Impact of Banking & Financial Services in Solomon Islands

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By: Martin Baddeley Housanau, Economist

Introduction:

A bank is a financial institution that handles money, including deposits, loans, and other financial services. We have four commercial banks in Solomon Islands namely; Australia & New Zealand Banking Group (ANZ), Banks of South Pacific (BSP), Bred Bank, Pan Oceanic Bank, a superannuation fund namely the Solomon Islands National Provident (SINPF), a development bank namely the Development Bank of Solomon Islands (DBSI).

Banking Operations in Solomon Islands:

The commercial banks and other financial institutions have an important role in developing the economy of Solomon Islands. This is because they provide funds for consumers and businesses to engage directly in production of goods and services for domestic consumption and exports. Continuous lending to the private sector is an important catalyst in developing our economy in terms of adequate production for consumption, increasing exports, increasing employment and access to finances for rural businesses.

The commercial banks operating in Solomon Islands were given banking licenses by the Central Bank of Solomon Islands (CBSI). The CBSI is the regulator of the banking and financial sector of Solomon Islands. These commercial banks accept deposits from consumers and businesses and pay interest in return. They then in turn invest those funds in loans to consumers, companies, and in securities. When the interest they earns from loans exceeds the interest paid on deposits, it generates income from the interest rate spread. The size of this spread is a determinant of a bank’s profit.

These banks also earn interest from investing cash in short-term securities like the Government Treasuries and development bonds and from fees charged for their products and services such as wealth management advice, checking account fees, overdraft fees, ATM fees, interest, and credit cards.

Let us look at the Audited Financial Statements of BSP (Solomon Islands) as an example to illustrate the impact of banking and financial services in Solomon Islands.

Income: (you can also read similar story here)  https://sbm.sb/bsp-customers-in-solomon-islands-deposited-2-5-billion-in-2024/

• BSP earned a minimum total operating income of SBD$200 million over the past two years in 2023 and 2024.

• Net Profit after Tax was SBD$73.0 million in 2024, and SBD$86.3 million in 2023, a reduction of SBD$13.3 million in NPAT.

• Total operating income was reduced by SBD$8.4 billion in 2024 due to declining economic activities, poor cash flow circulation, high interest rate on loans of 19% and above, and incapacity of small medium businesses for loan re-financing.

Balance Sheet:

• Cash held as deposits with other banks was approximately SBD$1.9 billion in 2024, and SBD$1.8 billion in 2024.

• Loans and advances to customers was approximately SBD$1 billion in 2023 and 2024.

• Investment securities was approximately SBD$48m in 2023 and 2024.

• Deposit from customers was SBD$2.5 billion in 2024, whilst SB$2.6 billion in 2023.

• The bank has excess liquidity of more than SBD$1.8 billion over the past two years 2023 and 2024.

Interest Rate Risk and Credit Risk:

• Interest rate riskis the spread between interest paid on deposits and received on loans over time. Deposits are typically short-term investments and adjust to current interest rates faster than the rates on fixed-rate loans.

• If interest rates rise, banks can charge a higher rate on their variable-rate loans and a higher rate on their new fixed-rate loans. If interest rates rise, banks tend to earn more interest income, but when rates fall, banks are at risk as interest income declines.

• Credit riskreflects the potential that a borrower will default on a loan or lease, causing the bank to lose potential interest earned and the principal loaned to the borrower.

Impact on the Economy:

The BSP illustration portrays how the banking and financial sector is operating in the Solomon Islands. BSP alone has an average excess liquidity of SBD$1.8 billion over the past two years from 2023 to 2024, with very little loans of approximately SBD$1 billion given to consumers and businesses in the same period.

The IMF and CBSI confirmed the excess liquidity in their findings over the past years, that excess cash remained idle with the banking and financial institutions. Based on the BSP case, approximately SBD$7 – SBD$10 billion remained idle within the banking and financial sector in Solomon Islands over the past years till now.

When there’s an excess in liquidity within the banking system but minimal lending, it can lead to a situation where the commercial banks hold onto excess cash rather than loaning it out. This is hindering the economic growth of Solomon Islands by limiting credit availability to businesses and consumers, while also potentially causing concerns about banks taking on excessive risk due to the large amount of idle funds; this can be exacerbated by factors like tight credit standards, economic uncertainty, or regulatory constraints that discourage lending.

Key points about this scenario:

• Reduced economic activity:

With less lending or loans given, consumers and businesses may struggle to invest and expand, impacting negatively on the overall economic growth. This is one of the major contributing factor towards the current declining state of the economic growth in Solomon Islands.

• Low interest rates:

Excess liquidity can push interest rates down, potentially discouraging savings and impacting the profitability of banks. However, this is not the case in Solomon Islands, as interest rates on lending remained high at 19%, contributing to the excess liquidity as less consumers and businesses taking loans.

• Potential for risk-taking behavior:

Although not always the case, some banks might be tempted to take on higher risk investments to generate returns from their large pool of liquid assets.

Reasons for minimal lending:

• Stricter regulations:New regulations can incentivize banks to hold more liquid assets to mitigate risk.

• Economic uncertainty:During uncertain economic times, banks may be more cautious about lending due to potential loan defaults.

• Low credit demand:If borrowers are not actively seeking loans, even with ample liquidity, banks may not see enough demand to increase lending.

• Internal risk management:Banks might choose to prioritize their own risk management strategies over increasing lending, even if liquidity is high.

Potential consequences:

• Asset bubbles:

If banks seek higher returns by investing in riskier assets, it could lead to asset bubbles in certain sectors. This is currently the case in Solomon Islands.

• Inefficient allocation of capital:

Excess liquidity can lead to inefficient allocation of capital if banks are not actively seeking out the best lending opportunities. The majority of small to medium businesses nationwide not seeking loans, resulting in underutilization of domestic resources to achieve optimum production of goods and services.

Conclusion:

Options for the CBSI and the Government to consider in dealing with the current situation:

• Adjust monetary policy:

Lowering reserve requirements or implementing measures to encourage lending can incentivize banks to loan out more of their excess liquidity. This is critical towards increasing domestic production of goods and services for consumption, creating more jobs, increasing economic growth and prosperity for ordinary Solomon Islanders and businesses.

• Targeted interventions:

Providing targeted lending programs to specific sectors or regions with high credit needs. The increase in lending towards the manufacturing and processing sector in Solomon Islands is most critical towards job creation, rise in technical skilled manpower, and sustainable economic growth in the medium to long term.

• Communication and transparency:

Clearly communicating the economic situation and policy intentions to build confidence in the banking system and encourage lending. There needs to be a proactive medium of communication between the Government, CBSI and Small to Medium businesses throughout the nation. The current Solomon Islands Chambers of Commerce (SICCI) dialogue with the Government inadequately embody the interest of growing the Solomon Islands economy, with its small to medium businesses and entrepreneurs, particularly the rural economy where the majority of ordinary citizens lives.