## 1.   Palau’s Banking System

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---

### A. Background and key impediments
- Structure of banking system:
  - Three branches of U.S. FDIC-insured banks (The Bank of Guam, The Bank of Hawaii, and Bank Pacific), two small non-FDIC-insured banks, and one state-owned development bank (NDBP).
  - U.S. FDIC-insured banks account for 98 percent of total deposits.
  - U.S. branches invest mostly offshore; branches deposit in headquarters and earn profit from those investments.
- Aggregate outcomes and ratios:
  - Net foreign assets amount to nine times greater than domestic private sector credit.
  - Total bank credit is around 25 percent of GDP and slightly over 10 percent of GDP for commercial banks.
  - Deposit levels are above regional averages in comparator markets.
  - Commercial bank assets total USD 416 million as of end-FY2024.
  - The system is highly liquid, with nearly 90 percent of assets held as balances due from headquarter to branches in Palau.
- Financial access and payment infrastructure:
  - Palau uses the U.S. dollar and lacks a domestic payment system, depending on U.S. financial market infrastructure.
  - Clearing checks typically takes four to five business days.
  - Internet penetration is 57.5 percent (compared to around 80 percent globally in 2025).
  - Mobile subscriptions exceed 25,000, equivalent to 144 percent of the population (vs. 105–110 percent globally).
  - Cross-border payments are around 0.7 percent of GDP as of 2023.
  - Cash and checks dominate retail transactions; credit and debit cards are widely accepted in tourist establishments.

### B. Role and constraints of the National Development Bank of Palau (NDBP)
- NDBP’s market share and portfolio:
  - NDBP credit accounts for about half of total domestic credit; NDBP accounted for 51.4 percent of overall private sector credit.
  - Around three quarters of NDBP’s portfolio consists of housing loans; aquaculture 2 percent; commercial loans 20 percent.
  - In FY2024, NDBP held USD 44.7 million in assets (equivalent to 11 percent of commercial banks’ assets).
- Financial performance and governance:
  - NDBP returned to profitability in FY2024, earning USD 1.3 million and achieving a return on assets (ROA) of 2.94 percent.
  - NDBP is well capitalized and had one of the lowest non-performing loan ratios (less than one percent as of FY2025) among Pacific Islands development banks before the Pandemic.
- Funding and supervisory constraints:
  - NDBP does not take deposits; it is mostly funded by the government and external lenders and relies on long-term borrowings and loan repayments.
  - The NDBP is not currently formally licensed and supervised by the FIC.
  - As a state-owned development bank, NDBP lending decisions reflect Palau’s development objectives and are not solely commercial-based.
  - Expansion in NDBP lending depends on additional loan liabilities and organic growth; loans liabilities account to 76 percent of total liabilities.

### C. Structural impediments to private credit intermediation
- Lending behavior and credit composition:
  - Commercial banks primarily extend unsecured, small-sized loans to individuals; approximately two-thirds of total loans and advances from commercial banks are unsecured.
  - Commercial bank lending is significantly lower than peers; total bank credit remains one of the lowest ratios among Pacific Island peers.
- Lending cap and interest-rate environment:
  - Usury law caps interest rate on commercial lending at the U.S. prime rate plus 4 percentage points — which amounted to 11 percent as of November 2025.
  - Interest rate on individual or personal loans is capped at 18 percent by law; the individual loan rate stood at 11.6 percent in FY2024.
  - The cap restricts lenders' ability to appropriately price risk and makes lending in Palau less attractive relative to U.S. investment opportunities.
  - Although NDBP is exempt from the usury law, it still maintains lending rates within the ceilings faced by other foreign branches.
- Information asymmetry and credit information:
  - Small firms often lack appropriate accounting practices, complicating creditworthiness assessment.
  - U.S. bank branches require borrowers to possess a U.S. FICO score; lack of a U.S. Social Security number prevents local borrowers’ loan repayment histories from being recorded in U.S. credit systems.
  - Establishing a credit registry (ongoing effort with ADB assistance) could help but would need integration with the U.S. system to be effective.
  - Lender requirements for two years of audited financial statements hinder SMEs without sufficient financial records; 2023 tax reforms (notably the Business Service Tax) have encouraged SMEs to improve business documentation.
- Collateral constraints:
  - Only residents can hold land titles with limited exceptions; communal landownership and limited fee-simple properties constrain use of fixed property as collateral.
  - Repossession by foreign banks is complicated in event of default.
  - The Secured Transaction Act (2012) ensures enforceability of security interests in personal property (excluding land) but has not led to a significant increase in collateralized lending.
  - NDBP remains the only institution accepting land as collateral, facilitating housing loans and SME financing.

