PAPUA NEW GUINEA - PNG BUAI DIGITAL INFORMATION PROJECT
18. CREDIT INFORMATION AND SMALL ENTERPRISES
By: David Kavanamur, Political & Administrative Studies Department, University of Papua New Guinea
This paper evaluates the importance of accessible information on sources and types of credit facilities that may be available to small enterprises. Our discussion of credit information and small enterprises centres around a number of propositions investigated in this paper. These are: 1) that information on formal credit sources and their procedural requirements is crucial to the survival of small enterprises as enterprise growth requires investment, and investment often requires credit; 2) that would-be enterprise borrowers unnecessarily spend too much time on obtaining information about sources of funds or bank facilities that may be available; 3) that in countries where there are numerous credit facilities (e.g. credit guarantee schemes or CGSs) operated by both development finance institutions (DFIs) and commercial banks for small enterprises, the majority of the targeted clientele are surprisingly unaware of the existence of such credit lines; 4) that small enterprises are affected the most by imperfect information than medium and small enterprises; and 5) that because of market failure in credit information, institutional intervention is required to ameliorate the lack of information.
The paper is structured as follows: section 2 illustrates the importance of credit to the growth of small enterprises; section 3 demonstrates how credit information can be a barrier to small enterprise credit access; section 4 analyses how imperfect information affects small enterprises' access to formal credit in Papua New Guinea (PNG) using the Small Business Development Corporation's (SBDC) Small Business Guarantee Facility (SBGF); and section 5 draws policy lessons aimed at alleviating market failure in credit information.
Before proceeding, a brief definition of what we mean by ''small enterprise"e; is in order. It is obvious from the literature that there are many different definitions, all of which are arbitrary. This paper adopts one - on which a limited consensus has been reached in the literature - which employs as its yardstick the number of workers in a firm, i.e., 1-5 (or 10) is a microenterprise; 5 (or 10) -25 (or 50) is a small enterprise; 25 (or 50) -100 is a medium enterprise; and over 100 is a large enterprise.
Another point that we should note is that the need to address important information on credit sources should be viewed more generally against the developmental potential of small enterprises in generating employment, operating in rural regions without "locational amenities"(e.g. high-tech essential services), to borrow a phrase from Teszler(1993), and so on. The details of such renowned strengths of small enterprises are not within the scope of this paper as they are already well documented elsewhere in the recent literature. Thus we merely refer the reader to the following sources for a succinct statement of these strengths: Schmitz (1982), articles in Levitsky (1989), Liedholm and Mead (1987), and Teszler (1993).
Neither formal financial institutions nor informal money lenders have adequately met the credit needs of evolving small enterprises, partly because of imperfect information and partly because of a myriad of other factors relating to procedural requirements such as record keeping and collateral volume, cost of capital, and government reserve requirements (Minimum Asset Liquidity Ratio). The need for working capital is readily identified to be a major constraint by entrepreneurs, according to numerous surveys, but these are often construed rightly or wrongly by researchers to be a mere smokescreen for other more pressing problems such as lack of managerial training and market saturation.
In line with data from other countries, studies in PNG show that firms rank the lack of credit as a major constraint which requires direct government intervention in its provision (Darkoh, Mawuli and Kavanamur 1996). At the village level, information on credit for small-scale economic development is also identified as the primary need (Temu 1986). Thus, notwithstanding the merits of arguments against credit as a major determinant of firm growth (Sowa, Baah-Nuakoh, Tutu, and Osei 1992) and that it cannot be a panacea for all that ails small enterprises (e.g. Kilby, Liedholm and Meyer 1984, Liedholm and Mead 1987), it is a truism that their growth requires investment, and investment often requires credit.
It is worth noting that small enterprises do raise their start-up capital (which mainly goes towards fixed assets such as tools and machinery) primarily, if not solely, from personal sources (Table 1). The same can be said of their working capital needs in roughly the first 3-4 years of operation (Liedholm 1990, 1991). In Papua New Guinea, this is also true as confirmed by a recent survey of 461 enterprises who ranked personal savings as the primary source of capital, followed by family members and relatives; and finally loans from commercial and institutional sources (Darkoh, et al.1996). That this is the case should come as no surprise since microenterprises need to build up their assets and reputation prior to any borrowing from either formal or informal credit sources. More so, it would be imprudent for both these sources to lend to firms still at incipient stages of growth where the chances of failure are equal to the chances of survival. In other words, microenterprises must first undergo a process of "e;initiation"e; before accepting higher liabilities.
