## _cr11163 ## Source details **Canonical URL:** [_cr11163](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11163.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11163.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11163.pdf.json) --- ### Executive Summary — key findings and risks - Global financial crisis had only a mild impact on PNG: financial sector insulated from global wholesale funding markets; limited use of derivatives and complex instruments. - Financial sector indicators: generally well capitalized and highly profitable. - System capital ratios are high, driven by capacity to serve larger clients, expected expansion in lending, and high holdings of government securities. - Underlying liquidity and concern regarding asset quality as the portfolio grows may justify high capital ratios. - Stress-test conclusion: banking system faces little near-term impact from interest rate and credit shocks; loan concentration in the commercial and financial sector could pose a risk. - Structural vulnerabilities: - Small open economy and concentrated financial sector focused on the formal (especially commercial) sector. - Significant growth expectations and limited secondary markets. - Rapid credit growth may overstate apparent resilience despite high capital and liquidity buffers. - Overall risk assessments (selected): - Credit Risk: medium. - Concentration Risk: medium (nature/source); high (likelihood/impact). - Operational Risk: high (nature/source); low (likelihood/impact). - Exchange Rate Risk: low. - Commodity Price Risk: medium. ### Macroeconomic setting and selected statistics - Real GDP growth: estimated 7 percent in 2010 (from 5½ percent in 2009). - Headline inflation: 7¼ percent in December 2010 (12-month rate). - Currency: Kina (K) = US$ 0.33. ### Financial sector structure and size - Total financial sector assets: K26 billion as of December 2010 (more than 100 percent of GDP), up from K9.5 billion at end-2005. - Banking sector assets: about 69 percent of total financial sector assets. - Market participants: - Four commercial banks. - Seven authorized superannuation funds (ASFs). - Five life insurance companies. - Other nonbank financial sector institutions licensed and regulated by BPNG. - Market features: - Largest domestic financial institution holds over half of total deposits and is systemically important. - No material fixed-income market other than government and BPNG issues; stock market has limited trading despite market capitalization exceeding GDP due to cross listings. ### Banking sector performance and key metrics - Asset and funding composition: - Deposits account for about 80 percent of liabilities. - Loans account for only one-third of total assets and are heavily oriented to business lending. - Recent loan growth slowed from well in excess of 30 percent per annum to about 15 percent on an annualized basis. - Excess liquidity has encouraged holdings of government securities. - Asset quality and capital: - NPLs: less than 2 percent of total loans. - Provisioning: high. - Sector CAR: around 28 percent as at end-2010 (more than twice the level required by BPNG, reflecting large holdings of government securities with a zero risk weighting). - Profitability and returns: - Returns on assets: 3.3 percent. - Returns on equity: 27.7 percent. - Liquidity: - BPNG minimum “unadjusted” liquid asset ratio: 25 percent. - In practice liquid asset ratio has been above 50 percent for most of the period since 2005. - Banks report that 95 percent of their deposits is for periods of three months or less. - Holdings of short-term Treasury or BPNG bills for which there is no secondary market raise realizability doubts. - Operational risks: - High security and fraud risk due to violence and crime; frequent security- and fraud-related events. ### Stress tests — design, scenarios, and main results - Approach: - Top-down, supervisory-data-based stress tests for all four commercial banks, then aggregated. - Single-factor shocks: credit (overall and sectoral), interest rate, exchange rate, liquidity, sectoral concentration, largest exposures. - Income statement and balance sheet baseline annualized from year-to-date data and calculated quarterly. - Net gains/losses treated as one-time immediate charges to capital. - Credit shock results: - Current NPLs < 2 percent of loans; uniform increases in NPLs have little effect on CAR given high capital. - To push CAR below recommended 12 percent, NPLs would need to grow to 18 percent of total loans. - Caveat: strong credit growth may compress current NPL ratio; NPLs may increase as loan portfolio ages. - Sectoral concentration results (commercial and financial sector): - 33 percent of sector loans defaulting with no recovery would push one bank’s CAR below 12 percent. - 50 percent default with no recovery would render one bank insolvent. - 100 percent default with no recovery would render three banks insolvent and compromise 98.7 percent of banking system assets. - Credit deterioration in other sectors would have little effect on CAR. - Largest exposures: - No single large exposure total loss presents system-wide risk; loss of three largest borrowers per bank would put only one bank below CAR 12 percent. - Interest rate and FX shocks: - A 50 percent increase or decrease in yields produced negligible impact on CAR. - Foreign exchange risks found immaterial. - Liquidity shocks: - Recalculating liquidity excluding government securities and term deposits yields substantially lower liquidity ratios. - Under revised definition, one bank already below 25 percent liquid ratio. - A 10 percent withdrawal of short-term deposits would cause a second bank to fall under 25 percent. - A 15 percent withdrawal would cause a third bank to fall under 25 percent. - Banks could require support from parent banks or the central bank in such events. ### Key recommendations from stress testing and liquidity analysis - Revise definition of liquid assets: remove large holdings of government securities from numerator where no secondary market or central bank discount window exists. - Improve liquidity management tools: - Open a discount window at the Central Bank. - Develop a repo or secondary market for government securities. - Strengthen data management and reporting: - Centralize data management systems; BPNG would benefit from TA. - Standardize financial statement reporting (currency, unit of measure, period, specify year-to-date where applicable). ### Supervision, regulation, and Basel Core Principles gaps - Legal and supervisory framework: - CBA and BFIA enacted in 2000; prudential standards exist for minimum capital (Basel I), problem loan classification, large and related exposures (revised large exposures prudential standard issued January 2011), and fit and proper definitions. - Significant gaps: no detailed requirements for liquidity risk, operational risk, interest rate risk, market risk, risk management, or governance. - BFIA allows issuing prudential standards but does not explicitly make compliance compulsory. - Enforcement and sanctions: - Administrative sanctions limited (license revocation, fit and proper determinations); no proportionate sanctions for minor failings. - Recommendation: amend BFIA to allow administrative penalties, automatic monetary penalties for delayed reporting, private/public censure, and discretion for administrative fines. - Supervisory resourcing and fees: - License fees realize just K250,000 a year (if collected in full) versus supervision cost of K3.9 million; supervision funded from BPNG income. - Recommendation: increase license fees over three to five years to fully meet supervision costs; adopt principle that regulated sector pays supervision costs. - Need for more supervision staff and flexible pay to recruit senior private-sector staff. - Supervisory approach and tools: - Move to full risk-based supervision; conduct and document a full risk assessment as basis for supervisory strategy. - Require financial institutions to conduct their own stress tests and report results. - Improve timeliness of on-site examination reports (current delays of "four-six months") and follow-up (action plans "six-nine months" after exam). - Use sanctions to ensure prompt remedial action; hold post-examination meetings with auditors regularly. - Consolidated and cross-border supervision: - BPNG engages in consolidated supervision but should develop methodology for consolidated prudential requirements and trace ultimate beneficial owners. - MOUs: one concluded with Solomon Islands; draft agreements with Fiji and Australia; recommendation to complete suite of MOUs and consider Malaysia. ### Crisis management, liquidity facilities, and financial safety nets - Crisis management framework: incomplete; no formal coordination arrangements, information-sharing, decision-making, or emergency liquidity procedures between BPNG and Ministry of Finance. - No deposit insurance or policyholder protection scheme; other resolution mechanisms outside administration and liquidation not fully specified. - Central bank facilities and market infrastructure: - No repo or reverse repo facility; standing facilities not yet in place. - BPNG can provide unsecured lending but government securities may not be used as collateral per current stance. - Recommendation: complete repo facility and establish a discount window and standing collateralized facilities priced with reference to policy rate. - Systemic vulnerability concern: - High concentration of banking system, lack of interbank secondary markets, repos, and discount windows pose challenges for systemic stability. - Serious problems at the largest domestic institution would require swift PNG action to avoid systemic crisis. ### Payment systems and National Payment System (NPS) - Legal/institutional findings: - Current legal framework does not recognize payment services as an independent activity; does not address netting, finality, zero-hour protection, agent provision, or electronic payment recognition. - Oversight powers of BPNG over payments and securities settlement systems not categorically stated. - Securities Commission lacks powers to specify operating requirements for brokers, license/oversee registrars and depositories, or oversee settlement systems. - Recommendation: establish a dedicated Payment Systems Department in BPNG. - Retail payments and costs: - No inter-bank electronic funds transfer system; high retail payment costs. - Small customers rely on expensive check discounting and cash-based domestic remittance services; ATP and POS fees are high. - Barriers to