Embattled Afghan lenders prove resilient

The loans scandal at Kabul Bank, which led to its collapse in 2010, hit not only Afghanistan's already fragile financial sector but also the country's political stability. But as those held responsible for the fraud have been brought to justice and more stringent legislation is put in place, the confidence of international backers is beginning to return.

The collapse of Kabul Bank in August 2010, which left a $900m hole in the bank in a country whose annual tax take is only $1.7bn, was an unmitigated disaster for Afghanistan’s fragile financial sector and for its economy in general. Yet it also stood as a testimony to the country’s resilience. The losses amounted to roughly 5% of Afghanistan’s gross domestic product (GDP).

Even worse for the country’s political stability and image, the Kabul Bank fraud extended beyond the financial sector. Some $900m in loans were made to insiders with little or no collateral and even no repayment plan in what auditors have described as effectively an extensive Ponzi scheme that misused depositors’ funds for fraudulent loans on Dubai and Afghan property.

Funding impact

For international donor and assistance agencies, this was one case of corruption that could not be ignored. The UK’s Department for International Development (DFID) halted its funding partnership with the Afghan government, in what one DFID source described as “a test of Afghanistan’s will to deal with a financial crisis”. The suspension of assistance remained in place for 14 months and was one of the key factors that encouraged the Afghan authorities to clean up the bank.

“DFID is keen to see investors come into [the bank],” says this source, “as this is the only bank with a nationwide payments system and it is important for it to survive and maintain a strong competitive advantage.” DFID funded forensic audits to prosecute wrongdoers and it is helping with the privatisation process.

When the scandal broke, the International Monetary Fund (IMF) refused to renew its credit programme for Afghanistan pending action on the bank. This led to the loss of millions of dollars in incentive funds and blocked other aid programmes from many countries. Western diplomatic sources said the arrest and prosecution of those responsible for the problems at Kabul Bank would represent a start towards satisfying the concerns of the international backers.

Under IMF guidance, the government has set up the New Kabul Bank with a clean deposit base, while the collapsed entity containing the fraudulent loans has been placed under Finance Ministry administration. “The idea is to privatise the good bank and recover the stolen assets from the bad bank,” says Wabel Abdallah, the IMF resident representative in Afghanistan. “The system needs to be strengthened to prevent a recurrence of the Kabul Bank affair. The aim is to bring improvements in areas such as supervision, transparency and enforcement, and ensure that shareholders do not sit on management boards.”

Fragile system

Afghanistan’s banking sector is less than a decade old, having developed alongside the hawala system based on traditional Islamic law, which functions through personal contact between trusted brokers for the transfer of money.

The system needs to be strengthened to prevent a recurrence of the Kabul Bank affair. The aim is to bring improvements in areas such as supervision, transparency and enforcement, and ensure that shareholders do not sit on management boards

Wabel Abdallah

“Afghans were used to this system, hence well over 90% of the population remains unbanked,” says Mr Abdallah. “The system is young and fragile and we are looking at a process of education to explain to people the functioning and benefits of depositing their money in a bank.”

Mr Abdallah adds that there have been informal expressions of interest in the New Kabul Bank, but that nothing concrete has yet materialised from talks with potential investors. “It is actually a very good deal,” he says. “It is a clean bank with quite a sizeable deposit base, a good IT system and with no loans. I would say it is an extremely attractive proposition in which higher margins compensate to an extent for the risks involved.”

To minimise the risk of another large-scale loan fraud, the bank has not been authorised to operate in the corporate or small and medium-sized enterprise sectors, which could deter an investor.

Embattled Afghan lenders prove resilient2

Security hurdles

In spite of the government’s efforts to clean up Kabul Bank, dark clouds remain over Afghanistan's financial sector. The chief concern of foreign banks that have considered starting operations in the country is the ongoing security threat to staff and premises. Standard Chartered is the only foreign bank with a physical presence in Kabul – but not for much longer.

