10 September 2010

Special Report on Economic Development in Afghanistan The Kabul Bank Crisis

What Happened & What It Means for Development, Governance & Security in Afghanistan Economic Development Knowledge Manager
steve.zyck@cimicweb.org www.cimicweb.org Steven A. Zyck

This document provides an overview of the crisis surrounding Kabul Bank. Further information is available at www.cimicweb.org.1 Sources for all information can be accessed by following the hyperlinks embedded in the text. Summary
Kabul Bank, the largest private financial institution in Afghanistan, has recently generated losses of around USD 300 million and has undergone a major change in senior management, according to major media outlets. Afghan government personnel and institutions reportedly brought about this change in management and have played an increasing role in stabilising the bank by guaranteeing its deposits, offering loans and providing physical security. Large-scale withdrawals were motivated by media reports and depositors resulting decline in confidence; depositor confidence in the bank seems to have somewhat rebounded as a result of assurances that all deposits in the bank would be guaranteed by the Afghan government and backed up by public loans. However, significant implications exist for the economy, governance and security, with the Kabul Bank crisis which has involved relatives of Afghanistans President and First Vice President serving as a powerful reminder of the scope of financial mismanagement and corruption in Afghanistan ahead of parliamentary elections scheduled for 18 September.

1. Background The arrival of the four-day Eid ul-Fitr public holidays in Afghanistan on the evening of 08 September marked not only the beginning of celebrations but also a brief respite for Kabul Bank. This private financial institution, the largest in Afghanistan, experienced a week-long run by depositors, who attempted to withdraw a significant proportion of the approximately USD 1.3 billion held in bank accounts. The situation was closely followed by Afghan and international stakeholders given its potential impact on Afghanistans economy and political system and given the role played by Kabul Bank in channelling payments to more than 250,000 Afghan teachers, police officers and soldiers. The situation began more than a month ago at a meeting where the Governor of Afghanistans Central Bank commonly referred to as Da Afghanistan Bank (DAB) presented evidence of Kabul Banks illicit dealings to Afghan President Hamid Karzai and others, including General David
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Petraeus, the commander of US and NATO Forces in Afghanistan. Following this meeting, President Karzai decided to take action to address the problem posed by the bank, a decision which was spurred by the news in August that the bank had lost approximately USD 300 million. The media first reported on 31 August that DAB had taken over Kabul Bank and forced the resignation of its Chairman and Chief Executive Officer (CEO), replacing the latter with DABs own Chief Financial Officer (CFO). DAB and Kabul Bank both claim that the removal of the banks two top leaders had been voluntary and in compliance with a June 2010 regulation forbidding shareholders from being senior managers. However, the media indicated that the Afghan government had threatened the two managers, particularly the banks chairman, Sherkhan Farnood, with arrest if they did not resign and return approximately USD 160 million in Dubai property to Kabul Bank. This property had been purchased with resources from the bank but had been officially registered as the personal property of Farnood and his wife rather than as Kabul Bank assets. Property in Dubai was to become a major issue as the crisis unfolded. According to numerous media outlets, including the New York Times and Al Jazeera, Mahmoud Karzai, brother of the Afghan President and the third-largest shareholder in Kabul Bank, had recently been residing in a villa in Dubai which was purchased with money loaned by Kabul Bank in 2007. According to Kabul Banks now-ousted chairman, Farnood, many properties in Afghanistan were purchased in his and his wifes names at the behest of powerful and wealthy Afghans in violation of Afghan law, which disallows the concealment of assets overseas using loans from Kabul Bank. When confronted about this practice earlier in 2010, Farnood told the Washington Post that [w]hat I'm doing is not properBut this is Afghanistan. These villas allowed Kabul Bank to use bank resources as a means of influence-peddling by offering luxury accommodation in Dubai to influential and powerful Afghans and their families, a practice which The Washington Post referred to as a form of crony capitalism in their first piece about the bank in February 2010. Other troubling activities involving Kabul Bank and its senior managers were also reported. The Wall Street Journal, citing information provided by US officials, claimed that Kabul Bank had moved almost USD 1 billion out of Afghanistan via New Ansari Exchange, the largest of Afghanistans clandestine money-transfer (or hawala) networks. Farnood had, furthermore, been accused of using funds to cover losses on another of his businesses, Pamir Airways, according to Al Jazeera. In sum it appeared as if Kabul Banks losses were rooted in a number of investments, such as those in Dubai real estate and Pamir Airways, which were either unlikely to or not intended to generate profits, thus resulting in the significant losses which prompted the Afghan government to become involved. As news of Kabul Banks troubles reached the Afghan media and population, depositors became nervous about the safety of their money. Between Wednesday, 01 September and the closure of the banks for the Eid ul-Fitr holidays on Wednesday, 08 September, depositors rushed to withdraw money from Kabul Banks 68 branches throughout Afghanistan. At one branch in Kabul, for instance, bank employees informed the New York Times that approximately 1,700 customers were served each day during the height of the crisis. The volume of depositors and their singular request to withdraw most or all of their money from the bank resulted in cash shortages at

