Abstract
This paper analyzes the workings and effectiveness of the monetary transmission mechanism in Papua New Guinea. The paper is organized as follows: it describes the current institutional structure in Papua New Guinea; interest rate is discussed; the evidence from vector autoregression analysis on the relationship between monetary policy variables and output and prices is considered; finally, implications are included. The Bank of Papua New Guinea (BPNG) uses a reserve money framework to conduct monetary policy operations. A macroeconomic balance approach estimates the REER, which simultaneously achieves internal and external balance.
IV. Financial Sector Developments in Papua New Guinea 1
A. Introduction
1. In recent years, Papua New Guinea’s financial system has experienced rapid transformation helped by sustained economic recovery, low interest rates, and high commodity prices of key exports. Following a period of severe economic and financial crisis in the late 1990s, the authorities began to introduce a significant reform of the financial system in 2000, including an increasingly prudent regulatory and supervisory regime, which has provided a viable environment for the financial sector to grow. This paper takes a snap shot look at the current status of the financial system, including its structure, the regulatory and supervisory framework, performance (using CAMEL approach), as well as the constraints and risks. In the last section, we conduct stress tests on the banking sector to assess its ability to absorb shocks. Finally, we discuss implication of our findings and areas of further reform.
B. Overview of the Financial Sector and Recent Developments
2. Papua New Guinea’s financial sector comprises four commercial banks, a number of finance companies, saving and loan institutions, superannuation funds, insurance companies, a government bond market and a stock exchange.
3. The banking system has four commercial banks (Australia and New Zealand Bank, Bank South Pacific, Maybank, and Westpac Bank). The domestic bank (Bank South Pacific) is the largest bank accounting for over 50 percent of the banking system. Total assets of the banking system have grown from 36 percent of GDP in 2000 to 51 percent of GDP at end-June 2007. Bank concentration estimated by the Herfindahl index (defined as the sum of squares of the shares of banks) shows a figure of over 40 percent having risen from 25 percent in 2000 following consolidation of the banking system.2 Papua New Guinea’s banks occupy a large share of the financial system (70 percent). However, despite the banking sector’s rapid growth in recent years, access to financial services remains poor, especially in rural areas. There is also a development bank (National Development Bank, formerly the Rural Development Bank) that lends with funds provided by the government.
4. The nonbank sector has grown significantly. The main institutions include ten licensed finance companies 3 (including microfinance companies) and seven superannuation funds.4 The superannuation funds have enjoyed rapid growth following their restructuring in the early 2000s. At end-2006, total assets of these funds amounted to K2.8 billion (one fourth of total financial sector assets or 16 percent of GDP). The two largest funds, Nambawan Super (formerly Public Officers’ Superannuation Fund (POSF)) at 56 percent and Nasfund at 31 percent share of the total, dominate the superannuation industry with 88,000 and 95,000 members, respectively. Prior to its reform in the early 2000s, POSF membership was restricted to government employees but is now opened to the private sector. There are also a number of small saving and loan institutions and insurance companies.
Financial Sector Assets: 2001-2006
(In percent GDP)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF staff calculations; Bank of Papua New Guinea; and Kina Securities Ltd.Financial Sector Assets: 2001-2006
(In percent GDP)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF staff calculations; Bank of Papua New Guinea; and Kina Securities Ltd.Financial Sector Assets: 2001-2006
(In percent GDP)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF staff calculations; Bank of Papua New Guinea; and Kina Securities Ltd.5. The securities market comprises a large government primary bond market and a stock exchange. The government bond market consists of short-term treasury bills and longer-term inscribed bonds (18 percent of GDP). Under the new government debt strategy, the short term instruments are being replaced by instruments with longer maturities in order to deepen the market. These securities are primarily held by commercial banks and other nonbanks. The Port Moresby Stock Exchange (POMSoX) is fairly thin having a share listing of only 14 companies 5 which have relatively high shareholder concentration; however, market capitalization has jumped from 52 percent of GDP to almost 130 percent of GDP during 2002–06, and has continued to rise sharply in 2007 helped by a positive economic environment and high profits of mining companies. The corporate bond market is virtually nonexistent.
Financial Sector Deepening
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, International Financial Statistics database; and CEIC Data Company Ltd.Financial Sector Deepening
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, International Financial Statistics database; and CEIC Data Company Ltd.Financial Sector Deepening
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, International Financial Statistics database; and CEIC Data Company Ltd.6. Despite rapid growth of the banking sector, financial sector depth is still low relative to comparator economies. While private sector credit growth has been high recently in Papua New Guinea, the ratio of credit to GDP is still low. To further estimate financial deepening, we included a sample of comparator Asian economies to examine the relationship between the level of private sector credit to GDP and its change over the last decade. We find that the degree of deepening in Papua New Guinea is low relative to comparators (ceteris paribus we would expect countries to fall along the negatively sloped line or countries with high level of private sector credit to GDP in 1995 to have slower private sector credit growth and vice versa).