“We have conducted a strategic review of our operations here, and in our view there has not been an acceptable enough improvement in the security situation to warrant a continued physical presence in Kabul,” says Ammar Husain, CEO of Standard Chartered Afghanistan. “There are a lot of opportunities here but the risks involved are leading many investors to rethink their strategies. We now operate out of our main branch, after having closed our other extension branch in the Unama [United Nations Assistance Mission in Afghanistan] compound in 2008 due to security concerns. We plan to transfer our business to Afghan International Bank [AIB], which is 25% owned by the Asian Development Bank. We will continue to manage our international clients doing local business through AIB.” Standard Chartered expects to exit Kabul in the fourth quarter of this year. 

Afghan International Bank’s CEO, Khalil Sediq, a former governor of Afghanistan’s central bank, says the move to take over Standard Chartered’s local business was a “mutual decision” in response to a shift in strategy by the UK bank. “It did a due diligence on several local banks and found AIB the most suitable for the deal,” says Mr Sediq. AIB has been operating since 2004 and is now Afghanistan’s largest bank in terms of assets and deposits.

AIB was the first private bank in the country to be promoted by multilateral development finance institutions as well as a number of local business leaders. The bank has experienced rapid growth since its start up, adding nearly 30 branch offices throughout the country, and there are plans to open another seven by the end of 2012. “Over the next five years we expect to grow our branch network by 50% and more than double the number of ATMs in service,” says Mr Sediq. “We have issued 15,000 debit cards so far, in a country in which less than 5% of the population has a bank account, and we hope to have up to 60,000 card customers in five years’ time.”

Risk vs reward

The risks of doing business in Afghanistan cannot be overstated, yet one could almost say the same of the potential rewards. The figures point to a latent demand for banking services, as well as a supply of consumer money to support them. In late 2001, after the fall of the Taliban regime, Afghanistan’s financial sector was in a state of devastation. The banking system at the time comprised six state-owned commercial banks that were largely inactive.

The sector has come a long way since then. A government bond (called capital notes) market is developing and international reserves have steadily increased to more than $5.5bn. New banking laws were passed in 2003 and in early 2004 based largely on international best practice. In 2004, total commercial bank assets amounted to less than $300m. By March 2008, the total assets of the operating banks had grown to almost $1.7bn. There are now 17 retail banks in Afghanistan, including a few foreign entities such as Pakistan’s Bank Alfalah and Habib Bank, and the Aga Khan Foundation’s First Microfinance Bank (FMFB). India’s Punjab National Bank also has a presence in the country. Together they account for nearly a quarter of the country’s GDP.

There are opportunities for foreign entrants in the Afghan banking market. The country is sitting on an estimated $1000bn to $3000bn in mineral wealth, according to US estimates, and there is a need to finance the mining projects that will be coming on stream

Khalil Sediq

There is also talk of telecommunications companies setting up their own banking operations to leverage off their customer base and technological infrastructure. MTN, the South Africa-based multinational mobile telecoms company, and Roshan, Afghanistan’s leading telecoms provider, which is majority owned by the Aga Khan Fund for Economic Development with minority stakes held by Monaco and Swedish shareholders, are mentioned as two possible new entrants. Both companies are well placed to launch a national mobile phone banking service, of the kind that has proved to be highly successful in developing countries such as Kenya.

Stringent legislation

But there is no denying the risks: a recent independent audit revealed concerns over shortcomings in the regulations. To help allay fears, the Afghanistan government
 has beefed up its governance and anti-money laundering legislation, though as far as the latter issue is concerned, the real problem would seem to lie outside the banking system.

“Each bank has its own anti-money laundering policy and some are more stringent than others,” says a banker in Kabul. “But it’s actually the semi-official money dealers who are at the root of the problem. People are crossing the border all the time with drugs and weapons, so it is no trouble to smuggle money out as well.” That does not take into account the $5m that US officials estimate is taken every day from Kabul airport to Dubai.

The central bank, working alongside international agencies, is keen to encourage a consolidation process to reduce the number of domestic retail banks to a more manageable level. “There are opportunities for foreign entrants in the Afghan banking market,” says AIB’s Mr Sediq. “The country is sitting on an estimated $1000bn to $3000bn in mineral wealth, according to US estimates, and there is a need to finance the mining projects that will be coming on stream. As for the financial sector itself, if all the rules and regulations enacted in recent years are implemented and enforced, there is every reason to believe it can develop into a sound, profitable system.”


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