 2000, just before the first phase of NBC's bank relicensing program, the commercial banking system consisted of 31 banks, including two Government-owned banks, 22 locally incorporated banks, and 7 foreign bank branches. In December 2000, NBC revoked the licenses of 12 banks classified as nonviable, and placed 16 banks under conditional licenses, entering into memoranda of understanding that required compliance with restructuring measures and prudential regulations (for example, minimum capital requirements) by the end of 2001 5. The five largest commercial banks, including the Government-owned Foreign Trade Bank (FTB), hold more than 50 percent of total banking assets and deposits. Deposits in foreign currencies, predominantly US dollars, make up 93 percent of total banking deposits. The US dollar is the primary medium of exchange, with the Cambodia riel (KR) used primarily in rural areas. The formal banking sector is concentrated in Phnom Penh, although 90 percent of the population resides in rural areas. As of December 2000, the total assets of the banking system stood at KR2,517 billionthe equivalent of $644 million, or 20 percent of GDP. This represented an increase of 20 percent since the end of 1999. During the same period, loans increased 31 percent to an, equivalent of $249 million, while deposits increased 40 percent to an equivalent of $382 million. Loan growth occurred predominantly in the manufacturing and service sectors.

Financial Sector Blueprint for 2001-2010 4

NATIONAL BANK OF CAMBODIA (CENTRAL BANK)

14 Commercial Banks

3 Specialized Banks

Micro Finance Institution

20NBC Prov.Braches Kampong Chan Sihanouk Ville Siemreap. Battambang Svay Rieng Kandal Prey Veng Kampong Thom Takeo Pursath Kampan Chhnaing Kampong Speu Kampot Koh Kong Preah Vihear Kratie Ratanakiri Mondolkiri Stung Treng Bunteay Meanchey

1 State owned Foreign Trade Bank

3 Foreign Branch Banks

First Commercial Bank Krung Thai Bank May Bank

10 Locally incorporated
Advanced Bank of Asia Cambodia Asia Bank Canadia Bank Ltd. (2) Cambodian Commercial Bank (1) Cambodian Mekong Bank (3) Cambodian Public Bank (6) Singapore Banking Corporation Union Commercial Bank (4) Vattanac Bank ACLEDA Bank Limited

Rural Development Bank

1 State owned

Licensed

Peng Heng S.M.E Limited Cambodia agriculture Industrial specialized bank

2 Privately owned

Enatien Moulethan Tchonnebat (EMT) Hatthakaksekar Tong Fang Micro finance Ltd. Thaneakea Phum Cambodia Cambodia Entrepteneur Building Ltd. Seilanithin Limited NGOs

29 Registered
Maxima org. for household Economic Development Ministry of Rural Development Credit Scheme Prasac credit Association Rural development association Rural economic development. Seilanithin Social development in rural Samakithor Organization World relief Cambodia World vision International Cambodia Women's saving and 4 development Cooperation Unregistered Around 60 NGOs Aid Farmers Association Arun Reah Organization Buddhism for Development Cambodian Business integrated in rural Cambodian Community Savings Federation Cambodia Credit to Abolish Poverty Organization Cambodia Health Committee Cambodia rural economic development organization Cambodia Women's Development Agency Concern Organization Handicap International Help the widow Organization Islamic local development Khemara Khmer Rural Development Association Kratie women welfare association Lutheran world Federation organization

Representative Office
Standard Chartered

License is to be renewed every 3 years. Officially opened

Exchange Bureau
Registered Phnom Penh Provincial 2.158 263 1.895

Figure 3.1The banking System in National of Cambodia Source: National Bank of Cambodia, 2004
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Despite the low level of lending, asset quality in the banking system: poor. According to NBC, the volume of nonperforming loans in the banking system is reported to be substantial and growing. The lack of both account standards and a uniform chart of bank accounts compounds concern about the accuracy of the reported non performing loans. In addition, the banking sector maintains excess liquidity with the percentage of cash to total assets at about 19 percent. Roughly 33 percent total assets are non-earning. The banking system provides a narrow range financial products, usually limited to demand, savings, and time deposits on the liability side. Loan portfolios tend to be confined to better-known firms. 2.3. Law on the organization and conduct of the NBC in brief This law, which was passed by the National Assembly on January 2, 1996, provides a new and clearer feature of the organization and the operation of the central bank. The principle mission of the Central Bank is to determine and direct the monetary policy aimed at maintaining price stability in order to facilitate economic development within the framework of the Kingdom's economic and financial policy. It shall publish in regular basis its monetary policy objectives (money-credit-exchange-interest rates) and statistics, including with respect to the money supply, prices, credit, the balance of payment and foreign exchange. The Central Bank shall have the following functions and duties 1: 1. To determine monetary policy objectives, in consultation with the Royal Government and consideration of the framework of the economic and financial policy of the kingdom; 2. To formulate, implement and monitor monetary and exchange policies at the determined objectives; 3. To conduct regular economic and monetary analysis, make public the results, and submit proposals and measures to the Royal Government; 4. To license, withdraw license, regulate and supervise banks and financial institutions and other relevant establishments such as auditors and liquidators; 5. To oversee payment system in the Kingdom, and to enhance inter-bank payments; 6. To act as the sole issuer of national currency of the Kingdom; 7. To undertake and perform, in the name of the Kingdom, transactions resulting from the participation of the Kingdom in public international institution in the banking, credit, and monetary spheres; 8. To establish the balance of payments; 9. To participate in the management of the external debt and claim;
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Law on the organization and conduct of National Bank of Cambodia, National Bank of Cambodia, 1996 5

10. To participate in the formation and supervision of the money and financial markets; 11. To license, withdraw license, regulate and supervise all those operating in securities and foreign exchange markets, the market for precious stones and precious metals; 12. To set interest rate.
Governor Deputy Governor Board of Director 5 Members of Board Director

Secretariat General

Director General

Cashier General

Inspection General

Cabinet

Supervion Department Banking Department

Issue Department

Non-Operational Inspection Department

Personnel Department Accounting Department Legal Department

Printing House Operational Inspection Department

Exchange Management Department

Economic Research Department Center for Banking studies Foreign Trade Bank of Cambodia

Municipal& Provincial Bank Branches

Figure 3.2 Organization Chart of National Bank of Cambodia

Source: Prakas No TH 898-385/prk of July 20, 1998

Although central bank can open accounts for banks and financial institutions licensed by the central bank, foreign central banks and public international financial institutions, it cannot open accounts for industrial and commercial enterprises even if they are state-owned. To accomplish its mission the Central Bank shall be permanently empowered and shall have operating autonomy and shall submit reports of the implementation and results of its mission to the National Assembly and the Royal Government. Managing organ of the central bank is the Board of Directors, whose chairman is the governor. It consists of 7 members, including the governor, the deputy governor and 5 other members, one being a representative of the head of the Royal Government, one a representative of the Ministry of Economy and Finance, one a member from the real economy, one an academic and one the representative of National Bank staff. The law makes clear in the conditions as being a member of the board and his/her terms. It also prohibits board members and their family members from being shareholders of any bank and financial institution regulated by the central bank. In its financial relations with public entities, the central bank is the sole depository, in the national currency, for the National Treasury. It receives from the National Treasury and disburses on its behalf, money and keep account thereof. The Central Bank shall be the advisor on monetary and financial matters to the Royal Government and has the duty to inform and advise the government on matters that affect the achievement of the financial policy. It shall assist in the debt management of the Royal Government or public entities by conducting securities operation including advising on the timing of securities issues and promoting the development of money and capital markets. The Central Bank may agree to act as the agent of the Royal Government or public entities for the following transactions:

marketing of securities issued by the Royal Government or by a public entity, and acting as a registrar and transfer agent therefor, payment of principal, interest and other charges, on such securities 2.

