26 April/June 2006 Africagrowth Agenda

Remittances and fi nancial sector development in confl ict-affected countries:Samuel Munzele MaimboSenior Financial Sector Specialist

INTRODUCTION

‘Remittances’, ‘fi nancial sector development’ and ‘confl ict-aff ected

countries’ are, individually, complex and challenging issues in de-

velopment studies. Combined, they create formidably dynamic

development complexities that do not easily lend themselves to

easy analytical segmentation and categorizations or standard static

best practice policy recommendations. At best, research can help

us learn from experience, and enable us be better prepared with a

wider range of policy options for us to consider when responding

to the next confl ict. And learn we must, for ‘remittances’, ‘fi nancial

sector development’ and ‘confl ict-aff ected countries’ are currently

at the top of the development agenda in many countries for the

following reasons:

• Remittances: Global remittance fl ows, including those

to confl ict-aff ected countries, are signifi cant and rising.

In 2005, remittance fl ows were estimated at US$167 bil

lion, up from US$160 billion in 2004. Of this amount,

sub-Saharan Africa received US$8.1 billion compared to

Latin America and the Caribbean (US$42.4), South Asia

(US$32), East Asia and the Pacifi c (US$43.1), Middle

East and North Africa (US$21.3) and Europe and Central

Asia (US$19.9) (World Bank, 2005; Maimbo and Ratha,

2005).

• Financial sector development: Empirical research increas

ingly demonstrates the critical role that well-functioning

fi nancial systems can play in private sector development,

accelerating growth and reducing poverty. Th e importance

of making wise fi nancial policy decisions, and of building

capable institutions, infrastructure and the legal and regu

latory frameworks to support the sound functioning of fi

nancial systems that can provide better access to fi nance for

all, without exacerbating the vulnerability of economies,

is a central challenge in the developing countries (World

Bank. 2006b).

• Confl ict-aff ected countries: Lasting peace can only be

achieved when the peace dividend – employment & entre

preneurial profi ts – exceed the benefi ts of confl ict – con

scription income and confl ict commerce. Attaining that div

idend, unfortunately, is challenging as no two confl icts are

alike. Each has unique characteristics that shape the result

ing peace process and the economic reforms associated

with it (World Bank, 2006c).

All three are related in the aftermath of sustained confl ict. Rees-

tablishing fi nancial institutions, systems and services is an essen-

tial part of restoring economic activities, and securing long lasting

peace.

Addressing all three elements is no easy task and requires

concerted eff ort. Financial sector development in confl ict-aff ected

countries is no where near a science. Th e opportunistic nature

with which entrepreneurs invest in essential fi nancial services is a

fascinating art. In recent times, Somalia and Afghanistan typify

the ultimate example of the fi nancial sector’s ability to use the

remittance business as the nucleus of fi nancial sector activities

during the period of confl ict as a life-line to a people affl icted by

sustained confl ict, and as a basis for rebuilding a new fi nancial

system on cessation of active confl ict.

THE CHALLENGE OF PROVIDING FINANCIAL

SERVICES IN CONFLICT-AFFECTED COUN-

TRIES

Providing access to fi nancial services in post-confl ict countries is

constrained by several factors. Th e basic infrastructure for fi nan-

cial services – legal and regulatory framework, monetary policy

framework, banking supervision structure, basic payments system

- is weak or absent. Th e large number of internally dispersed pop-

ulations with little or no documentation, the absence of physical

collateral and land-tenure systems that minimize the value and

use of land as collateral, the poor transport and communications

infrastructure, and past history of state involvement and subsi-

dized lending, leading to low recovery rates, complicate further

the usual problems often found in developing economies even in

the absence of confl ict. Th ese problems tend to be more acute

26 Africagrowth Agenda January - March 2007

Africagrowth Agenda April/June 2006 27

in rural areas where there will be added pressure for government

intervention.

For example, in Afghanistan, at the end of active confl ict in

December 2001, each of the problems listed above was present

(World Bank, 2004): Afghanistan’s 1994 Law on Money and

Banking, which provided the country’s only legal framework for

the fi nancial sector was designed on the now outdated socialist

principle that the purpose of monetary policy is to direct credit,

the legal framework was unsuitable for a market economy. No

functioning monetary policy framework was in place. Confi dence

in the national currency was low, as the Afghani had lost much of

its value during years of high infl ation. Banking supervision in a

modern sense did not exist.

