Somalia – Monetary Reform Agenda CONTENTS

Somalia – Monetary Reform Agenda

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RESTORING CREDIBIL ITY

—A MONETARY REFORM AGEN DA—

S O M A L I A ’ S M O N E T A R Y A N D F I N A N C I A L

P O L I C Y C H A L L E N G E S

Aues Scek, PhD

Fiscal and Financial Management

` Development Consultant

[email protected]

mailto:[email protected]


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CONTENTS

1 Background ..................................................................................................................................... 4

1.1 Critical Issue .............................................................................................................................................. 4

2 Monetary Policy Options for Somalia ............................................................................................. 6

3 Learning from similar experiences .................................................................................................. 8

3.1 Somalia a Fractured Country................................................................................................................. 8

4 Central Bank: Reviving Financial system ...................................................................................... 11

4.1 Revitalizing the CBS ............................................................................................................................... 12

4.2 Establishing Prudential Regulations........................................................................................................ 13

5 Monetary Policy and Currency Reforms ...................................................................................... 14

5.1 Central Bank of Somalia and a Currency Reform ................................................................................. 15

6 What Next? .................................................................................................................................. 16

6.1 Proposed Temporary Solution................................................................................................................... 17

6.2 Back to Basics .......................................................................................................................................... 17

References .......................................................................................................................................... 20


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1 BACKGROUND

In the wake of the formal recognition by the

International Monetary Fund (IMF) of the

Federal Government of Somalia in April

2013, the Central Bank of Somalia (CBS), in

cooperation with the IMF, initiated technical

work on rebuilding and reforming the CBS

and the monetary and financial framework.

The Federal Government of Somalia has

identified the reform of the national

currency as a high political priority. Higher-

level leadership has been pressing the CBS

for the early issuance of a new national

currency.

The CBS has limited financial and human

resources, an antiquated organization with

few trained and qualified staff to undertake a

comprehensive reform program. This

combination of factors reinforces the need

for thorough and careful planning for any

financial reform. On the other hand,

Somalia has a vibrant and dynamic but

unregulated Hawala system that operates all

over Somalia and connects the country

through the funds-transfer system with the

rest of the world.

Among the problems Somalia faces today,

the restoration of macroeconomic stability

is the key for promoting a return to normal

economic activity. During the two decades

of civil conflict, production, employment,

consumption, and distribution were

profoundly disrupted. Fighting forced people

out of locations in which they ordinarily

earned their livelihoods and destroyed

stocks of productive resources. Farming,

factories, and essential infrastructure such

as roads, bridges and other facilities were

often severely impaired. While attempts for

peace settlement and the fight against the

terrorists are showing progress, to halt

open internal conflicts, the aggregate

uncertainty of today‘s situation in Somalia is

in some ways working against economic

recovery. This is due to the sense of

outstanding risks, which makes it difficult to

foresee how the post-conflict environment

and particularly internal conflicts within the

executive on one side and the executive and

legislative on the other will unfold.

People and businesses are avoiding

committing themselves to investments that

would take time to yield and for which

returns are uncertain. Consequently, due to

uncertainty and insecurity, wealth continues

to be held in precautionary forms in

neighboring countries or in foreign currency

cash. Productive investment has been slow

to materialize. Displaced people both inside

and outside the country are hesitant to

return to their pre-conflict locations and

activities without means for livelihoods and

housing facilities. This state of limbo is

especially problematic because failure to

restore economic conditions may

jeopardize the ability to make attempts for

peace to stick.

1.1 Critical Issue

A critical issue now facing Somalia is the

monetary chaos that grew out of the more

than two decades of civil conflict. In the

absence of a functioning central bank,

warlords and local commercial interests

issued new fake banknotes and injected

those banknotes into the market without

any monetary or socioeconomic

considerations. This had severe negative

economic implications. Uncontrolled high


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rates of monetary growth pushed inflation

rates into high levels. At times, situations

similar to hyperinflation were created with

prices rising at seemingly incomprehensible

rates. The market value of the Somali

shilling nosedived to an exchange rate of

about 40,000 shillings to the USD in 2007 as

inflation ranged at levels of 250–300 percent

per annum.

As a consequence, inflation eroded the

confidence in the Somali shilling and

generated a wide-scale substitution of the

national currency with foreign currencies,

mostly the U.S. dollar ($). Somalis shifted

their savings to the extent possible into

foreign currencies. Given the fact that banks

and other financial institutions stopped

functioning, people were holding foreign

currencies in cash as the only practical store

of value, medium of exchange for

conducting transactions and as unit of

account in denominating values.

Such mortification of the national currency

combined with financial collapse in the

country has made it virtually impossible for

the Government to begin reconstruction

without first undertaking an essential

monetary overhaul. Absent a credible

national currency and a basic formal

payment system, the Government cannot

transfer funds to suppliers or to pay civil

servants. As a result, problems are being

prolonged. Against this background, the

Federal Government of Somalia has given

high priority to restoring a national

monetary policy system. The type of

monetary regime that would be appropriate

for Somalia has yet to be determined.

Discussions with the IMF, the World Bank

and development partners are ongoing to

identify the proper direction. Finally,

developing viable financial institutions that

are today totally missing along with

mechanisms for monetary policy is a matter

of governance that has been a nightmare for

the Government, that need to be tackled.