1. The Central Bank regularizes the domestic exchange rate and to this effect is authorize to:

buy, sell or deal in gold coins or bullion or other precious metals and precious stones; buy, sell or deal in foreign currencies using for these purposes any of the instruments commonly used by bankers;

Prakas relating to the implementation of law on banking and financial institutions, NBC, 2001-2002 7

purchase and sell treasury bills and other securities issued or guaranteed by foreign governments and public international financial organizations;

open and maintain accounts and act as agent or correspondent for foreign central banks, foreign governments, foreign governments agencies, and public international financial institutions;

determine the rate at which it will buy, sell or deal in foreign currencies; establish limits on the net foreign exchange position of commercial banks and nonbank foreign exchange dealers;

issue regulations in relation to exchange transactions and in respect of transactions in gold, other precious metals and precious stones;

declare the official foreign exchange rate for the Riel in relation to other currencies; and

participate in international financial agreements on behalf of the government.

2. The Central Bank may not provide to third parties guarantees, which have the effect of fixing future rates of foreign exchange and may not authorize or engage in multiple currency practices. 2.3.1. Relations with Banks and Financial Institutions The Central Bank shall be exclusively responsible for the licensing, withdrawing license and supervision of banks and financial institutions by issuing declaration, regulations and other directives and taking such other actions as it shall deem necessary to fulfill its functions. It also appoints, at its discretion, its officers or any other qualified person to regularly inspect any bank or financial institution and to examine its book, records, document and accounts. The Central Bank may open accounts for and accept deposits from banks and financial institutions doing business in the Kingdom including the payment of interest and the establishment of charges as it may determine. The NBC requires banks and financial institutions in the Kingdom to maintain required reserves, which are kept as cash holding or as special deposits in current accounts with the central bank. It shall determine the procedure and purchase from, sell to, discount and rediscount for banks and financial institutions 3:

Law on Banking and Financial Institutions, National Bank of Cambodia, 1999 8

Bills of exchange and promissory notes drawn or made for bona fide commercial, industrial or agricultural purposes;

Any government securities forming part of public issue and maturing with 90 days from the date of their acquisition;

Any private debt securities negotiable on the currency market as well as bank's private debts bearing creditworthy signatures and appearing on a list recognized by the board;

The central bank's own securities.

The Central Bank shall fix and publicly announce it minimum rates for rediscounts, advances, repurchases or loans. It may establish differential rates and ceilings for various classes of such transactions or maturities. It may grant to commercial banks advances on their current accounts, which are secured by government securities or government guaranteed securities. Banks and financial institutions must furnish the Central Bank such information and data it may require for the discharge of its functions and responsibilities. The central bank shall be responsible for promoting interbank services such as risk centralization and unpaid loans. In cooperation with commercial bank, central bank needs to establish a clearinghouse for the prompt and efficient clearing and settlement of interbank payment. 2.4. Monetary Policy The monetary authorities in Cambodia have to formulate and implement a system of monetary control that is appropriate to the emerging economic and financial structures and is effective in controlling inflation. This requires the introduction of monetary policy instruments that are appropriate to the current and evolving structure of financial markets. In the transitional phase of two-tier banking system and to well-developed financial markets, control of liquidity growth will probably require the use of both direct and indirect policy instruments. However, as the aim is to move as quickly as possible to the use of primarily, indirect, market-based instruments to control overall monetary and credit development, it will be necessary to develop information systems and research capabilities to analyze and monitor financial and economic development to assist in the formulation and implementation of monetary policy. Regarding the implementation of monetary policy, it is important that: (I) the channels of influence of NBC's actions on the price level be broadly understood; (II) a clear view of the developed money stock in Cambodia, distinguishing between those factors which
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can be influenced by central bank actions and those which are outside the direct control of the monetary authorities and (III) the determinants of the demand for the money in Cambodia to be identified and analyzed. It is also essential that the staff be well trained in economics and quantitative methods of analysis 4. 2.5. Banking Supervision Recognizing the need to withdraw itself from commercial banking activities, NBC developed proposal to divest its own interest from the joint venture banks. As an example, Canadia Bank, a former joint venture with NBC, is no longer in that form. The supervision functions have been strengthened with introduction of prudential ratios, loan classification and provisioning guidelines, and adequate procedures for review and examination of banks' returns for on-site and off-site inspection of their operations. The NBC has revamped the licensing procedure for commercial banks in order to ensure that the license will be issued only to banks with an adequate capital base and a sound managerial track record. Licenses granted to banks that had not yet commenced operations have been withdrawn 5. 2.6. Regulating banks and financial Institutions 2.6.1. Licensing In licensing a bank, which is incorporated under local law, the National Bank of Cambodia has specified all the requirements in a Prakas dated October25, 1996. The conditions for bank license are subject to a complete compliance, which are classified as follows 6:

Banking Activities Banking operations comprise of the following activities: a) The granting for profit of all types of credit to the public b) The acceptance of unallocated deposits from the public c) The provision of payment in local or foreign currency

Therefore, any entity that practices regularly any one of the above three categories of operation shall be considered to be conducting the banking business and thus shall have to comply with bank licensing conditions.

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Law on Monetary Policy, National Bank of Cambodia, 1997 Law on the organization and conduct of National Bank of Cambodia, National Bank of Cambodia, 1996 6 Law on Banking and Financial Institutions, National Bank of Cambodia, 1999 10

Any bank can undertake directly or indirectly (via subsidiaries) for its own accounts or on behalf of its customers some other financial activities such as securities and gold or precious metal operations except insurance.

Licensing Procedure For the reasons of impact on the creation of money and of the risk imposed on

depositors, the bank activities shall only be conducted by entities specially licensed by the National Bank of Cambodia, the authority of banking system, and formed either as companies incorporated under local law or as branches of foreign banks.

The written temporary approval is given with conditions to the applicants by the NBC after studying the main objectives of the project and the composition of capital. The official license shall be issued only after all conditions are fully complied including payment for document applying for license and license fee.

Conditions and formalities required concerning the shareholders for companies incorporated locally and the consistency of the documents to apply for license

Shareholding (Identity and financial position) The name list of shareholders whose shareholding is not less that five per cent (5%) shall be submitted to the National Bank of Cambodia. Beneath this threshold, the NBC assumes that these shareholders seek to incest their savings and not to be involved in the management of the bank. From that level up the regulatory authority may collect all information pertaining financial situations of the shareholders. Each shareholder on the list shall make a written declaration that the distribution of capital is on his own account. In the case that a shareholder of the forming banks or existing banks is a company the following conditions shall be complied with: a) The application shall attach the name list of major shareholders if the capital contributions equals or exceeds five (5%) per cent of the capital of the forming bank or the existing bank. b) The head office of the company, which is the shareholder, shall be situated in a financially regulated location and recognized as such by the NBC.

