Promoting Economic Resilience in Yemen

2. The Financial Sector  

The current conflict in Yemen has worsened the level of fragility, vulnerability, and exclusivity of the formal banking sector that existed prior to the conflict. The bifurcation of the Central Bank of Yemen (CBY) into competing institutions and gaps in regulatory and supervisory frameworks are among the most serious challenges facing Yemeni.

The solvency of the banking system is a concern, with elevated non-performing exposures to the sovereign sector and several large private counterparties. Also, the conflict has severely undermined the confidence of several foreign correspondent banks, given the level of perceived risks of money laundering and terrorism financing, isolating the Yemeni banking sector from regional and international financial networks. 

Banks’ limited ability to perform international financial transactions, along with the domestic liquidity crisis, has eroded public trust in the banking sector and increased reliance on microfinance and informal money exchange companies. Informal money exchangers have grown in number and importance and developed several key financial services, including collecting deposits and microfinance activities. Nonetheless, transitioning from providing payment services to performing financial intermediation exposes money exchangers to business models with various implications for risk management practices and resilience.

In the context of violence and deepening economic and humanitarian crises, remittances and international donor funding have become important sources of income for Yemenis living in Yemen. However, such external funding flows to Yemen have become more volatile and susceptible to decline depending on a range of external and internal shocks, creating exchange rate pressure in IRG areas and uncertainty with respect to the availability of foreign exchange for the purchase of essential imports. Another important challenge consists of underserved Micro, Small and Medium-sized Enterprises (MSMEs) given the underdeveloped state of the financial sector and disrupted financial intermediation channels in Yemen. For households, conflict and instability resulted in low financial resilience, as well as lack of trust in the financial institutions, and reliance on informal mechanisms, illustrating limited levels of financial inclusion in the country.

The challenge ahead in to facilitate the growth and depth of the financial system, while maintaining system stability and addressing any weaknesses within the fragile economic and political environment. Potential beneficiaries will include the Central Bank of Yemen, the Ministry of Finance, banks, and money exchange companies.

First, this chapter provides an overview of the financial sector focusing on the CBY’s supervisory and regulatory functions, the structure of the sector, the growing importance of money exchange companies, MSMEs’ business conditions and access to credit, and the status of financial inclusion, literacy, and consumer protection in the country. Second, it presents the challenges faced by each actor of the financial sector. Finally, the chapter discusses policy considerations towards helping to restore trust and resilience in the financial sector, enhance MSMEs access to credit, and promote financial inclusion, literacy, and consumer protection.

Policy assessments were informed by workshops held in 2022 and 2023 with Yemeni participants from central-level institutions based in Aden, including the Central Bank of Yemen, the Ministry of Finance, the Ministry of Industry and Trade, the Ministry of Planning and International Cooperation and the Small and Micro Enterprises Promotion Services headquartered in IRG areas. Contributions of international experts draw upon their established institutional practices, country experience and knowledge, with a specific focus on restoring trust and resilience in the financial sector and enhancing MSMEs access to credit.  

Context and Overview  

Supply Side:

Banking regulation and supervision by the CBY-Aden 

Since 2011, Yemen has suffered a series of crises resulting in the ongoing war, which began in September 2014 and has crippled the economy, resulting in an acute economic and humanitarian crisis. The conflict has led to a de-facto partition of the country into two territories with the emergence of two central banks in 2016. The two central banks operate independently and often in opposition to each other, undermining the implementation of coherent monetary policy and harmonised financial sector regulation. 

All banks in Yemen are de jure operating under the regulatory and supervisory authority of the CBY-Aden, given its status as the CBY linked to the internationally-recognised government, under the responsibility of the Departments for Supervision and Inspection within the Banking Risk Control Unit. Bank risk assessment is performed using the CAMEL approach mainly for capital adequacy, liquidity ratio, loan loss provisioning, and cost-to-income efficiency. Ratios are defined according to Basel regulatory principles and minimum requirements. Tools and procedures for on-site inspections include forms and questionnaires about the several types of banks’ activities and funding sources. The methodology used at the CBY-Aden aims at evaluating individual banks’ compliance with a number of important risk management principles, such as internal banks’ methodologies for granting loans to customers, assessing credit and liquidity risks, corporate governance principles and AML/CFT strategies and procedures. The CBY issues inspection reports, which are jointly signed with the banks to officially recognise possible violations and abuses detected by the supervisor before the imposition of legal penalties. Departments for Banking Supervision and Inspection are operating under a high level of co-operation to perform off-site and on-site supervision of Yemeni banks. 

The CBY-Aden has assessed the financial soundness of Yemeni banks and, since 2021, has implemented a range of measures aimed at promoting trust and restoring capacities in the Yemeni banking sector. Notably, the CBY-Aden has significantly improved its capacities for on-site and off-site inspections of Yemeni banks (Box 2.1). For example, in 2022, the CBY-Aden identified two local banks suffering from a significant deterioration in their financial indicators, mainly from low capital adequacy and liquidity ratios and significant foreign currency exposures. The measures aim at strengthening the capacities of Yemeni banks and reducing the size of the informal financial sector. While significant progress has been achieved at the CBY-Aden to help restore trust and capacities in the Yemeni banking sector, efforts are needed to enhance banking sector resilience and promote financial stability for sustainable and inclusive recovery. 

Box 2.1. . Bank regulatory and supervisory measures implemented by the CBY-Aden in 2021-2022 

The legal framework for banking regulation and supervision by the CBY-Aden includes the following legal references: Central Bank of Yemen Law No. (14) of 2000, Banking Law No. (38) of 1998, Islamic Banking Law No. 21 of 1996 and its amendments, Microfinance Banks Law No. (15) of 2009, AML/CFT Law No. (1) of 2010 and its amendments. In 2021 and 2022, the CBY-Aden has issued a number of regulations intending to strengthen the capacities and the resilience of the formal banking sector, including: 

• Board Resolution No. (7/2022) for the creation of a Licensing Committee. 

