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Banking in Papua New Guinea - Report of Committee, November 1972


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THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

1973— Parliamentary Paper No. 137

BANKING IN PAPUA NEW GUINEA

REPORT OF COMMITTEE

November 1972

Presented by Command 29 August 1973 Ordered to be printed 11 September 1973

THE GOVERNMENT PRINTER OF AUSTRALIA CANBERRA 1974

Printed by G . W. Robinson & Co. Pty. Ltd., 1-5 D elaine Ave., Edw ardstow n, S. Aust. 5039

CONTENTS

Page

Summary of Recommendations . . . . . . . 1

i. Introduction . . . . . . . . . . 3

ii. Papua New Guinea’s existing financial structure . . . . 5

iii. Housing finance and rural finance . . . . . . . 11

iv. Central bank . . . . . . . . . . 15

v. Special position of the Commonwealth Banking Corporation . . 23

vi. Elements of an appropriate institutional framework . . . . 25

vii. Statutory requirements and timetable for the establishment of a Papua New Guinea banking and financial system . . . 37

Attachment A . . . . . . . . . . . 39

Attachment B . . . . . . . . . . . 43

SUMMARY OF RECOMMENDATIONS

This Report sets out the major elements of a framework which, the Committee considers, would be appropriate to a separate banking and financial system in Papua New Guinea. It gives particular attention to the role which Papua New Guinea, Australian and overseas financial institutions might play in this system. Consideration is also given to the various legislative and other steps which would be necessary.

2. The Committee’s recommendations are intended to provide guidance in the establishment of a separate banking and financial system for Papua New Guinea subject to the control of the Papua New Guinea Government. In making these recommendations the Committee has sought to take full account of conditions in

Papua New Guinea and to recommend a framework appropriate to its needs. At the same time, it has sought to recommend a framework which could be adapted to the emerging requirements of the country. In this regard, the Committee recog­ nises that experience with the operation of a separate banking system in Papua New Guinea and the changing needs and circumstances as the country develops are

likely to require continuing changes in the financial structure and arrangements. 3. Subject to the recommendations of the Committee being accepted, appropriate action which might be taken both in Papua New Guinea and in Australia to imple­ ment them is set out in the tentative timetable in Chapter VII.

4. In summary, the main recommendations of the Committee are: (i) Control. That responsibility for licensing, control and supervision of banks and financial institutions operating in Papua New Guinea be vested in the Papua New Guinea authorities as soon as practicable; that legislation

for this purpose be enacted in Papua New Guinea (Chapter IV). (ii) Central bank. That a central bank be established in Papua New Guinea on the basis of the Port Moresby office of the Reserve Bank of Australia; that its charter cover both banks and other financial institutions; that it

be endowed from the outset with a full range of powers to act as a central monetary authority even though some of these powers could not be used in the immediate future; that legislation for this purpose be enacted in Papua New Guinea; that the Reserve Bank of Australia be asked to pro­

vide appropriate technical assistance to the new central bank for as long as may be necessary to maintain efficient operations following the transfer (Chapter IV). (iii) Commonwealth Banking Corporation. That the Papua New Guinea busi­ ness of the Corporation be transferred as soon as practicable to Papua

New Guinea Government ownership; that the Corporation should not compete for banking business with the government commercial bank following the transfer (such competition at this time could prejudice the success of the transfer); that the Corporation be asked to provide appro­

priate managerial and technical assistance to the government commercial bank for as long as may be necessary to maintain efficient operations following the transfer; that the extent to which, consistent with the above, the Corporation should be permitted to continue to engage in banking

business in Papua New Guinea, particularly in cases where there may be special contractual or financial problems involved in the transfer of accounts, should be a matter for further detailed consideration by the appropriate authorities (Chapter V).

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(iv) Government Bank. That a government commercial bank be established on the basis of the transferred Papua New Guinea business of the Commonwealth Banking Corporation; that the government bank under­ take a full range of banking services within a single institutional frame­ work, without the current legal separation of trading banking and savings banking; that the government bank be guided by commercial considera­ tions as far as possible; that legislation be enacted for this purpose in Papua New Guinea (Chapter VI). (v) Papua New Guinea Development Bank. That the Development Bank

operate on a somewhat broader charter than at present; that it maintain a separate identity at least for the time being but with close links with the government commercial bank; that it seek to establish appropriate agency arrangements with other financial institutions (Chapter VI). (vi) Investment Corporation of Papua New Guinea. That the Corporation

remain a separate entity with links as appropriate to the government commercial bank and the Papua New Guinea Development Bank (Chapter VI). (vii) Private commercial banks. That existing private commercial banks be

permitted to continue operations with appropriate changes in structures and procedures and subject to any conditions imposed by the Papua New Guinea Government; that there be no legal or institutional separa­ tion of savings banking and trading banking; that private commercial banks be permitted to compete freely with the government commercial bank; that greater efforts be made to accelerate the rate of localisation of bank staff (Chapter VI). (viii) Overseas banks. That the Papua New Guinea Government keep an open

mind on the question of allowing the entry of new overseas banks into Papua New Guinea until local control of the banking system has been effected and a local central bank established (Chapter VI). (ix) Savings and loan societies. That the savings and loan society movement

continue to receive official encouragement; that it become self-supporting as soon as possible; that arrangements for the mobilisation and use of funds be improved (Chapter VI). (x) Other financial institutions. That no special action be taken to promote new institutions although there is room for expansion of the operations of some existing institutions; that the appropriateness of the Papua New Guinea operations of authorised dealers in the Australian short term money market be reviewed (Chapter VI). (xi) Commonwealth legislation. That amendments to the relevant Australian

banking legislation be enacted to pave the way for establishment of a separate Papua New Guinea banking system and central bank; that legislation be enacted to provide for the transfer of the Papua New Guinea business of the Commonwealth Banking Corporation to the pro­ posed government commercial bank. (xii) Timing. That the tentative timetable as set out be adopted for planning

purposes; that every effort be made to have the necessary Papua New Guinea and Australian legislation enacted during the first half of 1973 (Chapter VII).

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INTRODUCTION

Origin and terms of reference of Committee The initial impetus for the establishment of the Committee on Banking was given by the Papua New Guinea Select Committee on Constitutional Development. In March 1971 this Select Committee of the Papua New Guinea House of

Assembly recommended that the development of Papua New Guinea be geared to preparing for internal self-government during the life of the ensuing House of Assembly from 1972 to 1976. Both the Australian Government and the House of Assembly endorsed the recommendations of the Select Committee.

2. The Minister for External Territories considered that banking was one of the areas to which the recommendations of the Select Committee should be applied and where appropriate arrangements should be developed in preparation for self­ government. The Minister in co-operation with the Treasurer set up a Committee of officials in September 1971 — chaired by the Department of External Territories with representatives from the Commonwealth Treasury, the Reserve Bank of

Australia and the Papua New Guinea Administration — to examine and report on the development of a Papua New Guinea banking system. 3. The Ministers approved the following terms of reference for the Committee: • to set out and advise on the major elements of a framework appropriate to

banking in Papua New Guinea at the stage of self-government and at the stage of independence giving special attention to the part which Australian, overseas and Papua New Guinea institutions should play in this system; • to consider and make recommendations as to the lines along which the Papua New Guinea banking system should be developed over the next few years; • to consider and make recommendations on the nature and the timing of the

various steps for setting up of an appropriate banking system in Papua New Guinea, taking account for that purpose of any legislative changes that may be needed in Papua New Guinea and in Australia. Interim Report 4. In March 1972 the Committee completed an Interim Report which was

subsequently presented to the Australian Government by the Minister for External Territories and the Commonwealth Treasurer. The purpose of the Interim Report was to advise on progress made and to seek the Government’s concurrence in principle with three basic propositions. The Interim Report was considered by the

Government in July 1972 which endorsed in principle the following three recommendations: (a) that responsibility for control of banking in Papua New Guinea be passed to Papua New Guinea as soon as this is practicable;

(b) that a central bank be established in Papua New Guinea on the basis of the Port Moresby office of the Reserve Bank of Australia with full powers to act as the central monetary authority for a separate banking system; and (c) that the business of the Commonwealth Banking Corporation in Papua New

Guinea be transferred to some form of Papua New Guinea ownership; the timing of the transfer and the precise form of future ownership (and the question of whether and to what extent the Corporation should continue to maintain a presence in Papua New Guinea) to be a matter for considera­

tion in the light of the Committee’s deliberations on the appropriate form of overall financial structure. 5. The Interim Report was subsequently submitted to the Papua New Guinea

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Government which also endorsed in principle the Committee’s recommendations. 6. The Australian and Papua New Guinea Governments’ endorsement of the recommendations contained in the Interim Report has enabled the Committee to

work to more detailed conclusions in this Report. It has also allowed a start to be made on discussions between the appropriate authorities and the Reserve Bank of Australia and the Commonwealth Banking Corporation in relation to recom­ mendations (b) and (c) above of the Interim Report. Preliminary comments 7. The terms of reference of the Committee are very broad. They include pro­

vision for recommendations not only on the transfer of powers and functions and the setting up of a distinct and unified Papua New Guinea banking system but also on the lines of development of that system over the next few years. The Committee recognises, however, that this is a time of rapid change in Papua New Guinea and the period ahead could see quite far-reaching reappraisals of what policies are in Papua New Guinea’s best interests. Particularly, the Committee is aware that after transfer of banking (and more general) powers the Papua New Guinea authorities could make adjustments to meet changing needs and circumstances or to accord more closely with developing national objectives. In some areas, therefore, the Report offers general guidance rather than recommends a firm course of action. 8. It could reasonably be said that the developed monetary sector in Papua New Guinea currently enjoys a high standard of commercial banking services. The Committee recognises, however, that Australian policies and practices are not necessarily appropriate to the needs of Papua New Guinea. There are prospects that the banks will adjust, of their own accord, to the newly emerging situation and rationalise their services to an acceptable degree. In determining the terms and conditions to apply to banks in Papua New Guinea in future, the Government will no doubt recognise the facilities currently available and take account of the need to maintain continuity in adequate banking facilities in Papua New Guinea. 9. There were various issues which the Committee would like to have examined

in more detail. The detailed arrangements for the transfer of the Commonwealth Banking Corporation’s business in Papua New Guinea to local ownership is a case in point as are the detailed operating procedures of banks generally. The Committee was aware, however, of the time constraints under which it was operat­ ing and of the need for early action on the fundamental changes required to establish a separate Papua New Guinea banking system by the time of self-govern­ ment. This urgency has been increased by the decision of the House of Assembly in September 1972 to seek self-government by 1 December 1973 or as soon as possible thereafter. The Committee, therefore, has preferred to present its Report

at this time with further study of some of the detailed issues that remain to be continued by the appropriate authorities in Papua New Guinea and Australia. 10. While recommending that there should be a separate banking system in Papua New Guinea, subject to local control, the Committee points out that this may require some barriers to be erected, through exchange controls or otherwise, to offset any tendency to take advantage of differences in monetary policies between Australia and Papua New Guinea. Should a separate currency be introduced in Papua New Guinea, some of the problems in this area will become more clearly defined.

11. The Committee has in its deliberations sought the views of a variety of institutions and authorities concerned with the financial structure of Papua New Guinea and their views have been considered in the framing of this Report. The Committee has also obtained the views of the Central Banking Service of the International Monetary Fund.

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PAPUA NEW GUINEA’S EXISTING FINANCIAL STRUCTURE The first part of this chapter outlines the main characteristics of Papua New Guinea’s financial structure. The second part examines its adequacies and shortcomings.

Main characteristics 2. In 1969-70 the contribution by Papua New Guineans to the Gross Domestic Product of Papua New Guinea was estimated at about 35 per cent. 3. The early dominance by the expatriate sector of Papua New Guinea’s monetary

economy is reflected in the financial structure in Papua New Guinea which has followed quite closely the Australian pattern and, not surprisingly, has been geared largely to the needs of the expatriate rather than the indigene. 4. The Papua New Guinea financial structure also reflects the fact that Papua

New Guinea uses Australian currency and has access to Australia’s foreign exchange reserves. In other words, it is part of the Australian monetary area. The Common­ wealth banking legislation applies to Papua New Guinea and the final responsibility for the control of banking in Papua New Guinea currently rests with the Reserve Bank of Australia and the Commonwealth Government. In day-to-day operations

these factors result in: • a free flow of funds between Australia and Papua New Guinea; Australian exchange control operates with respect to dealings with other countries; • the effective absence of balance sheet constraints on lending by banks in

Papua New Guinea, and the absence of any requirement for local investment of funds generated within Papua New Guinea; • the general application of Australian bank interest rates in Papua New Guinea. 5. The Reserve Bank of Australia has an office in Port Moresby. In addition to

providing banking and other financial services to the Papua New Guinea Govern­ ment and to the banks operating in Papua New Guinea, and undertaking various functions relating to Papua New Guinea Government securities, the Reserve Bank has a broad commitment to assist in the development of central banking in Papua

New Guinea. It has been involved in financial education, the development of indigenous banking staff, and in the development of the savings and loan society movement. The Bank has also supported government policy in urging banks to adapt their policies, structures and staffing to meet the growing needs of Papua New Guinea. The Rural Credits Department of the Reserve Bank provides seasonal

finance in Papua New Guinea to some primary producer organisations and statutory marketing boards. 6. Papua New Guinea has, for its stage of development, a wide range of com­ mercial financial institutions. Most of the financial services in Papua New Guinea

are offered by branches of Australian institutions. Four of the major Australian banking institutions are represented — the Commonwealth Banking Corporation, the Australia and New Zealand Banking Group Limited, the Bank of New South Wales and the National Bank of Australasia Limited. As in Australia, the banks

conduct trading and savings banking as distinct operations through separate entities. 7. Papua New Guineans make relatively extensive use of savings account facilities, but other banking services are used to a significant degree by only a small pro­

portion of the population. In part this may reflect a lack of demand for banking

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services arising from an historically large subsistence sector, unfamiliar with financial matters, a relatively small number of indigenous borrowers and the absence of registerable land titles which could be offered as security. It also probably reflects the fact that the banks’ structure, organisation and activities are geared more to Australian needs. The Committee recognises that efforts have been made in recent times to adjust to local conditions. However, general adherence to Australian operating patterns, the low ratio of indigenous to expatriate staff, and the short term assignment of most expatriate staff have been significant limiting factors. 8. The banks, particularly the savings banks, appear to have a much lower rate

of profitability than with their Australian operations. Indeed, indications are that they may be incurring losses on some of their Papua New Guinea operations. Low average balances coupled with high operating costs, largely a result of the high costs associated with expatriate staff, are said to be the main factors in this. They appear compounded by the fact that the interest rate structure determined for bank deposits and advances in Australia also applies to Papua New Guinea.

