Dr. Mohamed Ibrahim Nor, PhD
Financial reform in fragile states is often framed as a moral imperative: increasing transparency, strengthening regulation, reducing concentration, expanding formal banking, and modernizing the Central Bank. In principle, few would object. Formalization improves accountability, broadens the tax base, enhances consumer protection, and integrates economies into global financial systems. However, reform logic that works in consolidated states does not automatically translate into politically fragmented ones. In contexts where sovereignty is territorially uneven, institutions are thin, and markets are trust-based rather than law-based, speed can be destabilizing.
Somalia presents this dilemma precisely. For more than three decades, its financial system has functioned without the institutional architecture typically assumed in monetary textbooks. Instead of deep banking intermediation, the system evolved around hawala remittance networks, clan-guaranteed enforcement, telecom-driven mobile money platforms, and private settlement mechanisms. Enforcement is reputational rather than judicial. Liquidity circulates through networks rather than through a fully centralized clearing authority.
This is not financial backwardness. It is an adaptive equilibrium. In situations where formal contract law is weak, relational contracting often steps in. Similarly, network governance appears when state oversight is limited. Moreover, private payment systems fill the gaps in public monetary infrastructure. As a result, the system, although it seems informal by traditional standards, has shown resilience during periods of significant political instability. Therefore, any serious reform effort must begin by recognizing this existing structural reality.
Fragmented Sovereignty and Regulatory Limits
Somalia’s monetary authority operates within a politically fragmented settlement that fundamentally constrains the architecture of financial governance. Somaliland operates with de facto independence and maintains its own monetary arrangements; Puntland exercises quasi-confederal autonomy with distinct administrative control over financial affairs; and parts of the central and southern regions remain security-sensitive, with uneven territorial control and regulatory penetration. The result is a territorially discontinuous enforcement environment in which supervisory authority, prudential oversight, and monetary transmission mechanisms cannot be uniformly applied. In classical central banking theory, modernization presumes a consolidated Weberian state—one that commands undisputed jurisdiction, monopolizes legitimate enforcement, and exercises coherent seigniorage authority across its territory.
Somalia does not presently meet those conditions. Supervisory reach is mediated by political negotiation, fragmented fiscal and territorial realities constrain seigniorage authority, and payment system oversight is necessarily partial rather than comprehensive. Regulatory strategies that rely on a strong central authority risk overreach, undermining trust and unintentionally fragmenting the market. Therefore, successful financial modernization in Somalia requires a flexible approach, including regional agreements for implementation and a gradual political process. This approach should align regulatory goals with the country’s changing political landscape rather than rely on fixed institutional plans.
Financial Shallowness and Structural Constraints.
Somalia’s banking sector remains exceptionally shallow, with bank assets constituting only a small fraction of GDP, compared even to low-income Sub-Saharan African benchmarks, and deposit mobilization correspondingly thin. In many cases, liquidity primarily moves through mobile money platforms and informal transfer networks rather than through traditional credit systems. This situation highlights an economy where payments and remittances are more important than lending based on financial statements. This situation stems not only from regulatory delays but also from fundamental structural issues that significantly hinder financial growth. Low literacy levels hinder both financial inclusion and the use of complex financial products.
Widespread poverty effectively excludes substantial portions of the populace from traditional banking, given the constraints of conventional risk assessment methodologies. In areas outside of major urban areas, access to electricity is both limited and unreliable, thereby restricting the expansion of physical branches and the scaling of digital infrastructure. Furthermore, digital connectivity is inconsistent, and the lack of universal national identification systems complicates customer due diligence and credit profiling processes. Physical banking outreach and collateral verification are also hindered by transportation bottlenecks. Consequently, financial development is inextricably linked to broader processes of state-building and economic transformation.
Deepening the banking system is therefore a developmental sequencing challenge, not simply a compliance or supervisory one. Infrastructure must precede intermediation; human capital formation must precede prudential complexity; and regulatory ambition must follow institutional capacity rather than attempt to substitute for it. Reversing this order risks imposing systemic stress on an ecosystem that lacks the absorptive depth to sustain rapid formal expansion.
Reform Shock and Absorption Capacity
Financial modernization rarely arrives incrementally; it often appears in clusters—tighter AML/CFT enforcement, interoperability mandates, revised licensing frameworks, capital adequacy recalibration, and supervisory restructuring—each individually defensible from a prudential standpoint, yet collectively capable of overwhelming a fragile financial ecosystem. In trust-based systems, where liquidity flows through relationships rather than through large financial institutions, regulatory changes can spread quickly and unpredictably. Rapid compliance requirements can in liquidity, disrupt payment systems, encourage cash hoarding, or push activities into unregulated areas. In markets conversely, with a limited number of participants, fragmentation can diminish network efficiency, impair the capacity to withstand disturbances, and ultimately compromise overall system stability. This constraint is conceptualized in institutional economics as constrained absorption capacity, referring to the limited capacity of institutions, enterprises, and end-users to adapt to changes without incurring destabilizing costs.
