The Role of Somaliland Central bank on E (1)

CHAPTER 1
1. INTRODUCTION

1.1: Background to the study
Banking activities were sufficiently important in Babylonia in the second
millennium B.C. that
Written standards of practice were considered necessary. These standards
were part of the Code of Hammurabi – the earliest known formal laws.
Obviously, these primitive banking
Transactions were very different in many ways to their modern-day
counterparts. Deposits were not of money but of cattle, grain or other crops
and eventually precious metals. Nevertheless, some of the basic concepts
underlying today’s banking system were present in these ancient
arrangements. A wide range of deposits was accepted, loans were made, and
borrowers paid interest to lenders.1
Similar banking type arrangements could also be found in ancient Egypt.
These arrangements stemmed from the requirement that grain harvests be
stored in centralized state warehouses.
Depositors could use written orders for the withdrawal of a certain quantity
of grain as a means of payment. This system worked so well that it continued
to exist even after private banks dealing in coinage and precious metals

were established2.
We can trace modern-day banking to practices in the Medieval Italian cities
of Florence, Venice, and Genoa. The Italian bankers made loans to princes,
1 Davies, G. (1994) “A History of Money from Ancient Times to the Present Day”, Cardiff, UK,
University of Wales

Press.
2 Davies (1994) op. cit.
1

both to finance wars and their lavish lifestyles, and to merchants engaged in
international trade. In fact, these early banks tended to be set up by trading
families as a part of their more general business activities. The Bardi and
Peruzzi families were dominant in Florence in the 14th century and
established branches in other Parts of Europe to facilitate their trading
activities3. Both these banks extended substantial loans to Edward III of
England to finance the 100 years war against France. But Edward defaulted,
and the banks failed.
Perhaps the most famous of the medieval Italian banks was the Medici bank,
set up by Giovanni Medici in 13974. The Medici had a long history as money

changers, but it was Giovanni who moved the business from a green-covered
table in the market place into the hall of a palace he had built for himself. He
expanded the scope of the business and established branches of the bank as
far north as London. While the Medici bank extended the usual loans to
merchants and royals, it also enjoyed the distinction of being the main
banker for the Pope. Papal business earned higher profits for the bank than
any of its other activities and was the main driving force behind the
establishment of branches in other Italian cities and across Europe.
Much of the international business of the medieval banks was carried out
through the use of bills of exchange. At the simplest level, this involved a
creditor providing local currency to the debtor in return for a bill stating that
a certain amount of another currency was payable at a future date – often at
the next big international fair. Because of the church prohibition on directly
charging interest, the connection between banking and trade was essential.
The bankers would take deposits in one city, make a loan to someone
transporting goods to another city, and then take repayment at the
destination. The repayment was usually in a different currency, so it could
easily incorporate what is essentially an interest payment, circumventing the
3 Hoggson, N. F. (1926) “Banking Through the Ages”, New York, Dodd, Mead &

Company.
4 Goldthwaite, R. A. (1995) “Banks, Places and Entrepreneurs in Renaissance
Florence”, Aldershot, Hampshire,Great Britain, Variorum.
2

church prohibitions. For example, a Florentine bank would lend 1000 florins
in Florence requiring repayment of 40,000 pence in three months in the
bank’s London office. In London, the bank would then loan out the 40,000
pence to be repaid in Florence at a rate of 36 pence per florin in three
months. In six months, the bank makes 11.1 percent – that’s an annual rate
of 23.4 percent.
It is also interesting to note that a double-entry bookkeeping system was
used by these medieval bankers and that payments could be executed
purely by book transfer5.
During the 17th and 18th centuries the Dutch and British improved upon
Italian banking techniques. A key development often credited to the London
goldsmiths around this time was the adoption of fractional reserve banking6.
By the middle of the 17th century, the civil war had resulted in the demise of
the goldsmiths’ traditional business of making objects of gold and silver.
Forced to find a way to make a living, and having the means to safely store

precious metal, they turned to accepting deposits of precious metals for
safekeeping. The goldsmith would then issue a receipt for the deposit. At
first, these receipts circulated as a form of money. But eventually, the
goldsmiths realized that since not all of the depositors would demand their
gold and silver simultaneously, they could issue more receipts than they had
metal in their vault.
Banks became an integral part of the US economy from the beginning of the
Republic. Five years after the Declaration of Independence, the first
chartered bank was established in
Philadelphia in 17817, and by 1794, there were seventeen more. At first,
bank charters could only be obtained through an act of legislation. But, in
1838, New York adopted the Free Banking

5 Goldthwaite (1995) op. cit.
6 Davies (1994) op. cit.
7 Klebaner, B. J. (1974) “Commercial Banking in the United States: A History”:,

Hinsdale, Illinois, Dryden Press.
3

Act, which allowed anyone to engage in banking business as long as they
met certain legal specifications. As free banking quickly spread to other
states, problems associated with the system soon became apparent. For
example, banks incorporated under these state laws had the right to issue
their own bank notes. This led to a multiplicity of notes – many of which
proved to be worthless in the all too common event of a bank failure.
With the Civil War came legislation that provided for a federally chartered
system of banks.
This legislation allowed national banks to issue notes and placed a tax on
state issued bank notes.
These national bank notes came with a federal guarantee, which protected
the note-holder if the bank failed. This new legislation also brought all banks
under federal supervision. In essence it laid the foundations of the presentday system.

