Bank Regulation and Supervision and Their Effects on Financial Stability:The Role of Foreign Banks in Somalia—A System GMM Approach

Abstract

This paper investigates how the capital adequacy ratio (CAR) and the liquid asset ratio (LAR) affect bank stability, measured by the Z-score, using monthly financial data from a foreign bank operating in Somalia over the period 2023–2025. Motivated by the limited empirical evidence on the effects of regulation in frontier banking markets, the study adopts an explanatory research design within a positivist, deductive framework. Secondary data extracted from the bank’s monthly regulatory financial reports submitted to the Central Bank of Somalia (CBS) are analyzed using pooled ordinary least squares (OLS) as a baseline and the System generalized method of moments (GMM) as the primary estimator to address endogeneity and dynamic panel bias. The empirical results reveal that CAR exerts a highly significant, positive, and economically large effect on bank stability under both estimators, indicating that capital adequacy is the dominant correlate of institutional resilience in this context. LAR exhibits a positive but statistically insignificant effect, which is attributed to the bank’s persistently high baseline liquidity position. Profitability reinforces stability, whereas bank size exerts a significant negative effect under GMM estimation. The findings are consistent with the Basel regulatory framework’s emphasis on capital buffers as the primary safeguard against insolvency and carry direct policy implications for the CBS and Somalia’s evolving prudential supervisory architecture.