Kabul Bank: When They Don’t Fear the Regulators Enough to Even Hide the Abuses
The World Bank sent me to India several years ago to assist their anti-corruption unit in revising their computerized systems that search for likely fraudulent procurement practices. I have to be vague to maintain the effectiveness of the system, but I believe I contributed to an improved understanding of a particular business practice that the World Bank had treated as indicia of a potential cartel. First, I explained why the existence of the practice proved that supposedly competitive bidders had in fact engaged in collusion to rig their bids. The practice was not simply a warning flag, but a clear badge of collusion.
Second, the practice constituted such conclusive evidence of collusion – and there were alternative practices that, for trivial increases in cost, would hide the collusion – that the only rational inference was that that the bidders believed that they could engage in collusion with impunity. They must believe that the risk of detection and sanctioning their bid rigging is so trivial that it was not worth $5 – the cost of making two additional short “tuk-tuk” drives – to avoid providing us with evidence of collusion in bids worth hundreds of thousands of dollars. Corrupt firms did not fear that World Bank and Government of India procurement officials would detect their obvious collusion. The World Bank and Government of India could have thrown out the collusive bids and excluded the bidders (debarred) them from being eligible for making future bids. The collusive bidders were willing to provide clear evidence of collusion, which they could have avoided hiding by bearing a trivial cost in order to disguise the collusion, because they viewed the risk of sanctions as less than trivial.
Government of India and World Bank procurement officials consistently failed to identify the business practices that were badges of collusion. The bidders’ view of the risk of detection of sanction by the procurement officials of bid rigging schemes (close to zero) proved accurate. When the frauds don’t fear the regulators and prosecutors it’s a sure sign that “control fraud” is common.
Which brings us to Afghanistan’s Kabul Bank – the nation’s largest and, one fervently hopes, worst bank. Consider these passages from the New York Times’ August 31 column (Troubles at Afghan Bank Jolt Financial System):
Investigators and bank regulators say Kabul Bank is also tied to the inquiry into New Ansari, the money-transfer firm, or hawala, that is suspected of moving billions of dollars out of the country for Afghan politicians, drug traffickers and insurgents. Kabul Bank used the firm, whose dealings are nearly impossible to track, to transfer at least $60 million out of the country, a bank shareholder said.
For a bank to use a hawala to move money is inherently suspect, investigators say, because a financial institution like Kabul Bank already has the means to transfer the money electronically. Electronic transfers are easier for regulators to follow.
Kabul Bank and its chairman, Mr. Farnood, lie at the heart of the political and economic nexus that sustains — and is sustained by — the government of President Hamid Karzai. Mr. Frozi was an adviser to Mr. Karzai’s presidential re-election campaign last year, and Kabul Bank provided millions to Mr. Karzai’s campaign.
American investigators say that Mr. Farnood’s unorthodox financial dealings, which included lending tens of millions of dollars to himself and other politically connected Afghans, have long been shielded from scrutiny by his close ties to Mr. Karzai.
Later reporting claims that “at least $60 million” was actually roughly $1 billion and that Ansari had moved billions of dollars of cash out of Afghanistan.
As grotesque as the reported numbers are, the Washington Post reported on February 25, 2010 (Officials puzzle over millions of dollars leaving Afghanistan by plane for Dubai) that it represented only a portion of the looting of donor nations.
The total volume of departing cash is almost certainly much higher than the declared amount. A Chinese man, for instance, was arrested recently at the Kabul airport carrying 800,000 undeclared euros (about $1.1 million).
Cash also can be moved easily through a VIP section at the airport, from which Afghan officials generally leave without being searched. American officials said that they have repeatedly raised the issue of special treatment for VIPs at the Kabul airport with the Afghan government but that they have made no headway.
But here are the most telling passages from the same story:
The high volume of cash passing through Kabul's airport first came to light last summer when British company Global Strategies Group, which has an airport security contract, started filing reports on the money transfers at the request of Afghanistan's National Directorate of Security, the domestic intelligence agency. The country's notoriously corrupt police force, however, complained about this arrangement, and Global stopped its reporting in September, according to someone familiar with the matter.