The Government has been unable to

establish the minimum structure needed to

lead the operations of the CBS. The CBS

leadership needed to determine policy

goals, give direction, define rules and

provide authority for their conduct, has not

been established. This relates integrally to

processes of rebuilding trust and a sense of

shared public responsibility for the CBS, the

Ministry of Finance and related institutions.

This is particularly critical in establishing the

credibility of monetary and fiscal policies. It

is also necessary to attract trust from the

Somali citizens and the development

partners who are interested to be engaged

in the broader issues of the country‘s

reconstruction and development.

Structure of this paper: Section 2, examines

possible options that Somalia could

undertake in the coming years with respect

to monetary policy reforms. Section 3,

lessons and experiences from some post-

conflict countries are reviewed to learn

what worked or did not work. Section 4

explores various ways of rebuilding and

reviving the CBS. Section 5 describes, in

some details, the complexity and challenges

of executing monetary policy and currency

reforms. Finally section 6 recommends

some possible ways of addressing the

current impasse of the financial system

crises in Somalia.


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2 MONETARY POLICY OPTIONS FOR SOMALIA

In general, monetary reform in post-conflict

countries, such as Somalia, is not

substantially different to that of other

countries that have undergone long periods

of very high inflation. In both cases, one

would say that inflation has considerably

eroded the real value of the domestic

currency, so that a sack full of currency

would be required to purchase a 50 kg bag

of maize. Prices of basic commodities,

particularly staple foods, have skyrocketed

in Somalia, signifying crippling inflation,

mainly linked to an influx of ever more

counterfeit banknotes, printed in the

country or being imported. These and other

factors causing prices of commodities to

rise included:

General insecurity and instability;

Dependence on imports of basic food;

Huge injection into the market of

counterfeit currency in 2007 by crook

business people; and

Rampant piracy along the Somali coast, even though subsiding in recent

times.

These key factors generated spiraling

inflation of unparalleled precedence in the

last few months of 2007. Worldwide, the

dollar has largely been falling against other

currencies, but not the Somali shilling and

the earlier Zimbabwean Dollar. The US

dollar has been gaining strength, as the

exchange rate to shilling went up to within

the range about 33,000 to 39,000 shillings to

the dollar by the end of April 2008. In 2009,

the situation started to stabilize as the

printing spree subsided and the shilling

exchange rate to the dollar remained in the

range of 33,000 to 35,000 to the dollar.

The Transitional Federal Government

(TFG) initiated the process of printing new

currency in 2010 as consultations between

the Government and the World Bank took

place. The World Bank‘s suggestion was to

put on hold printing of any currency at the

time given (a) the fluid security situation; (b)

the lack of ability of the Somali authorities

to manage and formulate monetary policy,

particularly, in view of a dysfunctional

central bank and a weak Ministry of Finance.

The situation has not changed much since

then; the structures and functions of the

financial institutions continue to be weak.

This continues to persist as in the past two

decades as more individual Somalis and the

business community have adopted practices

and coping strategies aimed at minimizing

the real effects of the eroded use and value

of the national currency. These include

continuous price adjustments as well as a

growing use of foreign currencies as a store

of value, unit of account, and medium of

exchange.

The issue at stake right now is how to bring

the financial system under favorable control

so the banking system can start operating

and provide needed financial services.

Consideration should be given to rebuild

the CBS with needed skills, capacity to

operate, guide and supervise financial

institutions. This would imply strengthening

the mandate of the CBS by redefining and

enhancing its autonomy and also

accountability vis-à-vis the Federal

Government. It is of special importance to

stipulate that the CBS‘s primary long-term


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objective should be to restore and maintain

domestic price stability. This would, among

many other things, require commitment

within the Government towards sound

public finances.

The second major area that needs to be

considered is what should constitute the

national currency in the future. One

alternative would be the unilateral adoption

of a foreign currency to fully replace the

Somali shilling. Such a decision would per

definition eliminate uncertainty about the

value of the shilling. The cost of changing

funds into adopted new currency would

disappear. Currently, this is the system that

is de facto largely operating as most of

business transactions are undertaken using

U.S. dollars. The dollar is also used as unit

of account and store of value. The Somali

shilling is merely used for small-value cash

transactions and as a fractional currency to

one-dollar banknotes. Continuation of this

ad hoc system would seem to be the most

practical and cost effective option helping to

buy time for the Government to focus on

effectively rebuilding the Central Bank‘s

internal capacity and competence to

undertake eventual necessary monetary

reforms. However, this option impedes the

Government from any deficit financing thus

forcing fiscal discipline.

An alternative design would be to consider

firmly pegging the Somali shilling to one or

more major international currencies, such

as the dollar or euro. This is done through

what‘s called a currency board arrangement.

In this case, the shilling can be exchanged

for the foreign currency at a fixed rate

backed in full by reserves in the foreign

currency held at the CBS. There is

international evidence that a currency board

arrangement, in certain situations, can

establish a strong monetary credibility. This,

in turn, would promote trade and capital

inflows by eliminating exchange rate

fluctuations relative to the anchor currency.

Seigniorage can still be generated through

interest earned on foreign currency assets

held in reserve. Unfortunately, this option is

not readily available for Somalia as the CBS

today does not have any control over the

national currency in circulation.

Furthermore, Somalia does not have any

reserves in foreign exchange that could be

used as the base for currency board

arrangement. Accordingly, this alternative is

not an option at this time.