Private Sector Credit Growth, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, Information Notice System; and World Economic Outlook.Private Sector Credit Growth, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, Information Notice System; and World Economic Outlook.Private Sector Credit Growth, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, Information Notice System; and World Economic Outlook.
Private Sector Credit to GDP, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, Information Notice System; and World Economic Outlook.Private Sector Credit to GDP, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, Information Notice System; and World Economic Outlook.Private Sector Credit to GDP, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, Information Notice System; and World Economic Outlook.C. Regulatory and Supervisory Framework
7. Beginning in 2000, the authorities undertook a significant revamping of the regulatory framework. The current framework now encompasses laws governing the central bank, commercial banks and finance institutions, saving and loans, superannuation funds, and life insurance companies that were new or reformed at that time. The most recent reform was in 2007 relating to the superannuation industry to improve and further strengthen the effectiveness of regulations and supervision.6 The financial sector’s regulatory framework is transparent and is posted on Bank of Papua New Guinea (BPNG)’s website. Most institutions including the two largest superannuation funds disclose their financial results and are regularly audited as required by law. Papua New Guinea does not have an explicit deposit insurance system.7 New legislation has been passed by the parliament governing the newly-revived National Development Bank which aims to expand its activities into the microfinance sector with deposit-taking and lending to districts. However, the BPNG has not yet issued it a license for microfinance.
8. The banks’ supervisory framework is fully compliant with the 1988 Basel I Core Principles and efforts are being made to follow the Basel II recommendations. The outstanding issues are primarily related to capacity building and the establishment of a comprehensive bank database. Commercial banks, finance institutions and superannuation funds are supervised once a year through on-site examinations. Off site supervision is conducted quarterly. Currently, there are plans to extend supervision to all insurance companies.
9. Plans are underway to introduce a credit registration system for banks. Currently, borrower credit information is shared only informally. The International Finance Corporation is assisting the BPNG in setting up a credit bureau, which the commercial banks welcome.
10. The POMSoX rules and regulations closely follow the Australian stock exchange (ASX) model. The stock market regulations are considered to be generally appropriate although oversight is being tightened. The 1997 parliamentary passage of the Securities Act and Company Act paved the way for establishing the legal framework governing the exchange, and in 1998 POMSoX was incorporated as a private company. While there is a concentration of large shareholders, small investors are permitted to purchase shares in listed companies.
11. The liberalization of the capital account since 2005 has contributed to a conducive environment for financial sector growth. A key innovation, since 2005, is the permission to allow nonresident companies (notably mining) to borrow from banks. Foreign exchange accounts by both residents and nonresidents are permitted. Short-term commercial credits with less than one month maturity are not actively regulated. Large financial institutions are taking increasing advantage of investment opportunities abroad, although improved domestic economic conditions could offset the anticipated outflows.
D. Performance of the Financial Sector
Capital Adequacy
12. Backward looking indicators of capital adequacy are strong. At end-June 2007, commercial banks’ capital to risk weighted assets remained comfortable at 25 percent, against the prudential minimum requirement of 12 percent. This is significantly higher than the comparator Asian low income and small countries (LISC)8 where the average ratio was 18.3 percent at end-2006, and also higher than selected countries shown in the figure below. At the same time, latest data for Tier 1 capital to risk weighted assets in the Papua New Guinea banking system also shows a comfortable level (16.8 percent in June 2007) against the prudential requirement of 8 percent.
Capital Adequacy Ratio, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: Country authorities.Capital Adequacy Ratio, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: Country authorities.Capital Adequacy Ratio, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: Country authorities.
Non Performing to Total Loans, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: Country authorities.Non Performing to Total Loans, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: Country authorities.Non Performing to Total Loans, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: Country authorities.Asset Quality
13. Commercial banks’ asset quality is reasonably sound. Banks hold about a third of their portfolio in government securities, and have a preference for short-term instruments. In terms of lending quality, the ratio of nonperforming loans to total loans declined significantly from 16.9 percent to 1.8 percent from 2000 to 2007; comparatively, selected Asian countries had higher average ratios, including those that have also seen rapid rates of credit growth in recent years. At the same time, both Papua New Guinean banks and finance companies have maintained high provisioning ratios of loans losses relative to their NPLs.
14. Personal and commerce sectors comprise an important share of bank credit, while building and construction, and transport and communication have grown. Outstanding advances to mining and quarrying had also grown significantly over the past year (likely associated with the 2005 liberalization of lending to nonresident companies and increased mining activity) but fell substantially in September 2007.
