How will Papua New Guinea banks offset the impact of Covid-19?

The Covid-19 pandemic has brought substantial macroeconomic challenges throughout the world, leaving no country unaffected. Although Papua New Guinea has benefitted from its geographical isolation in terms of public health, its economic recovery will be highly dependent on international commodity prices, from where it receives the majority of its foreign currency. Nevertheless, the banking sector remains resilient and liquid due to the strength of key market players, as well as decisive action on the part of policymakers.

Structure & Oversight

As the country’s central bank, the Bank of PNG (BPNG) oversees monetary policy and is responsible for ensuring the country’s financial system operates smoothly. More broadly, it looks to underscore PNG’s macroeconomic responsibility and boost economic growth. Partly as a result of the market’s size, the banking sector in PNG is dominated by two Australian institutions, Westpac and ANZ; and two local banks, Bank of South Pacific (BSP) and Kina Bank. In September 2019 ANZ finalised the PGK24.2m ($7.1m) sale of its retail, commercial, and small and medium-sized enterprises (SME) arm to Kina Bank, in order to allow for more targeted operations in terms of institutional lending and large corporate clients across a number of different sectors.

Performance

Prior to the outbreak of the Covid-19 pandemic, the PNG banking sector was healthy. Liquidity increased substantially over recent decades, with the liquid asset ratio of commercial banks growing from 40% in 2003 to 49.6% in 2017. Meanwhile, the country’s loan-to-deposit ratio was estimated to be 73.4% in 2019, up slightly from 71.4% in 2018, according to the IMF. Although this demonstrates that the banking sector is relatively robust, it also suggests that there is more potential in the market, assuming an ideal loan-todeposit ratio of between 80% and 90%. Total deposits also demonstrated long-term stability, with the latest available data from 2016 showing that bank deposits to GDP stood at 32.62%, a figure which has fluctuated around the same level since 2009, following substantial growth during the previous decade. According to the World Bank, the country’s domestic credit to the private sector was 19.3% of GDP in 2018, down from a high of 25.1% in 2013, reflecting the decline in lending since the peak of the international commodity price cycle. In light of more challenging macroeconomic circumstances over recent years, the latest available data shows that non-performing loans as a percent of banks’ total assets was 1.35% in 2017, up from a low of 0.73% in 2012. However, in spite of ongoing and increasingly challenging economic circumstances, PNG’s banking sector can draw on a long record of resilience. “The banking sector has been through difficult times before and came through relatively unscathed,” Tony Westaway, CEO of MiBank, told OBG.

Covid-19

As a response to the pandemic, in 2020 BPNG implemented a number of measures to ensure the functionality of the banking sector. As a priority, it ensured that foreign currency was available and prioritised for the National Department of Health, as well as retailers and wholesalers of medical drugs. In addition, the central bank also committed to providing US dollar liquidity to the domestic interbank foreign exchange (forex) market. In terms of monetary policy, BPNG dropped the kina facility rate – the monthly policy signalling rate – from 5% to 3%, while it requested lenders to lower their indicative lending rates to reflect this drop in their commercial rates.

BPNG changed the regulations to provide more liquidity to commercial banks by reducing the cash reserve requirement from 10% to 7%. BPNG also looked to boost lending activity by increasing the margin on central bank borrowing from 25 basis points to 100 basis points. In operational terms, banks and other businesses had to scale back activities after a national state of emergency was declared in March 2020. Additional measures were enacted such as the provision of a three-month loan repayment holiday for clients seriously affected by the pandemic. Most importantly, in terms of macroeconomic stability, BPNG announced a quantitative easing programme to inject liquidity into the market, as well as its intention to repurchase government securities as part of this policy. The government has also negotiated with private sector lenders for loan repayment holidays, which they estimate to total PGK500m ($147.5m) in financial support. With a view to assisting micro-, small and medium-sized enterprises (MSMEs) with cash flow, additional budgetary measures have been made to ensure government debts to businesses are cleared by 2021, with PGK1m ($295,000) being cleared in 2020.

