Tackle corruption before bailing out Kabul Bank

During the mid-1970s, while working as a very junior banker in the City of London, I was an eyewitness to a bank run. It was not a pretty sight. Small savers in particular were desperate not to lose their life savings. And the desperation showed.

The run was a small part of a rash of bank failures that were taking place across Europe, among them the German Herstatt Bank, as well as London and County Securities in the UK. Apart from facing down angry clients, banks immediately pulled back from lending funds on the overnight market, for fear that they might not be repaid. This behavior only compounded an already difficult situation. (Ironically, one bank all we were ready to deal with was Moscow Narodny; everyone figured the Soviets would never let their bank go under.)

Afghanistan’s largest bank, Kabul Bank, is now in the midst of fending off a run on its deposit accounts. As was the case those many years ago in Europe, it is the small depositors who are the most angry, vociferous, and panicked. Big depositors are bailing out as well. Somewhere between $180 million and $300 million have been withdrawn, and the bank has only some $250 million left in liquid funds.

Like so many other institutions in Afghanistan, Kabul Bank is both politically well connected and the subject of rumors about corruption. Moreover, the news that Khalilullah Frozi, one the two largest Kabul Bank shareholders, was recently ousted as CEO because of purported corruption by the bank’s leadership, does not help matters at all. That one of President Karzai’s brothers, Mahmoud Karzai, is the bank’s third largest shareholder — and that the bank manages the government’s payroll — provides particular ammunition for Karzai’s enemies. Finally, because a bank run is not a rational affair — depositors panic when they read of other depositors withdrawing funds creating the human equivalent of a cattle stampede — it matters little whether the rumors of corruption are true or not.

The United States has rushed a small number of experts to Kabul to provide technical assistance to the bank and reassure depositors. Mahmoud Karzai wants more than just technical assistance, however. He is calling for American financial assistance to cover all depositors. Since the bank has assets of only about $1.3 billion, it is not a large sum relative to what the United States pours into Afghanistan on a monthly basis. The money is not really the issue, however.

The United States has still not pulled out of its own recession, and unemployment remains high. There is continuing resentment of the administration’s various bailouts, with anger directed at Wall Street in particular. In these circumstances, bailing out a foreign bank whose leaders are being accused (whether rightly or wrongly) of corruption is a highly risky undertaking. It does not help that Kabul Bank has acknowledged that it made some large and risky investments in Dubai villas for rich Afghans. These investments turned to dust when the real estate bubble in the Gulf state burst wide open in 2008. Moreover, American taxpayers could legitimately ask why Afghans are rushing to pull out their money, and where those funds are being deposited. Are they back in Dubai? In Switzerland? In the Cayman Islands? Or have they been retained in Afghanistan — as they should be — and recycled into the eight other, smaller, Afghan banks? And will Kabul Bank continue to manage the government’s payroll? Or will that lucrative business be transferred to another Afghan Bank?

It is critical that Washington continue to assist with the restructuring of the Afghan banking system in general, and with sorting out Kabul Bank’s problems in particular. A healthy banking system is critical to the strength of the Afghan economy, which in turn is a necessary condition for winning the war against the Taliban and other insurgents that plague the country.

Nevertheless, before any American money is funneled into the Afghan banking system, that system needs to be completely overhauled. Too much money has been alleged to have seeped out of the country to foreign bank accounts. It is therefore critical that the banking system be a model of financial probity. Until now, bank regulation clearly has not been all that it should be, and that must change immediately. In addition, there should be a loosening of the nexus between private ownership of the banks and the government. The tight links between the two sectors seem to have hurt both parties. Only if those conditions begin to be met should American taxpayers’ funds be used to prop up Kabul Bank — but by then, Kabul Bank will have become a very different kind of bank.