Banking Credit, 2000
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Banking Credit, 2000
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Banking Credit, 2000
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Banking Credit, Sept. 2007
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Banking Credit, Sept. 2007
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Banking Credit, Sept. 2007
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
15. While asset quality in terms of total assets is generally not yet of concern, certain underlying trends over the past year could be noted which may stretch supervisory capacity. Banks’ zero risk assets to total risk-weighted assets fell from 53 percent to 48 percent in June 2007 (y/y), while the share of 50 percent risk-weighted assets rose from 4 percent to 13 percent. Also, the stock of NPLs and past due loans have started to rise from negative growth in past years, although they are stable in relation to total loans. The NPLs of the National Development Bank have been reported to be around 100 percent on “old” and 20 percent on “new” loans.
16. At the same time, the overall banking system’s large borrower exposure is considered high. In particular, the exposure of the 25 largest borrowers against banking system’s total prudential capital base was about 100 percent in June 2007, although individual borrower exposures have not been high.
17. The rapid expansion of the superannuation funds so far does not seem to have an adverse effect on asset quality. While Nasfund and Nambawan Super have invested in the domestic equity and property markets, they have also expanded overseas investments to diversify their portfolio and now earn higher returns in both fixed income assets as well as equities (total international investments for the two funds accounted for 23.0 percent and 17.4 percent, respectively in 2006). Over the past few years, both funds have also enjoyed rapid asset growth.
Management Quality and Conduct
18. The return on assets, which measures the ability of management to utilize real and financial resources of a bank to generate returns, rose from 1.2 percent to 2.8 percent during 2000–07. The figure here shows Papua New Guinea’s return on assets relative to comparator Asian countries. Management accountability in key financial institutions is evidenced by the regular publication of financial reports and company information posted on their respective websites for the benefit of shareholders and customers.
Return on Assets, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: Country authorities.Return on Assets, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: Country authorities.Return on Assets, 2006
(In percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: Country authorities.Interest Rate Structure and Earnings Performance
19. Interest rate spreads (lending minus deposit rates) have declined in recent years (see figures below). Spreads were as high as 11 percent before easing to a still high 9.6 percent in 2006, likely reflecting macroeconomic uncertainty, high administrative costs of banks in rural areas, limited bank competition, and low incentive to attract deposits given banks’ relative preference to hold government paper in light of limited investment opportunities. While Papua New Guinea’s nominal lending rates in 2006 (10.6 percent) were lower than the LISC average (14.0 percent), real lending rates were comparable (7.0 percent). In comparison to U.S., Australia, and Indonesia, real lending rates are higher in Papua New Guinea, although they have declined over the years in part due to lower inflation.
Interest Rate Spreads, 1995-2006
Difference between lending and deposit rates
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: IMF, IFS DatabaseInterest Rate Spreads, 1995-2006
Difference between lending and deposit rates
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: IMF, IFS DatabaseInterest Rate Spreads, 1995-2006
Difference between lending and deposit rates
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Source: IMF, IFS Database
Interest Rate Spread
(In percent per year)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, International Financial Statistics and World Economic Outlook; and Fund staff calculations.Interest Rate Spread
(In percent per year)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, International Financial Statistics and World Economic Outlook; and Fund staff calculations.Interest Rate Spread
(In percent per year)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Sources: IMF, International Financial Statistics and World Economic Outlook; and Fund staff calculations.20. Both banks and superannuation funds have enjoyed high profitability in recent years. As the return on assets rose, the return on equity also increased from 21.7 percent to 38.9 percent over the same period. By contrast, low income and small Asian countries on average show an equivalent return on assets (3.0 percent), but a lower return on equity (29.5 percent) as of 2006. The largest superannuation funds, Nambawan Super and Nasfund, enjoyed high net after tax return (16 and 10 percent, respectively in 2006).
Liquidity
21. Liquidity in the financial system is high, constituting large holdings of government paper. Commercial banks’ liquidity (average liquid assets to total deposits) rose from 54 percent in 2002 to around 75 percent in 2007—significantly higher than the average for low income and small Asian countries (27 percent).
Efficiency
22. Banks have been generating strong profits and dividends resulting from a favorable economic environment and high commodity prices, but also due to their ability to control expenses. The “efficiency ratio” measured by noninterest expenses to gross income is around 40 percent and average gross income per employee (K274,000) for the banking system is significantly greater than per employee costs (K41,000).