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c) Shareholders formed under chain of shareholding companies shall not be permitted, except in the case that it has been thoughtfulness and shall be authorized specially by the NBC. The composition of the shareholders of the forming or existing banks shall be compulsory to have as follows: 1. Either one shareholder holding majority shares of the capital or the voting rights. 2. Or several shareholders, each of them owning enough participating interests to be supposed to have an obvious influence on the management of the bank,

The National Bank of Cambodia shall automatically consider any shareholder to be influential if his/her shareholding directly or indirectly at least equals to 20 per cent of the capital or the voting rights. Any shareholder with majority shareholding or influence shall be recognized that their own financial situation is capable in restoring, with other influential shareholders or alone or with the order from the regulatory authority, bank's financial situation when it appears weak. In the case that the bank faces solvency problems and in order to protect the clientele's deposits, the regulatory authority shall request to the majority or influential shareholders who are directly or indirectly responsible for managing the bank to take remedial measures to comply with all the prudential regulations concerning solvency, notably: 1. The level of minimum capital and its permanent counterpart, in real value, on the asset side in order that after deduction of invaluable assets, this real assets be permanently higher than the liabilities to the third parties by the amount at least equal to the minimum capital requirement; 2. And the Risk Cover Ratio as mentioned in the Regulation N795-03, dated May22, 1995 and Circular N795-03 dated May27,1995. In practice provided that the risk cannot be reduced, any shareholder with majority or influential shareholding shall be under the obligation to inject additional own funds or other permanent funds such as subordinated loans in order to avoid the threat of bankruptcy, otherwise the National Bank of Cambodia shall place the bank under (temporary) administrative receivership. A shareholder with majority or influential shareholding shall acknowledge in writing that he has understood completely his/her obligations as shareholder with majority or

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influential shareholding, including local banks which are subsidiaries of banks with overseas head office. The financial standing of every shareholder with majority or influential shareholding shall be evaluated by the National Bank of Cambodia in accordance with the following conditions: a) an individual (shareholder) will have to provide evidence in particular in providing data from banks and tax records showing the level and stability of revenues, personal wealth (fortune) notably fixed assets, and his/her business status; b) a company shall show the evidence of its financial standing by providing its audited balance sheet and profit and loss account for the last three (3) financial years with related data generated by banks and tax records; c) the shareholder with majority or influential shareholding of a shareholder company shall also show evidence about his/her financial standing in the same way. Procedure for applying operating license of the banks and financial institution, under the supervision of the National Bank of Cambodia shall conform to Prakas NThor 797-153 Bis, Pro, Kor dated October25, 1996. The founder of the institution shall be applying in three stages: 1. First Stage: Providing and Information and Guidelines on Conditions For the application. The establisher of an institution shall pay a fee of 700,000 (seven hundred thousand) riels to the National Bank of Cambodia for information and condition on the application. When an application is filed shall pay another fee of 3,000,000 (three million) riels for a processing fee. 2. Second Stage: Issuing Letter of Agreement in Principle. Letter of agreement in principle is issued by the National Bank of Cambodia after studying the document and found to be correct and complete to enable the transfer of capital to National Bank of Cambodia for setting up a bank premises and preparing for the commencement of operations as defined in the conditions stated on the letter of agreement in principle. In the case that the institution cannot be in operation at the assigned date as in the letter of agreement in principle, it shall be fined 5,000,000 (five million) riels per day for a period of 30 days. If still unable to operate the principle license shall be repealed.

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3. Third Stage: Issuing an Operating License. This operating license is issued to individual institution by the National Bank of Cambodia after examining that all conditions in the letter of agreement in principle and requirement documents are fully complied. The operating license (also include the license for branch of the institution) is valid for a period of 3 years for the issued date. Each institution shall apply for the renewal of its operating license to the National Bank at least 6 months before expiration. Failure to do so shall be fined 1,000,000 riels (one million riels) per day until such application is submitted. The operating license can be renewed when the institution has fulfilled all formalities or any document that concerns the validity and legality. If the institution cannot conform to all these conditions, it shall be fined 1,000,000 riels (one million riels) per day effective from the last valid date of the relevant operating license until renewal date is granted. Each of the following institution shall pay a yearly fee of its operating license for an amount of 70,000,000 riels (seven million riels) by January 15 of each year:

The locally incorporated institutions, its branches or representative offices in or outside Cambodia, and

Branches or representative offices of foreign institutions residing in Cambodia.

If an institution is created in the year, it shall pay a license fee from the beginning of the quarter in which the bank is established. In the case of late payment, the institution shall be penalized to pay an interest rate defined by the official refinancing rate for the period of 30 days. If still unable to make payment shall be subject to serious penalty. 2.6.2. Legal form All banks must be formed as limited liability companies. This means that shareholders of a bank are liable to pay the bank's debts up to the capital contribution of each shareholder. According to a 1992 sub-decree, no individual shareholder may own more than 20% of the shares. Bank shares are fully transferable, upon payment of a fee of 1% of the share value. 2.6.3. Board of directors and management Certain persons are forbidden from holding the positions on the board of directors of a commercial bank, or acting in a managerial capacity of any kind. For example, person convicted of crimes of dishonesty, as well as government official in political positions, may not hold such position.
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2.6.4. Capital requirements Under a 1994 National Bank regulation, the registered capital of commercial banks must be at least "Riel 10 Billion." A prakas dated December29, 1997 sets this amount at least Riel 50 billion for institution operated from 1997 on. The minimum capital shall be declared in national currencies and shall be fully paid up (100%) into the special account opened for the forming banks prior to the issuance of license. If the shareholders' subscriptions are made in foreign currencies the NBC may require them to sell them beforehand against the riels (to the NBC). The institution shall permanently maintain its net worth (own capital) mentioned above. The net worth of the institution shall be computed by the formula below: Net Worth = Paid-Up Capital + Reserves + General Provision Profit/Loss - Loans to Shareholders, Board of Directors and Managers Each institution shall deposit a capital guarantee in the account opened at the National Bank of Cambodia, for an amount of 5% of its registered capital with non interest bearing and another 5% with an interest rate of SIBOR (Singapore Interbank Offered Rates) - (minus one-fourth of SIBOR). The total ten per cent (10%) capital guarantee shall not be withdrawn by the institutional until liquidation. The registered capital of the institution can be increased or decreased on the following conditions: 1. The institution shall submit an application to the NBC for studying and approval at least three months prior to change. 2. In case of increasing capital: The institution shall pay a fee of 0.10% (zero point one per cent) on increased amount. 3. In case of decreasing capital: (1)The institution shall pay a fee of 1.00% (one per cent) on decreased amount. (2)The institution shall maintain the minimum capital not less than 50,000,000,000 (fifty billion) riels. The shares of the institutions shall be sold or transferred under the following conditions:

The institution shall submit an application to the NBC for study and approval at least three months prior to change.

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New shareholder shall increase his/her capital twice the value of shares obtained (that is to say that the new shareholder has to pay double amount for the shares obtained).

The shareholder shall apply for an amendment to its Articles and Memorandum of Association to the NBC for study and endorsement and the institution is required to pay a fee.

The articles and memorandum of institution can be amended according to the following conditions:

The institution shall submit an application to the NBC for study and approval in advance.

The institution shall pay a fee of 1,000,000 riels (one million riels) per amended page.