1.2. Area of the study
Somaliland is a self recognized country. It’s situated in northwestern Somalia
or exactly in horn of Africa, it gains its independence in 1991 from Somalia
while the central government collapsed and declares its independence as
Somaliland. From 1991, Somaliland had built strong government with proper
administration, laws, security, judiciary, foreign policy, banks and financial

institutions. Somaliland bank (BAANKA SOOMAALILAND) was established in
1994 together with appropriate laws, to ensure that banking regulations are
carried out as it is.

4

Somaliland bank (baanka soomaaliland)

Thus, the president of that time appointed a board of directors consisted of
governor (gudoomiyaha baanka), and director general to direct the activities
of the bank, and succeeds partially its task of opening the bank, which
means only three regions are opened out of six regions, while the three
remaining regions are not opened. In 1997 the administration are replaced
and nominated new governor, and two director generals, which one holds
two positions both vice-governor and director general.
Fortunately, these new administration are achieved the goal of expansion the
bank throughout the six regions and extended its functions and branches. In
addition to, Somaliland bank apart from its functions as a central bank runs
the activities of the commercial sector.

5

After short period of the stabilization of the central bank, the president of
that time (Mr. Egal) has suggested the former Somali currency should be
replaced to a new Somaliland shilling8. This task was appointed to the central
bank to issue a new currency and it was its first assignment. The central
bank sets the design, symbols, nodes, and all its features and then proposed
to the parliament and they approved in june-3-1994. Lastly the central bank
declared the bid and the British company named (Harrison and sons limited)
wins the contract and they signed the contract of printing the new currency
in June -9-1994 to the British company and the currency (Somaliland
shillings) received in 12-june-1994 and the central bank had declared in 20october-1994 for the replacement of the former Somali shillings.
Unfortunately, the central bank had completed this task partially, which
means only three regions ( Hargeisa, Borame and Ber-bera) had being
replaced their previous money out of the six while the other regions
remained unchanged and use their previous money. Furthermore, in 2002
had its second task when forgery money enters to the market and the
central bank printed a new money with slight modification of adding silver
wire in order, to know whether its forgery or not.
In 2011 the president (siilaanyo) suggested to replace again in former Somali

for the rest three regions and it achieved only Togdheer region and printed a
new paper money and former Somali had been burned. The current president
of Somaliland has tried many times to replace the previous Somali shillings
which is commonly used in eastern regions of the country, but nothing had
being achieved yet for this trials, because of lack of adequate capital to
collect and change it. The government paid 10 billion only the replacement
of former Somali currency in Togdheer which is highly cost and it does not
have this ability and capacity to print a new currency.

8 Shire (2009) central bank of Somaliland and exchange rate, graduate of admas university
(economy)

6

It’s very interesting to know, that the role of the central bank in the
regulation of the financial market is completely passive, and the hawala and
money changers regulated the market as they want and their expectations.
Though, the central banks have the highest authority for the regulation of
the money market and keep the prestige of the money and setup the rates.
According to the words of DE KOCK,9 ‘’the privilege of note-issue was almost

everywhere associated with the origin and development of central bank’’ the
role of bank is absolutely inactive, due to, the currency both Somaliland
shilling and dollar is the hands of the businesses and hawala and there is a
lack of collaboration between the government, businesses, and the bank.
However, the price stability and exchange stability were the traditional
objective of central banking and its banks duty creating strong relationship
for the concerned bodies in order to establish and setup a fixed rate of
exchange and keeping of the currency’s privilege by revaluation and play his
role for the financial market.
Somaliland bank (BAANKA SOOMAALILAND) has the highest financial
authority and is responsible for managing the expansion (supply of money to
the market and issuance of new money if shortage of money takes place)
and contraction of the volume of the money (if inflation arises and when
supply of the money is too high to the market). Thus, Somaliland has a
unique currency (Somaliland shilling) and firstly, was issued in 1994, while
the Somaliland president at that time (Mr. Egal) has suggested the former
Somali currency should be replaced by a new Somaliland shilling.
This duty was assigned in the central bank in order to establish and prepare
all features that the currency needed to have in terms of design, quantity,
symbols, and appearance. After long discussion and brainstorming, the bank

succeeded the execution of this job. In June- 3- 1994 sends to the parliament
and they are approved. It’s very interesting to know that the central bank
9 De cock, south African economist, central bank and the role of central banking in a
developing economy

