Banking in Somalia
Why the current limited purpose banking model in Somalia is not profitable, sustainable in the long-term or indeed risk-free.
One commonly-held, but wrong, view about banks is that they are merely intermediaries that take deposits from savers and lend it out to borrowers. Implicit in this idea is that bank lending depends entirely on the level of deposit inflows. Consequently, the flow of money to an economy is determined by the preference of depositors at the expense of their spending. In other words, if savers put money in the bank, rather than spend it, there will be less potential for the economy to grow as bank credit lending could not be a substitute for consumer spending on which economic growth depends.
Banks are important intermediaries, but not in the way just described. As customers’ deposits are the banks' liabilities, banks cannot simply lend them out in the same equal proportion as received. If they did that, they would be susceptible to a liquidity run – inability to pay liabilities as they fall due - and risk sudden insolvency.
Banks create money though their lending activities, and some of these loans may be funded by deposits, debt issuances and equity as part of a balanced funding structure that reflects risks appropriately. An important aspect of banks’ money creation is their ability to produce long-term liquidity funding by turning short-term liabilities into longer maturity assets. Get this wrong, and insolvency is inevitable.
"Stand back from the allure of Somali’s financial services market potential and the scale of the business model challenge for bank executives becomes apparent. Over time, as compliance and fixed costs increase, the current limited purpose banking model in Somalia, which most banks seem to have copied from each other, will burn shareholder cash at both ends and be neither profitable nor risk free."
When a bank fails, it has the potential to create a systemic risk that goes well beyond its shareholders, and the consequences for individuals, businesses as well as the whole economy is immense. The re-capitalisation drive in the developed economies that followed the 2007/2008 financial crisis was not so much as bailing out reckless bankers as insulating society and the wider economy from the unacceptably high cost of bank failures.
This context is important to underline why banks are tightly regulated entities. If a limited company were to fail, losses incurred by its shareholders will be limited to the face value of the shares held, limiting any losses arising to immediate shareholders and trading counterparties that have exposure to the company. A bank failure, on the other hand, has the potential to overwhelm entire economies.
This is the reason why banks are heavily regulated entities globally, and there is robust legally-binding disclosure standards on their governance structure, depositor protection, financial position, capital, liquidity and solvency. In order to have safer banks, a combination of legal and regulatory oversight measures is needed to safeguard people’s money and a country’s economic well-being.
Somali Banks
Banks in Somalia are in the main domestic limited purpose banking entities and provide basic banking and payment and trade services. The Central Bank of Somalia’s (CBS) Financial Institutions Law (FIL 2012) is the main regulatory framework that sets out the requirements for their licencing. FIL, whilst imperfect and out of date, is supplemented by two other regulations on capital adequacy and liquidity risk management. These requirements combined set out basic but important criteria for the oversight of financial institutions in Somalia.
There is no industry-wide deposit guarantee scheme which protects savers from the risk of bank failure, nor does the CBS have a resolution regime to deal with banks that get into trouble. In the absence of public disclosures, it is also difficult to know how the FIL’s requirements are realised in practice, or indeed if the CBS has credible oversight over the stability and solvency of these banks.
This observation draws out an important related question: Can the depth of Somalia’s financial services market support existing banks to remain safe, competitive and profitable in the long-term?
To answer this question, we need to look at existing banks and ahead to the future.
The future of banking in Somalia
What is currently the biggest bank by market capitalisation? Which bank has the largest retail or corporate/commercial market share? What is the capital and liquidity positions of the banks that operate in Somalia?
How are these banks funded, given there are no debt markets in Somalia and depositor base, as well as access to banking facilities, are very low? Somalia’s bank lending is underdeveloped and demand for credit is a function of one’s ability to post collateral, excluding the vast majority of individuals and businesses that need credit. As such, would the potential growth in this market be sufficient to satisfy the demands of an investor’s return on equity?
Are all the banks’ assets funded by equities, and if so, how would these banks be able to grow? What is ratio of the banks’ risk weighted assets to their equities or indeed their overall loss-absorbing capacity?
Do these banks run diversified balance sheets by currency, tenor and counterparty? Who are the majority shareholders of these banks, are their equities listed and can one invest in them? Do they have robust governance frameworks and internal controls, or do / publish audited financial statements? How does one know if these banks are indeed safe?
These questions are not insignificant. There is of course a broader public policy need to understand and regulate banks effectively in a way that supports Somalia’s economy, promotes competition and resilience and protects customers. That is why the country’s FIL (2012) mandates the public disclosure of a bank’s financial statements, capital and liquidity positions. However, it is not clear the extent to which industry compliance is achieved, if at all.
Besides the regulatory angle, banks are unlike normal privately-owned firms. They are entrusted with people’s money (without collateral) and rely on credibility and trust to function and thrive. This in turn largely depends on the health of bank’s accounts, the stewardship of its senior management; the credibility of its governance and risk management frameworks. In other words, a bank’s business viability and success are directly correlated to a staggering degree with its ability to publicly demonstrate good governance in managing financial and prudential risks – a fact that is not yet fully appreciated by banks in Somalia.
A bank can not rely on its own equity to be profitable however large its shareholder base might be – that would just be costly, if not impossible. Appropriate risk-taking and the ability to attract funding and investment for its activities and enhance its loss-absorbing capacity will be the key determinants for sustained profitability and long-term growth vital for success.
Stand back from the allure of Somali’s financial services market potential and the scale of the business model challenge for bank executives becomes apparent. Over time, as compliance and fixed costs increase, the current limited purpose banking model in Somalia, which most banks seem to have copied from each other, will burn shareholder cash at both ends and be neither profitable nor risk free. That is why the questions posed here are not optional extras for banks but critical to their business model success.
There is immense scope for growth in Somalia, especially in relation to corporate and investment banking - both advisory and the provision of investment products. There are hardly any banks that offer treasury and cash management; currencies; debt and capital market-making; advisory services for companies; support for mergers and acquisitions; wealth or asset management. This untapped fee income market potential is largely overlooked.
Bank executives that develop a differentiated business model which focuses on client needs; product development and robust risk management are likely to reap the rewards for their shareholders. Banking is one area where being ahead of the regulatory curve pays dividends and creates wider national and international market credibility.
Banks that carry on being limited purpose banking entities risk turning into just larger Hawalas in “bank” uniforms.
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The personal views, thoughts and opinions expressed in the text belong sorely to the author, and not necessarily to the author’s employer, organisation or other group or individual.
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