low-income customers: high operating costs of branches and KYC challenges. - Planned NPS (launched January 2010) to cover: - Automated Transfer system (ATS); - Integrated RTGS and Automated Clearing House/Electronic Funds Transfer system; - Legal reforms to address payment system issues; - Central Securities Depository (CSD) linked to ATS for securities settlement and collateralized liquidity support; - Card payment switch. ### Insurance, ASFs, and pension sector highlights - Insurance sector: - Not a major player; recent performance profitable for non-life; life sector reliant on investment income. - Life sector asset composition (end-2008): Investment property 42 percent; equities 17 percent; cash/bank deposits 10 percent; government securities 3 percent. - Total assets of life sector: 1 percent of total financial system assets as of end-2008. - Reinsurance usage: 0.68 percent of business reinsured as at end-2008. - Authorized Superannuation Funds (ASFs): - Superannuation is a relatively large component of financial sector assets and dominant source of long-term investment, though focused on formal sector. - Two largest funds, Nasfund and Nambawan Super, represent 87 percent of total ASF assets. - 2008–2009 performance: equities exposure ~55–60 percent in 2008 led to 70–75 percent lower but still positive returns vs 2007; in 2009 Nambawan’s profits up 40 percent and Nasfund’s up 177 percent relative to 2008 dip. - Selected total assets (K millions): DFRBF 299; Nambawan 2,622; Nasfund 1,779. ### Financial inclusion and AML/CFT gaps - Financial inclusion: - Nearly 85 percent of adult population excluded from formal financial sector. - Approximately 650,000 people (10 percent of population; 17 percent of adults) have access to formal financial services. - Over 3.3 million people do not have a safe place to keep savings or access loans. - Government commitments: PNG Development Strategic Plan 2010–2030 prioritizes expanding microfinance banking services; NPS Development Program aims to encourage cost-effective retail payment instruments with focus on unbanked. - Barriers to access: high levels of violence and weak security, corruption (PNG ranks in the lowest quartile on an international corruption ranking index), infrastructure weaknesses, limited financial literacy. - AML/CFT framework deficiencies: - Five years after POCA enactment, no legislation on terrorist financing and no enforcement of customer due diligence guidance. - POCA places enforcement with FIU, which lacks resources/expertise. - POCA grants total immunity to reporters of suspicious activities; recommendation to modify immunity to allow penalties for those who ignore FIU instructions. - Specific recommendations: - Introduce legislation on terrorist financing. - Issue regulation on customer due diligence to create obligation for account monitoring. - Give BPNG enforcement responsibility for financial institutions’ due diligence. - Remove blanket immunity for reporting institutions. - Require institutions to follow FIU instructions regarding reported funds. - Risk statement: without remedial action PNG could be regarded as non compliant with FATF recommendations, with severe consequences for cost of doing business. ### Sovereign Wealth Funds guidance - Past experience: - Mineral Resource Stabilization Fund (MRSF) and public trust accounts management was largely unsatisfactory; MRSF proved procyclical and public trust accounts had very low returns and costly BPNG absorption of excess liquidity. - Allocation of revenues to many trust accounts limited spending flexibility and raised governance issues. - Government decision (November 2010): form a pool to establish three SWFs with objectives: (i) fiscal stabilization; (ii) savings; (iii) infrastructure development. - SWF Working Group (March 2010) mandate: - Assess appropriateness of current framework; - Seek feedback and canvass options including offshore fund; - Report to the National Economic Council by June 30, 2010. - Operational priorities for SWFs: - Roles, responsibilities, and institutional arrangements; - Funding and withdrawal rules; - Risk management frameworks and investment strategies; - Transparency, accountability, and governance approaches. ### Recommended priority actions (synthesis of recommendations) - High priority, short-term: - Monitor current and emerging NPLs; analyze sectoral impacts. - Develop monitoring systems and stress tests with alternative liquid asset definitions. - Formalize bank liquidity support arrangements (repurchase agreements) and establish a discount window lending program. - Strengthen BPNG’s crisis preparedness and contingency planning framework for emergency liquidity assistance. - Complete repo facility establishment and related market infrastructure work. - Give BPNG responsibility for enforcing financial institutions’ AML customer due diligence; issue regulations on CDD. - Publish a full set of prudential standards starting with risk management, market and liquidity risk, governance, credit, and operational risk. - Medium term: - Centralize data management systems and standardize financial reporting. - Enhance supervisory staff capacity and shift to full risk-based supervision. - Introduce a noncompetitive auction segment for smaller investors and review regulatory infrastructure for market integrity and OTC trading. - Implement the National Payment System Development Program and establish a Payment Systems Department in BPNG. - Long term / lower priority: - Consider development of a deposit protection scheme. - Decide on SWF funding and withdrawal rules, institutional arrangements, and investment strategy; ensure consistency with macroeconomic framework. *Source: Excerpts from IMF staff report chapter provided in the source content unit.* ### Executive Summary ...................................................................................................... ### Executive Summary ### Key findings on financial sector performance and resilience - The global financial crisis had only a mild impact on PNG. The financial sector was largely insulated from global wholesale funding markets and limited use of derivatives and complex financial instruments reduced direct exposure. Increased public spending helped sustain growth despite indirect impacts from some commodity price declines. - Indicators point to a generally well capitalized and highly profitable sector overall. - System capital ratios are high, driven by capacity to serve larger clients, expected expansion in lending, and high holdings of government securities. - Underlying liquidity and concern regarding asset quality, as the portfolio continues to grow, may justify high capital ratios. - Stress tests indicate the banking system faces little impact from interest rate and credit shocks in the near term, although loan concentration in the commercial and financial sector could potentially pose a risk. - Structural vulnerabilities remain: - Small open economy and concentrated financial sector focused on the formal (especially commercial) sector. - Significant growth expectations and limited secondary markets. - Rapid credit growth may overstate apparent resilience despite high capital and liquidity buffers. ### Macroeconomic setting and selected statistics - Real GDP growth is estimated to have picked up to 7 percent in 2010, from 5½ percent in 2009, owing to a turnaround in the mineral sector and agricultural production and higher commodity prices. - Headline inflation reached 7¼ percent in December 2010 (12-month rate). - Currency: Kina (K) = US$ 0.33. ### Risk Assessment (summary of Table 1) - Credit Risk: Assessment: medium. - Lending to the private sector has seen a fourfold increase since 2005 (greater than GDP growth and deposit growth) and, after a dip, is expected to continue. - Although NPLs had increased in 2009 to 2 percent of total loans, banks remain profitable and relatively well capitalized. - Concentration Risk: Assessment: medium (nature/source); Assessment: high (likelihood/impact). - High sectoral loan concentrations and concentrations of loans to single borrowers and depositors. - Only four banks—shocks to large customers could be significant. - Operational Risk: Assessment: high (nature/source); Assessment: low (likelihood/impact). - Security and infrastructure conditions are challenging; frequent security- and fraud-related events. - Impact on financial stability would be low if events remain small in nature. - Exchange Rate Risk: Assessment: low. - Current account currently in deficit, expected to turn positive upon completion of LNG projects in 2014. - Banks have small net foreign exchange positions; possible downward pressures on the exchange rate not expected to significantly affect banks’ creditworthiness. - Commodity Price Risk: Assessment: medium. - A slow recovery in the global economy could result in a decline in commodity prices, reducing corporate profitability and adversely affecting banking asset quality. - Overall Level of Concern: table presents assessments for likelihood of severe realization sometime in the next 3 years and expected impact on financial stability if threat is realized, across these risk categories. ### Key recommendations and priorities (synthesized from Table 2) - Banking sector — Credit risk - Monitor current and emerging NPLs with regard to loan duration and sectoral impacts of macroeconomic changes. Priority: High. Time frame: Medium term. - Conduct a thorough analysis of counterparty exposure concentrations, with a full definition of interconnectedness. Priority: Medium. Time frame: Short term. - Conduct a thorough analysis of collateral and related lending exposures to property loans. Priority: Medium. Time frame: Short term. - Liquidity risk - Develop monitoring systems and conduct stress tests that assume alternative definitions of liquid assets. Priority: High. Time frame: Short term. - Ensure any withdrawal of government deposits from the banking system is done with careful planning and adequate consultation. Priority: High. Time frame: Short and Medium term. - Formalize bank liquidity support arrangements with the BPNG, including through repurchase agreements for government securities stock. Priority: High. Time frame: Short term. - Regulation and supervision - Centralize data management systems. Priority: Medium. Time frame: Medium term. - Conduct and document a full risk assessment as the basis for the supervisory strategy. Priority: Medium. Time frame: Short term. - Publish a full set of prudential standards, starting with risk management, market and liquidity risk, and including