In deciding on the future currency regime

Somalia is faced with several other

problems. First, governance itself is

fundamentally problematic. Fighting is not

yet over. Even though the Federal

Government controls key areas, the whole

of Somalia is not safe. Different forms of

arrangements have been put in place by the

Government and other stakeholders as a

basis for negotiating the forms and functions

of governance. However, the process of

rebuilding trust and a sense of shared public

responsibility among the contending parties

is clearly a long one. In the meanwhile, the

political, institutional and legal processes

needed to reform monetary framework are

not yet in place.

Somalia as a post-conflict economy has

most of its economic infrastructures in ruin.

Production system, employment,

consumption and distribution are severely

damaged or destroyed during the past two

decades of conflict.

Logistically, the destruction of physical

infrastructure has complicated the process

of initiating key reforms in the monetary

areas. These would prominently include

restoring a fully-functioning central bank and

replacing counterfeit currency with a new

national currency as legal tender. Moreover,

key economic statistics, by-and-large, do not

exist and the number of cadres of trained

professionals needed to undertake

substantial reform initiatives is lacking.


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Reform programs are associated with

compounding economic problems and of

state building. Somalia‘s reforms must not

only consider establishing new mechanisms

to regulate access to resources but also

ensure equitable opportunities for growth

and prosperity. This is difficult to achieve

without having a widely accepted vision of

the future of the national economy.

3 LEARNING FROM SIMILAR EXPERIENCES

In this section, a brief review will be

presented of the experiences of a few post–

conflict countries, which went through

similar situation as Somalia. The objective is

to clarify what worked and what didn‘t so

as to avoid repeating the same mistakes.

There are several countries that

experienced violent conflicts during the

1990s although severity and duration of

conflict varied. Most of these countries had

been in conflict for several years (including

Somalia). Also, in many cases fundamental

issues that were central to the conflict have

not yet been fully addressed, but remain

unresolved. It is well known that violent

conflict influences the behavior of state and

private sector actors, in addition to its

considerable institutional damage.

Therefore, it cannot be ignored as a factor

shaping financial and economic reforms of

any country. In most post-conflict countries,

looting of financial institutions has been

common, for example, in Afghanistan, Iraq

and Rwanda. Sometimes, looting has been

associated with the destruction of physical

infrastructure, as were the cases in East

Timor and Kosovo. The scale of these

effects depends on the nature of the

conflict, whether guerrilla insurrections,

military revolt that could be of temporary

nature (disruption or temporary shutdowns

of the financial institutions) or civil wars that

totally destroy financial institutions such as

the case of Somalia.

3.1 Somalia: a Fractured

Country

Somalia today has a number of states or

regional authorities, among them the

breakaway state of Somaliland. Somaliland

fought its way out of the control of the

central government, but has failed to win

international recognition, remaining in a

state of limbo where the future forms of

relationship with the Federal Government

will need to be resolved. After more than

two decades of internal fighting, Somalia has

experienced a profound fracturing of

authorities, with religious and political

groups and regional warlords holding

powers that would ordinarily be associated

with a nation-state. At this time, the layer of

the Federal Government is just one of the

many elements of this mix.

Reflecting the erosion of central authorities,

Somalia‘s monetary situation is in chaos.

There are several versions of Somali

shillings in circulation, and the vast majority

of those are counterfeit. Most of these

were issued during the 2000s by warlords

(and unscrupulous businessmen?) and some

state authorities. With the abundance of the

fake cash currency in circulation, the value

of the shilling had sunk to the point that the

largest denomination—1,000 shilling; the

only one in circulation—is worth about five

U.S. cents. There was also substantial

substitution into foreign currencies (such as,


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USD, Kenyan shilling and Ethiopian birr),

with supply coming from various sources or

remittance (Hawala) and other unspecified

channels.

The Transitional Federal Government of

Somalia initiated the process of

introduced/printing new currency in 2008

but never made any attempt to put in place

a legal framework to do so. In 2010 the

Government requested assistance from the

Government if Sudan to assist in printing

the currency. The Government of Sudan

agreed to assist and made available needed

financial and technical assistance.

The total estimated cost was be in the

range of US$ 17million for printing the new

currency to produce approximately 80 to

100 US$ million, which would replace

around US$ 60 to 70 million (guess

estimates). The proposed denominations of

the new notes include 1,000, 2,000, 5,000,

10,000, 20,000 and 50,000. These notes

were supposed to be introduced in three phases (all at one but step-wise). The first

three notes (1000, 2000 and 5000) will be

(the one to be) introduced first followed by

10,000 and 20,000 once people accept the

new denominations and in last phase (at

later stage) the 50,000 note will be released.

As the government did have any clear plan

the currency has been printed and now

lying at the Central Bank if Sudan Storage

since then. These seem to be a total waste

of resources as the currency is not going to

be introduced any time as the Government

and the deployment partners are exploring

on how to print and introduce a new

currency.

The CBS and the new Federal Government

elected in 2012 have been considering

various options including the replacement of

the shilling with the USD on a temporary

basis to expedite economic recovery and

reconstruction. This has been done in

consultation with the IMF technical staff and

development partners. Such an option is

attractive in the short run but difficult to

reverse in the long run and severely

restricts Government‘s flexibility for any

deficit financing. The second option

considered was to replace existing Somali

banknotes in combination with a

redenomination of the national currency.

This plan requires further consideration and

can only be realized if substantial support is

available from the key development

partners.