• Board of Directors Decision No. (8/2022) to increase bank capital requirements. The capital of commercial banks and Islamic banks has been raised from YER 6 billion to YER 45 billion (Yemeni riyal). The capital of microfinance banks has been increased from YER 500 million to YER 5 billion. 

• Board of Directors Decision No. (9/2022) for amendments to the mandatory reserve ratio. The percentage of legal reserves that banks must withhold from annual profits has been increased from 15% to 25% at least. 

• Board of Directors Decision No. (10/2022) for the conditions and the procedures for initial licencing of domestic and foreign banking entities. 

• Board Resolution No. (11/2022) for revisions of the Microfinance Banks Law. It is prohibited by law to combine money exchange and microfinance activities. Any application to establish a microfinance bank shall be rejected if all or a group of shareholders are also major owners of private commercial or industrial groups, unless the groups will be merged within such microfinance entity. Founders of a licenced microfinance bank should dedicate themselves to the new established financial entity and cease all their activities in the private non-financial sector if any, and within a period of one year since the start of their microfinance activities. 

• Board Resolution No. (/ 2022) for amendments to the regulatory requirements for payment service providers and payment system operators. Business model transition from payment servicers to financial intermediaries is encouraged for large money exchangers that are performing microfinance activities. A unified financial network has been established to limit operations performed by informal money exchangers. 

• Circular No. (1) issued in 2021 about business continuity plan. The launch of foreign currency auction programmes in November 2021 for all Yemeni banks that meet minimum requirements intends to facilitate imports of food and other commodities and help banks meet customers’ demand for cash. 

• Circulars No. (2,3) issued in 2021 including control procedures for AML/CFT and red-flag indicators. Instructions have been issued to banks and money exchangers for foreign currency exchange and foreign transfers to mitigate speculation and ML/FT. 

The CBY-Aden is considering several areas for future regulatory and supervisory improvements in the banking sector, including: i) the establishment of supervisory entities dedicated to payment service providers and payment system operators; ii) the elaboration of legal and regulatory frameworks for e-money issuance by non-bank financial institutions; iii) the strengthening of the role of public banks to support the CBY-Aden in implementing monetary policy and promoting financial inclusion through the expansion of a range of products and services targeted to client needs; iv) gradual improvements in banking regulatory and supervisory frameworks in alignment with international standards; and v) the strengthening of banking regulation and supervision for AML/CFT in close co-ordination with the Financial Information Collection Unit (FIU). A memorandum of understanding has been already signed between the two parties. 

Small Yemeni financial sector dominated by the banking sector  

Yemen’s formal financial sector is one of the smallest in the MENA region, characterised by a dominant banking sector. According to the Yemeni Institute of Bank Studies, total assets in the Yemeni financial sector accounted for 58% of total GDP at end-2019, which is one of the lowest asset-to-GDP ratios in the MENA region. Banks represent 75% of the total assets in the sector.  

22 banks are currently operating in Yemen: 3 state-owned banks, 4 domestic commercial banks, 4 foreign-owned commercial banks, 5 Islamic banks, and 6 microfinance banks. Most of them have become divided, with competing branches in Aden and Sana’a operating under IRG and DFA supervision, respectively. Despite the large number of banks, the market remains highly concentrated with three banks (i.e. the International Bank of Yemen or IBY, Tadhamon Bank, and CAC Bank) holding about 50% of the Yemeni banking system’s total assets in 2021 (Ministry of Planning and International Cooperation, 2021[15]).

Also, banking services are concentrated in the main cities, while rural and remote areas lack these services except for the financial transfer services that take place through branches of some banks, money exchange companies, and post offices. Concentration level suggests a considerably low degree of competition between Yemeni banks, which has likely influenced their efficiency and ability to attract deposits as well as their lending and financing operations. Also, other smaller banks are probably experiencing major challenges from deteriorated business conditions and financial soundness, which render them extremely fragile financially and almost non-viable.  

Prominent role of exchange companies for money exchange services  

The money exchange sector in Yemen predates the formal banking sector by decades. CBY is the licensing and regulatory authority for money exchangers. Nevertheless, CBY-Aden and CBY-Sana’a issue separate licenses and regulations. By law, money exchangers are licensed to sell and purchase foreign currencies and process local and international money transfers. Many money exchangers are integrated with regional unregulated (hawala) networks. In practice, their core business activity consists of processing the informal inflows and outflows of import financing and remittance delivery FX transactions that the remittance of migrants’ funds (Bahadur, J., 2020[16]; Rethinking Yemen’s economy, 2020[17]) .  

Money exchangers started to engage in several key financial services beyond the scope of what their licenses permit. With banks losing their role in trade financing and financial intermediation, and highly constrained demand from individuals for formal financial services in Yemen, money exchangers have accumulated tremendous amounts of customer savings. Particularly, in terms of trade financing, they have become the primary destination for deposits and source of credit for traders (including importers). Even before the conflict, many money exchangers held customer deposits. 

Since the onset of the conflict, informal money exchangers – both licensed and unlicensed – have grown in number and importance (Figure 2.1). In 2014, there were 605 licensed and no unlicensed money exchangers. In 2022, the number of money exchange businesses totalled 1 114, of which 800 (licenced and unlicenced) were operating in DFA areas and 314 were licensed by the CBY Aden (i.e. including 82 joint ventures with 717 branches). Money exchangers play a central and critical role in the Yemeni economy and for a much broader section of the population than banks as they are more accessible to the public, have been able to maintain a sustained flow of funds, and have wide and comprehensive networks (Bowers, C., 2019[18]). 

Figure 2.1. The significant expansion of the Yemeni money exchange sector 

Source: Central Bank of Yemen-Aden. 

As money exchangers have not been constrained by scarce liquidity like commercial banks, they have also developed microfinance activities in the most recent years.  