### D. Financial soundness and performance indicators
- Commercial banks:
  - Return on assets (ROA) averaged 3.28 percent in FY2023.
  - Nonperforming loans (NPL) for commercial banks were 0.38 percent in FY2023.
- Composition (FY2024):
  - NDBP assets USD 44.7 million; NDBP loan portfolio surpassed that of commercial banks, accounting for 51.4 percent of private sector credit.
  - NDBP ROA 2.94 percent in FY2024; NDBP profit USD 1.3 million in FY2024.
  - Commercial banks’ total assets USD 416 million (end-FY2024).

### E. Opportunities and risks from fintech and digital initiatives
- Palau Savings Bond (PSB) — blockchain-based retail bond:
  - Objective: mobilize savings, retain and mobilize bank deposits, channel funds through NDBP to finance infrastructure, housing and small businesses.
  - Design: retail system to use blockchain-based distributed ledger technology; development support from Japan and Soramitsu.
  - Pilot: blockchain-based retail platform pilot demonstrated in late FY2024; the bond has not yet been issued.
  - Risks and operational challenges:
    - Significant fiscal costs for maintaining the digital platform (cybersecurity, external legal scrutiny, operational costs).
    - Funds raised channeled through NDBP, which is not formally supervised by FIC—creating fiscal and systemic risk.
    - Need for NDBP to strengthen risk management, and recommendation to formalize supervision of NDBP by FIC.
    - Requirement for widespread digital and financial literacy, extensive public education, clear disclosures, and strong public understanding of risks.
    - Government of Japan is currently supporting development costs for the PSB.
- Tokenized Dollar (TD) and digital payments:
  - Payments landscape:
    - Commercial banks offer online and mobile banking but uptake is modest.
    - MTOs operating in Palau include two from the Philippines, Western Union, Wise, MoneyGram; payment apps like WePay and PayPal have entered the market.
    - Ongoing initiatives for mobile money by PNCC and partnerships with foreign mobile money providers.
  - Tokenized dollar initiative:
    - Pilot project for a U.S. dollar-backed stablecoin (pilot launched in FY 2023 with 200 government employees each provided 100 PSC to make purchases at select local retailers).
    - Pilot was put on hold due to difficulties finding a custodian bank; progress resumed with submission of the Palau Digital Service Bill (PDSB) to congress outlining the “tokenized dollar (TD)”.
    - Proposed operational design: TD issued by Ministry of Finance, redeemable on a 1:1 basis to the U.S. dollar, fully backed by reserves (cash, treasury securities, and other safe assets) managed by the Ministry of Finance.
    - Implementation requirements: legal bill approval, supporting regulations, and confirmation of a partnership with a custodian bank.
  - Potential benefits and limitations:
    - Intended benefits: make payments easier and more affordable, improve financial inclusion, support a more modern and efficient digital economy; could make payments cheaper, faster, more convenient depending on cost-sharing arrangements.
    - Limitations and risks:
      - Cost-sharing model among users, PSPs, and government remains unclear.
      - Uptake may be limited by cash preference, lack of buy-in from the two main commercial banks, and inadequate IT infrastructure.
      - Proposed use cases (retail P2B, government payments including customs, P2P transfers) may not be fully justified relative to alternatives (mobile money, improvements to existing payment system).
      - Cross-border use would require legal agreements and cooperation with other jurisdictions.
      - Financial inclusion is less pressing nationally than in other PICs; remote island challenges (lack of banking facilities for redemptions) may not be adequately addressed by TD.
- Timeline of Tokenized Dollar initiative (as presented):
  - Project announced (November 2021)
  - Partnered with Ripple (March 2022)
  - Pilot Launch (October 2022)
  - Analyze pilot feedback (2023-2025)
  - Payment System Bill at OEK (July 2025)
  - Next Steps (??)

