Central Bank Digital Currency: an “e-shilin” for Somalia?
A well-designed system which leverages on the existing private sector electronic money transfer infrastructure could work well for Somalia. There are considerable risks too.
If you are in Somalia and would like to buy goods or services, the only acceptable option is to settle in United States Dollars (USD) through one of the two dominant private sector electronic mobile money operators. The use of the fiat Somali Shilin currency – largely counterfeited over the decades – practically ceased to exist across the country, leading to a complete dollarisation.
For many years the Central Bank of Somalia (CBS), with the help of the IMF and World Bank, tried but failed to see through the maze of currency reform, wasting considerable resources in the process without achieving any of the intended outcomes. It is why the dollarisation of the economy (i) continues at pace, resulting in galloping inflation; (ii) led to overreliance on a few Electronic Mobile Money (EMM) operators which digitised the country’s payment system; and (iii) neutralised CBS’s ability to control the money flow through monetary policy levers.
The lack of a functioning national currency is also incentivising EMM operators to create their own private money. The use of EMM credit – more trusted as a medium of exchange than the Shilin, is practically equivalent to using privately-issued currency. This is making the role of the CBS, as the institution responsible for the country’s currency, redundant.
While so, the emergence of Central Bank Digital Currency (CBDC) concept provides a potentially neat solution to many of these problems. There are, however, three key hurdles to consider before an “e-shilin” could become a reality. First, is Somalia’s EMM system infrastructure capable of supporting a CBDC in the form of an “e-shilin”? Second, what would the design and operation of the “e-shilin” look like? Third, what are the key benefits and risks to Somalia’s economy, financial system and CBS’s monetary policy / prudential oversight role?
"The increasing trend of using digital alternatives to cash in Somalia (the EMM market has estimated transaction value of over $30 billion a year) is also unlikely to decline as most people in the country are now EMM-literate. The physical properties of holding cash to make and receive small value payments will therefore continue to decline in favour of using EMM as economic conditions further improve. This will support the case for considering an “e-shilin” CBDC capable of seamless integration into the existing EMM framework. "
(i) Somalia’s EMM system infrastructure
At present, the private sector EMM market is dominated by two large operators with systems that are not interoperable. This introduces significant friction into the payment system landscape and carries material risks for Somalia’s critical financial system infrastructure. CBS regulatory requirements, developed as part of the debt relief benchmarks, for EMM operators to have interoperable systems, and implement robust operational arrangements for managing prudential and conduct risks, remain largely ignored and unenforced.
The increasing trend of using digital alternatives to cash in Somalia (the EMM market has estimated transaction values of over $30 billion a year) is also unlikely to decline as most people in the country are now EMM-literate. The physical properties of holding cash to make and receive small value payments will therefore continue to decline in favour of using EMM as economic conditions further improve. This will support the case for considering an “e-shilin” CBDC capable of seamless integration into the existing EMM framework.
This first hurdle is therefore fairly surmountable, given the vast majority of settlements are made via EMM in the same way as holding a bank account. The investment needed to upgrade existing EMM infrastructure to expand the wallets to Shilin, and related lead time for developing and introducing the system, are likely to be very manageable for private sector operators. The diagram below provides a stylised example of this:
(ii) Design and operation of the “e-shilin”
There are two interrelated questions here: (a) how should the “e-shilin be designed, for instance, the denomination of the currency, including attendant monetary policy issues?; and (b) the question of who will operate the e-shilin infrastructure.
(a) Design of the “e-shilin”
The first important point to note here is that an e-shilin will be no different to fiat currency in so far as the functions of money are concerned. Any e-shilin in issue would need to be backed by the CBS in order to gain wider market acceptance, otherwise it would be worthless. This means completing key currency reform pillars; building cash buffers to back the e-shilin; and creating market credibility though strong governance arrangements within the CBS will be critical. The implementation of a CBDC can then follow a phased approach, focusing on low denomination e-shilin, helping to tame inflation (very small value goods can be settled in e-shilin) and gradually creating alternatives to the USD. Successful wider acceptance of lower e-shilin denominations could then open the door to more wider reforms of the currency.
