Somalia’s Banking System and Risks involved in the Banking sector

The first part of this article will begin by considering the current banking system in Somalia. The second part of the article will consider the risks involved in the banking system for a developing country such as Somalia and will also consider possible risk management.

According to the CIA website 1 , Somalia has a gross domestic product (GDP) of $5.896 billion and is considered by the World Bank as a low income country. 2 Somalia has been in a political turmoil since 1991, when the President, Siad Barre, was ousted and civil war broke out in the country. 3 It was not until August 2012 that a new internationally recognised government was formed and the country has moved towards stabilisation. 4 Since the formation of the current government not only has radical militants groups, such as Al Shabab, been weakened, but many diaspora Somalis have returned back to the country. This article will examine the current banking system in place in Somalia.

Development of Islamic Banking in Somalia
During the civil war in Somalia, there were no functioning banks in the country as there was no fiscal legislation. Prior to the current system, there were a number of money transfer companies, hawalas, that existed to allow diasporas to transfers money to their families. However, the Central Bank of Somalia was re-opened by the Transitional Government on 23 November 2009. 5 The Central Bank namely has two primary objectives. This namely includes; that the Central Bank achieves and maintains domestic price stability as well as fosters and maintains a stable and competitive market-based financial system. 6 There are currently two legislations in place within the legal system of Somalia that relates to the financial sector, namely The Central Bank of Somalia Act Law and The Financial Institutional Law 2011.

In accordance to the financial legislation, no banks or hawalas can operate without initially obtaining a license from the Central Bank. There are currently nine licensed Hawalas and six banks licensed to perform banking activities. 7

The Central Bank acts as a regulator as well as a supervisor for the financial system in Somalia. New Financial Institution opened such as International Bank of Somalia opened in October 2014. 8 It is therefore very difficult to assess the success of the banking industry because of the short period of time that the banking industry has developed. However, it is also notable that in a short period of time, since the opening of the first bank in October 2014, There are six banks including those evolved from hawala (Money Transfers units) and new banks that have been set up as commercial banks, which all were granted license by the Central Bank of Somalia.

Risks and risks management in the banking field

There are many risks that a bank may be involved in that can affect the successfully operation of a bank. This includes, amongst other things; legal risks, credit risks and operational risks.

Legal Risks
The definition of legal risk has proved to be difficult. Legal risks generally involve exposures to legal uncertainty that results to fines, penalties or punitive damages. Islamic banks face greater legal risks than conventional banks due to the premature nature of Islamic banking and the development of commercial law.

In respect of legal risks for emerging countries, the banks are exposed to even higher legal risks because of the lack of sufficiently efficient legal system. This is particular true for Somalia. This is because of the years of conflict that has made access to justice and rule of law limited and for a considerable long time only informal structures of clan or customary laws were in place. 9

Management of Legal Risks
One means of ensuring that legal risks are managed effectively is to have in place a sound legal system to provide protection for banks. Furthermore, for Islamic banks there also needs to be in place laws that recognise and protects both the banks and the banking customers. This is because the relationship between the banks and the banking customers is more geared to achieving financial development to the nature of their relationship. In this transitional period of change for Somalia, more financial laws should be enacted to attract more investors into the country and to ensure the success of the development of the Islamic banks.

Credit Risks
One of the greatest financial risks in the banking industry relates to the credit risk as this has been the main reason for major banks’ reason for failure. Credit risk refers to the variability of servicing loans that arises from the inability of a borrower to meet the contracted obligation. Islamic Banks arguably face a greater risk in respect of credit risks. This is because Islamic banks utilise the profit and loss system and this poses a greater risk.

This is because, as identified by Salem 10 in the profit and loss system credit risk is interlinked with market risk that makes it more severe for Islamic banks. This means that the ability of the borrower to repay the funds will depend on the market. This is particular importance for a developing country where the market will not be very developed.

Management for credit risks
Credit risks arise generally due to the lack of funds from the borrower. The Basel Accord (Basel I) was introduced in July 1988, by the Basel Committee on Banking Supervision (BCBS) for the purpose of applying minimum capital standards to the banking industries in order to protect against credit risks.