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many branches. The Bloomberg News Service described the experience of one construction company owner who attempted to withdraw USD 15,000 but was only permitted to take USD 1,000 from Kabul Banks main branch in Kabul. In the city of Mazar-e Sharif in northern Afghanistan, another businessman told the Associated Press that he was able to withdraw only USD 5,000 of the more than USD 50,000 he had deposited with the bank.
Box 1. How Much Money Was Withdrawn? The total amount of money withdrawn from Kabul Bank remains unknown, according to DAB, though media reports have suggested that the amount is between USD 200 million and USD 300 million. However, the underlying calculations are unclear and do not seem to reflect daily withdrawal figures reported by the media. For instance, withdrawals of USD 85 million and USD 109 million were noted on 01 and 02 September, respectively. While closed on Friday, 03 September, subsequent and large-scale withdrawals were reported from Saturday, 04 September through Wednesday, 08 September. While figures for this time period except for Monday, when USD 67 million was reportedly taken out by depositors are unknown, it appears as if USD 300 million in withdrawals should be viewed as the absolute minimum; far more may have actually been withdrawn. Some funds have been injected into Kabul Bank during the crisis but were overwhelmingly from the Afghan government for salaries of the more than 250,000 Afghan civil servants who receive their pay via the bank. To protect these funds, the Afghan Ministry of Finance has also ordered that the USD 100 million to USD 150 million in government funds held at Kabul Bank remain untouched except to pay salaries.

2. The Afghan Government Response Throughout the crisis, the Afghan government played a key and highly visible role. Regardless of ones interpretation of events, the Afghan government brought about the change in leadership at Kabul Bank which, while necessary, made the banks financial weaknesses a matter of public knowledge. Afghan officials subsequently took steps to cool tensions among depositors, the business community, international stakeholders and the broader Afghan public, with President Karzai, Minister of Finance Omar Zakhilwal and DAB Governor Abdul Qadir Fitrat making numerous statements on the fundamental soundness of Kabul Bank. Such comments, however, seemed to do little to reassure anxious depositors, who continued to withdraw money from the bank in large numbers. The situation appeared to calm slightly after Thursday, 02 September when President Karzai, at a press conference with US Secretary of Defense Robert Gates, announced that the Afghan government would guarantee all funds entrusted to Kabul Bank. President Karzai reportedly said the following: The Kabul Bank is safe. The government of Afghanistan is fully behind the bankWe have got at least $4.8 billion in cash; even if the whole financial system in Afghanistan collapses we still have the money to support it. However, given that withdrawals reportedly stayed strong in the few days after the government issued this statement, it is not fully understood whether the guarantee or some other dynamic (e.g., the completion of withdrawals by the most apprehensive depositors) caused the situation to improve. Indeed, the greatest improvements seemed to follow not from the Afghan governments guarantees but from the announcement two days later that the government was ready and willing to loan Kabul Bank as much money as necessary to ensure its continued liquidity. US government spokespersons confirmed that the 3/8

