Tech solutions extend banking to remote areas of PNG

The banking sector in Papua New Guinea is sound, growing and remarkably profitable. Its largest and only publicly traded institution, BSP, reports return on equity 10 percentage points higher than the large Australian banks, which are among the most profitable in the world. Continued expansion is expected. With 80% of the country unbanked, growth is almost assured as inclusiveness rises and more people open accounts. Parts of the economy long viewed as too expensive and difficult to serve are now seen as fertile soil for new business. Unlike the various overbanked parts of the West and Asia, PNG’s sector is not saturated and has plenty of room to grow.

Nevertheless, the sector faces challenges. Reaching PNG’s more remote corners will not be easy, given its tough geography and security issues. While rural regions offer great potential for branches and new customers, they are still very challenging. The reasons they were not adequately serviced before largely remain, and the sector is under pressure to change the way it does business. The central bank and the government are pushing banks to be more competitive in terms of interest rates and foreign exchange spread, and to focus on meeting society’s borrowing needs. As a result, margins could be squeezed and profits threatened. “They should concentrate on taking deposits and lending money,” said Loi Bakani, governor of the Bank of PNG.

Years Of Consolidation

Banking in PNG dates back to 1910, when the Bank of New South Wales and the Bank of Australasia established branches in what was then Australia’s Territory of New Guinea. The Commonwealth Bank entered Rabaul in 1916 when Australia took control of German New Guinea. The Australia and New Zealand Banking Group (ANZ) opened a branch in the country in 1953, and the National Bank of Australia came in 1957. For most of its pre-independence history, the banking system was an extension of the Australia’s, and its business was almost exclusively targeted to non-locals, according to “The Role of the Reserve Bank of Australia in PNG’s Decolonisation”. The paper notes that the Transactions With Natives Ordinance, which existed until 1963, prohibited banking with locals, making any transaction with a Papua New Guinean above $100 unlawful to protect them from exploitation.

Suddenly Bankable

Ahead of independence in 1975 – and in response to a new rule – the National Bank of Australia incorporated its PNG subsidiary and renamed it Bank South Pacific, which was then taken over by local interests. ANZ and the Bank of New South Wales restructured their PNG operations, and after Commonwealth Bank relinquished its franchise its network became part of PNG Banking Corporation, which was bought out by Bank South Pacific in April 2002. After 1983, new entrants were allowed into the market if they kept their shareholdings under 50%. Banque Indosuez and Lloyds Bank entered the country with the central bank as a major shareholder in their local subsidiaries. The Lloyd’s operation was purchased by ANZ in 1990. Bank of Hawaii, having bought Banque Indosuez’s operations in 1997, was itself bought out in 2001 by ANZ. Maybank, the PNG subsidiary of Malaysia's largest bank, entered in 1994 but was bought by Kina Group for PGK319m ($120.7m) in June 2015. Kina Group is PNG’s largest financial institution, with branches in Lae, Kokopo and Mt Hagen. The acquisition will see Kina become the fourth bank in the country.

BSP purchased Westpac’s Niue branch in 2004, Habib Bank Fiji in 2006 and, between 2006 and 2009, Commonwealth Bank’s interests in Colonial National Bank, to further expand in Fiji. In 2007 it also purchased the National Bank of the Solomon Islands, previously controlled by the Commonwealth Bank of Australia and the Bank of Hawaii. In January 2015, BSP agreed to acquire five Westpac Bank operations in the Pacific: Samoa, Cook Islands, Solomon Islands, Vanuatu and Tonga. The total deal value was A$125m ($100m), and the move affirmed BSP’s position as a major player in the South Pacific. Its footprint rivals that of ANZ, which operates branches or subsidiaries in some 12 Pacific jurisdictions.

Good Performance 

BSP is by far the largest bank in the country. According to Bank of PNG statistics, the institution had 56.88% of the sector’s assets as of the end of 2014. ANZ came in second, with 25.88% of the total, and Westpac third, with 14.74%. Maybank was a distant fourth, at 2.50%. In terms of deposits, BSP is in an even stronger position, with 59.99% of the total, compared to ANZ’s 23.96%, Westpac’s 14.17% and Maybank’s 1.88%.