### F. Policy implications and recommendations
- Improve supervision and regulation tailored to Palau’s scale and resource constraints:
  - Formalize supervision and licensing of NDBP by the FIC.
  - Strengthen NDBP risk management practices to identify, monitor, and mitigate fiscal and systemic risks from PSB and other initiatives.
- Address structural barriers to private credit:
  - Reassess interest-rate caps’ impact on commercial lending incentives and risk pricing (commercial lending cap: U.S. prime +4 percentage points = 11 percent as of November 2025; individual loan ceiling 18 percent; individual loan rate 11.6 percent in FY2024).
  - Advance credit information infrastructure and integrate the planned credit registry with systems used by U.S. bank head offices where feasible.
  - Promote adoption of accounting practices and business documentation among SMEs (building on 2023 tax reforms, including the Business Service Tax) to facilitate access to loans.
  - Improve collateral frameworks and mortgage markets where possible, recognizing land title and communal ownership constraints.
- Carefully weigh benefits and costs of digital initiatives:
  - For PSB and TD, ensure robust legal, regulatory, operational, cybersecurity, and fiscal safeguards before launch.
  - Conduct extensive public education and financial literacy campaigns to support uptake.
  - Clarify cost-sharing arrangements and custodian banking arrangements prior to scaling tokenized payment initiatives.
  - Consider incremental improvements to existing payment infrastructure and mobile money solutions as potentially lower-cost alternatives to full tokenization.

---

### 10. Tokenized dollars entail significant risks. Without robust regulation, TD can attract illicit

### Major risks and vulnerabilities
- Tokenized dollars (TD) present considerable AML/CFT and financial integrity risks, including attraction of illicit activities due to anonymity and rapid cross-border transfers.
- Reputational risks: Poor execution may undermine public confidence and hinder effective adoption.
- Cybersecurity vulnerabilities and overreliance on specific vendors and technologies increase operational fragility.
- Privacy concerns: Use of public ledgers for financial transactions can make transaction details publicly accessible and subject to misuse, compromising confidentiality of personal financial data.
- Fiscal and budgetary challenges: Infrastructure costs, salaries, energy implications, and government backing of reserves can create budgetary challenges and fiscal risks.
- Reserve inadequacy: If reserves are inadequate, stability of the peg may not be guaranteed and tokenized dollars can be vulnerable to speculative attacks.
- Institutional capacity gaps: Financial Institutions Commission (FIC) and Ministry of Finance (MOF) need significant strengthening to manage TD risks.

### Policy issues — Enhancing financial intermediation and mobilizing domestic credit
- Structural and supervisory reforms prioritized to strengthen banking system:
  - Establishment of a centralized credit bureau (with ADB support) to collect borrowers' credit histories to improve risk assessment and responsible lending.
  - Clarify legal uncertainties for foreign banks regarding land titles and foreclosure to overcome collateral barriers.
  - Re-evaluate the Usury Law lending rate cap.
  - Bring NDBP under FIC supervision to safeguard financial stability and improve resource allocation.
  - Diversify domestic economy and improve business environment to spur private sector and bank credit demand.

### Policy issues — Palau Savings Bond (PSB) and blockchain implementation
- Institutional, legal, and regulatory frameworks required for PSB implementation:
  - Costs: digital platform costs, fiscal risks from on-lending to NDBP, and spillovers from PSB interest rates to other NDBP loans.
  - AML/CFT risks: potential cross-border investment exposures need careful assessment.
  - Safeguards: legal, supervisory and regulatory frameworks (e.g., AML/CFT) must be in place.
  - Debt management: recently established debt management office must have resources and mandate to manage issuance and integrate PSB into fiscal risk assessment.
  - Institutional clarity: oversight of investment decisions and supervision of fund transfers must be clarified.
  - Digital and financial literacy: extensive public education required for effective citizen participation.
  - Prospectus requirements: clearly outline management, redemption, and transfer arrangements between treasury and NDBP.
  - Infrastructure planning: issuance platform, settlement system, central securities depository (CSD), and debt recording system should be thoroughly planned and costed.
  - Coupon rates and maturity: must balance demand, fiscal costs, and mitigate maturity mismatches.

### Policy issues — Improving payment system efficiency and sequencing
- Develop a comprehensive domestic payment strategy before launching individual digital/fintech initiatives, with technical support from World Bank and IMF.
- The Palau Digital Service Bill (PDSB) is a start, but key payment system building blocks need clarification and additional work to address risks and operational challenges.