(b) Operating the e-shilin system
This is where some of the biggest issues lie. The success of the private sector EMM model reflects investments in governance arrangements and controls as well as systems security to mitigate risks. If the CBS manages to design a safe and secure e-shilin, the considerable investment needed to operate individual and household accounts, to the same standard as the private sector, is clearly beyond the institution’s capability. There are other issues too: how would individuals be able to use the system if the CBS does not have a mobile network? Would the CBS – a government institution – be supposed to be running a parallel mobile EMM network in direct competition with the private sector, undermining their industry’s business model? Would individuals trust putting their money in a government institution in country where there is no rule-of-law safety net? What would be the acceptable means of identification in order to open an e-shilin account ? These are not insignificant issues.
Another alternative may be a system where the private sector acts as an intermediary between customers and the CBS, subject to a robust control framework. In essence, the CBS outsourcing the due diligence requirements to the private sector. This would allow individuals to open accounts at the EMM operators which are directly linked to the CBS and make / receive e-shilin through their EMM operator's account. The operator would in turn settle funds with the individual’s account at the CBS through the central bank clearing system. However, it is an arrangement that would require detailed legal framework and careful consideration of risks, including customer identification standards and potential credit risk exposures.
Running an e-shilin ledger also means putting in place enhanced security and controls, in addition to making sure the robustness of the operational resilience of the overall system. The CBS is unlikely to be in a position to be able to do this, given the investment and expertise required.
(iii) Key benefits and risks of an e-shilin
The potential benefits of introducing an e-shilin broadly fall into three categories:
(a) Economic growth: the introduction of e-shilin would reduce overreliance on the USD and dampen the rounding inflationary effect (i.e when prices are rounded up to the nearest $1); and open up a huge market of Shilin users to exchange good and services in the low-denomination sectors of the economy in which millions live.
(b) Monetary policy: the use of the dollar means CBS’s key monetary policy tools – to control money supply, stabilise exchange rates and inflation are pretty much non-existent. A gradual “shilinisation” of the country would help to restore the effectiveness of these central banking tools which are critical for the management of Somalia’s economy.
(c) Government policy: As the e-shilin would be accessible to a broader range of people, it would allow the government to provide relevant support to individuals directly in many parts of the country, reducing mismanagement.
There are material risks too for operating a central bank digital currency in Somalia:
(a) Privacy: an e-shilin has significant privacy implications. Having an e-shilin account means the government has your information and can control where, when and how you spend your money - unsettling scenarios. In countries where the rule of law is weak, a government can misuse an individual’s data in all sorts of ways or block their money at will. In Somalia, this risk is very real indeed.
(b) Banking Disintermediation: If a huge proportion of individuals and households were to hold a digital currency at the central bank, banks and financial firms would be disintermediated, creating wider financial stability risks. However, this is more of an issue for larger economies, given very few people in Somalia have accounts at private sector banks.
(c) Cyber Security: A digital currency would be susceptible to hacking of all kinds – criminals and hostile states. In a country like Somalia, the investment required to protect the system may become too prohibitive to sustain in the long-term.
(d) Money laundering and terrorist financing risks: by operating digital accounts, the CBS would have to vet and continuously assess, millions of account holders – a function that is costly and for which central bank is not designed to do. This will expose the CBS to material reputational and conduct risks.
(e) Government intervention: The government may come to see people's cash as a tempting target for spending or steal it outright.
Overall, there are no significant immediate advantages for Somalia to introduce an e-shilin. The overriding priority must be to work on the reforms needed to build a credible central bank, address the CBS’s leadership weaknesses and implement robust oversight over the financial system. An e-shilin cannot be a substitute for the difficult work that is needed for a proper currency and institutional reform at the CBS.
Furthermore, the CBS’s nascent clearing system needs to be used to help create EMM interoperability to support market competition and mitigate EMM systemic risks – a fairly obvious and much needed reform which continues to be overlooked. Given the external context in which Somali banks operate and the risks they face, they are unlikely to use CBS’s clearing system or park their intraday liquidity in an institution that is crying out for substantive reform. In the circumstances, having exposures to the CBS would not pass basic risk management tests.
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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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