7

were not have a capital to finance and it had signed a contract by a business
man named (Mr. ibrahim dhere) for the payment of the hard currency and he
will take the replaced former Somali shilling. Furthermore, when the money
received the bid has been declared and British company (Harrison and
sons limited) wins the tender and in june-9-1994 the contract has been
signed together and the order being placed. After a short period the Harrison
finished the issuance of the money and it reaches to the country in 12october-1994. The quantities that have been issued were only 5 billion, and
in 20-october-1994 had being declared its replacement. Fortunately
completed this heavy duty partially, which means only three regions
( maroodi-jeex, awdal and saaxil) have been collected their previous
currency and replaced by a new Somaliland shilling, while the other three
regions remained unchanged and used their previous money. The Somali
shilling which were used at that time are collected and putted in the hands of

the business men and therefore, the bank notes were issued with
denominations of 5,10,10, 20,50,100,500,1000,1nd 5000 shillings and coins’
of 1 shilling , with dates ranging from 1994 to 2011. Currently only the
500sh, 1000sh, and 5000shillings notes are in circulation and the coins and
other remaining notes are not currently minted or circulated.
For the first time, the Somaliland shilling enters to the market the exchange
rate ( SICIRKA SARIFKA) were $100=5000 shillings and it was very expensive
and the two neighbor countries Ethiopia and Djibouti argues its highly
revaluated

, on the other hand, the $1=5000 of Somali shillings. But, after

a time the exchange rate was progressively increased to 4200 shillings which
is 60% in a ratio. From time to time the Somaliland currency becomes
devaluated due to the lack of control of the central bank and the
excessiveness and repeated money printed. The depreciation happened in
Somaliland shillings causes the elimination of some coins and paper money
to be out of the current usage and in circulation. Here are sample of the

8

notes that are absolutely out of the circulation or extremely reduced their
usage.

Sample of Paper notes that are not currently in the
circulation

The central bank provides exchange services for various currencies at the
official government rate, but most people prefer the better. Although,
unofficial rates provided by the remittance agents (XAWILAADAHA) and
money changers (SARIFLAYAASHA) found on the streets of the main cities. In
November 2000 the official exchange of the Somaliland central bank was
4500 shillings for 41 US dollar. Unofficial exchange rates at the time
fluctuated between 4000 to 5000 shillings per dollar, and in December 2008,
the official exchange rate had fallen to 7500 shillings per US dollar.
The main causes of the devaluation of the Somaliland currency are issuance
of excessive money, lack of central bank control, civil war (1994), livestock
9

embargo and money changers whom setup any rates they want as central
bank employee reported and most of families lived in the country are
receive their livelihood from their relatives lived in abroad in dollar. Actually
the money changers set up the rates due to their expectations of increment
sand decrements of dollar and Somaliland shilling. For occasion, at the end of
the month when the salaries are given to the employee of international
agencies in dollar and the Diaspora remitted abroad to their relatives in
dollar they decrease the exchange rate of dollar against Somaliland shilling
revaluating the Somaliland currency in order to gain a large amount of dollar
amount in few amount of Somali land shilling.

Somaliland exchange market ( suuqa sarifka lacagta

ee

somaaliland)

All the above mentioned reasons has greatly affected the value of
Somaliland shilling against the international currencies particularly dollar.
However, it needs the interference of the central bank in order to regulate
Somaliland financial market and absolutely set its regulations and control.
10

The former and current governors of the central bank have tried many times
to capture the control of the financial market, but nothing had become
fruitful for this trials and it had become null and void.

1.3. Statement of the problem

In his well-known 2007 article, michiel hendric De cock, states that the
central bank ‘’is the organ of government that undertakes the major financial
operations of government and by its conduct of these operations and by
other means, influences the behavior of financial institution so as to support
the economy policy of the government’’10. Therefore, the Somaliland central
bank has the highest authority of undertaking all financial operations and
regulating the exchange market, unlike this, the central bank fails for doing
this task and money changers and few business men those both the two
currencies shilling and the dollar are their hands regulates the market.
Since, the Somaliland community is mainly depends on the money that their
relatives remitted from the abroad and livestock, it’s important to know the
impact of the floating rate to their livelihood. Although it is undoubtedly clear
that the intervention of the central bank is highly needed, still it is feasible
that the floating exchange rate and fixed exchange rate have an impact for
the society.
It is arguable that the passive role of the central bank in the financial market
will create classes for the society, because of the instability of the money
market and incompatibility of the goods and services. However, the central
10 michiel hendric Decock, 2007, the central banking

11

bank should create a strong relationship for the money changers, business,
and ministry of finance in order to establish the regulations of the market.
As result, it is important to look for a system which can re-establish the
power of central bank and the privilege of the Somali land shillings. In order
to scrutinize how the role of the central bank can be re-established, this
thesis will answer for the following research questions:


What are the causes of the fluctuations and devaluations of Somaliland



shillings?
Does floating exchange and fixed exchange rate have a negative



impact for the exchange and value of the money?
How we can re-establish the central bank’s authority of regulating



financial market?
Do money changers and hawala changers have an impact for the



exchange?
What role the community plays the fluctuations of the Somaliland
shilling?