Papua New Guinea: Banking System Financial Soundness Indicators, 2006
(in percent)
Papua New Guinea: Banking System Financial Soundness Indicators, 2006
(in percent)
| Indicator | All banks |
|---|---|
| Regulatory capital to risk-weighted assets | 24.8 |
| Tier1 capital to risk-weighted assets | 17.9 |
| Nonperforming loans (NPLs) to total loans (both net of accrued interest on NPLs) | 1.8 |
| Nonperforming loans (net of provisions and accrued interest) to regulatory capital | 1.7 |
| Loan loss provisions to nonperforming loans (net of accrued interest) | 73.6 |
| Return (before tax) on assets | 6.9 |
| Return (before tax) on equity | 60.1 |
| Interest margin to gross income | 45.8 |
| Noninterest expenses to gross income | 39.0 |
| Foreign exchange gains/losses to gross income | 39.5 |
| Total operating expenses over average assets | 4.4 |
| Average interest rate paid on interest-bearing liabilities | −1.5 |
| Average interest rate received on interest-earning assets | 7.2 |
| Gross income per employee (thousand domestic currency units) | 273.9 |
| Staff expenses per employee (thousand domestic currency units) | 40.5 |
| Share of foreign-currency deposits in total deposits | 7.9 |
| Ratio of net loans to total deposits | 37.0 |
| Liquidity ratio | 75.9 |
Papua New Guinea: Banking System Financial Soundness Indicators, 2006
(in percent)
| Indicator | All banks |
|---|---|
| Regulatory capital to risk-weighted assets | 24.8 |
| Tier1 capital to risk-weighted assets | 17.9 |
| Nonperforming loans (NPLs) to total loans (both net of accrued interest on NPLs) | 1.8 |
| Nonperforming loans (net of provisions and accrued interest) to regulatory capital | 1.7 |
| Loan loss provisions to nonperforming loans (net of accrued interest) | 73.6 |
| Return (before tax) on assets | 6.9 |
| Return (before tax) on equity | 60.1 |
| Interest margin to gross income | 45.8 |
| Noninterest expenses to gross income | 39.0 |
| Foreign exchange gains/losses to gross income | 39.5 |
| Total operating expenses over average assets | 4.4 |
| Average interest rate paid on interest-bearing liabilities | −1.5 |
| Average interest rate received on interest-earning assets | 7.2 |
| Gross income per employee (thousand domestic currency units) | 273.9 |
| Staff expenses per employee (thousand domestic currency units) | 40.5 |
| Share of foreign-currency deposits in total deposits | 7.9 |
| Ratio of net loans to total deposits | 37.0 |
| Liquidity ratio | 75.9 |
23. The thin securities markets limit financial deepening. Stock market capitalization (at over 100 percent of GDP) is amongst the highest as compared to the group of low income and small Asian countries (15 percent of GDP), helped by dual listing of several companies on both the Papua New Guinea and foreign stock exchanges (mainly Australia). However, at the same time, comparatively, there are fewer companies and the annual market turnover is relatively low (0.5 percent of GDP vs. 1.6 percent of GDP for sample of LISC countries). At present, there are only two brokers and relatively high shareholder concentration. The thin stock exchange potentially could limit the ability of firms (especially in the nonmineral sector) to secure equity financing, hence further increasing their reliance on banks. As regards other markets, there is only a primary government securities market with financial institutions holding about 85 percent of these securities.
E. Constraints, Vulnerabilities, and Risks
24. Papua New Guinea ranks relatively low in a global ranking of “getting credit” (115 out of 175 countries), according to the latest World Bank’s Doing Business survey. Focusing on the sub-categories, the “legal rights” index performs equally well relative to the region, while given an absence of a credit registry in Papua New Guinea, the “credit information index” (representing the access and quality of credit information available through public registries or private bureaus) receives a 0 rating out of a possible 6 (with a 2 rating for South Asia and East Asia/Pacific region). At the same time, Papua New Guinea also ranks relatively low in the categories of “enforcing contracts” (162) and “closing a business” (97).
Doing Business: Papua New Guinea and Comparators 1/
Economics are ranked on their ease of doing business, from 1-178, with first place being the best.
Simple average of countries in the region.
Doing Business: Papua New Guinea and Comparators 1/
| Overall Ease | Protecting Investors | Enforcing Contracts | Closing a Business | Getting Credit | |
|---|---|---|---|---|---|
| Papua New Guinea | 84 | 33 | 162 | 97 | 115 |
| East Asia and Pacific 2/ | 77 | 77 | 86 | 98 | 99 |
| South Asia 2/ | 107 | 70 | 132 | 113 | 102 |
Economics are ranked on their ease of doing business, from 1-178, with first place being the best.
Simple average of countries in the region.
Doing Business: Papua New Guinea and Comparators 1/
| Overall Ease | Protecting Investors | Enforcing Contracts | Closing a Business | Getting Credit | |
|---|---|---|---|---|---|
| Papua New Guinea | 84 | 33 | 162 | 97 | 115 |
| East Asia and Pacific 2/ | 77 | 77 | 86 | 98 | 99 |
| South Asia 2/ | 107 | 70 | 132 | 113 | 102 |
Economics are ranked on their ease of doing business, from 1-178, with first place being the best.