2.6.5. Reserve Requirements Banks must maintain two types of reserves: a capital reserve of 5% to 15% of registered capital, and a deposit reserve of 5% to 50% of deposits and other debts, calculated monthly. NBC regulation as of 1995 sets both the deposit reserve and capital reserves at 5%. 2.6.6. Reporting Requirements Banks are required to issue a monthly reserve report to the National Bank. Banks will be fined for temporarily failure to maintain proper reserves. Banks which fail to maintain reserves for more than two consecutive months, or three months during any year may be penalized as outlined below. The National Bank may also require commercial banks to submit report setting out the amount of deposits on other liabilities, the amount of cash present at any time (Riel and foreign exchange), and any other information the National Bank may request. 2.6.7. Accounting All commercial banks must appoint independent auditors. The accounting of commercial banks must be preformed by independent auditors, who are not employees of the banks. 2.6.8. Penalties The National Bank has at its disposition a range of penalties it may use against commercial banks for violations of banking laws and regulations. The National Bank may "admonish" commercial banks, require a change of management, suspend operations of banks, and also revoke the licenses of banks. Commercial banks and their directors are also
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subject to fines of 500,000 to 30,000,000 Riels or imprisonment of one month to 5 years. The National Bank also has the authority to bring judiciary action against banks. 2.7. Overview financial liberalization 2.7.1. Interest Rate The National Bank of Cambodia-Central Bank has liberalized the interest rate since February 1995. All commercial banks have the rights to determine the interest rate on deposit and interest-bearing loan according to each bank's ability. At the end of every months, all commercial banks must report in writing to the NBC the average interest rate as applied to deposits and to interest-bearing loans, including a specification of the basis of interest calculation. Anyway, in order to assist commercial banks in setting their own interest rates the NBC has determined the base rate of 1.23 percent per month 7. 2.7.2. Exchange market and exchange system During the 1980s, the foreign exchange market in Cambodia was inactive due to the trade embargo from the capitalist countries and the resultant international isolation. Gold was a major instrument of payments instead of foreign currency. In late 1980s and early 1990s with political negotiation and reconciliation, Cambodia opened its door more widely to the outside world and began gradually using foreign currency in place of gold. The law holds the Ministry of Finance and the NBC responsible for the management of foreign exchange reserves and exchange rate policy (as well as precious metal and stone). The law stipulates that the spread between buying and selling rate established by authorized foreign exchange dealers cannot exceed 2%. The following are some of the main points of the said law and sub-decree regarding the foreign exchange.

Right of possession: Cambodian nationals and foreigners are allowed to hold foreign currency whether in cash or in the bank accounts.

Settlement: the payment of goods or services in Cambodia in foreign currency is restricted. Only Cambodian currency riel is permitted. And foreign currency has to change into riel at the authorized foreign exchange dealers. (Commercial banks or authorized money changers) for the purpose of payment.

Accounts: (a) Residents and non-residents can keep in their account riel or foreign currency. (b)Commercial banks are allowed to have accounts abroad.

Law on the organization and conduct of National Bank of Cambodia, National Bank of Cambodia, 1996 17

Import-export of foreign currency: (a) There is no restriction on the import of foreign currency, but a declaration to the custom at the port of entry is required; (b) Residents traveling abroad can export foreign currency up to the equivalent of USD 3000 per person. The export more than these amount must be approved by the NBC; (c) Nonresident can export up to the amount brought in that was duly declared to the custom on their arrival.

Investment: Outward investment requires the prior approval from the government, whereas the inward investment has to be approved by the Council for the Development of Cambodia and capital brought in has to be declared to NBC. Referring to the relevant laws and regulations of NBC, investors can purchase foreign currencies for the discharge of financial obligations incurred in connection with their investments.

2.7.3. Exchange rate policy During much of this period, a parallel exchange market also existed. Although the parallel market is not legally recognized, in actuality it is widely accepted by the authority whose policies are to set the official exchange rate in close alignment with the parallel market rate. In order to have the official exchange rate more closely reflect market forces, from November 1992 the NBC began maintaining the official rate within a 5% margin of the average parallel market rate over the previous two-week period. From the beginning of 1994, the authority narrowed the spread between the official and parallel market rates to no more than 2% and to no more than 1% on the daily basis in March 1994, thus unifying the official and parallel market rates and eliminating the previous multiple currency practice. The authorities sample three major parallel market locations three times daily and set the official exchange rate each morning equal to the average parallel market rate (plus or minus 1%) from the previous afternoon. The authorities judge that the best way to achieve exchange rate stability in Cambodia's present circumstances is through appropriate financial policies, which the official exchange rate allowed to move freely in response to market forces. Commercial banks and other exchange dealers are free to buy and sell foreign currencies at rates, which they set themselves. There are no taxes or subsidiaries on purchase or sales of foreign exchange. 2.7.4. Its Problem Although the exchange regulations include a number of restrictive features, the de jure and de facto systems are not well aligned. In practice, the Cambodian exchange system operates in a liberal manner. For example, although the law specifies that foreign currency
18

may not be used to settle domestic transactions, in fact foreign currencies (primarily the US dollar, and to a lesser extent, the Thai Bath) are very widely used in the economy and transfers can take place through the commercial banks and the parallel market, and there are no effective restrictions on payments abroad. Although the law provides for limits on foreign exchange for travel, these limits are not implemented in practice. The authorities are drafting a new foreign exchange law that will better align the legal framework with existing policy. Other problems that constrain the implementation of foreign exchange regulation are listed below: a) The political uncertainty; b) The weakness of the enforcement of the laws; c) The loss of confidences of the people in banking system. Because they have a lot of experiences during the past period especially in Pol Pot regime, Cambodian people prefer keeping their assets in the form of gold and foreign currency to depositing in banks. 2.7.5. Clearing house With reference to the law governing, the renaming and reorganization of the NBC dated January 31, 1992 and the sub-decree Number 19 An.Kr dated June 22, 1992 in Chapter III section 17 regarding the Management of the Settlement System in Cambodia, and in order to provide an improved service to customers of the banking system in Phnom Penh, the banks and some other financial institutions operating in Phnom Penh shall constitute the bankers' Clearing House for the time being. This Clearing House, which opened in May 1994, required the members: a) Possess a valid banking license issued by the NBC and; b) Operate at least one license office within Phnom Penh; c) Maintain a settlement account denominated in Riel (Cambodian Currency) at the National Bank d) Share the cost of operation of clearing house in proportion to be determined by the committee. The clearing hold daily from Monday to Friday on the premises of the NBC. The clearing may have a number of daily sessions. The principal session takes place at 2 p.m. from Monday to Friday and there is a subsidiary session at 8:30 a.m. for the return of unpaid or ineligible items.

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Founding Member Banks Phnom Penh Bankers' clearinghouse 1. National Bank of Cambodia 2. The National Treasury 3. The Foreign Trade Bank of Cambodia 4. The Municipal Bank 5. The Cambodian Commercial Bank 6. The Cambodian Public Bank 7. The Canadia Bank 8. The Cambodia Farmers Bank 9. The Agriculture and Commercial Bank 10. The Cambodian Development Bank 11. The Krung Thai Bank 12. The Bangkok Bank 13. The Siam City Bank 14. The Thai Farmers Bank 15. Banque Indosuez 16. The Royal Cambodian Bank 17. The Phnom Penh City Bank 18. The Cambodia Asia Bank 19. The Chansavangwonk Banking Corp. 20. Singapore Banking Corporation 21. Caisse Franaise de Developpement 22. The Malayan Banking Berhad 23. The Singapore Commercial Bank

Source: the sub-decree Number 19 An.Kr dated June 22, NBC,1992 2.8. Overseas fund transfer The transfer of funds to overseas shall comply with the Roya1 Decree regarding the Management of Foreign Exchange No. Chs/RKM/ 0897/03, dated August 22, 1997 and all provisions set and announced by the National Bank of Cambodia includes: Payment for imports and overseas transfer of the principal and interest on loans. Payment of royalties and management service fees. Remittance of profit after payment of all financial obligations, taxes and related expenses. Remittance of investment capital overseas according to the company's installment payment plan. Money appropriately saved or remaining after salary expenditures.
8