Thereafter Basel II was introduced in June 2004 to ensure that capital requirements reflect more accurately the risks faced by the banking industries. The rationale behind Basel II was to ensure stronger risk management practices for banks to adapt a more risk sensitive capital requirements. Furthermore, Basel II was also more flexible than its predecessor, in that it promoted a more forward-looking approach to capital supervision. However, the financial crisis of 2007-2009 identified a number of weaknesses in Basel II and Basel III was introduced in December 2010 to addresses these weaknesses. The aim of Basel III was to reduce the probability and severity of future financial crisis. In terms of implementation of Basel III, the BCBS recommended that Basel III be implemented in phases from 1 January 2013, with the aim of full implementation of the key reforms by 1 January 2019.

Although Somalia has implemented the Basel Accords within its legal framework, the effectiveness of the Basel Accords for emerging countries is debatable on the basis that the Basel Accords were established with emerging countries in mind.

Operational Risks
Operational risk is defined under as risk of loss resulting from inadequate or failed internal processes, people, systems or from external events. 11 Therefore there are many situations in which operational risks may arise. Islamic banking faces more operational risks because of the specific contractual natures of the mode of finance and also because of the asset based nature of the contractual relationship between the bank and its customers. As an emerging country, Somalia faces even greater operational risk because of the lack of education and infrastructure in the country. This was noted from the interview of the CEO of The International Bank of Somalia. There is more need to train employees and also the fact that the country has survived without a banking system for over twenty-five years, it will be more difficult to attract customers.

Management for operational risks
In order to manage operational risks efficiently it is advisable for the banks to have systems in place that will protect shareholders and depositors. There is also a need for the bank to act in a fiduciary duty to its customers. One major concern in Somalia is the issue of corruption which needs laws to be implemented to ensure fair, and transparent dealings across the spectrum of financial markets and companies to have proper disclosures. Recently Anti-Corruption Act is brought to Somali parliament waiting to be passed.

In conclusion, it appears on the face of it, that in respect of the banking industry, the Somali government is moving towards the right direction. This is because there has been legislations put in place within the financial sector.

However, one of the main difficulties in assessing the current success rate of the banking system is based on the short period of time that the banking system has been in place.

There have also been very few studies on the current development of the Banking system. It is also advisable for there to be more transparency within the system and the Central Bank of Somalia should ensure that there is constant vigilance to ensure the smooth running of the financial system and to improve the economy of the country.

1. Central Intelligence Agency, ‘The World Fact Book – Somalia’,
publications/the-world-factbook/geos/so.html accessed on 27 May 2015, This figure is an estimate
in 2011

2. The World Bank, ‘Country and Lending Groups’,
groups Accessed 28 May 2015

3. For a full history of the political situation of Somalia please see, ‘Somalia Profile – Timeline’, accessed on 27 May 2015

4. Home Office, ‘Country Information and Guidance, Somalia: Security and humanitarian situation
in South and Central Somalia’ December 2014.

5. African Development Bank Group, ‘AfDB approves a $2m grant for Somalia’,
en/news-and-events/article/afdb-approves-a-2m-grant-for-Somalia-5415/, accessed on 20 June 2015

6. Part 4 (1) of the Central Bank of Somalia Act Law No. 130 of 22

7. This is as at 13 November 2015

8. African Union Mission in Somalia,‘ Somali Banking Goes International’ (2014) http://amisom-au.
org/2014/12/somali-banking-goes-international/ accessed on 20 June 2015

9. UKFCO, ‘Human Rights and Democracy Report 2013 - Section XI: Human Rights in Countries
of Concern – Somalia’ (2014),, accessed on
5 July 2015

10. Salem R. A., ‘Risk Management for Islamic Banks’, (Edinburgh University Press, 2013), 37

11. 65 Archer S. & Karim R. A. A., ‘Profit-sharing investment accounts in Islamic banks: Regulatory
problems and possible solutions’, Journal of Banking Regulation (2009) 10,

Maryam Sufi

Post a Comment

Previous Post Next Post