The Kabulbank scam in Afghanistan may be the largest theft of depositor money per capita the world has ever experienced. This is the first of a three-part series chronicling the unfolding and ultimate resolution of that scandal.
On Wednesday, Sept. 1, 2010, long lines of customers formed in front of Kabulbank, Afghanistan’s largest financial institution. Da Afghanistan Bank (DAB), the country’s central bank had removed the two top executives of Kabulbank and prompted a run on the bank by worried customers rushing to withdraw their funds.
One day later, Afghanistan’s President Hamid Karzai, trying to stem the tide, told concerned depositors, “Kabulbank is safe. People need not panic, need not be worried.”
Kabulbank had grown from nothing when it opened in July 2004 to the largest bank in Afghanistan in just a few years. After just five years Kabulbank had three times more deposits than the next largest bank in Afghanistan, and more than one-third of all deposits in the banking system.
In 2010, it had 68 branches serving most of the country, a large network of ATM cash machines, and a sophisticated IT and accounting infrastructure.
The following Saturday was a beautiful, late summer day in Washington, DC. I was sitting in the gazebo in my back garden reading Amy’s War, about the almost two decades of civil war in Sudan, in preparation for my planned trip to Juba, southern Sudan the following week. My 30-some years of experience with the International Monetary Fund (IMF) establishing and advising central banks, including introducing new currencies, was being called upon by Deloitte/USAID to help establish a new central bank and currency in the about-to-be new country of South Sudan.
While sitting there pondering how the authorities would handle the Kabulbank crisis, my blackberry rang. “Sorry to disturb you Warren,” said Luis Alberto Cortavarria-Checkley, a former banking supervisor in Peru now with the IMF on the other end. “We are sending a team to Kabul to advise DAB on the Kabulbank crisis. Are you interested in going?”
“Could you leave tonight? … Enrique Gelbard is the mission chief and is taking the last Air France flight to Paris tonight and on to Dubai. Marcin Sasin, the Afghan desk economist will be on the same flight. In Dubai you will met up with Melissa Tullis from the Fund’s Legal Department and you will all proceed from there on Safi Air at 3 a.m. arriving in Kabul at 6:30 a.m. Monday morning.”
“Sure,” I said, “Who is taking care of tickets and visas? They will have to arrange for me to get the visa after I arrive and I will need a letter to convince Safi Air to let me board in Dubai without a visa. I had better start packing.”
The birth and death of Kabulbank
When Afghanistan’s new, post-Taliban government introduced a new currency on Oct. 7, 2002, for all practical purposes there were no banks to help. The three state-owned commercial banks, Bank Millie, Pashtaney, and the Export Promotion Bank were zombies. They had been arms of the government—the pay masters that counted out the cash to pay government employees, handled the government’s foreign payments, and lent their depositors’ money to the government and state-owned enterprises, etc.
When I arrived in Kabul the first time in January 2002 they had not made any loans for a number of years. The branch infrastructure of these banks was not even sufficient to handle the introduction of the new currency and redemption of the old ones.
There were six issues of domestic bank notes in circulation in 2002 – all in the names of former Afghan leaders at the time of their issuance. Between October 7, 2002, and January 2, 2003, all of the old currency had to be exchanged for the new Afghani.
In the absence of functioning banks the exchange relied heavily on a centuries-old system of moneychangers known as Hawala dealers. These unregulated private entrepreneurs provided the services of exchanging one currency for another and money transfers, such as delivering cash to your profligate son backpacking around Europe.
An Afghan can take U.S. dollars to a Hawala dealer in Chicago and have an equivalent amount of dollars or Afghani delivered to a friend or relative in Kandahar within hours on the basis of a name and a password. Hawala dealers existed long before Western Union was even thought of. In 2002 the occupying U.S. military enlisted them to collect the old currencies in exchange for the new one, which required managing inventories of both all over the country.
Before he founded Kabulbank in 2004 as its chairman, Sherkhan Farnood was one of the biggest and most successful Hawala dealers.
As a banker Farnood was not entirely confidence inspiring. There was some concern at the central bank at the time whether the relationship lending that moneychangers sometimes engaged in, even though legally they were not supposed to take deposits or lend money, could successfully mature into the collateralized, business plan-based, creditworthiness assessment of modern bank lending.
On top of that, Farnood was proudly a world-class gambler and poker player, hardly the image the banking industry wishes to cultivate – modern day Wall Street aside.
On the face of it Kabulbank was successful. While the bank’s general and VIP savings deposits paid interest, Kabul Bank introduced a new deposit product in April 2006, the “Bakht Deposit,” which complied with Shariah requirements against paying interest – of interest to many Muslim customers in this overwhelmingly Muslim country.