This, the banks claim, leaves too narrow a margin in the Papua New Guinea situation. 9. Other financial institutions operating in Papua New Guinea include hire pur­ chase companies, life insurance companies, Australian short-term money market dealers, trustee companies and stock and share brokers. These, too, are mainly branches of Australian concerns and follow Australian business practices. There are, however, some institutions which have been established specifically to meet

the needs of Papua New Guinea. These comprise savings and loan societies, the Papua New Guinea Development Bank — the only bank actually incorporated in Papua New Guinea — and the Investment Corporation of Papua New Guinea. 10. The financial organisations in which Papua New Guineans are most promi­ nent are the savings and loan societies — both as depositors and borrowers —

and the Papua New Guinea Development Bank. Although in the past a large proportion of the Development Bank’s lending has been to expatriates, the activities of the bank are now geared more directly to the needs of indigenes. The bank is essentially a lending institution and draws only a very small proportion of its resources from deposits. To date most of its funds have been provided by govern­

ment grants; recently it has been assisted by loans from the International Development Association and the Asian Development Bank. 11. The Investment Corporation of Papua New Guinea was set up to acquire equity in major overseas enterprises operating in Papua New Guinea for eventual resale to local people. The Corporation has so far relied largely on grants from the Papua New Guinea Government.

Adequacies and shortcomings 12. Papua New Guinea already has a large number of institutions providing a wide range of financial services. These services are considered adequate to meet the requirements of expatriate businessmen but are not geared to meet the legiti­ mate demands of the indigenous population. 13. The Committee considers, however, that the financial institutions currently operating in Papua New Guinea provide a reasonable base for the development of a banking and financial system suited to Papua New Guinea’s needs. It does not see a need to build up a completely new financial infrastructure. It will be necessary, however, that the operations of existing financial institutions and financial arrangements generally adapt to the particular needs of the country.

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14. There are various shortcomings in the present financial system. These include particularly: (i) the minimal amount of control of the Papua New Guinea financial system which rests in the hands of the Papua New Guinea authorities;

(ii) the structual and organisational arrangements of the banks operating in Papua New Guinea; (iii) the system’s inability adequately or efficiently to meet the financial needs of Papua New Guineans. (i) Control 15. The Committee, as stated in its Interim Report, does not regard the present situation where Papua New Guinea’s control over its financial system is minimal as compatible with self-government. It considers that responsibility for the control and supervision of financial institutions operating in Papua New Guinea should be vested in the Papua New Guinea authorities as soon as possible. It is important

to produce a financial system more immediately responsible to the Papua New Guinea Government and more responsive to national needs. It is also necessary to provide a firmer foundation from which to plan the future development of a Papua

New Guinea banking system subject to a Papua New Guinea central monetary authority and to controls attuned to local needs. (ii) Structure

16. The Committee can see no reason for perpetuating in Papua New Guinea the formal separation of savings and trading bank business as in Australia. This separation in Australia arose from historical and social circumstances which do not appear relevant in Papua New Guinea. Similarly, the regulations governing

investment of savings bank funds in Australia are not considered appropriate to Papua New Guinea. 17. Organisational arrangements for banking in Papua New Guinea coupled with automatic adoption of Australian banking innovations without apparent regard to

local need or suitability have contributed to banking being a high cost and low profit industry in Papua New Guinea. The Committee sees this situation as undesirable and evidence that the present arrangements are to a degree inappropriate to Papua New Guinea's circumstances. The viability or success of

institutions providing financial services is dependent in the longer term upon the achievement of a reasonable rate of profitability. For government institutions, there is the additional consideration of efficiency in meeting community needs measured against the cost to government.

18. The low profitability of banking, and the associated inadequate organisational arrangements, are related to several factors — the use of high cost expatriate bank staff, the types of services being provided and the charges being made for them, and some unnecessary proliferation of branches.

19. The present situation where the financial structure is heavily underpinned by Australian personnel poses many problems. It would be unfortunate if problems were to arise on independence because of a preponderance of expatriate staff occupying key positions in the financial system. It could equally be difficult if, for any reasons, the bulk of expatriate experience was withdrawn and trained local replacements were not available. 20. There are limitations on the extent to which local staff are likely to be

available to handle the more technical and skilled banking operations. To some extent inadequate training and recruitment programs in the past have contributed to this situation. The Committee feels that every endeavour should be made by

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the banks and by the authorities to provide training facilities in order to speed up localisation in the banking industry. The recently introduced work permit scheme which extends to certain categories of banking positions is an indication of the

Papua New Guinea Government’s intentions to accelerate the pace of localisation. 21. It seems clear that certain services are being provided by the banks on an uneconomic basis. A notable example is the maintenance of indigenous savings bank accounts involving a large number of small transactions and small balances. The Committee recognises that changes directed at making banking less costly in

some instances may result in the cessation or reduction of facilities currently available to bank customers. However, such changes appear inevitable if banking in Papua New Guinea is to be efficient and viable. 22. Another factor which affects banks’ profitability in Papua New Guinea and

possibly their willingness to expand activities is the general basis of charges for services and the relationship between the interest rates charged on loans and paid on deposits. Essentially Australian scales of charges and rates are applied. This leaves a margin which appears low for Papua New Guinea. This problem could be reduced with the transfer of banking control powers to the Papua New Guinea authorities. At that stage it would be expected that Papua New Guinea would have an interest rate structure suited to its needs. There will be limitations, however, on the extent to which interest rates in Papua New Guinea and Australia can diverge while there is a free flow of funds between the two countries. 23. It has been put to the Committee that Papua New Guinea is ‘overbanked’. A decision on the ‘correct’ number of banks involves a number of subjective judgments (for example, how much competition should be allowed?). The Com­ mittee does not feel able to make these judgments on the basis of evidence available to it. However, the case for a reduction in the number of banks does not seem strong enough to warrant specific Government action. On the other hand, the Committee feels that the Government should not resist such a reduction should individual banks themselves take any action in this direction by withdrawal or some form of amalgamation. 24. The Committee feels there is clearer evidence that the number of branches of banks in some centres may be excessive. This view is shared by the banks themselves. 25. Some branches have been established by the banks to service particular customers and/or in anticipation of increased business in the future. The result is that in some centres there are more banks represented than the circumstances would seem to warrant. It is possible that the banks themselves will move to rationalise the branch banking structure in the light of any changes in banking arrangements generally or variations in patterns of demand for banking services. The Committee feels that the Papua New Guinea authorities should not resist and might well seek to encourage such branch rationalisation by the banks. (iii) Indigenous needs 26. The Committee has concluded that the financial system is less than adequate to meet the legitimate demands of Papua New Guineans. This is indicated by an examination of present arrangements. 27. Papua New Guineans in the monetary sector make considerable use of the deposit facilities of the savings banks. However, as suggested earlier, changes in savings banking arrangements cou'd align them more closely with local needs, put banks on a better financial basis, and ensure that deposits collected were used in forms of investment more closely attuned to the needs of the Papua New Guinea economy.

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28. The savings and loans societies play an important role in financial education, the encouragement of thrift, the mobilisation of savings and the making of small loans. These societies, however, face problems: • the movement is heavily subsidised by the Reserve Bank of Australia at the

present time and, in the absence of substantial changes, is likely to require continued financial support for several years; • societies have made particularly good progress in a couple of areas but in others there is only limited interest and, occasionally, apathy or reluctance

by local ‘big-men’ to become involved in societies; • societies and individual members lack familiarity with the use of credit; this leads to conservation in seeking or granting loans and to the current relatively low ratio between societies’ loans and deposits; • the lack of suitable local investment opportunities for surplus funds.

29. Achievement of complete financial autonomy by the savings and loan move­ ment as soon as possible should be a primary objective. It will depend on a number of factors: the growth in membership and savings; the cohesion of the movement; variations in existing benefits and charges; the demand for services provided by

the regional leagues and the Federation of Savings and Loan Societies. Experience in other countries suggests that while village societies will remain important, urban societies based on a common employment bond will come to provide the main strength of the movement. There are signs that the movement is developing in this

direction in Papua New Guinea. The ‘financial conservatism’ of members will, of course, be affected by any swing to urban societies; in the villages, it could perhaps be offset by a more concentrated educational effort. For the shorter-term, however, more might be achieved by encouraging the pooling of surplus funds held by some societies for channelling to deficit societies with worthwhile unsatisfied loan demand. The Federation of Savings and Loan Societies is well advanced with plans for such

a scheme. Perhaps other institutional funds could subsequently be channelled through this scheme (for example, from the Papua New Guinea Development Bank or banks generally). Similarly, the movement could benefit from the availa­ bility of better local investment facilities; under present arrangements, profitable

local investment is difficult within the constraints of the legislation under which societies operate. This applies particularly, but not wholly, to very short-term funds. 30. The lack of understanding by most Papua New Guineans of the processes of

borrowing and repayment makes it difficult to be specific about the shortcomings of the financial system in providing credit or ways to remedy these shortcomings. Many Papua New Guineans have no need at present for financial services since they are not involved in monetary sector activities. Others have only limited credit

needs which are adequately met by kinship and other traditional means. There is, however, evidence of a demand by individuals for fairly small scale credit which is neither adequately nor efficiently met. This demand applies in several areas and will grow with the spread of the monetary economy. Primary producers, particularly, those just entering the cash economy, sometimes require credit to launch or expand their enterprises. Small business ventures in transport, trading or manu­ facture often need access to credit. There is also a demand for some form of housing

finance by the increasing number of Papua New Guineans who are taking up permanent residence in the towns. With the growth in the wage-earning population there also appears a small but growing need for credit for the purchase of household

items and consumer durables.

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31. The questions of housing finance and rural credit are considered in Chapter III. The development credit needs of the local population are being met to an increasing extent by the Papua New Guinea Development Bank and general

credit needs to a limited extent by the savings and loan societies. The Development Bank has provided credit only for ‘developmental’ purposes. ‘Developmental’ has been narrowly defined excluding, for instance, rural seasonal marketing finance which has an important development role in Papua New Guinea. Some variations in the Development Bank’s operating charter might increase its effectiveness without unduly straining its staff resources. 32. The Committee would expect that many of the gaps which remain in the indigenous credit structure would be filled by the banks, especially a government commercial bank, adopting a more innovative approach to lending. To overcome the present ‘security’ problems, the Committee sees advantages in the hire purchase concept of financing in Papua New Guinea. However, it is also conscious of the high cost of this kind of finance. The introduction of hire purchase facilities by a government commercial bank could well reduce these costs substantially. The experience of the Development Bank in its hire purchase operations would support this view. Summary 33. Papua New Guinea has many financial institutions providing a wide range of services. These services are adequate for the expatriate sector but are not geared to meet the legitimate demands of Papua New Guineans. The Committee feels that the financial institutions currently operating in Papua New Guinea provide a reasonable base for the development of a banking and financial system suited to the country’s needs. A number of structural and procedural changes will, however, be required and closer relationships between the various elements of the system seem desirable. 34. As a first step, responsibility for the control and supervision of financial institutions operating in Papua New Guinea should be vested in the Papua New Guinea authorities as soon as possible. This would facilitate the process of adapting structures and operating procedures to the local situation. The Committee considers that formal separation of savings and trading banking business would be inappro­ priate. Similarly, other aspects of banks’ operations should be examined to ensure reasonable profitability consistent with the provision of adequate services. Greater efforts will be required to accelerate localisation of bank staff. 35. It was noted, however, that with banking under Papua New Guinea control, it may be necessary, even without a separate currency, for barriers to be erected, through exchange controls or otherwise, to counter any tendency to take advantage of differences in monetary conditions and policies between Australia and Papua New Guinea. 36. A decision on whether Papua New Guinea has too many banks involves subjective judgments which the Committee feels unable to make. However, it suggests the Government should not resist any initiative by the banks themselves through withdrawal or amalgamation. Evidence from the banks suggests that there may be too many branches in some centres, giving scope for some rationalisation. 37. A number of shortcomings can be identified in the financial system. These relate mainly to the needs of the indigenous population. Many of the gaps which remain in the credit structure would be filled by the banks, especially a government commercial bank, adopting a more innovative approach to lending.