governance, credit, and operational risk. Standardize financial statement reporting. Priority: High. Time frame: Medium term. - Increase the range of administrative sanctions and make compliance with prudential standards compulsory. Priority: High. Time frame: Medium term. - Enhance supervisory staff capacity through training to enable full risk-based supervision. Priority: High. Time frame: Medium term. - Systemically important institutions - Make arrangements for liquidity improvement and contingency planning that reduce the risk profile. Priority: Medium. Time frame: Medium term. - Crisis management - Establish a discount window lending program, including repurchase agreements. Priority: High. Time frame: Short term. - Strengthen BPNG’s crisis preparedness by developing a contingency planning framework, including internal procedures on emergency liquidity assistance. Priority: High. Time frame: Short term. - Consider development of a deposit protection scheme. Priority: Low. Time frame: Long term. - Government debt markets - Estimate the scale of broader public-sector debt obligations, such as borrowing and guarantees. Priority: High. Time frame: Short term. - Issue BPNG guidelines to market participants on sound procedures for repurchase transactions. Priority: High. Time frame: Short term. - Introduce a noncompetitive segment of the auction for smaller investors. Priority: Medium. Time frame: Medium term. - Review regulatory infrastructure to ensure market integrity and price reporting, to allow seamless over-the-counter trading. Priority: Medium. Time frame: Medium term. - Payment systems - Implement the proposed National Payment System Development Program. Priority: High. Time frame: Medium term. - Establish a Payment Systems Department in the BPNG, and exercise oversight of all payment and securities settlement systems. Priority: High. Time frame: Medium term. - Develop regulations/guidelines for mobile payments and securities settlements. Priority: Medium. Time frame: Medium term. - Insurance sector - Enhance supervisory functions regarding offsite reporting and monitoring and onsite inspections. Priority: High. Time frame: Short term. - Develop guidance on governance, risk management, and internal controls. Priority: Medium. Time frame: Medium term. - Implement the International Association of Insurance Supervisors’ principles, as appropriate to the PNG setting. Priority: Medium. Time frame: Medium term. - Financial inclusion - Establish a functional coordination mechanism on financial inclusion, including all government departments and agencies. Priority: Medium. Time frame: Short term. - Set up a national consultative process. Priority: Medium. Time frame: Short term. - Commence specific data collection on financial inclusion. Priority: Medium. Time frame: Medium term. - Anti-Money Laundering (AML) - Give BPNG responsibility for enforcing financial institutions’ obligations. Priority: High. Time frame: Short term. - Complete the customer due diligence regime (especially with more focus on monitoring accounts). Priority: High. Time frame: Short term. - Issue regulations on customer due diligence. Priority: High. Time frame: Short term. - Sovereign Wealth Funds (SWFs) - Authorities should decide on funding and withdrawal rules, institutional arrangements (including organizational structure, roles and responsibilities), and investment strategy for the funds decided by the Government. Priority: High. Time frame: Short term. ### Crisis management, markets, and operational reforms - PNG’s crisis management framework is incomplete and needs strengthening. - High banking concentration, lack of secondary markets for government securities, and absence of an effective mechanism for providing central bank liquidity could pose significant challenges in a systemic event. - Further development of local government securities markets is important for system stability. - Establishment of a standing facility for banks to access liquidity against collateral and the introduction of an active secondary and interbank market for government securities would mitigate liquidity risks and support bond price discovery. - Payment and settlement systems reform is required. - Current legal framework does not recognize payment services as an independent activity and does not address key payment system issues. - Oversight powers of BPNG are not categorically stated and oversight/regulatory powers of the Securities Commission are inadequate. - Establishing a dedicated Payment Systems Department in the BPNG is crucial. ### Financial inclusion and AML gaps - Around 85 percent of the adult population is excluded from the formal sector, largely those in rural communities. - Main barriers: operational challenges and infrastructure weaknesses that increase provider costs. - AML: Five years after enactment of the Proceeds of Crime Act (POCA), there is still no legislation on terrorist financing and no enforcement of guidance on detailed customer due diligence. - BPNG should be given enforcement responsibility for financial institutions’ due diligence and ensure proper monitoring of accounts, including reporting of salaried employees who deposit sizeable checks with no apparent justification. - BPNG should use existing supervisory powers to encourage banks to take customer due diligence more seriously and report suspicious activities, especially potential corruption and theft of government resources. ### Sovereign Wealth Fund guidance - PNG’s past management of resource export proceeds through the Mineral Resource Stabilization Fund (MRSF) and public trust accounts has been largely unsatisfactory. - As the authorities operationalize a new framework, priorities include establishing a sound institutional framework with appropriate governance structures, funding and withdrawal rules, and risk management and investment strategies. *Source: Executive Summary.* ### 13. A favorable external environment and the introduction of financial sector ### 13. A favorable external environment and the introduction of financial sector ### Overview and financial sector structure - Total financial sector assets increased to K26 billion (more than 100 percent of GDP) as of December 2010 from K9.5 billion at the end of 2005, with banking sector assets comprising about 69 percent of the total. - Market participants and structure: - Four commercial banks. - Seven authorized superannuation funds (ASFs). - Five life insurance companies. - A number of other nonbank financial sector institutions licensed and regulated by BPNG. - The financial sector is largely oriented to serve the formal sector and provides little reach to the very large informal, rural, and self-employed segments of the population. - The largest domestic financial institution holds over half of total deposits, is systemically important, has operations in other Pacific countries, and has issued convertible notes in Fiji (noted as the first public cross-border issue of its type in the region). - No material fixed-income market exists other than issues offered by the government and the BPNG; the stock market shows very limited trading despite market capitalization exceeding GDP because of a high number of cross listings with Australia. ### Banking sector performance and key risks (Section C) Findings: - Banks exhibit: - High asset growth. - Strong capital levels. - Profitability (though decreasing). - Significant liquidity. - Considerable deposit concentration given the small economy. - Funding and asset composition: - Banks are primarily deposit-funded and have no significant links to global wholesale funding markets. - Deposits account for about 80 percent of liabilities. - Loans account for only one-third of total assets and are heavily oriented to business lending. - Excess liquidity has encouraged holdings of government securities; recent loan growth slowed from well in excess of 30 percent per annum to about 15 percent on an annualized basis. - Asset quality and capitalization: - NPLs are very low (less than 2 percent of total loans). - Provisioning is high. - Sector CAR for the banking system stood at around 28 percent as at the end of 2010, more than twice the level required by BPNG, reflecting large holdings of government securities with a zero risk weighting. - Monetary and market environment: - BPNG resists increasing the stock of central bank bills (CBB) and the policy rate (KFR) is kept at 7 percent due to the challenge of sterilizing excess liquidity. - Property prices and rents have risen; near-term risk of property-market decline is judged small given high real-estate demand and potential constraints related to the LNG project. - Market risk and operational risk: - Banks have limited exposure to market risks (small foreign exchange positions, small interest rate exposures, no proprietary trading). - Operational risks are material, including high security and fraud risk in a country with significant violence and crime. ### Stress tests (Section D) Approach: - Single-factor shocks were applied for credit (overall and sectoral), market, and liquidity risks, with single-factor calculations covering credit risk, interest rate risk, sectoral concentration risk, liquidity risk, and large exposures. Main results: - Credit shocks: - Given very low NPLs (less than 2 percent of total loans) and high capital, a uniform increase in NPLs (assumed provisioned wholly and charged to capital) would have little effect on CAR. - To push CAR below the recommended 12 percent, NPLs would need to grow to 18 percent of total loans. - Caveat: current NPL ratio could be compressed by strong credit growth and may increase as the loan portfolio ages. - Sectoral concentration (commercial and financial sector) shocks: - It would require 33 percent of the loans to this sector to default, with no recovery, for the CAR to fall below the recommended 12 percent level (and this would be the case for only one bank). - A 50 percent loan default to this sector, with no recovery, would be required to render this one bank insolvent. - All loans to the sector would have to default, without recovery, to render three banks insolvent. - Credit deterioration in other sectors would have little effect on banks’ CAR observance. - Interest rate and exchange rate shocks: - A 50 percent increase or decrease in yields produced negligible impact on CAR given predominantly short-term assets and liabilities and high duration matching. - Foreign exchange risks were tested and found immaterial. - Insufficient information was available to conduct a thorough test on property-market