Reform sequencing theory emphasizes the importance of careful timing, thorough testing, and continuous learning. In contrast, macro-financial stability analysis warns against implementing multiple policy changes at once in systems that lack sufficient safeguards against economic downturns. Therefore, the main point is clear: reform should be implemented gradually, not all at once. System mapping must precede intervention, controlled pilots must precede nationwide scaling,and institutional feedback loops must precede regulatory expansion. Modernization that respects absorptive limits strengthens stability. Modernization that disregards them risks transferring fragility rather than reducing it.
The Private Sector as a De Facto Infrastructure
In Somalia, the private sector’s role extends beyond mere market participation; it functions as a quasi-governance structure integrated into the nation’s political economy. Owing to the lack of a unified state apparatus, private entities furnish employment, essential services, telecommunications, healthcare, education, transportation, and, crucially, the payment infrastructure that supports everyday economic activities. Mobile money platforms serve as the principal transactional framework for both households and businesses, while hawala networks facilitate remittance flows that bolster consumption and mitigate balance-of-payments challenges.
Telecom companies effectively manage financial channels that replace formal clearing and settlement systems, which are usually overseen by central authorities. Consequently, reform efforts cannot credibly advance through adversarial approaches or unilateral imposition. If modernization initiatives are perceived as punitive, extractive, or politically driven—particularly when targeting prominent operators—capital flight, regulatory evasion, and a reversion to informal, parallel systems may be viewed as rational defensive strategies.
In unstable and illiquid markets, regulatory legitimacy depends not only on legal authority but also on negotiated credibility, which is achieved through codesign with key stakeholders, predictable rule-making, phased implementation, and compliance frameworks that align with incentives. The situation becomes particularly delicate when concentration issues arise. The difference between effective systemic risk management and perceived political control can determine whether reform strengthens resilience or unintentionally undermines economic infrastructure.
How Formalization Should Proceed
Formalization in Somalia should not be understood as a replacement for informal systems; rather, it should be viewed as the strategic integration of formal protections into established trust-based networks that currently fulfill essential financial roles. The goal is to strengthen institutions, not to replace them. This necessitates a hybrid regulatory framework that explicitly acknowledges hawala operators and mobile money platforms as integral elements of the national payment system rather than as temporary exceptions.
Compliance frameworks should be tiered, proportionate, and adjusted to reflect demonstrated institutional capacity and systemic importance, rather than being directly adopted from more developed financial systems. Regulatory sandboxes can provide controlled environments for piloting prudential upgrades, interoperability standards, and reporting reforms before system-wide scaling. At the same time, incentive-based reporting mechanisms—grounded in supervisory cooperation rather than punitive enforcement—can gradually strengthen transparency without triggering liquidity withdrawal.
Sequencing is of paramount importance; therefore, reforms should be implemented over several years, contingent upon demonstrable infrastructure expansion, enhanced supervisory capabilities, and the penetration of digital identification systems, all while being coordinated with Federal Member States to account for territorial political dynamics. From a geographical perspective, modernization efforts should initially focus on relatively stable urban corridors, where enforcement feasibility and institutional density are greater, and expand incrementally as regulatory knowledge is acquired. Furthermore, reform must be carried out in collaboration with, rather than in opposition to, key stakeholders such as major telecom operators, mobile money leaders, regional monetary authorities, business associations, and, when pertinent, religious scholars, to ensure Sharia-compliant legitimacy. In contexts characterized by fragmented sovereignty, financial modernization does not constitute a technocratic mandate imposed by a central authority; rather, it represents negotiated institutional engineering that is attuned to the constraints of the political economy.
The Core Principle
Financial modernization is indispensable for Somalia’s long-term economic sovereignty; a system that remains persistently shallow, territorially fragmented, and externally dependent cannot indefinitely support sustainable growth, credit formation, or macroeconomic autonomy. However, modernization, when not grounded in the realities of the political economy, could destabilize the very structures that have enabled economic survival, especially when state capacity is limited.
The strategic objective, therefore, is not acceleration but durability. Reforms that inadvertently weaken the backbone of a fragile payment ecosystem do not eliminate systemic risk—they merely redistribute it across less-regulated or less-visible channels. In thin markets characterized by concentrated liquidity and trust-based networks, scale is often synonymous with stability; the policy challenge is not to reduce scale for its own sake but to embed that scale within a progressively regulated, transparent, and resilient national framework capable of gradual deepening. Incremental improvements in stability are achieved through effective formalization, which also bolsters supervisory legitimacy and expands institutional capacity in line with regulatory goals. In the context of fragility, transformation requires an evolutionary approach that avoids abrupt disruption. This process must be sequenced, negotiated, and absorptive, ensuring that modernization reinforces resilience rather than triggering systemic instability.
Dr. Mohamed Ibrahim Nor, PhD. is currently a Member of Somalia’s National Commission for Higher Education, former Minister of Rural Development and Resilience in South West State and Former Permanent Secretary of Office of the Prime Minister.