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CHAPTER III

HOUSING FINANCE AND RURAL FINANCE Housing finance The adequacy or otherwise of housing involves not only questions of finance but also questions of government social welfare policy which are outside the scope

of the Committee’s investigations. The Committee’s concern is to examine the adequacy of institutional facilities for providing housing finance and the role which the banking system might play in this field. However, it would draw attention

to the real costs involved in government providing housing on a subsidised basis. It is for consideration by the Papua New Guinea Government whether social and economic objectives might not be better served at lower cost and more effectively by Government giving cash grants where appropriate rather than by subsidising

housing through uneconomic rentals or low interest rate loans. Existing sources of housing finance 2. The main sources of finance for individual housing in Papua New Guinea at present are:

(a) the Housing Commission; (b) the banking system; (c) savings and loan societies. 3. The Housing Commission’s funds come from two main sources: (a) bank loans; (b) loans and grants from the Papua New Guinea Government. 4. The bank loans which comprised about 13 per cent of its available funds in 1971-72, are an indirect form of bank housing finance to the general public, both indigenous and expatriate. Houses built under the Housing Commission’s various schemes are occupied mainly by Papua New Guineans in the middle to upper income bracket and expatriates. 5. As a general practice the banking system makes housing finance directly available only to the upper income groups, almost entirely expatriates. Direct lending by the banks for indigenous housing is almost non-existent. Despite the great need for housing in urban areas the banks have experienced little demand for housing loans in these areas; in rural or village areas the lack of legally enforceable security over land is a major problem. In any case, the banks appear to have difficulty in assessing the credit rating of prospective borrowers or their repayment capacity. 6. Savings and loan societies provide small loans to members for building materials and equipment. This is often the only source of housing credit available to villagers. The savings and loan movement has not yet developed housing loans to any extent in urban areas though extension of their operations in this direction would be desirable. 7. Some finance for housing is also being provided by finance companies. Statistics on the amount involved are not available but it is not thought to be substantial and would be high cost finance provided for short terms and then mainly for construction of rental accommodation. Possible improvements 8. If it is Government policy, it would seem that the housing needs of the lower income groups, including the problem of squatter settlements, can only be solved by Government action, either direct or through the Housing Commission, rather than by influence on, or changes in, the banking/financial structure. Some in these

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groups have incomes too low to meet rentals or regular repayments of housing loans even on concessional terms. The solution of their housing needs is a social welfare matter. The Committee notes in this regard the work being done by the Housing Commission in no-covenant areas, and the recent determination of the Minimum Wages Board, particularly the provision made for housing in the new minimum urban wage. It is the intention of the Board that its determination will mean that a greater proportion of urban workers will be eligible for financial assistance for housing purposes from the Housing Commission or other institutional lenders. 9. Banks can be expected to increase their role in financing housing in urban areas. However, if they are to provide funds for village housing, in the absence of clear land titles, consideration could be given to the establishment of a housing loans insurance facility. This would undoubtedly, however, increase costs to borrowers. Some of the problems of banks’ assessment of housing loan proposals from Papua New Guineans could be overcome by channelling more bank finance through the Housing Commission for on-lending to individual borrowers or for construction of sale or rental houses. 10. The savings and loan movement could also play a greater part in the provision of finance for low income self-help housing in both rural and urban areas. By their organisation and structure the savings and loan societies seem particularly suited to provide housing credit for Papua New Guineans. The quality which renders them more adaptable for the particular circumstances of Papua New Guinea is their ability to use security other than land as a basis for lending. Savings and loan societies could also be used as agents by other institutions to channel additional funds into housing. 11. There does not appear to be any need at this stage for new lending institutions in the housing finance field although this does not rule out the possibility of such institutions developing at a later stage. To the extent that specialised facilities are required these could be provided by the Housing Commission, which is already performing a valuable role. This would involve some widening of the scope of its operations and extension of its activities to centres beyond the main urban areas in which the Commission is currently operating, perhaps on some agency basis with, for example, local government councils. It is understood that this possibility is currently under consideration by the Government. 12. One of the principal constraints under which the Housing Commission operates is the lack of available building land. The Papua New Guinea authorities are aware of the problem and steps have been taken which, hopefully, will increase the availability of land to the Commission. Land availability, however, will remain a critical problem.

Rural finance 13. The Overall need for credit by the rural sector in Papua New Guinea has been commented on in a number of other reports. A good deal has been achieved in recent years, particularly by the Papua New Guinea Development Bank, in improving the availability of credit to indigenous producers. The Committee feels, however, that the important area of marketing finance is still deficient. 14. Rural marketing finance is of essentially two types — short-term seasonal finance (crop advances etc.) and long-term finance for capital equipment (storage sheds, transport, etc.). In Papua New Guinea the latter is handled by banks, the Development Bank and some other finance companies (hire purchase or lease finance). The former is sometimes handled by banks indirectly through credit to

12

produce-buying companies, and occasionally by the Government, through its small crop buying arrangements. 15. However, the only formal arrangements for seasonal crop finance have been

through the Rural Credits Department of the Reserve Bank of Australia. This Department makes advances to eligible co-operative organisations or to statutory marketing boards to enable them to make cash advances to producers pending sale of the produce. Loans are repayable within one year. It would clearly be

inappropriate for the Reserve Bank of Australia to provide such assistance when a separate banking system is established in Papua New Guinea. The question arises whether this is a suitable function for the proposed Papua New Guinea central bank

to continue. On the one hand, such an arrangement involves an extension of central bank funds — with possible inflationary consequences — dictated by crop patterns rather than the broader monetary needs of the economy. On the other hand, it does not necessarily contribute to an efficient overall rural credit system.

16. The general experience in countries like Papua New Guinea is that rural credit, to be efficient, must be treated as part of an integrated rural development program. It tends to be more successful to the extent that the lending operation can be geared to the ultimate marketing operation.

17. Such an arrangement reduces the problems involved in supervision, timing of credit releases, and debt collection. The marketing body, be it co-operative or board, acts as intermediary for the lender, maintaining a fairly close contact with the borrower, perhaps acting as supplier of some necessary agricultural commodities

or implements, and deducting loan repayments from amounts due for sale of produce. The report of the Development Centre on Agricultural Credit for Africa held at Addis Ababa in 1962 found ‘a close relationship between agricultural credit and the marketing of agricultural produce, because only through marketing can the

money be earned to repay credit’. It further suggested that ‘a combination of credit and joint marketing seems to provide for an integration which could be one of the key factors to the success of both credit and marketing’. Credit was used in the sense of rural credit generally and not just of marketing credit.

18. The Asian Agricultural Survey published in 1968 by the Asian Development Bank drew attention to ‘the importance of an integrated approach in the field of credit, marketing and input supplies’ and to the need ‘to bring activities under one agriculture institutional setup’. It runs contrary to this concept of integration

to have a separate lender for seasonal marketing finance. 19. Apart from the rigidities which such a lender would tend to bring to the system, there would also be duplication of skilled staff and supervisory facilities. The Development Bank is at present the main supplier of non-marketing finance to

the indigenous sector and is likely to remain so. It has developed skills and experience in dealing with rural credit problems and has field supervisors available. Its own operations could be more effective if it became involved in the marketing area; the total rural credit system would be more coherent and, on the basis of

overseas experience, more efficient. 20. The Committee feels the Development Bank’s operating charter should be altered, if necessary, to permit it to enter the seasonal marketing field, at least so far as orderly marketing schemes are concerned.

21. The Committee considers that the role of the central bank in this area should be restricted to providing some funds to the Development Bank on a wholesale basis, if required and consistent with monetary policy. 22. The significance of the rural sector in countries like Papua New Guinea can

lead to pressure for finance on concessional terms. The question of whether rural

13

industries should be subsidised is a matter for Government policy and will depend on many factors. The Committee would point out, however, that concessional interest rates are basically an inefficient form of subsidy — it is difficult to ensure that the benefits flow to those for whom they are intended; and they could lead to serious misallocation of resources. If the Government feels it to be desirable to give special assistance to certain sections of rural industry (or other sectors of the economy) it is for consideration whether it would not be more effective, less costly, and less disruptive to efficient resource allocation to give direct aid to those in need rather than by providing indirect subsidies by way of concessional interest rates or other devices.

Summary 23. Housing problems in Papua New Guinea are social rather than economic. Present facilities for housing finance cater largely to the needs of middle and upper income earners; improvements are possible, particularly if more land was available to the Housing Commission. Banks have experienced little demand for housing finance from indigenous applicants and face problems under their present opera­ tional arrangements, in dealing with such applications. Some of these problems could be overcome if greater bank finance was provided through the Housing Commission. 24. Financial institutions are unsuited to solving the housing needs of lower

income earners who have not the capacity to service loans nor to meet commercial rentals. If it is Government policy to meet these needs, it will presumably provide solutions direct or through the Housing Commission. 25. In cases where mortgageable title is not available the feasibility of a housing loans insurance arrangement might be examined; however this would increase costs to the borrower. 26. Savings and loan societies might play a greater role also in such cases, particularly in village areas and perhaps as agents for other institutional lenders. 27. The Committee does not see a need to seek the establishment of additional

lending institutions in the housing field at this stage. 28. Some deficiencies exist in present rural finance arrangements; an important deficiency occurs in seasonal crop marketing finance. Apart from some finance provided through produce-buyers or through the occasional rural Administration crop buying schemes, the only formal arrangements are through the Rural Credits

Department of the Reserve Bank of Australia. 29. The Committee does not favour the continuation of these facilities by a Papua New Guinea central bank. The use of central bank funds for seasonal financing is dictated by crop patterns rather than the broader monetary needs of the economy, with possible inflationary consequences. Moreover, a separate lender for this type of finance runs contrary to the development of an efficient, fully integrated, rural development program with close links between the total lending

and marketing operations. 30. The Papua New Guinea Development Bank is already a major lender in the rural field with skilled resources available. The Committee feels that the Develop­ ment Bank’s charter should be altered, if necessary, to permit it to handle seasonal marketing finance, at least so far as orderly marketing schemes are concerned. 31. The Committee also draws attention to the problems which could arise if

concessional interest rates arc applied to rural industries (or other sectors of the economy).

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CHAPTER IV

CENTRAL BANK

In its Interim Report the Committee made reference to the possibilities of the functions of a central monetary authority for Papua New Guinea being vested with the Treasury, another government department, or in a central bank, and concluded that a central bank would be the most appropriate body. It noted that

an embryo central bank already existed within the Reserve Bank of Australia in the form of its Papua New Guinea Department, which includes the Port Moresby office, and that certain preparatory work had been done to establish a framework on which a separate central banking institution could be built when required, The

Committee also noted other reasons for establishing a separate central bank in Papua New Guinea, including: (i) the Government would be able to seek expert advice from an institution free from direct political influence and normal departmental relationships;

(ii) a central bank would be the main financial agency through which the Government implements its policies in the monetary field; (iii) the early establishment of a central bank would facilitate the growth of essential expertise in the various aspects of banking and monetary controls

and experience in financial matters generally; (iv) co-operation with the local banking community is likely to be easier for a central bank than for a government department. 2. The Committee also expressed the view that the central bank should be empowered to function as a fully-fledged central bank from the outset. It recognised

that in some areas this would involve granting powers well in advance of the immediate possibilities of their being used. It considered, however, that this would give the proposed central bank scope to develop instruments and policies to take account of changing local needs; a greater opportunity to develop local expertise

and responsibilities; an earlier and better awareness of the problems and policies that it will face in future; and a greater appreciation of the kinds of measures that might be considered necessary.

3. The Australian and Papua New Guinea Governments have agreed, in principle, to the recommendation that a central bank be established in Papua New Guinea on the basis of the Port Moresby office of the Reserve Bank of Australia with full powers to act as the central monetary authority for a separate banking and financial system.

4. Against this general background the views of the Committee as to the major structural and functional features appropriate to a separate central bank for Papua New Guinea are set down below. Charter and organisation

5. The Committee considers that the general charter of the central bank should not be restricted to a narrow concept of banking as in Australia but should cover other forms of financial institutions. In a developing country such as Papua New Guinea the central bank has an important role to play in developing an appropriate

financial system and financial services. Extension of its charter beyond banks will assist the central bank in this role. In some cases the actual supervision of non-bank institutions may be handled by registrars attached to other sections of Government, with the central bank retaining a right to intervene, if necessary, to promote its

objectives. 6. It would be necessary for the central bank to be equipped to act as banker to

15

the Government and as banker (and, at least to some extent, lender of last resort) to banks and to certain other institutions. However, it is not envisaged that it would provide commercial banking services for any sections of the community generally; it would be desirable for the enabling legislation to make this point clear. 7. It is envisaged that the central bank would have a board of directors appointed by the Government to be responsible for the bank’s policy but that management of the bank would be the responsibility of the Chief Executive (Governor) who would be chairman of the board and who would be appointed by the Government. 8. The Committee recognises that in a country where there is regional diversity, it is desirable to involve people of different backgrounds in decision-making and

that this should be reflected in the composition of the board of the central bank. The Committee considers that the size of the board should allow reasonable scope for representation of a spread of interests without becoming unduly cumbersome or taxing the limited supply of skilled personnel and transport/communication facilities. Probably something between eight and twelve members would be appropriate, including a representative from the Treasury. Beyond this it should not be necessary, and could be undesirable, to spell out criteria for the composition of the board in any degree of detail.

