SECTOR ASSESSMENT (SUMMARY): FINANCE

Microfinance Expansion Project (RRP PNG 44304) Sector Road Map SECTOR ASSESSMENT (SUMMARY): FINANCE 1. Sector Performance, Problems, and Opportunities 1. During 2000 2006, the growth in population in Papua New Guinea (PNG) was 17.5% (or a compound annual growth rate of approximately 2.7% per annum). During the same period, the growth in gross domestic product (GDP) for the agriculture market economy was 13.0% and for the nonmarket economy 16.9%. The rural population has become increasingly dependent on the nonmarket economy but its growth is slightly lower than the growth in population. The drivers for economic growth by size and by sector were construction, trade, nonmarket agriculture, manufacturing, finance, gas and water, and transport and communications and, apart from agriculture, most of this was urban rather than rural focused. These data illustrate the need to stimulate the rural economy so as to increase rural incomes. 2. Financial markets in PNG do little to support efficient investment and entrepreneurship. The ratio of private sector credit to GDP is below 30%, even though financial institutions have substantial liquidity. Financial markets remain underdeveloped. Although no official data exists, the Asian Development Bank (ADB) estimates that only 15% of the population has access to formal or informal banking facilities. Particularly in rural areas, access to finance remains extremely low. Small and medium-sized enterprises have difficulty getting financing, and credit is costly the spreads between borrowing and lending rates and on foreign exchange transactions are very high by international standards. 1 PNG does not have a secondary debt market. A rudimentary collateral framework and lack of credit information further inhibit lending, although a credit bureau was established in 2008, and ADB has recently begun work on collateral reforms through the Private Sector Development Initiative Phase II. 2 The recent growth of savings accounts among the few small scale finance institutions in PNG demonstrates significant unmet demand for deposit facilities. 3 3. PNG has four commercial banks, the state-owned National Development Bank, two major superannuation funds, a number of finance companies, two regulated microfinance institutions (first-tier microfinance institutions [MFIs]), about 20 savings and loan societies (SLSs), which are regulated by the Bank of PNG (BPNG) under their own act, and a number of unregulated semiformal and informal microfinance providers (second-tier MFIs). The commercial banks including the locally based Bank South Pacific, the Australia and New Zealand Banking Corporation, and Westpac comprise the largest lending group and generally target larger and more creditworthy customers. 4. The two principal microfinance providers PNG Microfinance Limited and Nationwide Microbank have expanded their rural outreach and have a total of 21 branches. SLSs and the second-tier MFIs have also grown. However, the cost of reaching rural customers through traditional branch networks remains high and institutions are increasingly looking to innovative models for rural outreach. This has involved creating links between the larger, regulated microbanks and local institutions, and branchless and mobile phone payments and banking models are attractive. These models are made possible by the increasing coverage of the mobile telephone network throughout PNG. 1 According to the Bank of Papua New Guinea (BPNG), in December 2009, the weighted average cost of deposits for commercial banks was 2.2%, against the average weighted cost of performing loans of 10.4% a spread of 8.2%. Loans outstanding were 50% of deposits and this surplus liquidity resulted in negative interest rates on deposits compared to a consumer price index increase of 5.7% for the year. 2 ADB. 2009. Technical Assistance to the Pacific Region for Private Sector Development Initiative Phase II. Manila. 3 The growth in deposits has been manifested through the opening of new branches by the regulated microbanks Nationwide Microbank and PNG Microfinance Limited.

