Afghanistan's banks face security issues, corruption problems and political instability, and have minimal international access or presence. Can they rise to the challenge of rebuilding in such an environment? Kimberley Long investigates. 


Afghanistan’s banking system is at an inflection point, following years of restricted growth due to the country's volatile political landscape. While under the control of the Taliban regime from 1996, the country lost access to international markets and business modernisation. While the conflict with the US-led coalition marked the end of the Taliban regime in 2001, the ensuing years of continued instability – with the Taliban still holding some areas of Afghanistan – saw international banks exit the country.

In March 2019, the US government and the Taliban met for talks in Doha, raising hopes of a peace deal. Meanwhile, Afghanistan is set to hold presidential elections in July 2019 (three months later than originally planned). President Ashraf Ghani, the only democratically elected president in the country’s history, is standing for re-election.

Despite this turbulent backdrop, Afghanistan’s economy has grown, reaching gross domestic product (GDP) of $19.5bn in 2017, a 2.7% year-on-year rise, according to the World Bank. The growth registered in 2016 was 2.4% ($19bn). The country's GDP peak came in 2013, at $20.5bn.

Strengthening foundations

Afghanistan is now tasked with rebuilding its fragile banking system and bringing it up to international standards. This challenge should not be underestimated, as none of its banks are rated by global credit rating agencies, and with a scarcity of skilled staff, management is often brought in from overseas.

Khan Afzal Hadawal, former first deputy governor of the central bank, Da Afghanistan Bank (DAB), says: “The banking sector is slowly developing, but at this stage we do not have liquidity, capital or equity markets. There is no stock exchange. The industry needs to be developed with modern products.”

The country's banking sector was dealt a blow in 2010 with the collapse of Kabul Bank following the loss of nearly $1bn amid a corruption scandal. After a run on deposits in which customers withdrew $180m in just two days, the DAB bailed out the failing bank and relaunched it as New Kabul Bank. Kabul Bank founder Sher Khan Fernod and chief executive Haji Khalil Ferozi were convicted of fraud and the embezzlement of $810m of the stolen $935m, and sentenced to 15 years in prison.

Christoph Duenwald, mission chief to Afghanistan for the International Monetary Fund (IMF), believes the collapse had a lasting impact on consumers. “The collapse of Kabul Bank cost the Afghan taxpayer $1bn. This experience was traumatic and has held back financial intermediation,” he says.

Developing Islamic banking

While those consumers who lost deposits in Kabul Bank became cautious of using banks again, those seeking sharia-compliant banking had claimed a lack of such services was preventing them from opening accounts. Some Afghan banks had offered an Islamic window facility, providing some Islamic services within a conventional banking structure, but that was as far as the provision went.

Salim Khan, CEO of microfinance institution Oxus Afghanistan, says: “Consumers are wary of banking being in breach of Islamic beliefs. Gaining interest on funds is haram [harmful], and people do not want to be associated with financial institutions that operate in this way.”

In 2018, DAB took steps to remedy this problem with the approval of Afghanistan's first fully Islamic bank. The Islamic Bank of Afghanistan (IBA) previously operated as a conventional bank under the name Bakhtar Bank. The licence was granted once the bank had converted its existing assets to meet specific principles, including bans on providing services for gambling and alcohol companies. In line with sharia rules, accounts will not earn interest.

Mr Duenwald believes the creation of IBA is a step forward. “Greater financial inclusion takes time, and requires the population to learn more about what they can do in terms of making deposits, borrowing and lending. Mobilising sharia-compliant financial services will attract more people to the financial system,” he says.

Adopting sharia operating standards at government level has also been recognised as a way to help make the country less reliant on foreign assistance. “The Afghan government is laying the groundwork for launching a sukuk bond,” says Mr Duenwald. “While it is in its infancy, it will be useful for the government to finance itself and contribute to becoming self-reliant. For now, and for some time to come, the government is reliant on aid.” Currently, about 40% of Afghanistan’s GDP comes from overseas aid.

