Financing the future: Public and private sector activity set to meet new challenges

Papua New Guinea’s banking sector experienced a mixed year in 2017, with commercial bank assets declining after four consecutive years of growth. Total loans to the private sector also fell against a backdrop of subdued economic activity, even as Bank South Pacific (BSP), the country’s leading commercial bank, recorded a strong rise in lending and increased profits. Moreover, although commercial banking retains high growth potential, the sector is characterised by low levels of consumer participation, with the majority of PNG’s population being currently unbanked. Furthermore, retail lending remains limited, despite recent growth in home financing supported by a government mortgage scheme for first-time home buyers.

Nevertheless, efforts are under way to overcome these challenges, with a focus on modernising existing infrastructure and improving financial inclusion. Under a far-reaching sectoral review, launched with support from the World Bank, the Bank of PNG – the country’s central bank – has made steady progress in upgrading the country’s interbank transfer network to support the development of a national payment system. The government has also adopted strategies to reduce the unbanked population, most recently partnering with international donors and governments to boost technological uptake.

Mobile banking is set to become a leading driver of growth over the coming years, while rising debit card penetration is set to help banks manage the high costs involved in expanding operations and boosting coverage in rural and remote areas. There are limits to technological uptake, however, with PNG’s rugged geography, limited rural connectivity and significant infrastructure deficit constituting major bottlenecks to the sector’s long-term development. Therefore, short-term expansion will likely remain dependent on continued macroeconomic stabilisation, as well as rising business and government lending activities.

AT A GLANCE: PNG’s commercial banking sector dates back to 1910, when the Bank of New South Wales, today Westpac, and the Australia and New Zealand Banking Group (ANZ) began operations, followed by the Commonwealth Bank (1915) and Kavieng (1916). There are four commercial banks active in the country today, including the two Australian institutions – Westpac and ANZ – and two local banks, namely BSP, originally the National Bank of Australasia, which began operations in 1957, and Kina Bank, which became operational in 2016.

Established in September 1973 the Bank of PNG – which currently operates under the Central Banking Act of 2000 – is the country’s autonomous monetary authority. It holds responsibility for providing means of payment in kina to commercial banks, operating interbank clearing and settling arrangements, acting as the government’s banker and fiscal agent, and operating mandatory exchange settlement accounts for commercial banking. The central bank’s policy remit is currently guided by the Strategic Plan 2016-20, which targets improvements in six key areas: policy dialogue between the national government and the bank, monetary policy management, foreign reserve management (see Economy chapter), completion of a national payments system, financial system development and internal capability.

MAJOR PLAYERS: BSP is the largest of the country’s four commercial banks, accounting for 59% of lending at the end of 2017. It was acquired by the state-owned Independent Public Business Corporation in October 1993 and privatised in April 2002 – being listed on the Port Moresby Stock Exchange in August 2003 – although government entities retain a majority stake (see analysis). According to its 2017 annual report, BSP’s holdings include 79 branches, 52 sub-branches, 351 agents, 499 ATMs, 11,343 electronic funds transfer at point of sale (EFTPOS) units and 4261 employees. Meanwhile, Westpac currently lists 16 branches and 19 ATMs in PNG. ANZ’s network includes 15 branches, 72 ATMs and 1877 EFTPOS units. However, these assets of ANZ are set to become part of Kina Bank, following its acquisition of ANZ’s retail and commercial wing – a deal announced in June 2018. The acquisition is expected to see Kina Bank’s lending market share rise from 5.8% to 8.8% once the transition is finalised in 2019. Additionally, 13 financial institutions, including microlenders, are licensed to operate in the country and there are nine authorised currency exchanges in operation. Digicel Financial Services is the sole company authorised to act as a mobile money network operator and remittance service, while there are also 22 savings and loans societies active in the country, according to the Bank of PNG.