Instead of receiving interest, the Bakht Depositers participated in weekly and monthly lotteries depending on the amount of their minimum balance. The new product proved extremely popular. Kabulbank’s already rapid growth exploded and it quickly became Afghanistan’s largest bank several times over.
But it was less clear what was happening on the other side of Kabul Bank’s balance sheet, i.e., its loan assets. Rumors began to circulate of questionable funding of Karzai government friends.
While the young and inexperienced supervisory department at Da Afghanistan Bank raised a number of governance concerns with Kabulbank during its first six years of operation, including the repeated rejection of its proposed external auditor, no serious supervisory measures were taken.
This changed when an eye-popping Washington Post article on Feb. 22, 2010, claiming insider lending abuses at Kabul Bank1 led former DAB governor Abdul Fitrat and the IMF to agree that a forensic audit was needed as standard prudential supervision is not well equipped to detect criminal behavior.
On March 29, 2010 the former governor requested technical assistance with such an audit from the U.S. Treasury Department and in May President Karzai affirmed his support for the audit. However, political tensions between the president and the U.S. over night raids on Afghan homes by American Special Forces resulted in a significant delay in the audit. In the end, Karzai refused to allow the U.S. to oversee the audit, which was eventually conducted by an international audit firm, Kroll, under the supervision of DAB in late 2011, well after its collapse.
Worrying that all was not right at Kabulbank, the central bank introduced a regulation on June 6, 2010, prohibiting large shareholders from holding management positions in their banks and used this regulation to force Farnood and Khalilullah Ferozi, repectively Kabulbank’s chairman and CEO, to resign at the end of August.
The public fuss over their “resignations” helped bring Kabulbank’s problems to the public’s notice and started the depositor run on the bank on Wednesday, September 1, 2010.
Monday, September 6, 2010
I sleep well on planes, thank God. We arrived at Kabul on schedule at 6:30 a.m. The immigration official at the airport had been notified of our expected arrival and allowed us to enter the country, but kept our passports. We were met at the airport by the IMF security officer resident at the IMF guesthouse where we always stay, and two armored cars.
We had time for a shower and breakfast at the guesthouse before proceeding to DAB and our meeting with Governor Fitrat followed by meetings with Qaseem Rahimi, head of the Financial Supervision Department, Ateeq Nosher, head of the Monetary Policy Department, and Rahim Zakir, head of the Market Operations Department.
These were followed by a briefing meeting with the World Bank financial sector team headed by Nick Krafft, and a large meeting at the U.S. Embassy led by my old Baghdad office mate Bill Block, which included representatives from the U.K Embassy, the U.K. Department for International Development, some vaguely identified AML security types, as well as the World Bank team.
Our own team was six strong (Enrique, Marcin, Melissa, myself plus Borja Garcia from the IMF’s Fiscal Affairs Department and Khanjar Wabel Abdallah, the IMF’s resident representative in Kabul).
The WB office is literally next door to the IMF guesthouse and the U.S. Embassy is only a few blocks away. By the time we returned to the IMF guesthouse at 5:30 pm, I collapsed in bed and slept through dinner.
Tuesday, September 7, 2010 – The War Room
In the first week of September Kabulbank’s deposit base of US$1.3 billion dropped by one-third. In response to the run, President Karzai announced, while we were in the air, that all depositors’ funds in Kabulbank would be protected (guaranteed somehow) and Governor Fitrat assured the public that the central bank would provide Kabulbank with all of the liquidity it needed to honor public demands for their money. The daily net deposit outflows fell from US$73 million on Aug. 31 to US$31 million on Sept. 7.
Also while we were in the air, DAB replaced Kabulbank’s management with a conservator, contrary to our advice that the bank be put into receivership. The law allowed placing a bank into conservatorship without the public announcement required for receivership and President Karzai clearly wanted as little publicity as possible.
The president is said to have been furious at the embarrassment brought to his name by his brother Mahmood Karzai,2 who owned 7 percent of Kabulbank’s shares, and the semi-public power struggle between Farnood and Ferozi. Apparently Karzai had instructed DAB governor Fitrat to fix the problem.
Bank panics, especially runs on large banks, are adrenaline-inducing events that virtually always lead governments to guarantee all deposits. This pushes the rot onto taxpayers without addressing underlying weaknesses in bank governance and/or supervision.
While the deposit guarantee was a fait accompli, and DAB did not have the expertise to implement quickly an orderly liquidation, we were determined to instill as much resolution good practice into the process as possible. I recommended that we recruit Kat Woolford, a bank resolution expert with whom I had worked in Baghdad, and she moved to Kabul a few weeks later.
Governor Fitrat had explained to us the day before, that he had set aside space on the third floor of the central bank – in the space used by the IMF actually – for what he called a ‘war room’. He wanted us to work together with the World Bank and the U.S. Treasury team to develop joint recommendations for stemming the run on Kabulbank and for its rehabilitation.