Functions and powers (a) Relations with Government 9. As the main financial agent of the Government, the central bank would be the Government’s principal banker and financial adviser. This would not exclude some of the Government’s banking needs being serviced by the government com­ mercial bank. As is usual in other countries, the Committee would expect the bank to administer and advise on the Government’s exchange control policies and conduct registries of government inscribed stock. 10. The bank should be authorised to make short-term advances to the Govern­ ment and the nature and extent of such advances should be specified in the legislation. Any such limitation is, of course, a matter for the Papua New Guinea Government to determine. However, overseas experience has been that specified limits are valuable, especially during the period while government financial practices are being developed. Without them, there can be heavy pressures on governments to resort to excessive deficit financing through the use of inflationary central bank credit. The following examples indicate some types of arrangement which operate in other countries. In Malaysia the central bank may make temporary advances to the Government in respect of temporary budgetary deficiencies but only to a maximum of 12i per cent of estimated annual revenue and then any such advances must be repaid within three months after the end of the financial year in which they are granted. In Canada, advances may be made for up to six months and are limited to 33 1/3 per cent of the estimated revenue for the financial year in which they are made: in any case advances must be repaid within three months after the end of the financial year. In India, there is no limit but advances are repayable within three months from the date on which they are made. In the Committee’s view the Malaysian approach commends itself as one worthy of study by the Papua New Guinea Government. 11. As noted in its Interim Report, the Committee contemplates that specific provision would be made to provide for the resolution of any differences of opinion which might arise between the central bank and the Government on questions of policy on the basis that ultimate responsibility for monetary policy and financial control should rest with the Government.

16

12. In line with this general principle, the Committee believes that the legislation should give to Government and to the Minister for Finance final authority in respect to the following matters:

• appointment of Governor, Deputy Governor(s) and other directors • changes in the prescribed minimum of external assets to be retained by the central bank • capital and reserves of central bank ® appointments of Governor and Deputy Governor(s)

outside the central bank • currency design and denominations ® the form of backing for currency • subscriptions by the central bank to approved finance

or economic development corporations • regulations issued by the central bank • the control of interest rates

In some cases it would be appropriate to provide for decisions to be taken ‘on the advice of the central bank’. (b) General powers

13. To enable it to carry out its functions as a central bank, including the provision of banking facilities for the Government, the banks and international institutions, it will be necessary for the central bank to be given a wide range of general powers. However, as noted above, the Committee considers that the

central bank should not provide commercial banking services for the community generally and that the legislation should, therefore, preclude the use of its powers for that purpose. This would prevent the central bank from competing with licensed commercial banks and guard against any weakening of central banking

expertise by unnecessary diversification of endeavour. (c) Development of financial structure 14. The Committee earlier indicated that the development of Papua New Guinea will inevitably be accompanied by institutional change and economic restructuring

and it is likely that weaknesses and inadequacies will continue to emerge from time to time. In these circumstances, it makes sense for the central bank to be able to promote or assist development of the institutional structure of the financial sector.

The Committee considers that there should therefore be provision for the central bank, subject to the Minister’s approval, to be able to promote and encourage development of a financial infrastructure appropriate to Papua New Guinea’s needs. This would be additional to the need to ensure that the financial system is soundly managed and would allow the central bank, with the Minister’s approval,

to provide capital for, to hold equity in, and take part in the management of, other institutions considered important for financial development. It may be appropriate for the amount of such investment by the central bank to conform to some statutory limitations.

15. Other than in areas where continued central bank participation was especially desired (for example, establishment and operation of bank clearing houses), the bank would normally be expected to phase out its participation in such ventures in favour of others as early as practicable. The possible demand on the central

bank in this area again points up the need to clothe the bank with a reasonably wide range of general powers.

Government

Minister for Finance

17

(d) Bank licensing and inspection 16. The Committee envisages that licensing of banks (and certain other classes of financial institutions) would be primarily a function of Government. The central bank will, however, have an important role in processing of applications for banking authorities, advising on policy considerations relating to such applications and possibly in supervising concerns which receive authorities to ensure that required conditions and standards are being observed. 17. Detailed consideration of requirements in this area is dealt with later in this chapter under the heading ‘Licensing and Supervision of Financial Institutions’. It is noted here that, in the Committee’s view, provision will need to be made for these functions to be carried out by the central bank, in some cases with require­ ments detailed in separate legislation.

(e) Monetary policy operations 18. So long as Papua New Guinea continues to use Australian currency with no restraints placed on movements of funds between the two countries there will be some constraints on its ability to pursue successfully an independent monetary policy or to apply banking regulations within its boundaries markedly different from those applying in Australia. 19. Without the erection of some barriers (for example, exchange controls or other direct controls), investment requirements which differ significantly from those applying in Australia may be avoided by movement of funds between the two systems. Similarly, while it remains a part of the Australian monetary area any move by Papua New Guinea to license non-Australian overseas banks could raise problems in relation to Australia’s long-standing policy against admission of over­ seas banks. If and when Papua New Guinea introduces its own currency, these problems may be easier to deal with. Until that time, exchange controls imposed by Papua New Guinea towards third countries will need to be co-ordinated with, and generally be at least as restrictive as, Australian exchange controls. There will also need to be close working arrangements between the Papua New Guinea central bank and the Reserve Bank of Australia in respect of the issue and withdrawal of

currency and the management of bank clearances. 20. The Committee considers, however, that the banking legislation should look beyond the present and provide a framework for central bank action as and when it may become necessary. 21. Beyond the normal responsibility for preserving, within the limits of its powers, the value of the currency, it is appropriate that a central bank in a developing country be concerned with the general economic situation. As such, given the dominant role of the Government, it should act as a financial and economic adviser to the Government and legislation could specify that it should inform the Government of any condition which, in its opinion, may pose a threat to the country’s monetary or economic stability. 22. Monetary policy practices/conventions can be expected to evolve between

the enactment of legislation and its effective use in Papua New Guinea. As in other developing countries, there will be need for adaption of and experimentation with .central banking techniques to find those most appropriate for Papua New Guinea conditions. Unnecessarily precise powers and limitations to powers could prove

to be too constricting, and in the Committee’s view should therefore be avoided. To specify various requirements could well encourage their premature use. 23. There is a wide variety of financial institutions and the Committee believes provision should be made to allow the central bank, with Ministerial approval,

18

to apply different types of policy measures to different types of institutions. The legislation could make the point that central bank policies should not differentiate between institutions of the same type but should be able to differentiate between different groups of institutions. 24. The central bank might therefore have simply expressed powers to:

(i) give general directions on the quantum of loans and the purposes for which loans may or may not be made. Power could also be given to determine the conditions on which credit is made available — for example, size of hire purchase deposits; (ii) issue directions to licensed organisations in respect of liquidity and other

‘balance sheet’ ratios; (iii) determine amounts that different types of financial insitutions must hold on deposit with the central bank; (iv) control interest rates on deposits and loans of financial institutions;

(v) engage in open market operations. This would probably be covered in the section on general powers, embracing the power to buy, sell, discount and rediscount bills of exchange, government securities etc. (f) Foreign exchange (including gold) 25. It is presumed that the central bank would be made responsible for preserv­

ing the external value of a separate Papua New Guinea currency, if and when issued, and for maintaining adequate foreign exchange reserves. To this end, it would need to be empowered to acquire, hold, transfer and sell foreign currencies, precious metals and foreign securities, open and maintain accounts, appoint agents and act

as agent or depository for overseas banks, governments and some international institutions. It would be normal for it also to have power (subject to commitments under international treaties etc.) to determine the rates at which foreign currencies and gold are bought and sold by authorised dealers.

26. It would be desirable for the central bank’s powers to mobilise/ration foreign currency to be specified in sufficiently general terms to fit whatever arrange­ ments should subsequently be settled for foreign currency dealings. However, at least for some time, it could be sensible for the central bank to hold all of Papua

New Guinea’s foreign exchange reserves apart from small working balances which might be held by the banks. 27. Whether or not the central bank would be accorded powers for policy

formulation and operation of exchange control or whether it might carry out certain functions in this area as an agent of Government would seem basically to be a matter for Government decision. The Committee recommends an arrangement which would leave final authority in this area with the Government and have the

central bank designated as the operative agency with an advisory function. (g) Currency issue 28. Currency arrangements for Papua New Guinea at the stages of self­ government and independence are being considered separately outside the Committee. It would, however, be normal for the central bank to be clothed with

powers of currency issue and distribution. The Committee see advantages in the responsibility for the issue of both notes and coins being vested in the central bank. This is a common practice in other countries. Licensing and supervision of financial institutions 29. The Interim Report envisaged licensing and supervision of banks and probably

other classes of financial institutions. The approach which commends itself to the Committee is to define broad categories of financial operations which could not

19

be conducted without authority from the Government. Provision would be made for exemption from licensing requirements for specific types of institutions, or institutions below a specified size, where supervision by the central bank was considered unnecessary. An alternative, which is less favoured because of defini­ tional problems, would be to extend licensing requirements to classes of financial intermediaries to be proclaimed from time to time. 30. As financial processes have become more complex, the distinction between banking business and other forms of financial intermediation is becoming more difficult to sustain. With the changes that will occur in Papua New Guinea financial arrangements as services develop to meet local needs, distinctions between institu­ tions (as opposed to types of services) will become increasingly blurred. Legislatively, therefore, it would be preferable to keep the central bank’s power to control as wide as possible. At the same time, it would be administratively impracticable to exercise this power in any meaningful way over all financial institu­

tions or all financial transactions. A limitation needs to be accepted; other institutions or transactions can be added (with Government approval) if and when necessary. It needs also to be clear that subjection to central banking control does not in any way imply a central bank guarantee of solvency. 31. The Committee favours the special recognition of a selected group of

financial institutions around which the financial system can be developed. These institutions would be expected to take on a rather special set of responsibilities in exchange for special relationships with the central bank. It could perhaps be argued that this system is discriminatory. However, it is important that there should be an efficient and reasonably inexpensive payments mechanism based on stable, well-managed institutions. It is reasonable for the Government, through the central bank, to offer some special considerations to achieve this. 32. The group best equipped to form the basis for the payments mechanism and

to form the corner-stone for the financial system is the commercial banks. This is in line with general overseas practice. 33. It could be that privileges enjoyed by the selected group would include access to last resort loans from the central bank, acceptance by the central bank of some responsibility to protect depositors, and special agency arrangements for foreign exchange business. Responsibilities could include stricter interest rate and liquidity controls, requirements for the provision of more detailed information

on business and higher standards in conducting business. 34. Consideration of the claims of other groups for central bank ‘protection’ could be dealt with as circumstances dictated; no specific legislative provision would seem necessary.

(a) Licensing arrangements 35. Two levels of licensing are envisaged by the Committee. For the selected group (initially authorised banks), it would seem desirable for the issue of licences to be a function of Government with the central bank processing applications and making recommendations. For other financial institutions, the licensing procedures might be less stringent; there should be no inference that the Government or the central bank accepts responsibility for the solvency or liquidity of these licensed concerns. Thus for banks and others in the selected group licences would combine privilege and regulation; for other groups, the essential purpose of a licence would be regulatory to ensure proper standards were observed. 36. There should be provision for attaching conditions to licences. Conditions facilitate differentiation between groups of institutions. Should a greater variety

20

of non-bank financial institutions emerge in Papua New Guinea in the longer ran, some capacity to differentiate, at least among more specialised groups, would be desirable. 37. The kinds of conditions which it might be necessary to impose as a counter­

part of licensing to ensure required standards of performance by financial intermediaries would presumably include the following: (i) minimum capitalisation; (ii) qualifications for directors and managers;

(iii) liquidity ratios with provision for specification of assets to be held and perhaps geographic location of assets; (iv) obligations to provide information to central bank/Treasury/registrar; (v) audit and inspection. 38. There is need for flexibility in setting requirements. There may well develop in Papua New Guinea a mixture of authorised banks as well as a diversity of non­

bank financial institutions. The advantage would therefore lie in not specifying in initial legislation minimum conditions in the various areas indicated above. As standards become codified, however, the setting of minimum conditions for various classes of financial intermediaries would be desirable.

(b) Supervision arrangements 39. The suggested demarcation between banks and other financial intermediaries at the licensing level should facilitate a similar clear demarcation at the supervisory level. 40. Given likely limited government audit facilities, there seems little alternative

to the central bank itself undertaking direct supervision and inspection of licensed banks. The link back to Government as the licensing authority would be achieved by having the central bank report to Government on any non-observance by banks of licensing conditions and any deficiencies in general operating standards.