Efforts to figure out just how much money is leaving Afghanistan and why have been hampered by a lack of cooperation from Dubai, complained Afghan and U.S. officials, who spoke on the condition of anonymity. Dubai's financial problems, said a U.S. official, had left the emirate eager for foreign cash, and "they don't seem to care where it comes from." Dubai authorities declined to comment.
The New York Times stated in its September 4, 2010 article (Afghanistan Tries to Help Nation’s Biggest Bank):
A major shareholder in the bank, Mahmoud Karzai, the brother of the Afghan president, said Saturday that government assistance would be unnecessary considering that the bank still retained half of its assets, which officials say are about $2 billion. He said the government “will absolutely guarantee” the salaries of public servants and was transferring money to Kabul Bank each day.
First among the beneficiaries was Mr. Farnood himself, the officials said. He invested about $140 million of the bank’s money in the real estate market in Dubai in the United Arab Emirates, said Mahmoud Karzai, the president’s brother and a Kabul Bank shareholder. Among those properties were more than a dozen multimillion-dollar villas in Mr. Farnood’s name, some of them on Palm Jumeria, an island off Dubai’s coast, Mr. Karzai said.
The Dubai real estate market collapsed in 2008, wiping out much of Mr. Farnood’s investment and leaving Kabul Bank with the losses. A senior Afghan banking official said that the bank’s estimated losses were believed to be about $300 million, with assets of about $120 million.
Mr. Farnood closed his hawala and started Kabul Bank in 2004. From the beginning, the Afghan banking official said, Mr. Farnood ran Kabul Bank outside the law, daring regulators to rein him in. Kabul Bank often exceeded the limit of what it was allowed to lend on any particular project, and it sometimes skirted collateral and deposit requirements.
“Sherkhan Farnood is a very clever individual,” the Afghan banking official said. “Keeping the bank in line with the law was a constant challenge for us.”
New Ansari is known to be intimately connected to another financial institution, Afghan United Bank, officials say.
Asked why Mr. Farnood would use a hawala to transfer money abroad, Mahmoud Karzai, a shareholder, said he did not know. “This a very legitimate question,” Mr. Karzai said. “You should ask Sherkhan.”
The New Ansari case has drawn close attention, and not only because American investigators say the money trails lead to Afghan political elites, insurgents and suspected criminals. One of the men arrested in connection with the inquiry is a senior aide to President Karzai. The aide, Mohammed Zia Salehi, was released in early August after investigators were pressured by President Karzai himself.
Mr. Farnood and Mr. Frozi together owned more than half of the bank, meaning that the other shareholders had little leverage with them, officials said. It was only recently, as the bank’s losses mounted, that the two men began to disagree.
The Financial Times reported on September 2, 2010 (Fraud Fears Lead to Run on Kabul Bank):
Afghanistan’s central bank governor on Wednesday night tried to reassure customers that the bank was sound, saying the corruption and money-laundering allegations were “wrong and baseless”.
“Kabul Bank has no liquidity problems. Right now the Kabul Bank is functioning all over the country. Kabul Bank will never have liquidity problems in the future, inshallah (God willing),” said Abdul Qadir Fitrat, the head of the central bank.
“The central bank, the government of Afghanistan, is standing behind Kabul Bank and will never allow it to collapse,” he added.
“The Kabul Bank is safe,” said President Hamid Karzai at a press conference with Robert Gates, US defence secretary. “The government of Afghanistan is fully behind the bank ... We have got at least $4.8bn in cash; even if the whole financial system in Afghanistan collapses we still have the money to support it.”
A.P. reported on the same day (Kabul Bank Bailout? Mahmoud Karzai, President’s Brother, Calls for U.S. to Shore Up Bank):
But Afghan Finance Minister Omar Zakhilwal said that fears about the stability of Kabul Bank had not sparked a "crisis" at Kabul Bank.
"We are 100 percent sure that Kabul Bank is safe," Zakhilwal said. "I, as finance minister, am giving you my guarantee that your money is safe - if it's one Afghani, one dollar, one euro, up to millions. ... Kabul Bank is not in danger." Zakhilwal said every penny of customers' deposits would be guaranteed.