Afghanistan, a country with rather similar

political and security situation as Somalia,

did successfully implement a currency

exchange from October 2002 through

January 2003. Prior to the reform,

Afghanistan had several versions of the

national currency in circulation in addition

to the use of U.S. dollars, Pakistani rupees,

and Iranian rials. Some estimates indicate

that about 60 percent of the national

currency in circulation was not issued by Da

Afghanistan Bank (the central bank of

Afghanistan) but rather by warlords and

others groups.

At one point, the option of replacing the

Afghani (the national currency of

Afghanistan) with the dollar was considered

as a temporary measure to facilitate the

removal of counterfeit currency and

reconstruction. This option leaked to the

Kabul money markets and the value of the

national currency plummeted. People were

worried about whether the Afghani could

be exchanged and if the authorities had

enough resources to cover the exchange.

The Afghan authorities decided to put aside

this plan and opted instead to introduce a

redenominated version of the national

currency with a new series of banknotes to

replace existing banknotes. This succeeded

in restoring a measure of confidence in the

currency, combined with the withdrawal of

the many versions of the Afghani in


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circulation and replacing them by new

banknotes with enhanced security features.

With technical advice provided by IMF staff

and the financial and physical assistance of

the U.S., the Da Afghanistan Bank made all

the necessary efforts to prepare a plan with

all the needed details before implementing

the currency exchange. A comprehensive

logistical framework was developed that

took into account the challenges that one

could expect. These included: poor

infrastructure; the relative lack of security in

many areas of the country and the lack of

solvent commercial banks1, leading to an

extensive use of the Hawala system.

Somalia can learn a lot from this similar

experience; that the introduction of the

new currency requires careful planning and

detailed implementation preparations. Most

important is also to have on board key

partners that can advise and assist through

the entire currency exchange process.

Sudan is another country with a somewhat

similar situation to Somalia‘s that also went

through a comprehensive currency reform

including introduction of a new national

currency in 2007. Sudan‘s currency

exchange was based on the Comprehensive

Peace Accord that was signed in January

2005, and aimed at introducing a unified

national currency for north and south

Sudan. The currency conversion went quite

smoothly, although there were obstacles.

These included: (a) a higher cost of

producing the banknotes compared to the

estimated initial cost; (b) delays in opening

of many currency exchange sites; (c)

security hazards; (d) lengthy procedures

adopted by the World Bank in approving

drawing of funds offered by donors in

support of the currency exchange program;

and (e) other legal and procedural

1 There were 2 commercial banks in operation but

they were and are still insolvent: Bank Milli as well as

Pashtun Bank.

processes that needed to be put in place

through legislative approval.

Despite all these obstacles, the replacement

program went well, as planned activities

were implemented after careful

preparations. Again, the IMF played a key

role as technical advisors in the planning and

preparations of the currency reform. They

did, however, not take part in the

implementation of the currency exchange,

which was entirely handled by the Central

Bank of Sudan and, in South Sudan, by the

Bank of Southern Sudan.

The results gave a driving force to the

Central Bank of Sudan to achieve its main

objective, which was a unified national

currency in which the general public had

confidence. This and other objectives were

achieved through informing and educating

the public about the currency exchange

through alert campaigns in various media.

From this experience, Somalia can learn to

plan, prepare, and consult with all key

stakeholders at each stage of the currency

reform process. The advice and guidance by

international experts in this area is also

critical to maintain control of such a

complex undertaking.

Other Related Experiences: Rwanda‘s

reform aims were to restore economic

activities and to render null and void the 30

billion Rwandan Francs and cash from vaults

stolen by the Hutu militias. A rapid

introduction of the new national currency

rendered the looted cash worthless. This

has worked reasonably well as the

government managed to keep the looters at

bay and also keep inflation under control.

Zaire in 1990s resorted to the printing

presses to finance war and civil unrest. This

led to an eventual breakdown of the

banking system and the central bank‘s

control of the monetary and financial

sectors. Large-scale thefts from banks by


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insiders and elites were further

manifestations of a fundamental breakdown

in governance.

Angola’s currency reform in the late 1990s

was chaotic, poorly planned and executed.

This resulted in more inflation and

deepening economic mismanagement.

Other countries that went through the

currency reform process with some more

positive results included Eritrea and Ethiopia

during their war in 1990–2000. During this

conflict, the two countries managed to run

their economies surprisingly quite well by

retaining the public‘s confidence in their

currencies and their financial systems.

Overall, Somalia can learn from the above

successful experiences that currency reform

is a key element of establishing a conducive

environment in which production,

consumption, employment and investment

can begin to recover. It also helps to build

positive expectations of improved

governance after the period of conflict. The

critical point here is to eliminate monetary

instability as a source of uncertainty by re-

establishing credible monetary system and

reforming policy that can bring inflation

under control.

4 CENTRAL BANK: REVIVING FINANCIAL SYSTEM

A central bank normally facilitates market

exchange by acting as a monopoly supplier

of legal tender banknotes and coins. In

1991, when the Somali state authority

collapsed and with it the CBS, new suppliers

of currency soon emerged. These were

warlords, crooked business people and

some local or state authorities who

colluded with the crooks and warlords and

printed a parallel currency which was

injected into the market alongside the old

legal tender.

In 2011, after more than two decades of

civil conflict, Somalia‘s economy was mostly

devastated. The country was divided into

fiefdoms with confusing systems of justice

with an informal economy operated by

warlords and their militias. Nearly all

national institutions, including the CBS,

businesses and infrastructure were either

severely damaged or completely destroyed.

There were (and still are) several versions

of the same Somali currency in parallel co-

circulation and the vast majority of these

banknotes are counterfeit. As a result, the

Somali shilling experienced spiraling inflation

and lost public confidence. These led prices

of basic commodities, including food items

to skyrocket.