Business conditions and MSMEs financing 

Micro, Small and Medium Enterprises (MSMEs) play a major role in most economies, particularly in emerging markets and developing economies. However, access to finance is frequently identified as a critical barrier to growth for MSMEs, including in Yemen. It is the second most cited obstacle facing MSMEs to grow their businesses in emerging markets and developing economies. MSMEs are less likely to be able to obtain bank loans than large firms; instead, they rely on internal funds, or cash from friends and family, to launch and initially run their enterprises. Yemenis exhibit a high level of borrowing activity, with approximately 65% of the population aged 15 or older engaging in formal or informal borrowing (Figure 2.2). However, the amount of informal borrowing represents 60 times the amount of formal borrowing.  

Figure 2.2. Borrowing trends in the Arab World 

Note: On the left figure, borrowing include formal and informal transactions in 2021. 

Source: World Bank (Findex, Consultative Group to Assist the Poor). 

MSMEs are subject to greater financial instability. An unexpected exogenous shock can impact MSMEs through the reduction in the supply of labour and the interruption of the supply chains (i.e. supply side) or a drop in spending and consumption. Hence, MSMEs are less resilient and flexible in dealing with the costs that wide, unexpected shocks entail. 

Like in many emerging and developing economies, the microfinance industry in Yemen plays an important role in supporting the overall expansion of the Yemeni economy. Over the past two decades, the microfinance industry in Yemen issued loans for a cumulative value of approximately USD 50 million (i.e. around 800 000 loans given to a total of 100 000 micro and small enterprises that have created over 9 895 jobs). The potential market for MSMEs finance in Yemen has a size of around 1.78 million microenterprises and 85 000 small enterprises. Nevertheless, the current microfinance industry in Yemen serves approximately 9% of the actual market size. And over 61% of the rejected loan applicants were rejected due to the lack of sufficient collaterals. Unfortunately, a vast majority of Yemeni entrepreneurs cannot provide the required guarantees, in whole or in part, though they are capable of paying instalments and performing subsequent obligations in order to secure the service. Therefore, the need for services that provide a conducive business environment for MSMEs to take advantage of opportunities in the economy has become urgent and essential.  The Small and Micro Enterprises Promotion Services (SMEPS) and the Yemen Loan Guarantee Fund have developed the following supportive measures: 

• The SMEPS supports beneficiaries through cash transfer programmes and grants for MSMEs, or by providing the equipment needed to support continuity and growth. Also, SMEPS provides training to improve MSME’s founder’s performance and help them achieve the required level of knowledge and skills. 22 529 micro producers received technical support since 2017, 20% of whom are females. Overall, 8 624 micro producers were granted to increase their incomes and productivity; and 115 927 permanent or temporary job opportunities have been created. Also, SMEPS intends to support private sector development by providing technical to 5 644 enterprises since 2017, of which 1 183 enterprises received financial support in the form of matching grants and 1 122 SMEs benefited from SMEPS support. A total of 150 firms have accessed financial loans, and 47 928 jobs have been created, of which 36% were for females and 60% were permanent sustained jobs. 

• The Yemen Loan Guarantee Program (YLG) aims to facilitate financial accessibility for MSMEs through the provision of partial loan guarantees on loans made by banks and microfinance institutions to MSMEs located in Yemen. The YLG primarily concentrates on enterprises that operate in agricultural, manufacturing and industry, and technological sectors. Since 2017, the YLG has guaranteed 5 731 transactions, of which 72.7% were granted to men-owned businesses, 60% to businesses located in rural areas and 55% to young-owned businesses.  In nominal terms, the YLG has provided a cumulative amount of USD 42.8 million of guarantees for a loan principal amount of USD 63.6 million. The largest share of the amount of guarantees has been provided to agricultural businesses (36%), followed by commercial (29%), livestock (19%), services (9%), industrial and manufactures (7%) and fisheries (4%) businesses. 

 Demand Side:

Financial well-being, inclusion and literacy 

People living in Yemen have limited financial resilience, financial inclusion and limited financial literacy. They live day to day, they are indebted, they rely on informal mechanism for transacting and making ends meet, and they have limited or no financial buffers. 

Financial well-being and financial resilience in Yemen are extremely low. The financial well-being score in Yemen is 15 out of 100, the lowest among the countries that participated in the OECD/INFE 2023 International Survey of Adult Financial Literacy. Across participating countries and economies, the average financial well-being score was 42 out of 100 points (47 out of 100 across participating OECD countries) (OECD, 2023[19])​.  

Financial inclusion and access to formal transaction accounts in Yemen is low (amongst the lowest in the Middle East and North Africa region) and was low even before the start of the conflict (4% in 2011 and 6% in 2014​​ (FinDev Gateway, n.d.[20])). Access to formal banking services in Yemen is significantly low. Just 12% of adults declared having a current account at a formal financial institution and 11% declared having a savings account, while these two products are the most widespread financial products in Yemen. Moreover, a significant percentage of those Yemenis with an account at a formal financial institutions had difficulties accessing it, resulting in individuals and businesses relying on cash or informal money transfer services.  

Financial literacy levels in Yemen are also low and they are correlated with education and income levels, as well as location. The average financial literacy score in Yemen is 42 out of 100, which is lower than the score of any other country that participated in the OECD/INFE 2023 International Survey of Adult Financial Literacy (OECD, 2023[19]).

Financial Consumer Protection framework 

Findings suggested that, as of end 2021, there was no clear financial consumer protection framework in place for bank or microfinance organisations clients. Within the Yemeni Banking Law (Law 38, 1998) there were provisions in relation to privacy protection. There were, in addition, ethics provisions written into some commercial bank charters, but there was no specific entity with a clear mechanism to govern or enforce these, nor to impose penalties in case of irregularities.   