Source: Compiled by author from Kilby et al. (1984), Liedholm et al. (1987), Liedholm (1990, 1991), and McLeod (1991).
In the period after the first 3-4 years, however, their need for credit becomes increasingly pronounced (Table 1). This need is more acute for working capital than for fixed capital among small enterprises relative to their medium and large counterparts. The result is that accessible information on credit sources needs to be made available to assist firms to obtain the requisite credit for their growth.
Barriers to credit access are many. These are often classified into two broad groups. The first comprises interest related factors - entailing the overall cost of credit - and the second, non-interest related factors - comprising, notably, government reserve requirements. Information as a barrier is a component of the first category. Information costs generally add onto the overall cost of credit or loan. It comes under the generic term of transaction costs.
The Macmillan dictionary of modern economics (1992) defines transaction costs as those costs other than price which are incurred in trading goods and services. Von Pischke (1991:11) further enlightens us on the essence and significance of transaction costs:
Transaction costs are admission tickets to financial markets; they govern access to financial services. They must be paid by all parties: depositors, borrowers, intermediaries, guarantors, insurers and others offering or using financial relationships. They include information gathering, security arrangements to protect cash, documents and other data, recording systems for transaction processing, and queuing and decision-making.
For both the borrower and the lender, the transaction cost has two components: the explicit costs (fees charged for application forms, telephone costs, fees charged for information about a credit facility, transport costs for additional trips to the lending institution, fees for documentation and valuation of assets often to the bank, cost of professional services, "e;gifts"e; to bank officials, and so on) and the opportunity costs (lost income incurred while in pursuit of a loan). Transaction costs, in fact, form a major component of the overall cost of credit and, as a result, financial relationships between small firm borrowers and lenders are contingent upon them.
With respect to the would-be borrower, [s]he has to spend time obtaining information about sources of funds or bank facilities that may be available, and studying their respective terms and conditions. Although this may seem a mundane point, it is interesting to note that many studies have documented the fact that in countries where there are numerous credit facilities (e.g. CGSs) operated by both DFIs and commercial banks for small firms, the majority of the targeted clientele are surprisingly unaware of the existence of such credit lines. The lack of awareness exemplifies the point that information about which facility to use is not obtained easily. The search itself can be costly in terms of actual expenses and opportunity costs. Having identified possible facilities, the typical borrower has to attend an interview with the manager or loans officer in which [s]he has to sell his investment proposal to the bank. It is essential for the prospective borrower to communicate effectively with the lender and to be armed with the requisite detailed financial and personal information. The following documentary requirements are not uncommon: latest audited/unaudited financial statements of borrower, business registration certificate, memorandum and articles of association, certificate on updated tax return, business profile, previous years' finances, and cashflow projections and related documents. If these are satisfactory then the documentation of security commences together with the valuation of assets. The transaction is formalised by a letter of offer and upon acceptance, drawdown from the loan facility may commence.
In practice, however, loan negotiation is not as straight forward as the above linear process may suggest. Long delays taking up to a year can be caused by failure of borrowers to meet the requirements, especially those relating to security and financial statements. Kariuki (1993:195) shows in her sample of 52 first-time small and medium firm borrowers in Kenya that over 60 per cent had to endure a period of at least two months before their loans were approved.1 Such delays must be at least partially attributed to her observation that "e;... while a majority of the firms keep the very basic cash book, fewer maintain invoice and receipt files against which entries in the cash book can be checked"e;, and in addition, "e;... not all the firms with such records utilise them to generate the slightly more elaborate ledgers from which the profit and loss accounts and cash flow statements can be extracted"e; (ibid.:209-21 0).
Elsewhere, however, relatively few small firms kept even the most basic cash book noted above. Most small enterprises are content with keeping mental records of prices, costs, revenues, and debts, such that banks are not able to judge the financial prospects of a firm. Several studies (as shown in Figure 1) have shown that the percentage of adequate record keeping ranged from a high of 18 per cent in Sierra Leone to a low of 6 per cent in Egypt and Bangladesh. The very low percentage noted here compared to those in Kariuki's study is to be expected since her study includes medium firms which are more likely to keep some records than small firms, and are therefore not exactly comparable to those in Figure 1. Nonetheless, the basic argument remains valid - that poor record keeping by small firms inhibits credit access and that this is likely to lead to the perpetuation of negative attitudes by banks towards small firms. The problem of bookkeeping further complicates the preparation of business plans, which are an important requirement of potential financiers.
