Steady on: Increased domestic involvement and solid oversight point towards future growth

Despite a number of ongoing challenges, Papua New Guinea’s banking sector is poised for expansion in the coming years. The industry has seen significant growth over the past decade, primarily as a result of government leadership and rapid development in the economy due to a handful of major energy and mining projects. In general, three commercial banks –the Bank of South Pacific (BSP), Australia and New Zealand Banking Group (ANZ) PNG and Westpac PNG – currently dominate the sector. As of early 2012, the great majority of bank revenues came from corporate business. PNG’s burgeoning middle class, however, represents a potential growth driver going forward. In an effort to tap into this nascent market, many local financial institutions are in the process of designing and rolling out new retail products and services, for both the small and medium-sized enterprise (SME) market and the currently underbanked retail market. With this in mind, banking penetration – currently around 15%, according to the Asian Development Bank (ADB) – is expected to jump substantially in the coming years.

CASH RICH: Despite the positive indicators, the financial services industry may face a number of challenges. Perhaps most importantly, lending rates are relatively low, despite the fact that the banking system is holding an excess of cash. According to the IMF, since 2005 liquid assets have accounted for more than 50% of total assets. The country’s central bank, the Bank of Papua New Guinea (BPNG), is working to reduce the amount of liquidity in the market, primarily by encouraging banks to lend more – particularly to SMEs – and to develop the retail side of their business. Sali David, the manager of the economics department at BPNG told OBG, “We are trying to reduce the amount of liquidity in the system by getting more people into the banking system and by encouraging institutions to boost their lending facilities.” The central bank also releases short-term central bank bills (C-bills) on a weekly basis, with the goal of mopping up excess liquidity. In addition to high liquidity levels, PNG’s banks are currently dealing with a number of other challenging issues, including a volatile political situation at home, high security costs and a lack of financial awareness among the population.

THE FUNDAMENTALS: Despite these issues, solid fundamentals point towards growth. BSP loans’ compounded annual growth rate (CAGR) has been 37% since 2005, while the investment CAGR has been around 26%. BPNG, which is widely regarded as an effective and resilient regulatory body, recently introduced an ambitious development plan for the sector, with a focus on effectively managing liquidity and inflationary pressures, increasing lending and boosting overall economic growth (see analysis).

Additionally, the competition for retail customers is expected to spur innovation and ongoing improvement among the country’s leading banks. With this in mind, PNG’s banking industry is planning for steady expansion in the coming years.

A LONG HISTORY: While the financial framework currently in place is a relatively recent development, many of PNG’s leading banks have been active in the country for more than a century. Both ANZ and Westpac opened branch offices in Port Moresby in 1910, and have offered a variety of banking services since then. BSP was launched in 1957 as a branch of the National Bank of Australasia. BPNG, meanwhile, developed out of the Port Moresby branch of the Reserve Bank of Australia (RBA) in 1971, when PNG’s Select Committee on Constitutional Development set up a Committee on Banking. The bank grew alongside the young country, which achieved self-rule in 1973 and independence in 1975. In July 1973 the nascent government asked the Department of Finance and the RBA to design a national currency. Two years later, in April 1975, BPNG launched the kina and toea, which remain the national currency of PNG today. BPNG was officially established by the Central Banking Act of 1973, which itself was based on Australia’s Reserve Bank Act of 1959, as well as other pieces of legislation in the Australian system.

EVOLVING TIMES: From independence through the late 1990s, the banking sector developed slowly. In the 1980s and 1990s, PNG faced several economic challenges, including balance of payment shortfalls, excessive budgetary deficit financing and declining average incomes among a substantial percentage of the rapidly expanding population.

Despite introducing a structural adjustment programme (under the auspices of the World Bank and the IMF) in 1990, average income in PNG fell from $1300 to $744 between 1994 and 2000, according to a 2004 study done by the PNG Institute of National Affairs, a private, non-profit policy research institute based in Port Moresby.

In 2001, in an effort to improve governance over the country’s financial institutions and increase financial inclusion among the population, the government carried out a major financial sector reform project. Perhaps most importantly, the sector’s legislative framework was completely rewritten, which set the stage for substantial growth in the following decade. New laws introduced as part of the reform project – and still in place today – include the Central Banking Act of 2000, the Banks and Financial Institutions Act of 2000 and the Superannuation Act of 2000.

Since 2000, PNG’s financial services sector has grown substantially. The industry suffered a minor contraction in the wake of the 2008 global economic downturn, but in general the sector has remained well insulated against international volatility. Additionally, good provisioning at banks and other financial institutions meant that most local firms were more prepared for the economic crisis.