### Key preparations and regulatory components required before launching TD
- Legal Framework:
  - Clarify tokenized dollar legal status and implications.
  - Address potential conflicts of interest and MoF resource constraints.
  - Define roles/responsibilities of custodian bank, wallet providers.
  - Develop bankruptcy laws, privacy and data protection laws, and a cybercrime bill.
  - Note: Bankruptcy laws: rights of holders in the event of insolvency of financial intermediaries, such as wallet provider.
- Prudential and Conduct Frameworks:
  - Reserve asset management: composition and investments to ensure safety and liquidity, custody and concentration risks.
  - Stabilization mechanism: ensure reserves cover stablecoins issued and stablecoins are redeemed at par.
  - Segregation policies for reserve assets.
  - Disclosure and periodic independent audits.
  - Clarify redemption policies.
  - Regulations governing wallets, exchanges and financial institution exposures.
  - Benchmark regulations against international standards (FSB/IOSCO) to identify gaps.
  - Outsourcing regulations.
  - Supervisory framework for operational resilience and enforcement capacity.
  - Policies for storage of private keys.
- Governance and Institutional Arrangement:
  - The absence of a central bank adds complexity; TD reserves should be strictly ringfenced from fiscal use.
  - Explore options to strengthen oversight and ensure MoF or a designated agency assumes central bank–like functions, including transparency in reporting issuance and activity.
- AML/CFT Measures and Supervision:
  - Conduct a thorough ML/TF risk assessment for TD to guide mitigation and amendments to legal framework.
  - Legal framework should explicitly address ML/TF risks with provisions for customer due diligence, transaction monitoring, suspicious transaction reporting.
  - Align framework with FATF Recommendations on virtual assets (VAs) and virtual asset service providers (VASPs).
  - Clearly identify the supervisory entity and ensure it has capacity to supervise issuer/manager compliance.
- IT Operational and Cyber Risk Framework:
  - Notable progress exists, but significant gaps remain; ISO27001 adoption is in early stages and cyber-crime bill is draft.
  - Overreliance on vendors/third parties can create fragmentation and vulnerabilities.
  - Gaps in cyber incident response arrangements and deficiencies in cyber/digital resilience may lead to fraud or downtime.
  - Low banking penetration and low digital literacy increase cyber vulnerability.
  - Suboptimal internet connectivity in remote islands limits rollout.
- Resources:
  - Ensure resources to maintain resilience of infrastructure, technology, and human capital.
  - Infrastructure needs: access, stability, and availability of critical national systems; adequacy of enablers such as Digital IDs; efficiency and stability of Internet and broadband connectivity.
  - Establish threshold security and governance requirements for sector participants, including supply chain and outsourcing partners.
  - Core systems must be fit-for-purpose, governed, scalable, secure, and efficient.
  - Human capital: raise risk awareness to reduce attack surface from poorly onboarded individuals.
- Feasibility and Cost-benefit Analysis:
  - Conduct a feasibility study to identify risks, assess market demand, evaluate technology and infrastructure, review legal/regulatory framework, and determine financial viability and operational capacity.
  - To avoid conflicts of interest, analysis should preferably be by an independent agency as MoF manages the TD project.
- Public Trust:
  - Certify associated agreements and ensure funds are properly approved before proceeding.
  - Address risks and vulnerabilities identified in pilot Public Auditor report.
- Reserve Management:
  - TD is government-backed; government bears ultimate responsibility for redemption, implying fiscal risks.
  - Establish a transparent and verifiable reserve management system.
- Capacity of FIC:
  - FIC must play a critical role in ringfencing risks, including supervising custodian bank creditworthiness.
  - FIC currently faces capacity and resource constraints.

### National payment system and alternatives
- Establishing a national payment system suited to Palau’s size and resources is the key priority; develop a comprehensive domestic payment strategy that:
  - Assesses current strengths and weaknesses.
  - Identifies urgently needed payment infrastructure components.
  - Explores options suited to Palau’s economic size and capacity constraints.
  - Fosters competition and requires robust physical infrastructure, enhanced financial/digital literacy, improved telecom infrastructure, and a strong legal/regulatory framework.
- Consider alternatives to the tokenized dollar such as fast payment systems or mobile money.
- Licensing and promotion of mobile money operators (MMOs) could be beneficial:
  - Palau has mobile connectivity equivalent to 144 percent of the population.
  - MMOs tend to have greater reach than bank accounts, especially in rural and hard-to-reach areas.
  - E-money issuers should be properly supervised for AML/CFT compliance and cyber concerns.
- Case study — Solomon Islands (lessons):
  - In 2020, cash accounted for about 80 percent of transactions.
  - SOLATS launched April 2024 with RTGS and ACH components to improve settlement times and enable third-party innovation.
  - M-SELEN mobile money platform serves over 350,000 registered users (i.e. half of the population) and operates through 3,000 agents, including rural areas.
  - Remaining challenges: regulatory gaps in cybersecurity, AML compliance, fintech oversight, data protection; absence of national digital ID complicates KYC; low digital and financial literacy; limited connectivity; high costs of internet and electricity.