41. In respect of non-banks, supervision would be based mainly on regular statistical returns directed to the central bank or to the appropriate registrar (as for State registrars of building societies etc. in Australia at present). Provision for regular audit or inspection would be necessary but this could be arranged at some

remove from the central bank/Treasury. Some link back to the central bank may be desirable and perhaps could be achieved by a reserve provision empowering the central bank to make detailed inspections and recommend suspension or can­ cellation of licences where it considered circumstances warranted. 42. An outline of the kinds of provisions— and some comments on them—which

might be contained in the Papua New Guinea legislation to give effect to the various recommendations in this chapter is contained in Attachment A.

Summary 43. The central bank should be empowered to function as a fully-fledged central bank from the outset. The general charter of the bank should not be restricted to a narrow concept of banking but should extend to other forms of financial

institutions. 44. The central bank would be the Government’s principal banker and financial adviser, authorised to make limited short-term advances to the Government. Ulti­ mate responsibility for monetary policy and financial control should rest with the

Government. 45. The central bank should have power to engage in the whole range of banking services, but legislation should exclude it from engaging in commercial banking activities with the general public. The objects and powers of the bank should

21

include promotion and development of a financial infrastructure appropriate to Papua New Guinea needs. 46. It is envisaged that the power to license banks (and certain other financial institutions) would rest with the Government, but the central bank would process and advise on applications. While the licensing and control provisions of the legislation should be as wide as possible, exercise of this power in any detailed sense over all financial institutions would be administratively impracticable. Some limits would need to be set. 47. The Committee favours a selected group of institutions as a corner-stone around which the financial system can be developed. The licensed banks would comprise this group initially but claims of other groups for inclusion could be dealt with as circumstances warranted. 48. In regard to monetary policy operations, banking legislation should look beyond the present and provide a framework for central bank action as and when it may become necessary. Unnecessarily precise powers and limitations to powers could be too constricting and should be avoided. To specify various requirements could well encourage their premature use. The central bank should be allowed to differentiate between types of institutions in applying policy but should not differentiate between institutions of the same type. 49. So long as Papua New Guinea continues to use Australian currency with no restraints placed on movements of funds between the two countries there will be some constraints on its ability to pursue successfully an independent monetary policy or apply banking controls within its boundaries markedly different from those applying in Australia. In such circumstances there will need to be close co-operation between the central banks of the two countries. 50. If the central bank in Papua New Guinea is to be responsible for maintaining adequate foreign exchange reserves and for preserving the external value of Papua New Guinea currency, if and when issued, it will need powers relating to the mobilisation/rationing of foreign currency. Such powers should be specified in sufficiently general terms to fit whatever arrangements might subsequently be settled for foreign currency dealings. For some time at least it could be sensible for the central bank to hold all Papua New Guinea’s foreign exchange reserves. In regard to exchange control policy and operation the Committee recommends an arrangement where final authority rests with the Government and the central bank is the operative agency with an advisory function.

22

C H A PT E R V

SPECIAL POSITION OF THE COMMONWEALTH BANKING CORPORATION In view of the significance of the Commonwealth Banking Corporation’s future in planning the institutional structure for banking in Papua New Guinea, and in the Corporation’s own interests, the Committee indicated in its Interim Report that it would see considerable advantages in an in-principle decision being taken at that time to the effect that the business of the Corporation in Papua New Guinea be transferred to some form of Papua New Guinea ownership. This recommendation

was agreed to in principle by the Australian and Papua New Guinea Governments. 2. In terms of its share of total banking business in Papua New Guinea the Corporation is the most important of the four Australian commercial banks operating there. It conducts trading and savings banking through 13 branches, 2

sub-branches and 140 agencies, of which 85 are offices of the Administration. The Commonwealth Trading Bank has 70 per cent of trading bank business in Papua New Guinea and the Commonwealth Savings Bank accounts for 64 per cent of total depositors’ balances with savings banks. Seventy per cent of Papua New

Guineans’ deposits with all banks are held with the Commonwealth Savings Bank— though they represent only 43 per cent of total deposits with the Commonwealth Savings Bank.

3. Although the Commonwealth Banking Corporation operates on a commercial basis, it is an Australian Government owned bank established as a statutory cor­ poration under Commonwealth legislation. As such, and in view of the major share of banking business it conducts in Papua New Guinea, the Committee feels

it would be inappropriate for the Corporation to continue there on the present basis. This could conflict with the basic principle of a locally controlled banking system in Papua New Guinea. 4. There are other arguments for the transfer of the business of the Corporation

in Papua New Guinea to local ownership. The transfer would ensure that a large segment of general banking business was conducted through a Papua New Guinea institution with any benefits from the business accruing directly to Papua New Guinea. It would also facilitate, as discussed in Chapter VI, the establishment of a

Papua New Guinea commercial bank. 5. In regard to the form of future ownership of the Corporation, the Committee feels that 100 per cent ownership by the Papua New Guinea Government would be the most appropriate eventually. This would provide a fully national bank in Papua

New Guinea aiming generally at commercial viability but able also to play a special role if required in, say, financial education, bank staff training and in adapting banking arrangements more closely to the needs of Papua New Guinea. 6. The Committee considered the question of a continued presence by the Com­

monwealth Banking Corporation after self-government. It was put to the Commit­ tee that it would be reasonable for the Corporation to maintain banking facilities at least in Port Moresby and retain certain elements of its present business in respect of which it had continuing contractual obligations or which it might regard as important to its Australian operations (and competitive position). 7. The Committee sees as a possibility to be considered a transitional arrange­ ment involving a joint venture between the Corporation and the Papua New

Guinea authorities, with perhaps the Corporation’s interest and contribution being tapered off progressively over a period of years.

23

8. The Committee appreciates the reasons why the Corporation might wish to retain some elements of its Papua New Guinea business which have advantages for its Australian operations. However, such business would probably also be important to a national bank and could possibly mean the difference between a viable and non-viable total operation; in the Committee’s view, the national bank must be established on a sound financial basis. 9. It is important that the transfer of business from the Commonwealth Banking Corporation to a Papua New Guinea government commercial bank should be achieved as smoothly and as effectively as possible. It is, therefore, necessary that the Commonwealth Banking Corporation should not compete for banking business with the government commercial bank following the transfer; such competition at this time could prejudice the success of the transfer. 10. The Committee recognises that there could be accounts which give rise to special contractual or financial problems. Consistent with the principle that it should not compete with the government commercial bank, the extent to which the Corporation should be permitted to continue to engage in banking business in Papua New Guinea in respect of such accounts should be a matter for further detailed consideration by the appropriate authorities.

11. Discussions are already underway between the Corporation and the appro­ priate authorities on questions associated with the transfer of the Corporation’s business to Papua New Guinea control. Final decisions to some extent will depend on the outcome of these discussions.

12. The Corporation has given an assurance of its willingness to collaborate and assist in establishing and developing the government commercial bank during a transitional period of some years. The details of such assistance can be settled, along with compensation, timing, etc., in discussions between the appropriate Papua

New Guinea and Commonwealth authorities.

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C H A PTE R VI

ELEMENTS OF AN APPROPRIATE INSTITUTIONAL FRAMEWORK In its Interim Report the Committee outlined the main elements of a financial infrastructure appropriate for Papua New Guinea at this stage in the following terms:

(a) facilities for safekeeping of savings; (b) machinery for the efficient mobilisation of personal and corporate savings for purposes of capital formation; (c) a sound and adequate payments mechanism;

(d) institutional links providing access to overseas sources of capital; (e) machinery for allocating investible funds which takes some account of basic development needs and priorities; (f) a central monetary authority with powers and reponsibilities for control and

supervision.

2. The requirements for a central monetary authority were considered in an earlier chapter. This chapter brings together the Committee’s views on an appropriate institutional framework for the remainder of the financial system. 3. As noted earlier a fairly broad range of financial institutions presently operates in Papua New Guinea. In the Committee’s view the existing range of financial insti­

tutions provides a reasonable base for the development of a banking and financial system suited to Papua New Guinea needs. 4. At the same time, the Committee has pointed to shortcomings and inadequacies in the financial system in a number of important respects and to the need to seek

ways and means of overcoming these. The following sections outline in some detail the conclusions reached in the Committee’s study of the major institutional group­ ings presently represented in Papua New Guinea. It also presents—in seeking to establish the broad elements of an appropriate financial framework for Papua New

Guinea— proposals for modifications to existing arrangements where these are considered desirable. Papua New Guinea Government Bank 5. In Chapter V the Committee recommended that the operations of the Common­

wealth Banking Corporation should be transferred at an early date to Papua New Guinea Government ownership. This would form the basis of a national commercial bank for Papua New Guinea. Such a bank could play a significant role in the financial structure, particularly in developing the banking system to meet more

appropriately the needs of Papua New Guineans. 6. The Committee envisages that the government bank would continue to provide trading and savings account facilities and would also be linked with the Papua New Guinea Development Bank. While such an organisation would undoubtedly be a formidable package for Papua New Guinea to staff and administer, in the Com­

mittee’s view it would be worthwhile and practicable. For some time, due to current and prospective shortages of trained and experienced Papua New Guinea staff, there will be a need to use skilled staff from outside Papua New Guinea but in the longer term this problem should be overcome.

7. There is no particular virtue in perpetuating in Papua New Guinea either for the government bank or private banks, the institutional and legal separation of trading and savings banking. Removal of this distinction should provide some economies in staffing and other administrative costs; it would afford more flexibility

in funds management; and avoid some duplication of services.

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8. Accordingly, the Committee would favour the establishment of a government bank handling a wide range of accounts (including savings accounts) and servicing some of the banking needs of the Papua New Guinea Government not handled direct by the central bank. It would have a single corporate structure and a single line of management. A link with the Papua New Guinea Development Bank could be provided by some overlap in board membership. 9. It is considered desirable that means should be found which would permit the government bank to assess the costs of providing particular types of services. This would illustrate the element of subsidy involved in some ‘socially desirable’ opera­ tions and would enable the bank to relate costs and returns as part of the overall objective of determining a pattern of interest rates and charges suited to Papua New Guinea. The question of the costs of providing savings facilities and financial educa­ tion is considered in more detail in the section on ‘Private Commercial Banks’.

10. It is not envisaged that all branches of the government bank need conduct a full range of banking services. Some branches, staffed at a lower level of manage­ ment expertise, might handle only savings accounts (with perhaps other limited services). Loan applications, etc. would be referred to head office or a larger branch in the region. The Committee considered the possibility of establishing a separate national savings bank or a post-office savings bank. Neither is favoured. In Papua New Guinea a post-office savings bank is not regarded as feasible because of the thin spread of post offices throughout the country. In any event the experience of other countries is that a postal savings system is not competitive with a branch banking system with widespread agencies offering savings account facilities.

11. If, as is suggested in a later section, the private commercial banks are allowed to offer savings deposit facilities, it could be argued that the government bank might find itself in a position where the only funds lodged with it were funds which the commercial banks did not choose to bid for. In the Committee’s view, however, banks’ shares of savings deposits in Papua New Guinea are likely to be closely related to branch/agency representation. The Committee would expect the govern­ ment bank to operate branches in major centres of population to compete with facilities offered by commercial banks and to get a reasonable share of the business. In any event, the Committee is not so pessimisitic about the prospects for the government bank that it regards it as necessary to reserve to it a monopoly of savings account business in Papua New Guinea, denying commercial banks the opportunity to participate.

Development Bank 12. The Papua New Guinea Development Bank is the only locally incorporated bank. To an increasing extent it is providing credit facilities for small indigenous rural and business enterprises as well as assisting larger-scale commercial ventures and projects of national importance. To date the Development Bank has relied heavily on government funds supplemented by some government-sponsored loans from international sources. Loan repayments are gradually providing a larger proportion of the funds available for new lending. 13. The Papua New Guinea Development Bank has demonstrated a useful capacity and seems well-placed to play an expanded role in catering for development credit needs, particularly at ‘grassroots’ levels. As with other small operations in remote areas, these latter transactions are costly and all possible ways of spreading these costs warrant consideration. In one such respect Development Bank operations

have greatly benefited from expert advice and technical assistance provided by government departments particularly the Department of Agriculture, Stock and Fisheries.

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14. The Committee considers that the Development Bank might contribute use­ fully to cost reductions on a national basis as well as further its own operations by promoting a better integrated approach to lending, particularly in the rural

sphere, by seeking a somewhat more flexible definition of ‘development’ as related to loan proposals and by forming associations with other financial institutions to help spread costs of remote area operations. The first two of these possibilities are mentioned in Chapter 111.