. This repatriation

2.9. Rights, duties and roles of the auditor The Board of Directors will propose the appointment of one or more auditor eachyear to the Council of Ministers for approval. The first auditor shall work until the completion of the financial year and prepare the balance sheet and profit and loss account as stipulated in. The Board of Directors may renew the appointment of the auditor at the end of the mandate. The auditor shall not he an employee of the National Bank or a member of the

20

Board of Directors. In the event the position of auditor becomes vacant during the year the Board may appoint a new auditor automatically to fill the vacancy for the remaining mandate. The auditor shall examine the regularity and thoroughness of the balance sheet against inventories in accordance with the banking accounting system. The auditor may advise the Governor and the Board of Directors on all matters involving the rate of exchange, the discount rate, credit interest rate and the purchase of securities 9. The auditor whilst carrying out his duties shall audit the books of accounts and other records of the National Bank and may require from employees explanations as deem necessary. III. Evaluation of the National Bank of Cambodia performance The information and facts that exist in the previous two chapters would enable us to analyze them and find reasons to them. Having gone through the system and its mechanism in the society as well as the business community, we have found some obstacles that block the way of progress of the banking industry. This is why some institutions work and study very hard to help bring those countries, which confront the problems and are threatened to bank failure, from difficulty. We can point out some of the main factors that contribute to Cambodian banking industry development in the following sections. 3.1. People's behavior toward bank This should be the very important factor for banking to survive. Today Cambodian people have not fully taken part in the banking as they ever had in the previous time. Because of war and social instability, almost all people become tightly close to their money and properties. The idea that they have to hold money in their hands in the country's events and probably in calamity (at wartime), has been in the mind of every people. Moreover, it is unforeseeable to when or where the incidence or a problem can take place. People's outlook into the industry with reference to their understanding and perception will cause the insecure feeling of the banking system, as it has not been unveiled that it is good, reliable, guaranteed and creditworthy for them to base on. Dealing in the transaction without banking system has already familiarized the people. However we can have firms and organizations operated through banking system. It is a breakthrough that we can mark off. It is until people have been well educated can we talk about the development of the system. Some do not want to get involved in the formality or procedure that bank requires.
8 9

Law on Foreign Exchange, National Bank of Cambodia, 1997 The internal rule of National Bank of Cambodia, National Bank of Cambodia, 1999 21

The comparison between banks and the external market practice is a component that banks explained is a most difficult concept to convince. Truly, we will never be able to compare what the banks, which are highly regulated, are operating with the one that is uncontrollable. Some enforcement on legal issues is unlikely to happen because customers do not partake in implementing the rule or law
10

. Despite that many of them do not agree to make it. They

convey this into something that tells them about the bad news and considered it as an undercutting of their life expectancy. So it is bank that has to adapt to the customers' desire. We can expect the progress of the system but may not be for now. It takes time to make people trust bank and encourage them to partake in the business society that is now contained a lot fraud, cheating and illegality. "Dedollarization" is to some extent difficult to succeed because almost all Cambodians know Dollar and accept its legal tender. We can find Dollar in most pockets and people are now acting as they are in a Dollar-society. The price of goods and services will be paid in USD rather than Riel as riel will be overpriced by the sellers for them to buy dollars for the cost. However, there is also some satisfaction from foreign investors and companies as well as local business units and businessmen with current banking system. Versatility of the practice, less intense investment law regarding the flight of their capital, good business opportunities to seize and some other factors concerning the banking issues attract many investors to come to Cambodia, though it is high risk but it will provide high returns. 3.2. Government factors Besides the people factor, the government factor is the most important one that we cannot leave out. The economic and monetary policy set by the government for banking system will determine the success or failure of the system. The government and the NBC have the implementing role and guarantee that commercial banks and financial institutions are operating under the law and regulation. It is generally accepted that the law enforcement is yet effective. This is why we can see some law is just on the paper. According to a conclusion, it said that the NBC is well aware of the problems and the symptoms but just they let them go because NBC alone cannot perform the restoring task of the system and develop the entire banking and to keep the country easy for investment. There are many other relevant institutions and cooperation from various sources to help put the banking on the right track. The International Monetary Fund had recommended to the Ministry of Finance that "dedollarization" be pursued. It is outlined that the dedollarization helps develop and
10

Bulletin term 04 #06,National Bank of Cambodia, 2003 22

strengthen the banking system and this is the great burden that government as well as the NBC has to find way to success. This is a very complicate task to achieve as Cambodian society has now flooded by USD. "It is not through legislation but through the creation of an economic environment which is clearly to the people's advantage to switch to riel," said Mr. May Tola, former deputy director of the NBC's Exchange Management Department 11. Additional support from international communities and organizations such as technical assistance, funds, equipment, advice, policymaking etc. is essential to the NBC to streamline its policy and the industry toward the growth. We understand the condition of the current situation and that we cannot head to the goal without first preparing ourselves. We still lack many other things that are help tools in accomplishing the plan. To foster the banking industry, government has the duty to make economy take a very good shape. The standard of living of the people needs to be higher for them to be able to deal with bank. When economy does well, almost everything will run smoothly and banking industry will be depended on to handle trade and business transactions. The government must find the way out to strictly control commercial banks and prevent them from insolvency, which could lessen the people's confidence in the system. The preparations of legality, other commercial laws and effective judiciary system have to be conducted and formed up. Only the government that can lead the way in convincing people and sometimes require them to do things by bank. Incentive and encouragement or promotion for the bank usage should be in consideration by the government. Among other reasons in preventing the dollarization, government remains tough in its position toward the clearinghouse matter. It has been explained that the reason that we still cannot have the clearing system for check made in USD or foreign currency is the government does not want to promote the dollar and would restrict that by creating the barriers like charge on check etc. Any assistant in the dollar clearinghouse system would automatically fuel the domination of dollar in Cambodian society and that Riel would no longer be Cambodian currency. To make sense, the government should endeavor to create a computer or an electronic system that could handle the payment as well as the clearing system. In the case of Thailand, the first phase of payment system modernization was set for 1993- 1996. The objectives of the modernization plan are to increase the payment system's efficiency by reducing paper based and increasing electronic means; and to manage and contain payment system risks. The
11

Bulletin term04 #04, National Bank of Cambodia, 2003 23

plan consists of three major initiatives. These are BATHNET-Bank of Thailand Automated High-Value Transfer Network, which is a large-value interbank electronic funds transfer system, ELECTRONIC CHEQUE CLEARING SYSTEM (ECS)- a system for electronic presentment and clearing of checks, and MEDIACLEAR-an electronic interbank clearing system of retail payments for bills, direct deposit of payroll, dividends, interests, and other similar types of consumer payments. We are optimistic that in the near future we will have a good economy and then example from the Bank of Thailand would be good for Cambodia to learn and study in order to create one realistic system for its own 12. 3.3. Environmental condition The expectation of having good system is connected to the climate around it. There is more than one reason to address the weakened banking system. Security Matter should be the one that any body pays their concern to. Although Cambodia is a cash-society, people and business units are still fearful in holding large amount of cash. Referring to this, safety and security are accounted for that cause. The danger and risk occur when we are outside the bank. Of course, we have to cash a check or bring cash to bank for deposits or hold cash withdrawn from an account to our own premise by our own means and responsibilities. And with the bad social insecurity, that cash holding is very dangerous. The holder can be robbed at any time even the bank itself was also robbed. The robbery often took place at the time the cash holder exited the bank and although there is nothing to happen, it still makes a kind of fear. Therefore, some people do not like bank and some would rather keep the money with them to meet other expenses. As dealing with bank is not an everyday practice for Cambodian people, it is presumed that those who deal with bank must hold great amount of money. Then it would be unsafe and uncomfortable for those who do. This factor partially creates a barrier for banking system to develop and attain the people's confidence. Security issue raises concern among customers, banks and their regulator. That caused banks to set a rule about bank's working hour and some banks even close very early (2:30 PM) to be safer 13. Our today economy implies that banking system should be at the beginning of the way. There is not much activity in the economy. If we view the financial market, we can see that it seems not to work, no stock exchange, no big classes of transaction for financial
12 13