In Somalia, the state of the fi nancial sector in early 2006,

during a period of relative calm, was no less desperate (Maimbo et

al, 2006): All state institutions that provided services and regulat-

ed the economy collapsed, including the Central Bank of Somalia

and the entire banking system. Th e commercial bank liabilities that

had survived the 1989 bankruptcy of the only commercial bank in

the country disappeared. Some semblance of a central banking au-

thority evolved in the North-West region (Somaliland) and in the

North-East region (Puntland) of Somalia. Th e two regional banks

established in both northern regions established several branches

and off ered very limited commercial banking services in deposit

accounts and trade fi nance. However, their primary function re-

mained that of treasurer of their respective regional governments.

In the South/Central region, no banking institutions existed.

In both Afghanistan and Somalia, the state of the fi nancial

sector precluded the entry of the level of private sector invest-

ment that is necessary to alleviate poverty, create economic op-

portunities, generate employment and contribute towards overall

economic growth.

THE OPPORTUNITIES AND THREATS OF RE-

MITTANCES IN CONFLICT-AFFECTED COUN-

TRIES

In the face of many confl ict-aff ected environments in the world

today, understanding the role and impact of remittance systems

during periods of confl ict is of vital importance. Fundamentally,

the story of remittance systems in confl ict environments is about

entrepreneurs formally or informally moving money into or out of

the confl ict-aff ected country between parties that, primarily, are

either – collectively or individually – surviving or exploiting the

confl ict.

• ‘Survivors’ use the remittance system to sustain the liveli

hoods of friends and family members who remain in the

country during the period of confl ict. Th e

remittances from those abroad are used to pay for

education, medical and other social services that a

state in confl ict is unable to provide for its citizens. ‘Survi

vors’ routinely invest in infrastructure - largely housing and

small scale enterprises - to provide an income (often mod

est) to those directly enduring the confl ict.

• ‘Exploiters’ abuse the remittance system to launder the

proceeds of crime or fi nance the confl ict for fi nancial gain.

Th e absence of public legal regulatory institutions makes

confl ict-aff ected countries attractive for laundering the pro

ceeds of confl ict diamonds, opium production, arms smug

gling, and other crimes – the proceeds of which are then

often invested in more stable countries.

Countries in confl ict or emerging from confl ict are often caught

between these two protagonists. On one hand, remittance systems

have sustained the livelihoods of many a people living in the poor-

est countries in the world. On the other hand, remittances service

comes with some risks, and potential for abuse. Th e benefi ts of

the remittance services can be exploited to facilitate the launder-

ing of criminal proceeds. Th e challenge is distinguishing between

the myths and realities of the remittance companies and, in the

long run, rebuilding a sustainable fi nancial sector that provides a

broader range of fi nancial services when peace returns in earnest.

PROMOTING FINANCIAL SECTOR DEVELOP-

MENT

To make the most of remittance systems (formal and informal) as

tools for fi nancial sector development in confl ict-aff ected coun-

tries, policy makers need to make a mental shift from an insti-

tutional view of the fi nancial sector. Instead, they need to focus

on fi nancial products and services instead of the bricks and mor-

tar of institutions. People emerging from confl ict do not want a

‘commercial bank’; they want seed and working capital for their

businesses; they are not looking for a ‘development bank’; they

are looking for long term fi nance for their more ambitious infra-

structure projects. Policy makers therefore need to remember that

a country may not have:

• a credit registry, but it has established social norms and

practices that determine an individual’s fi nancial standing.

In Afghanistan, for example, when a money remittance

company obtained a commercial banking license on June

26, 2004, it was able to grow its lending business faster

than any other bank in the country using its relationship

banking network built over 14 years in the remittance busi

ness.

• an active property registry to facilitate collateral based

January - March 2007 Africagrowth Agenda 27

28 April/June 2006 Africagrowth Agenda

lending; but have non-collateralized lending practices that

have survived the war. In Afghanistan, there is an estab

lished form of credit for opium at the time of planting,

which suggests that there is a chain of credit not just from

farmer to fi rst-level trader but also beyond, including in

ternationally that was not dependent on collateral (Th omp

son, 2006).