ASSETS & LENDING: Assets in the commercial sector have recorded exponential growth since 2002, with the Bank of PNG reporting that total commercial banking assets rose from PGK3.9bn ($1.2bn) in that year to reach PGK20.3bn ($6.3bn) in 2011. Growth has been slower in recent years, however, with total assets rising from PGK22.7bn ($7.1bn) in 2012 to a high of PGK29.6bn ($9.3bn) in 2016, before moderating to PGK29.4bn ($9.2bn) in 2017.

Meanwhile, the central bank reports that foreign assets in the commercial system have dropped off significantly since hitting a high of PGK2.7bn ($843m) in 2013, dropping to PGK1.6bn ($500m) in 2014, before rising to PGK1.7bn ($531m) in 2015, then falling to PGK1.4bn ($437m) in 2017. Lending to the private sector has also risen steadily in recent years. The Bank of PNG reports that total kina-denominated private sector lending rose from PGK1.3bn ($405.8m) in 2002 to PGK8.7bn ($2.7bn) in 2016, before reaching a high of PGK8.74bn ($2.73bn) in 2017. Foreign currency lending has also grown, albeit less rapidly in recent years, rising from PGK99.1m ($30.4m) in 2003 to reach a high of PGK1.2bn ($375m) in 2016, before falling to PGK719.3m ($225m) in 2017.

Additionally, total business lending has risen significantly since 2013, with total outstanding advances to businesses rising from PGK8bn ($2.5bn) to a high of PGK11.3bn ($3.5bn) in 2016. While outstanding advances to businesses fell to PGK10.5bn ($3.3bn) in 2017, this still represented a 30.8% gain on the 2013 figure and, therefore, may indicate volatility rather than a precipitous decline.

CREDIT QUALITY: Overall, the sector appears stable despite recent macroeconomic uncertainty. In a June 2017 report the National Development Bank stated that domestic credit quality had not deteriorated significantly, with Moses Liu, managing director of the bank, reporting there had been only a slight rise in recorded defaults. Nevertheless, in order to ensure the long-term stability of the country’s financial services, there has been a growing interest in credit quality checks, with assessments of credit history expected to average 20,000 per month in 2018, according to the country’s industry-financed Credit and Data Bureau (CDB). Furthermore, the CDB has reported that the banking sector continues to hold significant liquidity, largely as a result of a foreign exchange shortfall (see Economy chapter).

BSP has also reported stable operations, with its provision for bad debts remaining at 4.9% in 2017, while its capital adequacy ratio was 22.8%, more than double the minimum requirement stipulated by Basel III. Furthermore, Robin Fleming, group CEO of BSP, told local media that the bank’s non-performing loan ratio stood at between 1.2% and 1.3% in January 2018. Stakeholders report that banks often adopt a conservative approach to lending for private projects, with the IMF highlighting structural issues including land tenure, property rights and contract affordability as impediments to the expansion of credit provision. In their most recently published country report the IMF projected domestic credit would grow 5.8% over 2018, against 24.6% in 2016, while credit to the private sector is forecast to fall to 3% in 2018, down from 7.2% in 2016. According to the IMF, these developments in the credit market relate directly to the slowing pace of economic activity in the country as a whole. The growth rate has fallen from its previous accelerated pace as a result of a fall in global commodity prices and the impact of poor weather conditions on farming. Nevertheless, the IMF has highlighted that the non-performing loan ratio has remained at around 3%, and the banks remain well-capitalised with excess liquidity.

BY SECTOR: This overall slowdown of lending as a result of broader macroeconomic trends is evident when credit flows are analysed on a sectoral basis. According to the Bank of PNG, total agricultural loans rose from PGK236.7m ($73.9m) in 2013 to hit PGK262.9m ($82.1m) in 2014, before dropping to PGK190.3m ($59.4m) in 2016 and recovering to PGK202.5m ($63.2m) in 2017. Meanwhile, loans to the manufacturing sector have vacillated since 2013, rising from PGK989.2m ($308.8m) that year to PGK1.07bn ($334m) in 2015, before falling to PGK954.8m ($298.1m) in 2016 and only PGK560.5m ($175m) in 2017. Transportation loans rose from PGK1.39bn ($434m) in 2013 to hit PGK1.83bn ($571.3m) in 2016, before moderating to PGK1.67bn ($527.6m) in 2017. In addition, loans to the building and construction sector have also dropped in recent years, falling from PGK691.7m ($215.9m) in 2014 to PGK548.6m ($171.3m) in 2015, before recovering slightly to reach PGK591.8m ($171.3m) in 2017.