Monetary Policy

BPNG governs the country’s monetary policy with four specific objectives. It seeks to retain confidence in the kina exchange rate alongside providing sound economic management to provide the government with a base for stable fiscal operations. It also looks to establish certainty to enable businesses to make long-term policy decisions, as well as provide a stable macroeconomic environment. BPNG’s reserve money framework governs its monetary policy. Specifically, this involves using banking instruments to control the growth of reserve money within the economy. Reserve money is defined as the amount of currency in circulation within the economy plus the deposits of commercial banks. In addition, BPNG uses open market operations, which involves the government trading securities to regulate the supply of money that is in the country’s banks. This, combined with the cash reserve requirement, forms BPNG’s principal policy instruments to manage monetary policy and liquidity. To supplement this, a quantitative easing programme was introduced to act as a stimulus for growth in light of the Covid-19 pandemic, with the specific aim to provide additional liquidity to the banking sector.

Inflation

A decline in the prices for basic seasonal goods, a light depreciation of the kina in foreign currency markets and an increase in domestic consumption have caused a steady fall in the consumer price index – which measures annual headline inflation – since 2016. The inflation rate fell from 4.8% in December 2018 to 2.9% in December 2019. In March 2020 BPNG forecast a slight rise to 3.5% and a medium-term inflation rate of 3%. Potential factors affecting these figures include a further weakening of the kina against other currencies or unforeseen disruptions to the supply of goods.

Bonds

In September 2018 PNG raised $500m in its debut sovereign dollar-denominated issuance of 10-year bonds at an initial interest rate of 8.36%, with the majority of the demand coming from the US. In mid-2019 the PNG Treasury outlined how the price of the bonds had risen since its issuance, potentially making future debt cheaper to service as the interest rate had fallen to 6.85%. This led to an interest rate convergence on the country’s domestic and international debt. The bond issuance therefore allowed PNG to move away from its dependence on its domestic banks to buy its debt, thanks to the fact that 7% of PNG’s government debt is now denominated in US dollars. As a response to the uncertain economic conditions caused by the pandemic, in April 2020 the government issued a PGK2.5bn ($737,000) Treasury bond to finance 43.9% of the stimulus package. The interest rates for these bonds were between 8% and 9.5%, depending on the terms. Perhaps due to the high interest rate, the bond was oversubscribed, with domestic banks and superannuation funds showing particular interest.

Forex

Even before the onset of Covid-19, PNG faced a number of challenges regarding forex flows. In response to the lack of forex, in 2014 BPNG positioned the kina in a trading band in order to prevent a depreciation of the currency. In OBG’s most recent CEO survey – undertaken before the pandemic – the majority of respondents said that a shortage in forex was the main barrier to doing business in PNG.

Even though the situation improved slightly since the sovereign bond issuance in 2018, the fall in international commodity markets in 2020 put the country in a challenging position regarding forex, given how intrinsically its economy is linked to the export of liquefied natural gas and minerals (see Economy chapter). Speaking to local media on April 21, 2020 Loi Bakani, the governor of BPNG, stated that the country had around PGK6.9bn ($2bn) in forex reserves, equivalent to 9.3 months of non-mining import cover and 5.4 months of total import cover. He added that the central bank would intervene in the forex market to ensure health care institutions and related businesses could meet their import needs.

Financial Infrastructure

All payments in PNG’s formal economy are governed by BPNG’s national payment system, which was established in November 2009. However, the wider approach of the system is constantly being reviewed and upgraded to adapt to changing economic conditions. The national payment system forms the backbone of PNG’s payment infrastructure, which is supported by a wider framework to bring together financial institutions and service providers to ensure payments can be successfully made between two parties using cash, cheques, electronic transfers or card/mobile payments. BPNG is the regulator, operator and a participant in the system, the last due to its role as the banker to the government.

Financial Inclusion

Around 70% of the population of PNG is unbanked, which directly correlates to the high levels of informality seen in its wider economy. The amount of unbanked money in circulation in the economy is estimated to be around PGK12m ($3.5m). The high value of its informal economy discourages many individuals and firms from formalising. As such, approximately 80% of the population and 49,000 companies participate in the informal sector. To help address this, a key policy goal for the government has been to incorporate 1m unbanked and underbanked people into the financial system, 50% of which should be female, given that women typically experience some of the lowest banking penetration levels in rural areas.

This move towards a more financially inclusive PNG is being driven by the comprehensive efforts of the Centre for Excellence in Financial Inclusion (CEFI), which was established by the government in 2013. The organisation’s goal is to reduce poverty by increasing financial inclusion for the entire population. CEFI worked with stakeholders to develop the National Financial Inclusion Strategy 2016-20, an overarching roadmap to overcome barriers to financial inclusion. This was followed by the CEFI’s Financial Sector Development Strategy 2018-30, the primary aims of which include the development of a national payments system, the strengthening of the country’s bonds and capital markets, and the improvement of the operational and regulatory framework for the country’s financial sector.