Original text contents from Bank of Thailand, Http: www.bot.or.th . Bulletin, National Bank of Cambodia, September 2003 24

market to serve. The economic activity centralizes in Phnom Penh only and that is really small in terms of size of the market. Provinces can be left out as it does have trade area or much investment for banks to service. We also can see that there are few banks opened in the main provinces only. Business activity remains in central Phnom Penh as the economy has not yet grown up to its optimal level which could share to the province. Banking activity is mainly located in Phnom Penh. The prospect for Cambodian people to save money in bank could, however, be possible in the capital city for in the near future but it may be a very long journey to have those in the countryside done the same. Again, the payment system has represented a big barrier to the NBC. As we do not use bank to process our payment how can bank work much better? People do not use check to pay because they can directly pay by cash, thus a clearinghouse cannot take shape owing to the fact that amount of checks in a day is small and does not have to use clearing house. It should be started from this point that the government introduces the payment system through bank to the people. Commercial Banks themselves have to lead the way too in easing the people. The government (NBC) only sets rules and regulation to them, but they are the ones that deal with the real situation and practice. They have to make people feel secure and trust them. The services they provide, convenience and reliance the banks offer need to facilitate the people and the customers. People will react to the service the banks offer but probably not directly to the law the government set up. Therefore, commercial banks must ensure that they are accurately performing customer-hosting role, they service the people best and make the people trust 14. Even though that is the fact, but still the inevitable bank collapse cannot guarantee the success of goals. The previous and recent bank insolvency induces the people into despair. They cannot draw their money and bank remains close door. It is unconfirmed that the NBC, commercial banks' parent, will compensate the bank's creditors and customers. This is why people are still afraid of banks. To get the banking system developed, some analyses and studies were done to pave the way and give reform features of what banks should change and adjust their current status. In a seminar on banking system development dated 30 March- 3 April 1995, a group of people from world bank outlined important points that need to be developed for banking excellence and were pointed as follow:
14

Bulletin term01 #07, National Bank of Cambodia, 2004 25

Banking is in the midst of change. As governments seek to improve economic efficiency and better allocate natural resources, policymakers are shifting economies toward openness, competition, and market discipline. Privatization is spreading and state firms, including banks that were once highly regulated, are being given greater autonomy. To survive and prosper, bankers must jettison their bureaucratic culture and become competitive entrepreneurs, responding and adapting to a market economy 15. Direct management of banking by government, too, must change. This includes strengthening prudential regulation and monitoring the quality of bank assets earnings, accounting procedures and management controls. The two-volume Banking Institution in Developing Markets is aimed at managers, regulators, analysts, and policymakers involved in banking in emerging market economies. The first volume, Building Strong Management and Responding to Change, focuses on the reform of management structures, policies, and procedures, in particular on developing: A strategy for competition An organization and effective management to support the strategy Management of critical financial and operating risks of banking A system for planning, budgeting ad measuring risks of banking A program for human resource management Strong internal controls Information technology.

Volume 2, Interpreting the Financial Statements, shows how to analyze capital adequacy, liquidity and asset quality, as well as profitability, intermediation margins and efficiency. It also discusses economies of scale in banking, peer bank analysis and trend analysis. 3.4. The Importance of Management Financial liberalization, widened competition and diversification expose banks to new risks and challenges. Without new ways of managing the business, banks, not just in developing but also developed financial markets, can be thrown into crisis. Witness the nearcollapse of the saving and loan industry and commercial bank failures in the United States in the late 1980s. One reason for the crisis was the failure of bank management to act effectively
15

Financial sector blueprint for 2001-2010, Royal Government of Cambodia, August 24, 2001. 26

and prudently in a deregulated environment; another was the failure of federal overseers to tighten prudential regulation and enhance supervision 16. If no economic crisis or regulatory change challenges them, undermanaged banks anywhere can be (or, at least, appear to be) profitable and financially sound. In developing financial markets, such undermanagement is not an option. Banks there are increasingly subject to tighter prudential regulation, strengthened supervision and more rigorous accounting standards which expose weaknesses. 3.5. The Preconditions for Sound Bank Management In a competitive market, banks need autonomy to define an operating role and strategy and to carry out lending and management independently and professionally. While theoretically amenable to governance by law, contract or formal agreement, in practice, autonomy is largely determined by ownership. Autonomy is, essentially, the freedom to hire and compensate staff based on market conditions, to undertake expenditures based on objectives for financial performance and more important, to make loans based on an evaluation of risk and efficiency. Autonomy can be evaluated through assessing a bank's policies on lending, financial management, and personnel and its compliance with these policies; the objectives for institutional performance and the way they are established and evaluated; and the extent of government-directed credit programs and their effect on the bank. The composition, role and objectives of the board of directors also provide good indicators of autonomy. And lastly, and perhaps most importantly, it is critical to evaluate the way in which presidential appointments are made. 3.6. Corporate Governance Proper conduct, control, and professional management should mean that banks are prudently run and meet regulatory standards and laws. External auditors and bank supervisors may verify that a bank comes up to regulatory scratch but owners and directors are responsible for running it 17. 3.6.1. The Primacy of the Board of Directors Bank directors should normally: 16 17

Hire and fire executive managers Approve corporate plans and budgets

Bulletin term02 #08, National Bank of Cambodia, 2004 Bulletin term02 #08, National Bank of Cambodia, 2004 27

Monitor quarterly performance and advise management Approve large loans or exceptions to bank lending policy Approve major investments, asset sales, and compensation programs Avoid self-serving practices and preferential transactions with insiders Establish an Audit Committee to review financial statements and maintain internal controls

Set corporate policy on finance, credit, and personnel.

3.6.2. Policymaking In developing markets, bank policy is often formulated by the monetary authorities. In some smaller banks, run by personalized management, there are no formal policies. And in socialist economies, bank policy is usually synonymous with government policy. Formulating bank policy, particularly in the crucial areas of credit and finance, should be a priority for banks in all developing financial markets. Developing and implementing policy integrates organizational needs, regulations, laws and management philosophy. It fosters the development of a corporate culture. It provides for continuity of action and is a yardstick for performance, as well as the basis for internal and external audit. The need for policies grows with expansion, decentralization and autonomy. Bank policies normally cover major functions: credit and lending, investments in securities and subsidiaries, major capital expenditures, personnel, internal controls and financial management. Policy development is frequently based on industry practice, local custom and input from executives and the board directors. 3.6.3. The Characteristics of Sound Management Management systems, particularly their formality and decentralization, depend on many factors, including the size and structure of the business, the style of senior management, as well as competition, and economic regulation. As organizations expand and diversify, they need to rely more on impersonal system of management. Although precise definition of good management is difficult to formulate, observable aspects exist and proficiency in their execution can be evaluated. Success in any business requires leadership and competency in strategic analysis, planning, policymaking and in the management functions intrinsic to the business. Banks are no exception.