*Source: sipea2026010 (IMF).*

### 1.   Palau’s Banking System _________________________________________________________________ 7

### 1.   Palau’s Banking System _________________________________________________________________ 7

### A. Background and key impediments
- Structure of banking system:
  - Three branches of U.S. FDIC-insured banks (The Bank of Guam, The Bank of Hawaii, and Bank Pacific), two small non-FDIC-insured banks, and one state-owned development bank (NDBP).
  - U.S. FDIC-insured banks account for 98 percent of total deposits.
  - U.S. branches invest mostly offshore; branches deposit in headquarters and earn profit from those investments.
- Aggregate outcomes and ratios:
  - Net foreign assets amount to nine times greater than domestic private sector credit.
  - Total bank credit is around 25 percent of GDP and slightly over 10 percent of GDP for commercial banks.
  - Deposit levels are above regional averages in comparator markets.
  - Commercial bank assets total USD 416 million as of end-FY2024.
  - The system is highly liquid, with nearly 90 percent of assets held as balances due from headquarter to branches in Palau.
- Financial access and payment infrastructure:
  - Palau uses the U.S. dollar and lacks a domestic payment system, depending on U.S. financial market infrastructure.
  - Clearing checks typically takes four to five business days.
  - Internet penetration is 57.5 percent (compared to around 80 percent globally in 2025).
  - Mobile subscriptions exceed 25,000, equivalent to 144 percent of the population (vs. 105–110 percent globally).
  - Cross-border payments are around 0.7 percent of GDP as of 2023.
  - Cash and checks dominate retail transactions; credit and debit cards are widely accepted in tourist establishments.

### B. Role and constraints of the National Development Bank of Palau (NDBP)
- NDBP’s market share and portfolio:
  - NDBP credit accounts for about half of total domestic credit; NDBP accounted for 51.4 percent of overall private sector credit.
  - Around three quarters of NDBP’s portfolio consists of housing loans; aquaculture 2 percent; commercial loans 20 percent.
  - In FY2024, NDBP held USD 44.7 million in assets (equivalent to 11 percent of commercial banks’ assets).
- Financial performance and governance:
  - NDBP returned to profitability in FY2024, earning USD 1.3 million and achieving a return on assets (ROA) of 2.94 percent.
  - NDBP is well capitalized and had one of the lowest non-performing loan ratios (less than one percent as of FY2025) among Pacific Islands development banks before the Pandemic.
- Funding and supervisory constraints:
  - NDBP does not take deposits; it is mostly funded by the government and external lenders and relies on long-term borrowings and loan repayments.
  - The NDBP is not currently formally licensed and supervised by the FIC.
  - As a state-owned development bank, NDBP lending decisions reflect Palau’s development objectives and are not solely commercial-based.
  - Expansion in NDBP lending depends on additional loan liabilities and organic growth; loans liabilities account to 76 percent of total liabilities.

### C. Structural impediments to private credit intermediation
- Lending behavior and credit composition:
  - Commercial banks primarily extend unsecured, small-sized loans to individuals; approximately two-thirds of total loans and advances from commercial banks are unsecured.
  - Commercial bank lending is significantly lower than peers; total bank credit remains one of the lowest ratios among Pacific Island peers.
- Lending cap and interest-rate environment:
  - Usury law caps interest rate on commercial lending at the U.S. prime rate plus 4 percentage points — which amounted to 11 percent as of November 2025.
  - Interest rate on individual or personal loans is capped at 18 percent by law; the individual loan rate stood at 11.6 percent in FY2024.
  - The cap restricts lenders' ability to appropriately price risk and makes lending in Palau less attractive relative to U.S. investment opportunities.
  - Although NDBP is exempt from the usury law, it still maintains lending rates within the ceilings faced by other foreign branches.
- Information asymmetry and credit information:
  - Small firms often lack appropriate accounting practices, complicating creditworthiness assessment.
  - U.S. bank branches require borrowers to possess a U.S. FICO score; lack of a U.S. Social Security number prevents local borrowers’ loan repayment histories from being recorded in U.S. credit systems.
  - Establishing a credit registry (ongoing effort with ADB assistance) could help but would need integration with the U.S. system to be effective.
  - Lender requirements for two years of audited financial statements hinder SMEs without sufficient financial records; 2023 tax reforms (notably the Business Service Tax) have encouraged SMEs to improve business documentation.
- Collateral constraints:
  - Only residents can hold land titles with limited exceptions; communal landownership and limited fee-simple properties constrain use of fixed property as collateral.
  - Repossession by foreign banks is complicated in event of default.
  - The Secured Transaction Act (2012) ensures enforceability of security interests in personal property (excluding land) but has not led to a significant increase in collateralized lending.
  - NDBP remains the only institution accepting land as collateral, facilitating housing loans and SME financing.