Nevertheless, loans to the commerce sector – which includes buyers, processors, exporters, wholesale traders and retailers – have recorded strong recent growth. The total value of loans to the sector rose from PGK1.43bn ($446.4m) in 2013 to hit PGK1.78bn ($555.7m) in 2017. Meanwhile, loans to the mining and quarrying sector have risen significantly, jumping from PGK205.9m ($64.3m) in 2013 to PGK1.31bn ($409m) in 2016, before easing to PGK941.3m ($293.9m) the following year.

MORTGAGE LENDING: While lending to different sectors of the country’s industry has been uneven – rising in some sectors and falling in others – the provision of credit to consumers remains persistently limited. Nevertheless, considerable progress has been made in developing a mortgage market following the launch of the government’s First Home Ownership Scheme (FHOS) in September 2014.

The FHOS offers loans ranging from PGK200,000 ($62,400) to PGK400,000 ($125,000) and a 4% fixed interest rate. In an effort to support low-income home buyers, loan tenures are set at a maximum of 40 years and no fees are charged on early repayment. Beneficiaries must be first-time buyers, provide a 10% down payment and submit supporting documentation, including proof of employment and income, as well as proof that the home will be their personal residence. The FHOS is intended to provide a more competitive deal than commercial banks, which generally offer interest rates of between 8.5% and 9%, maximum tenors of 30 years and charge additional fees. On unveiling the programme, the government announced it would provide PGK200m ($62.4m) each year to BSP – which is tasked with implementing FHOS on behalf of the state.

In November 2016, BSP announced it had funded PGK160m ($50m) of mortgages under the scheme. In its most recent annual report, the bank highlighted retail lending as a high-growth segment of its operations, with total lending rising by PGK36.6m ($11.4m) in 2017 to PGK259m ($80.9m), led by an PGK121m ($37.8m) increase in home financing which was supported by the FHOS.

POLICY DIRECTIVES: Recognising the need to strengthen financial inclusion the government has adopted a number of strategies aimed at modernising banking infrastructure. Key policy aims include electronic payments, improved interoperability and the establishment of a national payment system.

In order to achieve these objectives the government formed a partnership in 2015 with the World Bank to launch a review of the sector and formulate a development strategy. The sectoral review is being undertaken by a technical working group including staff from the World Bank, the Bank of PNG and Department of Treasury. The group has completed the review’s first phase, which included producing diagnostic technical reports addressing the development of a national payment system, government bonds and capital markets and an improved regulatory framework for the sector.

FINANCIAL INCLUSION: Nevertheless, a major challenge that presents an impediment to the expansion of consumer credit is the high proportion of the citizenry that remains financially excluded. Out of a population of around 8m, 85% lack a bank account, according to a report published by the University of Queensland’s International Mining for Development Centre (IMDC) in July 2015. The report highlights that PNG has one of the highest ratios of unbanked citizens in the world, citing linguistic diversity and the infrastructure gap as factors for this. The state has undertaken a host of initiatives aimed at improving participation in the formal financial system, often with the support of international partners. Under the National Strategic Plan, or Vision 2050, the government’s long-term economic development framework, PNG launched the National Inclusion and Financial Literacy Strategy in 2014. The policy employed principles derived from the Maya Declaration, a global financial inclusion initiative launched under the auspices of the Alliance for Financial Inclusion in 2011. Prior to this, in 2013, authorities established the Centre for Excellence in Financial Inclusion (CEFI), which is mandated to facilitate improvements to financial services delivery.

