Hiiraan Online

 

The Central Bank of Somalia (CBS) is tentatively considering granting licences to foreign banks to operate in Somalia. It is a process which, while invariably linked to politics, had been in the regulatory pipeline for many years. The government appears to be of the view that the market signalling of having a foreign bank operating in Somalia would show Somalia Plc is open for business. Others believe foreign banks will inject much needed challenger bank competition into the local market, driving up the standards of local banks and supporting overall growth in financial services. There is also the assumption that bringing in foreign banking expertise to the country will have wider positive spill-over effects across the financial services industry.

Focusing on these perceived benefits is looking things in the wrong way. The question is not so much whether Somalia needs foreign banks to improve local standards as to whether the country’s central bank can adequately regulate them. The considerable business opportunity that makes Somalia alluring to foreign banks is indeed the very thing that makes these banks very risky for Somalia. 

Banks are not ordinary companies. if a limited company were to go bankrupt, 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. However, when a bank fails, it has the potential to create a systemic risk for the home and host country 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 whose safety and soundness is intertwined with a country’s economy. A banking firm’s incentive is to take on excessive risks than the public interest would accept – so called moral hazard. This then imperils a country financial system. It is why countries have extensive regulatory systems and controls within which banks must operate to be considered safe.

Somalia is not ready to welcome foreign banks primarily for two reasons: there is no legal authority on Somalia’s statue books that adequately defines licensing conditions for foreign banks; and CBS’s regulatory approach is at best deficient, and non-existent at worst.

No legal authority for licensing foreign banks

There is no law in Somalia that specifically outlines the legal basis for licensing foreign banks The current Financial Institutions law 130 (FiL) is decades old and substantially inadequate as a basis for licensing foreign banks in Somalia. The law does not outline the difference between a branch and subsidiary which, in banking terms, have materially different risks and oversight outcomes; it does not set out legal accountability and risk transfer ownership, including funds repatriation risks (eg. if the foreign bank were to transfer Somali funds to home country), nor set out the ability of the CBS to act as a regulator with defined regulatory powers; it does not  include the insolvency procedures to follow if the foreign bank were to fail and the funds belonging to Somalis were to become encumbered or lost; it does not outline the legal basis for accessing regulatory information or the ability to enforce regulatory submissions on the foreign bank; and there is no legal framework to define what is a regulatory activity and what is not? For instance, permitted and prohibited services, including engaging in risk booking arrangements; client account trading; ownership of non-bank entities; or investment banking activities. All of these are areas critical for bank regulation.    

More broadly, Somalia does not have any regulatory equivalence agreements with foreign countries. If Somalia were to grant a licence to a foreign bank, it is almost certain these foreign countries will not allow Somali banks to operate in their jurisdictions on the same regulatory terms. As the legislative and regulatory frameworks between both countries will be different, Somalia will be supervising the foreign bank on existing weak framework as local firms, while Somali firms will face much more rigorous regulatory barrier in the foreign country. The absence of a reciprocal regulatory approach, giving Somali banks the same opportunity to operate in the foreign country, will be a bad outcome for Somalia Plc.   

The home-host supervisory cooperation and associated legal and regulatory framework, that would outline the legal basis for CBS to secure accurate information from the bank’s foreign regulator, does not currently exist under Somali law. Without this legal framework, it would be impossible for the CBS to mitigate the risks these foreign banks pose to Somalia’s financial system. The current licensing process does not also include the option of applying constraints (licensing with conditions) on the number of customers, business activities, jurisdiction of risk takers, etc. In other words, the CBS does not have regulatory brakes to apply if things go wrong.

CBS’s regulatory oversight

There are two issues to consider here: the potential impact a foreign bank’s operation has on Somalia’s financial system; and issues of operational resilience, including foreign bank’s governance, risk management and control.

First, the CBS does not currently have regulatory requirements to assess bank business model viability in order to mitigate impact on Somalia’s financial system. There are no regulatory disclosures for capital and liquidity (the FiL defines equity capital, rather than regulatory capital - a true reflection of the risks a bank runs). The CBS does not assess the ratios of the banks’ risk weighted assets to their equities or overall loss-absorbing capacity; no regulatory assessment whether banks in Somalia run diversified balance sheets by currency, tenor and counterparty – the sort of information needed for robust regulatory assessment of business risks. Without clear regulatory framework, a foreign bank is unlikely to provide this level of information or comply with credible disclosure standards.   

Risk management is another. There are no regulatory requirements that set out the expectations of the composition and location of foreign bank’s management and Board of the Somalia entity. What is the requirement for having Somali executives on the Board or senior management to be based in Somalia? Who would be accountable for ensuring obligations for Somali law are effectively discharged? Would there be separate authorisation for the Board, the key risk takers and risk managers? What are the definitions in relation to the “fit and proper” requirement to be managing the bank’s operation in Somalia? What would be the approach for taxing the bank’s profits; what would be the requirements for ring-fencing capital and liquidity? The list of risks and questions are almost endless indeed.  

Finally, the question on whether or not to grant a licence to a foreign has nothing to do with competition or indeed positive signalling. In essence, the real questions are  (1) does Somalia have the right laws and regulations to regulate foreign banks effectively?; (2) does the CBS have the regulatory and legal tools to deal with a foreign bank that becomes a significant source of risk for Somalia or engages in business that is damaging to Somalia?; (3) does Somalia have the legal and regulatory safeguards to ensure Somali funds will be safe in these foreign banks; and (4) what’s in for Somalia – would Somali banks and businesses  have the same level of access to this foreign country under comparable regulatory requirements?  

This is why Somalia is not ready to welcome foreign banks, yet.

Abdi Ali