2 5. The Microfinance Competence Centre lists more than 90 organizations or institutions (MFIs, including nongovernment organizations of varying description) involved in microcredit, and 21 of these have expressed interest in working with the project. Data has, however, been supplied by only 13 of these MFIs as summarized in the following table. There are significant size and outreach differences between these MFIs the smallest has total assets of less than K200,000 while the largest has total assets of K61 million. They serve around 43,000 borrowers with K67 million in loans outstanding and have almost 250,000 deposit accounts totaling K169 million. Their total lending is about 0.6% of the formal finance sector. Institutions Interested in Project Participation MFIs MFIs Loans Counted Reporting Outstanding (no.) (no.) (K million) Net Worth (K million) Category of MFI Savings and loan societies 6 5 30 4.9 36 Licensed microbanks 2 2 22 12.1 12 Other microcredit providers 13 6 15 0.5 81 Total 21 13 67 17.5 53 MFI = microfinance institution, PAR = portfolio at risk. Note: The quality of microfinance institution reporting is substandard, apart from two microbanks and one savings and loan society. Source: Asian Development Bank estimates. 6. The table outlines a number of issues across the MFIs that need to be addressed. The sense of ownership by SLS members is also low, as many of the SLSs were initiated by provincial governments. The issues identified are that: (i) (ii) (iii) (iv) PAR (%) only 3 out of 13 MFIs have accurate and timely financial reporting systems; many MFIs are inadequately capitalized; the portfolio at risk of most MFIs is unacceptably high; and while most of the SLS lending is fully backed by customer deposits, the portfolio at risk indicates low turnover of loans and customer dissatisfaction. 7. Microlending is generally categorized as (i) household and consumer lending, (ii) microenterprise lending, and (iii) micro and small enterprise (MSE) lending. Consumer borrowing is mainly for home appliances, school fees and ceremonies, and loans range in size from K500 to K1,500. Generally, consumer loans are fully secured against savings accounts and/or salaries. Microenterprise loans are usually in the K1,000 K15,000 range and the MSE loans are usually K15,000 K100,000, with an average in the K40,000 K50,000 range. Microenterprise loans are usually for small-scale agricultural activities, cocoa fermenting, trading, and workshops. MSE loans are often for motor vehicles for transport or trading purposes and a variety of businesses that include trade stores, bakeries, and guesthouses. MSE loans are usually secured against savings accounts plus security over the asset, such as a motor vehicle, financed by the loan. For the larger MSE loans, MFIs are competing with commercial banks and finance companies. Few commercial bank business loans are for less than K50,000, and most are for more than K200,000. 8. There are significant constraints on increased rural lending, and the resolution of these requires a multifaceted approach. In the past, most agricultural lending was project-related and loan repayment obligations were not rigorously enforced. Sociological constraints were neither fully identified nor adequately addressed. Road access to many rural communities is poor or nonexistent. Lending in the future should be accompanied by a change in the perspective of rural borrowers reinforced by financial education programs, the building of recoverable loan security such as savings accounts, improved loan portfolio management, and general community acceptance of the need for, and rules for, ongoing financial services.

3 9. Community conflict is a widespread and not infrequent occurrence. In a rural socioeconomic context in PNG, conflict has many causes, but the most common are (i) jealousy as a result of a perceived economic advantage, (ii) differing objectives as a result of age disparity, and (iii) increased population density on family-owned plots. While in some cases the wantok system smoothes over differences, in other cases it acts as a barrier to increased economic growth. 4 Special care is needed in the provision of rural financial services to ensure these proceed with the widespread and inclusive support of community organizations, households, and traditional ties. 10. An antiquated collateral framework, which discourages financial institutions from accepting movable property as collateral for borrowing, also inhibits access to finance. Reforming this framework and creating a functioning filing archive will allow anyone to borrow against future cash flows, inventory, vehicles, or other movable property, thereby significantly expanding their collateral base and encouraging greater lending. 2. Government Sector Strategy 11. The PNG Development Strategic Plan 2010 2030 acknowledges that financial services have failed to reach the majority of the population, and that the depth of services remains thin and underdeveloped, especially in rural areas. 5 Significant progress is needed to extend the availability of low-cost financial services to the wider population. The plan stresses the role of informal financial institutions that operate savings, credit, and other financial services, and acknowledges that a suitable regulatory framework is needed. A lack of access to credit is identified as a major impediment to the development of small and medium-sized enterprises. 12. The 2010 budget notes that improved access to credit is an important tool in the promotion of rural development and poverty reduction, and commits the government to supporting the development and expansion of a sustainable microfinance industry. 6 Such support fits well with the goals of ADB's proposed Microfinance Expansion Project. There is strong support for capacity development from government institutions such as the Department of Treasury, the Department of National Planning and Monitoring, and the BPNG. In the 2010 budget, the government allocated K20 million to the state-owned National Development Bank for the rural credit extension. 3. ADB Sector Experience and Assistance Program 13. Since 2001, ADB has supported the development of the microfinance subsector in PNG through the Microfinance and Employment Project. 