Why Somalia's banks must consolidate

Somalia's banking sector, long dormant during decades of conflict, has staged an impressive - yet precarious - comeback. Where once, formality barely existed, the last ten years have seen a rapid expansion of licensed institutions, a quadrupling of both assets and customer deposits, and a marked rise in credit to the private sector.

This growth underscores the potential of a country in economic transition and the willingness of entrepreneurs to build from the ground up. Yet for all its dynamism, Somalia's banking is still fragmented, structurally fragile and hampered by risks that, if left unaddressed, could choke the country's financial future.

The heart of the matter is that consolidation and deep structural reform have become essential, not optional. Only by tackling weaknesses in capital, liquidity, governance, and trust can Somalia unlock the full potential of financial intermediation, enhance its competitiveness in East Africa, and ultimately develop functioning capital markets.

This urgency is heightened by rapid integration and reform among regional peers, and a volatile investor mood that penalises perceived financial instability.

Somalia's banking sector counted 13 licensed commercial banks as of 2024, a testament to both societal resilience and pent-up demand for banking services. These banks are overwhelmingly privately owned and Sharia-compliant, reflecting local preferences and the lack of a tradition of state dominance seen in some neighbouring countries.

Despite these strengths, the landscape remains fragmented, with no strong tier-1 institution able to anchor systemic stability or lead in innovation.

Most Somali banks operate under highly similar business models: providing commercial retail banking, trade finance, and basic investment services, often through Islamic structures. The sector is urban-centric: activity is heavily concentrated in Mogadishu and a handful of other urban centres, meaning rural and peri-urban areas - where the majority of Somalis live - are vastly underserved.

The major players - such as International Bank of Somalia (IBS), Premier Bank, Salaam Somali Bank, Dahabshiil International Bank, and Amal Bank-are part of larger informal conglomerates that typically also operate hawalas (money transfer businesses) and, increasingly, mobile money and telecom ventures.

Somalia's financial institutions are dwarfed by regional peers; most remain small and undercapitalised by any international measure, lacking the heft to drive significant transformation of the broader economy.

According to the International Finance Corporation (IFC), by the end of 2023, total banking assets reached $1.8bn, while customer deposits climbed to $1.43bn. Credit to the private sector also more than doubled to $404m in five years. Still, these headline numbers mask a fundamental weakness: the sheer number of small, undercapitalised banks relative to the size of the economy and population.

Weak foundations for growth

Most Somali banks operate with minimal paid-up capital, making it difficult to meet even basic prudential norms. Capital buffer requirements - central to the global Basel standards - are frequently unmet, exposing the sector to solvency shocks and limiting intermediation capacity.

The regulatory capacity of the Central Bank of Somalia (CBS) has been improving, but progress remains gradual given limited resources and capacity constraints.

Somalia's deposit base, at about 5% of GDP, is one of the lowest ratios in Africa. Part of the reason is a deeply entrenched preference for mobile money or cash transactions, fuelled by decades of distrust in formal institutions and the absence of a robust deposit insurance mechanism. Without credible safeguards, Somalis, individuals and businesses alike, are reluctant to entrust their savings to banks.

The lack of an effective insolvency framework further erodes confidence; bank failures, should they occur, risk inflicting significant losses on depositors and triggering systemic panic.

Somalia lacks a functional interbank market; thus, banks hold large sums as idle cash or in correspondent accounts, draining profitability and limiting the efficient allocation of capital.

The CBS does not yet possess the tools of an active monetary authority - most crucially, it cannot act as a lender of last resort, and it does not use open market operations to manage systemic liquidity. This severely restricts banks' ability to lend and to absorb shocks.

Profitability remains fragile. While improved asset quality and prudent management have helped commercial banks remain often profitable, margins are thin and return on equity is volatile.

According to a study focusing on Premier Bank, capital adequacy and liquidity have contributed positively to profitability, but low scale and systemic vulnerabilities keep risks elevated.

Market fragmentation has created an eco-system of many small banks, each lacking the critical mass to invest meaningfully in risk management, compliance infrastructure, staff training, or digital transformation.

As a result, it is challenging to attract significant domestic or foreign capital. Investors are wary of small, thinly capitalised banks likely to face mergers or failures late in a cycle.

Weak institutions have limited credit underwriting skills, perpetuating low loan-to-deposit ratios and stunted private sector growth. In addition, technological and regulatory investments - essential for combating money laundering and supporting innovation - are beyond the means of most individual banks.