Figure 1. Percentage record keeping by country of small scale manufacturing proprietors
Source: Jamaica: (Fisseha and Davies 1981); Sierra Leone: (Chuta and Liedholm 1985); Honduras: (Stallmann 1983) Egypt: (Davies et al. 1984); Bangladesh: (BIDS 1981) - Cited in and adapted by author from Kilby et al. (1984:33).
Moreover, loan negotiations may be complicated by a lack of sufficient collateral on the part of borrowers to satisfy the often stringent requirements of commercial banks. Even among graduating firms, collateral requirements may still be a problem since banks prefer unencumbered assets which they can easily sell to recoup part of the loan in the event of default. In most countries lending is based more on the magnitude of collateral than on the basis of potential cash flows to be generated by the loans, as is the case in Kenya (Republic of Kenya 1988).
Implicit in the borrowers transaction costs are opportunity costs. These are calculated by imputing a value to time spent away from work in connection with a loan. The actual estimation of opportunity costs is done by multiplying the hours and days spent away by the estimated average daily income (Ahmed 1989), with some allowance, of course, for peak and slack periods in a year. While proximity to a bank may help reduce the amount of time spent away in pursuit of a loan, such benefits may be entirely erased if the necessary financial statements and requirements are not in order. These often include land titles, mortgage documents and feasibility studies, which often require the services of professionals. The absence of such factors, together with the inefficiencies in lender delivery systems, increases the cost of investment opportunities lost; borrowers often request lenders to finance some special and/or urgent business opportunity which they must take advantage of in the short run (Christen 1990:78).
On the lender's side, transaction costs are incurred in the collection of information and data on the operations of the borrower, obtaining information on and assessing/verifying collateral or guarantees - titles and property offered by the borrower and guarantors. In addition, there are monitoring and supervisory costs, and costs associated with enforcing collection in case of default. In all, depending on the cost and time taken in concluding a transaction, a final rate of interest2 will be offered to the borrower together with the requested credit and conditions of instalments. In smaller loans (within the K50-K500 range) it is often the case that transaction and administrative costs outweigh the amount requested. If we consider these high costs against the fact that commercial banks unlike DFIs are not developmentally oriented but are profit motivated (with the shareholders' and depositors' interests in mind) then it is not difficult to see why commercial banks tend to avoid transacting with small firms. A major concern here is that because small amounts of money loaned to small firms can be potentially and profitably invested elsewhere, commercial banks are always wary of opportunity costs.
Clearly, transaction costs are borne by both the borrower and the lender. On the borrower's side there are explicit costs such as those relating to information gathering on, for instance, which bank and loan facility to use, transportation costs and "e; gifts "e; to bank officials, and fees for application forms. In addition, there are opportunity costs which are implicit in the borrower's transaction costs. These are indirectly imposed on the borrower and their magnitude depends on the efficiency of the lender's delivery system. However, these costs are not paid to the lender. A major cost in this regard is the foregone income and urgent business contracts arising from time spent in pursuit of a loan. The longer it takes the borrower to deal with the lender, the higher the opportunity costs.
The main transaction costs incurred by the lender on the other hand, are related to the collection of information and data on the operations of the borrower and obtaining information on and assessing/verifying collateral or guarantees. These tasks constantly require the use of personnel who in turn incur opportunity costs to the bank in lost time either when a deal falls through, when collection and enforcement are required, or when costs far outweigh the amount requested. Opportunity costs in lost income are also incurred when funds loaned to small firms can be invested elsewhere with the prospects of higher rates of return. It is difficult to collect perfect information in a world of imperfect information. This renders the screening of those who are likely to default from those who are not likely to default much more difficult.
4.1 Case Study: Small Business Guarantee Facility (SBGF) administered by the Small Business Development Corporation (SBDC)
The SBGF is a credit guarantee facility which was instituted by the PNGSBDC in 1996 with the support of the government of Papua New Guinea (GoPNG). Its aim is to help address the lack of access to credit by small enterprises in PNG.
The SBGF commenced with a capitalisation of K8 million from the GoPNG (Kl.6 million) and the Asian Development Bank (K6.4 million). Additional funding from AUSAID of Kl.8 million and the UNDP of K115,000 has also been given specifically for setting up a national business training program. The training program is administered by the UNDP and experts from the International Labour Organisation (ILO) through the SBDC. Many of these courses have come on stream such as the Start Your Own Business (SYOB) course.
