Somalia’s Fragile Banking System Takes a Hit

Somali businesses and homes are starting to feel the pinch of depleted money transfers, sparking panic across the impoverished country. In recent years, regulators in the U.S. have forced American banks to end their money transfer programs to Somalia, citing concerns that these payments could be used to fund terrorist organizations. Nearly all banks have stopped these programs over the past few years. However, the biggest holdout, Merchant’s Bank of California, only closed its accounts on February 6th. The bank, which is responsible for 80% of U.S. transfers to Somalia, was crucial for Somali-Americans in sending money back home.

Remittances transferred through the bank are $200 million per year, accounting for about 80% of U.S. transfers and 15% of the estimated $1.3 billion overall sent to the country from across the world. This deals a huge blow for Somalia’s citizens, as forty percent of the population is dependent on remittances for support.

The recent decision will only aggravate Somalia’s slow recovery process. These funds are often used to finance the construction of schools and hospitals and to pay for basic supplies such as food and water. Charity organizations warn that the crackdown on transfers could push the market underground and reduce transparency; they also argue that ordinary Somalis will suffer the most while criminal gangs could potentially expand by capitalizing on the economic disruption.

These regulations stem from the 2003 Patriot Act, which stipulates the possibility of a federal lawsuit if U.S. businesses are found funding a known terrorist group. In June of last year, the U.S. Treasury’s Office of the Controller of Currency sent a cease-and-desist order to Merchant’s Bank of California, citing that its anti-money laundering procedures were inadequate. The bank was unable to meet the requirements and was thus forced to shut down its transfer program. This measure, albeit intended to curb the financing of terrorist groups like al-Shabab, could ironically be used as a recruitment tool for these groups as desperate Somalis may start blaming their situation on Western actions.

Somalia’s federal banking system has been largely nonexistent since the collapse of the central government in 1991. In order to fill this void, the centuries-old practice of hawala, or money transfer, has expanded and adapted to suit the modern world. This informal network, built largely on trust and cultural practices, allows for Somalis to exchange money amongst themselves and also enables expats to send money back home. Because this network is unregulated, Western governments have feared that money could be funneled into terrorist activities and thus have become focused on shutting this system down.

Somalia’s formal banking sector has made a resurgence over the past few years, however. The first commercial bank in Somalia in over 20 years opened in June of 2012. Fittingly called the First Somali Bank (FBS), it marked a major milestone in the country’s slow recovery. Since then, more banks have been established, prompting thousands of Somalis to open official bank accounts, which will allow them to receive money from abroad via transparent banking institutions. These banks also have the potential to fund agriculture, livestock and fishery projects to develop the economy. Last December, Salaam Somali Bank set up the country’s first ever ATM, making cash transfers even easier.

The recent growth in the formal banking system can make Somalis less reliant on the hawala network. Because these banks are far more transparent, they make it easier for Somalis to access official lines of credit. However, the hawala system still remains popular among Somalis, as it is far more widespread and thus can reach out to isolated rural areas. It also offers transfer rates far lower than those of wire transfer. Thus, the recent crackdowns have been crippling for the average Somali.

With the war-torn country still highly dependent on remittances, U.S. regulations, although well-intentioned, will only make the situation worse. While Somalia’s commercial banking sector has grown, it is still in its infancy; thus, the informal system remains crucial to the rebuilding of the country. Policies that encourage greater transparency, such as Britain’s recent Safer Corridor initiative, are far more constructive and will go a long way in ensuring that money transfers reach the right hands.