15. The most useful and fundamental association from the national viewpoint would, in the Committee’s view, be a close link with the government bank. While the Development Bank might appropriately maintain its separate identity for the time being there should be close co-ordination with the government bank in

terms of a sharing of facilities and staff, some overlap in directorships, and in the efficient allocation of domestic savings to meet local credit needs. In the longer term, when the problems which will arise from converting the Papua New Guinea business of the Commonwealth Banking Corporation and getting the government

back on to a proper operating basis have been overcome, an even closer association between the Development Bank and the government bank (or their eventual amal­ gamation) could be considered. 16. More precise details of the associations which the Committee would envisage

initially for the Development Bank would be: (i) to have the Development Bank provide savings account deposit and with­ drawal facilities on an agency basis at centres where it is represented but the government bank is not represented; (ii) as a corollary to (i), the government bank might perhaps supplement the

funds of the Development Bank by making loans to it; it should also work closely with the Development Bank in credit operations in remote areas to avoid duplication in supervision— rationalisation of representation/field staff could under such arrangements lead to the government bank and the Development Bank undertaking operations on an agency basis for each other

in credit extensions and loan supervision; (iii) to have the Development Bank channel some credit through savings and loan societies in circumstances where the size and range of individual loans involved would otherwise be prohibitively expensive to administer. 17. The existence of the Papua New Guinea Development Bank as a government agency does not, of course, preclude the establishment of further entities of this type. In fact, there are at present some private development finance institutions

operating in Papua New Guinea predominantly serving expatriate enterprises. At least for some time, however, the scope for viable operation of specialised private entities in the development financing field would seem fairly limited. With the recent establishment of the Investment Corporation of Papua New Guinea, the

Committee feels that there is little justification for further governmental develop­ ment finance agencies at least for the immediate future. However, it does see a need for existing institutions to expand and rationalise their operations. Investment Corporation

18. The Committee considered the possibility of closer association between the Investment Corporation and the proposed government bank or the Development Bank. It concluded that the functions of the Corporation were basically dissimilar from commercial or development banking; the type of management expertise

required was also dissimilar. On the balance, therefore, the Committee feels it would be preferable to maintain the Investment Corporation as a separate entity. Some linkage to the government commercial bank and a continuation of the linkage

27

to the Development Bank through overlapping board memberships (though not a common board) could have advantages as could the use of common facilities. Private commercial banks

Savings banking 19. Evidence before the Committee suggests that savings banking in Papua New Guinea under present arrangements is unprofitable and that existing savings banks would prefer not to engage in savings banking business except as part of their general banking operations. As stated elsewhere in the Report, the Committee sees no particular virtue in perpetuating the institutional and legal separation of savings and trading banking in Papua New Guinea. Without this separation, savings accounts would be conducted by commercial banks as part of their normal business and would not necessarily be subject to the kinds of special legislative arrangements that currently apply in Australia. 20. It has been put to the Committee that there are various ways in which the cost of conducting savings facilities in Papua New Guinea could be reduced. These include the pruning of uneconomic services; revised interest rate structure; aboli­ tion of interest payments on small balances; levying of charges on transactions; simplification of procedures; computerisation; incentives to depositors to hold larger accounts; and increased employment of local staff. The implementation of some of these changes may mean reduced services and/or higher costs to clients. However, the Committee believes that this situation may need to be accepted. Unprofitable business should be conducted only if it is offset by desired benefits; even then it is necessary to be aware of the real costs involved. More work needs to be done, in conjunction with the banks, on identifying uneconomic areas of operation and simplifying procedures generally. 21. In some areas, the Committee envisages that bank branches may provide only savings account facilities with, perhaps, other limited services. Judged on purely commercial criteria, such facilities in remote areas are unlikely to be attractive to private commercial banks. If the Government feels they are desirable in the national interest, it could presumably direct private banks to conduct them as a condition of licensing or it could require the government bank to do so either direct or through agents. The former approach is not favoured by the Committee. 22. Arrangements wherein private commercial banks may be directed to establish branches/agencies at points where they have little prospect of proving commercially viable even in the long run are best avoided as introducing relationships between Government and private commercial banks which are likely to create more prob­ lems than they resolve. On the other hand, to saddle the government bank with responsibilities for providing non-economic savings account facilities also has dis­ advantages, mainly insofar as it tends to undermine the capacity of the bank to compete effectively with its private counterparts. Considerations of financial educa­ tion and extension of the cash economy, etc. may outweigh these disadvantages.

Again, it is important that the costs be recognised; if they are not covered by commercial returns but are to be accepted in the national interest, it can be argued that they should be met by direct Government subventions. Alternatively, they should be taken into account in determining the conditions under which banks operate.

Trading banking 23. There are four trading banks presently operating in Papua New Guinea; one Australian Government bank and three private banks. All are conducted as branches of banks whose main operations are in Australia. There is no locally incorporated trading bank.

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24. In discussions with the Committee the private banks all indicated a desire to continue operations in Papua New Guinea, though not necessarily in their present form. Leaving aside the special position of the Commonwealth Banking Corporation, which was discussed in Chapter V, it would be unusual for the Papua New Guinea authorities to refuse to license an existing private bank which wished to continue operating in Papua New Guinea after self-government and was willing

to accept whatever conditions the Government imposed. The possibility exists that the existing private trading banks might combine in some ways to reduce the number of separate units below three. The future form of representation of Australian banks in Papua New Guinea will depend on many factors, some of which have

still to emerge, and this suggests it would be wise not to prejudge this issue. For example, depending on the banking law finally accepted by the Papua New Guinea Government it is possible that one or more of the Australian banks may adjust its (their) operations by closing a number of existing branches and with­

drawing to one or two main points where they would assume a posture not dis­ similar to the so called foreign exchange banks in some other developing countries. This would, of course, reflect the commercial judgment of each bank and would assume that operating conditions would be such as to permit the kind of re­

organisation a bank might propose. 25. The question of local incorporation of banks will depend largely on the political philosophy of the Papua New Guinea Government. From the point of

view of a bank, local incorporation can more closely identify it with indigenous endeavours in the expectation of business rewards; it sometimes can confer taxa­ tion advantages; it can facilitate local capital raising (particularly equity capital); it permits separate corporate arrangements and greater freedom of manoeuvre in

policy formation without affecting the policy of the parent; it limits the legal responsibility of the parent in the event of financial difficulties. It also facilitates the establishment of a separate employment service independent of conditions in the parent’s country of origin. From the Government’s point of view, local incor­ poration constitutes a display of confidence in the new country; it facilitates local

monetary control; it is likely to result in more rapid staff localisation without direct Government coercion. On the other hand, local incorporation might raise barriers to the free import of funds from the parent should excess demand develop for loans; it might also place some constraints on the present access to technical

expertise at the overseas ‘head office’. On balance, the Committee regards local incorporation as desirable. 26. On structure, the comments made earlier in this chapter are applicable, particularly as regards the combining of trading and savings banking into one

overall operation. Again, a good deal of work remains to be done in conjunction with the banks to rationalise and re-organise structures and procedures to meet Papua New Guinea needs. 27. The Committee also gave consideration to whether a system of regional banks — that is individual banks serving only particular geographical areas— would offer

any significant advantages in Papua New Guinea. 28. A branch banking system is already established. The Committee is not aware of any initiative to start regional banks; and their introduction would add further to the number of banks in some areas and require additional resources of capital

and scarce manpower. For these reasons, the Committee could see no clear cut advantage from a regional banking system. This does not, of course, preclude the possibility of a new bank (or banks) being formed to operate primarily in one part of the country if such initiative, capital and staff were available and the Govern-

29

ment was willing to grant a licence. However, any bank so formed need not be restricted to operate in a specific region or town but could have the same freedom to open branches in other parts of Papua New Guinea as do other licensed banks.

Overseas commercial banks 29. The Committee’s terms of reference require it to give ‘special attention to the part which Australian, overseas and Papua New Guinea institutions should play’ in the future banking system. 30. The distinction between Australian and other overseas institutions which is made in this reference is valid under present circumstances. It is more difficult to sustain, however, when Papua New Guinea has its own banking legislation and the Australian based banks currently operating there also become overseas banks. 31. The Australian based banks presently operating in Papua New Guinea will, of course, be in a somewhat different position from other overseas banks. In their case, it will not be a question of allowing them to commence operations but of allowing them to continue their operations. 32. The Committee recognises that presence does not in itself justify continued presence. The considerations relevant to determining whether overseas banks generally have a useful role to play in Papua New Guinea apply in large part both to Australian-based banks and to other overseas banks. It is the value of the ser­ vices which individual banks can and are willing to provide which should be the principal criterion in the decision regarding the granting of a banking licence. The earlier discussion of the role of Australian banks and the Committee’s concluding view— that there is a strong case for allowing those private banks which wished to do so to continue their operations in Papua New Guinea, provided they are prepared to comply with the conditions of licensing— takes full cognisance of the general considerations and criteria outlined below in regard to the role of overseas banks. 33. The final decision on overseas banks is clearly one for the Papua New Guinea authorities and is likely to be influenced by a number of non-economic and economic factors. The Committee recognises the differing weights likely to be given to some of these factors depending on a future Government’s political philo­ sophy and national aspirations. It has refrained, therefore, from making a firm recommendation but offers the following summary of possible advantages and disadvantages of admitting overseas banks and suggests some criteria against which any application for a banking licence by an overseas bank might be assessed. 34. It is suggested, however, that a firm government policy on overseas banks (and presumably the entry of any new banks from Australia) might be deferred at least until local control of the banking system has been effected and the local central bank established. Policy can then be formed by local authorities in the light of assessed local needs.

Possible benefits of overseas banks 35. The specific benefits which Papua New Guinea might derive from the opera­ tion of additional overseas banks will vary depending on the type of service and facilities which each overseas bank is prepared to provide and which the Papua New Guinea authorities can negotiate. In general terms, possible benefits are said to include the following:

(1) Greater competition, especially from institutions offering a wide range of facilities and with broad experience in financial matters, could lead to increased efficiency and possibly lower costs in the financial system. An efficient financial market is an important factor facilitating economic growth.

30

(2) Capital inflow for investment could be stimulated: • investors could regard the operation of their own country’s bank as evidence of confidence in the stability of the economy; • overseas banks would be in a better position to present Papua New Guinea

as a potential foreign investment outlet to their customers; as a corollary, overseas investors would be more inclined to rely on economic, business and political information gathered and passed on to them by a bank they know. Such functions could, of course, be carried on by overseas non­

bank financial institutions operating in Papua New Guinea, such as some merchant banks in Australia but the greater status and contacts of the well-known banks are likely to bring more benefits in this regard; • overseas banks authorised to operate in Papua New Guinea may be

prepared to bring in their own loan funds and to organise consortium finance for large projects as an extension of established practice else­ where. (3) Overseas banks familiar with other developing countries could possibly be

of special benefit in providing facilities particularly suited to Papua New Guinea. (4) Familiarity with trade and financial conditions as well as language in the overseas banks’ home countries may enhance Papua New Guinea’s export

prospects. The expertise in foreign exchange transactions which overseas banks can bring may also be relevant. (5) Papua New Guinea banking authorities might find it easier to guide the development of a system comprising banks from a number of overseas

countries rather than one confined to the Australian banking community. (6) A range of diverse banking organisations (with overseas experience) operat­ ing in Papua New Guinea would tend to broaden the scope for training Papua New Guineans in banking practices.

Possible disadvantages of overseas banks 36. The possible disadvantages which could be associated with the operation of overseas banks in Papua New Guinea are said to include the following: (1) If Australian-based banks continue to operate in Papua New Guinea

together with a government bank and these are providing adequate services, the admission of other overseas banks could cause greater over-banking, add to the costs of banking services and result in even lower profits (greater

losses) than at present. This could lead to a lack of interest in Papua New Guinea business by banks operating there and may contribute to their unwillingness to undertake business expansion, particularly in the indigenous sector. (2) Overseas banks would be likely to want to limit their operations to the main

commercial centres and their main source of business, at least initially, would probably be companies of the same nationality. Certainly they would be concerned with the more profitable forms of business. Thus, in the early stages at least, they may not regard the provision of better or different ser­

vices for the local community as a very important aspect of their operations. (3) It is possible that the entry of additional overseas owned banks could, in the short term at least, interfere with the viability of any newly established Government owned bank.

(4) The greater the number of overseas banks the greater would be the degree of foreign ownership of banking business in Papua New Guinea, unless new

31

overseas banks were to come in at the expense of one or more of the existing Australian based banks. (5) The presence of branches of overseas banks may promote short-term destabi­ lising transfers of funds; an overseas bank with access to funds from its head

office may be able to circumvent credit restraints imposed by the central bank. (6) An increase in the number of banks would increase the drain on scarce resources (particularly skilled manpower) and might also add to the adminis­

trative problems of banking control. Branches of large foreign banks are also sometimes difficult to bring under local monetary control. 37. Some of the disadvantages mentioned above would not apply if overseas banks were admitted to Papua New Guinea, not as separate entities, but on a partnership/consortium basis with existing institutions. On the other hand, some of the suggested advantages would not materialise if overseas banks were admitted only on a partnership/consortium basis.

