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Somalia’s Central Bank still has more tools to restore banking sector’s credibility

Does Somalia’s Central Bank still have enough ammunition needed to improve the visibility and credibility of the country’s commercial banks? Yes it does.

George Bodo

In the last issue, I opined about the apex bank encouraging more foreign banks that are currently on queue to establish presence on the ground so as to gain control of currently licensed banks instead of seeking new licenses. And as I pointed out, foreign players have the potential of bringing in global best practices and in the process help elevate the profile and credibility of the sector. But what if that doesn’t happen? What other options are on the table?.

Well, another option involves being creative about regulation. The good thing is that central bankers are increasingly being encouraged to do so in the face of increasing dynamism among licensees. Here are other three concepts that the regulator can implement: The first idea is about the Central Bank being able to withdraw current universal banking licenses it has issued and pegging re-issuances on banks meeting certain pre-set compliance requirements. The affected bank(s) will then be issued with a regional license which will have two key limitations: First, allowing for business only within a certain geographical zone – in this case Mogadishu (or any other major urban centre); and second, apart from the geographical limitation, the regulator can also cap the extent of their creation of risk – adjusted assets by way of elevating the minimum ratio of risk-adjusted assets to total capital by anything between 100 to 200 basis points.

This will limit their intermediation capabilities thereby weakening their core business. Think about it, out of the current six banks operating in the country (as of now), only one has no hawala history. And as I pointed out before, banks with hawala history came into being by simply regularizing their hawala licenses into banks – in which case I can say, with high degree of certainty, they could have skipped a number key pre-licensing compliance requirements.

These regional licenses will, of course, be too limiting for some of the ambitious banks and will force them into complying with regulatory requirements as far as compliance is concerned. Additionally, it will paint the Central Bank as having strong teeth, and is able to bite as and when required. Remember too, it is this perceived lack of teeth by the regulator that has exacerbated credibility issues for the entire banking system.

The Central Bank should consider doubling its core capital regime to encouratge only stronger banks to remain in business. Doubling it will also encourage licensed banks to seek external partnerships especially foreign banks.

The second idea is on core capital regime. At the current level of USD5 million, it looks a bit on the lower side and even so, it is reported that not all banks are in compliance. The Central Bank should consider doubling its core capital regime to encourage only stronger banks to remain in business. Doubling it will also encourage licensed banks to seek external partnerships- especially foreign banks.

My third idea is around Somalia’s Central Bank regaining its lender of last resort function. This is one of the most powerful functions of any Central Bank in the world – the ability to control money creation in the economy. However, Somalia’s central bank can only achieve this by finding mechanisms of gradually reintroducing the local currency into the market. The lender of last resort function will give the apex bank tools to conduct such things as Open Market Operations and hence withdraw or inject liquidity depending on its monetary policy objective at any given time. It also gives the apex bank tools to sanctions banks which are Does Somalia’s Central Bank still have enough ammunition needed to improve the visibility and credibility of the country’s commercial banks? Yes it does. Banking in non-compliance with its prudential rules.

With time, and if the reintroduction of local currency gains traction, the Central Bank can then think of broadening its monetary policy framework. Lastly, there is need for a risk-based supervision approach to regulation. There’s no doubt that banks take different risks-either in quantity or nature. On top of credit risks, banks are often predisposed to market, liquidity as well as operational risks. And even if you further dissect credit risks, you find there are certain segments of the economy that are much riskier than others. For instance, exposure to unsecured consumer market is riskier than opening a fully cash-covered letters of credit (for purposes of importing a commodity into the country).

Another example will be exposure to the commercial real estate market versus exposure to the rental market, each exposure has its unique own risks. All these segmental considerations should go into risk computations. Therefore, beyond asking banks to keep a certain amount of minimum capital, monitoring of capital levels as well as gaps should be based on the amount of risks a bank is holding in its balance sheet.

It is uncommon to find banks holding similar amounts and nature of risks. Therefore, to a large extent, banks should be asked to provide a capital planning in view of risks they are holding, as well as the expected risk, curve and other corporate actions that will likely result into appropriation of capital, such as payment of dividends and impairment adjustments to risk assets.

For instance, Kenya is in the process of implementing an Internal Capital Adequacy Assessment Process (ICAAP) for banks, which will basically gives banks the leeway to plan for their own capital adequacy under the supervision of the Central Bank of Kenya (CBK).

The CBK has already issued draft guidelines to banks on how to develop a sound internal ICAAP model; and banks will be assessed on the strength of their ICAAP framework. ICAAP is in use globally especially by some of the leading banking sector regulators, most notably the US Federal Reserve (Fed) and the Bank of England. By definition, it is a process to ensure that the management body of a commercial bank (both supervisory and board) achieve three core tasks: (i) identifies, quantifies and monitors an institutions’s risks in the course of business; (ii) ensures that an institution holds adequate capital in relation to its risk-profile; and (iii) makes use of sound risk management tools and develops them further. ICAAP itself sits within an institution’s internal governance framework.

However, I need to say that some of these ideas will require legislation and Somalia’s Central Bank has to kick-off the process as soon as possible in order to regain full grasp of the market.

For instance, the regulator will have to put forward proposals, to the country’s next legislators, for adjustments in core capital regime for passage as well as a consideration for re-designating the local currency as legal tender (which in itself has profound political impacts).

The apex bank will also need to expand its license issuance scope to include two grades of licenses (by probably seeking an amendement to the legislative act on which it was established). Such proposals sound difficult, and require significant political goodwill, but are actually achievable in the both the short and medium term-in my view.

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