Gen. David Petraeus, top commander of U.S. and NATO forces in Afghanistan, was asked about Kabul Bank's woes at a round-table with reporters on Thursday.
"I'm not really the guy in the financial sector here in Afghanistan but financial issues can have security issues and therefore we keep an eye on them," Petraeus said. "In this case our assessment is that the governor of the central bank has taken prudent measures. He has announced what it is that he has been doing to reassure depositors ... Our sense is that he and the minister of finance have taken a very prudent course," that should reassure depositors. "I think this will be OK."
The Guardian reported on September 3, 2010 (Afghan officials resist clean-up of Kabul Bank as scandal engulfs elite):
Officials in Afghanistan are resisting US pressure for a wide-ranging clean-up of Kabul Bank, which is mired in allegations of corruption that have engulfed some of the wealthiest and most powerful people in the country.
The central bank on Tuesday ordered that the chairman and chief executive of Kabul Bank, who are both large shareholders in the bank, should step down from their positions and a government official be appointed to manage the bank.
But western officials with intimate knowledge of the financial drama said the US treasury wanted to see much stronger action. That would include bringing the bank into line with international norms, not least the appointment of a fully independent board capable of standing up to overmighty shareholders.
Such independence would risk bringing to light allegations that members of the country's business and political elite have, for years, apparently got away with using deposits of thousands of ordinary Afghans to fund lavish lifestyles. The bank's funds are said to have been used to invest in loss-making enterprises and, allegedly, the re-election campaign of President Karzai.
In the words of one foreign official, the US treasury is anxious to "rip the lid" off the cowboy capitalism that has been allowed to flourish at Kabul Bank.
But sources close to the negotiations say the central bank is under intense pressure to resist US demands.
The Wall Street Journal reported on September 3, 2010 (Karzai Kin Asks U.S. to Bolster His Bank):
If the withdrawals continue apace, Mr. Karzai said, the bank would be effectively insolvent by early next week. The bank has $1.3 billion in deposits, and its total assets are almost equal to its liabilities. But the lender only had $500 million in cash on hand at the start of the crisis, he said. Its other assets—including Dubai real estate investments of uncertain value—aren't easily convertible into cash.
Mr. [Mahmood] Karzai's numbers were confirmed by a senior central bank official.
That story was a follow up on the Wall Street Journal’s August 31, 2010 story (Afghan Bank’s Managers Ousted):
Kabul Bank figures into a major Afghan and U.S. investigation into the New Ansari Exchange, the largest of Afghanistan's hawala money-transfer firms, which have allegedly helped Afghan politicians, drug barons and even the Taliban move billions of dollars out of the country. Kabul Bank has used the hawala to clandestinely transfer almost $1 billion out of Afghanistan in the past few years, U.S. officials say.
A U.S. official sought to portray the president's willingness to allow the changes at Kabul Bank, whose chairman was a major contributor to his fraud-tainted re-election campaign last year, as a sign the Afghan leader may finally be heeding U.S. and European pressure to take a tougher line against corruption in his administration.
An Afghan banker with knowledge of the situation offered a less optimistic view, saying the move may have more to do with shifting political and business alliances among the country's small, clubby elite.
Mahmood Karzai, for example, has recently forged stronger links with the owners of Afghan United Bank, a competitor of Kabul Bank. Afghan United Bank's chairman owns a 20% stake in a housing development that Mahmood Karzai is building outside the southern city of Kandahar, where U.S. forces are making a major push against the Taliban.
Afghan United Bank is owned by the founders of New Ansari, the hawala that is being investigated. U.S. officials say the bank's owners still control the hawala, although the bank's owners say they have cut ties to the money-transfer business.
Corruption, of course, is a well known problem under the Karzai regime. The Wall Street Journal reported on August 12, 2010 (Afghanistan Money Probe Hits Close to the President) about the January 14, 2010 investigative raid that helped kick off the recognition of the scandals at New Ansari and Kabul Bank. (It would be naïve at this point to assume that only these two banks are problems.)
