Banking sector in PNG well positioned to meet challenges

Papua New Guinea’s banking sector is sound, stable and profitable. Despite slow economic growth in the country in recent years, institutions have managed their exposures well and entered the current weak patch in a strong position. They are generating good results and investing in future growth. Regulation is solid and improving, with the central bank updating key laws and bringing the sector closer to international standards in terms of anti-money laundering (AML). Innovation is helping to improve customer experience and geographic coverage, while it also promises to revolutionise the way money moves in the country. The establishment of Kina Bank in 2015 did not result in a dramatic change in the competitive landscape, but the dynamics of the sector are evolving, with institutions increasingly responsive on price and offering. At the highest levels work on inclusion continues (see analysis).

Challenges 

Balancing the positives are factors and trends that suggest underlying challenges. The economy and the finances of the government have raised concerns, with at least one ratings agency warning of the banking industry’s vulnerability to shocks from outside of the sector.

While the institutions have adjusted to the current conditions, they are nevertheless part of a system that is under some strain. In the eyes of the international ratings companies they can be no more creditworthy than the country.

A number of recent hoped-for deals did not come to pass, due to both technical hiccups and concerns about the assets in question.

More generally, efforts to broaden the appeal of banking in the country have not moved far beyond official promotion and policy, and commercial training. PNG remains one of the world’s least banked countries. While work being done should increase numbers at the margin, it will be more difficult to reach the vast majority of the country (see analysis).

Storied Past 

Commercial banks have been active in PNG for more than a century. The Bank of New South Wales, now Westpac, was established in what was then an Australian territory in 1910, while the Commonwealth Bank came to Rabaul in 1915 and Kavieng a year later. Australia and New Zealand Bank, now ANZ, arrived in the market in 1910, while the National Bank of Australasia – which later became Bank South Pacific (BSP) – opened a branch in Port Moresby in 1957. Maybank, which was sold to the Kina Group in 2015, was established in PNG in 1994. A number of other banks arrived and subsequently left over the years, including Nuigini Lloyds, Banque Indosuez and Bank of Hawaii.

Strength In Depth 

While the sector is relatively small in terms of the number of institutions, by some measures the country has a healthy complement of banks and banking-related enterprises.

At the top are the four main commercial banks, two of them local and two from Australia. PNG also has 12 licensed financial institutions (including microfinance institutions and companies making personal loans), 22 savings and loans societies, one mobile network operator, two authorised foreign exchange dealers, nine authorised money changers and one authorised money remitter. The Credit and Data Bureau has been in existence since 2008. Overall, the country’s banking ecosystem is broad and deep, with a wide range of institutions catering to a diverse set of needs and interests.

That said, concentration is a reality. The total number of commercial banks has fallen from six in 2000 to the current four, and these account for 94% of total financial sector assets. Among the commercial banks, BSP is the clear leader and the dominant player. According to the bank, it has 55.4% of total loans outstanding in the market, against ANZ’s 26.6%, Westpac’s 14.3% and Kina Bank’s 3.7%. BSP has 44 branches in PNG, as well as 45 sub-branches, 307 ATMs and 178 agents. That compares with Westpac’s 16 branches, ANZ’s 16 and Kina Bank’s four. Nationwide Microbank (MiBank) has 12 branches.

Performance 

Overall, the sector is healthy and growing steadily. Total commercial bank assets rose from PGK22.7bn ($7.2bn) in 2012 to PGK28.7bn ($9.1bn) in September 2016, with assets up 7.5% year-on-year (y-o-y). Loans outstanding totalled PGK13bn ($4.1bn) in the third quarter of 2016, up from PGK8.9bn ($2.8bn) in 2013. In September 2016 total loans had grown by 11.2% y-o-y.

Microfinance assets hit PGK258.5m ($81.9m) by the end of 2016, up from PGK159.5m ($50.6m) in 2012, according to central bank figures. Savings and loans society assets rose from PGK742m ($235.2m) in 2012 to PGK1bn ($317m) by September 2016. The finance company subsector has been weak, though it is relatively small, with assets falling significantly since hitting a peak of over PGK1bn ($317m) in 2015. By September 2016 the total was PGK567m ($179.7m), lower than 2012’s PGK661m ($209.5m).