Simple average of countries in the region.
Doing Business-Getting Credit Sub-indices: Papua New Guinea and Comparators
Higher score the better. Legal Rights Index has a score from 0-10 and Credit Information Index from 0-6.
Doing Business-Getting Credit Sub-indices: Papua New Guinea and Comparators
| Legal Rights Index 1/ | Credit Information Index 1/ | Public Registry Coverage (% of adults) | Private Bureau Coverage (% of adults) | |
|---|---|---|---|---|
| Papua New Guinea | 5.0 | 0.0 | 0.0 | 0.0 |
| East Asia and Pacific | 4.5 | 1.9 | 5.5 | 10.8 |
| South Asia | 3.9 | 1.9 | 0.7 | 1.9 |
Higher score the better. Legal Rights Index has a score from 0-10 and Credit Information Index from 0-6.
Doing Business-Getting Credit Sub-indices: Papua New Guinea and Comparators
| Legal Rights Index 1/ | Credit Information Index 1/ | Public Registry Coverage (% of adults) | Private Bureau Coverage (% of adults) | |
|---|---|---|---|---|
| Papua New Guinea | 5.0 | 0.0 | 0.0 | 0.0 |
| East Asia and Pacific | 4.5 | 1.9 | 5.5 | 10.8 |
| South Asia | 3.9 | 1.9 | 0.7 | 1.9 |
Higher score the better. Legal Rights Index has a score from 0-10 and Credit Information Index from 0-6.
25. The scope for financial deepening is also constrained by weak corporate insolvency and debt recovery procedures (see Appendix Table I, lines 1–20).9 These procedures include formal and informal rules for enforcement of debt contracts, bankruptcy liquidation, and the rehabilitation of distressed firms. We note that while the procedures for acquiring collateral are comparable to sample countries, the process of collateral enforcement is weaker. More generally, a high degree of communal land ownership (about 97 percent of all land) and less liquid asset markets could be constraining the ability of lending institutions to secure and especially enforce collateral requirements. Given weaknesses in formal debt recovery procedures, informal procedures could be preferred (e.g., lines 11–14). More positively, the judicial processes for debt recovery (lines 17–20) appear to be relatively more efficient in Papua New Guinea compared with most sample countries including Bangladesh and Indonesia.
Stress Tests for Papua New Guinea Banking System
26. In order to examine the vulnerability of the banking sector, stress tests were performed.10 Our analysis uses the 2006 audited annual reports of the four commercial banks as well as end-2006 banks’ financial statements provided by BPNG. The sensitivity analysis replicates plausible scenarios from the late 1990s economic and financial crisis in Papua New Guinea as well as aspects of the 1997 Asian crisis that include a rise in the share of nonperforming loans to total loans to 15–20 percent and a near doubling of interest rates. Looking forward, these events could arise in an environment of weak domestic policies and rapid decline in commodity prices. The main focus of the analysis is on (i) credit and borrower concentration risk; (ii) risk arising from migration of assets from low to high risk-weight groups; and (iii) interest rate risk. Foreign exchange risk is not analyzed since we do not have sufficient individual bank data on foreign exchange (FX) assets and FX liabilities. From the aggregate data that is available on banks, it appears that the risk is not high at present (FX deposits comprise only 8–10 percent of total deposits and FX loans constitute around 6–10 percent of total loans). Moreover, liquidity risk does not seem to be a concern at present since the liquid assets to total deposits were 76 percent in 2006.
Box. What are Stress Tests?
Stress tests are analytical techniques for quantifying the vulnerability of banks’ portfolio to exceptional but plausible changes in the macro environment.1 Under the stress tests, the effect of shocks on banks’ soundness is measured by their impact on banks’ regulatory capital to risk-weighted assets.
Credit risk stress tests quantify the effect on banks’ soundness of deterioration in the average asset quality of their portfolios. The deterioration of asset quality has both a repricing and a net income effect on banks’ regulatory capital. The following credit risk tests were applied:
(i) Increase in nonperforming loans: the nonperforming loans approach involves reclassification of existing current loans to nonperforming, with corresponding increases in the level of specific provisions and a decrease in the level of general provisions;
(ii) Large exposures to borrowers: the stress test on banks’ large exposures to borrowers is a specific parameterization of the credit risk stress test based on the nonperforming loans approach. It involves the reclassification of all loans to each bank’s largest borrowers (assumed to be current prior to the stress test) to nonperforming, with corresponding increases in the level of specific provisions and a decrease in the level of general provisions; and
(iii) Increased provisioning approach on existing NPLs: the provisioning approach involves the reclassification of existing nonperforming loans into categories indicating a higher degree of impairment. A corresponding increase in the level of specific provisions would need to be set aside by banks to cover the upwardly revised expectations of losses.