American government would provide technical assistance for efforts to stabilise Kabul Bank but would not provide any direct financing for a bail out.2 Beyond steps to improve public confidence in Kabul Bank, the Afghan government also shifted responsibility for security at Kabul Bank branches from Khurusan Security Services, a private company affiliated with the banks former CEO, to the Afghan National Police (ANP) and National Directorate of Security (NDS), the domestic intelligence agency, as of 05 September. Initial progress was also made in recouping losses from Kabul Banks major shareholders and loan recipients. Five individuals, including the former Chairman, CEO and Deputy CEO, were forbidden to sell any property held in their name within the capital, according to the Washington Post. The other two individuals affected by the asset freeze are Haseen Fahim, the brother of Afghanistans First Vice President, and a businessman, Abdul Ghafer Dawi, who the Washington Post describes as having large outstanding loans with the bank.3 While symbolically important in suggesting that individuals involved in creating the Kabul Bank crisis would face consequences, the widely reported asset freeze applied only to real estate in Kabul rather than throughout the country and had no bearing on these individuals other assets, particularly their bank accounts in Afghanistan and overseas. For example, Britains Guardian newspaper found that officials in Dubai or elsewhere in the United Arab Emirates (UAE) had not received any requests to freeze assets of implicated individuals. Furthermore, the fact that these restrictions did not apply to Mahmoud Karzai, the banks third-largest shareholder and brother of the Afghan President who does not own property in his own name in Kabul was greeted with suspicion by the international media and by Afghanistans international donors, who began calling for an investigation once the situation seemed to be cooling. 3. Implications of the Kabul Bank Crisis There are a range of economic, governance and security implications of the ongoing crisis. Despite the fact that a relatively small proportion of Afghans estimated at 3% by Reuters have bank accounts, the reach of this incident is much broader. It conveys implicit messages which are being watched and interpreted by a significant proportion of the Afghan population, including insurgent elements.

3.1 Economic Implications

Despite reassuring statements from DAB and the slowdown in withdrawals from Kabul Bank, Afghan and foreign investors will likely grow less willing to invest in Afghanistan if they fear that the banking system cannot be entrusted with their funds (or that it may collapse and negatively effect the entire economy). According to a Financial Times interview with former Afghan Minister of Finance Ashraf Ghani, depositors are likely to grow increasingly concerned about storing their money within the formal banking system unless confidence-building measures are implemented. Fewer deposits will significantly undermine banks liquidity and their corresponding ability to lend.
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The Economist noted, however, that given that 90% of the Afghan governments budget is provided by international donors, American funds will indirectly contribute to any bail out of Kabul Bank. 3 A company owned by Haseen Fahim was also subject to the asset freeze.

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Capital for nascent entrepreneurs may be harder to find, though micro and small enterprises will likely find the microfinance market, which is increasingly trusted given its widespread adoption of Islamic lending methods, unaffected.
Box 2. Overview of Banking in Afghanistan Banking in Afghanistan has largely been built from scratch since 2002. The pre-existing banking regulations were primarily based upon Soviet procedures. Likewise, private banks had been forbidden under the Taliban, and informal banking and money exchanges proliferated. The hawala system, while best known for transferring money across the world, was also used to take deposits and provide loans before, during and since the Taliban era in Afghanistan.