ANZ has a strong loan book, with 26.97% of the total, while BSP has 57.9%, Westpac 13.75% and May-bank 1.39%. BSP’s profits after tax rose from PGK436.8m ($165.3m) in 2013 to PGK507.3m ($192m) in 2014, and its net profits are up PGK224.2m ($84.8m) over five years. BSP, listed on the Port Moresby stock exchange since 1993, initiated a buyback programme in July 2014. The bank said it would be seeking to purchase on the open market 15m shares over a 12-month period. The shares would subsequently be cancelled.

In its 2014 Article IV Consultation report, the IMF noted that the sector is stable and characterised by good capitalisation and adequate liquidity. Non-performing loans (NPLs) are up from 1.2% in 2013, but they are still a reasonable 1.6% (which is lower than the recent highs of 2% reached in 2011 and 2012, and a significant improvement over the 15% of 2000). Provisions for NPL losses are at 220.2%. Capital to risk weighted assets, according to the IMF, was 28.7% in 2014, about the same as it has been in recent years, while Tier 1 capital was 20.5%. Meanwhile, the loan to deposit ratio has crept up a bit in recent years, hitting 52.8% in 2014, up from 49.9% in 2010.

Boom & Bust

The business environment has been difficult, because of the boom and bust cycles inherent in a resource-based economy such as PNG’s. Banks are continually having to deal with high demand for credit, followed by quick contraction, and with the construction phase of the PNG liquefied natural gas (LNG) project now over and production ramping up, banks are between cycles.

“The market has not seen yet the full benefits of the PNG LNG project, but when you plug a $20bn project into a $12bn economy, an adjustment period is to be expected,” Mark Baker, managing director of ANZ PNG, told OBG. “With the potential third train and an additional project coming on-stream in the coming years, we expect PNG’s GDP to grow 5% to 6% in the longer term.” According to the IMF, both broad money supply and private sector credit growth fell to zero in mid-2014, after broad money’s peak of 25% in 2010 and private sector credit growth of 30% in 2009. Broad money grew 1.2% in 2014.

Still, banks have, on the whole, managed this transition well. While NPLs have inched up, the commercial banks are conservative in their lending habits, and they are not overly exposed to vulnerable sectors. According to central bank figures released in September 2014, only 14.3% of outstanding advances were to the real estate sector. That is down from the 2011 ratio (14.6%). The mining and quarrying category was only 4.3% of total exposure and retail and wholesale trade is at 14.3%. There are signs that banks are starting to make a healthy shift from the extractive to the productive: loans to manufacturing almost tripled between 2011 and late 2014. “The transition comes with a number of challenges,” Baker told OBG. “It is difficult to absorb a project of that size without structural issues. For us, we have managed it pretty well. We are not seeing a lot of stress, we are within our risk parameters across the board. However, businesses and banks have to keep a disciplined eye on costs and productivity in the downturn that has followed the end of PNG LNG construction. As Warren Buffet said, ‘You only find out who is swimming naked when the tide goes out.’”

Offshore Recovery

Another part of the problem for the banks, and for business in general, is the nature of the recovery. A good part of the banking for the major projects is done offshore, with some investors getting exemptions and being permitted to net out export earnings from offshore expenses. Significant flows are therefore outside the banking system. The production phase is particularly light, in terms of its impact on the domestic economy. It employs few workers and sources very little from PNG in terms of goods and services. Some of the new investors in the economy are structured in such a way that their local presence is especially light. In the case of Chinese construction projects, for example, the money comes from China, workers are often brought in and much of the work is done in the home country, with prefabricated sections being imported. Thus, banks get little exposure beyond payroll for local workers and possibly some banking facilities.

Highly Concentrated

While the country has 21 savings and loans societies and 11 other licensed financial institutions (LFIs) four commercial banks dominate the landscape, with 91.7% of all assets. This level of concentration appears to have reduced competition and, while the sector is strong, pricing may not be at an ideal level, according the donor community and researchers. “There are relatively few organisations supplying financial services in the PNG financial sector. In this environment it is likely the competitive pressure is relatively light,” according to an Australian Treasury report.

According to the Institute of National Affairs’ “PNG Private Sector Assessment 2014”, “Banks have secure deposit-based funding, high profitability and adequate capital ratios. Yet, there are indications of insufficient competition.” Low competition is reflected in the loan-deposit interest rate spread, last measured by the World Bank at 9.8% in 2011, up from under 1% in 1989. That compared with Malaysia’s 1.6%, Australia’s 2.9% and Singapore’s 5.2%. In terms of apparent competitiveness, PNG is similar to smaller Pacific island nations, which tend to have few banks. According to the paper “Interest Rates and Bank Profitability in the South Pacific”, return on average assets in PNG was double that of Australia from 2005 to 2009, but the simple spread between deposits and loans was also about double.

