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Kabul Bank (now “New Kabul Bank”) was Afghanistan’s largest private, or commercial, bank. It opened on June 24, 2004, and by August 2010 had 75 branches with at least one branch in each of Afghanistan’s 34 provinces. At the end of August 2010, Kabul Bank had received $1.3 billion in deposits from the Afghan public. Kabul Bank also managed a $1.5 billion annual contract to pay the salaries of about 80% of Afghanistan’s government workers.
Kabul Bank’s two leading shareholders, Sherkhan Farnood and Khaliullah Fruzi, the chairman of the Board of Directors and the chief executive officer respectively, were fired for mismanagement on August 30, 2010. Their dismissals triggered a deposit run on September 1, which led to a government bailout. The bank went into receivership in April 2011. The functioning part of the bank continued as New Kabul Bank.
The Kabul Bank Shareholders
Sherkhan started Kabul Bank in order to make a lot of money -hundreds of millions, if not eventually billions of dollars- through successful business ventures in so-called “blue chip” companies. Such businesses may require many millions of dollars in startup capital. Where was Sherkhan going to get that kind of money? He could get it by starting his own bank.
However, Afghan banking law made it difficult, but not impossible, for Sherkhan to lend at least some money to his own businesses. To completely avoid related party lending restrictions and limits on large scale lending, and to spend Kabul Bank’s money in any way that he wanted to, Sherkhan set up an illegal loan system, which hid how and where the bank’s money was really being spent.
According to Q, Sherkhan never planned to fail in any of his businesses, but usually did because he repeatedly committed basic business blunders. Q has identified five such business mistakes. Sherkhan:
- put unqualified people (usually relatives) at the helm of his businesses,
- rarely drew up proper business plans,
- kept poor records,
- never established operational systems and procedures, and
- frequently changed personnel and powers.
By running an illegal loan network, Sherkhan was rejecting Afghanistan’s Western banking laws -not because he wanted his bank to fail- but so that he could decide how Kabul Bank’s money would be spent. Sherkhan had a very high opinion of his business capabilities. He believed that he could make more money for himself by investing in his own businesses with the bank’s deposits as opposed to merely collecting interest and fees by managing the bank according to Western banking laws.
However, running a big business successfully challenged Sherkhan. The case of Pamir Airways, Sherkhan’s airline, is the textbook example. Sherkhan wanted the airline to succeed and fought hard to that end. He sunk over $90 million dollars of Kabul Bank money into the venture, or a little over 7% of the bank’s total deposits, but the airline still went out of business.
When Sherkhan founded Kabul Bank in 2004, he already owned two Dubai-based businesses: Shaheen Exchange and Sherkhan Farnood General Trading. Shaheen Exchange is a money exchange business and Sherkhan Farnood General Trading is a real estate business. Neither is a parent company nor a subsidiary to any other business although both companies are headquartered in the same building in Dubai.
According to United Arab Emirates’ business law, foreigners may not own more than 49% of any company, unless that business is located in a “free trade zone.” Since Shaheen Exchange and Sherkhan Farnood General Trading were not located in a free trade zone, Sherkhan was permitted to own only 49% of both companies, which he did. For the Shaheen Exchange, Sherkhan took his 49% shares and divided them among other shareholders. By the time Kabul Bank was formed, Sherkhan’s Shaheen Exchange shares were divided among five people.
Two United Arab Emirates’ (UAE) citizens owned separately the remaining 51% shares of both companies. However, according to Q, while the two UAE citizens legally owned 51% shares of Sherkhan’s Dubai-based companies and reaped windfall profits in the form of dividends from both companies, they were not an operational part of either company. This is why both companies were named after Sherkhan. “Shaheen” was the name of Sherkhan’s son and the real estate company literally took Sherkhan’s full name.
Q says that many foreigners who wish to establish businesses in the UAE (in non-free trade zones) do what Sherkhan did: they partner with a UAE citizen, letting the latter reap share dividends while the foreigner actually runs the business. The UAE citizen does not even invest any money in the company, not at the start up or along the way.