1.4. Objectives of the study
1.4.1. General objectives
This study will identify the functions of the central bank and how the central
bank regulates to the market. Furthermore, scrutinize the causes of the
devaluation of the Somaliland shillings. it will also examine the impact of
floating exchanges and fixed exchanges to the financial market. It focuses on
the main causes of the fluctuations of Somaliland shilling, and ultimately, it
will develop the possible solutions for the fore mentioned problems in order
to safeguard both the society and the value of the shilling and activating the
role of central bank to regulate the financial market.

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1.4.2. Specific objectives.
 To know how the Somaliland central bank works
 To identify the role central bank plays in the financial market, and
 The main causes of the devaluation of Somaliland currency
against foreign currency.
 to know the causes of the fluctuations of the shilling
 the impact of the fluctuation for the value of the shilling and the
community
 to highlight and create active central bank to regulate financial
and exchange market
 to obtain a bachelor degree of accounting

1.4.3. Significance of the study
This study focuses on the causes the devaluations of Somaliland shilling. It
specifically focuses on the exchange rates and its impact of the economy
and the society. In addition to, it will explore the affects of the money
changers and the Xawaala changers for the devaluation of the Somaliland
shillings against the dollar. Furthermore, the study seeks logical solutions for
the excessive fluctuations in the shilling through strengthen the role of the
central bank.
With view of this, this thesis will assist:






Central bank board
Government,
Businesses,
Community, and
Other concerned bodies to understand deeply and in profound way the
main causes of the devaluations of the shilling and the role the money
changers play the financial market.

13

 It also helps from the board of the bank to realize that the fluctuations
and the loss value of the currency can be resolved through the
enhancement and the effective of the central bank and creating strong
relations for all the concerned bodies.
 It will also further provide for researchers, academics and student
reliable data about the role of the central bank of the devaluation and
fluctuations of Somaliland shillings

1.5. Scope of the study
The study uses the Somaliland central bank as a case study. It examines the
causes of the fluctuations and devaluations of Somaliland shillings. With
regard to the causes of the fluctuations the study will only address the
passive role of the central bank as the primary causes which caused the loss
value of the shillings and put the market in the hands of the money
changers. The study will not be tasked to examine the other related causes
of the fluctuation and devaluation of the shilling. On other hand, the thesis
examines the possibilities of a controlling the financial market through
activating the role of the central bank and its structure. With regard to this, it
will examine the compatibility between the bank, money changers,
government institutions, and the business men and creating strong
relationships for them.

1.5.1. Limitation of the study
This study will address:
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 The passive role of the central bank as the main causes of the
fluctuation and devaluation of the Somaliland shillings.
 With regard to the other sources and the roots of the causes of the
devaluation and the fluctuations, this study will not be tasked to
address other causes.
 On other hand, the constraints of the study faces are lack of relevant,
accurate and sufficient information.

1.6. Research methodology
This study will be analytic. It will consist of an analysis on both the primary
and secondary sources. The primary data source will be
 face to face approach interview,
 Focus group discussion;
 In addition, the study will try to conduct through phone interview and
distribute a questionnaire.
Then the information that has been received will be analyzed and
incorporated to this analytical study.
The secondary sources will be gathered from the related books, magazines,
articles and Google and is mainly is used to cover the historical background
of the study.
The study uses a sample size consisting of 21 respondents out of 39

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CHAPTER TWO
LITERATURE REVIEW

2. Theoretical framework
2.1. Introduction
In this chapter the researcher will explain and describe the concepts that are
relevant in the field of central bank and exchange and necessary to facilitate
a comprehensive analysis and understanding of the research. In particular,
the frame of reference which was used in this study will be presented.

2.2. Central banking

A central bank is a public institution that manages a state’s currency, money
supply, interest rates. Somaliland central bank also usually oversees the
commercial banking system of their respective countries. In contrast to a
commercial, a central bank possesses a monopoly on increasing the
country’s monetary base. And usually also prints the national currency,
which usually as the nation’s tender.
The primary function of the central bank is to manage the nation’s money
supply (monetary policy), through active duties such as managing interest
16

rates, setting the reserve requirement, and acting as a lender of the last
resort to the banking sector during times of bank insolvency and financial
crises. Central banks usually also have supervisory powers, intended to
prevent bank runs and to reduce the risk that commercial banks and other
financial institutions engage in reckless (out of control) or fraudulent
behavior. Central banks in most developed countries are institutionally
designed to be independent from political interference.
Somaliland bank is planned to be independent for the political interference
like the political parties, government institutions and the commercial sector.