OVERSIGHT & REGULATION: BPNG has a mandate to oversee the country’s financial markets, currency, monetary policy and the banking sector, among other areas. The central bank issues licences and enforces regulations for all banks and other licensed financial institutions. Additionally, the regulator oversees PNG’s small life insurance industry (see Insurance chapter) and superannuation (or pension) funds. Unlike some other public institutions in PNG, the central bank enjoys a positive reputation throughout the country. “BPNG is widely regarded as a bastion of stability,” said Aaron Batten, an economist at the ADB in PNG.

The central bank has implemented a number of development initiatives in recent years. The regulator’s first four-year plan, which ran from 2005 through 2008, saw the bank focus on clarifying its core functions and values. In 2011 BPNG introduced a second four-year programme – the 2012-15 Strategic Plan – which is currently being implemented. Under the new plan, the bank will focus on updating PNG’s monetary policy to take into account high liquidity in the financial system; reforming the national payments system; and boosting financial inclusion, particularly among the country’s large rural population. Indeed, as of April 2012 the bank was testing a new kina-denominated automatic transfer system (KATS), which will operate in real time – a major improvement on the existing manual bank-check system.

“We are moving to implement KATS before the end of the year,” said Robert Kule, the head of banking at BPNG. The 2012-15 Strategic Plan is closely linked with PNG’s 2011-15 Medium-Term Development Plan, in addition to Vision 2050, the country’s long-term planning initiative (see analysis).

BY THE NUMBERS: The commercial banking sector is dominated by BSP, ANZ, and Westpac. A local subsidiary of Malayan Banking (Maybank), Malaysia’s largest bank, is also active in PNG, though it only controls around 2% of the market. According to official data from BPNG, as of the end of October 2011 – the most recent date for which statistics are available – the four commercial banks held assets of PGK19.82bn ($9.43bn), up substantially from PGK16.93bn ($8.06bn) at the end of 2010 and PGK15.26bn ($7.26bn) at the end of 2009. BSP accounted for PGK9.69bn ($4.61bn) of the October 2011 total, equal to almost 49% of total assets; ANZ held PGK6.1bn ($2.9bn), some 31% of total assets; Westpac held PGK3.59bn ($1.71bn), around 18%; and Maybank held PGK425.1m ($202.31m), around 2%. Some 50% of the October 2011 total was held in cash, while the remainder was primarily made up of government bonds, such as Cbills and treasury bills (T-bills). Commercial banking revenues are high, with returns on assets at 3.3% and returns on equity at 27.7%, according to a July 2011 IMF report. Despite such high levels of profitability, lending in PNG remains relatively low, at around onethird as a proportion of total assets, due to excess liquidity allowing banks to earn revenue by other means.

MAJOR PLAYERS: BSP dominates most segments of the banking industry in PNG. In addition to controlling half of overall commercial banking assets and liabilities, the institution is home to 54% of deposits by volume. BSP also operates a network of 35 branches in PNG. Additionally, BSP is active in Fiji, the Solomon Islands and Niue. From 1957, when it was founded, through the mid-1970s, BSP was a branch of the National Bank of Australasia, an Australia-based institution. In October 1974 BSP was incorporated as a wholly owned subsidiary by its parent company, which maintained control of the bank until 1993, when BSP was acquired by National Investment Holdings, an investment vehicle for private shareholders. In 2002 BSP acquired the PNG Banking Corporation. Since then, BSP has grown substantially. The government owns 18% of the bank, and the International Finance Corporation has shareholding of 10%. The bank is the only company offering both a standard security and a debt listing on the Port Moresby exchange. In 2011 BSP posted pre-tax profits of PGK466.2m ($221.86m), up 15.9% from PGK402.1m ($191.36m) in 2010.

ANZ, which currently operates 12 branches in PNG, set up its first office in the country in 1910. In 1976 the PNG division was incorporated as a subsidiary of the Australia-based parent firm. Since then, ANZ’s PNG business has grown substantially. The institution primarily caters to blue-chip firms in the natural resources and infrastructure sectors, though it is also working to develop its domestic retail business. “We are confident about future economic expansion in PNG,” said Mark Dawson, the head of corporate and institutional banking at ANZ PNG. “There is quite a lot of opportunity for growth in natural resources, infrastructure and agriculture, among other areas.” ANZ is active in many markets around the world.

Westpac, Australia’s oldest bank, is the successor to the Bank of New South Wales, which set up a branch in PNG in 1910. Today the institution offers a variety of personal and business products and services, though the great majority of revenues come from the corporate segment. “The majority of our revenue comes from corporate banking,” Mal Smyth, the head of finance and company secretary at Westpac PNG, told OBG. “But our strategy also involves banking the unbanked via retail channels and using e-business to take the strain off our branch network.” Westpac currently operates 16 branches within the country.