Sherkhan did a peculiar thing when he started Kabul Bank. He took the Shaheen Exchange’s shareholders (excluding the UAE citizen) and made them the same shareholders of Kabul Bank (Table 1). Sherkhan kept the shareholdings of both companies linked for as long as he was over Kabul Bank. Q explains that when future shareholders were added to Kabul Bank’s shareholding, they actually purchased Shaheen Exchange shares and, in addition, were given Kabul Bank shares as a sort of “bonus.”
Kabul Bank opened its doors to the public on June 26, 2004. The shareholders approved its founding document, the Memorandum and Articles of Association, on September 1, 2003. The Afghan central bank approved the document on November 3, 2003. The Memorandum and Articles of Association states that Kabul Bank’s initial capital investment was $5 million, which was comprised of 50,000 ordinary shares at $100 each and distributed among the five shareholders noted above.
Q suspects that the initial $5 million investment into Kabul Bank was just a “book entry.” The actual money that was invested likely was what Sherkhan spent to make Kabul Bank operational, such as the remodeling of the first headquarters in Kabul and the purchasing of office equipment, computers, furniture, etc. From time to time after Kabul Bank’s founding, Sherkhan approved increases in the amount of share capital and the number of shareholders. According to Q, the shareholders never met again in an official Kabul Bank capacity after the bank began operations, although the annual audit reports state that they met usually a few times a year. Sherkhan was the king, ruling with absolute power, and that was all that mattered.
Q says that none of the five men had any actual or significant banking experience before founding Kabul Bank. Operating a money exchange business does not count as banking experience because the two ventures are very different. The former’s primary service is merely to transfer money from one place or party to another place or party, and charges a fee for doing that. The latter holds deposits and earns its money through a combination of fees and interest. Managing a bank is a highly technical job that requires an intricate understanding of finance and accounting principles.
Obaidullah Khan Saderkhail, usually referred to as “Haji Obaidullah” in Kabul Bank’s records, was Sherkhan’s driver and bodyguard in Dubai before Kabul Bank was started. Obaidullah left Kabul Bank in 2007. Sherin Khan is Sherkhan’s brother. Ahmad Jawid is also a relative of Sherkhan through marriage. Jawid and Sherkhan’s wives are related. Jawid was the manager of the Shaheen Exchange’s main branch in Dubai.
Fraidoon Noorzad was Kabul Bank’s first and only vice president. In 2006, Fraidoon was forced out of Kabul Bank and sold all 1,000 of his shares to Sherkhan. He later started Maiwand Bank. According to Q, with the exception of Sherkhan and Fraidoon Noorzad, the other three original shareholders did nothing for Kabul Bank except to brag about being Kabul Bank shareholders and to take out illegal loans for their business ventures.
According to Afghan banking law, while the shareholders compose the bank’s supreme leadership body, they are not involved in a bank’s day-to-day affairs. It is the directors that are more closely associated with a bank’s operations. However, at Kabul Bank, all five original shareholders were also the five original directors. Sherkhan was chairman of the board and Obaidullah Khan Saderkhail was vice-chairman.
Kabul Bank’s third leadership body, or the “Management Board,” was thoroughly immersed in day-to-day operations. In mid-2006, it was composed of the chief executive officer, deputy chief executive officer, the general manager, and four department heads including the chief operations officer, chief credit officer, chief financial officer, and chief audit officer. More positions were added to the Management Board after 2006. Most members of the Management Board were from India and Pakistan and some were from Afghanistan. It was in the Management Board that one could find bona fide bankers.
Kabul Bank’s fourth leadership body, or the Audit Committee, was established in late 2007. The Audit Committee was not a significant force in the bank. During its absence, the audit department (sometimes called “internal audit”) reported directly to the Board of Directors.
From 2006-2007, or Kabul Bank’s third financial year, Kabul Bank dramatically increased its number of shareholders to 16 (officially). The reason behind the shareholder expansion was to correct for falling capital adequacy ratios due to an exponential increase in loans and advances that were fueled by exponential growth in deposits. Advances are temporary loans issued to companies with a good credit standing. They are issued without supporting collateral and are expected to be repaid in a week or less. The best (and legal) solution to the falling capital adequacy ratios was to raise capital by expanding the shareholding.