The commercial banking sector loan book is diverse, and exposure to potentially problematic sectors appears to be limited. Advances to building and construction, which could face problems due to overbuilding and slower economic growth, are down slightly. They totalled PGK685.5m ($217.3m) in 2013. By September 2016 they were PGK522.4m ($165.6m), after peaking at PGK863m, or $273.6m, in 2015. That compares to total advances to all businesses of PGK11.3bn ($3.6bn).

A few areas have recorded significant growth. The real estate renting and business services subcategory increased from PGK1.4bn ($443.8m) to PGK1.8bn ($570.6m) between 2013 and late 2016. Advances to mining and related fields jumped from PGK85.2m ($27m) to PGK1.2bn ($380.4m). Lending to agriculture is down somewhat, while advances to manufacturing have increased slightly. “Some businesses may have overleveraged in the construction phase of the liquefied natural gas (LNG) project. They may not have considered the fall off in business. Retail has been falling off, and we have been cautious about the property sector,” said Robin Fleming, CEO of BSP. “Overall, the situation hasn’t got any better but it hasn’t got any worse.”

Despite the sluggishness of the economy – with GDP up 2.6% in 2016, compared with the record high growth rate of 13.3% in 2014 – the banks have been performing well. Net profit after tax at BSP, the country’s benchmark institution, was up 21% in 2016, while loan growth was 17.2%. While most of BSP’s income comes from interest, the fastest growth was recorded in foreign exchange, up 42% in 2016. Capital adequacy at the bank was reported to be 23.1%. MiBank reported a significant increase in profits, rising from PGK63,374 ($20,090) in 2015 to PGK905,351 ($287,000) in 2016.

Caution 

The IMF has noted that banks have been very cautious, and that the closure of the Ok Tedi Mine for a period in 2016 also had an impact on credit growth. It expects continued moderate growth in credit and the banking sector overall to remain sound, profitable and liquid.

The fund said that the capital adequacy of the three largest banks is very high, at an estimated 32.3% as of mid-2016. In its 2016 Article IV report, the IMF did note an increase in problem credits. Non-performing loans hit 2.6% of the total, up from 1.4% a year earlier, while past due loans rose to 3.9%, from 2.7% a year earlier. However, it is not overly concerned about the uptick as only around half of banking assets are loaned out.

Standard & Poor’s (S&P) notes that the banks are managing their risks well but said that they are vulnerable to larger, more general problems over which they have no control. With the economy weak, government finances strained, the country dependent on foreign financing and the economy tied to the global resources markets, which have been volatile, the institutions are limited in what they can do and their ratings are capped at a fairly low level. S&P expects the loan situation to worsen, but it does not expect the resulting losses to be significant.

Strong Regulation 

The sector is regulated by the Bank of PNG, the central bank, which is regarded as one of the strongest institutions in the country. A number of key pieces of legislation govern the sector: The Savings & Loan Societies (Amendment) Act 1995 – an amendment of the original 1961 Act – the Banks & Financial Institutions Act 2000 and the National Payment Systems Act 2013. The minimum capital for banks is PGK15m ($4.8m) and for Licensed Financial Institutions PGK1.5m ($475,500).

Significant work has been undertaken to further strengthen the sector. In 2011 the central bank issued a prudential standard regarding single borrower limits and large exposure limits. Financial institutions are permitted to loan a maximum of 25% of their capital base to any person or group of closely related persons and 40% of their capital to a single corporate group. All exposure is capped at 800% of the capital base. Some exceptions are allowed.

Fit and proper requirements have been established, effective from 2017 with full implementation set for 2018. Under the standards, boards of financial institutions must publish a fit and proper policy and review it regularly. The Bank of PNG will conduct a fit and proper assessment of any person who becomes a shareholder controller of a financial institution. The standard instructs institutions regarding the criteria to be used to determine whether a person is fit and proper, including offences, acts of fraud, bankruptcy and taxes.