### D. Financial soundness and performance indicators
- Commercial banks:
  - Return on assets (ROA) averaged 3.28 percent in FY2023.
  - Nonperforming loans (NPL) for commercial banks were 0.38 percent in FY2023.
- Composition (FY2024):
  - NDBP assets USD 44.7 million; NDBP loan portfolio surpassed that of commercial banks, accounting for 51.4 percent of private sector credit.
  - NDBP ROA 2.94 percent in FY2024; NDBP profit USD 1.3 million in FY2024.
  - Commercial banks’ total assets USD 416 million (end-FY2024).

### E. Opportunities and risks from fintech and digital initiatives
- Palau Savings Bond (PSB) — blockchain-based retail bond:
  - Objective: mobilize savings, retain and mobilize bank deposits, channel funds through NDBP to finance infrastructure, housing and small businesses.
  - Design: retail system to use blockchain-based distributed ledger technology; development support from Japan and Soramitsu.
  - Pilot: blockchain-based retail platform pilot demonstrated in late FY2024; the bond has not yet been issued.
  - Risks and operational challenges:
    - Significant fiscal costs for maintaining the digital platform (cybersecurity, external legal scrutiny, operational costs).
    - Funds raised channeled through NDBP, which is not formally supervised by FIC—creating fiscal and systemic risk.
    - Need for NDBP to strengthen risk management, and recommendation to formalize supervision of NDBP by FIC.
    - Requirement for widespread digital and financial literacy, extensive public education, clear disclosures, and strong public understanding of risks.
    - Government of Japan is currently supporting development costs for the PSB.
- Tokenized Dollar (TD) and digital payments:
  - Payments landscape:
    - Commercial banks offer online and mobile banking but uptake is modest.
    - MTOs operating in Palau include two from the Philippines, Western Union, Wise, MoneyGram; payment apps like WePay and PayPal have entered the market.
    - Ongoing initiatives for mobile money by PNCC and partnerships with foreign mobile money providers.
  - Tokenized dollar initiative:
    - Pilot project for a U.S. dollar-backed stablecoin (pilot launched in FY 2023 with 200 government employees each provided 100 PSC to make purchases at select local retailers).
    - Pilot was put on hold due to difficulties finding a custodian bank; progress resumed with submission of the Palau Digital Service Bill (PDSB) to congress outlining the “tokenized dollar (TD)”.
    - Proposed operational design: TD issued by Ministry of Finance, redeemable on a 1:1 basis to the U.S. dollar, fully backed by reserves (cash, treasury securities, and other safe assets) managed by the Ministry of Finance.
    - Implementation requirements: legal bill approval, supporting regulations, and confirmation of a partnership with a custodian bank.
  - Potential benefits and limitations:
    - Intended benefits: make payments easier and more affordable, improve financial inclusion, support a more modern and efficient digital economy; could make payments cheaper, faster, more convenient depending on cost-sharing arrangements.
    - Limitations and risks:
      - Cost-sharing model among users, PSPs, and government remains unclear.
      - Uptake may be limited by cash preference, lack of buy-in from the two main commercial banks, and inadequate IT infrastructure.
      - Proposed use cases (retail P2B, government payments including customs, P2P transfers) may not be fully justified relative to alternatives (mobile money, improvements to existing payment system).
      - Cross-border use would require legal agreements and cooperation with other jurisdictions.
      - Financial inclusion is less pressing nationally than in other PICs; remote island challenges (lack of banking facilities for redemptions) may not be adequately addressed by TD.
- Timeline of Tokenized Dollar initiative (as presented):
  - Project announced (November 2021)
  - Partnered with Ripple (March 2022)
  - Pilot Launch (October 2022)
  - Analyze pilot feedback (2023-2025)
  - Payment System Bill at OEK (July 2025)
  - Next Steps (??)

### F. Policy implications and recommendations (as indicated in the source)
- Improve supervision and regulation tailored to Palau’s scale and resource constraints:
  - Formalize supervision and licensing of NDBP by the FIC.
  - Strengthen NDBP risk management practices to identify, monitor, and mitigate fiscal and systemic risks from PSB and other initiatives.
- Address structural barriers to private credit:
  - Reassess interest-rate caps’ impact on commercial lending incentives and risk pricing (commercial lending cap: U.S. prime +4 percentage points = 11 percent as of November 2025; individual loan ceiling 18 percent; individual loan rate 11.6 percent in FY2024).
  - Advance credit information infrastructure and integrate the planned credit registry with systems used by U.S. bank head offices where feasible.
  - Promote adoption of accounting practices and business documentation among SMEs (building on 2023 tax reforms, including the Business Service Tax) to facilitate access to loans.
  - Improve collateral frameworks and mortgage markets where possible, recognizing land title and communal ownership constraints.
- Carefully weigh benefits and costs of digital initiatives:
  - For PSB and TD, ensure robust legal, regulatory, operational, cybersecurity, and fiscal safeguards before launch.
  - Conduct extensive public education and financial literacy campaigns to support uptake.
  - Clarify cost-sharing arrangements and custodian banking arrangements prior to scaling tokenized payment initiatives.
  - Consider incremental improvements to existing payment infrastructure and mobile money solutions as potentially lower-cost alternatives to full tokenization.