The book value for Kabul Bank’s shares, or $100 per share, remained the same in 2006 and 2007; however, Sherkhan added a $181 “share premium” to the book value. The share premium was a subjective figure that Sherkhan added per each share due to Kabul Bank’s reputation based on its performance, which in 2006 was outstanding. That is to say that the new shareholders paid $281 for each of their Kabul Bank shares. For example, Mahmoud Karzai’s 13,072 shares of Kabul Bank did not cost him $1,307,200 (or 13,072 x $100); they cost him $3,673,232 (or 13,072 x $281).
None of the new shareholders paid for their shares with their own money. They all took out Kabul Bank loans to pay for their Shaheen Exchange/Kabul Bank shares. According to Q, the new shareholders were expected to repay their loans for shares but never did.
Since the new shareholders did not pay for their shares in cash, Kabul Bank’s need for capital infusion technically was achieved by transferring some of its deposits to its equity capital via illegal loans. The transfers were camouflaged by wiring the money out of Kabul Bank to Shaheen Exchange in the form of illegal loans to shell companies, and then returning the money the same way –wiring from Shaheen Exchange to Kabul Bank- in the name of the new shareholders to make it appear as though the new shareholders paid for their shares in cash.
The new shareholders included relatives, business associates, and those who Sherkhan thought might bring political influence to Kabul Bank. In some cases, Sherkhan merely transferred the title of his shares to relatives while indirectly retaining influence over the shares. Examples of Sherkhan’s relatives receiving shares included Shokrullah Shokran, Sherkhan’s cousin, who received 0.85% shares and Qushqar Morad who received 1.69% shares. Farida Farnood, Sherkhan’s wife and a medical doctor, is a special case because she was not a true shareholder.
While Shaheen Exchange and Kabul Bank shares were linked, there was a large group of 11 “small time Dubai businessmen,” as Q calls them, who actually owned Farida’s shares (Table 4). These were people with whom Sherkhan wanted to further business ties and, subsequently, gave these shares to them. Loans were still taken out for these shares and the money transferred to the bank’s equity capital, but unlike the other new shareholders, these 11 individuals were not expected to repay those loans because their shares were gifts. However, Sherkhan did not want the group of 11 to receive dividends from Kabul Bank (only from Shaheen Exchange) so he hid their shares in Farida’s name.
Most of the new shareholders were Sherkhan’s business associates. Mohammed Tahir, often referred to as “Haji Tahir” in Kabul Bank documents, is Fraidoon Noorzad’s uncle who lives in Dubai, but is originally from Mazar-E-Sherif, Afghanistan. Tahir owned an import business and dealt in real estate in Dubai. Jamal Khil was a close business associate of Sherkhan in Russia in the 1980s when Sherkhan was operating his illegal hawala. He became the CEO of Kabul Neft, Sherkhan’s oil company. Rabiulla Kakar was another Dubai businessman who knew Sherkhan while the latter was in Russia. Mohammed Ishan Rafet runs a real estate business in Dubai and also deals in sugar and oil.
Kifayat Ltd. is a company owned by two brothers who run a prominent hotel resort in Mazar-E-Sherif. Kifayat Ltd. did not hold on to its Kabul Bank shares for very long, as one of the brothers was no longer interested in keeping the shares. Hayatullah has businesses in Afghanistan and Dubai. Nesar Ahmad imports steel from the central Asian states to Afghanistan. He also has business interests in Dubai.
Ghulum Farooq Naseeb’s shares actually belonged to his brother, Dawood. The Naseeb brothers own Naseeb Food Industries. Dawood could not take Kabul Bank shares in his own name because, in 2006, he had taken out a Kabul Bank loan in his name for Naseeb Food Industries. Had Dawood taken his Kabul Bank shares in his own name, he would have been required to resign from Naseeb Food Industries and sell off his company shares to avoid related party regulations, something he was unwilling to do.
The most important shareholder to join Kabul Bank in 2006 was Khaliullah Fruzi.14 At first, Fruzi received 9% shares and then 17.57%, just shy of a qualifying holding. Fruzi’s large number of shares was indicative of his rising stature at Kabul Bank. In total, Kabul Bank’s new shareholding reflected the bank’s evolving power structure.