U.S. and Afghan officials say they have found evidence that New Ansari was helping to launder profits from the illicit opium trade and moving money earned by the Taliban through extortion and drug trafficking. The officials also say they have found links between the money transfers and some of the most powerful political and business figures in the country, including relatives of Mr. Karzai.
The New Ansari probe is now threatening to disrupt relations between the Afghan president and his U.S. allies. Last week, Mr. Karzai took more direct control of the task force that staged the raid, the Sensitive Investigative Unit, and another U.S.-advised anticorruption group, the Major Crimes Task Force. He ordered a handpicked commission to review scores of past and current anticorruption inquests.
Senior U.S. military and civilian officials with direct knowledge of the events regard Mr. Karzai's move as an effort to protect those close to him and, in the process, to quash the investigation into New Ansari. The officials describe it as a blow to American-backed anticorruption efforts. Members of the Sensitive Investigative Unit are vetted and trained by the U.S. Drug Enforcement Administration, and the Major Crimes Task Force is trained by the Federal Bureau of Investigation.
Afghan officials have known since the January raid, if not earlier, that New Ansari has played a central role in moving cash, U.S. officials say. Before the raid, so much money was passing through New Ansari in so many different currencies that it effectively set Afghanistan's exchange rates, says an official at Afghanistan's central bank and the senior U.S. official.
Afghan customs documents reviewed by the Journal indicate that $3.18 billion of cash was flown out of the country between the start of 2007 and February 2010. Couriers identified by U.S. and Afghan officials as working for New Ansari carried $2.78 billion of it, according to the documents.
Preliminary evidence collected by Afghan and U.S. investigators indicates that while some of the money came from legitimate businesses, some was diverted Western aid and logistics money, opium profits and Taliban funds, according to the U.S. and Afghan officials. Investigators are trying to uncover the exact sources of the money and determine who is benefiting.
U.S. officials say the customs records are incomplete, and that the sum carried out over that period likely is much larger than $3.18 billion.
Because law enforcement is so lax, "anybody can choose his or her own law. New Ansari is not unique," says Amrullah Saleh, former chief of Afghanistan's intelligence service, who was dismissed in June over disagreements related to the president's efforts to start peace talks with the Taliban.
On September 2, 2010, the Washington Post reported on the U.S. Treasury Department’s praise of the state of Afghani financial regulation (Nervous Afghans pull money from Kabul Bank, raising fears):
David Cohen, the Treasury Department's assistant secretary for terrorist financing, praised the Central Bank's leaders for acting "aggressively, decisively and as a bank regulator should act under the circumstances." He said the Treasury Department is "confident" that the Central Bank "has the expertise to handle the situation with Kabul Bank."
Treasury has assigned a small team of experts to work with the Central Bank on the matter.
The U.S. government has spent millions of dollars on contractors, Treasury Department advisers and computers for Afghanistan's Central Bank in an effort to fortify feeble supervision of a financial sector rooted in the fast-and-loose practices of the "hawala" money exchanges. Sherkhan Farnood, Kabul Bank's founder and ousted chairman, got his start by running a successful but corner-cutting hawala network, with branches in Russia, Dubai, Afghanistan and elsewhere.
The Washington Post explained in an earlier column (August 31, 2010: Afghan authorities take over biggest bank to avoid meltdown) the lack of financial regulatory success in Afghanistan despite U.S. technical support:
Kabul Bank was once hailed as a banking pioneer in Afghanistan, where it introduced ATMs, produced glossy brochures and drummed up business by holding prize drawings for depositors. But it then expanded into the airline business, took in politically connected figures as shareholders and became an emblem of the cowboy crony capitalism that has helped disfigure the country since the U.S.-led rout of the Taliban in late 2001.
Murky transactions by Kabul Bank, first detailed by The Washington Post this year, include large property purchases in Dubai with bank money. The properties include at least 16 multimillion-dollar villas on Palm Jumeirah, a luxury development in the Persian Gulf, and two towers under construction. All were registered in the name of Farnood and his wife.
Several of the Palm Jumeirah waterfront villas, each with a swimming pool, are occupied by prominent Afghans, including Mahmoud Karzai, who used to run an Afghan restaurant in Baltimore.