Additional comments on advantages/disadvantages 38. Judgments about the relative importance of the advantages and disadvantages of overseas banks, which have been listed above, are likely to vary between indi­ viduals. Such differences in judgments emerged in the Committee’s own detailed discussions of this question. This applies even without consideration of non­ economic factors which to some could be paramount in considering the question of overseas banks. The Committee felt it might be helpful to spell out in greater detail particular aspects of the role of overseas banks and the various views which came out of the Committee’s discussions. 39. Considerable emphasis was given by some members of the Committee to the increased competitiveness and greater efficiency in financial markets which could emanate from the entry of non-Australian based banks into Papua New Guinea. This emphasis derived in part from the belief that the entry, or the possibility of entry, of new overseas banks would encourage existing banks to become more efficient. It also derived from the belief that new overseas banks, with their wider technical experience and capabilities in such areas as foreign exchange operations, together with a greater willingness and the experience to provide credit facilities more suited to the needs of a developing country, could be of substantial benefit to Papua New Guinea. 40. Against this, the view has been expressed that Papua New Guinea is already well supplied with banks and that the admission of additional banks would involve a waste of scarce resources, particularly labour, and result in a clearly ‘over­ banked’ position. Increased competition, it was suggested, could reduce the profit­ ability of banking and the extent and quality of banking services currently offered, rather than lead to increased efficiency. Additionally, new banks would be likely to concentrate on the more profitable areas of business at the expense of current operators. This could, in turn, make existing banks less keen to continue some less

profitable business (i.e. small branches) leaving this to the government bank. 41. Another view put forward was that overseas experience suggested that promises by overseas banks of specific benefits had to be viewed with reservation. This applied particularly in regard to those services which, while perhaps desired by the authorities— for example the conduct of business in outlying districts—are likely to be unattractive to the bank. While it might be possible to include licensing provisions to compel the banks to live up to their undertakings, it was generally accepted that a difficult and undesirable situation could arise if these were too stringent or different obligations were placed on different banks.

32

Other considerations associated with entry of overseas banks 42. The Committee recognised that the admission of new overseas banks before the Papua New Guinea Government had assumed control of its own currency arrangements could cause problems for the Australian monetary authorities. The

long-standing policy of the Australian Government has been not to grant overseas interests authorities to carry on banking business in Australia or to allow them to acquire interests in Australian banks. If non-Australian banks were licensed to operate in Papua New Guinea, they might be in a position to carry on banking business for customers on the Australian mainland and perhaps avoid restrictions current in Australia at any time. These problems would not necessarily be insuper­

able although they may pose technical administrative difficulties. 43. The Committee considered the methods of selection of overseas banks that might be adopted should the Papua New Guinea authorities desire to permit the entry of new overseas banks. One possible course of action would be for the

authorities to make their desire known to selected banks which, they believed, might have an interest in carrying on banking business in Papua New Guinea. In the view of the Committee, while such a procedure, unless based on reasonable assumptions, could result in the Papua New Guinea authorities being rebuffed

by banks which did not wish to operate in Papua New Guinea, it would be likely to have less risks in this regard than a general open invitation. 44. Another course of action, which could have particular advantage, would be for the Papua New Guinea authorities to indicate to banks concerned that an

additional licence(s) to operate in Papua New Guinea was being considered and, if interested, they should indicate the benefits their operations would bring to Papua New Guinea. This would allow banks (or a bank) to be admitted while not placing a limit on the total numbers. A further advantage of the approach would be that

the competitive offers of various overseas banks wishing to establish in Papua New Guinea could be considered at the one time, with a licence(s) being awarded to the bank(s) whose offer(s) seemed most advantageous to the country. Should no bank be willing to advance a sufficiently attractive proposition, there need be no onus

on the authorities to grant a licence at that time. The avoidance of a commitment to accept any particular application would, in fact, be a desirable feature of any such arrangement. Alternatively, the Government could adopt a passive attitude and deal with any application on its merits.

Possible criteria for considering applications for entry 45. In the light of the considerations outlined above— and with the obvious point in mind that the Papua New Guinea authorities should seek, as far as practicable, to maximise the possible advantages and minimise the possible disadvantages—

the Committee suggests that if the Government is to consider admitting additional banks, applications should be considered on the basis of the particular bank’s ability and willingness to meet certain criteria. These criteria could also apply in considering applications for licences from the existing Australian based banks.

The suggested criteria are as follows (these criteria should be distinguished from the minimum conditions to be included in banking licences which are discussed elsewhere in the Report):

(i) Contribution to improvement of financial services, particularly in areas of need as determined by the Government. This could include services associated with the mobilisation of domestic savings and the provision of credit and other facilities both for individuals and the business and

commercial community.

33

(ii) Establishment of links with overseas capital markets and contribution to the promotion of exports, including the development of new markets for Papua New Guinea products. (iii) Provision for employment and training facilities for local staff.

(iv) Provision of opportunities for local ownership, if desired, and local partici­ pation in management. (v) Introduction of overseas capital. (vi) Local incorporation, if thought desirable. (vii) Investment in Government issued securities. Savings and loan societies 46. The Committee sees savings and loan societies as serving useful functions in three major ways: they provide facilities for both savings mobilisation and credit distribution and, in the process, contribute to financial education— all at the ‘grass­ roots’ level which is of particular importance in an economy at Papua New Guinea’s stage of development. The movement is not very demanding in its call on scarce resources of skill and knowledge, yet it is reasonably well-structured and appears to have potential for further useful growth and expansion. 47. These considerations suggest to the Committee that the movement is deserving of continued active promotion and encouragement. With the inevitable imbalances between deposits and loans in individual societies, further growth and development of the movement calls for pooling of funds between societies on an increasing scale. The Committee feels that the movement offers scope for useful association with a major financial institution or group of institutions which could facilitate this pooling and could make available bulk credit lines from time to time. Such an association could possibly be quite sensible and profitable in an organisational sense to a major institution insofar as the savings and loan societies would act both as deposit mobilisers and retailers of small loans in areas sometimes remote, where scale of operations and spread of business would probably not, in the normal course, be sufficient for the major institution to operate directly. 48. The type of major institution which would seem to fit best as an associate of the savings and loan movement would be some form of banking organisation. At least in the longer run this should probably be a commercial organisation rather

than the central bank. The requirement would be for an organisation with sub­ stantial resources and a reasonably wide spread of branches. The range of choice would in these terms encompass both the government bank and the Development Bank. 49. For some time to come it would appear that the savings and loan movement will continue to need external financial support. The Committee feels, however, that the objective over the next few years should be to make the societies self­ supporting both financially and in terms of providing their own staff. Since the inception of the movement in Papua New Guinea, considerable financial support

has been provided by the Reserve Bank of Australia. The Committee understands the Reserve Bank is prepared to continue supporting the movement on the basis that the amount involved will be progressively reduced. It is noted, however, that it would be in line with the Australian and Papua New Guinea Governments’ general approach if support for the savings and loan society movement was channelled through the official Commonwealth aid program for Papua New Guinea.

Other financial institutions 50. To date the participation of non-bank financial intermediaries in Papua New Guinea financing has been fairly limited. Apart from the savings and loan societies already discussed, life companies, finance companies, short-term money market

34

dealers, merchant banks and superannuation funds are represented but the volume of dealings varies a good deal and, for the most part, is not very extensive. 51. In the Committee’s view, apart from the authorised dealers in the short term money market, there is no immediate call for disturbing their existing operations.

It is envisaged that banks may expand their operations into at least some of these fields, leading to increased competition. The need to provide adequate local invest­ ment opportunities for such institutions requires detailed study. 52. The authorised money market dealers are in a somewhat special position. Their operations result in the transfer of investment funds from Papua New Guinea

to Australia and depend on facilities provided by the Reserve Bank of Australia. Without prejudging the issue entirely, the Committee feels it would be inappropriate for them to be permitted to operate portfolios based on Australian securities. Indeed, their continued operations in Papua New Guinea would appear to depend

on the demand for their services in a Papua New Guinea investment context and on the facilities, if any, provided for them by the Papua New Guinea central bank. The Committee considers that this matter should be reviewed by the Papua New Guinea authorities in due course

53. It has already been noted, however, that Papua New Guineans have a small but growing need for credit for the purchase of household items and consumer durables. As the urban population grows, and rural incomes increase, this need may be expected to expand. It is important that there should be adequate facilities

to meet it, on terms and conditions reasonably consistent with the risk, the scarcity of capital and national priorities for its use. The existing means would appear to be confined to the savings and loan societies and the hire purchase companies.

These are unlikely to be adequate and the latter do not seem particularly keen to undertake this class of indigenous business. It would seem desirable for the central bank to keep a close watch on needs and developments in this area. Attention might be given both to the volume and availability of finance, and to the terms on

which it is supplied. There may be a need for consumer education and controls to encourage the rational use of hire purchase and to prevent abuses. Consideration might also be given to the development by the government bank and private com­ mercial banks of a personal loan system geared to the incomes and needs of Papua

New Guineans. 54. In due course other classes of intermediaries are likely to emerge in Papua New Guinea as a demand for their services develops. Building societies and govern­ ment security dealers are possibilities. While there is no obvious reason for Papua

New Guinea to discourage development of additional specialist financial institutions, official action to promote their development in any specific fields does not yet seem called for.

Summary 55. In the Committee’s view, a banking and credit system adequate to Papua New Guinea’s present requirements and likely future requirements should encom­

pass the following: A central bank with the organisation, functions and powers discussed in detail in Chapter IV. A government commercial bank undertaking a full range of banking services and without the current legal separation of savings and trading banking. It is felt the operations of the government bank should be guided by basically commercial considerations.

The Papua New Guinea Development Bank operating on a somewhat broader

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charter than at present, maintaining a separate identity, at least for the time being, but with closer links with the government bank and agency arrangements with other financial institutions. The Investment Corporation should remain a separate entity with linkages, as appropriate, to the government commercial bank and/or the Development Bank.

Private commercial banks operating in accordance with Papua New Guinea legislation and with appropriate changes in structures and operating procedures. Separation of savings banking and trading banking would be discontinued. The Committee recommends that private commercial banks should not be restricted in any way in their competition with the government bank.

Any decision to allow additional overseas banks to operate in Papua New Guinea will rest with the Papua New Guinea Government. The Committee has refrained from offering a firm recommendation on this question; it has canvassed the range of issues which the Papua New Guinea authorities will need to take into account. It suggests that a firm policy on overseas banks might be deferred until local control of the banking system has been effected and the local central bank established.

Savings and loan societies serve the needs of Papua New Guineans at ‘grass­ roots’ level. The movement is deserving of continued active promotion and encouragement. The Committee feels it offers scope for useful association with a banking institution, as a deposit mobiliser and retailer of small loans in remote areas. Continued financial support will be necessary for some time but the move­ ment should be encouraged to become self-supporting as soon as possible.

In regard to other financial institutions, the Committee does not consider that special action is required to promote new institutions. However, there will be con­ siderable room for expansion of the operations of existing institutions and some variations to the charters of government institutions. The monetary authorities will need to watch developments closely in an endeavour to ensure that facilities generally are adequate to meet emerging demands. The position of authorised dealers in the Australian short term money market will need special consideration. 56. The licensing and supervision arrangements for financial institutions are considered in Chapter IV.

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CHAPTER VII

STATUTORY REQUIREMENTS AND TIMETABLE FOR THE ESTABLISHMENT OF A PAPUA NEW GUINEA BANKING AND FINANCIAL SYSTEM

In the preceding chapter the Committee outlined what it sees as an appropriate institutional framework for the financial system in Papua New Guinea. Chapter IV outlined the major structural and functional features for a separate central bank for Papua New Guinea. The Committee is firmly of the view that powers for the

control of banking and other financial institutions should be passed over to Papua New Guinea not later than the date on which it achieves self-government; indeed, the Committee would see advantages in the transfer being effected before then. However, the timing of the transfer of banking powers, the establishment of a

central bank, and the transfer of the operations of the Commonwealth Banking Corporation in Papua New Guinea to local ownership, will depend on decisions taken by the Governments of Australia and Papua New Guinea on the recommen­ dations in this Report and the necessary legislative and administrative machinery.

2. Preliminary discussions on administrative and technical matters are already in progress between the Reserve Bank and the Commonwealth Banking Corpora­ tion and the appropriate authorities. This should allow the administrative machi­ nery to be more speedily set up if the respective Governments of Australia and Papua New Guinea accept the final recommendations of the Committee. As regards legislative measures to effect the changes envisaged in the Report, the Committee’s

thinking, as indicated in its Interim Report, is that there would be separate pieces of legislation to establish the central bank (see Attachment A), to set up arrange­ ments for the licensing and supervision of banks and other classes of financial institutions (see Attachment B) and to create a government commercial bank. 3. Work on the legislation should start as soon as possible. The Committee envisages that the Papua New Guinea Government might seek assistance in this task from the appropriate Australian authorities. 4. In regard to Australian legislation, a basic requirement is to amend the Banking Act 1959-1967, the Reserve Bank Act 1959-1966 and the Commonwealth Banks Act 1959-1968 so that they no longer apply to banking operations in

Papua New Guinea. Specific legislation, however, could be required to transfer the Papua New Guinea assets and liabilities of the Commonwealth Banking Corporation and the Reserve Bank of Australia to Papua New Guinea ownership. While it is proposed that certain powers, such as those relating to currency

issue, mobilisation of foreign exchange reserves and exchange control, should be included in the Papua New Guinea legislation there would need to be co­ operation on these matters with Australian authorities so long as Papua New

Guinea uses Australian currency and has access to Australia’s overseas reserves. This would need to be allowed for either in the relevant legislation or by some form of formal agreement or arrangement. 5. The Committee considered it would be useful to set out a simplified timetable— based on the assumption that the main recommendations of the Report would be

accepted— which would enable the two Governments to relate the recommendations of the Committee to some time perspective. In the terms of the recommendation contained in the Interim Report, the timetable is drawn up to achieve the establish­ ment of a separate banking system as soon as practicable. This is thought to be

about September 1973. The timetable seeks to take account of constraints associated

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with drawing up and enacting the required legislation and the substantial admini­ strative reorganisation which would be involved. It is difficult, however, to anticipate fully the constraints which may be involved in these areas. 6. On timing there may be some scope for various aspects of the Papua New Guinea legislation to be proclaimed separately. However, in the Committee’s view

there are strong reasons for seeking to bring the major substantive provisions of the required legislation into force at one time and in joint proclamation with the appropriate changes in Australian banking legislation. Any other timing could involve transitional legislation. 7. Irrespective of what date(s) might ultimately be decided upon for the com­ mencement of the relevant pieces of legislation, the preparation of each Bill could be put in hand independently. The Committee strongly suggests that this be done as soon as practicable so as to permit the introduction (and enactment) of the individual Bills in the respective Parliaments during the first half of 1973, if possible. 8. On the above basis, the following tentative timetable is put forward by the Committee:

November 1972 Commencement of preparations for transfer of Common­ wealth Banking Corporation’s operations in Papua New Guinea to local ownership. December 1972 Consideration of the Committee’s Report by Papua New

Guinea Government. Decisions on recommendations for establishment of a separate banking system. February 1973 Consideration of the Committee’s Report and Papua New Guinea Government decisions, by the Australian Government.