There are three (3) types of bank guarantees under the SBGF depending on the type of collaterals pledged by the borrower (see SBDC 1996). First, is the Clean Loan Guarantee (CLG). This is exclusively for loans which are not covered or secured by any hard collateral or liquid asset, even though the client may declare collateral in kind or mortgaged properties. The CLG is also particularly for those firms with a clean track record or a reputable credit history and are well known to the participating financial institution (PFI). The guarantee coverage is 50% on the total loan amount. Second, is the Collateral Short Guarantee (CSG). This is for borrowers who have insufficient collatorals and therefore are unable to have the loan fully secured. The guarantee then, which may go up to 100%, covers the unsecured portion of the loan which should not exceed 70% of the total loan amount.
The final type of guarantee is the Credit Risk Guarantee (CRG). This is for loans which are partially or fully covered by any type of collateral other than cash deposit hold-out. Under the CRG, the borrower is eligible for 80% guarantee coverage on the loan amount. The CRG is similar to the CLG except that eligible clients are those lacking in track record, are just starting-up business or are introducing new technologies.
The success of the SBGF, however, depends on the willingness of financial institutions to participate in the scheme since the modus operandi of the scheme is such that the SBDC will only provide bank guarantees to eligible small firms who have applied for loans through commercial banks accredited to SBDC and not through SBDC itself. In other words, to avoid potential political interference, a factor that has marred past schemes, SBDC depends on PFIs to screen and approve loan applications although the SBDC may actually assist clients with their loan proposals and provide training courses. Interest rates charged on loans are market rates as opposed to subsidised rates. Thus far, only two commercial banks have volunteered to participate in the scheme namely the Bank of South Pacific (BSP) and the Australia and New Zealand Bank (ANZ).
4.1 Information constraints
Notwithstanding the points that the SBGF is a relatively new scheme established in 1996, and that only two commercial banks have volunteered to participate in the scheme so far, anecdotal evidence shows that imperfect information has been a real barrier among other factors, preventing small firms from accessing funds from formal sources under the scheme during the short time it has been in operation.
This is evident in the fact that so far only two clients have taken out loans under the Collateral Short Guarantee, at least in the Southern region, while none has participated in the other two guarantees. This is not surprising as the SBDC's delivery network is currently confined to regional branches in Port Moresby, Kokopo, Lae, and Mt Hagen with sub-agencies in Wewak and Kimbe. And although information about the SBGF is being disseminated via the print and electronic media, specific information on procedural requirements remains to be disseminated. In any case, spreading information in PNG has hitherto been constrained by a myriad of factors, such as the topography of the country, scattered human settlement, absence of physical infrastructure in most parts of the country, and a high rate of illiteracy particularly among women.
Even if information reaches potential small firm borrowers in rural PNG, accessibility would still remain a problem because the two current PFIs - BSP and ANZ - like the SBDC do not have branches in many of the provinces in PNG, except for their regional branches. Hence, even if a small firm borrower is qualified to obtain a loan under the SBGF, [s]he will not be able to obtain a loan simply because the PFIs are not represented in his/her province. Currently, both BSP and ANZ are unable to approve loans to clients in provinces which are not within their delivery network because it would be too expensive to effectively supervise the loans from their regional branches.3 According to the Financial Incentive Schemes Officer of the Southern region, over 50 potential clients who have applied to the SBDC have been denied loans because of the above problem. This problem will however be lessen if the Papua New Guinea Banking Corporation becomes one of the PFIs since it has the most extensive delivery network out of all the commercial banks in the country.
A final barrier to information about the SBGF which is worth mentioning is the Kl 0.00 fee that a new client is charged by SBDC for information about the scheme. If we take into account the transaction costs that one may incur as a result of limited SBDC and PFIs branch network, the constraints on information dissemination in PNG due to structural constraints, and the additional K10.00 information cost, then we can also conclude that information cost is an important factor in the credit access equation for small businesses in PNG. Although we have confined ourselves to discussing the types of information costs that small firms have to contend with when dealing with the SBDC, we can also safely conjecture that the problems highlighted here are reminiscent of those faced by the PNG Rural Development Bank, NGO-supported credit schemes, credit unions or savings and loan societies, and the special credit lines for women in the Home and Youth Affairs Department. The effects of information cost are borne out by the limited coverage of those sources in PNG as is the case all over the world (Kavanamur 1994).
It is clear that information about which credit facility to use does not come by easily. A would-be borrower actually has to pay for and invest time into obtaining information prior to dealing with procedural requirements for a loan. Several measures are ventured here that have the potential of reducing some of the information hurdles highlighted in the foregoing.