PROGRESS MADE: As a result of these efforts progress has been made in reducing the country’s unbanked population. The Bank of PNG reports that the number of adults with a bank account at a formal financial institution nearly doubled between June 2013 and June 2016, rising from 20% to 37%. Looking to build on this, the Bank of PNG published its second National Financial Inclusion Strategy 2016-20, which prioritises encouraging digital financial services, while educating consumers and small businesses on making use of financial products.

“Accessibility and coverage remain a serious problem,” Robin Fleming, group CEO of BSP, told OBG. “A major boost will come from the expected decrease of internet prices in the coming years, making it more easy to reach the new generation.” Furthermore, in June 2017 the central bank unveiled plans to boost financial inclusion by an additional 2m people, including 1m women, through collaboration with the UN, as well as local financial service providers.

MOBILE MONEY: According to the CEFI, developing mobile money has proven to be one of the most effective measures through which to boost financial inclusion in PNG. The centre reports that market liberalisation in 2007 led to several new players entering the mobile money segment.

The mobile finance sector is already fairly well developed, with some offerings predating the changes to the regulation of the telecoms sector. Products include: Mobile SMK, by Post PNG; BSP Mobile Banking; BSP’s Wantok Money; Digicel’s CellMoni; Nationwide Microbank’s MiCash; ANZ goMoney, which will migrate to Kina Bank as part of its acquisition of ANZ; and Westpac’s Everywhere Banking. An estimated 9.2% of the population has access to mobile banking. “Mobile banking is already here: around 90% of the 10m reported transactions are conducted electronically and about 860,000 via bank branches,” Fleming told OBG. “The sector has made huge investments in improving coverage and mobile facilities and mobile activity is already reaching an extremely high percentage in PNG, and is likely to grow even further over the coming years.”

Nevertheless, mobile money transfers have yet to gain the same traction in PNG as they have in comparable emerging markets, preventing many recent initiatives from scaling up beyond the pilot stage (see analysis). Furthermore, the majority of financial technology (fintech) products have not been supported by domestic investment, but rather by international donor agencies and bilateral partners. Despite this, major stakeholders have noted that mobile money transfer platforms hold significant potential for future expansion.

For example, Westpac announced in March 2017 that it had launched a low-cost banking product, called Choice Wantok, designed for people living in rural and remote communities who are unable to visit a branch or ATM. Using the product, customers are able to access mobile banking to make savings deposits, send and receive money, and pay utilities bills, all without monthly fees. The service is a joint initiative between Westpac, the government of Australia and the UN Pacific Financial Inclusion Programme, a Pacific-wide programme managed by the UN Capital Development fund and UN Development Programme, with funding from the EU and the governments of Australia and New Zealand. The programme – which aims to support 1m low-income people in the broader Pacific region gain access to financial services by 2019 – provided $1.75m of funding for to mobile money service.

Nevertheless, Westpac reports that infrastructure and logistics challenges remain a significant obstacle to widespread adoption of this and similar fintech solutions. Due to the substantial infrastructure gap in the country, an agent-operated touch point would be needed in each locale to carry out cash settlement services. Similar limitations have also proven problematic for other fintech innovations, including the blockchain distributed ledger system, with near-term development more likely to focus on improving bank interoperability than blockchain and mobile money transfer platforms.

“Infrastructure is so important because transport is so difficult,” Mark Baker, managing director of ANZ PNG, told OBG. “The country’s Highland regions are very fertile, but it is very difficult to transport goods out of the area, which is why a city like Port Moresby has to rely on imports,” he added.

CARD PAYMENTS: Although mobile money may be several years away from widespread adoption, significant growth potential remains in the debit and credit card segments. This offers banks a way to reduce costs associated with the expansion of current networks while supporting ongoing efforts to develop a national payment system.

As of October 2017 the Bank of PNG reported that 1.2m debit cards had been issued by the four commercial banks, as well as a small selection of second- and third-tier financial institutions. The lender projected 6.1m domestic transactions would be made via debit cards in 2017. Currently, ATMs are the favoured platform for debit card transactions, accounting for 70% of total transaction volumes.