Over the course of the Project, several important developments in terms of financial regulation and financial consumer protection have taken place in Yemen. In July 2022, and over the course of 2023, the CBY-Aden has decided to prioritise financial inclusion and financial consumer protection policies, as key pillars to rebuild the resilience of the Yemeni financial sector and of financial consumers.  

As a result, in 2023, the CBY-Aden started to develop a comprehensive Financial Consumer Protection framework aligned with the G20/OECD High-Level Principles on Financial Consumer Protection. The Regulatory Instructions for Financial Consumer Protection, which were reviewed by the OECD, were adopted by the CBY-Aden in August 2023 and at the time of writing are in the process of being implemented.

Current Challenges

Supply Side:

Challenges faced by the CBY under current fragile conditions  

The CBY faces a number of challenges, which are undermining its regulatory and supervisory functions. During their presentation at the OECD workshop, the experts from the CBY-Aden highlighted two major types of challenges facing CBY with respect to banking sector regulation and supervision: 

The CBY faces legal and regulatory challenges, including: 

• Deficiencies in the legal framework to define the role of the CBY for banking sector regulation and supervision (i.e. laws implemented are outdated). 

• Weaknesses in some of the supervisory requirements and remaining gaps to comply with the best international standards and analytical methodologies for comprehensive banking sector oversight and control, including: i) capital standards defined according to Basel I framework; ii) the lack of implementation of IFRS 9 accounting standards; iii) the lack of efficient accounting and data reporting frameworks and iv) the lack of stress test performed by the CBY in the banking sector. 

The CBY is experiencing a range of operational challenges, including: 

• The lack of technology and efficient operating systems to compile comprehensive financial databases at the CBY, such as improving capacities of a credit bureau system to provide accurate credit information of new borrowers to Yemeni banks’ and allow for accurate credit risk assessment. Lack of efficient accounting and data reporting frameworks prevents the CBY-Aden from performing effective supervision of Yemeni banks. 

• Dual currency system and different exchange rates used to valorise assets of banks in IRG versus DFA areas require additional efforts by the CBY to obtain accurate assessments for consolidated banking data. 

• The fact that many Yemeni banks are headquartered in Sana’a poses challenges to the CBY-Aden to perform effective supervision and implement new regulatory requirements. For instance, it does not have access to the monetary data and customer details of the banks headquartered in Sana’a due to restrictions imposed by the DFA (Sana’a Center for Strategic Studies, 2020[21]).  

• Lack of resources in CBY-Aden. The relocation by the Internationally Recognised Government (IRG) of the CBY headquarters to Aden in 2016 was performed without first securing the institutional expertise and staff, information archives or financial reserves necessary for the new location to carry out central bank functions (Sana’a Center for Strategic Studies, 2019[22]). In fact, while the CBY in Aden has gradually developed greater capacities and is internationally recognised, this loss of employees generated a lack of institutional and technical capacity (i.e., knowledge and skills in the workforce) to supervise domestic banking operations or evaluate banks’ liquidity needs, among other deficiencies.  

Yemeni’s banks limited ability to play their role as financial intermediaries to support a sustainable and inclusive economic recovery  

A number of challenges are limiting Yemeni banks’ ability to play their role as financial intermediaries to support a sustainable and inclusive economic recovery. During their presentation at the OECD workshop, the experts from the CBY-Aden have highlighted the following major challenges identified in the Yemeni banking sector: 

• Gaps in CBY regulatory and supervisory frameworks and regulatory competition between CBY-Aden and CBY Sana’a threaten the banking sector’s resilience. Besides creating regulatory uncertainty and conflicting requirements for financial institutions, it raises their operational costs and undermines their ability to intermediate and conduct traditional banking functions. Ultimately, it can have detrimental effects for individual bank risk management, solvency and resilience.   

• The majority of Yemeni banks are private owned companies by large commercial or industrial groups, for which corporate governance standards suffer many gaps compared to international standards and best practices. 

• Large non-performing foreign currency exposures of Yemeni banks are resulting from facilities granted to related parties and major clients without sufficient guarantees taken as collateral, which has been aggravated by the significant depreciation of the Yemeni riyal. 

• Yemeni banks have been required to invest a significant proportion of their cash in the form of mandatory reserves, current accounts and other investments at the CBY-Sana’a that cannot be withdrawn (i.e. from frozen accounts in Sana’a).  

• Regulatory deficiencies and gaps in controls for combating ML/TF in the Yemeni financial sector has contributed to erode the reputation of Yemeni banks domestically and abroad, and to their classification as high-risk counterparties. As a result, they are unable to operate international transactions for remittances.  

• As a result of the depletion of local and foreign currency reserves and of the depreciation of the Yemeni Rial and the dual currency system, Yemeni banks are experiencing a liquidity crisis. Their inability to perform international transactions due to limited access to foreign currency reserves and customers’ inability to withdraw their savings amid restrictions implemented on deposit withdrawals contribute to the erosion of public trust in the banking sector.  

Money exchangers subject to a low level of scrutiny and money laundering and terrorism financing  

The inability of financial institutions to meet the financing needs of the customers led to the erosion of public trust in the banking sector and the expansion of an informal network of money exchange companies, further weakening the financial intermediation role of Yemeni banks. Transitioning from providing payment services to performing financial intermediation exposes money exchangers to new business model and risks with various implications for risk management practices and resilience.  

• No adequate regulatory and supervisory frameworks governing money exchange companies 

Money exchange companies holding customer deposits and granting loans raises challenges with regards to their solvency and depositors’ protection, as there are no adequate regulatory and supervisory frameworks for the moment. For instance, customers’ deposits are not covered by any deposit guarantee scheme (DGS). A portion of depositors have lost their money as several money exchangers went bankrupt in 2020-2021.  To address this challenge, the CBY-Aden has asked money exchangers either to close savings accounts by the end of 2022 or to apply for a licence to become microfinance banks that would operate under the supervision of the CBY.  