2.2.1. Naming of the central bank

There is no standard terminology for the name of a central bank, but many
countries use the ‘’bank of country’’ form. Some are styled ‘’national’’ banks
such as ‘’national bank of Ukraine’’; but the term national bank is more often
used by privately owned commercial banks, especially in the United States.
In some cases, central banks may incorporate the word ‘’central’’ (for
example European central bank; but the central bank of India is a
government owned commercial bank and not a central bank.
Other central banks are known as a monetary authority such as the monitory
authority of Singapore and many countries have state owned banks or other
quasi-government entities that have entirely separate functions, such as
financing imports and exports.
Similarly, as the article 4 of the Somaliland banking laws11 stated, Somaliland
uses the term of central bank in order to indicate both the monetary
authority and leading banking entity
11 Somaliland banking laws ‘’ XEER Lr. 54/2102

17

2.2.2. Functions of the central bank
. Central banks are charged with the responsibility of keeping the physical
reserves of the country (e.g. gold) and regulating the amount of money
in circulation and the credit supplied to the economy.
They are the sole suppliers of banknotes (the issue of coins is not
always the sole right of the central bank). Central banks are responsible
for monetary policy which keeps the national currency as stable as possible.
They represent the national interest in relations with the International
Monetary Fund, the World Bank and other international financial institutions.
Two of the four central banks in this study have banking supervision
responsibilities. Although this study is not on banking or bank supervision
practices, it is relevant to note that the principles which are relevant for bank
supervision are to a great degree similar to the internal control principles of
central banks. In this context, we draw the reader’s attention to a recent
publication by the Basle Committee on Banking Supervision, which issued a
draft framework for the evaluation of internal control systems. Central banks
play an important and unique role in a country’s economy in providing
for monetary stability. They share this responsibility with government and
parliament. In many countries, central banks combine this responsibility
with that of the bank supervision agency; in other countries, this role is
assigned to a separate authority. The central bank might view its primary
function as protecting banks, not protecting the public interest (for example,
a central bank could be said to be reluctant to raise interest rates and stem
inflation whenever such actions would hurt the banks). Voters, politicians
and oversight committees might view bank failures as evidence of poor
supervision. Central banks, conscious of their reputation, might then
refrain from monetary policy which would be disadvantageous for the
banking industry, and overall monetary policy might suffer. On the other
hand, separation of monetary policy from the supervision function might lead
18

central banks to neglect the impact of monetary policy on the health of the
banking system, which itself could have an impact on the nation’s banking
system and therefore the entire economy.

2.2.3. Monetary policy

Central banks implement a country’s chosen monetary policy. At the most
basic level, this involves establishing what form of currency the country may
have, whether a fiat currency, gold backed currency (disallowance for the
countries with membership of the international monetary fund), currency
board or currency union. When a country has its own national currency, this
involves the issue of some form of standardized currency, which is
essentially a form of promissory note (a promise to exchange the note for
money under certain circumstances). Historically, this was often a promise to
exchange the money for precious metals in some fixed amount. Now, when
many currencies are fiat money, the ‘promise to pay’’ consists of the
promises to accept that currency to pay for taxes.
A central bank may use another country’s currency either directly (in a
currency union), or indirectly (a currency board). In letter case, local currency
is backed at a fixed rate by the central bank’s holdings of foreign currency.
Somaliland central bank sets a fixed exchange rate for all the foreign
currencies such as, dollar, Riyal, Birr, pound etc, but unfortunately the
19

Somaliland bank has not backed the foreign currency and the money
changers hold the currencies due to the passive role of the bank. The holding
of foreign currencies can be backed and hold through using banks control
mechanism and other active measures undertaken by the monetary
authority.

2.2.3.1. Goals of monetary policy

There is motive behind the each countries monetary policy. But in the
common, the monetary policy enhances the employment rate it controls the
frictional unemployment (the time period between the jobs when a worker is
searching for, or transitioning from one job to another) and the structural
unemployment. It also sets price stability and promotes the economic growth
by encouraging the capital investment and lowering the interest rate in order
the firms can loan money to invest in their capital stock and pay less interest
for it. It keeps the economy from overheating and avoids market bubbles. It
makes:
 Financial market stability
 Foreign exchange market stability
 Interest rate stability

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However, the Somaliland bank has its own monitory policy and it fails
the stabilization of the exchange rate and these causes by the
devaluation of the shilling against the dollar.

