PACIFIC ECONOMIC BULLETIN Economic survey The financial sector in Vanuatu: reform and new challenges Patrick de Fontenay The financial sector in Vanuatu is relatively large for a country Patrick de Fontenay is at its level of development. In 1998, financial services, including a Visiting Fellow with insurance, accounted for 7.5 per cent of GDP and 10.6 per cent the National Centre for of foreign exchange receipts from exports of good and services. Development Studies, About half of this was contributed by the offshore centre, the The Australian National University. He was largest in the region. formerly with EDI, the This survey describes the structure of the financial sector training institute of the and the weaknesses which necessitated a major reform and International Monetary restructuring effort. The offshore centre is analysed, and Fund. outstanding issues for the future of the financial sector are discussed. The financial sector1 promote a sound financial structure, and foster economic conditions conducive to the The Vanuatu financial sector, which orderly and balanced economic development includes the central bank and all financial of Vanuatu. intermediaries, is comprised of a broad range The act strictly limits the independence of institutions, from affiliates of large of the RBV. The government owns all of the international banks to micro-credit systems. RBV’s capital and is entitled to its profits. The Governor of the RBV is appointed by the The Reserve Bank of Vanuatu Prime Minister on the recommendation of the The Reserve Bank of Vanuatu (RBV) was Minister of Finance. Of the four members of established in 1980, the year Vanuatu became the Board of Directors of the RBV, one is a independent. The Bank’s main objectives, representative of the Ministry of Finance, two according to the Central Bank of Vanuatu others are appointed by the Minister of Act, are to issue currency, promote monetary Finance, and the fourth is the Governor of stability, manage the country’s official the RBV, who is chairman of the board. reserves, advise the government on banking If conflict arises between the bank and and monetary matters, supervise the banks, the Minister of Finance, ‘the Council of 17 PACIFIC ECONOMIC BULLETIN Economic survey Ministers may, by directive, determine policy There are two other distinguishing to be adopted by the Reserve Bank’. The features of commercial banking in Vanuatu. Minister of Finance can thus revoke First, the bulk of deposits recorded as decisions taken by the board. The most residents’ deposits, which excludes deposits publicised of such actions took place in 1998. of offshore institutions, are denominated in On 27 March, following 20 per cent exchange foreign currencies. At the end of September rate devaluations by Fiji, Papua New Guinea, 1999, these deposits represented 71 per cent and Solomon Islands, the RBV announced a of total deposits. Some of the foreign currency 20 per cent devaluation of the vatu,2 but the deposits, mainly time and savings deposits, government revoked the decision and are believed to be owned by non-residents dismissed the Governor. Conflicts are, and offshore companies. The degree of however, unusual. ‘Shared responsibility’ for currency substitution for domestic trans- monetary policy and close consultation is the actions appears to be relatively small. Second, usual practice. the interest spread—the difference between the weighted averages of interest rates on loans and deposits—is high, fluctuating The commercial banks around 9 per cent throughout the 1990s. Possible explanations include the low cost Vanuatu has five banks with domestic of funds due to the absence of taxation, the banking licenses. Three are foreign owned— high risk of loans (due to the shortcomings of ANZ, Westpac, and Banque d’Hawaii. One, the legal and land ownership systems), and the National Bank of Vanuatu, is state insufficient competition in the banking sector. owned. The fifth and smallest, European Bank Limited, operates almost entirely in the Development Bank of Vanuatu (DBV) offshore market. At the end of 1999, the total The DBV, which succeeded the Development assets of these five banks amounted to VT38.2 Bank of the New Hebrides, was established billion. as a statutory corporation in 1983 to promote The National Bank of Vanuatu (NBV) the development of the natural resources of commenced operations at the end of 1991 Vanuatu. Poor lending practices led to with a view to providing banking services to mounting losses and the bank closed in 1998. the local population—including those in the rural areas—by creating a network of Vanuatu National Provident Fund (VNPF) branches capable of serving small communi- ties and supporting local entrepreneurship. The VNPF covers all salaried workers in The bank’s operations expanded rapidly, Vanuatu. Its funding comes from and it is the only bank currently operating contributions from employers and employees. outside the urban areas of Port Vila and Following an Ombudsman’s report criticising Luganville. This expansion was accom- the lending practices