Although there has been progress in using digital technologies to boost financial inclusion, the growth in the penetration rate has so far been minimal. In order to support the development of the segment, BPNG introduced a regulatory sandbox for authorised financial services providers to test their new products and services using real customer data in December 2019. The sandbox is the first of its kind among Pacific Island states. Moving forwards, the regulatory sandbox may give rise to functional solutions that could be replicated in other markets in the region.

Digital Banking

While BPNG’s sandbox ecosystem provides a promising environment for new financial technology firms, mainstream banks have also been developing innovative ways to provide services to existing clients. One such example of this is BSP, which launched its digital strategy in 2019 to be implemented over three years across PNG and other South Pacific nations such as Fiji, Samoa and Tonga. The strategy aims to facilitate and optimise digital services for banking customers, especially those in rural areas who have to travel far to reach a branch or an ATM.

Apps such as BSP’s All Aboard will enable customers to purchase goods using biometrics and contactless payments with their mobile devices. With the onset of the Covid-19 pandemic and the resulting restrictions on movement seen in countries around the globe, digital banking and e-payments have become increasingly valuable services. “Covid-19 led to a significant uptake in digital financial services, much of which may be irreversible,” Westaway told OBG. “Much of this growth is spread nationwide, with mobile wallets being more widely used.” The shift towards cashless payments saw a boost in support through the launch of the Retail Electronic Payments System in late July 2019. The new system provides a platform to link all domestic and financial institutions through a centralised portal in order to boost efficiency across the entire banking system. The next phase of the project will look to incorporate small domestic banks alongside international payment providers such as Visa and Mastercard.

Obstacles to Growth

While many emerging economies experience imbalances in access to financial services, PNG has a particular set of circumstances that presents additional challenges to the overall goal of boosting financial inclusion. In light of its largely rural population, a number of underlying structural and developmental issues have to be addressed in order to provide the conditions for greater financial inclusion. Low rates of electrification, gender inequality and a lack of access to the internet are some of the obstacles to improving financial inclusion across the board. Over 80% of the country’s population lives in rural areas.

In addition to this, geographically inaccessible terrain, limited infrastructure, and lack of knowledge regarding technology and financial services make the government’s objective to boost financial inclusion more challenging. Nevertheless, efforts are being made to address these issues, with the Coral Sea Cable System helping to expand access to affordable internet services (see ICT chapter). In addition, the government is engaging with its counterparts in Australia, Japan, New Zealand and the US to achieve the goal of 70% electrification by 2030 (see Energy chapter).

“The biggest risk in pushing a universal financial penetration initiative is that development may disproportionately favour urban areas over rural areas,” Robin Fleming, CEO of BSP, told OBG. “Expansion should be done cautiously and consciously, as there are a lot of fixed costs involved.” In addition, power cuts are disproportionately more likely to occur in rural areas, which can indirectly affect the disruption of the entire financial system. “Relatively frequent power shortages have a notable negative impact on the finance sector, with telecoms, ATMs and business systems regularly experiencing interruptions,” Fleming added.

In an effort to boost female participation in the banking system, the Asian Development Bank has implemented a policy known as the Microfinance Expansion Project. This initiative looks to enhance the capacity of lenders to expand financial services provision in rural areas alongside developing more comprehensive industry regulations. The programme has a specific focus on lending to MSMEs and in particular to female customers. Women’s Micro Bank received its licence in 2014 and had over 27,000 customers in 2019. It aims to have 30,000 by the end of 2020, to coincide with the planned delivery of its first dividend. There are over 13,000 female shareholders of the bank, and it only provides loans either to women, or to men accompanied by their female partner, or alternatively to a self-reliance group whereby female members serve as mutual guarantors. The bank offers loans ranging from PGK300 ($88.50) in the informal sector to PGK300,000 ($88,500) in key industries such as agriculture.

Outlook

Largely due to the onset of the global Covid-19 pandemic and the resulting slowdown in the international economy, PNG’s banking sector is set for weak credit growth and tightened forex liquidity over the short to medium term. The sector’s subdued performance is a result of dampened demand for the country’s key commodity exports, which has led to lower business confidence and has affected overall demand for loans. Ongoing initiatives to address spatial and social inequalities in PNG’s banking sector will prove crucial to its long-term objectives, and CEFI’s comprehensive programme provides a solid framework with which to move forwards and reach its goals of increased digital penetration and financial education.