The bank's future will depend in part on the Dubai property market, where the price of real estate purchased with cash from the bank has plummeted and created big losses, at least on paper. Another major source of concern, bankers and officials said, is a hidden web of large loans, many of them to Kabul Bank's own shareholders. Afghan regulators did not uncover the insider loans, which exceeded legal limits, despite extensive assistance from the United States.
It is extremely unlikely that “Afghan regulators did not uncover the insider loans.” Indeed, that claim is bizarre given the February 22, 2010 expose by the Washington Post (In Afghanistan, signs of crony capitalism):
Afghanistan’s biggest private bank -- founded by the Islamic nation's only world-class poker player -- celebrated its fifth year in business last summer with a lottery for depositors at Paris Palace, a Kabul wedding hall.
Prizes awarded by Kabul Bank included nine apartments in the Afghan capital and cash gifts totaling more than $1 million. The bank trumpeted the event as the biggest prize drawing of its kind in Central Asia.
Less publicly, Kabul Bank's boss has been handing out far bigger prizes to his country's U.S.-backed ruling elite: multimillion-dollar loans for the purchase of luxury villas in Dubai by members of President Hamid Karzai's family, his government and his supporters.
The close ties between Kabul Bank and Karzai's circle reflect a defining feature of the shaky post-Taliban order in which Washington has invested more than $40 billion and the lives of more than 900 U.S. service members: a crony capitalism that enriches politically connected insiders and dismays the Afghan populace.
"What I'm doing is not proper, not exactly what I should do. But this is Afghanistan," Kabul Bank's founder and chairman, Sherkhan Farnood, said in an interview when asked about the Dubai purchases and why, according to data from the Persian Gulf emirate's Land Department, many of the villas have been registered in his name. "These people don't want to reveal their names."
Afghan laws prohibit hidden overseas lending and require strict accounting of all transactions. But those involved in the Dubai loans, including Kabul Bank's owners, said the cozy flow of cash is not unusual or illegal in a deeply traditional system underpinned more by relationships than laws.
The curious role played by the bank and its unorthodox owners has not previously been reported and was documented by land registration data; public records; and interviews in Kabul, Dubai, Abu Dhabi and Moscow.
Many of those involved appear to have gone to considerable lengths to conceal the benefits they have received from Kabul Bank or its owners. Karzai's older brother and his former vice president, for example, both have Dubai villas registered under Farnood's name. Kabul Bank's executives said their books record no loans for these or other Dubai deals financed at least in part by Farnood, including home purchases by Karzai's cousin and the brother of Mohammed Qasim Fahim, his current first vice president and a much-feared warlord who worked closely with U.S. forces to topple the Taliban in 2001.
At a time when Washington is ramping up military pressure on the Taliban, the off-balance-sheet activities of Afghan bankers raise the risk of financial instability that could offset progress on the battlefield. Fewer than 5 percent of Afghans have bank accounts, but among those who do are many soldiers and policemen whose salaries are paid through Kabul Bank.
The result is that, while anchoring a free-market order as Washington had hoped, financial institutions here sometimes serve as piggy banks for their owners and their political friends. Kabul Bank, for example, helps bankroll a money-losing airline owned by Farnood and fellow bank shareholders that flies three times a day between Kabul and Dubai.
Kabul Bank's executives helped finance President Hamid Karzai's fraud-blighted reelection campaign last year, and the bank is partly owned by Mahmoud Karzai, the Afghan president's older brother, and by Haseen Fahim, the brother of Karzai's vice presidential running mate.
Farnood, who now spends most of his time in Dubai, said he wants to do business in a "normal way" and does not receive favors as a result of his official contacts. He said that putting properties in his name means his bank's money is safe despite a slump in the Dubai property market: He can easily repossess if borrowers run short on cash.
A review of Dubai property data and interviews with current and former executives of Kabul Bank indicate that Farnood and his bank partners have at least $150 million invested in Dubai real estate. Most of their property is on Palm Jumeirah, a man-made island in the shape of a palm tree where the cheapest house costs more than $2 million.