The nation’s banks largely attribute the structure of their asset side to the limited number of opportunities to make loans. Most businesses in need of money lack collateral, so contracts are difficult to enforce. Most of all, the country is not a good place for making loans based on the value of land. An estimated 97% of real estate in PNG is customary land, for which there is no title. Even when land is freehold, it is often subject to competing claims. In this environment, the options for banks are highly limited. They can primarily lend to large corporations, projects and institutions that have long histories and good records of repayment.

Still, this does not mean banks have not found niches to support. “There are tremendous opportunities in the growth of light industries across PNG,” Geoff Toone, managing director of Westpac PNG, told OBG. “Such companies are well positioned to take advantage of the affordable labour market and proximity to the Asian marketplace, provided we see significant and ongoing infrastructure investments.”

Despite these and other opportunities, banks operating in PNG are conservative and generally do not change their standards for the environment. They continue to adhere to international norms; Westpac uses the same credit analysis manual that is used in the home market of Australia. Few companies in the country are able to come up with the necessary cash flow, collateral and documentation that is required to meet these standards, and that results in loans being dispersed to a narrow range of clients.

The Bank Fights Bank

The central bank has been taking aim at the sector, in particular the foreign exchange spread. “The market is experiencing a shortage of foreign currency at the moment, as the prices of export commodities like gold, copper and nickel continue to be depressed, while the need for imports remains intact. This is causing short-term challenges to paying suppliers,” Baker told OBG. To address this, central bank tightened the trading band in which the kina could be bought and sold in June 2014. Foreign exchange dealers were required to deviate no more than 75 basis points on either side of the official Reference Rate. In an instant, the kina jumped from about 2.8 to the dollar to 2.43.

The authorities said that the regulation was not published to intervene in the currency markets, but rather that it was done to eliminate the high profits that were being earned by the banks as a result of the large spread between the bid and ask on foreign exchange. They felt as though the institutions were taking advantage of their market positions and not actually making money from banking.

“When you look at the last four or five financial reports of all three big banks, you will see that large portions of their profits came out of foreign currency trading, which means that they are not lending enough money to our businessmen and women,” remarked Prime Minister Peter O’Neill in a story for PNG Today. “We want them to increase their [banks’] lending book, we do not want them to increase their foreign currency trading. So that is why we have limited the margins in foreign currency trading.”

The central bank has also worked to prevent offshore trading of the kina. On March 5, 2015, the Bank of PNG issued a public notice stating that banks outside the country would no longer be permitted to do business in kina via vostro accounts at local banks within the country, and that people making deposits into these vostro accounts would only be able to do so if the kina deposited was from an exchange made through one of the country’s authorised foreign exchange dealers. A vostro account is a custodian account held by a local bank in the local currency for a foreign bank, so limiting the range of opportunities to transact business with such accounts also limits the potential for currency manipulation.

Another Intervention

In March 2015 the central bank announced that local residents would no longer be able to open foreign currency accounts and that existing foreign currency accounts would be audited. All offshore accounts not approved by the bank were to be closed within two months. The notice added that the only exceptions were accounts opened with the permission of the central bank and accounts allowed under project development agreements. Still, even in the case of these accounts, the central bank requires approved exporters to remit any surplus after payment of foreign liabilities within three months. The banks have traditionally earned a large portion of their profits from foreign exchange. This is reflected in their income statements. In 2013, before the change in the rules on the trading bands, BSP earned more from non-interest income than from interest income – PGK781.2m ($295.6m) versus PGK740.9m ($280.4m). It is also notable that BSP’s non-interest income had grown PGK529.5m ($200.4m) in the previous five years against PGK266.9m ($101m) for interest income.

The intervention in the market has affected banks’ profitability. Foreign exchange earnings at BSP dropped significantly during 2014, from PGK184.5m ($70m) in the first half of the year to PGK83m ($31.4m) in the second half. Meanwhile, non-interest income fell from PGK781.2m ($295.6m) in 2013 to PGK729.8m ($276.2m) in 2014, while interest income continued to rise: from PGK740.9m ($280.4m) in 2013 to PGK852.9m ($322.7m) in 2014. Loans and advances to customers jumped from PGK1.5bn ($567.6m) to PGK6.8bn ($2.6bn).