Finally, we also performed a test for migration of risk-weighted assets from low risk to high-risk weights.
Interest rate risk is estimated using the duration model, which measures the impact of interest rate changes only on the price of securities held by banks. Duration can be defined as the weighted-average of time to maturity, using the present value of cash flows as weights. In Papua New Guinea, banks hold government securities only sold in the primary market.
27. Individual stress test analysis shows that the banking system is resilient to moderate shocks:11
Starting with baseline capital asset ratio of 24.8 percent (regulatory minimum is 12 percent), the reclassification of existing NPLs indicating a higher degree of impairment for each NPL category 12 (i.e., 33 percent in each category) only shows a marginal decline in the capital asset ratio.
The capital asset ratio falls to 22.1 percent under the condition that all existing NPLs shift from substandard to bad.
While the current NPLs to total loans is low at the present time, the deterioration of loans so that 15 percent of current loans become substandard NPLs reduces the capital to risk weighted assets ratio to 22.2 percent. This scenario is similar to the events that marked the 1997 Asian crisis (see Hussain and Wihlborg, 1999) and the late 1990s Papua New Guinea crisis.
The interest rate risk test (duration test) for a doubling of interest rates (as in the Papua New Guinea crisis) reduces the ratio to 20.4 percent.
The stress tests indicate that the risk from large borrower exposure is high. The loss of the single largest borrower of each bank reduces capital adequacy ratios to 18.3 percent.
The test for migration of assets from low to high risk weights (by 25 percent) reduces the capital asset ratio to 17.7 percent.
In the case that 15 percent of current loans become “loss” or bad loans (delinquent for more than 360 days), the capital asset ratio declines to 14.6 percent.
An extreme crisis scenario involving the loss of each bank’s five largest borrowers almost exhausts the capital of the banking system.
Capital to risk weighted assets
(in percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Capital to risk weighted assets
(in percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
Capital to risk weighted assets
(in percent)
Citation: IMF Staff Country Reports 2008, 093; 10.5089/9781451831740.002.A004
28. The integrated approach using a “scenario” analysis combining some of the above individual tests shows a greater degree of vulnerability in the banking system. We examined two combined shock scenarios (see figure above):
Combined shocks 1: 15 percent of current loans become substandard, doubling of interest rates, and migration of assets from low to high risk weights (by 25 percent) reduces the capital adequacy ratio to 12.4 percent (to the required regulatory minimum); and
Combined shocks 2: loss of the largest borrower, doubling of interest rates, and migration of assets from low to high risk weights (by 25 percent) leads to a deterioration of capital adequacy ratio to 9.4 percent (below the required regulatory minimum). Although not included in the figure, the most extreme scenario, which involves the loss of the five largest borrowers in each bank, along with the interest rate and migration risk, completely exhausts the banking system capital.
F. Conclusions and Implications
29. The backward looking soundness indicators show that the financial system is sound. However, stress test analysis finds that while the system can absorb moderate shocks, a combination of shocks brought about by weak macro policies and an unfavorable external environment (with declining commodity prices) could add significant vulnerability. Our examination of the financial system illustrates that financial deepening is still low despite high credit growth in recent years. Looking forward, continued high credit growth and growing international investment opportunities for financial institutions requires that these institutions strengthen their internal risk management systems in addition to improved supervision by the authorities. In this regard, the authorities are appropriately considering the establishment of a credit bureau. The authorities should also ensure that due diligence and fit and proper criteria are applied for all new applicants for licenses, including for the Development Bank. Moreover, prudent macroeconomic policies are the only means of averting financial crisis given past experiences of Papua New Guinea and other countries. In order to enhance financial deepening, the authorities should reduce structural rigidities in the system, including improved rules for collateral and procedures for insolvency and debt recovery, and further develop the securities markets. In this regard, a Financial Sector Assessment Program (FSAP) conducted jointly by the IMF and World Bank could be useful to provide an assessment of recent developments and recommendations for the way forward.