Responsibility for bank supervision in Afghanistan lies with the Afghan central bank, whose duties include preventing foreign property speculation. The United States has spent millions of dollars trying to shore up the central bank. But Afghan and U.S. officials say the bank, though increasingly professional, lacks political clout.
The central bank's governor, Abdul Qadir Fitrat, said his staff had "vigorously investigated" what he called "rumors" of Dubai property deals, but "unfortunately, up until now they have not found anything." Fitrat, who used to live in Washington, last month sent a team of inspectors to Kabul Bank as part of a regular review of the bank's accounts. He acknowledged that Afghan loans are "very difficult to verify" because "we don't know who owns what."
Kabul Bank's dealings with Mahmoud Karzai, the president's brother, help explain why this is so. In interviews, Karzai, who has an Afghan restaurant in Baltimore, initially said he rented a $5.5 million Palm Jumeirah mansion, where he now lives with his family. But later he said he had an informal home-loan agreement with Kabul Bank and pays $7,000 a month in interest.
"It is a very peculiar situation. It is hard to comprehend because this is not the usual way of doing business," said Karzai, whose home is in Farnood's name.
Karzai also said he bought a 7.4 percent stake in the bank with $5 million he borrowed from the bank. But Gopalakrishnan, the chief audit officer, said Kabul Bank's books include no loans to the president's brother.
Also in a Palm Jumeirah villa registered in Farnood's name is the family of Ahmad Zia Massoud, Afghanistan's first vice president from 2004 until last November. The house, bought in December 2007 for $2.3 million, was first put in the name of Massoud's wife but was later re-registered to give Farnood formal ownership, property records indicate.
Massoud, brother of the legendary anti-Soviet guerrilla leader Ahmad Shah Massoud, said that Farnood had always been the owner but let his family use it rent-free for the past two years because he is "my close friend." Massoud added: "We have played football together. We have played chess together." Farnood, however, said that though the "villa is in my name," it belongs to Massoud "in reality."
Haseen Fahim, the brother of Afghanistan's current first vice president, has been another beneficiary of Kabul Bank's largesse. He got money from Farnood to help buy a $6 million villa in Dubai, which, unusually, is under his own name. He borrowed millions more from the bank, which he partly owns, to fund companies he owns in Afghanistan.
Fahim said two of his companies have borrowed $70 million from Kabul Bank. Insider borrowing, he said, is unavoidable and even desirable in Afghanistan because, in the absence of a solid legal system, business revolves around trust, not formal contracts. "Afghanistan is not America or Europe. Afghanistan is starting from zero," he said.
Kabul Bank also plunged into the airline business, providing loans to Pamir Airways, an Afghan carrier now owned by Farnood, Fruzi and Fahim. Pamir spent $46 million on four used Boeing 737-400s and hired Hashim Karzai, the president's cousin, formerly of Silver Spring, as a "senior adviser."
Noor Delawari, governor of the central bank during Kabul Bank's rise, said Farnood and his lieutenants "were like wild horses" and "never paid attention to the rules and regulations." Delawari said he didn't know about any property deals by Kabul Bank in Dubai. He said that he, too, bought a home in the emirate, for about $200,000.
Fitrat, the current central bank governor, has tried to take a tougher line against Kabul Bank and its rivals, with little luck. Before last year's presidential election, the central bank sent a stern letter to bankers, complaining that they squander too much money on "security guards and bulletproof vehicles" and "expend large-scale monetary assistance to politicians." The letter ordered them to remain "politically neutral."
Kabul Bank did the opposite: Fruzi, its chief executive, joined Karzai's campaign in Kabul while Farnood, its poker-playing chairman, organized fundraising events for Karzai in Dubai. One of these was held at the Palm Jumeirah house of Karzai's brother.
The government has returned the favor. The ministries of defense, interior and education now pay many soldiers, police and teachers through Kabul Bank. This means that tens of millions of dollars' worth of public money sloshes through the bank, an unusual arrangement, as governments generally don't pump so much through a single private bank.
Soon after his November inauguration for a second term, President Karzai spoke at an anti-corruption conference in Kabul, criticizing officials who "after one or two years work for the government get rich and buy houses in Dubai."