From cash to digital

As Mr Duenwald states, Afghans are typically having to be shown the benefits of banking before they will open accounts. Afghanistan has a population of 35 million, but only about 10% has a bank account, and the number with credit or debit cards is even lower.

As such, the country relies heavily on cash. Anthony Barned, CEO of Afghanistan International Bank (AIB), says the reluctance of merchants to accept credit cards creates a “reinforcing cycle” of cash being the primary transaction method. AIB is currently one of the few banks in the country to offer cards to customers.

As so few consumers have bank accounts, money is often transferred through the sharia-compliant hawala network. Customers take the cash to a 'hawala' broker, who will notify another broker of the intended transfer of funds. The recipient will then contact the second broker with a previously agreed password to obtain the funds. There is no transfer of money between the two brokers, meaning both brokers must have enough liquidity. Operating on an honour system, there is no document transfer.

This kind of informal banking sector creates uncertainty, according to Mr Hadawal. “Most people have their cash at home or held in the informal banking sector. There could be billions of dollars in cash held informally in the country,” he says. 

Faburama Cessay, acting CEO of First Microfinance Bank (FMFB), says even business loans are still transacted in cash. “About 95% of the business we do is cash based. Loans are paid out by the bank and repaid to the bank in cash in our branches,” he adds.

Financial inclusion

Supporting financial inclusion means adapting to customer requirements. Microfinance bank Finca has established a women-only branch, responding to the needs of its female customers, who make up 61% of its borrowers. FMFB also has a women-only branch with a staff of 21 female employees. Though the expansion of mobile money has had a dramatic impact on financial inclusion rates in other developing markets, the pace of change is slower in Afghanistan.

Mr Khan of Oxus says that while there are 18 million mobile phone users in Afghanistan, only 54,000 have signed up to mobile money, and just 35,000 are actively using it. “The numbers could be improved if some people were pushed into using it, such as government employees to receive salary payments,” he adds. “This would also significantly reduce the cost of paying the funds to them and reduce the risk of corruption.”

Afghanistan introduced Safaricom’s M-Pesa mobile wallets in 2008. It rebranded as M-Paisa (paisa means cash in the local languages of dari and pashto) and is run by a local mobile provider, Roshan Telecom Afghanistan. Mr Cessay says FMBF launched an M-Paisa branch, but even this form of digitisation relies on access to cash. “[However], for mobile money to work more widely, there has to be a strong agent network to receive cash deposits and to make payments. Most importantly, they have to be liquid,” he adds.

Lending and microfinance

With such a limited formal banking infrastructure in place, the provision of microfinance has been instrumental in assisting Afghanistan’s businesses to develop. But even these institutions require help. The Afghan Credit Guarantee Foundation (ACGF) was founded in 2009, following on from its predecessor the Credit Guarantee Facility for Afghanistan (CGF-A). From the founding of CGF-A in 2005 to June 2018, the organisation has guaranteed $200m in loans, supporting 4800 small and medium-sized enterprises (SMEs).

Having loan guarantees is often essential in Afghanistan due to difficulties in providing collateral. For example, about 80% of the property in the country is not registered properly, making it difficult to prove ownership, according to Bernd Leidner, chairman and CEO of ACGF. 

Even with international backing, the financial support the business community receives is low. During 2018, 50% of all business loans in Afghanistan were guaranteed by the ACGF. Mr Leidner says that while this demonstrates how deep the ACGF’s reach in the country is, it also shows how underdeveloped and shallow the provision of loans is.

SMEs also face the challenge of obtaining funds in local currency. Due to the volatility of the afghani, which saw its value plunge to an all-time low of 77 afghanis to the US dollar in September 2018, depositors favour holding funds in dollars. Mr Khan says: “The banks are liquid, but cannot lend. Across all the banks, about 66% of deposits are in US dollars. They do not have the funds available to lend in afghanis.”