STRATEGIC OPPORTUNITIES: The central bank notes that between 25% and 30% of the country’s current customer base for banking services requires cards that can be used in New Zealand and Australia. In order to be fully operative in these countries these cards require bank identification number technology. Access to this technology among domestic financial institutions currently presents a bottleneck to the expansion of the segment. Although this technology has been provided under third-party agreements, these remain limited and there is, therefore, further potential for the expansion of this technology among commercial banks.

There is also room for expansion when it comes to credit cards. The central bank estimates that by 2020 PNG could have around 150,000 in circulation, although currently BSP, Westpac and ANZ are the only commercial banks issuing credit cards in the country. With this area being undersaturated, opportunities exist for second- and third-tier financial institutions to obtain a share of the market. Furthermore, the ongoing development of a national payments system will likely boost the adoption of both debit and credit card usage in PNG.

NATIONAL PAYMENT SYSTEM: In order to facilitate the development of such a system, the Bank of PNG launched a strategy for the implementation of a national payment system in 2009. The framework prioritised the establishment of secure and reliable mechanisms for the transfer of funds and the provision of access to modern payment services, both domestically and internationally to customers and firms in PNG. Furthermore, the plan envisioned shifting the country away from its current cash-oriented payment practices towards non-cash electronic payment instruments, in compliance with internationally recognised standards. It also sought to create an integrated competitive market among payment services providers. “The next phase for the banking sector will involve reducing overall reliance on cash in the market as a whole and especially in rural areas,” Fleming told OBG. “The main issue is how to develop acceptance of electronic payment technology.” Under this strategy, the implementation of the new payment system is set to be overseen by the central bank. Interbank transfers will be settled on the same day as they are made, and electronic trading of both foreign exchange and securities would be supported by new electronic delivery mechanisms. The plan also stipulates that payment service provision will not be the exclusive domain of commercial banks, rather it recommends that participants compete on services but cooperate on the development of infrastructure, thereby facilitating interoperability between providers.

The National Payment Systems Act was promulgated in 2013, establishing the mandate for the functions and powers of country’s central bank with regards to payment systems, security, collateral and assets, as well as regulations for electronic money transfers. The act also established the National Payments Council as a facilitator of institutional discussions around payment systems.

An updated policy framework, the Strategy and Action Plan for the Development of the PNG National Payments System 2015-18, was published in October 2015. The document provided details on the progress made towards the establishment of the system and provided an outline of the policy needed to complete the project. The document highlights that bank authorities have begun to implement a mandated modernisation process under the auspices of the original plan. One critical component of this has been the introduction of a Kina Automated Transfer System (KATS), a hybrid payment processing system enabling unified real-time gross settlement and automated clearing house functionality. KATS participants communicate with the system through the international SWIFT network, as well as a new fibre-optic network connecting banks to the Bank of PNG. This, in turn, is backed up by a microwave network under lease from the National Information and Communication Technology Authority.

MODERNISATION PROGRESS: The first stage of KATS went live in 2013, introducing interbank payment processing to PNG. The second stage – which included full electronic cheque truncation – came on-line in 2014, applying international standards for magnetic ink character recognition for all cheques. The Bank of PNG and all commercial banks now exchange cheques electronically under a four-day settlement cycle enabling banks to verify signatures prior to final settlement. The system has allowed banks to reduce cheque processing times and lower incidence of fraud. In February 2015, interbank retail direct credits settled through KATS were introduced, with the central bank reporting that it intends to introduce direct debit functionality at a future stage.

OUTLOOK: Despite an overall slowdown in financial activity, the banking system of PNG remains robust and well capitalised. The government has made progress in a number of key areas and lending in some sectors remains buoyant. Furthermore, ongoing economic stabilisation will likely support business and government lending activities in 2018, and the sector should see assets and business lending activities expand this year and next. Nevertheless, the majority of the country remains financially excluded. Tapping this large underserved consumer market will remain a major challenge for commercial banks. Mobile banking and fintech solutions have great potential, but require improvements in the country’s banking and telecommunications infrastructure.