• a national payment system, but have a national network

of intermediaries that facilitate the clearance of bills of

exchange. In Somalia, because of security concerns, remit

tance companies have been very resourceful in minimizing

this risk by minimizing the physical transportation of cash

by using cash from local traders who want to be paid in a

major commercial centre or in another country where they

import or buy their stock.

• a legal and prudential framework, but have codes of con

duct enforced by member associations and traditional sys

tems of justice. In the absence of a central government to

regulate the remittance companies, the Somali Financial

Services Association regulates the industry itself through

membership guidelines.

By focusing on what is left after the confl ict, rather than what is

lost, it is then possible to begin to see the full potential of remit-

tance systems as potential partners in the development of fi nancial

systems. Having sustained a rudimentary fi nancial system during

the confl ict, remittance companies can, as suggested by the exam-

ples above, contribute to the reconstruction of the fi nancial sector

which in general will include:

(1) Drafting new or updating the legal framework and re-build-

ing the regulatory enforcement capacity; (2) Re-establishing cor-

porate governance mechanisms in the banking system, and; (3)

Developing creative systems for facilitating access to fi nancial

services in the economy.

However, because no two confl icts are alike, the sequencing

and degree of reforms associated with each reform depends on the

duration of the confl ict, but also – in varying degrees: the state of

the fi nancial sector before the confl ict; the presence of mineral

resources in the confl ict aff ected regions; the role of ethnic diff er-

ences in fueling or sustaining the confl ict, and; the resulting level

of political fragmentation in the post-confl ict state building proc-

ess.

POLICY LESSONS

In addressing these challenges, and pursuing overall fi nancial sec-

tor development objectives in confl ict-aff ected countries, it is es-

sential that policy makers bear in mind the following lessons from

other confl ict-aff ected environments.

• Sustainable fi nancial reforms have a long maturity period.

Enacting legislation, improving governance structures, de

veloping competitive fi nancial practices, building fi nancial

infrastructure, and encouraging international and domestic

confi dence in fi nancial institutions require patience and de

termination – all of which must be properly sequenced.

• Financial reforms are incomplete without well-conceived

measures for introducing and supporting a competitive envi

ronment. Reforms should be designed to have long-term ef

fects, always keeping in mind the ultimate objective of es

tablishing a competitive environment based on principles of

safe and sound banking under stable fi nancial conditions. Fi

nancial sector legislation and regulations (along with appro

priate tax policies and open current and capital accounts)

constitute the basis for a competitive policy.

• Eff orts to recapitalize previously existing and troubled

banks should be pursued only as a last resort (resulting

from the absence of new investment and in the interest of

broad provision of banking services), and within the con

text of a time-bound privatization program. It takes a long

time for private banks to tool up in an environment like Af

ghanistan. However, because the costs of recapitalizing trou

bled state banks are high relative to monetary and fi scal re

turns, any move to rehabilitate any of the existing troubled

banks should be carried out using performance-based con

tracts.

• Financial reforms are not sustainable unless they are com

prehensive and penetrate institutional structures. Strength

ening fi nancial infrastructure requires several developments.

A good starting point is to ensure the central bank’s ability

to supervise banks. Attention must next be given to infra

structure, including the payment and settlement system,

accounting and auditing standards, the framework for se

cured transactions, and institutional capacity to comply

with and enforce prudential norms.

• Reforms will not succeed without development of the sys

tem for payments and settlements. Th e lack of a formally

functioning payments system for international and domes

tic funds transfers has been an important obstacle to the

timely and eff ective delivery of reconstruction assistance in

Afghanistan. It has also impeded support of central author

ity, as the government has had problems paying civil serv

ants. Action to improve the payments system should be ac

celerated.

REFERENCES

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tor: A Macroeconomic Perspective In Maimbo (ed) Remittances

28 Africagrowth Agenda January - March 2007

Africagrowth Agenda April/June 2006 29

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World Bank

Lindley, A. (2006) Th e Infl uence of Migration, Remittanc-

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June - August 2006 Africagrowth Agenda 29