PNG’s banking system graduated off the Financial Action Task Force grey list in June 2016 as a result of a raft of new laws and following an on-site audit conducted by the Asia/Pacific Group on Money Laundering. The laws, passed in 2015 and effective 2016, were: the Criminal Code (Money Laundering and Terrorist Financing) (Amendment) Act 2015; the UN Financial Sanctions Act 2015; the Anti-Money Laundering and Counter Terrorist Financing Act 2015; the Proceeds of Crime (Amendment) Act 2015; and the Mutual Assistance in Criminal Matters (Amendment) Act 2015.

Savings & Loan Soceity Upgrades 

The Savings & Loan Societies Act 2015 has been passed and is awaiting implementation.

The legislation completely overhauls the segment, with an entirely new regime for licensing created. Institutions will have to apply first to a registrar before seeking central bank approval.

Minimum capital requirements have been established, and the method of supervising savings and loans has changed, bringing oversight more in line with that for larger, more mainstream financial institutions. Directives, for example, are being replaced with prudential standards. The segment will also be made more open and competitive, and any person in the country will be able to apply for an account at any savings and loans society.

Savings and loan societies have had a volatile history. The ordinance governing the institutions was published in 1962, with the first society, at Sideia in Milne Bay Province, established the same year. The subsector initially saw rapid growth, with the number of institutions reaching 328 by 1973. However, the total then fell to 127 by 1981. The sector was poorly managed and regulatory oversight weak.

The central bank has made reform of this subsector a high priority, as outlined in its Strategic Plan 2016-20. Despite their small size and some historical problems, savings and loans societies have great potential in terms of improving financial access for communities. In early 2016 the societies were beginning the transition to the new act, with workshops being held by the PNG Federation of Savings and Loans Societies. As of mid-2017 the law was still awaiting official approval.

Moveable Assets 

In early 2016 a moveable assets registry was introduced. The hope is that the registry, which can include anything from vehicles to stock, will make lending to small enterprises easier and will help the country mobilise the value of so-called dead capital. Lenders can register their claim against an asset and can also check to see whether the asset is already otherwise encumbered. It has also been noted that lenders do not now need to go through the courts to repossess assets.

Excluded from the registry are some mining assets, oil and gas licences, and land, though most other types of personal property are eligible. The range of qualified interests is broad, including mortgages, book debts, chattel paper and interest on loans with terms of longer than one year.

The Personal Property Security Act (PPSA) was developed with the assistance of the Asian Development Bank (ADB) and was officially passed in 2011, although the registry was not up and running until 2016. It was modelled on the Australian Personal Property Securities Act 2009. The new law supersedes existing legislation and significantly changes the legal approach towards security interests, going from one of form to one of substance.

The Personal Property Security Registry (PPSR) does not accept physical documents, and is strictly online. Existing security interests needed to be registered within six months of the commencement of the PPSA. Previously, some types of registration were accepted at the Companies Registry, but after the new registry had become active these security interests had to be transferred. The process is not automatic, and some observers believe that this process will be a significant burden.

Concern has been raised in Australia about whether the new registry could result in the owners of aircraft and oil and gas assets inadvertently losing their rights if they fail to undertake proper registration. Unless the PPSR is utilised, a lessee of that property can sell it and the buyer can claim damages if the original owner seeks repossession.

Competition 

Despite the sector’s top-heaviness and the inherent conservative nature of the institutions, signs of competition are evident.

Banks are starting to pressure each other, and a sense is emerging that the model followed to date needs to be modernised. The new player is coming in with a number of early initiatives. While it is still too small to shake up the sector, Kina Bank is selectively picking opportunities to get noticed. In May 2017 it opened a branch in Vision City, the country’s largest mall. The location will have 15 staff. Kina Bank plans to open branches in other parts of the country, and the Vision City location is setting the standard.

In 2017 Kina Bank and the ADB signed a trade finance agreement under the Trade Finance Programme that will allow for $4m in loan guarantees. Kina Bank can now utilise the “AAA” rating of the ADB when offering trade finance. Kina is the third bank in the region to join the Trade Finance Programme, with Australia providing funds for the rollout of the programme in the Pacific.

BSP is continuing to upgrade and is staying competitive on price. In early 2017 the bank started offering cash deposit machines on a limited basis. Small and medium-sized enterprise customers are able to utilise the devices, located at BSP’s Harbour City and Boroko branches, using a special card. After a trial period is concluded the bank may start allowing other card types to be used in the machines.