7 The project, which closed at the end of June 2010, has built a solid base for microfinance in PNG and has developed microfinance as a suitable tool for rural development in the country. It has laid the foundation of a nascent microfinance subsector and has been successful in both delivering services directly and generating broader competencies in the subsector. Microfinance institutions and SLSs have extended their outreach to about 400,000 clients. The project created the Microfinance Competence Centre to provide training services to the subsector and, more recently, has supported the development of the PNG Association of Microfinance Institutions, a practitioner-led advocacy group that seeks to develop the subsector further. The project has undertaken rural linkage pilot programs in four locations to further extend the reach of microfinance. ADB also assessed the potential for mobile banking to reduce transaction costs dramatically and increase access to finance in rural areas. 4 The wantok system could be seen as an unwritten contract between those that speak the same language, to assist each other in times of need. This ranges from little things such as assistance in school fees to favors that border corruption, such as offering a job or contract to a person or persons because they are a wantok [one talk]. Extract from Solomon Times Online article: The Cost of the Wantok System. February 16, 2008. www.solomontimes.com 5 Government of Papua New Guinea, Department of National Planning and Monitoring. 2010. Papua New Guinea Development Strategic Plan 2010 2030. Port Moresby. 6 Government of Papua New Guinea. 2009. Budget 2010. Port Moresby. 7 ADB. 2000. Report and Recommendation of the President to the Board of Directors: Microfinance and Employment Project for Papua New Guinea. Manila.

4 14. In 2004, the project launched one of the first licensed microbanks in PNG, Wau Microbank. Since then, the microbank has established 12 branches throughout the country, provided savings services to about 120,000 clients, and made more than 25,000 loans. The bank was renamed Nationwide Microbank (NMB) in 2008 and was issued a full banking license by the BPNG in the same year. The NMB has made a small profit in each year since 2006 and showed a return on average equity of 6.75% for 2009. ADB has assisted the NMB in strengthening its operations. 15. While the microfinance subsector in PNG is an emerging success story, a number of development issues remain, including (i) continued poor access to financial services, particularly in rural areas; (ii) poor financial literacy and business management skills; (iii) low capacity among microfinance and socioeconomic institutions; (iv) increasing demand for borrowing by micro and small enterprises; and (v) lack of a microfinance-specific legal and regulatory framework. 16. ADB will continue to support the growth of the microfinance subsector through the proposed Microfinance Expansion Project, which will seek to extend and build on the achievements of the Microfinance and Employment Project. It will have five main components: (i) increasing business and product management capacity for participating institutions, (ii) increasing the capacity of clients and potential clients to use financial services, (iii) the publication and monitoring of industry standards, (iv) streamlined and improved regulation and supervision, and (v) support for increased lending to MSEs. The project will particularly seek to improve the availability of financial services and training for women. In addition, through the Private Sector Development Initiative Phase II, ADB is pursuing collateral or secured transaction reforms, and will continue to assist in the development of branchless banking. 8 17. ADB s support for improved access to finance in PNG reflects one of the five core areas of specialization under Strategy 2020 finance sector development. 9 ADB s activities support one of the key drivers of change in ADB's Pacific Strategy 2010 2014: an improved private sector environment. 10 The outcome is financial institutions that can sustainably and safely provide financial services to a substantially increased number of clients across PNG. The outcome will be measured by the growth in microfinance customers, efficiency of MFIs, and effective regulation. 18. ADB's work in access to finance in PNG through activities in microfinance, branchless banking, and collateral frameworks contributes directly to improving income-earning opportunities. ADB will also pursue private sector investment opportunities in the finance sector in PNG through the Private Sector Operations Department during the country partnership strategy period (2011 2015). Such opportunities will complement ADB s existing activities in the sector. 19. Cooperation with development partners is an important feature of ADB s activities in support of improved access to finance in PNG. The Australian Agency for International Development (AusAID) has provided significant grant cofinancing for ADB s access to finance interventions, including the Microfinance and Employment Project, as well as ADB s Private Sector Development Initiative. 11 AusAID is expected to provide grant cofinancing for the proposed Microfinance Expansion Project. ADB, AusAID, the International Finance Corporation, and other bilateral and multilateral development partners involved in private sector development work across the Pacific meet quarterly to coordinate their activities. These meetings involve discussions of general private sector development issues as well as access to finance. Development partner activities in PNG account for a significant part of these meetings. 8 ADB. 2009. Technical Assistance to the Pacific Region for Private Sector Development Initiative Phase II. Manila. 9 ADB. 2008. Strategy 2020: The Long-Term Strategic Framework of the Asian Development Bank, 2008 2020. Manila. Strategy 2020 focuses ADB operations in five core areas and three complementary areas. The five core specializations are (i) infrastructure, (ii) environment, (iii) regional cooperation and integration, (iv) finance sector development, and (v) education. 10 ADB. 2009. ADB s Approach to Assisting the Pacific, 2010 2014. Manila. 11 ADB. 2006. Technical Assistance to the Pacific Region for Private Sector Development Initiative. Manila; and ADB. 2009. Technical Assistance to the Pacific Region for Private Sector Development Initiative Phase II. Manila.