2.2.4. Currency issuance

Similar to the commercial banks, central banks hold assets (government
bonds, foreign exchange and other financial assets) and incur liabilities
(currency outstanding). Central banks create money by issuing interest-free
currency notes and selling them to the public in exchange for interestbearing assets such as government bonds. When a central bank wishes to
purchase more bonds than earlier respective national governments make
available, they may purchase private bonds or assets denominated in foreign
currencies.
Since Somaliland bank is non-interest bearing still offers a loan to the
government and makes receipts and collections of some money such as the
employee income tax, and all deductions that is necessary to be made and
usually charges a fees. Then, the central bank remitted this income for the
accounts of the government institutions. This income, derived from the
power to issue currency is called seigniorage , and usually belongs to the
central government

2.2.5. Limits on policy effects
Although the perception by the public may be that the ‘’central bank’’
controls some or all interest rates and currency rates, economy theory
(substantial empirical evidence) shows that it is impossible to do both at
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once in an open market. Robert Mundell’s ‘’impossible trinity’’ is the most
famous formulation of these limited powers, and postulates that is
impossible to target monetary policy, the exchange rate (through a fixed
rate) and maintain free capital movement, this essentially means that central
banks may target interest rates or exchange rates with credibility, but not
both at once. In most famous case of policy failure, Black Wednesday,
George Soros arbitraged the pound sterling’s relationship to the EUC (after
making $2 billion himself and forcing the UK to spend over $8 billion
defending the pound), and forced it to abandon its policy. Since then he has
been a harsh critic of clumsy bank policies and argued that no one should be
able to do what he did.
The most complex relationships are those between the yen and US dollar,
and between the euro and its neighbors. The situation in Cuba is so
exceptional as to require the Cuban peso to be dealt with simply as an
exception, since the dollar were ubiquitous in Cube’s markets its
legislations in 1991, but were officially removed from the circulation in 2004
and replaced by the convertible peso.
According to this the US dollar is every were in Somaliland markets. It needs
a legislation prohibiting the dollar in the hands of the money changers and
the community. The central bank should propose a law prohibiting the dollar
in the market to the parliaments to approve it.

2.2.6. Policy instrument
The main monetary policy instruments available to central banks are open
market operation, bank reserve requirement, interest rate policy, re-lending
and re-discount (including using the term repurchase market), and credit
policy (often coordinated with trade policy).

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While capital adequacy is important, it is defined and regulated by the bank
for international settlements, and central banks in practice generally do not
apply stricter rules.
To enable open market operations, a central bank must hold foreign
exchange reserves (usually in the form of government bonds) and official
gold reserves. It will often have some influence over any official or mandated
exchange rates: some exchange rates are managed, some are market based
(free float) and many are somewhere in between managed and dirty float).
By far the most visible and obvious power of many modern central banks is
to influence market exchange rates. Although the mechanism differs from
country to another, most use a similar mechanism based on a central bank’s
ability to create as much fiat money as required.

2.2.7. Open market operation
Through open market operations, a central bank influences the money
supply in an economy directly. Each time it buys securities, exchanging
money for the security, it raises the money supply. Conversely, selling of
security lowers the money supply. Buying of securities thus amounts to
printing new money while lowering supply of the specific security.
The main open market is operations are:-Temporary lending of money for
collateral securities ("Reverse Operations" or "repurchase operations",
otherwise known as the "repo" market). These operations are carried out on
a regular basis, where fixed maturity loans (of 1 week and 1 month for the
central bank of Somaliland ) are auctioned off. Buying or selling securities
("direct operations") on ad-hoc basis. Foreign exchange operations such as
the Somaliland currency and dollars

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All of these interventions can also influence the foreign exchange market and
thus the exchange rate. For example the People's Bank of China and the
Bank of Japan have on occasion bought several hundred billions of U.S.
Treasuries, presumably in order to stop the decline of the U.S. dollar versus
the renminbi and the yen.

2.2.8. Capital requirements

All banks required to hold a certain percentage of their assets as capital, a
rate which may establish by the central bank or the banking or the banking
supervisor. For international banks, including the 55 members’ central banks
of the bank for international settlement, the threshold is 8% of risk adjusted
assets, whereby certain assets (such as government bond) are considered to
have lower risk and are either partially or fully excluded from total assets for
the purposes of calculating capital adequacy. Partly due to concerns about
asset inflation and repurchases agreements, capital requirement may be
considered more effective than reserve requirement in preventing indefinite
lending; when at the threshold, a bank cannot extend another loan without
acquiring further capital on its balance sheet.