Lower Fees

In March 2015, BSP said it would be lowering its fees on deposits, ending the practice of charging PGK3.50 ($1.32) for each cheque processed. In part, the policy change is the result of the introduction of the Kina Automatic Transfer System (KATS), which has an automated clearing house and real time gross settlement (RTGS) functions. In the past, cheque settlement was physical. Cheques had to be transported from one bank to another, and this added costs and caused considerable delays in the clearing of funds. Settlement could take seven to 14 days under the manual system.

As of October 2014, the commercial banks and the central bank were using the RTGS component of KATS in order to facilitate high value payments between the institutions. The second phase went live in September 2014. Following the implementation of this phase, cheques are scanned and the magnetic ink character recognition (MICR) number is captured. The information is processed electronically and the cheque itself is not exchanged with the counterparty bank. Cheques that are not compliant with the MICR format are rejected, and the customer must present a new document. This has resulted in an increase in the number of dishonoured cheques. The third phase of KATS went live in February 2015. This element of the programme allows for direct payments between account holders at commercial banks. Some fees, however, remain high. For BSP Kundu standard account holders, deposits made at a teller window attract a PGK3.00 ($1.14) charge, and withdrawals are charged PGK4.00 ($1.52). Deposits and withdrawals made at an agent location are charged PGK1.00 ($0.38). Banks say that this largely reflects the costs of doing business in the country. To keep branches open, they must fortify bank locations, staff them with guards and increase the level of security when moving money. According to the World Bank, crime is high in the country, especially in Port Moresby and Lae, and that this translates into a material burden on businesses.

Diverse Strategies

Despite the limited number of banks in the market, there is a diversity of strategy among commercial banks. ANZ has historically been less focused on the retail side of the business and has been the banker of choice for corporations with regional interests and exposure. Its territory extends from Beijing, through South-east Asia, all the way to American Samoa, via the Pacific Islands.

For potential clients in need of international reach or expertise, ANZ’s network is unmatched within the country. Westpac, for its part, has historically been more of a corporate bank, serving local clients and clients from its home country of Australia, while BSP is a locally owned institution that gets a major share of government and local business, and additionally has a strong retail network. Westpac has 16 branches throughout the country, BSP has 85 (44 regular and 41 rural), ANZ has 15 and Maybank 2. In terms of NPLs, there is significant disparity between the major institutions: ANZ had an NPL ratio of 0.48% as of end-2014; BSP was by far the lowest, at 0.34%; and Westpac came in at 0.91%.

Mobilising

It appears that change could be afoot. A sector in which three major institutions have played their respective roles for more than a decade is about to become more competitive. The moves made by the central bank are necessitating adjustment and pushing banks to become more aggressive and inclusive. All the major institutions are working to make their presence felt within the country and are increasing their exposure. In light of the high costs associated with establishing and maintaining physical bank branches, the sector is pushing the use of mobile services for retail transactions.

ANZ has been offering its goMoney product in the country since June 2013. The product allows people to make deposits and withdrawals, make payments and transfer funds. Westpac has Mobile Money, BSP has Mobile Banking and Nationwide Microbank has MiCash. What is particularly useful about these offerings is the way they can be used to establish branch type services via merchants. Any retail establishment is able to provide cash-in and cash-out for customers, who access their bank accounts using the bank’s merchant-integrated mobile platform. This allows banks to access customers in remote areas without actually setting up a formal outlet.

Digital cash is quickly growing as well. Digicel has had cellmoni since 2011, which allows customers to conduct transactions similar to those offered by the banks. BSP followed up with Wontok Moni, which allows for transfer to individuals who have a mobile phone but no bank account.

At least one institution is making more of a strategic play, not only seeking to expand more into rural areas and retail but also to change the fundamental structure of the market. Westpac, which reduced its presence within the country in the 1990s and lost ground as BSP grew, is attempting a comeback. The bank is opening branches and endeavouring to gain share on the two other main competitors. “Our balance sheet is in growth mode,” said Toone.

Another Player

Another commercial bank is a possibility. The central bank has said that it would like to see a new entrant into the market. It is open to foreign institutions coming in and said that a number of parties have expressed interest, including Malaysia’s CIMB Bank. In 2011, a high level delegation from the Malaysian bank, including the bank’s chief financial officer, visited Port Moresby. Many in the country and some in the sector are positive about the idea that the country could become the host of another major financial institution. “There needs to be a fifth bank here,” said Tony Westaway, managing director of Nationwide Microbank.