Summary Evaluation of Processes for Debt Recovery
Summary Evaluation of Processes for Debt Recovery
| Papua New Guinea | Bangladesh | Indonesia | Korea | Malaysia | Philippines | Taiwan Province of China | Thailand | |
|---|---|---|---|---|---|---|---|---|
| 1 = low cost (or not expensive), easy, very efficient, quick; | ||||||||
| 3 = very expensive, very difficult, inefficient and very slow | ||||||||
| 1. Process for acquiring security (collateral) over land | 1.50 | 3.00 | 2.75 | 1.25 | 1.25 | 1.50 | 1.50 | 1.50 |
| 2. Process for acquiring security over other property | 1.50 | 2.55 | 2.75 | 1.25 | 1.25 | 1.50 | 1.50 | 1.50 |
| 3. Process for enforcement of security over land | 2.50 | 3.00 | 3.00 | 1.25 | 1.25 | 2.00 | 1.75 | 1.25 |
| 4. Process for enforcement of security over other property | 2.00 | 2.50 | 2.50 | 1.25 | 1.25 | 2.00 | 1.50 | 1.75 |
| 5. Process for debt collection | 2.50 | 2.75 | 2.50 | 1.25 | 1.25 | 3.00 | 2.00 | 1.50 |
| 6. Process for winding up insolvent corporation | 2.00 | 3.00 | 2.50 | 1.25 | 2.00 | 3.00 | 2.00 | 1.50 |
| 7. Process for reorganization/restructuring | 2.50 | 3.00 | 2.50 | 1.75 | 2.00 | 2.25 | 2.25 | 1.50 |
| 8. Time for winding up | 6-12 months | 7-8 months | 4-6 months | 6-12 months | 6-12 months | #x0226B;6 months | #x0226B;6 months | #x0226B;6 months |
| 9. Time for formal reorganization | 6-12 months | 7-8 months | 12-18 months | 2-4 months | 8-12 months | #x0226B;18 months | 8-12 months | #x0226B;18 months (since 98) |
| 10. Time for informal workout | 6-12 months | 7-8 months | 4-8 months | 2-4 months | 2-4 months | 12-18 months | 12-18 months | #x0226B;18 months |
| 11. Incidence of bankruptcy/liquidation | Low | Very low | Very low | Low | High | N/A | Very low | Low |
| 12. Incidence of reorganization/restructuring | Low | N/A | N/A | High | High | N/A | Very low (since 98) | |
| Workouts preferred because: | ||||||||
| 13. Bankruptcy procedures are a real alternative | Not really | No | Adverse effect | Government Encourages workout | Yes | No | No | Yes |
| 14. Better outcome than under formal procedures | In most cases | No | No | No, for secured creditors | Yes | No | Yes | No |
| Predictability of positive outcome of: | 1 = very high 5 = very low | |||||||
| 15. Process for security enforcement; land | 3.00 | 5.00 | 5.00 | 2.00 | 2.00 | 2.00 | 2.00 | 2.00 |
| 16. Process for security enforcement other than land | 3.00 | 4.50 | 5.00 | 4.00 | 2.00 | 2.00 | 1.00 | 3.00 |
| 17. Judicial handling of security enforcement | 3.00 | 5.00 | 5.00 | 3.00 | 2.00 | 3.00 | 2.00 | 2.00 |
| 18. Judicial handling of debt collection | 2.00 | 5.00 | 5.00 | 3.00 | 2.00 | 3.00 | 1.00 | 2.00 |
| 19. Judicial handling of bankruptcy/liquidation | 3.50 | 5.00 | 5.00 | 4.00 | 2.00 | 4.00 | 5.00 | 4.00 |
| 20. Judicial handling of rehabilitation | 3.50 | 5.00 | 5.00 | 4.00 | 3.00 | 4.00 | 5.00 | 5.00 |
Summary Evaluation of Processes for Debt Recovery
| Papua New Guinea | Bangladesh | Indonesia | Korea | Malaysia | Philippines | Taiwan Province of China | Thailand | |
|---|---|---|---|---|---|---|---|---|
| 1 = low cost (or not expensive), easy, very efficient, quick; | ||||||||
| 3 = very expensive, very difficult, inefficient and very slow | ||||||||
| 1. Process for acquiring security (collateral) over land | 1.50 | 3.00 | 2.75 | 1.25 | 1.25 | 1.50 | 1.50 | 1.50 |
| 2. Process for acquiring security over other property | 1.50 | 2.55 | 2.75 | 1.25 | 1.25 | 1.50 | 1.50 | 1.50 |
| 3. Process for enforcement of security over land | 2.50 | 3.00 | 3.00 | 1.25 | 1.25 | 2.00 | 1.75 | 1.25 |
| 4. Process for enforcement of security over other property | 2.00 | 2.50 | 2.50 | 1.25 | 1.25 | 2.00 | 1.50 | 1.75 |
| 5. Process for debt collection | 2.50 | 2.75 | 2.50 | 1.25 | 1.25 | 3.00 | 2.00 | 1.50 |
| 6. Process for winding up insolvent corporation | 2.00 | 3.00 | 2.50 | 1.25 | 2.00 | 3.00 | 2.00 | 1.50 |
| 7. Process for reorganization/restructuring | 2.50 | 3.00 | 2.50 | 1.75 | 2.00 | 2.25 | 2.25 | 1.50 |
| 8. Time for winding up | 6-12 months | 7-8 months | 4-6 months | 6-12 months | 6-12 months | #x0226B;6 months | #x0226B;6 months | #x0226B;6 months |
| 9. Time for formal reorganization | 6-12 months | 7-8 months | 12-18 months | 2-4 months | 8-12 months | #x0226B;18 months | 8-12 months | #x0226B;18 months (since 98) |