2.2.9. Reserve requirement
Historically, bank reserves have formed only a small fraction of deposits, a
system called fractional reserve banking. Banks would hold only a small
percentage of their assets in the form of cash reserves as insurance against
bank runs. Over time this process has been regulated and insured by central
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banks. Such legal reserve requirements were introduced in the 19th century
as an attempt to reduce the risk of banks overextending themselves and
suffering from bank runs, as this could lead to knock-on effects on other
overextended banks.
As the early 20th century gold standard was undermined by inflation and the
late 20th century fiat dollar hegemony evolved, and as banks proliferated
and engaged in more complex transactions and were able to profit from
dealings globally on a moment's notice, these practices became mandatory,
if only to ensure that there was some limit on the ballooning of money
supply. Such limits have become harder to enforce. The People's Bank of
China retains (and uses) more powers over reserves because the yuan that it
manages is a non-convertible currency. Loan activity by banks plays a
fundamental role in determining the money supply. The central-bank money
after aggregate settlement – "final money" – can take only one of two forms:


physical cash, which is rarely used in wholesale financial markets,



central-bank money which is rarely used by the people

The currency component of the money supply is far smaller than the deposit
component. Currency, bank reserves and institutional loan agreements
together make up the monetary base, called M1, M2 and M3. The Federal
Reserve Bank stopped publishing M3 and counting it as part of the money
supply in 2006.
Central banks often have requirements for the quality of assets that may be
held by financial institutions; these requirements may act as a limit on the
amount of risk and leverage created by the financial system. These
requirements may be direct, such as requiring certain assets to bear certain
minimum credit ratings, or indirect, by the central bank lending to

25

counterparties only when security of a certain quality is pledged as
collateral.

2.2.10. Exchange requirements
To influence the money supply, some central banks may require that some or
all foreign exchange receipts (generally from exports) be exchanged for the
local currency. The rate that is used to purchase local currency may be
market-based or arbitrarily set by the bank. This tool is generally used in
countries with non-convertible currencies or partially convertible currencies.
The recipient of the local currency may be allowed to freely dispose of the
funds, required to hold the funds with the central bank for some period of
time, or allowed to use the funds subject to certain restrictions. In other
cases, the ability to hold or use the foreign exchange may be otherwise
limited.
In this method, money supply is increased by the central bank when it
purchases the foreign currency by issuing (selling) the local currency. The
central bank may subsequently reduce the money supply by various means,
including selling bonds or foreign exchange interventions.

2.2.11. Banking supervision and other activities
In some countries a central bank through its subsidiaries controls and
monitors the banking sector. In other countries banking supervision is carried
26

out by a government department such as the UK Treasury, or an independent
government agency (for example, UK's Financial Services Authority). It
examines the banks' balance sheets and behavior and policies toward
consumers. Apart from refinancing, it also provides banks with services such
as transfer of funds, bank notes and coins or foreign currency. Thus it is often
described as the "bank of banks".
Many countries such as the United States will monitor and control the
banking sector through different agencies and for different purposes,
although there is usually significant cooperation between the agencies. For
example, money center banks, deposit-taking institutions, and other types of
financial institutions may be subject to different (and occasionally
overlapping) regulation. Some types of banking regulation may be delegated
to other levels of government, such as state or provincial governments.
Any cartel of banks is particularly closely watched and controlled. Most
countries control bank mergers and are wary of concentration in this industry
due to the danger of groupthink and runaway lending bubbles based on a
single point of failure, the credit culture of the few large banks.

2.2.12. The independence of the central bank
Over the past decade, there has been a trend towards increasing the
independence of central banks as a way of improving long-term economic
performance. However, while a large volume of economic research has been
done to define the relationship between central bank independence and
economic performance, the results are ambiguous.
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Advocates of central bank independence argue that a central bank which is
too susceptible to political direction or pressure may encourage economic
cycles ("boom and bust"), as politicians may be tempted to boost economic
activity in advance of an election, to the detriment of the long-term health of
the economy and the country. In this context, independence is usually
defined as the central bank's operational and management independence
from the government.
The literature on central bank independence has defined a number of types
of independence.

 Legal independence
The independence of the central bank is enshrined in law. This type of
independence is limited in a democratic state; in almost all cases the central
bank is accountable at some level to government officials, either through a
government minister or directly to a legislature. Even defining degrees of
legal independence has proven to be a challenge since legislation typically
provides only a framework within which the government and the central
bank work out their relationship.

 Goal independence
The central bank has the right to set its own policy goals, whether inflation
targeting, control of the money supply, or maintaining a fixed exchange rate.
While this type of independence is more common, many central banks prefer
to announce their policy goals in partnership with the appropriate
government departments. This increases the transparency of the policy
28

setting process and thereby increases the credibility of the goals chosen by
providing assurance that they will not be changed without notice. In addition,
the setting of common goals by the central bank and the government helps
to avoid situations where monetary and fiscal policy are in conflict; a policy
combination that is clearly sub-optimal.

 Operational independence
The central bank has the independence to determine the best way of
achieving its policy goals, including the types of instruments used and the
timing of their use. This is the most common form of central bank
independence. The granting of independence to the Bank of England in 1997
was, in fact, the granting of operational independence; the inflation target
continued to be announced in the Chancellor's annual budget speech to
Parliament.