5 Problem Tree for the Finance Sector MFI = microfinance institution; MSEs = micro and small enterprises. Source: Asian Development Bank.

6 Outcomes with ADB Contribution Financial institutions sustainably and safely provide financial services to a substantially increased number of clients across PNG Sector Results Framework (Finance, 2011 2015) Country Sector Outcomes Country Sector Outputs ADB Sector Operations Indicators with Indicators with Planned and Targets and Outputs with ADB Incremental Targets Ongoing ADB Baselines Contribution (Baselines Zero) Interventions By 2015: 100,000 increase in households with active deposit accounts (baseline 187,500, 2010) 30,000 increase in households with current loan accounts (baseline 43,000, 2010) The PAR30 is <10% (excluding loans that are 100% cash collateralized) and financial selfsufficiency is >100% for 70% of sustainable microfinance institutions by 2015. By 2015, 80% of MEPsupported MFIs and SLSs are compliant with BPNG regulations. Business and product management capacity of financial institutions is increased Microfinance clients and potential clients understand, and know how to access, financial services for personal or business use. The PNG Association of MFIs monitors jointly agreed microfinance subsector standards. BPNG regulation and supervision of microfinance and savings and loan services is streamlined and improved. A risk-share facility supports increased MSE lending. A collateral registry is established and operational. At least 85% of MEPsupported financial institutions produce accurate annual financial accounts by end of 2013 At least 70% of MEP trainees sign up for new financial products within 12 months after completing a training program (at least 35% of these are women) 100% of MEP-supported financial institutions report agreed standard indicators by end of 2015 MFIs and SLSs are classified according to risk by end of 2013. Risk sharing on >$15 million in MSEs loan portfolios established by 2015 The first 100 security interests registered within 1 year of passing of new collateral law Planned key activity areas: Microfinance (90% of funds) Collateral reforms (10% of funds) Projects in the pipeline with estimated amounts Microfinance Expansion Project ($24.06 million) Ongoing projects with approved amounts a Regional TA with focus on access to finance, SOE reforms and PPPs, and improvements to the legal enabling environment for business Main Outputs Expected from ADB Interventions Planned key activity areas: Participating financial institutions sustainably and safely provide financial services to a substantially increased number of clients across PNG Projects Business and product management capacity of PFIs is increased. Microfinance clients and potential clients understand, and know how to access, financial services for personal or business use. The PNG AMFI monitors jointly agreed subsector standards. BPNG regulation and supervision of MFIs and SLSs is streamlined and improved. An RSF supports increased MSE lending. Ongoing projects MEP design completed Collateral reforms completed ADB = Asian Development Bank, AMFI = Association of Microfinance Institutions, BPNG = Bank of Papua New Guinea, MEP = Microfinance Expansion Project, MFI = microfinance institution, MSEs = micro and small enterprises, PAR = portfolio at risk, PFI = participating financial institution, PNG = Papua New Guinea, PPP = public private partnership, RSF = risk-share facility, SLS = savings and loan society, SOE = state-owned enterprise, TA = technical assistance. a ADB. 2009. Regional Technical Assistance for Private Sector Development Initiative Phase II. Manila (TA 7430, for $12 million approved on 10 December 2009). Source: Asian Development Bank.