One of the most important tasks at this

time is to rebuild the monetary and financial

foundations to support economic recovery.

This requires, among other things, a strong

commitment by the Government to

maintain fiscal discipline. This will by no

means be an easy task as the reconstruction

of the country and the development needs

are immense. The resurrection of a strong,

independent CBS and a robust financial

sector to channel savings into investment to

stimulate economic recovery had to be

postponed. The CBS greatly lacks the

necessary human and financial resources

and more importantly, an appropriate

governance structure. There were/are a few

stand-alone computers that do not speak


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(networking) to each other. The CBS has

no communication mechanisms either with

any of its own branches (if there were any)

or with its correspondent banks both

regionally and internationally.

Against this background, in September

2012, the newly elected President and the

new Government recognized that an

adequate degree of financial stability was

critical to put in motion a much needed

economic recovery and sustainable

economic growth. In this context, high on

the priority agenda was the implementation

of public financial management reforms,

development of a sound framework for

monetary policy and rebuilding the capacity

of the CBS to perform key central banking

functions.

With recent changes in the CBS‘s

leadership, priority was given to establish

internal and external communication

mechanisms; strengthening cooperation

with the International Financial Institutions

in dealing with the urgent issues related to

building sound financial institutions,

currency reform program; conversion

program and implementing the introduction

of the new currency. These required the

CBS to take the necessary steps to initiate

reforms in order to lay the foundation for a

sounder and more efficient financial system.

These include the strengthening of banking

regulations and prudential supervision,

which are keystones to a sounder and more

resilient banking sector. Other financial

reforms planned, or under way, include

strengthening the CBS by increasing

resources for the Banking Supervision

Department, setting up a Credit

Information Bureau, improving the

Accounting and Auditing Departments, as

well as strengthening the legal and

regulatory framework for microfinance.

This has been put aside due the lack of

governance structure at the CBS. Although

the CBS Act requires it, there is no Board

of Directors to determine central bank

policy or to oversee central banking

operations. The resignation or the removals

of CBS governors and related factors have

contributed to delay or postponed any

reform programs.

4.1 Revitalizing the CBS

Efficient clearing of domestic and foreign

payments, the use of deposit accounts by

households and enterprises, and the

provision of loans for private investment are

all essential for the resumption of normal

economic activities. The business of the

financial sector in Somalia has also a poverty

impact dimension. Substantial remittances

from the Somali diaspora are the lifeline to

the survival of a large number of households

in Somalia who will benefit from a stable

payment system. Better channeled the

contributions from these remittances

cannot be underestimated.

As of early February 2014, there were no

commercial private or public banks

operating in Somalia. There are, however,

several Hawala entities filling this gap. They

offer not only transfer of funds, but many

also accept deposits and often provide

some loan facilities to their clients. All this is

done informally as they are not formally

licensed. This was due to the fact that the

CBS neither has the capacity to license

banks nor the capacity to supervise financial

institutions in the country.

Experience from other countries with

similar situations as Somalia, points to the

fact that there is no one-size-fits-all; there

are peculiarities in each country that needs

to be taken into account. Every country has

its own peculiar situation and needs specific

issues to be addressed within its own

context. For example, Rwanda‘s central

bank re- opened within a year after the


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genocide and had to immediately address

the fact many commercial banks that were

plundered during the genocide. In Liberia,

the Central Bank of Liberia replaced the

pre-war dilapidated central bank in 1999

under an IMF Staff-Monitoring Program. The

operations of the central bank were shut

down during the intensification of the war in

2002–03. In some other countries, such

Angola, Ethiopia and Eritrea, the central

banks continued to function, but with

varying degrees of effectiveness during

periods of considerable internal conflict.

The CBS remained closed longer than any

central banks in conflict countries. It was

closed after the looting in 1991 and

remained closed till the mid-2005 when

several attempts were made to reopen but

most of the time failed. As a result, the CBS

was operating only as the fiscal and financial

agent to the Government for several years.

In 2012, the CBS was reestablished under

the new CBS Act of April 2011. Since then,

the CBS has been operating but not fully as

most of the functions defined in the CBS

Act could not be implemented due to lack

of resources, organizational governance

structure, technical and financial capacity.

From January 2013 to early February 2014,

there have been four CBS governors, no

appointed Board of Directors, and most

importantly, no governance system to

operate the central bank in a transparent

and accountable manner.

Whatever route Somalia chooses to bolster

the CBS and the Somali banking system in

general, it would require to be carefully

sequenced with appropriate reform in other

fiscal and financial sectors as well as the legal

system. This is to say that Somalia will have

to implement large measures of financial

reform to ensure economic recovery.

Most of these reforms could be similar to

those of non-conflict countries, but the

tasks are tougher, the resources (both

financial and human) are scarcer combined

with severe political constraints. Not to

forget the task of prudential regulations and

supervision are much more challenging than

in most other places. Since there is very

little in place, almost everything will have to

be developed anew from scratch.

4.2 Establishing Prudential

Regulations

Today, Somalia is prone to perverse

sequencing problems, in part because most

of the informal funds transfer institutions

known as Hawala entities can easily convert

to banking institutions by obtaining license

as a bank. They can open for business and

maneuver faster than the authorities can

build regulatory capacity. The existing

informal financial sector has already much

greater resources and capacity than do the

public regulatory authorities. Moreover, the

state faces many urgent needs to fund,

including poverty, which compete with the

need to re-establish and strengthen the

CBS.