• Vulnerability to money laundering and terrorism financing  

In addition, concerns are rising about the origin and transparency of equity financing of some money exchangers. Money exchangers are vulnerable to money laundering and terrorism financing as almost 70% of financial transactions in Yemen are currently performed outside of the formal financial sector. Therefore, money exchangers need to be subject to adequate AML/CFT standards and compliance monitoring frameworks to promote sound business practices and enhance borrowers’ and depositors’ protection. It will also safeguard financial stability and prevent possible competition distortions for the incumbent commercial banks in Yemen. 

MSMEs’ limited access to credit in Yemen  

During their presentation at the OECD workshop, the experts from the CBY-Aden and the Small and Micro Enterprises Promotion Services (SMEPS) discussed a number of challenges for MSMEs’ access to credit in Yemen. The major challenges include the following: 

• the lack of investors’ trust (including banks and MFIs) in small-scale borrowers’ ability to meet their financial obligations under fragile economic conditions. This is because MSMEs are subject to greater financial instability. An unexpected exogenous shock can impact MSMEs through the reduction in the supply of labour and the interruption of the supply chains (i.e. supply side) or a drop in spending and consumption. Hence, MSMEs are less resilient and flexible in dealing with the costs that wide, unexpected shocks entail. 

• the seasonal characteristics of remittances that are primarily used for primary expenses of families rather than for business investments. 

• risk management challenges at Yemeni banks and MFIs due to the lack of sufficient collaterals, the lack of information about the credit history of small-scale borrowers and their limited repayment capacities. Default probability of small-scale borrowers is subsequently higher amid the very short-term duration of the loans, which often results in due repayments exceeding borrowers' revenue generation capabilities. 

• family-owned banks in Yemen and the issue of connected lending that is undermining the availability of credit for MSMEs. 

• temporary grants provided to small-scale borrowers given the limited capacities of national agencies (such as the Small and Micro Enterprises Promotion Services and the Yemen Loan Guarantee). 

• the lack of a guarantee fund and problem loan resolution strategies to absorb loan losses and strengthen the resilience of credit institutions. 

• the lack of collaboration between the various types of businesses involved in the supply chain. 

Demand Side:

Financial well-being, inclusion and education constrained by conflict

The political, social, economic and financial instability resulting from the conflict in Yemen has affected the business sector, limiting the opportunities to work and make a living. A lot of people lost their job, cannot work because of instability or do not receive their salaries on time. Hence, access to financial resources became difficult. This has had negative effect on the demand of credit, and has greatly affected people’s lives, including their ability to cope with expenses or access financial resources to smoothen financial shocks.

Following the start of the conflict, financial institutions in Yemen have persistently faced difficulties in performing their regular operations, including providing a safe place for people to store their savings or extending credit lines. This has weakened the population’s trust in the formal financial sector, resulting in limited financial inclusion levels. The high cost of financial services and the lack of financial resources, financial education and infrastructure enabling financial inclusion further explains the limited engagement with formal financial services.  

In Yemen, much of the needed infrastructure for an effective operation of the financial sector (including banking and payments) was limited or severely affected by the war. This is particularly true in rural and remote areas as banking services were originally concentrated in the main cities. Damaged electricity and telecommunication infrastructures further prevent the development of Fintech and digital financial services, which could be key in expanding financial services to excluded population, in the absence of a capillary bank branch network and difficulties in physical access to banking infrastructure. Instead, Yemenis rely on informal financial services providers, which threaten financial sector’s stability and financial consumer protection as previously mentioned.  

Insufficient regulatory supervision and capacities regarding financial consumer protection

While the Regulatory Instructions for Financial Consumer Protection that were adopted by the CBY-Aden in August 2023 align with the OECD Financial Consumer Protection (FCP) Principles, the CBY-Aden team mentioned challenges related to the effective implementation and supervision of these Regulatory Instructions. The implementation challenges are due to limited human resources and capacities of the banking supervision department, as well as more generally given the current context of a fractured landscape of central banking in Yemen. A lack of standardise disclosure practices and an absence of training requirements for financial services providers also hinder the effective supervision of the Regulatory Instructions. 

Moreover, remaining regulatory gaps impede the effective protection of financial customers. For instance, consumers have currently no avenues for complaints or redress for consumers of money exchange companies. This is especially affecting customers facing frozen deposits and cross-border transactions. For more information on Consumer Protection Challenges.  

 

Policy Priorities  

Supply Side:

Enhancing intermediation capacities and resilience of banks and licensed money exchangers 

Any initiatives to strengthen the Yemeni banking sector are invariably tied to the evolving political situation in Yemen, including but not limited to the division between IRG and DFA areas. Restoring trust and capacities in the Yemeni banking sector is a precondition to any progress to achieve an inclusive and sustainable recovery. Many initiatives could be launched to help resolve a number of challenges identified in Yemeni banking and money exchange sectors and promote resilience. Relevant policy considerations include enhanced AML/CFT supervision and correspondent banking capacities, strategies to unfreeze bank accounts and strengthen the Deposit Guarantee Scheme (DGS), improvements of financial institutions’ regulatory and supervisory frameworks, a resolution strategy in the banking sector, and the restructuring of financial intermediation. 

Strengthening risk-based and thematic AML/CFT supervision in the financial sector under fragile conditions 

The CBY-Aden should build upon its existing efforts to develop adequate monitoring and supervisory capacities to independently assess and address AML/CFT deficiencies in the Yemeni banking and money exchange sector. Better risk knowledge could be promoted by supporting financial institutions to identify, assess and understand the type and the nature of ML/TF risks in business operations (i.e. product and services, customer risks, geographical risks and channel of delivery).

The CBY-Aden could perform targeted supervision by developing a risk-based AML/CFT model for banks and licensed money exchangers based on the identification and assessment of ML/TF risks, planning of supervisory action and monitoring and follow-up. Encouraging digitalisation could facilitate customer registration systems and information sharing between custom authorities and financial institutions.  