Key Banking Indicators in Afghanistan, 2004-2008

2004 261 139 18 60 2005 386 212 58 182 2006 614 295 162 394 2007 1083 431 439 812 2008 1674 578 805 1278

Total Assets Cash and Bank Balances Loans and Advances Total Deposits

Source: Da Afghanistan Bank and the International Monetary Fund

The international reconstruction process in Afghanistan since 2002 brought with it a high degree of attention to banks and the introduction of new banking regulations in 2003 and early 2004. Regulatory reform and the founding of DAB were followed by rapid growth in commercial banking. Since 2003, Afghanistan had grown from just two state-owned banks to 17 banks in 2009 with several billion US dollars in deposits; the microfinance industry was also booming throughout the country thanks primarily to international organisations and NGOs. Challenges were increasingly visible, however, given the low ratings provided to most of Afghanistans banks by the International Monetary Fund (IMF) and others. Lending grew rapidly among recently established, private Afghan banks despite contextual challenges such as corruption and limited contract enforcement, which would make it difficult for lenders to ensure repayments. Furthermore, studies have shown that banks tended to value personal reputation or other non-financial factors in giving loans rather than any assessment of the borrowers business; financial statements for businesses requesting loans were rarely requested. TIME Magazine first recognised in 2006, a fact which, with some exceptions, still applies today: Afghanistans banking sector is largely unregulated, and loan officers have little experience in assessing the risk of business lending.

The banking and finance sector in Afghanistan is likely to suffer as a result of this crisis. Commercial banks as well as the Afghan governments regulatory capacity have been undercut by recent events, thus making it unlikely that the two state-run or the 14 other commercial banks will pick up a significant proportion of current and future depositors fleeing Kabul Bank. Individuals and businesses with larger sums to deposit are likely to sidestep the Afghan banking system altogether if possible and establish accounts with international banks offering services in Afghanistan. Smaller depositors may also be attracted by emerging savings schemes being designed by microfinance institutions (MFIs) in Afghanistan or may prefer to keep possession of their money rather than keeping it at any bank. Customary and informal banking systems, such as those utilised during the 1980s and following the rise of the Taliban in the mid-1990s, are likely to grow, thus reversing the trend towards formalisation in Afghanistans banking sector. Hawala 5/8

exchanges, in particular, are likely to see a significant resurgence as a result of the Kabul Bank crisis.

3.2 Governance Implications

One depositor succinctly described his feelings regarding the government and the bank when stating the following to Agence France-Presse: The bank is finished. The government can make assurances, but the problem is that no one here trusts the government. The governments inability to contain the Kabul Bank crisis with re-assuring statements reflected the states limited credibility among the Afghan population; however, the crisis also appears to have further eroded the populations trust in Afghan government officials and institutions. The banks former chairman, Farnood, was a close adviser to President Karzai during his re-election campaign in 2009; Kabul Bank also allegedly provided as much as USD 14 million for President Karzais campaign. Furthermore, with his brother being the third-largest shareholder in Kabul Bank, President Karzais attempts to restore confidence in the bank and his offers of government loans have been interpreted by political opponents as self-interested. Abdullah Abdullah, Hamid Karzais principal rival in last years presidential election, suggested that personal rather than national interests were the driving force behind the Afghan Presidents support for Kabul Bank during a press conference, saying You are the president of a country and your prime responsibility is to help your own family? Perceptions that corruption may have contributed to the Kabul Bank crisis or had prevented a stronger government response appeared particularly potent. While Afghans commonly express their discontentment with corruption within the Afghan public administration, this instance seemed to be in some respects worse given that the funds being put at risk belonged to ordinary Afghans rather than foreign donors. The imagery of Afghanistans political and economic elite abusing the money of school teachers and Afghan police and soldiers in order to fund luxurious retreats in Dubai was repeated in a number of editorials. Summarising a common sentiment in Kabul, TIME Magazine reported the following: While complaints over systemic graft have been a common refrain among ordinary Afghans unhappy with their government, the prospect however real or distant of personal deposits falling into jeopardy due to alleged insider dealings has been received particularly emotively. Such sentiments were particularly significant given that they emerged during Ramadan and shortly before Eid ul-Fitr, which are Islamic holidays that stress self-sacrifice, modesty, spirituality and charity. As such, this crisis may have far-reaching political and governance implications which will influence the upcoming 18 September Parliamentary elections and attempts to undermine the insurgency by building popular support for the Afghan government. Indeed, given the Taliban regimes previous ban on commercial banks, the insurgency may be able to use this crisis to polish its image.