The financial informal sector can use its

greater resources to bid skills away from

the CBS. These point to the need for

considerable technical assistance that should

be provided by the IMF, other international

financial institutions, and central banks of

donor countries to support reform

initiatives. If this happens and on time, then

it would take an estimated time of 5–10

years of substantial training before the skills

needed would be near the capacity found in

the neighboring countries. This time lag

before full effectiveness is achieved can be

very long for Somalia. But this is not to say

that progress cannot be achieved.

Regulatory self-control is a major problem

in today‘s Somalia; the governor and deputy


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governor have not been appointed, and no

CBS Board of Directors exists. This gap can

be used by unscrupulous people operating

in money laundering and other criminal

activities with the CBS exercising non-

existent supervision.

In other countries with similar situations to

Somalia‘s, it has been observed that bank

licensing was one of the major factors that

hindered international efforts to combat

money laundering and the global financial

flows associated with conflict, in addition to

the adverse effects on the country‘s own

financial stability. These symptoms are now

observed in Somalia where attempts to

obtain licenses by many business people or

Hawala entities that are operating illegally

and trying to formalize their activities

through licensing.

The CBS currently displays several

weaknesses in the supervisory area. One is

that the CBS Act does not provide clear

prudential regulations. In addition, there is a

profound lack of needed supervisory skills

among CBS staff. All this has created serious

problems for the major Hawala entities to

implement anti-money laundering and

counter terrorisms financing. Some of the

accounts of Hawala operators in several

western countries have been closed due to

unsatisfactory implementation procedures

on anti-money laundering and the

combatting of financing of terrorism. This is

threatening what little that has been

achieved in macro-economic stability in

Somalia in recent times.

5 MONETARY POLICY AND CURRENCY REFORMS

Restoring the CBS has been the highest

priority within the institutional capacity

building program for the Somali

Government. This has not only been from

domestic political pressure to create an

independent central bank but also impetus

from international community to establish a

transparent financial and banking system in

the country. This has been seen as part and

parcel of the overall reform of public

financial management. In the wake of trying

to re-establish the formal banking system in

Somalia under the prevailing difficult

conditions where the starting point would

be strengthening and restructuring the

existing CBS. In addition to reestablishing a

proper governance structure of the CBS,

consideration has been given to plan, design,

and produce and issue a new national

currency to replace the existing old and

counterfeit currencies in circulation.

The FGS has to aim at facilitating economic

stabilization, promoting recovery, and

underpinning sustainable economic growth.

To achieve this, it needs to establish an

adequate degree of financial stability as early

as possible.

From the political point of view, the

authorities view the new currency as an

important ―symbol of national

sovereignty and unity” of Somalia. While

the authorities also recognize the risks

posed by counterfeits to financial stability,

they believe these risks would be diminished

by introducing new security features in the

new currency. In addition, the authorities

intend to use internationally reputable

company that has been printing currencies


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for several years for many countries to print

the new Somali currency after a transparent

process of international competitive bidding.

As of February 2014, the national currency

in circulation currently consisted of one

banknote denomination—1,000 Somali

shilling—worth about 5 US cents. This is highly inefficient as a means of payment. The

value of the 1,000 shilling banknote may be

too high for some transactions that poor

people would like to make, but more

importantly, its value is far too small for

most economic transactions. As a result, a

great deal of time is wasted counting vast

numbers of banknotes. In addition, the

storage and transportation of the local

currency is very inefficient and expensive.

All of the current 1,000 shilling banknotes

are similar in design to the notes produced

by the pre-civil war Somalia and have been

produced to benefit various crooked

businessmen and warlords. All of the

banknotes have a formal printed date of

either 1990 or 1996, but most have been

printed more recently. The better quality

banknotes were printed abroad, but some

banknotes now circulating are simply fuzzy

photocopies. Size wise, the banknotes are

very bulky, partly because the size of the

note is too large for a denomination of such

a little value. It takes about 900 notes

weighing about 1.5 kilograms to make a

payment worth $20.

5.1 Central Bank of Somalia and a

Currency Reform

Somalia is at a crossroads of moving from a

transition of insecurity to stability, economic

recovery and long-term economic

development. As such, the objective of the

CBS is to promote monetary and financial

stability and foster sound and dynamic

financial system so as to achieve sustained

and equitable economic growth and

prosperity of Somalia. The responsibilities of

the CBS include:

Issuance of a national currency;

Maintenance of external reserves to

safeguard the international value of

the Somali currency;

Promotion and maintenance of monetary stability and sound and

efficient financial system;

Acting as a banker and financial

advisor to the government; and

Supervising and regulating banks and

other financial institutions.

Currently, Somalia with its fractured

political and economic situation, is operating

with more than one currency (legal tender,

counterfeit currency, and several

international currencies). This is not an

optimal system to facilitate business

transactions and payment system. It

requires Somalia to have a national currency

that could facilitate financial intermediation

and the operations of the payment system.

Introducing a new national currency

requires taking into account many factors

and these include, among others:

Having a strong central bank to guide

and lead the process;

Having clear governance structure;

Consulting with the IMF and other

financial institutions on the

implementation of a new currency;

Choose security features of the new

currency and the selection of reliable

and trustworthy currency printing

firms;

Having available resources required to

print the new currency;

Negotiating and agreeing on the

design, quality and quantity of the new

currency and the costing;

Logistical factors need to be put in

place for the introduction of a new

currency:

o Safe storage at the CBS head

office;


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o Safe storage at the peripheries

(states, regions and districts);

o Transportation and security from

the head office to other locations.