BSP raised its interest rates on accounts and lowered loan rates in early 2017. Its PlusSaver account now pays a maximum of 3.5% a year, while the Sumatin account pays 1.6%. The Kundu Standard account, which charges no fees if the customer does not use the account, pays 0.25%. Personal unsecured loans now attract 29.9% a year interest.

In general, loan interest rates charged by commercial banks have been falling steadily over time, from 10.7% (on a weighted average basis) in 2012 to 8.16% at the end of 2016. Deposit rates have risen slightly, from 0.34% to 0.74%. BSP notes that it is making sure that customers have options, and that costs are controlled. “We have not raised fees in four years,” said Fleming.

Some competitors argue that while the three top banks are large in terms of asset size and total deposits, the market is more dynamic than it at first appears. Smaller institutions pick up a disproportional number of customers, and it is likely that this is where much of the growth will be in the future. These banks and non-bank financials can be more responsive and offer products that make more sense for the vast majority of people in PNG. “Some 25% of accounts in the country are outside the Big Four,” said Tony Westaway, managing director at MiBank. “The general public is not beholden to them. There is a need for more competition in retail banking.”

Microfinance 

The microfinance institutions themselves see inclusion developing naturally as individuals are provided with offerings that are competitive and convenient. They do not necessarily see the business as being too complicated, but add that it is a mistake to get distracted by the highly challenging component of the equation: extending credit. They say that the first steps are to provide deposit and withdrawal services and then provide value-added services, such as bill payment and money transfers. Making loans will come in time as people build credit and need additional funding. “Access to credit is overstated. Most people come to us as a place to put their money. Microfinance is savings led,” said Westaway (see analysis).

Big Picture 

The large institutions in the country are each pursuing unique strategies. Despite the sector being small in terms of the number of commercial banks, it is in some ways quite diverse in terms of market positioning and outlook.

BSP is increasingly focused on regional growth, especially since its purchase of Westpac’s Samoa, Cook Islands, Solomon Islands, Vanuatu and Tonga businesses in 2015, which followed the acquisition of Westpac’s Niue operation in 2004. The bank is becoming a pan-Pacific institution. It has 17 branches in Fiji, eight in Solomon Islands, three in Samoa, and two each in Tonga, the Cook Islands and Vanuatu, for a regional total of 72. It has strong or dominant market positions in most countries where it operates. In Fiji its share of loans is 22%; in Solomon Islands, 46%; the Cook Islands, 34%; Samoa, 22%; Tonga, 37%; and Vanuatu, 13%. Market share in deposits has been growing rapidly in the Cook Islands. Fiji is particularly strong, but it also has a dominant position or good growth in all the other Pacific markets. The bank said that in some smaller markets expansion comes from both acquiring customers from others and organic growth.

ANZ’s strategy has evolved considerably in recent years. At the corporate level, the bank is reassessing its aggressive global expansion and has started to divest assets in the Asia-Pacific region. It sold its retail banking businesses in Singapore, Hong Kong, China, Taiwan and Indonesia to Singapore’s DBS Bank in late 2016, a stake in a Shanghai bank in 2017 and its Vietnam retail banking operations, also in early 2017. In the rethink of the overall banking strategy, ANZ decided to shift reporting lines and merge its PNG operations with its Australia-based business, which previously it had considered a Pacific market.

Westpac, meanwhile, has reaffirmed its commitment to the country. While the bank is number three in PNG, with 14.3% of total loans, it has decided that it will stay and build its business. While the bank is noted to be conservative in its management, it sees PNG and Fiji as being particularly promising due to their size and economic potential. “We are here for the long term,” said Adrian Hughes, managing director of Westpac PNG. For the bank, that means being competitive in a number of ways. While it will stay primarily focused on the corporate side of the business and deal mainly with larger clients, retail will remain an important part of the mix.

Westpac believes that you must have a mass market presence to sustain a bank. It is also looking closely at fee structures and believes that there may be room in the market for more competition in terms of costs. The bank is inclined to move towards charging for account use and away from fixed monthly fees. “As a bank you have to do number of things well,” said Hughes. “You can’t have a business franchise without a retail strategy.”