Despite these issues, the default rate on loans remains low. Mr Khan says: “Figures from the World Bank show the default rate on loans in Afghanistan in 2017 was 16.9%. Our portfolio is much better than that, with a default rate of just 3% on all microfinancing in the country.”

Having a hands-on approach to choosing which projects to support seems to be ensuring quality. Mr Leidner says the banks that ACGF works with will visit the borrowers personally to understand both the business and the owner. They have seen a net loss ratio of just 1.3% since inception.

Operating securely

Knowing business owners and the districts in which they operate is more important in Afghanistan than in most other countries. A report from the Special Inspector General for Afghan Reconstruction, using statistics from the US military, stated that in October 2018 the Afghan government-controlled land that is home to 63.5% of the country's population, with the Taliban-controlled territory housing 10.8% of the population. The remaining population are located in rebel-held areas.

This creates significant financial risk. “On average, about 7% of loans across all microfinance institutions are in PAR [portfolio at risk]. In other words, these loans may not be paid back,” says Mr Ceesay.

It is not just portfolios at risk, either. Former FMFB CEO Manoharan Kamaleson was one of four people killed by a Taliban truck bomb in Kabul in January 2019; Mr Ceesay was appointed as acting CEO in March. “Security is the biggest issue for the bank,” says Mr Ceesay. “FMFB spends $1.8m a year on security, which is the bank’s single biggest expense.” This is a significant sum for a bank that had $180.5m in assets and $23.6m in Tier 1 capital in 2017, according to The Banker Database.

All of which only serves to emphasise the importance of Afghanistan cementing a peace deal. Mr Duenwald says: “The IMF currently expects Afghanistan to grow between 3% and 5% in the coming years, assuming the aid flows continue and the security situation doesn’t worsen. The hope for Afghanistan is that a durable peace settlement would enable the economy to grow much more quickly and thereby lift many Afghans out of poverty.”

However, even with a settlement headwinds would remain according to some experts. Insurance brokerage and risk management group Marsh assessed Afghanistan in its Political Risk Index 2019, reporting: “Even if peace were achieved, political risks would remain high, due to Afghanistan’s ethnic diversity, high levels of poverty and illiteracy, de facto warlordism in large parts of the country, and very high degrees of corruption.”

Regulatory reform

Afghanistan will have to make significant progress if it is to meet the expectations of the international banking community. In February, the European Commission published a revised list of 23 countries with deficiencies in their anti-money laundering (AML) and counter-terrorist frameworks, which included Afghanistan. Finding a new way of banking that works around the issues the country faces, but meets international standards, is a particularly daunting challenge. 

DAB’s Mr Hadawal advocates regulatory reforms that allow the country to thrive while complying with Islamic banking structures that are acceptable to the population. “In the past, the regulatory frameworks have been based on those in place in other countries, but these are often developed markets using conventional banking,” he says. “Afghanistan needs to look to growing economies with defined Islamic banking sectors, such as Indonesia and Malaysia, and replicate their systems.”

The country's banks are under significant controls that prevent them from expanding their portfolios. “We would benefit from less stringent lending regulation,” says AIB’s Mr Barned. AIB has the highest Tier 1 capital in the country with $42.7m, as of the end of 2017, a 0.7% increase on the previous year, according to The Banker Database.

“We understand that some of the banks in the country probably require these rules, but AIB is very well capitalised and we would like our board to have more discretion over our collateral requirements. Requiring 120% cover for real estate collateral, for example, prevents us from lending as much as we would like,” adds Mr Barned.

Mr Hadawal believes greater honesty from the central bank would foster trust in Afghanistan's banking system, especially if restrictions are preventing Afghanistan from operating in the international markets. “The central bank needs to be transparent to the public about what it is doing and what it can deliver,” he says. “If international markets change their views on Afghanistan [such as being placed on the European Commission AML watchlist], the central bank has to explain why. Other countries are facing [similar] difficulties. Afghanistan is not alone in this, and should not be ashamed.” 


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