Consolidation would bring multiple benefits: Stronger, merged institutions are better equipped to meet regulatory thresholds and absorb shocks; scale enables meaningful investments in technology and financial products such as digital payments and SME lending and as seen elsewhere in Africa, consolidation can build the public and international trust needed for banks to serve as credible counterparties and intermediaries.

Lessons from Ethiopia

Ethiopia's experience shows that even in challenging environments, managed liberalisation and firm regulatory oversight can transform a banking sector. The country's shift from a state monopoly in the 1990s to a more competitive market was paired with steadily rising minimum capital requirements, stronger supervision from the National Bank of Ethiopia, and investments in payment infrastructure. This allowed banks to achieve scale, improve risk management, and prepare for technological adoption - without destabilising the system.

For Somalia, key lessons are clear: consolidation is best pursued alongside stronger capital and liquidity standards, with regulatory capacity rising in tandem.

Building foundational infrastructure such as interbank markets, credit registries, and deposit insurance will bolster trust, while leveraging mobile and digital finance can expand access well beyond urban centres. Ethiopia demonstrates that gradual, well-sequenced reforms can yield a banking sector both resilient and ready to support economic growth.

Ethiopia's path makes clear that banking transformation requires more than just organic market growth - it demands deliberate, sequenced reforms that pair rising capital requirements with stronger supervision and modern infrastructure.

Somalia's challenge is sharper: a fragmented sector, low public trust, and a regulatory authority still building its toolkit. Yet precisely because the market is young, Somalia has the advantage of designing reforms in a forward-looking way, skipping outdated models and embracing both digital finance and modern prudential standards from the outset.

For reforms to succeed, the CBS will need to strengthen its institutional capacity while signalling a clear, phased policy roadmap that motivates consolidation without triggering instability.

Drawing on Ethiopia's experience, Somalia's focus should be on building the foundations of scale, trust, and liquidity circulation - the pillars of a banking system that can serve domestic needs and link credibly with regional and global markets. To do this, it will need to pursue several measures including strengthening CBS supervisory capacity by investing in technical training, regulatory technology, and staffing to enable risk-based supervision, proactive enforcement of capital adequacy, and robust anti-money laundering oversight.

It will also have to phase in higher capital requirements by gradually raising the minimum paid-up capital to encourage mergers and create banks with the scale to absorb shocks and finance larger projects.

It will be important to adopt tiered licensing - allow well-managed smaller banks to operate as niche or regional players under lighter requirements, while encouraging over-fragmented institutions to merge into stronger entities.

There will need to be the creation of safeguards to build trust: Launch a deposit insurance scheme and a public credit registry to protect savers and improve credit assessment, catalysing private sector lending. The country will also need to leverage digital finance for inclusion. Formalise mobile money operations within the regulatory framework and promote bank-fintech partnerships to expand services beyond urban centres.

By sequencing these measures and anchoring them in a credible reform timetable, Somalia can lay the groundwork for a resilient banking sector that mirrors the most successful elements of Ethiopia's progress - scaled for Somalia's unique market realities.

Regional integratio

Somalia's financial future is inseparable from regional economic integration and the development of capital markets. Without strong domestic banks, it will be impossible to develop a sovereign bond market or attract institutional investors, both foreign and Somali diasporan. Robust banks are essential for trade finance and for connecting with regional cross-border payment systems such as those evolving in the East African Community (EAC) and COMESA.

Somalia's urban entrepreneurs, agricultural exporters, and infrastructure planners simply cannot rely on banks that are institutionally fragile, unable to underwrite large projects or provide reliable cross-border services. As the Horn of Africa's economies modernise and integrate, the opportunity cost of maintaining a fragile, fragmented banking system will only grow.

The case for consolidation and reform is irrefutable. The alternative - perpetuating a proliferation of small, weak banks - would entrench Somalia as a financial backwater, shut out from the opportunities of regional integration and dynamic capital markets. Reform is not a choice between optimism and realism; it is the only credible path forward.

With pragmatic leadership and a focus on regulatory modernisation, Somalia can build a banking system worthy of its ambitions - a sector that serves all citizens, earns public trust, attracts investors, and anchors the next phase of economic transformation.

The future of Somali finance depends on bold choices and cohesive action today. The moment for strategic, system-level reform is now, before opportunity turns to setback, and the sector's promise, once again, slips from reach.

Mohamed Ibrahim is a former Economic and Financial Policy Advisor to the Office of the Prime Minister of Somalia.