At the massive meeting at the U.S. embassy the day before, the World Bank and U.S. Treasury teams had agreed to meeting with team in the war room at DAB at 8:30 a.m. Someone forgot to tell the IMF office manager who had the key to the room and didn’t usually arrive until 9 a.m. We moved down to the room outside the governor’s office and began our discussions until the war room was opened.
Working with other international organizations can be a challenge. Working against them can be a disaster. We are born with strong family/tribal instincts, which in the modern world tend to take the form of nationalism of one sort or another.
Among groups working internationally each group tends out of instinct and habit to defend its turf and approach against any other organization. Even members of our own IMF team from different departments had perspectives that reflected the mandates of their departments.
The member from the IMF’s Fiscal Affairs Department argued from the perspective of the finance minister and the members from the Monetary and Capital Markets Department defended the perspective of the central bank. The interagency struggles among American advisers from different U.S. government departments in Iraq when I was working there in 2004-05 were the worst I had ever seen anywhere.
Fortunately, we on this occasion were all on the same page, which was to minimize the cost to the government and maximize market discipline of banks for the future. Our differences concerned how far it was practically and politically possible to press for these principles.
If we could make our war room collaboration work, it would greatly strengthen the power of our recommendations and assistance, which ran against the instincts of the Afghan authorities. Our first session around the war room table was an important occasion for establishing confidence that we were each honestly sharing the information we had. It was a kind of mating dance. We swapped our usual jokes with the World Bank team and they did with us.
At our meeting the day before at the U.S. embassy, our mission chief had failed to mention that we knew DAB had already extended a lender of last resort loan of $100 million to Kabulbank and I worried that this oversight would sour the confidence building among the groups that was needed. Fortunately it did not and a genuine rapport and cooperation quickly developed.
My day ended with dinner in the Canadian Embassy two doors down from the IMF guesthouse with my friend, Canadian Ambassador to Afghanistan Bill Crosbie.
September 8 – 11, 2010
We expected Wednesday to mark the end of Ramadan and the beginning of the feast of Eid ul-Fitr, the Festival of the Fast Breaking. During the three-day holiday plus normal weekend banks would be closed giving us all a chance to catch up with events and for DAB and Kabulbank branches to restock their currency inventories.
Muslim holidays follow a lunar calendar and thus fall on different dates each year. However, Eid throws in the further wrinkle that someone somewhere must actually see the new moon in order to start the celebration. Whoever that all-important person is didn’t see it as expected and Eid started a day later, something all Afghan Muslims and we learned on what we thought would be the last day of Ramadan.
Because DAB was closed during this holiday period, the closest thing Muslims have to the Christian Christmas, our daily or twice-daily war room meetings with the World Bank and U.S. Treasury moved to the conference room of the IMF guesthouse where we resided.
During these days we met with Masoud Musa Ghazi, the conservator of Kabulbank the governor had appointed a few days earlier, who reviewed his plans for gaining control of the bank. He shared, in confidence, his preliminary findings on the condition of the bank, and its loans to its principal owners, which exceeded our wildest expectations.
By and large all the deposits raised by Kabulbank had been “lent” to its owners and friends of the Karzai government. The scale was truly staggering and shocking.
As prudential regulations limit the amounts that can be lent to single or connected parties, the amounts going to the owners and their friends were disguised as loans to other unrelated parties and dummy companies.
The owners invested the bank’s money lent to them in various companies and properties – the most frequently cited being $160 million worth of luxury villas in Palm Jumeirah, Dubai, purchased by Farnood and his wife. With the bursting of the global real estate bubble and the associated recession, the value of these properties and other business investments of Kabulbank’s borrowers fell as well. This was not a bank that lost money from mismanagement and excessive risk taking. It was a bank that had been a criminal enterprise for stealing depositor money from the beginning, covering its tracks with bribery and skill.
In a meeting at the IMF guesthouse Kabulbank’s internal auditor Raja Gopalakrishnan gave what would have been an Academy Award-winning performance.
He bragged about the skill with which he had designed the fraud and covered up the bank’s crimes and he provided us with a number of detailed examples. We nicknamed him “the liar” for short because his last name was unpronounceable and because he told us a number of things that we knew were not true.
He ended by almost threatening us. “This is Afghanistan, Kabulbank will never be put into conservatorship. Never! Not as long as we are alive.”
He marched out leaving us shocked and speechless.
His sentiment was echoed by ousted Kabulbank CEO … Ferozi who told the Washington Post “if there is no Kabulbank, there will be no Karzai, no government.”
Equally telling was his statement that the bank’s loan system wasn’t perfect, but that was to be expected “in a country like Afghanistan,” where personal relationships carry more weight than “being a professional” in the field.
