OPENSSH SFTP-SERVER authentication failure

Running Ubuntu 12.04

I can successfully login via SSH using any user (root included), however whenever I attempt to SFTP into the server I get an authentication refused. Below is the error on client side (winscp), and below that the "/var/log/auth.log". It is worth noting that I can also SFTP locally. This shouldn't be a firewall problem, especially as a port scanner reveals that the server is listening on port 22.

Authentication log (see session log for details):
Using username "test-user".

Authentication failed.

Apr 29 07:34:29 HOST_NAME sshd[3453]: Accepted password for test-user from X.X.X.X port 43592 ssh2
Apr 29 07:34:29 HOST_NAME sshd[3453]: pam_unix(sshd:session): session opened for user test-user by (uid=0)
Apr 29 07:34:31 HOST_NAME sshd[3564]: subsystem request for sftp by user test-user
Apr 29 07:34:48 HOST_NAME sshd[3453]: pam_unix(sshd:session): session closed for user test-user

Not sure where else to really start from debugging this. I have already completely uninstalled OPENSSH-SERVER and re-installed. Let me know if there are further details required (exact commands will probably save time =P)

EDIT: /etc/ssh/sshd_config

# Package generated configuration file
# See the sshd_config(5) manpage for details

# What ports, IPs and protocols we listen for
Port 22
# Use these options to restrict which interfaces/protocols sshd will bind to
#ListenAddress ::
#ListenAddress 0.0.0.0

Protocol 2
# HostKeys for protocol version 2
HostKey /etc/ssh/ssh_host_rsa_key
HostKey /etc/ssh/ssh_host_dsa_key
HostKey /etc/ssh/ssh_host_ecdsa_key
#Privilege Separation is turned on for security
UsePrivilegeSeparation yes

# Lifetime and size of ephemeral version 1 server key
KeyRegenerationInterval 3600
ServerKeyBits 768

# Logging
SyslogFacility AUTH
LogLevel INFO

# Authentication:
LoginGraceTime 120
PermitRootLogin yes
StrictModes yes

RSAAuthentication no
PubkeyAuthentication no
#AuthorizedKeysFile     %h/.ssh/authorized_keys

# Don't read the user's ~/.rhosts and ~/.shosts files
IgnoreRhosts yes
# For this to work you will also need host keys in /etc/ssh_known_hosts
RhostsRSAAuthentication no
# similar for protocol version 2
HostbasedAuthentication no
# Uncomment if you don't trust ~/.ssh/known_hosts for RhostsRSAAuthentication
#IgnoreUserKnownHosts yes

# To enable empty passwords, change to yes (NOT RECOMMENDED)
PermitEmptyPasswords no

# Change to yes to enable challenge-response passwords (beware issues with
# some PAM modules and threads)
ChallengeResponseAuthentication no

# Change to no to disable tunnelled clear text passwords
#PasswordAuthentication yes

# Kerberos options
#KerberosAuthentication no
#KerberosGetAFSToken no
#KerberosOrLocalPasswd yes
#KerberosTicketCleanup yes

# GSSAPI options
#GSSAPIAuthentication no
#GSSAPICleanupCredentials yes

X11Forwarding yes
X11DisplayOffset 10
PrintMotd no
PrintLastLog yes
TCPKeepAlive yes
#UseLogin no

#MaxStartups 10:30:60
#Banner /etc/issue.net

# Allow client to pass locale environment variables
AcceptEnv LANG LC_*

Subsystem sftp /usr/lib/openssh/sftp-server

# Set this to 'yes' to enable PAM authentication, account processing,
# and session processing. If this is enabled, PAM authentication will
# be allowed through the ChallengeResponseAuthentication and
# PasswordAuthentication.  Depending on your PAM configuration,
# PAM authentication via ChallengeResponseAuthentication may bypass
# the setting of "PermitRootLogin without-password".
# If you just want the PAM account and session checks to run without
# PAM authentication, then enable this but set PasswordAuthentication
# and ChallengeResponseAuthentication to 'no'.
UsePAM yes

Comment out the "AcceptEnv LANG LC_*"