In early 2007, the first brothers became shareholders: Mahmoud Karzai, the brother of Afghan President Hamid Karzai, and Haseen Fahim, the brother of First Vice President Marshal Fahim. Sherkhan inducted the two first brothers into Kabul Bank for their political influence and business potential. They, in turn, benefited from Kabul Bank, which could provide capital for their business ventures.
With a few exceptions, the shareholders during Kabul Bank’s third financial year were the same shareholders during the September 2010 deposit run. However, their number and percentage of shares changed considerably, particularly among the seven leading shareholders (Table 5).
Notably, Fruzi’s shares grew while Sherkhan and Farida’s shares (or those of the 11 hidden shareholders) reduced, which resulted in Sherkhan and Fruzi having the same number of shares in 2009. Q says that it was Sherkhan’s idea to increase Fruzi’s shares. The thinking was that Fruzi’s shares should reflect his growing stature at the bank.
Becoming the Number One Bank
In Kabul Bank’s second annual audit report, Sherkhan recalls the bank’s June 2004 “humble beginning.” However, much had changed by June 2006, or at the end of Kabul Bank’s second financial year. The bank now had over 165,000 customers, 440 employees, and eight branches (Table 6). It had established Internet and mobile banking, was a principal agent in Afghanistan for Western Union, completed its first Automated Teller Machine (ATM) transaction, and set up “Bakht Deposit,” a draw of lots (lottery-like) scheme that triggered a flood of deposits.
2006 was a special year for Kabul Bank. It was the year Kabul Bank became the largest commercial bank in Afghanistan. In retrospect, 2006 marked the beginning of Kabul Bank’s “golden age.” Banks are rated across a wide range of categories, such as amount of deposits, balance sheet size, profits, number of customers and employees, the branch network size, and more. However, the most important features of a bank that reflect its financial size are asset totals followed by net profits.
A bank’s assets include its loan portfolio, “cash and cash equivalents” (or “liquid assets,” which include the cash at all branches, ATMs, and balances maintained with other banks), and fixed assets (tangible assets like, land, buildings, cars, vaults, furniture, computers, and other equipment and intangible assets). In Kabul Bank’s case, its asset totals were not a true indicator of its size, since most of its loans were illegal and not being repaid. A better indicator of the bank’s size was its total deposits, which funded the loans. Kabul Bank had amassed $1.3 billion on the eve of the September 2010 bank run (Graph 1). Its nearest competitor, Azizi Bank, is thought to have had about a third of that amount.
A bank’s net profits are its earnings after taxes and other expenses are subtracted. Kabul Bank was very profitable, earning its money from a variety of fees and interest (Graph 2). Kabul Bank charged fees on banking services such as wiring money, bank guarantees, and salary disbursements. Kabul Bank earned interest from the loans it issued and from money it kept at other banks.
However, it should be noted that while on paper Kabul Bank’s loans were being repaid with interest, in reality only about 35% of the bank’s loans were being repaid. Most of Kabul Bank’s illegal loans were issued to Sherkhan and his associates, many of whom were Kabul Bank shareholders. Most of these people were not repaying their loans. Consequently, other illegal loans were issued to pay down previous illegal loans and the interest on those loans. Put another way, a portion of Kabul Bank’s profits from loan interest actually was money moved from the loans and advances (assets) column of its books to the interest earned column via illegal loans.
As is customary among banks, Kabul Bank also kept part of its money in NOSTRO accounts, or accounts that it maintained with the Afghan central bank and with international banks, located in and out of Afghanistan, for money transfers and clearing purposes (Graph 3). The money held in the NOSTRO accounts earned interest for Kabul Bank. The central bank paid the most interest and, consequently, Kabul Bank kept more of its money at the central bank than at international banks.
Interest earned on Kabul Bank’s balance kept with the central bank was good until early 2009, ranging from 4% to 10%. After that, interest rates dropped sharply during the worldwide recession. From least to greatest, the following list identifies where Kabul Bank made most of its money.
- Fees from wire transfers
- Interest from NOSTRO accounts with international banks
- Fees charged for Western Union remittances and disbursements
- Income (fees and interest) from salary disbursements
- Interest from the central bank
Q says that the key to Kabul Bank’s spectacular growth was the adoption of a service- oriented business model, with an emphasis on technology-oriented services such as Internet and mobile banking, ATM access, issuing proprietary debit cards, issuing MasterCard credit and debit cards, and more.