Decision on the establishment of a separate banking system. March-April Papua New Guinea legislation establishing a central bank. 1973 May 1973

June 1973

September 1973

Commonwealth legislation to pave the way for establishment of a separate Papua New Guinea banking system and central bank. Papua New Guinea legislation providing for local control of financial institutions. Papua New Guinea legislation establishing a government commercial bank. Australian and Papua New Guinea Governments finalise organisational arrangements to establish a separate banking system. Separate banking system in operation in Papua New Guinea.

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ATTACHMENT A

CENTRAL BANKING LEGISLATION OUTLINE OF POSSIBLE BASIC PROVISIONS

This attachment provides an outline of the kinds of provisions (and some comments) which might be contained in Papua New Guinea legislation to give effect to the establishment of a Papua New Guinea central bank along lines recommended in Chapter IV.

A. Charter and organisation 1. The policy of the bank will be determined by a board. Comment. A board, with Government representative(s), preserves a degree of independence for a central bank while enabling the Government’s position to

be considered in decision making. It also ensures that the Government is informed on the attitudes and assessments of the central bank. Participation in decision making by a number of people of different back­ grounds is seen to be an advantage. It also gives the central bank access to a

wider range of expertise. 2. The board within the limits of its power should be charged to: (i) ensure that monetary policy is directed to the greatest advantage of the people of Papua New Guinea; and

(ii) direct its efforts to promote a sound monetary, credit and banking system and to pursue certain objectives, for example, orderly and balanced development of the country or the achievement of full employment of the country’s productive resources. Comment. Reference could be made to the legislation of other developing countries. 3. The size of the board to be such as to allow a spread of representation without being too cumbersome— say from 8 to 12 members including the Governor, a Deputy Governor and a representative from the Treasury. Members of the board to be appointed by the Government. The Governor to be Chairman. Usual criteria for appointment of non-official members; term three years. Terms of Governor,

Deputy Governor and the Treasury representative to be determined in accordance with Government policy and to provide reasonable continuity. Comment. Selection of board members should take account of the calibre of the members and endeavour to ensure a variety of backgrounds and geo­

graphical areas. It would be unwise to be too specific in the legislation on the basis for selecting board members. With educational and career progress likely to be rapid in Papua New Guinea, a shorter period of appointment of non-official members than in

Australia seems desirable. 4. The bank to have a Governor and Deputy Governor(s), appointment by the Government. Management of the bank to be the responsibility of the Governor. 5. Functions— the bank to be limited to central banking except as provided by the

legislation. Comment. It seems desirable to include a specific provision that the central bank should not undertake banking business for the public generally. 6. General powers—the bank to have such powers as are necessary for it to function as a central bank and in particular:

(a) to issue currency and to maintain reserves safeguarding the external value and convertibility of that currency; (b) to receive money on deposit;

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(c) to borrow and lend money; (d) to buy, sell, discount and rediscount bills of exchange, promissory notes and treasury bills; (e) to buy and sell securities, foreign exchange, gold and other precious metals;

(f) to establish credits and give guarantees; (g) to issue bills and drafts and effect transfer of money; (h) to underwrite loans; (i) to establish bank clearing houses in such places as the bank may consider

necessary; (j) with the approval of the Minister, to subscribe to, buy, hold and sell shares of any enterprise, the participation in which promotes the bank’s aims or is generally in the interest of the national economy; and (k) to do anything incidental to any of its powers. Comment. These powers aim to allow the central bank to act as a banker for Government and for certain financial institutions including banks. They include powers to allow the central bank to be a lender of last resort to selected institutions and to conduct open market operations.

These general powers follow the Australian pattern except (a), (i) and (j). The inclusion of (a) follows the practice in other developing countries; it may be unnecessary if specific provisions for currency are included; (i) and (j) are common in developing countries and could be important in enabling the central bank to foster its objectives. B. Relations with the government 1. Central bank to act as banker and financial adviser to the Government. 2. Central bank to inform the Government of any condition which may threaten the country’s monetary stability or development. 3. Central bank and Treasury to keep each other fully informed on matters of joint interest.

4 . Central bank to act as agent of the Government, where appropriate. Comment. This could include such operations as exchange control and the keeping of the inscribed stock registry. 5. Central bank may make temporary advances to the Government in respect of temporary deficiencies of budget revenue.

Comment. There are usually limitations to this power; the type of limitation varies from country to country. The Malaysian example in Chapter IV of the Report is recommended for consideration. 6. The board to inform the Government of its policies. In the event of a disagree­ ment between the Government and the board, the Government’s view to prevail. The board would be required to implement Government policy but there would be provision for tabling in the House of Assembly both sides of the disagreement. C. Relations with banks and other financial institutions 1. Provision for the central bank to set minimum reserve requirements for banks and selected financial institutions. There should be no differentiation within classes of institutions but different requirements may be set for different classes of institu­ tions. The central bank to have power to determine what assets are to be included in minimum reserves. 2. Power to compel banks and other financial institutions to hold special deposits with the central bank. 3. Power to set the ratio of deposits, debentures, etc. to be held in these special deposits, again providing for differentiation between classes of institutions but not

within classes.

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4. Provision for repayment of excess and for augmenting shortfalls in these deposits. 5. Provision for limits on the central bank’s power to alter the size of these deposits.

Comment. A ratio is normally used as the basis for these deposits because it is considered more equitable between institutions. It is reasonable to place a limit on the extent to which the central bank can increase these deposits at one time or within a specified period. Unrestricted

power to call funds to special deposits could introduce an element of uncertainty which would pose serious administrative problems for banks and other financial institutions. 6. Provisions for the central bank to issue directives to all financial institutions on the quantity of advance and other types of credit outstanding and the purposes for which advances and credit should or should not be made available. 7. Provisions for the central bank to control, subject to the approval of the Minister for Finance, the level of interest and discount rates, including those for particular classes of customers. 8. Power to obtain details of a bank or financial institution’s operations and statistics and to obtain information relating to the financial stability of any financial institution. 9. Responsibility to investigate the affairs of a bank or some other (specified) financial institution (i) after it has been informed by the institution concerned that it is likely to become unable to meet its obligations or is about to suspend payment, (ii) after the institution becomes unable to meet its obligations or suspends payment or (iii) in the case where a central bank inspector reports that, in his opinion, the bank is likely to become unable to meet its obligations. 10. In order to protect the interest of depositors power to take over the manage­ ment of a bank or other (specified) financial institution with the concurrence of the Minister for Finance after an inspection under (9) above.

Comment. A central bank’s interest in the depositors is normally limited to banks and certain other (specified) financial institutions. In recognition that confidence can be seriously damaged by the collapse of some other (specified) financial intermediaries the central bank to be given sufficient power to facilitate orderly liquidation. The central bank’s duty should be limited to

safeguarding depositors’ interests and not to guaranteeing the deposits. 11. Power to order the winding up of an institution with the concurrence of the Minister for Finance after an investigation under (9) above. D Foreign exchange

1. Power to mobilise foreign currency and to administer exchange control as agent of the Government Comment. This power provides for foreign currency reserves to be centralised in the central bank and enables the Government through the bank, as its

agent, to determine the purposes for which these reserves may or may not be used. The section would only be expressed simply and in general terms. 2. Power for the central bank to determine what proportion of financial institu­ tions’ liabilities in Papua New Guinea should be held in assets in Papua New

Guinea. Comment. This allows the funds of the financial system to be mobilised for the benefit of Papua New Guinea; as a corollary, it will be necessary that there should be adequate avenues for local investment of these funds.

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3. Provision for the bank to maintain a minimum reserve of external assets. Comment. It is usual for a central bank to maintain a reserve of external assets as cover for its various obligations. To maintain public confidence and convertibility this is regarded as especially important if the country has its own currency.

At the time the central bank was formed in Malaysia, for example, these external assets were to be held in the form of gold, currency or money at call in approved countries, Treasury bills or other short term securities of approved governments/international finance institutions, or approved foreign bills of exchange maturing within three months. The aggregate value of this reserve of external assets was to be at least 35 per cent of the bank’s deposit liabilities plus a specified percentage of the value of currency issued. A similar situation

existed in Nigeria where there was an additional provision that, after five years, the reserve could be reduced to 40 per cent of demand liabilities including currency. Examples such as these may be useful for the Papua New Guinea authorities to study. They are typical of the kind of action taken by countries to promote confidence in the value of their currency both within the countries themselves and in the eyes of the rest of the world. E. Currency 1. The sole right of issuing notes and coin in Papua New Guinea to be vested in the central bank. 2. Only notes and coin issued by the central bank to be legal tender (some transi­ tional arrangements would be required if a separate Papua New Guinea currency were introduced). 3. Provision for penalties for offences relating to notes and coin. F. Audit 1. The central bank to inspect the accounts of banks and certain selected financial institutions and report to the Minister for Finance should this inspection disclose

any irregularities or suggest that the bank is unlikely to be able to meet its obligations. Comment. An alternative would be for a government auditor to inspect the accounts. However, government audit facilities in Papua New Guinea are

likely to be fully extended in the foreseeable future. G. Capital 1. Provision for capital and reserves. 2. Provision for building reserves out of profits. 3. No provisions for separate treatment of profits from different types of

operations. Comment. Separate treatment complicates accounting procedures and is usually arbitrary. H. General I. Provision for the central bank to make regulations with the approval of the Minister for Finance to amplify or support the legislative provisions.

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ATTACHMENT B

FINANCIAL INSTITUTIONS LEGISLATION OUTLINE OF POSSIBLE BASIC PROVISIONS

A. Definitions 1. Financial institution to be any person who accepts deposits from the public and makes advances to the public. Provision for exclusions (specified types or on grounds of inadequate capital).

Comment. Person to include corporate bodies. Provision to be made to exclude small intermediaries to avoid costly and unnecessary administration. B. Licensing 1. All financial institutions not exempted by the Minister to be licensed. 2. Licences to be issued for different classes of financial institutions. One of these

classes to be banks. Comment. Specification of more than two classes enables policy to be imple­ mented without differentiation between institutions but allows for differentiation between types of institution. It is undesirable to specify classes in the legislation

itself as these could soon become dated. The Minister will have to define each class, presumably on the basis of predominant type of business. There should be provision for consultation between the central bank and the Minister before classes are changed. 3. Banks to be corporate bodies. Provision for local incorporation.

4. Applications for licence, specifying the type of licence required, to be made in writing to the Minister through the central bank. 5. Applicant to supply whatever information is requested by the central bank on its business or proposed business and its directors or owners.

6. Provision for a licence to be granted subject to conditions. 7. The Government to approve issue of licences for banks. The Minister to approve and issue licences for other institutions. 8. Provision for revoking licences and for altering conditions. Provision for notice

and appeal.

C. Duties of financial institutions 1. A reserve fund to be maintained; its size and composition to be specified by the central bank. 2. All licensed institutions to furnish audited profit and loss account and balance

sheet to the central bank annually 3. Provision for statistics to be furnished to the central bank and the statistician; information on the affairs of an individual customer not to be sought. Comment. Rather than specify a comprehensive range of statistics in schedules

it is considered best to allow for a gradual and use-oriented build-up of statistics; a general power is thus considered best. 4. A financial institution to inform the central bank if it is unable to meet its obligations or if it is likely to be in such a position.

5. All licensed institutions to inform the central bank of changes in corporate structure or of any change in nature of business.

D. Miscellaneous 1. Accounts of all licensed financial institutions to be audited by an approved auditor. 2. Provision for restrictions on a licensed financial institution’s transactions with

its directors and employees.

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3. Exclusion of bankrupts from directorships of licensed financial institutions. 4. Except as approved by the Minister, prohibition on the use of word ‘bank’ in the registered name of institution which is not a licensed bank. 5. Provision for the Minister for Finance to refuse to allow the use of any name by a financial institution.

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