3.3 Security Implications

It remains without question that the economic and, in particular, governance implications noted above will have an effect on security. A government which has lost a portion of its legitimacy

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during the crisis and an insurgency which may receive added support will certainly have a direct impact, which must be closely monitored, upon stabilisation efforts. Given that such implications have yet to emerge, this report will primarily concern itself with the direct and short-term security implications of the crisis. Soon after the media began reporting on the financial difficulties being faced by Kabul Bank, AlJazeera suggested that conflicts between unpaid workers, private security guards and armed depositors were feared by some in Afghanistan. Yet, the Kabul Bank crisis was notable in that few security incidents were reported. Depositors attempting to withdraw funds from the bank were described as panicked and angry but not violent, even in those instances in which particular branches were, due to cash limitations, unable to provide customers with the full amounts requested. The most notable security incident resulting from the crisis occurred on Wednesday, 08 September in the final hours before the main Kabul Bank location closed for the Eid ul-Fitr holiday. A group of more than 500 depositors comprised mostly of civil servants who were attempting to withdraw their recent salary payments from the bank in advance of the four-day holiday were reportedly punched, shoved and threatened by members of the Afghan domestic intelligence service, the NDS, who were guarding the branch. No further violence was reported, though tensions were running high among Afghan civil servants, including members of the security services, who were unable to withdraw funds from their Kabul Bank accounts in advance of an important and frequently expensive holiday weekend. 4. Conclusion The Kabul Bank crisis will have wide-reaching and likely long-term effects on economic development, governance and, perhaps, security in Afghanistan. The governments response, in particular, will merit close attention during the upcoming months, and investor confidence should be bolstered in order to prevent this crisis from impeding what have hitherto been impressive rates of economic growth in Afghanistan.

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Annex A. Additional Resources

Research and Organisational Reports Arteaga, Ximena. 2009. Assessing the Demand for Savings Services among Microfinance Clients in Afghanistan. Kabul: Microfinance Investment Support Facility for Afghanistan. International Monetary Fund. 2008. Islamic Republic of Afghanistan: Selected Issues.
Washington, DC: International Monetary Fund.

Pavlovi, Jelena and Joshua Charap. 2009. Development of the Commercial Banking System in Afghanistan: Risks and Rewards. Washington, DC: International Monetary Fund. Kabul Bank Da Afghanistan Bank Afghan Ministry of Finance http://www.kabulbank.com/html/index.aspx http://www.centralbank.gov.af/ http://www.mof.gov.af/

Websites

Annex B. Shareholders in Afghanistans Kabul Bank Shares 1. Mr. Sherkhan Farnood 2. Mr. Khalilullah Ferozi 3. Mr. Mahmood Karzai 4. Mr. Mohmmad Taheer 5. Mrs. Farida Farnood 6. Mr. Haji Sherin Khan 7. Mr. Ghulam Farooq Naseeb 8. Mr. Zahed Faheem 9. Dr. Ahmad Javid 10. Mr. Jamal Khil 11. Mr. Nesar Ahmad 12. Mr. Abdul Rab 13. Mr. Hayatullah 14. Mr. Mohammad Ihsan Rafet 15. Mr. Shokrullah Shokran 16. Mr. Rabiullah Kakar 78,083 78,083 20,548 18,699 18,534 16,439 8,219 8,219 6,000 5,343 4,726 4,110 4,110 2,466 2,055 1,644 % Ownership 28.16 28.16 7.41 6.74 6.68 5.93 2.96 2.96 2.16 1.93 1.70 1.48 1.48 0.89 0.74 0.59

Totals
Source: Kabul Bank, Financials.

277,278

100

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