Kabul Bank offered a multitude of free banking services to attract new customers who, in turn, deposited their money at the bank and paid for certain other financial services. Within this service-oriented framework, Kabul Bank aggressively expanded itself through the opening up of new branches and added an increasing variety of services when possible. For example, Kabul Bank began issuing MasterCard credit and debit cards in 2009.
However, while having a good strategy is essential for any business to succeed, there also must be skilled management and staff. Sherkhan was challenged in this regard because, after 30 years of war, Afghanistan did not have enough people skilled in banking and finance. Most of its professional class had fled Afghanistan, immigrating to America, Germany, and other Western countries. Most of these Afghans did not wish to return to Afghanistan, even after the Taliban government was overthrown in late 2001.
What to do? Sherkhan recruited foreign professionals, mainly from India and Pakistan. The expatriates became the brains of Kabul Bank and were placed in senior management positions and certain other lesser staff positions, such as loan officers. Q believes that Kabul Bank could not have achieved the success that it did without its vibrant expatriate community. Afghanistan’s other commercial banks also hired expatriates for the same reason as Kabul Bank.
Expatriates were even paid more than Afghans. At Kabul Bank, expatriates in the non- management positions received more than $2500 a month, or $30,000 a year. “Chief” salaries initially ranged from $6,000 to $8,000 per month, but frequent salary hikes from the second half of 2008 pushed their monthly salaries to nearly $15,000 by 2010, or $180,000 annually. Amitava Basu and Dr. Avinash Chandra Jha (both discussed shortly) earned about $20,000 a month. Sherkhan and Fruzi’s salaries were $25,000 a month.
However, the average Kabul Bank salary for Afghan employees was $600 a month, or $7,200 annually, which incidentally was still more money than most Afghan government workers earned. Q says that the salary difference generated some tension at the bank with the Afghan employees feeling like they were being treated like second-class citizens. Sherkhan and Fruzi justified the higher expatriate salaries by arguing that expatriates had sacrificed by leaving their families and countries to work in Afghanistan, so the extra income would help expatriates to make ends meet since they had no one else to depend on.
One of the terms of employment for expatriates at Kabul Bank was that the bank would provide for their food and lodging. In fact, Kabul Bank hired cooks to prepare food for all of its employees, both foreign and Afghan. For the former, insecurity prevented them from wandering Kabul freely on their lunch breaks and the latter could not afford to eat at good restaurants due to their modest salaries. Q says that many businesses in Afghanistan have adopted the practice of hiring cooks for their employees, including the central bank and the other banks.
The commercial banks’ practice of hiring foreign nationals was challenged in 2007 after the central bank issued what might be termed an “Afghanisation” hiring regulation for positions below department heads. The flood of international money and investment in the post-Taliban era triggered job creation, but foreigners were filling many of the new jobs, particularly the higher paying jobs that required technical capacity.
The central bank’s Afghanisation hiring policy was aimed at forcing banks to hire more Afghans, even for technical positions, but excluding department head positions. The banks objected during their monthly Commercial Banks Consultative Group (CBCG) meeting. The central bank chairs the CBCG meetings, which are attended by all commercial and foreign banks operating in Afghanistan.
The banks argued that they could not function as an efficient whole if only the department heads were competent. They said that certain low and middle level technical positions also needed to be filled by expatriates. However, the central bank rejected the banks’ argument. If necessary, the central bank wanted commercial banks to train Afghans so that they could fill the technical positions. Commercial banks were ordered to comply with the Afghanisation regulation by the end of 2009.
Prior to the hiring regulation, Kabul Bank hired its employees primarily on a voucher system, which was somewhat similar to the U.S. system of providing “personal” and “professional” references to an interested employer. Someone already at Kabul Bank had to be able to vouch for a new job candidate. Q argues that the voucher system makes sense in Afghanistan since poor records make it difficult to verify a candidate’s true identity and work history. The tazkira (the Afghan ID card) is insufficient because it does not provide enough applicable information. Work ID cards issued by previous employers are unreliable because they can be forged easily.