Building trust and confidence with the

community to accept and believe in

the new currency.

Investigation of the actual demand for

money;

Determination of different currency

denominations;

Need for a redenomination of the

currency;

Issues related to the techniques for

invalidating and destruction of

obsolete banknotes; and

Last, but not least, the importance of a

successful public education and

information campaign directed to the

general public as well as the business

communities. In addition, the

CBS/FGS cannot avoid on addressing

the issue of banknotes issued by

Somaliland and other counterfeit

banknotes.

In order to gain acceptance, both from the

citizens, international financial institutions

and development partners, the FSG/CBS

would need to carefully explain the reason

for the introduction of new currency and

the kinds of denomination it proposes to

introduce, for example, new higher

denomination banknotes. It would also be

desirable to explain if the Government is

considering changing the value of the local

currency by making one new shilling equal

to 1,000 existing shillings, plus introducing

other higher denominations to facilitate

different transaction sizes.

However, all these reforms will have to be

deferred until the CBS has been

strengthened. Examples of such measures

include having a CBS Board of Directors in

place; the governor‘s and deputy governors

and the entire CBS governance system

operating efficiently and effectively. During

this transition, efforts should be made to

remove from circulation counterfeit

currencies by totally dollarizing the whole

economy and improving the use of mobile

banking system widely to facilitate the need

of small denominations and changes.

6 WHAT NEXT

Where do we go from here? Given the fact

that the governance structures of the CBS

have not been put in place, focus should be

directed on rebuilding the CBS, followed by

currency reform, the revitalization of

banking system, and the strengthening of

prudential supervision and regulations. As of

now, the CBS remains very weak, is

inadequately staffed, and is under-

resourced. As a consequence, it is not able

to license, regulate and supervise existing

financial institutions, which are mostly

composed of Hawalas and exchange

bureaus. A number of Hawalas lost their

licenses to operate in many western

countries, due to ineffective regulatory

framework in Somalia. Furthermore,

regulatory forbearance of most informal

financial institutions has been undermined

by both the technical weakness of the CBS,

but also the pressures of powerful interests

(including business people, warlords and

high level politicians) that straddled both

regulatory and the financial institutions. The


17 | P a g e

consequences of excessive risk exposure

leading to loss of trust and credibility of the

CBS creating confusion in the financial

sector, mismanagement and corruption and

a general failure to curb emergent bank

crises cannot be underestimated. All these

are expected to contribute to destabilize

economic recovery from the civil war and

the fiscal burden of bank crises that will limit

development thereby threatening post-

conflict recovery itself.

Somalia needs to rebuild and reform the

financial system as it seeks to achieve a

recovery from conflict that is broad–based.

Benefiting the majority of people and those

working in the financial sector in both public

and private need to understand how conflict

affects policy reform as well as the chances

of success and how problems that beset all

financial system can be especially severe in

the coming years. This means that there is

no ad hoc solution to address financial

sector reforms but rather a comprehensive

and broad-based reform approach.

6.1 Proposed Temporary Solution

The high-level political proposal made by

the Government and donors to establish a

Financial Governance Advisory Committee

to address issues related to the

revitalization of the CBS and reforming the

financial sector looks like a delay tactic and

is essentially a dead end. In the first place,

this Advisory Committee the way it is

proposed, practically takes over the roles

and responsibilities of the Board of

Directors of the Central Bank as defined in

the CBS Bank Act. One would then ask why

not establish the Board of Directors to do

what‘s mandated by the Act of the

Parliament in the first place? The answer to

this question should make it clear whether

there is a full commitment of the

Government and the development partners

to really address the fundamental issues

facing the CBS and the financial sector.

The facts, suggest that there is limited

commitment from both sides. In fact, in less

than a year, there were three CBS

governors appointed, fired or forced to

resign. One governor appointed by the

Government with excellent qualifications

and a suitable educational background had

to resign under donor pressure. Another

governor appointed but resigned before

even settling into the office, just with five

days in office. With this kind of dismal

record no truly qualified candidates will

have reason to consider the CBS jobs

seriously.

The solution lies not in establishing

committees and subcommittees but to put

in place at the CBS an appropriate Board of

Directors, proper management with

adequate skills, help them recruit qualified

staff and provide them with the financial and

technical resources to succeed. In summary,

putting in place a clear and appropriate

governance structure to include a strong

Governor at the CBS would be by far the

best and a more lasting solution at this time.

6.2 Back to Basics

The focus of rebuilding the CBS must be

addressed within the framework of a plan

for institutional capacity building and

institutional reforms. This provides a strong

effort to rationalize an environment

necessary for productive and effective

provision of public services. A major gap in

this regard has been the knowledge of

manpower demands and requirement for

the entire CBS. This situation has been

compounded by the significant increases in

the establishment of new departments

which require CBS staff as well as the

enhanced responsibilities of CBS with

regard to the constitutional mandate given

to the institution. To address these gaps,


18 | P a g e

top management and experienced staff must

be recruited and supervised in their

operations by a future Governor and

supported by an independent CBS Board of

Directors, which is not in place and need to

be appointed without any delay. This cannot

and should not be replaced by any

temporary committee of any form.

The CBS has an estimated staff of about 84.