The CBY-Aden could also impose a range of disciplinary and financial sanctions (i.e. the power to withdraw, restrict or suspend the bank’s licence) and other administrative measures (i.e. public statement, cease and desist order and temporary ban). A maximum amount of the sanction should be defined by law (or as a share of the total annual turnover).  

Guidance for actions by the FATF would help the CBY-Aden adopting and implementing its resolution strategy to promote a culture of compliance by raising awareness and implementing training programmes for practitioners in the financial sector. The aim is to educate practitioners about the best principles and practices to implement due diligence procedures and safeguard the progress achieved for AML/CFT in the Yemeni banking sector.

To licensed money exchangers, the CBY-Aden should consider ultimate beneficiary owner and appointing compliance officers in its framework for addressing AML/CFT risks. The role of the compliance officer should be clearly defined. The regulation should ensure that the compliance officer possesses adequate knowledge and expertise to perform his tasks.

Restoring correspondent banking capacities in Yemen 

Yemeni authorities may identify ways to guarantee correspondent banking relationships with Yemeni banks. The IRG and CBY-Aden may collaborate by developing legal frameworks and supporting interventions required to address systemic vulnerabilities and improve the confidence of the global financial community in the operational capacity in Yemen to combat illicit financial flows. Implementing global AML/CFT standards would help identifying and verifying the identity of customers and beneficial owners, receiving and sharing customer and transaction information, screening for targeted financial sanctions and establishing and maintaining correspondent banking relationships. 

Unfreezing accounts and resolving liquidity shortages for banks and depositors 

Restoring access for banks in IRG areas to frozen deposits in Yemen and abroad would ease liquidity pressures for both banks and the Yemeni population and restore trust in the banking sector. Dialogue and mediation between the CBY in Aden and in Sana’a on the banking sector could be initiated by a consortium of large players, including banks and licensed money exchangers. Also, an independent third party (international organisation for example) could co-ordinate with private financial companies on de-confliction and de-escalation efforts. Progress achieved to address AML/CFT, improve corporate governance and strengthen the resilience of the Yemeni banking sector would help restoring confidence of international counterparts in Yemeni banks. Therefore, accounts of Yemeni banks abroad would be gradually unfrozen to meet the liquidity needs of their clients. 

The CBY-Aden should continue its efforts to efficiently regulate the foreign exchange market, against currency speculation and arbitrage, and addressing the impact of continued depreciation of the Yemeni riyal (YER) in IRG areas on inflation. Nonetheless, halting the depreciation of the riyal is challenging as either IRG needs to reduce its deficit, or CBY-Aden needs to increase its FX reserves, or both. More stable monetary conditions could help restoring public confidence in the financial sector that would increase Yemenis’ willingness in granting loans and mitigate their high preference for holding tangible goods and cash. Reducing the gap between Yemeni riyal exchange rate in DFA and IRG areas would enable an accurate valuation of Yemeni banks assets and liabilities to assess bank capitalisation needs, assets credit quality, liquidity positions and implement effective resolution strategies. However, reducing such a gap could be challenging as it either requires exchange rate adjustment on the part of DFA (something it has been reluctant to do, even though its exchange rate is overvalued), or fiscal consolidation on the part of IRG, or an increase in CBY-Aden’s FX reserves. 

Improving deposit safety within the Deposit Guarantee Scheme 

The CBY-Aden could elaborate a strategy to establish a DGS that would cover local currency deposits held in IRG areas. Under the current DGS, some 70% of deposits would be covered in case of a bank failure and depositors would receive their compensation within one month. Yet DGS funds are currently stored in accounts administrated by the CBY in Sana’a. Another major challenge is that DGS funds have been invested in distressed sovereign government bonds. Given a significant amount of deposits have been frozen since 2016, but other accounts (i.e. cash accounts) have been opened since then, international experts suggested that the CBY-Aden could partner with banks and the IRG to develop a DGS that would cover deposits on “cash accounts” held in IRG areas denominated in Yemeni riyal.

An estimate of the number of deposits that could be covered by the DGS would be needed to help the CBY-Aden and the Ministry of Finance to jointly define DGS funding needs (and financing channels) to help restoring public trust in the Yemeni banking sector. Also, the CBY-Aden may need to strengthen its capacities to supervise such DGS, elaborate diversification strategies of DGS funds and perform regular stress-testing exercises. Renewed dialogue between the CBY in Aden and in Sana’a (while not likely to be immediate or straightforward) could enable coverage expansion to other deposits held in DFA areas in the future and implement a single adequately funded and managed DGS. Also, the Yemen Banks Association (YBA) may facilitate the mediation between individual banks and the CBY-Aden to support the initiative and promote depositors’ protection broadly in the Yemeni banking sector. 

The CBY-Aden could include licensed money exchangers in its strategy to establish a DGS to enhance depositors’ protection, which would cover local currency deposits held in IRG areas. Like with banks, the CBY-Aden would have to estimate the number of deposits at licensed money exchangers that could be covered by the DGS and collaborate with the IRG MoF to jointly define additional DGS funding needs (and financing channels). The Yemeni Money Exchangers Association may also facilitate the mediation between individual licensed money exchangers and the CBY-Aden to support the initiative and promote depositors’ protection broadly in the Yemeni money exchange sector. An alternative to a DGS might be an institutional protection scheme (IPS), which is formed by licensed money exchangers and where the entities adhering to the scheme guarantee to prevent any default of a member of the scheme. 