*Source: sipea2026010 (IMF).*

### 10. Tokenized dollars entail significant risks. Without robust regulation, TD can attract illicit

### 10. Tokenized dollars entail significant risks. Without robust regulation, TD can attract illicit

### Major risks and vulnerabilities
- Tokenized dollars (TD) present considerable AML/CFT and financial integrity risks, including attraction of illicit activities due to anonymity and rapid cross-border transfers.
- Reputational risks: Poor execution may undermine public confidence and hinder effective adoption.
- Cybersecurity vulnerabilities and overreliance on specific vendors and technologies increase operational fragility.
- Privacy concerns: Use of public ledgers for financial transactions can make transaction details publicly accessible and subject to misuse, compromising confidentiality of personal financial data.
- Fiscal and budgetary challenges: Infrastructure costs, salaries, energy implications, and government backing of reserves can create budgetary challenges and fiscal risks.
- Reserve inadequacy: If reserves are inadequate, stability of the peg may not be guaranteed and tokenized dollars can be vulnerable to speculative attacks.
- Institutional capacity gaps: Financial Institutions Commission (FIC) and Ministry of Finance (MOF) need significant strengthening to manage TD risks.

### Policy issues — Enhancing financial intermediation and mobilizing domestic credit
- Structural and supervisory reforms prioritized to strengthen banking system:
  - Establishment of a centralized credit bureau (with ADB support) to collect borrowers' credit histories to improve risk assessment and responsible lending.
  - Clarify legal uncertainties for foreign banks regarding land titles and foreclosure to overcome collateral barriers.
  - Re-evaluate the Usury Law lending rate cap.
  - Bring NDBP under FIC supervision to safeguard financial stability and improve resource allocation.
  - Diversify domestic economy and improve business environment to spur private sector and bank credit demand.

### Policy issues — Palau Savings Bond (PSB) and blockchain implementation
- Institutional, legal, and regulatory frameworks required for PSB implementation:
  - Costs: digital platform costs, fiscal risks from on-lending to NDBP, and spillovers from PSB interest rates to other NDBP loans.
  - AML/CFT risks: potential cross-border investment exposures need careful assessment.
  - Safeguards: legal, supervisory and regulatory frameworks (e.g., AML/CFT) must be in place.
  - Debt management: recently established debt management office must have resources and mandate to manage issuance and integrate PSB into fiscal risk assessment.
  - Institutional clarity: oversight of investment decisions and supervision of fund transfers must be clarified.
  - Digital and financial literacy: extensive public education required for effective citizen participation.
  - Prospectus requirements: clearly outline management, redemption, and transfer arrangements between treasury and NDBP.
  - Infrastructure planning: issuance platform, settlement system, central securities depository (CSD), and debt recording system should be thoroughly planned and costed.
  - Coupon rates and maturity: must balance demand, fiscal costs, and mitigate maturity mismatches.

### Policy issues — Improving payment system efficiency and sequencing
- Develop a comprehensive domestic payment strategy before launching individual digital/fintech initiatives, with technical support from World Bank and IMF.
- The Palau Digital Service Bill (PDSB) is a start, but key payment system building blocks need clarification and additional work to address risks and operational challenges.