To review the bidding: there was easily available public record information showing that there were massive insider transactions by Kabul Bank’s controlling shareholder (who took an active managerial role). The story documented his insider dealings in Dubai and with his airline. The thing they were hiding was how many of Karzai’s cronies had become wealthy and lived in palatial dwellings in Dubai. Kabul Bank’s controlling shareholder promptly admitted, when confronted with this information, that what he had done was improper. There is no evidence that the Afghan Central Bank responded to this article (which predicted the Kabul Bank run over six months ago) with any order preventing the insider abuse until roughly a week ago. There is strong reason to believe that the controlling owner’s close ties to President Karzai, President Karzai’s brother, and other close associates of President Karzai protected him from the regulators until President Karzai’s brother began to become more closely associated with a rival bank.
In earlier years, boosters made strident claims that Afghan banking was a tremendous success, that its regulation was sound, and that Afghans were unusually honest. U.S. businesses were chastised by a column (The Virgin Market) in the April 26, 2006 Wall Street Journal for not jumping into Afghanistan. The author assured them that: “while Afghans are lacking in education and management skills, they have a culture that values honor and honesty.”
A September 2006 Euromoney article (Afghanistan Gets Back to Business) praised Kabul Bank and Afghani financial regulation.
[I]nside its ancient headquarters, Afghanistan’s central bank governor, Noorullah Delawari, micro-manages staff to such an extent that he gives instructions on how to maintain the building’s toilets, because no-one else will.
A banking success story
Despite the banking system’s eccentricities, Noorullah Delawari, an affable 62-year-old who had a career as a commercial banker in southern California before returning to help rebuild the land of his birth in 2002, is confident that progress has been made. “The development of a banking system has been one of Afghanistan’s success stories since we were liberated. We have come a very long way in a short time,” he says.
An Islamic bank or a lottery?
A sign of confidence is perhaps a generous way of looking at Kabulbank’s achievements. The bank’s sudden success might be more to do with the fact that Afghans like a punt as much as the next person. Indeed, an examination of Kabulbank’s operations brings to mind that old saying that if it walks like a duck and quacks like a duck, then it most likely is a duck. Consider Kabulbank’s Bakht deposit account, launched in April. In the Dari tongue of Afghanistan, the word bakht means “fortune”, which explains the bold exclamation advertised around Kabul that Bakht is “The easiest way to earn a million.”
Since Kabulbank started touting Bakht to customers, its customer base has tripled, making it the biggest of the 11 banks that have opened since the Taleban was ousted by the Americans in 2001, to add to the two moribund state commercial banks. Every $100, or Af5,000, deposited in a Bakht account entitles the depositor to a ticket in a lucky draw, based on an average monthly minimum balance. The draw is held every month, in a lively night of frivolity in a Kabul wedding hall, and beamed across the country on each of its four TV stations. Prominent Afghans join with bank officials and academics to pull winning tickets from a tub – since it is just a few years since the ascetic Taleban were kicked out they haven’t yet descended to bikini-clad barrel girls. The winning ticketholder’s name is read out and if he’s in the room – it’s almost always a man who wins – he’s handed a mock cheque for Af1 million, or $20,000.
The revelations of massive corruption and control fraud at Afghanistan’s leading financial institutions – tied to the nation’s ruling elites – has led the U.S. to decide to downgrade its concerns about corruption. The Washington Post reported this policy decision on September 4, 2010 (U.S. to temper stance on Afghan corruption).
But U.S. officials and defense analysts say that challenging local power brokers and criminal syndicates, many of which depend on U.S. reconstruction contracts and ties to the Afghan government for support, would likely add to the unrest in southern Afghanistan and produce a higher U.S. casualty rate. "Putting an end to these patronage networks would not come cheaply," said Stephen Biddle, a senior fellow at the Council on Foreign Relations who has advised U.S. commanders in Afghanistan.
By contrast, allowing some graft among Afghan power brokers on the condition that they agree to limit their take and moderate predatory activities, such as their use of illegal police checkpoints, could promote near-term improvements, Biddle said. "We spend a lot more money in Afghanistan than the narcotics trade," he said. "A lot of money that funds these networks comes from us. So we can essentially de-fund these networks, taking away their contracts."