Alternatively, the new institution could be created internally. PNG has a large number of players in the market that could merge or upgrade to become full-fledged commercial banks. For example, as of November 2014 there were 21 savings and loan societies in operation in PNG. It is a sub-sector with a long history and a solid customer base, with the first such institutions having been founded in 1962. Trust in this model was so great that by 1967 the country has 189 savings and loans, according to the book, “State and Society in PNG”, though by 2000 that number had fallen to 101. Savings and loans are essentially mutually owned credit cooperatives, and they tend to be formed for residents of certain areas or employees of certain companies. Some examples include the Air Niugini Savings & Loan Society, the East New Britain Savings & Loan Society and the Teachers Savings & Loan Society.

Legislative support for the model is under way and a Savings and Loan Bill has been under discussion for some time that would greatly change the sub-sector. It would bring in a minimum capital requirement of PGK100,000 ($37,840), give more responsibility to the Federation of Savings and Loan Societies, make possible the publishing of prudential standards for these institution and call for better corporate governance. Most importantly, it will allow these banks to break out of their traditional place in the economy. Under the bill, they will be freed from rate ceilings, allowed to do business beyond their local home markets, and more easily able to merge with and acquire each other.

Licence to Lend

In addition to the big players and savings and loans societies, PNG has 11 LFIs (which includes microfinance companies and non-bank financials), two authorised money remitters, six authorised money changers and two authorised foreign exchange dealers (both of which are also LFIs). In this ecosystem, some of the players are significant. Moniplus, for example, offers a range of services, including fixed-term deposits, loans, asset financing and foreign exchange trading. Nationwide Microbank, meanwhile, has 12 branches in the country, from Buka to Wewak, and provides most of the services that are offered by traditional banks.

While the size of these institutions are small, and their exposure to the more profitable elements of the business is limited, they are important to the sector. The LFIs and savings and loans together have about 7.5% of the banking assets and an estimated 25% of accounts. These institutions could merge to form a commercial bank or one of their number could be a target for an overseas acquirer.

Despite the potential, some market participants are sceptical. The existing banks are so well established that it would be difficult to gain any market share from them. The best institutional deposits are locked up while retail deposits are hard and expensive to attract. It is also a matter of capital. Central bank regulations state that only the equivalent of 10% of capital can be tied up in the trading of a single currency, so a new bank would have to invest PGK100m ($37.8m) to take on PGK10m ($3.8m) of foreign exchange trading risk. As most trades go via the dollar, the limit for all currencies is effectively 10% of capital. This requires a huge commitment for a foreign bank to get an effective piece of what was historically the most lucrative part of the business.

Concerns

One of the major concerns in the market is the presence of unlicensed institutions. These range from get-quick-rich schemes marketed on street corners to lenders that exist without the approval of the central bank. The Bank of PNG is worried about the destabilising effect of these enterprises while the sector worries about the damage they do to the legitimate firms. Since they have no compliance burden, they can undercut the licensed players. At the same time, they are unstable and prone to collapse, making people more distrustful of financial institutions in general. PNG has a long history of Ponzi schemes. More than a decade ago, U-Vistract Financial System offered 100% monthly returns, conned an estimated 100,000 people and decamped to Bougainville, where an estimated 60,000 people – nearly the entire adult population of the islands – were cheated out of their money.

As a result, PNG was placed on the Financial Action Task Force (FATF) grey list. In a 2011 review of 40 FATF recommendations on money laundering and nine on terrorist financing, it was found that PNG was only compliant with two. The country was largely compliant with six, partially compliant with 19 and non-compliant with 22. In early 2014 PNG was found to be a jurisdiction that had made a significant political commitment to resolving its deficiencies, but the FATF still recommended that it undertake several key measures: creating adequate laws against money laundering; setting up procedures for confiscating money that has been laundered; creating systems for tracing and freezing assets; establishing a structure for the reporting of suspicious transactions; and setting up control systems for cross-border currency transactions. If it does not make improvements in these areas, the country could be labelled a jurisdiction “not making sufficient progress”. In 2014, the central bank sent out terms of reference seeking a consultant to help it address these issues.

Outlook

The sector is undergoing a transition. While the central bank works to make commercial banks more competitive, institutions are pushing to expand into under-served areas. If the transition is managed well, banks may experience significant growth and find margins largely intact, despite the loss of some foreign exchange earnings. The increase in competition and the lowering of rates and fees, meanwhile, could have a positive effect on the economy and in turn create more business for the banks.