### Key preparations and regulatory components required before launching TD
- Legal Framework:
  - Clarify tokenized dollar legal status and implications.
  - Address potential conflicts of interest and MoF resource constraints.
  - Define roles/responsibilities of custodian bank, wallet providers.
  - Develop bankruptcy laws, privacy and data protection laws, and a cybercrime bill.
  - Note: Bankruptcy laws: rights of holders in the event of insolvency of financial intermediaries, such as wallet provider.
- Prudential and Conduct Frameworks:
  - Reserve asset management: composition and investments to ensure safety and liquidity, custody and concentration risks.
  - Stabilization mechanism: ensure reserves cover stablecoins issued and stablecoins are redeemed at par.
  - Segregation policies for reserve assets.
  - Disclosure and periodic independent audits.
  - Clarify redemption policies.
  - Regulations governing wallets, exchanges and financial institution exposures.
  - Benchmark regulations against international standards (FSB/IOSCO) to identify gaps.
  - Outsourcing regulations.
  - Supervisory framework for operational resilience and enforcement capacity.
  - Policies for storage of private keys.
- Governance and Institutional Arrangement:
  - The absence of a central bank adds complexity; TD reserves should be strictly ringfenced from fiscal use.
  - Explore options to strengthen oversight and ensure MoF or a designated agency assumes central bank–like functions, including transparency in reporting issuance and activity.
- AML/CFT Measures and Supervision:
  - Conduct a thorough ML/TF risk assessment for TD to guide mitigation and amendments to legal framework.
  - Legal framework should explicitly address ML/TF risks with provisions for customer due diligence, transaction monitoring, suspicious transaction reporting.
  - Align framework with FATF Recommendations on virtual assets (VAs) and virtual asset service providers (VASPs).
  - Clearly identify the supervisory entity and ensure it has capacity to supervise issuer/manager compliance.
- IT Operational and Cyber Risk Framework:
  - Notable progress exists, but significant gaps remain; ISO27001 adoption is in early stages and cyber-crime bill is draft.
  - Overreliance on vendors/third parties can create fragmentation and vulnerabilities.
  - Gaps in cyber incident response arrangements and deficiencies in cyber/digital resilience may lead to fraud or downtime.
  - Low banking penetration and low digital literacy increase cyber vulnerability.
  - Suboptimal internet connectivity in remote islands limits rollout.
- Resources:
  - Ensure resources to maintain resilience of infrastructure, technology, and human capital.
  - Infrastructure needs: access, stability, and availability of critical national systems; adequacy of enablers such as Digital IDs; efficiency and stability of Internet and broadband connectivity.
  - Establish threshold security and governance requirements for sector participants, including supply chain and outsourcing partners.
  - Core systems must be fit-for-purpose, governed, scalable, secure, and efficient.
  - Human capital: raise risk awareness to reduce attack surface from poorly onboarded individuals.
- Feasibility and Cost-benefit Analysis:
  - Conduct a feasibility study to identify risks, assess market demand, evaluate technology and infrastructure, review legal/regulatory framework, and determine financial viability and operational capacity.
  - To avoid conflicts of interest, analysis should preferably be by an independent agency as MoF manages the TD project.
- Public Trust:
  - Certify associated agreements and ensure funds are properly approved before proceeding.
  - Address risks and vulnerabilities identified in pilot Public Auditor report.
- Reserve Management:
  - TD is government-backed; government bears ultimate responsibility for redemption, implying fiscal risks.
  - Establish a transparent and verifiable reserve management system.
- Capacity of FIC:
  - FIC must play a critical role in ringfencing risks, including supervising custodian bank creditworthiness.
  - FIC currently faces capacity and resource constraints.

### National payment system and alternatives
- Establishing a national payment system suited to Palau’s size and resources is the key priority; develop a comprehensive domestic payment strategy that:
  - Assesses current strengths and weaknesses.
  - Identifies urgently needed payment infrastructure components.
  - Explores options suited to Palau’s economic size and capacity constraints.
  - Fosters competition and requires robust physical infrastructure, enhanced financial/digital literacy, improved telecom infrastructure, and a strong legal/regulatory framework.
- Consider alternatives to the tokenized dollar such as fast payment systems or mobile money.
- Licensing and promotion of mobile money operators (MMOs) could be beneficial:
  - Palau has mobile connectivity equivalent to 144 percent of the population.
  - MMOs tend to have greater reach than bank accounts, especially in rural and hard-to-reach areas.
  - E-money issuers should be properly supervised for AML/CFT compliance and cyber concerns.
- Case study — Solomon Islands (lessons):
  - In 2020, cash accounted for about 80 percent of transactions.
  - SOLATS launched April 2024 with RTGS and ACH components to improve settlement times and enable third-party innovation.
  - M-SELEN mobile money platform serves over 350,000 registered users (i.e. half of the population) and operates through 3,000 agents, including rural areas.
  - Remaining challenges: regulatory gaps in cybersecurity, AML compliance, fintech oversight, data protection; absence of national digital ID complicates KYC; low digital and financial literacy; limited connectivity; high costs of internet and electricity.

*Source: sipea2026010 - 10. Tokenized dollars entail significant risks. Without robust regulation, TD can attract illicit. International Monetary Fund.*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2026/english/sipea2026010.pdf_