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3.7. Institutional Development of the Key Banking Functions Institutional development of a bank undergoing restructuring or a marked change begins with diagnostic studies, which focus on the bank's strategy and organizational structure, as well as credit risk management, financial management, planning and budgeting and performance reviews, human resource management, compliance and control systems and information technology. Diagnostic studies undertaken as part of the World Bank programs have found that banks in developing markets share certain deficiencies-lack of a strategic plan, ineffective organizational structure, inefficient workflows, cumbersome procedures, lack of written policies, inadequate management information and lack of credit and financial skills. The functional areas that most often need strengthening are 18: 3.7.1. Planning The planners' motto is "if you don't know where you're going, you'll end up somewhere else." Competition stimulates the need for internal and external analyses, the establishment of performance objectives and the strategies and plans to carry them out. Good planning encompasses budgeting, reviews, and incentives. In budgeting, plans are quantified according to anticipated revenues and expenses; a pro forma balance sheet and income statement for the next year will reflect a financial structure and earning performance commensurate with institutional objectives. Management incentives may be linked later to budget achievement. 3.7.2. Credit Risk Management In response to their greater responsibility for managing credit risk, some banks have begun to develop credit risk management by devising credit policies, procedures and analytical capabilities. These efforts usually need to be expanded into full credit risk management--including origination, approval, monitoring and problem loan management-tailored to the needs of each bank. Attention should be devoted to explicit and effective internal controls, assessing and dealing with credit risk, and classifying, monitoring and following up on late payments and arrears. This aspect of institutional development should begin as soon as possible because of the critical nature of the credit function. 3.7.3. Financial Management As interest rates are liberalized, financial markets broadened with new instruments, and banks permitted to lend, deposit or trade foreign exchange, assets and liabilities of banks become more diversified and interest-sensitive, both in maturity structure and rate volatility.
18

Financial sector blueprint for 2001-2010, Royal Government of Cambodia, August 2001 29

It is therefore essential to build systems and skills in liquidity management, asset and liability management and foreign exchange management. 3.7.4. Human Resource Management Banking is a highly competitive service industry and depends heavily on wellqualified, highly motivated people. Personnel policies and procedures are vital to the development and continuity of high-quality staff. Professional managers may ensure that traditional personnel procedures are implemented (for example, job descriptions, recruitment, training and professional developing, performance appraisals) but, in developing markets, fostering an effective and successful banking culture goes well beyond that. In commercial banking, managing people must be a fundamental line management responsibility if highquality staff is to be developed and maintained. Moreover, attitudes and behavior often need to change to increase efficiency and institutional capacity. The organizational structure of a bank is closely linked to its business strategy and its degree of decentralized decision-making. The structure should be designed to define lines of accountabilities, authority and responsibility and limit duplication of effort. 3.7.5. Compliance and Control System To ensure that a bank operates in a sound and safe manner, the directors in consultation with management and specialized staff, implement control systems to ensure that employees perform their duties in accordance with bank policy and procedures, as well as the law. Control systems may include auditing, internal controls, asset quality reviews, establishment and review of financial risk management and compliance management. 3.7.6. Information Technology Money has been called "information in motion" and information technology has become an integral part of service delivery. It also provides important support for bank management. Banks must carefully consider hardware and software selection, phasing of programs, and its ability to absorb the technology. A misconception prevalent in developing markets is that automation will modernize bank management. In fact, only bank banks with sound management will be able to define the technology needed. Technology is a tool, though a critical one. It is a lagging factor in institutional development.

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Credit Policy and Supervision

Figure 4.1 the organizational structure of a bank Source: Annual Report, World Bank, 2002

3.8. Managing Credit Risk 3.8.1. The Objectives of Credit Risk Management Credit risk management lies at the heart of commercial banking. Although banks initially emerged as deposit takers, they soon matured into intermediators of funds, thereby assuming credit risk. Credit became "the business of banking, and the primary basis on which a bank's quality and performance are judged". The credit management process deserves special emphasis, because proper credit management greatly influences the success or failure of financial institutions. Studies of banking crises throughout the world have concluded that the most frequent factor in the failure of banks has been poor asset (usually loan) quality. Many bankers and regulators believe that an understanding of a bank's credit risk management process provides a leading indicator of the quality of a bank's loan portfolio. 3.8.2. The Challenge of Credit Risk Management in Developing Markets Banks in developing markets face intense challenges in managing credit risk. Government controls, external and internal political pressures, production difficulties, financial restrictions, market disruptions, delays in production schedules, and frequent
31

instability in the business environment undermine the financial condition of borrowers. Moreover, financial information is often unreliable, and the legal framework frequently does not support debt recovery. In many of these countries, the difficult external context is reinforced by internal weaknesses, further undermining asset quality. Banks in developing markets often do not have a well-developed process for managing credit risk. The following deficiencies are among the most common: The absence of written policy. The absence of portfolio concentration limits. Excessive centralization or decentralization of lending authority. Poor industry analysis A cursory financial analysis of borrowers. An excessive reliance on collateral. Infrequent customer contact. Inadequate checks and balances in the credit process. The absence of loan supervision. A failure to improve collateral position as credits deteriorate. Poor controls on loan documentation. Excessive overdraft lending. Incomplete credit files. The absence of asset classification and loan-loss provisioning standards. A failure to control and audit the credit process effectively.

This deficiencies lead to loan portfolio weaknesses, including: an overconcentration of loans in one industry or sector, large portfolios of nonperforming loans, credit losses, insolvency, and illiquidity. 3.9. Credit Policies, Directives, and Procedures 3.9.1. Credit Policy Credit policy provides the framework for the entire credit management process. Written credit policies are the cornerstone of sound credit management. They set objective standards and parameters to guide bank officers who grant loans and manage the loan portfolio. They also provide the board of directors, regulators, and internal and external auditors with a basis for evaluating a bank's credit management performance. When credit policies are carefully formulated, administered from the top, and clearly understood by all
32