| 10. Time for informal workout | 6-12 months | 7-8 months | 4-8 months | 2-4 months | 2-4 months | 12-18 months | 12-18 months | #x0226B;18 months |
| 11. Incidence of bankruptcy/liquidation | Low | Very low | Very low | Low | High | N/A | Very low | Low |
| 12. Incidence of reorganization/restructuring | Low | N/A | N/A | High | High | N/A | Very low (since 98) | |
| Workouts preferred because: | ||||||||
| 13. Bankruptcy procedures are a real alternative | Not really | No | Adverse effect | Government Encourages workout | Yes | No | No | Yes |
| 14. Better outcome than under formal procedures | In most cases | No | No | No, for secured creditors | Yes | No | Yes | No |
| Predictability of positive outcome of: | 1 = very high 5 = very low | |||||||
| 15. Process for security enforcement; land | 3.00 | 5.00 | 5.00 | 2.00 | 2.00 | 2.00 | 2.00 | 2.00 |
| 16. Process for security enforcement other than land | 3.00 | 4.50 | 5.00 | 4.00 | 2.00 | 2.00 | 1.00 | 3.00 |
| 17. Judicial handling of security enforcement | 3.00 | 5.00 | 5.00 | 3.00 | 2.00 | 3.00 | 2.00 | 2.00 |
| 18. Judicial handling of debt collection | 2.00 | 5.00 | 5.00 | 3.00 | 2.00 | 3.00 | 1.00 | 2.00 |
| 19. Judicial handling of bankruptcy/liquidation | 3.50 | 5.00 | 5.00 | 4.00 | 2.00 | 4.00 | 5.00 | 4.00 |
| 20. Judicial handling of rehabilitation | 3.50 | 5.00 | 5.00 | 4.00 | 3.00 | 4.00 | 5.00 | 5.00 |
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Prepared by Qaizar Hussain. This chapter is based on a presentation delivered at the Bank of Papua New Guinea in Port Moresby in November 2007 and benefits from comments received at that time.
Bank South Pacific has about 40 branches in Papua New Guinea (along with a branch in Niue and newly acquired banks in Fiji and Solomon Islands). The Australian bank subsidiaries, Australia and New Zealand Bank and Westpac Bank, have 9 and 15 branches, respectively, and Maybank, a subsidiary of a Malaysian bank, operates 2 branches in Papua New Guinea (see Briggs, 2007). Along with the branches, the number of Automatic Teller Machines continues to grow rapidly.
These financial institutions are restricted from issuing checkable deposits.
In a superannuation fund, members’ entitlements are calculated by reference to the amounts standing in the members’ individual accounts and not by reference to defined or guaranteed benefits. It provides for compulsory savings for retirement through mandatory and/or voluntary contributions by employees and employers.
Of the 14 companies, nine have home listings and five have dual listings. Companies comprise mainly mining and financial companies. In addition, there is one company having a debt listing.
A key change was the requirement for compulsory superannuation coverage for companies to 15 from 20 employees while the change to also include noncitizens was delayed for a year.
Like Papua New Guinea, Australia, New Zealand, and Singapore have implicit deposit insurance; by contrast, other neighbors such as Indonesia, Malaysia, and Thailand have explicit deposit insurance.
The sample includes Bangladesh, Bhutan, Brunei Darussalam, Cambodia, Fiji, Kiribati, Lao P.D.R., Maldives,
We obtained an assessment of processes for debt recovery from a banking expert in Papua New Guinea during the 2007 Article IV mission. The table compares Papua New Guinea with several low and middle income countries in the region reported in previous studies (Hussain and Wihlborg, 1999 and Hussain, 2002). The country wide comparisons should be treated with caution since we used different time periods, and procedures would be expected to improve over time. Also, there is a risk that each individual country survey could employ a different “scale” for evaluation.
The stress tests reported for the Papua New Guinea banking system in this sub-section were performed using templates accompanying the “Stress Test Toolkit” prepared by Plamen Iossifov (IMF), 2007.
The discussion for individual stress tests in this paragraph corresponds to declining capital assets ratios in the figure below (from left to right).
According to Papua New Guinea’s prudential standards, loans are classified as (i) pass, or acceptable; (ii) special mention (past due for 60–90 days); (iii) substandard (past due for 90–180 days); (iv) doubtful (past due for 180–360 days); and (v) loss (past due for more than 360 days).