exposures. - Liquidity shocks: - Absence of a secondary or liquid interbank market for government securities increases vulnerability, though mitigated by very short duration of bank holdings (significant weekly maturities). - BPNG has no repo facilities or discount window; stress tests adjusted liquidity ratios by excluding government securities from the numerator and term deposits from the denominator. - Assuming a 10 percent withdrawal of short-term deposits, two banks would have “adjusted” liquidity under 25 percent. - A 15 percent withdrawal would result in a further third bank falling below 25 percent. - In such cases, banks could require support from parent banks or the central bank. - Note on liquidity metric: - The BPNG imposes a minimum “unadjusted” liquid asset ratio of 25 percent. ### Banking supervision and regulation (Section E) Current status and gaps: - Legal and supervisory framework: - Reforms of 2000 produced a new Central Banking Act (CBA) and Banking and Financial Institutions Act (BFIA). - BPNG has developed supervisory techniques with support from PGSG and APRA; examination staff are developing a reputation for competence. - Risk-based supervision and tools: - BPNG is encouraged to conduct and document its own assessment of risks to financial stability and to link this to supervision strategy and ongoing monitoring. - BPNG’s own stress testing should be supplemented by a requirement for financial institutions to conduct their own stress tests and report results regularly. - Move to full risk-based supervision is recommended. - Prudential standards: - Standards exist on minimum capital ratios (consistent with Basel I but without market risk component), problem loan classification, large and related party exposures (revised large exposures prudential standard issued in January 2011), and fit and proper definitions. - Prudential standards are urgently needed for governance, risk management, credit risk, market risk, interest rate risk, liquidity risk, and operational risk. - Governance and overall risk management of all financial institutions should be subject to clear standards. - Legal and enforcement gaps: - BFIA allows issuing prudential standards but does not explicitly make compliance compulsory. - Apart from license conditions, the only administrative sanctions under BFIA are determinations of not fit and proper or license revocation, which are ineffective for minor failings. - BFIA should be amended to allow BPNG to impose administrative penalties for failure to comply with prudential standards; penalties should include automatic monetary penalties for delayed reporting, private and public statements of censure, and administrative fines at BPNG discretion. - Use of existing powers: - BPNG has the power to require a financial institution to commission a report from a skilled professional, but this tool has never been used. - Auditors are required to report breaches, but auditors have never reported breaches (and cannot report weaknesses in areas not yet covered by prudential standards). - Funding and resourcing of supervision: - License fees currently realize just K250,000 a year (if collected in full) against a cost of supervision of K3.9 million; the balance is made up from BPNG income. - Supervision resources were cut in 2008 and 2009 due to losses on monetary policy operations. - Principle that financial institutions should pay for their own supervision was adopted for ASFs and should apply to banks and other licensed financial institutions. - The level of license fees should be raised, over a three to five year period, to fully meet the cost of supervision. - Supervision department needs more staff and a more flexible pay system to recruit senior staff from the private sector; this should be accompanied by greater accountability. - Operational reporting to the Minister should be expanded to include performance against measurable targets; operational and financial reports should be published in a timely fashion to allow parliamentary scrutiny. - Supervisory assertiveness: - BPNG should avoid leaving necessary prudential statements in draft for extended periods (example: revised large exposures prudential standard left in draft for over five years). - With complete regulations and new tools, BPNG can ensure good risk management practices and move to risk-based supervision, but will need further assistance to build capacity. ### Crisis management and financial safety nets (Section II) - No crisis management framework: - No formal coordination arrangements within BPNG or between BPNG and the Ministry of Finance for handling problems in larger institutions or potentially systemic issues. - No arrangements for information-sharing, decision-making, external communication, or procedures for emergency liquidity assistance. - No experience of bank or deposit-taking institution failure since the 2000s reforms; two non-life insurance failures occurred previously. - No deposit insurance or policyholder protection scheme exists. - Other resolution mechanisms outside of administration and liquidation are not fully specified. - Systemic vulnerabilities and recommended measures: - High concentration of the banking system and lack of interbank secondary markets, repos, and discount windows pose significant challenges for systemic stability. - If liquidity problems emerge in PNG operations of the three commercial foreign-owned banks, their parents would most likely provide support given their relative small size. - Serious problems at the largest domestic financial institution or at the parent of one of the foreign-owned banks would require PNG to act quickly to avoid systemic crisis. - PNG has no deposit insurance scheme and delays in deposit payouts in liquidation can increase run risk. - BPNG is working on a repo facility and should complete it as soon as practical. - BPNG should develop a contingency planning framework, including internal procedures on emergency liquidity assistance. - Insurance sector: - Two insurer failures did not create systemic risk but highlighted the importance of arrangements to deal with insurer failure and coordination between the Insurance Commission and the BPNG. ### Government debt and money markets (Section III) Key facts: - Government debt levels: - Overall indebtedness declined to 32 percent of GDP at the end of 2009, down from 48 percent in 2005. - External debt is mainly concessional and represents 40 percent of the total. - Domestic debt represents 60 percent of overall government debt, up from 48 percent in 2005. - Debt profile and contingent liabilities: - Domestic debt stock exhibits an uneven maturity profile caused by a large stock of Treasury bills, with 45 percent of the debt being short term. - Bunching maturities of Government Inscribed Stock start in 2011 with K500 million maturing. - Broader public-sector debt obligations, including borrowing and guarantees associated with the LNG project, the large unfunded pension liability, and government commitments under the memorandum of agreement with landowners, constitute significant sovereign contingent liabilities. - Monetary policy and market infrastructure: - Foremost challenge for BPNG is to deal with excess liquidity in the financial sector. - Main indirect monetary instrument is the weekly auction of short-dated central bank bills (CBBs). - BPNG can provide unsecured lending in case of an overall system liquidity shortfall, but no repo or reverse repo facility is available; no general standing facilities exist for deposit-taking institutions. - Standing facilities would typically be collateralized, priced with reference to the policy rate, rules-based, short-term (overnight), and implementable at the request of a commercial bank. - Market regulation: - Government debt instruments are specifically excluded from the Securities Market Law; regulatory structure of the market is guided only by respective laws on the instruments. - Investor protection is limited and no rules exist on operation of the secondary market. - Supervision of the primary market rests with BPNG and the Treasury and is limited to monitoring bids and participation in the primary market. - Regulatory gaps would need to be filled if the secondary market became more active and included the general public; cooperation between BPNG and the Securities Commission would be required. *Source: Excerpt from IMF country report chapter provided in the source content.* ### 43. The current legal framework does not recognize payment services as an ### The current legal framework does not recognize payment services as an independent activity. ### Payment systems: legal and institutional findings - The current legal framework does not recognize payment services as an independent activity. - The legal framework does not address payment system issues like netting, finality, zero-hour protection, using agents to provide payment services, and recognition of electronic payments as a valid means of discharging obligations. - The oversight powers of BPNG over payments and securities settlement systems are not categorically stated. - The oversight and regulatory powers of the Securities Commission are inadequate: - it does not have powers to specify operating requirements and guidelines for brokers; - it cannot license and oversee registrars and depositories; - it cannot oversee settlement systems. - Recommendation: Establishing a dedicated Payment Systems Department in the BPNG is crucial to support oversight of all payment and securities settlement systems. ### Retail payments, costs, and planned National Payment System (NPS) - Lack of an inter-bank electronic funds transfer system has resulted in high costs being charged for retail payments. - Consequences for consumers: - Small retail customers use expensive check discounting services and cash based domestic remittance services. - Automated-trading-program (ATP) and point-of-sale (POS) transaction fees are high. - High operating costs of traditional bank branches and issues meeting know-your-customer requirements have been a barrier to low-income customers, leading to very limited penetration of banking services. - Planned National Payment System (NPS), launched in January 2010, would cover: - an Automated Transfer system (ATS); - an integrated Real-Time Gross Settlement System (RTGS) and Automated Clearing House/Electronic Funds Transfer system; - legal reforms to address payment system issues; - a Central Securities Depository (CSD) with linkages to the ATS for securities settlement and for collateralized liquidity support mechanisms; - a card payment