The current staff comprises of mostly

middle level technicians and supporting staff

and all of whom are deployed at the head

office in Mogadishu.

A key strength of the CBS is an expansive

structure and institutional framework that

reflects the central bank broad functions as

defined in the new CBS Act of April 2011.

In addition, there are two or three technical

staff or consultants attached by some

development partners. This is

complemented by elaborate systems,

policies, regulations and legal framework

under the process of being developed with

IMF staff assistance to guide implementation

of reform activities. A well-established

relationship with the international financial

institutions, particularly the IMF, the World

Bank and the African Development Bank, is

essential also for key Government

institutions, as well as other stakeholders in

and outside the country.

It is clear that there is a need to assist the

CBS to acquire adequate staff to enable it to

carry out its mandated functions. In this

respect, the CBS has to undertake at

minimum the following activities to move

forward with its reform program:

Establish the Board of Directors by

appointing competent and well-

respected individuals with high

integrity;

Appoint a governor and his/her and

go in as a team with a minimum of a

four-year mandate and commitment

of noninterference from higher

leadership. The governor‘s contract

should stipulate that he cannot be

removed without due process, unless

there was proven and documented

fraudulent cause or demonstrable

malfeasance before the end of his/her

term, as defined in the CBS Act 2011.

Recruit key management staff to fill

managerial positions;

Put in place an attractive and

competitive compensation package to

help recruit and retain qualified and

experienced personnel.

Undertake a workload analysis to

establish optimal staffing levels for

technical, administrative and

supporting staff while reviewing the

existing CBS structure;

Deal with the current excessive

management turnover currently being

experienced within the CBS as well as

continuing recruitment and

promotions to fill staffing gaps;

Invest in training and development of

current staff in skills (through the IMF

and IFIs) that will enhance their

performance.

Proceed with needed reforms and

develop policies, strategies and

guidelines for the implementations of

all the reform programs.

The process should be led by a competent

Governor and supported by an independent

Board of Directors. Any external

committee established should be under the

direction of the Governor who is the

principal policy maker of the CBS as defined

in the CBS Act.


19 | P a g e

It is not necessary or practical that all

donors participate or become members of

every reform committee or committees to

be established under the leadership of

Board of Directors. Donor representation

should be based on competitive advantages

of what each donor member can offer on

addressing the specific reform initiatives.

For the time being, the priorities to be

addressed include reestablishing and

revitalizing the CBS, monetary policy,

currency reform and restoring trust and

credibility. All these are specialized areas of

the IMF, where they have expertise and

competencies. In this case, donor

representation should be through the IMF.

This will avoid confusion and conflict of

interest among the development partners

and will help CBS build its internal capacity

and competence. Some other areas such

Anti-Money Laundering and Counter

Terrorism Financing (AML/CFT) could be

led by the World Bank and so on. All other

donors should provide needed support

through their representatives without any

restriction.

It is important to note that financial reforms

are not simply pure technocratic processes

but also contain political aspects. Politics

determine the way reforms are accepted,

implemented and their probability of

success. In the case of the CBS, the

authorities cannot delegate their

responsibilities to other institutions (such as

donor institutions) to appoint or directly

select the governor because it is

problematic and would be controversial as

it would be tantamount to abdicating

constitutional authority. Appointing the

governor, deputy governor and the

members of the Board of Directors is the

responsibility of the Government and it

should not be delegated under any

circumstances. The Government (the

President, the Prime Minister, and the

Cabinet) will have to take their

responsibilities as defined and mandated by

the parliamentary Act of 2011 regarding the

CBS where it is specified that on the

recommendation of the Cabinet, the

President appoints the governor, deputy

and Board of Directors who are competent

and have adequate experience and

educational background. “Responsibility

cannot be delegated” What would be

constructive is for the donors to

contribute to a transparent selection

criteria to help guide the evaluation of

candidates for Governor based on

relevant experience, qualifications,

ethical standards and integrity that

should produce a short list of capable

individuals that can be recommended to

fill all key positions.

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REFERENCES

Central Bank of Somalia, 2013, Strategic Plan 2013-2018: Building a Robust Financial System and

Promoting and Fostering Financial Stability, Central Bank of Somalia. Mogadishu

Lönnberg, Åke, 2013, New Money: Introducing a new currency is a complex process-one that

Turkmenistan completed successfully, in Finance and Development, IMF, Volume 50 No 4

Lönnberg, Åke, 2013, Turkmenistan‘s Successful Currency Reform, Lincoln University Press.

Central Bank of Sudan, 2007, The Project of Currency Conversion 2007, Sudan

Warren, Coates, 2007, Monetary Policy Issues in Post Conflict Economies,

Gray, Simon, 2006, Central Banking in Low Income Countries, Bank of England, London

Starr, Martha A. 2004, MONETARY Policy in Post conflict Countries: Restoring Credibility, American

University, Washington

Addison T., Geda A., et. Al, 20…, Reconstructing and Reforming the Financial System in Conflict and

―Post Conflict‖ Economies.

http://www.american.edu/cas/econ/workpap.htm

Mubarak, J.A., 2002, ‗A Private Supply of Money in Stateless Somalia‘, Journal of African Economies,

Vol. 11, No. 3 pp. 309-25.

Polizatto, V., 1993, ‗Prudential Regulation and Banking Regulation: Building an Institutional

Framework for Banks‘, in P. Collier (ed.) Financial System and development in Africa,

Washington, DC: World Bank, pp. 173-99.

http://www.american.edu/cas/econ/workpap.htm

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