On Saturday morning at about 1 a.m. I was dragged out of bed to join a teleconference with IMF headquarters in Washington in which we discussed our recommendations. A first draft of our joint note and recommendations to the governor was prepared and discussed with our World Bank and U.S. embassy colleagues. Everyone checked back with their head offices for guidance and approval.
That evening, Wabel, the IMF resident representative, and I had dinner, again for me, with the Canadian ambassador. Thank God for Wabel to keep the conversation going as I literally nodded off over and over again at the dinner table.
My departure was booked for Sunday so that I could arrive in Juba, South Sudan on Monday the 13th. Enrique asked if I could delay by two days and I agreed.
Our war room team was working in remarkable harmony. We knew that the American team had intelligence that they didn’t always share, such as the movements of the Kabulbank principals, but trusted that they were sharing everything relevant to our joint work. We began round after round of revisions to our joint report to the governor and minister.
Everyone would review the latest draft electronically and each of the three teams would consolidate their edits and send them to Enrique to merge into the next draft that we would then discuss in the war room. Our goal was to send the finished document to the governor and minister on Sunday for discussion with them on Monday when banks reopened. Saturday evening each group sent the “final” draft to our respective headquarters.
September 12 – 14, 2010
Sunday morning following additional teleconferences with our headquarters, with the same presumably going on with the World Bank and U.S. Treasuy, it was obvious that we would have trouble sticking to our timetable. Our HQ pressed some good suggestions for strengthening our recommendations. The World Bank accepted them and the U.S. Treasury very reluctantly accepted them.
We all recognized that there was great value in having a joint report, and that would require compromises here and there. The U.S. Treasury came back with its own changes requested by its head office. The “final” report was sent to the governor and minister on Monday morning and discussed with them later in the day.
Following those discussions a few more changes were agreed to and the “final, final” report was issued Tuesday, my departure day. The first banking day following the holiday saw continued net deposit drains from Kabulbank but at the more modest rate of $19 million.
Given Kabulbank’s size – one-third of all deposits in the economy – and the government’s demand that it be saved, we agreed with the government’s strategy of guaranteeing deposits and of DAB providing all of the liquidity support to Kabulbank needed to allow depositors to withdraw their funds if they wanted. However, we thought that the governor should provide the public with more information on the measures being taking to clean up the bank.
The removal of Kabulbank’s chairman and CEO had been announced, but it had not been announced that the bank had been placed under the control of a DAB-appointed conservator who could act with all of the powers of the shareholders. Deposits of the owners had been frozen, as were their real estate assets in Kabul. The more difficult recommendations dealt with how to clean up the bank and its governance and what to do with the politically well-connected owners. President Karzai wanted as little publicity as possible.
We made a new lending program with the IMF contingent on, among other things, a forensic audit of Kabulbank, an independent public review of the Kabulbank crisis, putting the bank under receivership and its controlled liquidation by selling off its good assets, a serious effort at asset recovery from “borrowers,” and prosecuting wrongdoers if criminal activity at Kabulbank were found.
Achievement of these benchmarks came slowly and the approval of a new program with the IMF was significantly delayed. Kabulbank was not put into receivership until April 20, 2011, at which time it was split into a good bank and bad bank –Kabulbank in liquidation and a successor New Kabul Bank. While Karzai commissioned a quick and dirty report by an Investigative Commission Evaluation of Kabulbank submitted six weeks later, it was not acceptable to the IMF.
A proper internationally conducted forensic audit, the Kroll report, was not completed until March 14, 2012. A Special Tribunal established by President Karzai to hear Kabulbank-related cases convicted the two main architects of the fraud of a range of relatively minor charges on March 5, 2013.
At 5:15 a.m. Tuesday the security officer at the IMF guesthouse helped me put my suitcase and computer bag in the IMF’s armored car and we drove to the airport. As it happened, the Afghan First Vice President Mohammad Qasim Fahim, the brother of Haseen Fahim, a major benefactor of Kabulbank, was arriving from his hospital stay in Germany and the main access to the airport was closed. We were directed to parking area C, which is further from the entrance than are areas A and B.
I said good-bye to Wahid, our driver and the security officer and I started the trip to the terminal and the airline check-in counter. At the first of many security check points I marveled that the guy in front of me received a full body search while his bulging back pack went unexamined. My security officer, who was kindly pulling along my bag, was stopped and not permitted to proceed because he was not a passenger. He presented his case for accompanying me to the guard, “but Sir, I need to carry his bag. He is old.” Another bubble deflated, and I flew off to Juba, South Sudan.
To be continued….
- Andrew Higgins, “In Afghanistan, Signs of Crony Capitalism”, The Washington Post, February 22, 2010.
- I met Mahmoud Karzai the first time in his Baltimore restaurant in January 2002 just before leaving for my first of many visits to Kabul. He was surprised and happy to meet someone on their way to his country and I was eager to learn as much from him as possible before going. But during that first January no one knew much of anything.