switch. ### Insurance sector key findings - Insurance companies are not major players in the PNG financial sector. - Recent insurance sector performance has been profitable; the non-life sector has shown growth in real terms. - Non-life sector: - making underwriting profits and further supported by investment income. - Life sector: - premium income is not sufficient to cover claims, commission, and operating expenses and is reliant on investment income to make profits. - small in size and has significant asset concentration. ### Life sector asset composition (as of end-2008) - Investment property: 42 percent of total assets. - Investments in equities: 17 percent of total assets. - Cash and bank deposits: 10 percent of total assets. - Government securities: 3 percent of total assets. - Total assets of the life sector contribute only 1 percent to the total assets in the financial system as of end-2008. - Reinsurance usage: 0.68 percent of the business was reinsured as at the end of 2008. - Risk management practices: mortality due to HIV/AIDS and morbidity mainly managed through exclusion clauses or prior medical testing. ### Superannuation funds (ASFs) and recent performance - Superannuation is a relatively large component of financial sector assets and the dominant source of long-term investment, though focused on the small formal sector. - All funds, except the Defense Force scheme, are defined contribution in nature. - The two largest funds, Nasfund and Nambawan Super, represent 87 percent of total assets and predominantly cover private sector and public sector employees, respectively. - After a sharp deterioration in 2008, returns of the two major ASFs rebounded in 2009: - equities exposure in the two major funds in 2008 were about 55–60 percent of the total investment portfolio, which led to 70–75 percent lower, but still positive, returns compared to 2007. - In 2009, Nambawan’s profits increased by 40 percent, and Nasfund’s by 177 percent compared to the dip in 2008. ### Selected investment portfolio figures (table summary) - Total assets (presented in table): DFRBF 299; Nambawan 2,622; Nasfund 1,779 (All amounts in K millions unless otherwise specified). - Memorandum items: - Active members (‘000s): 2.0 (DFRBF), 129.3 (Nambawan), Nasfund figure not separately shown in excerpt. - Inactive members ('000s): 1.8 (DFRBF), 168.0 (Nambawan). - Total members: 3.8 and 297.3 (presentation in table). ### Financial inclusion: scope and government response - Nearly 85 percent of the adult population is excluded from the formal financial sector. - Approximately 650,000, or 10 percent of the population and 17 percent of adults, currently have access to formal financial services. - Over 3.3 million people do not have a safe place to keep their savings or access loans. - Majority of the financially-excluded reside in rural communities living a cash and subsistence lifestyle with minimal infrastructure and savings. - Government commitments: - PNG Development Strategic Plan 2010–2030 identifies expanding microfinance banking services to all districts as a priority. - NPS Development Program aims to encourage introduction and use of innovative, convenient, and cost-effective new retail payment instruments, with special focus on the currently ‘unbanked’ sectors. ### Barriers to financial access (service provider perspective) - Operational challenges related to high levels of violence and weak security, especially in urban areas. - Corruption: PNG ranks in the lowest quartile on an international corruption ranking index. - Weaknesses in infrastructure. - Limited financial literacy of the population. ### Anti-money laundering (AML/CFT) framework findings and recommendations - Five years after enactment of the Proceeds of Crime Act (POCA), there is still no legislation on terrorist financing and no enforcement of guidance on detailed customer due diligence. - PNG is viewed as subject to a serious money laundering risk due to a worrying level of corruption. - POCA creates some very basic obligations on financial institutions for customer identification and transaction reporting, but: - enforcement responsibility lies with the Financial Intelligence Unit (FIU), which lacks resources and expertise to discharge it. - Recommendations and observations: - The BPNG should be given enforcement responsibility for financial institutions’ due diligence and ensure proper monitoring of accounts to identify and report unjustified sizeable deposits by salaried employees. - POCA currently gives total immunity from any, even criminal, proceedings for those who report suspicious activities; immunity should be modified to allow for penalties for those who ignore FIU instructions. - Institutions should be required to follow FIU instructions in respect of funds that are the subject of reports. - FATF requires certain obligations to be in the form of legislation; compliance with FIU guidelines is not enforceable under POCA—shortcomings put PNG at risk of being assessed as noncompliant with FATF recommendations. - Limited awareness of AML obligations in the insurance sector. - Specific areas for strengthening the AML/CFT framework: - (i) introducing legislation on terrorist financing; - (ii) issuing a regulation on customer due diligence, thus creating an obligation for account monitoring; - (iii) giving BPNG enforcement responsibility; - (iv) removing the blanket immunity given to institutions that report suspicious activities. ### Sovereign Wealth Fund (SWF) developments and guidance - Past experience managing resource export proceeds via the Mineral Resource Stabilization Fund (MRSF) and public trust accounts was largely unsatisfactory: - MRSF proved procyclical because of poor integration in the budget and fiscal policy objectives. - Public trust accounts raised issues including very low returns and costly BPNG absorption of excess liquidity. - Allocation of revenues to many trust accounts limited government spending flexibility and raised governance issues. - Government decision in November 2010 to form a pool of resources to establish three SWFs with objectives: - (i) fiscal stabilization; - (ii) savings; - (iii) infrastructure development. - A joint Department of Treasury-BPNG SWF Working Group was formed in March 2010 with mandate to: - (i) assess the appropriateness of the current framework; - (ii) seek feedback from international institutions and other governments; - (iii) canvass possible options for government consideration, including possible creation of an offshore fund to manage windfall revenues arising from the LNG project; - (iv) report back to the National Economic Council by June 30, 2010. - Operational guidance offered to authorities emphasized consistency between SWF objectives and the macroeconomic framework, including: - (i) roles, responsibilities, and institutional arrangements of the SWFs; - (ii) adoption and implementation of funding and withdrawal rules; - (iii) risk management frameworks and investment strategies; - (iv) approaches to address transparency, accountability, and governance issues. ### Basel Core Principles—supervisory regime summary, key findings, and recommendations - The BPNG is developing its supervisory regime but substantial work remains to complete it. - Supervisory regime basis and gaps: - Based on the BFIA (enacted in 2000) and supplemented by prudential standards covering minimum capital ratios, asset classifications, large and related party exposures, and other matters. - Substantial gaps include no detailed requirements relating to liquidity risk, operational risk, interest rate risk, and market risk, and no standards on risk management or governance. - Money laundering defenses lack proper enforcement, a serious concern given high corruption, robberies, and violent crime. - While capital, asset quality, and liquidity position of banks appear strong in 2010, positions could change as the banking system develops and grows. - Recommendations: - BPNG needs to conduct a proper risk assessment to focus supervisory priorities. - Complete the supervisory regime and make fuller use of its powers. - Enhance staffing, pay flexibility, and accountability at the BPNG. - Institutional and market structure highlights: - The financial sector is dominated by the largest domestic bank, which: - holds half of PNG’s banking system assets and liabilities; - has 85 percent of deposits by volume; - is the only bank with a significant branch network in the country. - Total assets of the four banks are 15.5 billion Kina (approximately US$5.1 billion), which amounts to 62 percent of GDP. - Two small microfinance banks exist (government has an interest); 8 licensed financial institutions are privately owned. - Total assets of non-bank licensed financial institutions and microfinance banks are 420M Kina (US$130 million). - The stock exchange liquidity is thin; large capitalization (over 200 percent of GDP) is due to substantial cross listings. - Domestic capital market largely confined to the primary market in short term Treasury and BPNG bills almost all bought and held by commercial banks. - Capital and profitability metrics: - Minimum risk asset ratio: 12 percent. - Banking system capital: around 25 percent of risk weighted assets. - Lending as a proportion of total bank assets: about a third. - Securities (mostly government bonds) account for half the assets. - Banks are profitable with returns on assets of 3.3 percent and returns on equity of 27.7 percent. - Liquidity concerns: - BPNG imposes a minimum liquid asset ratio of 25 percent; in practice the ratio has been above 50 percent for most of the period since 2005. - Banks report that 95 percent of their deposits is for periods of three months or less. - Liquid assets include substantial holdings of short-term Treasury or BPNG bills for which there is no secondary market, no active interbank market, no repo facilities with the central bank, and no discount window—raising doubts about realizability in a stress event. *Source: IMF staff report excerpt.