organizational levels, they enable bank management to maintain proper credit standards, avoid excessive risks, and evaluate business opportunity properly. The primary role of banking is to gather and husband deposits with safety, and to relend them on a sound basis; other services are subsidiary and peripheral. Sufficient funds must be available at all times to meet withdrawals by depositors and borrowing demands from borrowers with a legitimate call on lending resources. Both depositors and regulatory authorities expect that deposits will be safeguarded through adequate liquidity and risk diversification, and that the inherent risk in each credit extension be held to a minimum. A bank must decide what loans it will or will not make, how many of each type of loan it will make, to whom it will lend, and under what circumstances it will lend. There are few businesses in which one can get into trouble so quickly. Risk cannot be ignored. All of these critical decisions call for policy objectives to maintain a desirable relationship among loans, deposits and other liabilities, and capital. Developing credit policies is particularly important when a bank must adapt to a complex and rapidly changing economic environment and faces issues that formerly received little or no attention. Most important, policy formulation induces the board of directors or senior credit policy committee to determine the level of acceptable risk in light of desired profitability and efficiency, while considering the needs of the markets in which the bank operates. 3.9.2. Directives To address policy issues in response to changes in markets and economic conditions, banks often disseminate specially designated credit policy directives. The directives typically provide general parameters for the types of credit the bank will offer and the types of customers and markets it will serve, as dictated by current strategic decisions. The directives and the policy manual constitute the sum of total of the credit policies of a bank at any one time. Officers must familiarize themselves and comply with these documents. Compliance is controlled both during the process of loan approval and after disbursement. Many banks assign responsibility for developing and disseminating policies and directives to one staff group, and assign the task of monitoring the application of these lending policies (as well as the quality of the bank's portfolio) to another group. 3.9.3. Procedure The lending procedures, also usually compiled in the credit policy manual, may cover the submission and processing of credit applications, the credit analysis process, and general
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procedures for maintaining credit files and exchanging credit information with banks and suppliers. Procedures may also cover the aspects of lending that are governed by regulation or law. Other items often included pertain to credit reviews and inspections, outstanding debts, doubtful assets, and the recovery process. Operational procedures--the process for carrying out the lending function-- are generally included in an operations manual for the credit department. The procedures include maintaining and generating liability records to support periodic reviews for credit renewal, generating loan-compliance checklists, and preparing reports on account profitability and market exposure. IV. Conclusion and Recommendation The research has shown that it is probably a long journey for National bank of Cambodian to progress nationwide. We believe that in Phnom Penh, which is the central place of everything and the economic center, growth is likely to go with ease but for the rest of Cambodia, especially the countryside, it seems to be harder. The inevitable facts to face are poverty and low progressive pace of the country's economy. It is until they can prove that Cambodia's economy moves a step ahead can we expect the spread of the industry. Even there are some bank branches in main provinces, it cannot be interpreted that those branches are working best. They may be mainly used for the trading and payments only. Folks are not rich enough to save their earnings in bank account either. The presentations of the real situation of the system, the analysis and understanding of it allow us to learn and perceive the facts and the banking environment. We have gone through the system and we are now aware of the ongoing conditions. There have been some missing points and lacks of effectiveness in monitoring and controlling subordinate banks by NBC so does the monetary policy by the government. The biggest obstruction for government and/or the NBC to develop and strengthen the banking system is the invasion of dollar in our society. It is really hard in restoring the condition of Riel valuation. This is the key to the banking. Now it is confusing in the economy about the use of the currency. Cash mostly dominates payment system. It is recommended that the government take the right steps in establishing a better and reliable means of payment. A country's economy can run well until its payment system does not primarily base on cash. Payment through banks, financial institutions or any other effective methods like electronic machines, computers and other rapid instruments with technology needs to start replacing the cash method. Look at industrial nations and developing countries,
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they are pursuing to decrease the level of cash usage in their society. We, therefore, should follow the successful guidance those countries have already experienced. We believe that any intent for the application of technology and new facilities for improving the payment system is likely to succeed, as today Cambodians are ready to give their support if it is not too much expensive for them to afford. They tend to learn new thing now and we even can notice that foreign language education and computer knowledge by new generation is on the ascendancy. Credit card is really a very good means of payment that a country like Cambodia should take. It will help a lot in processing the purchase and sales transaction. It provides enough safety for us in terms of personal security and accurate payment calculation. Getting this done will develop much of our banking system. Loan issue is still low rating for now. This sometimes indicates good looking to the economy as well as the country. Even many Asian nations encountered banking crises in the recent economic crisis; Cambodia seemed to be the same as it had been before. Those countries needed bail out packages in helping to survive their banks because there were a great deal of nonperforming loans. For Cambodia, there was not such a case in which we can infer that the loan activity is not that much to worry the economy. However, this should not be considered as an acceptable condition of the economy. NBC should try to create a policy or environment that escalates the lending activity to businesses and other sectors of the economy. We need to have more lending and borrowing to run a better free market economy. In terms of credit enhancement for other facets of the economy such as agriculture, productions and manufacturing, the government itself is the determiner. That is the NBCbased policy and banks will follow as regulated. Because NBC is the central bank, which will say the amount of deposit reserve each bank required to put, it is up to the NBC's policy to what level it wants to enhance credit for which sectors of the economy. More loans will be granted to those as long as NBC lessens its principle toward deposit reserve by cutting down the required reserve amount. This, in turn, will enable banks to lend more, as reserve is less and vice versa. Legal issues must be put on the table for the government to discuss and find an excellent reform. It is very clear that now judicial system is not much reliable. The system of one court cannot help the country in resolving the different perspective cases. Today, the court performs multi functions and it applies in all cases. There should be functional courts, which distinguish the different cases. The court for business and trade needs to take shape for it to serve the needs of business sector. When we have a court that is competent in enforcing
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the law, then we surely have a good structure of banking system. Bank operations will be obviously run by law and people will have confidence and trust in the system. To commercial banks' side, although they are under the NBC's control and supervision, they have to simultaneously support the NBC in accomplishing the development program. Experts recommend that commercial banks besides having more branches in the provinces must have more correspondent banks in the overseas countries. This is very helpful in bringing about more investments, trade and businesses and also to establish good economic conditions. Banks' internal structure has to be in conformity to the one that competitively and competently stands in the free market economy. Bureaucracy must be mitigated so as for the staff to fully assist and participate in implementing the corporate strategies. For now, there seems to be more bureaucracy in terms of management and more family concentration in terms of shareholding. This could somehow lead to unbalance power management, which could make no improvement in making management decision. To this brief, we believe and feel more positive that we will have a responsive banking system for Cambodia to service the markets. This also calls for the support from our people in promoting our banking. With the effort in modernizing the banking activities by banks, success is with hand. For the bright of Cambodia's future, banking will actively assist in trade, investment, business and country's economy. We have to help the country in transforming our Cambodia to a country ruled by law, which, in return, creates the trustworthy and dependable climate for our people and business organization.

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V. Reference and bibliography

1. Bulletin term 01 # 03, National Bank of Cambodia, 2002 2. The National Bank of Cambodia 2002 Annual Report, 2004 3. Law on the organization and conduct of National Bank of Cambodia, National Bank of Cambodia, 1996 4. Prakas relating to the implementation of law on banking and financial institutions, NBC, 2001-2002 5. Law on Banking and Financial Institutions, National Bank of Cambodia, 1999 6. Law on Monetary Policy, National Bank of Cambodia, 1997 7. Law on Banking and Financial Institutions, National Bank of Cambodia, 1999 8. Law on Foreign Exchange, National Bank of Cambodia, 1997 9. Bulletin term 04 #06,National Bank of Cambodia, 2003 10. Bulletin term04 #04, National Bank of Cambodia, 2003 11. Original text contents from Bank of Thailand, Http: www.bot.or.th . 12. Bulletin, National Bank of Cambodia, September 2003 13. Bulletin term01 #07, National Bank of Cambodia, 2004 14. The internal rule of National Bank of Cambodia, National Bank of Cambodia, 1999 15. Financial sector blueprint for 2001-2010, Royal Government of Cambodia, August 24, 2001. 16. Bulletin term02 #08, National Bank of Cambodia, 2004 17. Financial sector blueprint for 2001-2010, Royal Government of Cambodia, August 2001 18. National Bank of Cambodia. Bulletin, September 2003. 19. Royal Government of Cambodia: Financial Sector Blueprint for 2001-2010, 2001. 20. Cambodian National Assembly. Law on the Organization and Conduct of the National Bank of Cambodia. Cambodia, 1996. 21. Em Tiprithy. Country Paper on Financial Liberalization and Innovation. Cambodia: NBC, July 1995. 22. Huy Navy. Management of International Reserves of Cambodia. Cambodia, 1994. 23. Mak Vantha; Rath Sovannorak; Chan Mony. Banking Laws and Regulations. Cambodia, 1994. 24. Mekong Law Reports, Cambodia. April 1996 Edition.
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25. National Bank of Cambodia. Prakas Regulation and Circular 1993-1997. 26. National Bank of Cambodia. Economics and Monetary Statistic Review N54. Cambodia, 1998. 27. Seminar on Banking Development. Cambodia, 1998. 28. International Institute of Economics. Http://www.iie.com/banking.htm 29. International Monetary Fund. Http://www.imf.org 30. World's Central Banks. Http://www.bis.org.

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