One of the surest way of reducing information costs is if financial institutions naturally extend and improve their delivery service network. It is clear from our case study of the SBDC that many eligible small firm borrowers may not be able to access loans from the accredited commercial banks via the SBGF because these banks do not have branches where they are located. Considering the points that there are about 100,000 to 150,000 microonterprises and about 10,000 small enterprises in PNG (PNG-Australia Development Cooperation Program 1996), and the limited resources available to the SBDC, it is apparent that the SBDC will not be able to make a significant impact on the needs of the large number of micro-and small-enterprises, and on the needs of small enterprises in locations remote from the offices of the SBDC and its PFIs.
However, efforts aimed at extending branch networks in PNG has hitherto been constrained by problems created by deteriorating law and order. Many financial institutions have actually closed down branches due to persistent criminal activities. At end-1995 there were 74 commercial bank branches/sub-branches and 90 additional agencies.4 The majority of these branches and agencies belong to the PNG Banking Corporation,5 while most foreign-owned bank offices are located in urban centres (Meesook 1996:2). Thus, if financial institutions are to extend their delivery services, law and order problems have to be effectively addressed by the state.
A second method of ameliorating the impact of information costs on small businesses is for a concerted effort by public and private institutions dealing directly or indirectly with small firms towards providing requisite information for the growth of small enterprises. Specialist bodies such as non-governmental business organisations, Chambers of Commerce and Industry, the PNG National Business Association (PNGNBA), the Business Enterprise Support Team (BEST), the Kum Gie Consult founded by the Friedrich Ebert Stiftung Foundation of Germany, the Rural Development Bank, the Commerce and Trade Department, the Home and Youth Affairs Department, the SBDC, commercial banks, and savings and loan societies should act as conduits for the dissemination of information on formal credit sources. Pamphlets about sources and procedural requirements can be channelled through these bodies. Special information desks and toll-free telephones could be installed in these agencies to enable would-be borrowers to enquire about sources of credit. This option appears to be plausible because it is obvious that no single agency has branches throughout the country for such purposes. For instance, the existence of the PNGNBA is not known to the bulk of the clientele which is supposed to serve (The National 24 November, 1994).
A third conduit for disseminating information on credit sources would be to establish Community Information Centres (CICs) as suggested by Temu (1986) in the context of extension programs. A CIC should be placed in a defined community entailing a village or cluster of villages; should serve its community as a focal point of enquiry, as a general information resource, and as an effective link in the flow of information from others to rural people; and should develop in the community a conscious awareness of their access to information on all matters of interest (Temu 1986:14). The CIC should be controlled by a Board of Management drawn from the community, as is already the practice for all community schools and should be the operating base for a District Information Officer. The CIC would be a centre where pamphlets, leaflets, and other printed materials on credit sources, among other topics, would be stocked for villagers. It is hoped that these option could be incorporated into the framework of the reformed provincial government system.
A final method concerned with easing information hurdles faced by small enterprises when accessing credit from formal sources is the need to establish an NGO concerned with information and its communication. This idea is currently being mooted by the South Pacific Centre for Communication and Information in Development (SPCenCIID) at the University of PNG whereby the agency to be known as INFORM PNG will work as a pressure group to ensure that information issues get the attention they deserve. The agency could also be responsible for collecting information on credit sources, among other topics, from agencies listed in the first method discussed in this section and supply them to the institutions discussed in the second and third methods of overcoming information costs.
The purpose of this final section was to distil policy lessons which could be useful for reducing information costs incurred by both potential small firm borrowers and financial institutions. The methods considered are complimentary and are not exclusive. It is also clear from the foregoing that market failure in information provision as regards formal credit sources are not insurmountable. However, it is the belief of this author that no one single method of overcoming information hurdles can address the problem of imperfect information. This constraint can only be effectively addressed through a multitude of methods of providing credit information for small enterprises in PNG.
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1.According to Kariuki, those who loans were approved within less than two months had on-going personal facility with the bank which helped to short-circuit some of the time consuming procedures. She also notes that personally knowing the bank manager had made loan approvals for some within a week of requesting possible (Kariuki 1993:195).
2.Commercial banks do not have much leeway in determining this final interest rate as there are government controls on lending rates such that they may not be able to cover all their transaction costs. However, they may, as they do in many countries, compensate for these by charging fees for application forms, documentation and valuation fees, and commission.
3.Interview with Michael Karon, Financial Incentive Schemes Officer (Southern Region), SBDC, Gordon.
4.Agencies collect deposits but do not engage in lending activities.
5.The PNGBC currently 45% market share.
CREDIT INFORMATION AND SMALL ENTERPRISES
By: David Kavanamur, Political & Administrative Studies Department, University of Papua New Guinea
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