* ### 65. Supervision is conducted by the BPNG, which was created in its present form by ### _cr11163 - 65. Supervision is conducted by the BPNG, which was created in its present form by ### Supervision framework and institutional setup - Supervision is conducted by the BPNG, which was created in its present form by the CBA in 2000. - The BPNG is the sole supervisory authority for banks; supervisory powers are provided by the BFIA. - BFIA defines two kinds of financial institution: banks and licensed financial institutions, collectively known as authorized institutions. - Licensed financial institutions: - Permitted to take deposits but may not offer demand deposits or issue checkbooks. - Microfinance banks: - Exempt from the requirement to be authorized but are subject to conditions which reapply the entire regulatory regime except for minimum capital. - Permitted minimum capital: K1.5million (the same level as licensed financial institutions). - Unlike licensed financial institutions, microfinance banks may offer demand deposits. - Anti–money laundering / terrorist financing: - Defenses against money laundering (but not terrorist financing) established in the POCA, enacted in 2005. - Guidelines on customer due diligence issued in 2007. ### Governance, reporting, and operational capacity of BPNG - Leadership and appointments: - BPNG headed by the Governor, who exercises supervisory powers, and a Board. - Both the Governor and the Board are appointed by the Head of State of PNG, acting on the advice of her PNG Ministers. - Reporting and data dissemination: - BPNG publishes an annual report of its financial performance and prepares an operational report for the Minister of Finance. - Data on financial strength of the banking system is prepared fortnightly and fortnightly statistics are published on the BPNG web site. - Other data, including laws and regulations, are available on the web site. - Staff and independence: - BPNG staffed by professional, competent, and diligent supervisory staff who exercise functions without apparent compromise to their independence from the government. ### Economic and market context (Preconditions) - Economic structure and dependence: - Papua New Guinea’s economy primarily based on agriculture; developed economy dominated by exploitation of minerals. - For 75 percent of the population, agriculture provides means of sustaining livelihood. - Mineral deposits (including copper, gold and oil) account for nearly two thirds of export earnings. - New LNG project from natural gas reserves likely to provide significant export earnings and government revenues. - Fiscal and macro performance: - Fiscal position strong until 2009, then substantial deficit due to increased spending and lower commodity prices. - Since 2006, budget broadly in balance with surpluses not exceeding 3 percent of GDP. - In 2009, fiscal deficit of 8 percent. - Total GDP growth: over 7 percent between 2007 and 2008; below 5 percent in 2009. - Inflation peaked at over 13 percent in Q3 of 2008; reduced to just under 6 percent in 2009 following BPNG policy actions. - Foreign exchange and trust funds: - Foreign exchange receipts from mineral exploitation held by BPNG; corresponding domestic currency funds provided to Government. - Profits from mineral exploitation held in trust funds — some held at BPNG and some drawn down by government and placed in the largest domestic bank. ### Legal, accounting, and operational environment - Legal infrastructure: - Companies Act follows New Zealand company legislation model. - All companies file accounts (not all audited); accounts available for a fee. - Private property laws enforceable; judicial system can be effective but may be slow for private citizens. - Insolvency Act dates to 1951. - BFIA allows BPNG to appoint a statutory manager and wind up a bank. - Outside urban areas, land registry and charge registration information may be incomplete or unreliable; delays in registering charges on property, mortgages on ships and aircraft. - Accounting and audit: - Papua New Guinea has adopted IFRS. - Certified Practicing Accountants Association of Papua New Guinea (CPAPNG) maintains a register of qualified accountants and continuing professional development. - No effective monitoring of accountancy standards. - All banks and most licensed financial institutions audited by one of the three global accounting firms with presence in PNG. - BPNG has authority to object to an auditor who fails to apply international standards but has never done so. - Security and infrastructure challenges: - High levels of violence (threats, kidnapping, armed robbery, attack) affecting bank staff and branches, particularly in rural areas; heavy security costs. - Telecommunications, power supplies, and road network subject to failures; banks often maintain own power supplies and broadband internet communications. - Road network incomplete; frequent landslips and roadblocks. ### Market structure and liquidity facilities - Market concentration and competition: - Domestic retail market dominated by one large systemic bank with a national branch network. - Foreign-owned banks focus on niche or commercial sectors. - Competition limited; high returns and wide spreads. - BSP has effective monopoly on Government accounts (including operational accounts and trust funds). - Corporate lending margins reported as narrow due to direct competition. - Depositor protection and central bank facilities: - No depositor protection scheme and no explicit government guarantee of banks or other financial institutions. - No BPNG repo facility (one is in preparation), no discount window, no facility for BPNG to buy bills from banks to relieve liquidity shortages. - BPNG has stated government securities may not be used for collateral but would be willing to lend on an unsecured basis to banks if necessary. ### Main findings — objectives, independence, powers, transparency, cooperation (Principle 1) - Independence and resourcing: - BPNG acts independently but independence should be reinforced with greater freedom over fees, staff salaries and the budget. - No evidence of government interference; independence underpinned by statute. - BPNG cannot currently meet targets for on-site inspections and lacks sufficient staff for risk, trend, and financial stability analysis. - Banking supervision largely financed from BPNG profits and has been cut back when profits dip. - Recommendations (fees and staffing): - Extend principle that regulated sector should pay regulation costs to banks (already adopted for superannuation and insurance). - Governor should have power to set license and annual fees for authorized institutions under the BFIA and, over a transition period, increase fees until they cover supervision costs. - Pay for staff should be freed from Government pay scales and set to allow regular transfers with private sector. - Conduct proper training needs analysis and deliver a training program using all available techniques, including TA where appropriate. ### Enforcement powers and accountability (Principle 1 continued) - Current powers and gaps: - BPNG has essential powers to license, set standards, monitor and enforce, but sanctions limited to license conditions (remedial) and revocation. - Minor breaches are often tolerated due to lack of proportionate sanctions. - BPNG considers timeliness and quality of quarterly reporting by authorized institutions insufficient. - Recommended sanctions and accountability: - Introduce a wider range of penalties: statements of censure (public and private), monetary penalties (automatic modest fines for late/inadequate returns; heavier penalties for serious breaches). - BFIA should allow BPNG to impose formal sanctions where an authorized institution fails to comply with prudential standards. - BPNG to devise guidance for proportionate and consistent application of sanctions. - Strengthen accountability: publish financial statements without delay; operating report to include specific objectives, targets, and performance; publish the report and encourage parliamentary scrutiny. ### Licensing, ownership controls, and governance (Principles 2–5) - Licensing and governance: - BPNG has detailed criteria for license applicants but should strengthen governance requirements. - Applicants should demonstrate adequate governance arrangements including non-executive directors, appropriate Board skill balance, proper internal controls (including internal audit), and risk assessment/mitigation strategy. - Shareholding changes and acquisitions: - BFIA requires authorized institutions to seek permission for changes in significant shareholders or indirect controllers. - Decisions on fit and proper matters should be taken solely by BPNG; current Minister role should be removed to preserve independence. - No requirement for prior consent for major acquisitions—this should be rectified. - BPNG’s information gathering should extend to ultimate beneficial owners; BPNG has power to seek this information and should use it. ### Prudential regulations, risk management, and liquidity (Principles 6–16 and 17) - Current prudential standards: - BPNG issues prudential standards on capital adequacy, asset classification, large and related exposures, foreign exchange transactions and other matters. - BPNG reinforces standards with an on-site manual (not public). - Gaps and priorities: - No standards imposing an overall risk management framework (risk assessment, mitigation, controls, training, evaluation). - No standards on market risk, interest rate risk in the banking book, liquidity risk, credit risk or operational risk. - Existing standards needing strengthening: - Require monitoring of collateral value and borrower repayment ability throughout loan life, continuous oversight of problem assets, procedures for collecting past due obligations. - Large exposures standard lacks an aggregate limit; definition of connected parties too narrow; definition of related parties needs broadening; participation restrictions in loan approval should be more comprehensive. - Liquidity facilities: - Authorized institutions need access to a guaranteed liquidity facility. - Absence of liquidity regulation exacerbated by lack of interbank market, discount window, and repo facility. - Government and BPNG bills that make up most assets may not be easily turned into cash. - BPNG is working on a repo facility and should complete this task with all possible dispatch. - Priority standards: - Highest priority: standard on a risk management framework and a standard on market risk (including interest rate risk). - On-site manual least useful for market and interest rate risk given its Australian market focus; PNG-specific interest rate risk in the banking book should be actively managed. ### Anti–money laundering and customer due diligence (Principle 18) - Legal and enforcement gaps: - Five years after POCA enactment, there is still no legislation on terrorist financing and no enforcement of detailed customer due diligence guidance. - POCA creates basic obligations for customer identification and transaction reporting but enforcement responsibility lies with FIU, which lacks resources and expertise. - BPNG should be given enforcement responsibility for financial institutions’ due diligence. - Current POCA does not cover abuse of financial institutions for terrorist financing. - Customer due diligence enhancements: - Guidance gaps include absence of requirement for authorized institutions to have policies/procedures for monitoring accounts of customers against expected activity profiles. - Institutions should implement customer acceptance policies defining acceptable customers and ensuring high risk customers are accepted only with appropriately senior sign off. - Immunities and reporting compliance: - POCA grants immunity from civil action for institutions reporting transactions and goes further to grant total immunity from any proceedings for reporting institutions. - Institutions should be required to follow FIU instructions on reported funds; immunity should be modified to allow penalties for those who ignore such instructions. *Source: IMF staff assessment text from the supplied content unit.