The downside of the voucher system was that it was difficult to get qualified employees and, once hired, it was difficult to rein in the employees to follow Kabul Bank’s procedures and policies. Q says that the reason for the latter was that, in Afghanistan, an instinctive patronage mindset is common. Once hired, many Afghan employees melted into patronage networks whereby new hires showed loyalty to those who vouched for them and not for their expatriate supervisors. As the number of employees grew in each department, expatriate department heads faced opposition from their entire staff when trying to rein in certain employees.
Kabul Bank responded to the downside of the voucher system and to the central bank’s new hiring policy by putting together an entrance examination to test job candidates’ knowledge of banking, finance, computer skills, aptitude, and more. However, candidates still needed to be vouched for by reputable people. Complete strangers to anyone in Kabul Bank were permitted to apply and to take the entrance test. However, the new hiring practice failed because none of the Afghans could pass the test. Some graduates from Kabul University were hired but even they “failed to perform.”26 Moreover, Q says that many of the job seekers could not get anyone, including a past employer, to vouch for them, and consequently resorted to forging recommendation letters.
By April 2010, some of the private banks still had not fully complied with the Afghanisation hiring regulation. The banks argued that while cashiers, cooks, and drivers could be filled by Afghans, low and middle-level positions -such as loan officers and loan providers- still needed to be filled by foreign professionals. Moreover, many Afghans who were hired by the banks, and then trained to bring them up to speed, left their bank jobs for jobs with non-governmental organizations (NGOs) that paid significantly higher salaries.
While Sherkhan and Fruzi put foreigners in senior management positions, or on the Management Board, with one exception, foreigners were not brought into the bank’s inner sanctum, or its two top leadership bodies: the General Meeting of the Shareholders and the Board of Directors.
Only one foreigner, Amitava Basu, formerly the credit manager and later the chief credit officer, was ever made a director. Basu led the backdoor operation to forge loan documents for the illegal loans. Another foreigner, Dr. Avinash Chandra Jha, led the Audit Committee, which Q says was a powerless body at Kabul Bank and served as a rubber stamp for the Board of Directors.
Kabul Bank Battles to Stay Number One
With Kabul Bank’s success came new challenges and problems. Q says that Kabul Bank’s competitors and other detractors were determined to limit Kabul Bank’s market share. If they could not match Kabul Bank’s superior performance and results, they would resort to other methods to resist Kabul Bank, such as spreading rumors about Kabul Bank to Western agencies and media outlets. The result was Kabul Bank’s portrayal in the media as the symbol of Afghanistan’s “crony capitalism,” which in the banking context referred to insider loans and a general way of functioning that played favorites.
To be sure, Q agrees that Kabul Bank was guilty as charged; however, he also argues that Kabul Bank’s competitors were doing the same things. In addition, the Afghan central government that worked with banks was also steeped in corruption by collecting bribes from the banks in exchange for approving shareholders, administrators, policies, and annual audits. Everyone was corrupt but Kabul Bank was being singled out.
Q identifies two episodes in 2006 that led Kabul Bank’s leadership to conclude that the “playing field” or “the rules of the game” had changed once Kabul Bank became the number one bank. Prior to 2006, Kabul Bank had struggled inwardly to become a better bank by focusing on its operations and offering a variety of services to its customers.
However, from 2006, Kabul Bank also had to fight outwardly by resisting its banking competitors and even the central bank that feared Kabul Bank was becoming a monopoly. The first episode in 2006 describes Kabul Bank’s efforts to install its own ATM network and the second episode explains the salary disbursements that Kabul Bank made to Afghan government employees.
In January 2006, Kabul Bank took its first steps in setting up its own ATM network. ATM’s were a critical component of Kabul Bank’s growth strategy. Kabul Bank believed that it could attract thousands of new customers, including Westerners working in Afghanistan, by offering ATM services across Afghanistan.
Banks usually outsource part of the setting up of an ATM network to its software provider, which in this case was an Indian-based company called Virmati. However, Q says that by January 2006, Virmati was a struggling company that was rapidly losing market share to its competitors and did not have the necessary expertise to set up an ATM network. As a result, Kabul Bank decided to figure out on its own the entire process of how to set up an ATM network.
Sherkhan assembled a task force of Kabul Bank employees to research and implement an ATM network. The task force figured out what contributions would be made by the various stakeholders, or the hardware providers, software providers, communication providers, etc, and instructed them accordingly. Setting up the ATM network was Kabul Bank’s greatest technical challenge.