Analysis and Questions Arising from this Scandal
I will return to Biddle’s remarks in a later column. I believe he is wrong about corruption, fraud, and predation. Biddle finds it necessary to create this euphemism for corruption (“patronage networks”). He believes that he can calibrate graft and dial his desired level of corruption as if he were using a rheostat to change the intensity of a light. He thinks he can get them to “limit their take” and “moderate” “their “predatory behavior.” He thinks he can get Karzai to “defund” his political cronies. His appeasement strategy has never worked. It will fail and the failure will “not come cheaply.” It will kill and maim Afghans, NATO troops, and foreign aid and construction workers.
Let’s turn to the most significant lessons for financial regulation arising from the Kabul Bank crisis. "Control fraud" is the central economic and political problem that we face in Afghanistan and it cripples our effectiveness against the insurgency. Control fraud is a crimonology concept that describes what happens when those that control a seemingly legitimate entity use it as a weapon to defraud. The Kabul Bank case exemplifies (crude) banking control fraud and public sector control fraud. Afghanistan is a kleptocracy. It is another depressing example of crony capitalism. Afghanistan’s “growth” in GDP is the product of massive international aid. Too many of Afghanistan’s leading business leaders destroy wealth – that’s what fraud and corruption inevitably cause. It is naïve vanity to believe that one can create an effective financial regulatory system in an endemically corrupt nation. It is naïve to believe that “private market discipline” will function effectively in an endemically corrupt nation. Endemically corrupt nations do not perform well.
Massive insider transactions are the marker of the crude control frauds. Such frauds need political allies – and find it easy to obtain them in corrupt nations. When you see crude frauds of this nature you can infer that they do not fear the regulators.
It is also absurd to believe that had “international financial standards” been in place in Afghanistan the problem would have been avoided (and it is outright bizarre for the Guardian to make such a claim). Have we forgotten the nations that did supposedly employ international financial standards found that these standards were outright criminogenic? The Guardian raged at the failures of those standards. Does anyone seriously think that Treasury – which missed everything in our crisis – has some surplus team of anti-fraud financial experts that can produce magic in Kabul while Karzai and his cronies remain in power? Actually, does anyone seriously think that Treasury has any team of anti-fraud financial experts? Treasury, until passage of the new financial reform bill, had two financial regulatory bureaus, the OCC and the OTS. Their spokespersons told the Huffington Post that the agencies had made zero criminal referrals for mortgage fraud – during what the FBI aptly termed an “epidemic” of mortgage fraud. Maybe we can get Afghanistan to send us some of their anti-fraud and anti-corruption expertise.
Where were the auditors? PWC was Kabul Bank’s auditor. It missed everything.
Two theoclassical theoretical claims failed again in the Kabul Bank context. Easterbrook & Fischel (1991) argue that agency problems should be minimized when a dominant shareholder also serves as the senior manager. Kabul Bank illustrates the same lesson as the S&L debacle – the greater the insider monopoly on power the greater the fraud risk. Afghanistan does not have deposit insurance. The claim that deposit insurance drives crises by triggering moral hazard has not been supported. Worse, this case illustrates the near impossibility of making any credible claim that the government will never bail out a financial institution that is not insured by the government.
Why are so many of Karzai’s cronies wealthy? Why do so many have homes in Dubai?
Why does Kabul Bank with (purported) roughly $1 billion in total assets (purportedly) have $500 million in liquid assets? That would mean (A) that its non-liquid assets are overwhelmingly insider loans and (B) that it makes a trivial contribution to financing growth in Afghanistan. It would mean that its primary function was to borrow money from depositors and purchase Afghani bonds.
Why did Kabul Bank reportedly make enormous transfers via hawala?
What is General Petreus doing opining about the safety of Kabul Bank – particularly when the Afghan authorities are busy misleading their public about the bank’s financial condition?
Why do they also call bank runs “panics” when it is perfectly sensible (and publicly desirable) for an uninsured depositor to seek to remove funds from control frauds?
Bill Black is the author of The Best Way to Rob A Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.
Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony and musing about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.
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