Maybank, meanwhile, which has been active in PNG since 1994, primarily offers corporate services to the fishery and timber industries. The institution operates two branches, one in the capital and one in Lae, the country’s second-largest city.

MICROFINANCE: In addition to the commercial banks, PNG is home to a handful of microfinance banks (Nationwide Microbank and PNG Microfinance lead the segment) and seven other licensed financial institutions, including First Investment Finance, the Finance Corporation, Kina Finance and Credit Corporation, among others. The microfinance sector is a major potential growth driver in PNG. The country’s massive rural population represents a large source of potential business for the financial services sector.

With this in mind, the country’s microfinance institutions are preparing for substantial growth in the coming years (see analysis). As of the end of October 2011, the microfinance banks and other licensed financial institutions boasted total assets of some PGK574.4m ($273.35m), which was up substantially from PGK478.1m ($227.53m) at the end of 2010 and around PGK380.2m ($180.94m) at the end of 2009.

BPNG also oversees five superannuation funds. These are the National Superannuation Fund ( NASFUND), Nambawan Super (NS), Comrade Trustees, Sios Workers Ritaia Fund and Aon Master Trust. The two largest funds, NASFUND and NS, count as members a substantial number of PNG’s largest companies and government entities.

MONETARY POLICY: The central bank makes use of a variety of tools to manage PNG’s monetary policy. BPNG has currently implemented Basel I standards, though according to George Awap, the manager of the banking supervision department at BPNG, many of its supervisory practices are already in line with Basel II. “Additionally, in terms of capital requirements we already comply with Basel III,” Awap told OBG. The existing minimum capital requirements are PGK15m ($7.14m) for banks and PGK1.5m ($713,850) for other licensed financial institutions, according to information from the central bank.

Rapidly rising liquidity levels in the financial services sector have been the primary challenge in recent years. According to BPNG statistics, as of the end of October 2011, liquid assets in the four commercial banks totalled PGK7.99bn ($3.8bn), up from PGK6.62bn ($3.15bn) at the end of 2010 and PGK6.61bn ($3.14bn) at the end of 2009. These numbers are considered high by international standards, in some cases equalling nearly half of total commercial banking assets.

“The main source of liquidity is the foreign exchange reserve build-up, stemming largely from dollar-denominated mineral tax earnings, inflows related to the PNG LNG project and other private foreign direct investments,” said Loi M Bakani, the governor of BPNG, in a speech delivered March 2012. “Whilst liquidity does not seem to currently have an impact on inflation via private sector credit, despite strong economic growth, [BPNG] is concerned about its potential adverse impact on price stability.”

INFLATION: Despite ongoing concerns about high levels of liquidity over the past few years, at the end of 2011 inflation was 6.9%, compared to nearly 10% at the end of the second quarter of 2011, according to official government statistics. (These numbers are disputed though, with some unofficially estimating inflation at the end of 2011 was closer to 12%.) The decline in the inflation rate over the second half of the year is the result of kina appreciation and monetary tightening efforts at the central bank. BPNG has raised the cash reserve requirement (CRR) for commercial banks a number of times in recent years. The CRR jumped from 3% in 2009 to 4% in October 2010, and rose again to 5% in July 2011, 6% a month later in August 2011, and 7% as of May 2012. The central bank projects that headline inflation will reach 8% in 2012. According to the IMF, raising the CRR further would be a less costly way to reduce high liquidity than choosing to issue more C-bills.

BPNG is also aiming to minimise foreign reserve accumulation for the foreseeable future, as it has been a major cause of the jump in liquidity. “The balance of payments recorded a surplus in 2011 and is projected to increase further in 2012,” said Bakani in a statement released in March 2012. “At the end of 2012, the gross foreign exchange reserves are projected to be around PGK10.59bn ($5.04bn), sufficient for 7.6 months of total and 19.9 months of non-mineral import cover.” According to the IMF, minimising the accumulation of foreign exchange reserves would likely result in market-driven kina appreciation in the coming years, which would in turn exert downward pressure on the inflation rate.

CHALLENGES: A substantial percentage of the sector’s cash holdings – nearly PGK3bn ($1.43bn) as of March 2012, according to BPNG figures – are made up of government trust accounts, which have attracted criticism from numerous sources in recent years. “The money in the government trust accounts is officially set aside to be used in development projects over the course of the year,” said Simon Gaius, the manager of the financial markets department at BPNG. “This money should be deposited in the central bank.”