* ### 87. The Financial Action Task Force (FATF) requires certain obligations to be in ### _cr11163 - 87. The Financial Action Task Force (FATF) requires certain obligations to be in ### AML/CFT framework, FIU, and FATF compliance - The FATF requires certain obligations to be in the form of legislation, whereas compliance with the guidelines issued by the FIU is not enforceable under the POCA. - The FIU has the power to issue regulations and should use it to implement the customer due diligence obligations. - The present regime is described as clearly incomplete. - Risk and consequence statements: - Unless remedial action is taken soon, Papua New Guinea would be in danger of being regarded as non compliant with the FATF recommendations. - Non-compliance could carry severe consequences for the cost of doing business. ### Broader financial-abuse coverage and Basel principles - While completing the AML/CFT regime is the priority, the BPNG should also cover other forms of financial abuse. - Basel principles require supervisors to enforce defenses against financial abuse in general rather than just money laundering. - The BPNG should consider these implications when drafting its AML prudential standard. - Footnote observation: - The mission did not conduct a full AML/CFT assessment but considered compliance with Principle 18 (financial abuse) of the Basel Core principles, from which assessment the conclusions in this paragraph are drawn. ### Supervisory methods and approach (Principles 19–23) Findings - The BPNG has developed supervisory techniques substantially but needs a more forward looking and holistic approach. - On-site manuals (largely copied from the Australian regulator) and support from the Pacific Governance Support Group have strengthened methods. - On-site examinations are well planned and thorough. - Quarterly reporting covers key financial information. - Gaps identified: - The BPNG does not make an overall assessment of financial sector risks as the basis for supervisory strategy. - Comparisons of trends, risk profiles of different institutions, and judgments about likely future developments in key risk areas are not undertaken. - No auditor has ever reported a breach of compliance as required under the BFIA and prudential standards. - Meetings with auditors following on-site examinations are rare. - No effective enforcement of accounting and auditing standards beyond checking continuing professional development obligations. - Not all issues from on- and off-site reporting are followed up effectively; internal process and paper handling need to be sharper. - Long delays between examination and report: "four-six months" is cited as quite common. - Action plans may be agreed "six-nine months" after the examination. - Where responses are inadequate, current sanctions are limited to repeated letters and meetings. - Staff training gap: interest rate and market risk. Recommendations (summary) - Undertake overall risk assessments and analyses of trends and risk profiles. - Make better use of supervisory powers and tools: - Discuss expectations with auditors regarding reporting. - Hold post-examination meetings routinely. - Discuss with the CPAPNG how enforcement of accounting and auditing standards can be made more effective. - Improve internal processing to reduce delays and use sanctions powers to insist on prompt remedial action. - Ensure staff training on interest rate and market risk. ### Consolidation and cross-border issues (Principles 24–25) Findings - The BPNG engages in consolidated supervision and can exchange information with foreign regulators. - Groups must prepare consolidated reports with licensee results shown separately. - The BPNG should develop methodology for imposing overall prudential requirements on consolidated groups and should look back through ownership structures to find overall owners and controllers. - The BPNG has concluded only one MOU (with the Solomon Islands); draft agreements exist with Fiji and Australia. - The BPNG should always seek information on key officials of authorized institutions when they seek permission to work in Papua New Guinea and have employment history in one of the MOU counterparts. Recommendations - Complete the suite of MOUs (and add Malaysia). - Discuss with foreign supervisors what regular and exceptional information should be exchanged. - Develop methodology for consolidated prudential requirements and trace ultimate owners/controllers. ### Table A1.1 — Summary Compliance with the Basel Core Principles (selected findings) - 1. Objectives, independence, powers, transparency, and cooperation: - BPNG given appropriate responsibilities, has most necessary powers, can assert independence in day-to-day operations; independence could be strengthened and accountability more robust. - 1.2 Independence, accountability and transparency: - Powers for the Minister to intervene on shareholders of banks; funding of supervision dependent on operating profits of the BPNG (and is not sufficient); desire to reach consensus with industry leads to substantial delays to new regulation. - 1.4 Legal powers: - BPNG has most necessary powers but there is no enforcement provision for prudential standards and insufficient administrative sanctions. - 6. Capital adequacy: - BPNG imposes capital requirements in accordance with the first Basel capital accord but has not implemented any requirements for market risk. The absence of requirements for credit risk also affect the rating for this principle. - 11. Exposure to related parties: - Prudential standard limits exposure to related parties but the definition is too narrow, insufficient requirements for detecting related party loans, and regulation does not prevent beneficiaries of such lending from having roles in approval. - 13. Market risk: - There is no requirement for capital to be held against market risk. - 14. Liquidity risk: - No regulation on liquidity risk; a prudential standard is in draft. - 16. Interest rate risk in the banking book: - No requirements on interest rate risk in the banking book; on-site module derived from APRA not appropriate for PNG markets. - 18. Abuse of financial services: - The Proceeds of Crime Act imposes general requirements but there is no detailed guidance and no effective enforcement of the provisions. - 19. Supervisory approach: - Significant improvement in understanding risks facing banks but no comprehensive assessment of banking system risks or documented risk monitoring strategy. - 20. Supervisory techniques: - Regular on-site inspections and comprehensive manuals; delays in implementing on-site program and following up on recommendations. - 21. Supervisory reporting: - Regular returns required and analysed, but some returns not submitted timely and some specific returns not fully understood or analysed by the off-site team. - 22. Accounting and disclosure: - Banks required to follow international accounting and auditing standards; BPNG could better engage auditors to fulfil statutory duty to report compliance breaches. - 23. Corrective and remedial powers: - BPNG has powers to insist on corrective and remedial action but most sanctions are very severe and rarely used; no contingency plan for a bank failure. - 24. Consolidated supervision: - BPNG has powers and collects consolidated information but does not impose standards on a consolidated basis. - 25. Home-host relationships: - MOU with the Solomon Islands exists; similar agreements with Fiji and Australia are in draft. ### Recommended Action Plan (selected recommended actions by Core Principle) - 1.(2) Independence, Accountability & Transparency: - Amend the BFIA to enable the Governor to set license fees; - Strengthen BPNG accountability; - Amend the BFIA to remove the ability of the Minister to object to shareholders or indirect controllers; - Amend the CBA to remove the ability of the Minister to determine the level of BPNG Reserves; - Increase license fees over a reasonable period until they meet total supervisory costs; - Increase the budget and staff numbers for the supervision department ;and - Introduce a comprehensive training needs analysis. - 1(4) Legal powers: - Amend the BFIA to provide for enforcement of prudential standards; - Extend the range of administrative sanctions; and - Amend the BFIA to clarify the inspection power. - 1(6) Co-operation: - Amend the BFIA to protect confidential information passed to a Minister or department. - 3. Licensing criteria: - Include corporate governance and the balance of Board skills in the fit and proper requirements; - Give authorized institutions the responsibility to ensure that all staff are fit and proper persons; and - Amend the licensing manual to include the need to get a statement of no objection from a foreign supervisor. - 4. Transfer of significant ownership: - BPNG to seek information on ultimate beneficial owners or 2nd and 3rd tier shareholders or indirect controllers on a regular basis. - 5. Major acquisitions: - Draft and issue a prudential standard on major acquisitions to give BPNG the right of prior consent; - 7. Risk management process: - Issue a prudential standard that requires an authorized institution to adopt an appropriate risk management framework; - 8. Credit risk: - Draft and issue a prudential standard on credit risk; - 9. Problem assets, provisions and reserves: - Amend the prudential standard to add requirements for continuous review of the value of collateral; - Add guidance on detecting deterioration in borrowers’ ability to repay. - 10. Large exposure limits: - Introduce a new prudential standard on large exposures. - 11. Exposures to related parties: - Amend the prudential standard to broaden definition of related party and deal with conflicts of interest; repeal provisions on related party lending in PS 3/2000; ensure all related party lending is properly reported. - 12. Country risk: - Include a section on country risk within the credit risk prudential standard. - 13. Market risk: - Draft and issue a prudential standard on market risk. - 14. Liquidity risk: - Draft and issue a prudential standard on liquidity risk; - Complete establishment of a repo facility so banks may have guaranteed access to liquidity using government bills as collateral, should the need arise. - 15. Operational risk: - Draft and issue a prudential standard on operational risk. - 16. Interest rate risk in the banking book: - Include a section on interest rate risk in the banking book in the recommended market risk prudential standard. - 17. Internal control and audit: - Include requirements for an Audit Committee, obligations to adopt IFRS, further reporting on fitness and properness, a requirement for internal audit and rules on role segregation in the recommended prudential standard on a risk management framework. - 18. Abuse of financial services: - Seek amendments to the Proceeds of Crime Act to: - Criminalize terrorist financing; - Give the BPNG responsibility for monitoring compliance with FIU guidelines; - Impose an obligation on the BPNG to report suspicious transactions; - Require authorized institutions to follow FIU instructions after submitting an STR; - Modify protection given to those who have submitted STR, to allow criminal proceedings for a bank which, after making a report, fails to abide by FIU instructions or colludes with the money launderer. - BPNG to draft and issue a prudential standard that requires authorized institutions to comply with the FIU guidelines; - BPNG to draft an internal policy and procedure on AML compliance; - BPNG to agree MOU with FIU; - FIU issue amended guidelines that fill the gaps described in this assessment; - FIU to consider regulations under Section 178 to impose CDD requirements. - 19. Supervisory approach: - Conduct a full risk assessment; - Develop a risk assessment training program; - Seek assistance in developing stress-testing, detecting industry trends and risks on a forward-looking perspective; - Develop information systems and consolidated databases; - Seek assistance in developing a full risk-based approach to supervision; - Provide guidance to authorized institutions on matters to be reported under Section 35 BFIA; - Meet other regulatory authorities regularly. - 20. Supervisory techniques: - Issue examination reports in one month; - Use additional sanctions to ensure action plans/timetables are agreed quickly and met; - Review internal paper handling and procedures for monitoring follow up action; - Hold meetings with external auditors on a regular basis. - 21. Supervisory reporting: - Gather information via quarterly financial returns from holding companies and significant branches operating outside PNG; - Enhance quality and timeliness of quarterly returns; - Arrange training in market and interest rate risk sensitivity analysis. - 22. Accounting and disclosure: - Discuss with CPAPNG to establish effective enforcement program for accounting and auditing standards; - Inform CPAPNG of requirement in 7/2003 and enquire why there have been no reports; - Meet auditors of each authorized financial institution following each on-site inspection to compare findings; - Amend prudential statement 7/2003 to provide guidance on content of the annual report. - 23. Corrective and remedial powers: - Seek amendment of BFIA to enhance availability of sanctions; - Further develop guidelines for application of corrective and remedial actions; - Draw up and test regularly a contingency plan for dealing with failure of an authorized institution. - 24. Consolidated supervision: - Develop a methodology for assessing strengths of consolidated groups; - Amend on-site manual to instruct examiners to consider treatment of data in foreign operations; - Assess adequacy of information flows between branches/subsidiaries and head office. *Source: _cr11163 - 87. The Financial Action Task Force (FATF) requires certain obligations to be in (PDF).* ### 25. Home host relationships ### 25. Home host relationships ### MOUs and supervisory cooperation - Complete the MOUs with Fiji and Australia. - Discuss with its counterparts to the MOUs what information should be exchanged routinely and on an as required basis. - Seek the opinion of foreign supervisors as to the fitness and properness of the officers appointed to the BPNG operations from overseas. - Consider an MOU with the Central Bank of Malaysia. - Seek legal advice to confirm that there is no impediment to a foreign supervisor conducting an on-site visit and inform counterpart authorities of the BPNG’s willingness to permit such inspections. ### Authorities’ response to the assessment - The authorities have indicated that they accept the majority of the recommendations but have concerns about those affecting independence and terrorist financing. - The authorities provided the mission with a comprehensive response; virtually all recommendations have been accepted and priorities for actions were indicated. - The authorities did not accept the recommendation that license fees be increased to meet the cost of supervision on the grounds that this would raise the cost of borrowing and other banking services. - The power of the Minister to reject applications from significant shareholdings is considered important by the BPNG because it regards government support as important when rejecting applications. - The authorities consider that the Proceeds of Crime Act is sufficiently flexible to cover terrorist financing. - The authorities consider that the current arrangements for disclosing information on banks’ performance and financial strength are adequate. - In other respects, the authorities have accepted the report’s recommendations. ### Stress test design and methodology - Stress test design was based on detailed discussions between the FSAP team, the BPNG, and local banking sector stakeholders, focusing on PNG’s macro-economic context, financial system structure, and financial soundness indicators and outlook. - Implementation used a top-down approach with supervisory data; tests were performed individually for all four commercial banks and then aggregated. - Baseline scenario analysis for income statement and balance sheet was implemented for each bank; income statement data were annualized from reported year-to-date information, with calculations at a quarterly frequency. - Single-factor shocks applied: credit risk, interest rate risk, sectoral concentration risk, liquidity risk, and largest exposures. - Single-factor shocks were implemented through estimated effects on income statement and balance sheet; net gains/losses treated as one-time immediate charges to capital. - For credit risk (including sectoral concentration and largest exposure), charges consisted of increases in provisions assuming no recovery. - For interest rate and liquidity shocks, charges consisted of net gains or losses generated by interest-bearing assets and liabilities. - Presentation: aggregate impacts shown, with distribution of individual banks across "buckets" in terms of CAR and liquid ratio. ### Main stress test results (system-level) - The banking system faces little credit risk under current conditions: - NPLs are less than 2 percent of total loans. - Doubling, tripling, or quintupling of NPLs would have little effect on CAR given low NPLs and high capital. - To push CAR levels below the recommended 12 percent, NPLs would need to grow to 18 percent of total loans. - Loan concentration risk: - The commercial and financial sector is the most vulnerable sector. - A 33 percent deterioration in loan performance in the commercial and financial sector would lower CAR to below recommended levels for one bank. - A 50 percent deterioration would make one bank insolvent. - A 100 percent deterioration in this sector’s loans would render three banks insolvent and compromise 98.7 percent of banking system assets. - Credit deterioration in other sectors would have little effect on commercial banks’ CAR. - Largest exposures: - No single large exposure becoming a total loss would present a system-wide risk. - If loans to the three largest borrowers of each bank do not perform, only one bank would see its CAR drop below 12 percent. - Interest rate risk: - A 50 percent increase or decrease in yields produced negligible impact on CAR given the current structure of assets and liabilities. - Liquidity risk: - Recalculating liquidity ratios excluding illiquid government securities and term deposits produced substantially lower liquidity ratios. - Under the revised calculation, one bank was already below the government’s recommended 25 percent liquid ratio. - If short-term deposits decline by 10 percent, another bank would fall under the 25 percent liquid ratio. - If short-term deposits decline by 15 percent, a third bank would fall under the 25 percent liquid ratio. ### Main recommendations (from stress testing and analysis) - Revise the definition of liquid assets for liquidity supervision: - Remove large holdings of government securities from the numerator where there is no secondary market or central bank discount window, as these may not be convertible to cash with speed and without significant loss. - All liquidity ratios would decline under this change. - Improve liquidity management tools: - Open a discount window at the Central Bank. - In the medium term, develop a repo or secondary market for government securities to provide liquidity under short-term deposit stress. - Strengthen data management and reporting: - BPNG would benefit from TA to centralize data management systems; expertise from previous assistance may have been lost. - A centralized database would aid management of financial data from different sources and enhance stress testing. - Standardize financial statement reporting, particularly at foreign banks: - All reports should include currency of reporting. - All reports should include unit of measure (units, thousands, millions). - All reports should include period of report in the title. - If data is year-to-date data, this should be clearly specified in the report title. *Source: _cr11163 - 25. Home host relationships* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11163.pdf_