of the VNPF, riots broke panied, however, by an increase in non- out in Port Vila and the government allowed performing loans, which came to represent the VNPF members to withdraw their more than half the bank’s loan portfolio, accumulated savings from the Fund. ultimately leading to restructuring. Subsequently, the VNPF was restructured All the commercial banks operate in the (see next section) and its charter amended. offshore market (although only to a limited extent in the case of NBV) and it is difficult to Other institutions draw a clear line between their offshore and Other institutions in the Vanuatu financial domestic business. system include a lease finance company, 18 PACIFIC ECONOMIC BULLETIN Economic survey credit unions, a micro-credit scheme to light serious governance problems in (VANWODS), savings clubs and other self- public enterprises and financial institutions, help groups in the informal economy. There whose losses were still mounting. In early are about 20 active credit unions, mainly in 1998, macroeconomic stability was the rural areas, with total assets in excess of threatened by the government’s decision to VT30 million. Loans are made (in order of allow VNPF members to withdraw their importance) for school fees, agriculture, contributions. This, combined with business, housing, and other purposes. The exchange rate devaluations in three other Vanuatu Credit League provides training, Pacific islands states, led to expectations of auditing, and other financial services to a devaluation of the vatu, capital outflows, credit unions, and generally promotes and and large losses in official reserves. The RBV, supports the credit union movement (with which had until then displayed a rather financial assistance from various donors). passive stance and allowed banks to hold Until the Credit Union Act of 1999, credit sizeable excess reserves, acted forcefully to unions were unregulated. The Act legally tighten monetary policy and impose capital establishes the credit union system in controls.3 This more active style of monetary Vanuatu and provides a framework for the management required changes in the formation, operation, and regulation of credit instruments used by the RBV to influence unions. The Financial Services Commission bank liquidity and to defend the currency. is now responsible for the registration and In February 1997, the government and supervision of credit unions. the RBV had reached an agreement on the need for comprehensive reform of the public sector, promotion of private sector Reform and restructuring of the development, as well as the need to involve financial sector the funding agencies in the formulation and implementation of a comprehensive reform During the period 1996–98, Vanuatu program. The Asian Development Bank experienced severe political instability and (ADB) took the lead role in this process. The financial turmoil. The ombudsman brought comprehensive reform program came into Box 1 The Vanuatu Women’s Development Scheme (VANWODS) VANWODS is a successful micro-credit scheme for low-income women sponsored by the Department of Women’s Affairs and financed by the United Nations Development Programme. It consists of 17 ‘centres’ of no more than 30 women each. Total membership had reached 405 by the end of 1999. Each centre surveys the needs of its area and selects a group of five women, who, after some training, prepare a project that will bring enough income to repay a loan, and decide on the first two women to receive the loan. First loans are for VT 5,000–15,000 at an interest rate of 16 per cent. At the end of 1999, the amount of loans disbursed was VT11.2 million and the repayment rate was 100 per cent. Loan repayments totalled VT8 million. Since the inception of the scheme, the minimal staff of four has been maintained and, as a consequence, total expenditures have only reached VT 155,000. 19 PACIFIC ECONOMIC BULLETIN Economic survey effect in mid July 1998 and was supported and the Repurchase Agreement—which by a US$20 million loan commitment from replaced the existing Advance Facility in the ADB. The comprehensive reform program May 1999. The effectiveness of the new focuses on governance and public sector instruments has been limited, however, by reform, reform of the financial sector and the the absence of an active inter-bank market tax system, private sector development, and a secondary market for RBV notes and social equity, and sustainability. It was an government securities. ambitious program, requiring a number of new laws to be passed.4 The financial reform Regulation and supervision of domestic program included introduction of indirect banks market-based instruments for monetary The failure of a domestic bank, Olilian Bank, management, strengthening of bank in 1996, the mounting problems of the supervision, and restructuring of public National Bank of Vanuatu, and the lessons financial institutions. of banking crises in Asia and elsewhere made it imperative to strengthen the prudential Reform of monetary policy instruments supervision of Vanuatu banks.