Strengthening regulatory and supervisory frameworks for in-depth financial stability analysis 

The CBY-Aden could include licensed money exchangers in its programme, in addition to banks, to develop high-quality supervisory and risk information about the financial sector. Business model monitoring and financial stability reports would provide up-to-date and comprehensive assessments of risks and loss absorption buffers in the Yemeni banking and money exchange sectors. The business model monitoring report would be complementary as it provides information about the nature of the risks attached to the several types of banks and licensed money exchangers, by using comprehensive databases and monitoring tools, and the relative contribution of each identified business model to systemic risk throughout the economic cycle (Euro-Mediterranean Economists Association, 2022[23])​.

To licensed money exchangers, the CBY-Aden should continue its efforts in introducing minimum capital requirements (such as requiring minimum provision rates to compensate for the lack of collateral). A risk-sensitive approach could be used to define minimum capital requirements based on the array of activities performed by licensed money exchangers and/or on the volume of transactions that they execute. It could be linked either to the total assets (i.e. total assets cannot exceed 10 times the capital) or the volume of transactions (such as risk-based capital requirement could be calculated by multiplying a scaling factor with the payment volume. Moreover, the CBY-Aden could enhance its capacities to educate money exchangers to transition from providing payment services to performing financial intermediation. In particular, the CBY could develop a manual that will be circulated to licenced money exchangers including practical guidance for sound business conduct, risk management and key regulatory and supervisory requirements (including information about licencing and inspection procedures).

Strengthening resilience through a resolution strategy in the banking sector

CBY-Aden efforts in performing an independent asset quality review (AQR) of the leading banks would help assessing actual capital shortfall to implement accurate resolution strategy. The CBY-Aden could establish so-called early intervention indicators to recognise at an early-stage banks’ problems. When it comes to resolution, standard principles for addressing losses in banks’ balance sheets include a recognised hierarchy of losses, sustainability, and equity. Options based on bank-by-bank assessment may include liquidation, negotiated recapitalisation, statutory bail-in, asset separation/transfer or merger for a limited number of cases.

The CBY-Aden could consider liquidating banks with a non-viable business structure, in duly justified cases, and remaining performing assets may be transferred to a bridge bank (i.e. indirect bail-in). Besides, bank-by-bank assessment may also be performed by individual banks in Yemen following an agreement between themselves on a set of regulations that would disaggregate successful banks from banks that are struggling to operate. For that purpose, the YBA may be one possible party to facilitate the mediation and support self-regulation.

Restructuring financial intermediation

Prioritising actions to help restructure the banking sector in the medium-to-long term to better reflect the reality of how the sector operates and the complementary services that banks and money exchangers provide. For instance, efforts to address AML/CFT could help commercial banks developing their trade finance activities to support the recovery in some strategic sectors (such as agricultural, fisheries, and possibly other sectors). In the longer term, banks may also consider diversifying their credit activities and develop products targeted to the needs of their customers.

Besides, licenced money exchangers could focus on enhancing their offer of payment services and the safety of transactions. As money exchangers benefit from substantial outreach in rural areas, they may consider developing further their financial intermediation activities to individuals and MSMEs. This would contribute to a higher degree of diversification in the Yemeni banking sector, including institutions with different business models and client bases. Overall, this would contribute to the promotion of financial inclusion of retail and business clients to support an inclusive recovery. 

Promoting a holistic approach to improving MSMEs access to finance 

A holistic approach may integrate advisory and lending services for targeted borrowers in the MSME sector and promote collaborations between several central-level Yemeni financial institutions (such as the CBY-Aden, the IRG Ministry of Trade and Industry), national agencies (such as SMEPS), and financial intermediaries (i.e. banks, MFIs, money exchangers). Relevant policy considerations include targeted credit strategies to strategic sectors, sound governance and business conduct practices, complementary public support measures, and the use of digital technologies and Fintech. 

Designing credit strategies targeting MSMEs in strategic sectors for development 

Collaboration between the CBY-Aden, Yemeni banks, and licensed money exchangers could facilitate the evaluation of the finance gap of MSMEs that would enhance the provision of credit and savings services to MSMEs in identified strategic sectors. The starting point for Yemeni policymakers should consist in clarifying the appropriate definition of an MSME. In addition, public authorities should be able to gather data about the financial soundness of the firms to identify the viable firms that will effectively contribute to economic growth. In that perspective, the CBY-Aden should consider the involvement of public banks in prioritising credit allocation to viable MSMEs operating in strategic sectors, including agriculture, fisheries, retail goods and services, and manufacturing. Positive outcomes could lead to better financial integration of public and private banks and licensed money exchangers, which would promote financial inclusion (including supporting women and young entrepreneurs) and inclusive economic recovery in Yemen. 

Enhancing sound governance and business conduct practices to promote public trust in MSMEs 

The corporate governance framework should operate to achieve robust and transparent risk management and decision making, which would contribute to boosting performance and strengthen public trust and reputation for all companies across economic sectors in Yemen.^vi Identifying priority needs and adopting measures to promote a culture of sound corporate governance, including practical guidance and good practices, is essential. Raising entrepreneurs’ awareness about the importance of a symbiotic relationship among capital providers, key stakeholders, and the management of a company, could help achieve sound governance.

The G20/OECD Principles of Corporate Governance (OECD, 2015[24]), the OECD Guidelines on Corporate Governance of State-Owned Enterprises, 2015 Edition (OECD, 2015[24]), and the OECD Guidelines on Anti-Corruption and Integrity in State-Owned Enterprises could support Yemeni policymakers in developing guidance, consistent with international standards. Better accountability of Yemeni entrepreneurs and board members, transparency and disclosure, would enable Yemeni supervisory to perform effective monitoring and identify compliance gaps. Such efforts should be complemented by judiciary reforms that provide stakeholders with incentives to comply with sound governance and equip judges to impose fair sanctions. In addition, alignment with international standards is beneficial to improve foreign investors’ trust (i.e. international organisations and international donors) as they highly value having prior knowledge of the prevailing standards in a particular country. 