 Management independence
The central bank has the authority to run its own operations (appointing
staff, setting budgets, and so on.) without excessive involvement of the
government. The other forms of independence are not possible unless the
central bank has a significant degree of management independence. One of
the most common statistical indicators used in the literature as a proxy for
central bank independence is the "turn-over-rate" of central bank governors.
If a government is in the habit of appointing and replacing the governor
frequently, it clearly has the capacity to micro-manage the central bank
through its choice of governors.
It is argued that an independent central bank can run a more credible
monetary policy, making market expectations more responsive to signals
29

from the central bank. Recently, both the Bank of England (1997) and the
European Central Bank have been made independent and follow a set of
published inflation targets so that markets know what to expect. Even the
People's Bank of China has been accorded great latitude due to the difficulty
of problems it faces, though in the People's Republic of China the official role
of the bank remains that of a national bank rather than a central bank,
underlined by the official refusal to "unpeg" the yuan or to revalue it "under
pressure". The People's Bank of China's independence can thus be read more
as independence from the USA which rules the financial markets, than from
the Communist Party of China which rules the country. The fact that the
Communist Party is not elected also relieves the pressure to please people,
increasing its independence.
Governments generally have some degree of influence over even
"independent" central banks; the aim of independence is primarily to prevent
short-term interference. For example, the chairman of the U.S. Federal
Reserve Bank is appointed by the President of the U.S. (all nominees for this
post are recommended by the owners of the Federal Reserve, as are all the
board members), his choice must be confirmed by the Congress, and he
must appear and testify before congress twice a year.
International organizations such as the World Bank, the Bank for
International Settlements (BIS) and the International Monetary Fund (IMF) are
strong supporters of central bank independence. This results, in part, from a
belief in the intrinsic merits of increased independence. The support for
independence from the international organizations also derives partly from
the connection between increased independence for the central bank and
increased transparency in the policy-making process. The IMF's Financial
Services Action Plan (FSAP) review self-assessment, for example, includes a
number of questions about central bank independence in the transparency

30

section. An independent central bank will score higher in the review than one
that is not independent.

2.3. Conceptual framework

2.3.1. Exchange rates
In finance, an exchange rate (also known as the foreign-exchange rate, forex
rate or FX rate) between two currencies is the rate at which one currency will
be exchanged for another. It is also regarded as the value of one country’s
currency in terms of another currency. For example, an interbank exchange
rate of 91 Japanese yen (JPY, ¥) to the United States dollar (US$) means that
¥91 will be exchanged for each US$1 or that US$1 will be exchanged for
each ¥91. Exchange rates are determined in the foreign exchange market,
which is open to a wide range of different types of buyers and sellers where
currency trading is continuous: 24 hours a day except weekends, i.e. trading
from 20:15 GMT on Sunday until 22:00 GMT Friday. The spot exchange rate
refers to the current exchange rate. The forward exchange rate refers to an
exchange rate that is quoted and traded today but for delivery and payment
on a specific future date.
In the retail currency exchange market, a different buying rate and selling
rate will be quoted by money dealers. Most trades are to or from the local
currency. The buying rate is the rate at which money dealers will buy foreign
currency, and the selling rate is the rate at which they will sell the currency.
31

The quoted rates will incorporate an allowance for a dealer's margin (or
profit) in trading, or else the margin may be recovered in the form of a
"commission" or in some other way. Different rates may also be quoted for
cash (usually notes only), a documentary form (such as traveller's cheques)
or electronically (such as a credit card purchase). The higher rate on
documentary transactions is due to the additional time and cost of clearing
the document, while the cash is available for resale immediately. Some
dealers on the other hand prefer documentary transactions because of the
security concerns with cash

2.3.1.1. Exchange control
exchange control is one of the important devices to control international
trade and payments. It aims at equilibrium foreign receipt and payments, not
through such market forces as fixed or flexible exchange rate but through
direct and indirect control of foreign exchange rate. Prof. Ellsworth defines
exchange control (exchange controls deals with the balance of payments
difficulties, disregards market forces and substitute for them the arbitrary
decisions of government officials. Imports and other international payments
are no longer determined solely by international price comparisons, but also
by considerations of national need. The exchange control system has the
following main features:
1. it involves complete government control over the foreign exchange market
2. All foreign currencies are required to be surrendered to the central bank
3.the central bank fixes the official exchange rate
4. Only specified bank and licensed dealers can deal in foreign exchange
5. The central bank acts as a discriminating monopolist by charging low rates
of exchange for the purchase of essential imports and high rates for
purchasing luxury imports

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2.3.2. Retail exchange market
People may need to exchange currencies in a number of situations. For
example, people intending to travel to another country may buy foreign
currency in a bank in their home country, where they may buy foreign
currency cash, traveler’s cheques or a travel-card. From a local money
change