Competition from foreign banks will restore Somalia’s banking sector sanity

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By George Bodo

Somalia needs foreign banks-especially from its key allies and neighbours such as UK, Kenya, Turkey and Ethiopia to bring in global best practices and in the process help elevate the profile and credibility of the sector

A couple of weeks ago, I coincidentally got caught up in origination of nostro relationships between a Somali bank and two South African counterparts non-concurrently. I didn’t follow all the discussions up to the end but from my inquiries later on, it seemed as if nothing crystallized. On further inquiry, the sticky points weren’t much to do with existing sanctions – which appear not to target normal financial services – and neither were they to do with any money laundering red-alert concerns-as Somalia is currently not on the Financial Action Task Force’s list of jurisdictions that have strategic Anti Money Laundering deficiencies.

Rather, from my assessment, the issues gravitated around the fact that the Somali Central Bank (SCB), the regulatory judicature for commercial banks, was viewed as largely incapable of elevating its anti-money laundering oversight capabilities. This concern is likely to continue being an obstacle in originating new correspondence banking relationships between Somali banks and their foreign partners-especially those whose countries do not have any bilateral relationship with Somalia.

Since the economy is dollarized, I’m talking of such currencies as the Rand and Euro. But make no mistake, Somalia’s banking sector remains a beehive of activities; and the market potential is huge. Two Kenyan banks-KCB and Commercial Bank of Africa-have expressed an intention to enter the market. At the same time, there are reportedly a number of Gulf banks also seeking licenses to operate in the country. In total, 12 commercial banks have supposedly applied for a banking licence. Of course this points to the huge market potential.

So what could have attracted these twelve banks to Somalia? The answer is three-pronged. First is access to zero-cost US dollar customer liabilities. Somalia still remains a dollarized economy. Back-of-the-envelope calculations suggest that 99% of payments, from retail to wholesale, are done in US dollars. Therefore the strong dollar deposit franchise in Somalia remains a huge attraction to foreign-domiciled banks-especially Kenyan based, who often struggle to raise US dollars at the right cost.

This is realizable in two ways: Establishing physical branch presence in the country-especially in the commercial hub of Mogadishu; and developing a value proposition in the processing of in-bound payments. In the diaspora remittances space, the pie looks quite big. Somalia is estimated to receive approximately $1.4 billion annually through remittances, especially from Europe and the Americas.  Beyond diaspora remittances, the humanitarian community (especially UN agencies), the African Union mission in Somalia as well as some of the multinationals that have set-up base in the country all need some form of in-bound payment services.

Secondly, off-balance sheet opportunities remain abound. Somalia is an acutely import-dependent economy and due to the dollarization element, it makes it cheaper to import rather than manufacture locally. Consequently, documentary credits remain a huge attraction especially for banks with strong trade and commodity financing capabilities. Just to give you some perspective, in 2015, official statistics from Trademap show that Somalia’s imports stood at $2 billion, although this was a 22% year-on-year decline from the $2.57 billion recorded in 2014. If you anecdotally adjust to include unofficial inflows, the figure could be much higher than that. Food items accounted for 57% of total imports. One of the biggest single import commodities in this category is sugar-whose import value stood at USD180 million in 2015. Effectively, issuance of guarantees and letters of credit for the importation of such vital commodities to the economy is a lucrative business. Externalizing trade and commodity financing capabilities into Somalia to capture such flows is attractive to any commercial bank. Finally, there are also on-balance sheet lending opportunities-specifically in niche real estate as well as targeted high-net worth individuals (HNIs).

The demand for affluent housing in Mogadishu is rising with housing prices elevated in US dollar terms. Due to the lack of a robust land titling as well as financial dispute resolution mechanisms, a well ring-fenced lending (often mostly through secured pre-sales) to this sector could be one of the only ways out. On the HNI front, cash-covered products will always suffice to the high liquid nature of the target market. However, the market is still not ripe for any mass-market focused lending product due to the lack of credit referencing, robust identification system as well as a water-tight financial dispute resolution mechanism. All in all, the market is still relatively untapped-it just requires a root-to-branch confidence.

But with all these massive growth bumps, it will take a very long time for the international banks, especially names in jurisdictions that do not have bilateral exposure to Somalia or are not immediate neighbours, to build full confidence in the country’s banking sector. However, I don’t think confidence rebuilding will come from the Central Bank putting its house in order. Some banks are already too large to fit into a new regulatory cube. Additionally, some banks came into being by simply regularising their forex bureau licenses (hawallas) into banks, in which case they could have skipped some key pre-licensing compliance requirements.

Instead, I think that Somalia will need foreign banks, especially, from its key allies and neighbours such as UK, Kenya, Turkey and Ethiopia to bring in global best practices and in the process help elevate the profile and credibility of the sector. Already, the Somalia Central Bank has reportedly declared a moratorium on licensing of new commercial banks. In a thinly-veiled statement attributable to the SCB Governor, the apex bank was recently quoted as saying it will only license “reliable” lenders. If indeed this is true, then it is my considered view that the SCB should stretch this moratorium period by up to a minimum of five years and utilize this period to encourage some of the top foreign banks whose applications, especially, the two Kenyan banks currently in queue-to acquire some of the dominant local names.

By allowing this, the SCB will achieve three goals: One, being able to bring under control the too-big-to-fix names by unwrapping the personality-cult plastered around these institutions, thereby restoring some levels of corporate governance in the process. Secondly, utilizing this moratorium period to recapacitize its oversight capabilities especially the supervision functions and three, taking advantage of de-elevated vested interests to draft and promulgate the requisite key banking sector regulations. I see three ways of achieving this. It could start with capping individual ownership of commercial banks at a single-digit figure. Secondly, capping ownership of commercial banks by legal entities at not more than a quarter of issued and fully paid capital-and beneficial ownership of such legal entities fully disclosed; and lastly, significantly elevating minimum paid up capital requirement for existing licensees with a compliance period of between 12-18 months to the extent that they have to resort to selling majority stakes in order to comply.

In signing off, I just don’t think that allowing foreign banks to set-up shop in Somalia through Greenfield operations will help the SCB achieve its goal of wresting back oversight of the market from the gnashing teeth of vested interests. SCB’s continued lack of total grip of market oversight will continue to dent market’s credibility as well as fail to spur confidence in the sector. The ultimate losers will be the seemingly compliant-initiative banks in their quest to establish correspondent relationships outside of the country as they strive to offer a bouquet of trade payment solutions to their clients.

The author of this article is banking sector analyst, tracks banking sector policy matters, balance ‎growth dynamics as well as risk pricings. He can be Tweeted @GeorgeBodo