Providing complementary public support measures to MSMEs lending 

The combination of public support measures, such as central bank credit facilities and government-backed credit guarantees, is essential to addressing the financing gap faced by MSMEs within a fragile economic environment. First, the CBY-Aden could assess the amount of liquidity needed, the interest rate, the maturity of the credit facility and the amount of collateral required that would incentivise banks to effectively expand their lending activities to MSMEs. Establishing the magnitude and terms of these credit facilities is crucial for guiding monetary policy decisions towards achieving targeted policy objectives and safeguarding financial stability. Second, government-backed credit guarantees would help address the lack of sufficient collateral as MSMEs would pledge the government’s resources as (partial) collateral. In order to protect MSMEs from interest rate fluctuations and safeguard their credit quality, loans should be granted at a fixed interest rate with a maturity that would imply affordable due repayments considering borrowers' revenue generation capabilities. Overall, the IRG MoF and the CBY-Aden, jointly with other relevant bodies, should assess the number of guarantees needed and credit line facilities from the CBY-Aden to commercial banks, to determine the capitalisation requirements of the guarantee fund and the sustainable funding approaches. These measures would strengthen the resilience of financial intermediaries and borrowers’ credit quality.  

Promoting digitalisation and Fintech to unlock capital sources and promote the development of MSMEs businesses 

Financial technology (FinTech) could enhance the performance of lending activities for MSMEs through new value-creation opportunities and competitive position for lenders, including by reaching out to clients in rural areas and by providing a range of products targeted to borrowers’ needs. Also, accumulated information from digital transactions could be used to create credit information and collateral registration databases to improve the assessment of the historical probability of defaults of MSMEs, transparency for effective borrower monitoring processes and problem loan resolution procedures. 

In terms of regulation, the creation of a FinTech regulatory sandbox and a review of the banking law could be performed by the CBY-Aden to support the expansion of the Fintech sector while preserving financial stability. A sandbox could enhance authorities’ understanding of the impact of innovative mechanisms on financial activities, enable supervisors to better monitor and ensure compliance of FinTech activities, and enhance communication between firms and authorities through targeted dialogue and customised guidance. 

A client protection pathway (CPP) gives providers a roadmap for implementing client protection standards and helps them tracking achievements, which would contribute to increasing client trust and loyalty as well as reducing risk exposure and reinforcing the social responsibility of Fintech lenders. The consumer protection department at the CBY-Aden should monitor the compliance of FinTech lenders to the standards and good practices and facilitate the disclosure of the level of achievements on a regular basis (i.e. at an annual or bi-annual frequency). Also, certification by the consumer protection department at the CBY-Aden should require full compliance with a subset of minimum requirements for a gradual convergence to a satisfactory level of compliance.

Demand Side:

Promoting financial inclusion, literacy, and consumer protection 

Increasing access to transaction accounts to deepen financial inclusion 

Transaction accounts are the core financial products which provide basic services to consumers, allowing them to store financial resources safely, make payments or receive remittances. They enable use of other types of financial services such as savings, credit or insurance. Increasing access to transaction accounts should therefore be prioritised.  

Efforts could be made to render financial services more accessible and affordable. Policymakers and financial services providers could work hand in hand to address the limited and costly supply of financial services. Policymakers should also ensure that funds frozen in customers’ bank accounts become accessible again. Situations where bank clients are not in a position to access their savings should be avoided in the future, in order to maintain the trustworthiness of the financial sector.    

Finally, electronic money accounts could be leveraged to increase financial inclusion levels, especially for those living in remote areas. In fact, financial inclusion levels are especially low in rural areas, and access to mobile phones (68%) is higher than financial inclusion levels (below 10%).   

Implementing financial education programmes which address and support Yemenis’ ability to do more with limited resources  

Financial literacy can help individuals to manage wisely limited financial resources, to take advantage of various financial products (as needed) and avoid situation which could result in financial loss. While the habit of saving seems to be very limited in Yemen, saving even small amounts of money can make a significant positive contribution to people’s lives. Similarly, avoiding borrowing for day-to-day costs unless strictly necessary may also support resilience and financial independence in the longer term.  

Targeted financial education programmes could emphasise the benefits of saving and, perhaps, facilitate formal and informal ways in which people could start saving. Such programmes could focus in particular on vulnerable groups (such as women, low income and low education people, or those out of the labour force) which are also more likely to rely on informal support and have limited safety nets (see also following recommendation). These programmes could also focus on familiarising individuals with the formal financial sector, showcasing the potential risks of informal borrowing or depositing in non-regulated financial institutions and making individuals aware of their rights as customers of formal financial services.     

Targeting the most vulnerable groups with tailored interventions   

Important disparities in terms of access to financial services, financial literacy and financial well-being exist based on gender, income and education level. Policies to advance financial inclusion, financial literacy and financial well-being should consider these differences and, when possible, tailor interventions to the needs of the most vulnerable populations.  

There is a significant gender gap in Yemen in terms of access to financial services, with women having much lower levels of financial inclusion and financial literacy compared to men. Financial education programmes could focus on enhancing financial knowledge of women and could be matched with specifically targeted basic financial services that consider the specific needs of women. Such programmes may contribute to shifting the balance of power in household decision making in favour of women, as Yemen has among the lowest percentage of women in charge of household financial decision making compared to other OECD and non-OECD countries who participated in similar data collection exercises. 

Building capacity within the new FCP department at the CBY-Aden and ensure the Enforcement of the Regulatory Instructions  

The enforcement of the recently adopted Regulatory Instructions is necessary step to achieve financial consumer protection.   The CBY-Aden needs to strengthen capacities, such as increasing and training staff in its new established FCP department.  Additionally, addressing remaining regulatory gaps, ensuring clear governance, and implementing effective supervision will be essential to increase financial consumer trust and establish a comprehensive framework for financial consumer protection.  To build consumer trust, there is a need for consumer complaint and redress avenues and functional credit reporting system, which could help lower borrowing costs for consumers.