Local and international authorities alike have criticised the system, pointing to a handful of recent instances of politicians using the accounts as a personal slush fund. According to a late 2010 report on PNG’s 2011 budget, published by the Australian National University’s Development Policy Centre, “there continues to be a lack of transparency on how trust fund monies are being used, making it hard to verify the degree to which spending is aligned with development priorities.” In a March 2012 speech in Port Moresby, Bakani requested that the government transfer all government trust accounts currently held at commercial banks to the central bank. “Depositing all government trust account funds at the central bank and [the] smooth spending of those funds over time will assist with liquidity management,” he said.

In an effort to mop up the excess liquidity, BPNG issues short-term C-bills almost every week and the Department of Treasury issues T-bills on a regular basis as well. Commercial banks, which have cash to spare, purchase the overwhelming majority of these products. “The commercial banks load up on C-bills every week and T-bills whenever they are issued,” said David. “They are able to turn a profit without lending very much at all.” Indeed, high levels of corporate and government deposits and the lucrative government bond market have had a negative effect on lending rates and retail deposits, particularly among the rural population. “Banks have so much cash on hand that in some rural provinces, they have been discouraging new deposits,” said Batten. “In some cases, it can cost more than the value of the deposit to transport the cash back to the capital.” However, some banks, such as BSP, dispute claims that they are discouraging deposits, pointing to new developments in providing low-cost channels to help promote savings.

POTENTIAL GROWTH AREAS: Indeed, boosting financial inclusion among rural communities – which makes up 80-85% of PNG’s total population – is a major challenge. In an effort to address this issue, the National Development Bank (NDB), a state-owned entity, has been taking a number of actions over the past few years. The NDB was launched in 2007 as a successor to the Rural Development Bank (RDB), which was set up in 1967. Since then, the institution has provided more than PGK1bn ($475.9m) in development credit to citizens in rural provinces.

More than half of these loans went to the agriculture sector, which continues as a major economic contributor (see Agriculture chapter). The Independent Public Business Corporation, a state entity that oversees a portfolio of state-owned enterprises, currently owns the NDB. The bank offers long-term agriculture and commercial loans, and maintains 18 branches spread throughout the country.

Prior to the 2007 reform, the NDB had suffered from mismanagement and corruption. In 2004 the institution announced that it was insolvent for the third time since its inception in 1967. Primarily due to the 2007 restructuring, however, the NDB’s financials have improved dramatically. In 2004 some 70% of the bank’s loans were more than 90 days overdue. By 2009, the first year the bank posted a profit since its last insolvency, this number had dropped to just 2%, which puts the bank on an equal footing with the commercial institutions in terms of loans in arrears. In December 2011 the government announced it had allocated PGK130m ($61.87m) for the NDB in the 2012 budget, which will allow the institution to expand existing loan programmes and roll out new initiatives.

GOING MOBILE: To some extent, boosting financial inclusion in PNG is not a matter of extending existing branch networks. “No matter how many brick-andmortar outposts the commercial banks set up, a large percentage of the population will continue to go unbanked,” said Awap. With this in mind, PNG’s commercial players are focusing on mobile banking as a primary means of reaching the rural population (see analysis). “Where the banks cannot make it, the mobile phone companies will,” Awap told OBG.

Indeed, mobile banking has the potential to dramatically boost financial penetration in the coming years. Microfinance institutions, such as Nationwide Microbank, are working to roll out low-cost mobile products aimed at the large low-income rural population. Likewise, BSP has been operating mobile banking since 2009, and sees some 1m transactions each month from its 250,000 registered users. “Mobile technology has created massive new opportunities for the rural population,” said Tony Westaway, the managing director of Nationwide Microbank. “We want to bank this population through branchless banking.”

Other challenges currently facing the banking sector include a general lack of financial awareness and literacy among the population. Both the government and a number of commercial institutions are working to address this issue, primarily through awareness-raising initiatives in Port Moresby and some provincial capitals. Westpac’s Financial First Steps programme, for example, which is funded by AusAID, the Australian government’s overseas aid office, offers workshops on banking in conjunction with businesses, schools, churches and community groups.

OUTLOOK: PNG’s banking sector is preparing for substantial growth in the coming years. The sector is underpinned by the country’s surging energy and mining industries, which, if all goes according to plan, are expected to continue to expand over the coming decade. The industry benefits from the involvement of BPNG, which is widely regarded as a high-quality, independent regulatory presence in a challenging environment. The central bank has worked alongside the commercial players and other financial institutions in recent years to clear the path for continued growth and development in the industry. Under its 2012-15 strategic plan, BPNG will work to better manage liquidity, ensure a sound operating environment and encourage competition among commercial banks, with the overarching goal of fostering economic growth in the industry. With this in mind, the sector is looking at a future with several growth prospects.