Home Loans 

BSP has committed PGK160m ($50.7m) to the government’s First Home Ownership Scheme (FHOS). Under the programme, which was started in 2014, customers are offered highly favourable loan terms and conditions.

Normally home loans run for a maximum of 25 years, require a deposit of at least 20% and attract an interest rate of 8% a year. Under the FHOS, the duration of the loans is 40 years, the minimum deposit amount is 10% and the interest rate is 4%, with loan amounts ranging from PGK200,000 ($63,400) to PGK400,000 ($126,800). The funds must be used for new construction, the purchase of land and a house on a state lease, or the purchase of a house less than six months old on state land.

The government funds are not actually loaned to the customers, but are paid to the bank to cover the cost of the lower rates and compensate the bank for the better-than-market conditions offered. Some critics say that even with the programme, the average person has difficulty buying a home in Port Moresby, where prices are high.

Interest in home ownership is on the rise, with more people starting to attach importance to having their own house. BSP has noted an uptick in enquiries and found that customers are positive after seeing others successfully make a purchase. Mortgage applications are on the rise from people outside of Port Moresby, with new business coming from Lae, Kokopo, Alotau and Madang. Historically, banks have not played a significant role in the financing of homes, with most of the money coming from foreign sources or superannuation funds.

Mixed Signalling 

Some regulatory and governance issues have been noted. In 2016 the central bank changed the way interest rates are transmitted to the market, utilising the 63-day Treasury bill yield rather than the kina facility rate. It made the change to improve signalling. However, the IMF believes that the new mechanism is not effective because the banks do not see the right kind of opportunities in the economy and are concerned about the creditworthiness of the customers applying.

While PNG has done a good job of improving its legislation regarding money laundering and its efforts have been recognised, problems remain. The IMF notes that financial institutions have at times lost their correspondent banking relationships. It encourages the country to continue working on AML and know-your-customer initiatives.

The biggest problem has been the management of the foreign exchange markets. In 2014 the central bank tightened the trading range of the kina, resulting in a persistent shortage of dollars. This has significantly affected the banks. Directly, they are having trouble filling orders for dollars, while indirectly their clients, especially importers and wholesalers, are suffering. A number of attempts have been made to relieve the situation. In 2016 the country sought a $250m loan from the IMF to help it work through the backlog of dollar orders. That never materialised, but the government did raise $200m in late 2016 from a syndicate led by Credit Suisse. The loan was increased in 2017, with discussion of further expansion up to a possible $500m.

The central bank has said that the foreign exchange situation is improving, with the time needed to get currency falling from almost two months in 2016 to one to two weeks in 2017. Bankers have noted that the wait period has shortened and that they are able to fill orders more quickly.

Deals Not Done 

Kumul Consolidated was said to be considering a shareholding in BSP, and has also been discussing the possibility of forming a joint venture with the bank for the purpose of operating insurer Pacific MMI. As of early 2017 the insurance transaction had not happened.

BSP had been planning an initial public offering on the Australian Stock Exchange (ASX), with UBS and Morgan Stanley advising, but as of early 2017 the transaction had been put on hold due to structuring issues, according to the Australian Financial Review. The offering met with some scepticism in Australia.

Lender Moni Plus has been working on a listing in Singapore for some time in the hope that this would allow it to achieve liquidity in its shares and easier access to international capital. Moni Plus had considered the Port Moresby Stock Exchange and the ASX, but found Singapore to be the best route to market. It would be the first PNG company to be listed on the Singapore Exchange. However, due to heightened scrutiny by authorities in the country, as a result of the Malaysia 1MDB scandal, the listing has been delayed. In the transaction, Jaya Holdings, a corporate entity with $12.3m in cash and no operations, was to issue 725m new shares for the purchase of Moni Plus. The company was to have been valued at $168.1m.

Outlook 

The banking sector is well run and well capitalised. More could be done in terms of inclusiveness and some would like to see increased competition, but the consensus is that the institutions have managed themselves wisely, especially given the fall in growth in recent years. It is expected that they will continue to play an important and constructive role in terms of lending, intermediation and services, and that their businesses will expand considerably as growth rates increase when the new LNG project begins to contribute to the economy. It is also expected that any gaps in terms of coverage or services will increasingly be seen as opportunities to be taken up by the established players or others.