- Introduction
Foreign Exchange (Forex) is characterized as the exchanging of one currency for another. The Foreign Exchange market is an over-the-counter market for purchasing and selling monetary standards, implying a worldwide, decentralized market. Therefore, there is no real or physical place, and this market manages forex rates for each currency. It contains all elements of selling, purchasing, and exchanging of all foreign currencies at spot or future rates.
An informal foreign exchange market has been available in Somalia (e.g., Bakara market and others). These forex traders have only a few foreign currencies such as national currency (Somali Shillings), US dollar, Euro, British Pound, Saudi Riyal, and so on and make transactions through face-to-face contacts. However, online forex emerged in 2019, organized as forex companies and trade currencies through online platforms. Unfortunately, all these currency traders have bankrupted and lost all coins collected from society. Therefore, this article discusses what causes forex trading failure in Somalia, how local financial crises affected Somalis society, and the conclusion and recommendations.
- A Pyramid scheme forex trading experience in Somalia
In 2019, many FOREX traders emerged in the capital city, Mogadishu, and other cities in Somalia. These currency traders organized as FOREX companies, and they announced to pool money from investors promising 50-70% returns from their invested funds. These investment opportunities available in the foreign exchange market attracted many large and small investors. Unfortunately, FOREX traders exited from the market entirely after collecting millions in US dollars from the investors. Therefore, some reasons behind the failure of FOREX trading is discussed below:
To begin with, FOREX is associated with high risk or volatility in nature. A principle in finance states that an increased risk requires a reward which means if you invest high-risk assets, then you expect a high return; otherwise, other investment alternatives must be executed. Since FOREX is more increased risk investment, it is perfect for promising higher returns to investors (e.g., 50-70%), but is it accurate to pay such gains? Understanding excessive risk in FOREX can help investors to manage any risks related to changing exchange rates. Hence, FOREX trading must be fully understood and known by investors before investing in it.
Secondly, a lack of regulation is another factor that causes the failure of forex traders. Typically, any financial institution whose core business is currency (e.g., Banks, currency traders, etc.) must have a license from a government agency (Central Bank). After registration, all business activities should be controlled and monitored by the government. Moreover, financial institutions must deposit reserves, pay taxes and follow all rules and regulations set by the government. This may reduce the frequency and severity of the losses facing financial institutions, including currency traders.
Thirdly, financial fraud is committed by FOREX traders. Large numbers of currency traders have emerged quickly and have been trusted by large and small investors. However, most currency traders are scammers, which means that they are not real traders. This looks like Ponzi schemes.
In Boston during the 1920s, Charles Ponzi, an Italian worker, had what probably appeared like a brilliant (if illicit) thought: Start a financial firm called the Securities Exchange Company that would offer savers a spectacular half (50%) return from an investment maturing in only 45 days. Ponzi’s offer will undoubtedly draw in numerous investors with other identical investments offering yearly financing costs of 5%. Indeed, before long, Ponzi set up his firm, a great many dollars overwhelmed from large and small savers. In any case, how is it possible that Ponzi would conceivably put this cash in a manner that would make enough to meet his commitments to financial backers and still make a profit?
Even though Ponzi told financial backers that he would utilize their cash in an arbitrage strategy that elaborate worldwide reply coupons, he expected to use some money from new investors to pay the premium vowed to exist investors and take care of any financial backers who demanded accepting their cashback. In the end, a series of newspaper articles questioning his venture system caused a flood of financial backers requesting their cash back, and Ponzi’s plan bankrupted. In short, a Ponzi scheme refers to a financial scam or fraud in which the person running the system uses funds from new investors to pay interest to existing investors without acquiring any returns from the scheme.
Fourthly, Mismanagement related to pooling funds for running this business is one the most factors which led to forex trading bankruptcy. In the last two years, FOREX traders have done investment activity that seems like mutual funds. Mutual funds refer to pooling money from large numbers of people and then managed by professionals investing in other companies (e.g., pension fund, etc.). Moreover, these professionals usually set financial and strategic objectives and maintain and achieve such goals in an investment period. Therefore, lack of management skills such as planning, organizing, staffing, directing, and controlling for pooled funds is one of the main factors which has caused the failure of forex traders in the market.
Fifth, Lost confidence; confidence or trust is one of the most crucial factors that should be considered for any business, especially financial institutions. Many forex investors lost their faith after rumors disseminated news against forex trading on social media such as Facebook. It led to many investors who suspected that forex trading might be in danger of failure and demanded their money back. Consequently, many FOREX traders simultaneously experienced runs, resulting in forex companies being unable to return investors’ money and temporarily close their doors. Later on, all forex companies in Somalia bankrupted, and many stockholders lost their invested assets in the FOREX market. Lastly, Covid 19 effects is another factor that caused the failure of forex trading since this pandemic disease has negatively affected the whole economy in the global markets.
- Negative impact on the economy
When many forex traders have collapsed or bankrupted, many Somali citizens are affected on their lives explicitly or implicitly. These effects can be categorized into three parts: the banking sector, real estate market, and savings of individuals or households. Let us explain each of them briefly.
Emerging currency traders negatively affected the banking sector. Commercial Banks typically allow deposits from their customers by opening different accounts such as current accounts, saving accounts, etc. Since Somali forex traders promised investors to pay high returns, many individuals satisfied this investment which led large numbers of banks’ clients to withdraw their money from bank accounts to invest in forex. Hence, liquidity problems could happen if many banks’ customers demand their deposits simultaneously.
On the other side, many real estate owners sold their properties to invest in this profitable business. Usually, a massive amount of property supply leads to a sharp decline in the price of supplied properties, whether real estate or commodities. Therefore, the value of the real estate (lands or buildings) was affected by forex due to giving high incentives to its potential investors. Lastly, individuals or households invested their savings into forex without hesitating. All forex traders got their investment funds from individuals that enabled them to pool vast amounts of money. Unfortunately, all these funds from individuals and households were entirely lost at the hand of forex traders.
- Conclusion
In short, many factors caused the collapse of FOREX, which emerged in the country in 2019. These factors include forex activities having high risk in nature, lack of regulations, financial fraud, Mismanagement of pooling funds, Covid19, lost confidence, and many more. Furthermore, emerging forex activities affected the daily life of society in different aspects such as the banking industry, real estate markets, and savings or reserves of individuals and families.
Eventually, I recommend that the government cope with regulations and monetary policies regarding this issue and similar business activities. Management skills are very crucial for making any investment. Lastly, the best solution to escape being caught in a dishonest financial scheme is to trail the old advice that says, “never invest in something that you don’t understand.”
Yonis Ali Mukhtar is the head of Logistics of operations division, SIMAD University