ATM’s communicate with a bank’s main software through “ISO 8583” formatted messages, a standard that was developed by the International Organization for Standardization (ISO) for card-based electronic transfers. ISO 8583 messages ensure the uniformity of ATM communications for banks throughout the world. However, banking software cannot understand ISO 8583 messages so banks require what is called “host banking” software to convert (translate) ISO 8583 messages so that a bank’s computer system can understand them. Kabul Bank tasked Virmati to develop the host banking software.
Getting ATMs to communicate with banks is another challenge. It is not feasible to connect all ATMs directly to the banking software because each ATM would need its own router (routes the ISO 8583 messages to the bank’s host software) and controller (controls the ATM). Instead, the job of routing and controlling ATM messages is achieved by what is called an “ATM switch.” The bank’s host software communicates with the switch, which is often located on a server at a bank’s branch headquarters. A switch functions as a router and runs a special software.
The ATM switch is also capable of directing messages when different banks (other than the bank which operates the switch) use the ATMs connected with that switch. For example, if someone uses a Maiwand Bank debit or credit card at a Kabul Bank ATM, Kabul Bank’s switch directs the messages from the ATM to Maiwand Bank’s host software. In the case of someone having a VISA or MasterCard, when Kabul Bank became an associate MasterCard member, it connected its switch to the VISA/MasterCard network, thus enabling each Kabul Bank ATM to be a part of that network.
In addition, ATM’s may be installed in far-flung locations, provided there is a robust communication network built upon a dedicated telephone network. Afghanistan does not have sufficient telephone line infrastructure so ATMs must communicate wirelessly using microwave technology. Since cell phone towers use microwaves, Kabul Bank signed long-term service agreements with several of Afghanistan’s cell phone companies, such as Roshan, AWCC, and Etisalat. These service agreements were important because they gave Kabul Bank priority in limited bandwidth areas.
Kabul Bank’s deployment of its own switch offered huge earnings potential. In 2006, Kabul Bank and Afghanistan International Bank (AIB) were the only Afghan banks that had their own switches. This meant that Kabul Bank and AIB Bank could make money by entering into service contracts with other banks by leasing their switching service to them. Q says that while Kabul Bank aggressively pursued service agreements with other banks, AIB Bank did not do the same due to a lack of vision and aggressiveness.
In March 2006, Kabul Bank successfully completed an ATM alpha test and, in June, its first ATM transaction occurred at the main branch in Kabul. The first ATM transaction was a huge achievement for Kabul Bank’s staff and it encouraged them to believe that they could accomplish any technical challenge presented to them. Kabul Bank employees felt like the superheroes of Afghanistan. Sherkhan gave an immediate pay raise to everyone involved in the project.
Immediately following June’s successful ATM transaction, Sherkhan and Fruzi co-hosted a brainstorming session with leading Kabul Bank shareholders, directors, and senior managers. Q presents the brainstorming session as a significant event because it helped to harness the optimism of the moment and to direct it for achieving larger goals. Sherkhan asked those present how Kabul Bank could remain the premiere bank in Afghanistan. After reviewing the factors that led to Kabul Bank’s current success, those present told Sherkhan and Fruzi that Kabul Bank should stay the course by continuing to follow the same strategy. Three components were identified.
- Develop an extensive branch network in each province.
- Invest heavily in Internet technology.
- Offer basic banking services free of cost while augmenting revenue through value added services.
By January 2009, Kabul Bank had built a network of 10 ATMs. That June, Kabul Bank negotiated for a MasterCard associate membership through CreditCard Services Company (CSC) in Lebanon. Prior to the MasterCard membership, Kabul Bank could only issue proprietary debit and credit cards. However, with its MasterCard associate membership, Kabul Bank was authorized to issue MasterCards to its customers. In addition, any one owning a MasterCard or a VISA card, including non-Kabul Bank customers, could now use those cards at Kabul Bank ATMs.
With MasterCard services in hand, Kabul Bank moved aggressively to sign contracts with all-star hotels, supermarkets, large NGOs, and other big businesses. Kabul Bank agreed to install ATMs on their premises in exchange for these companies opening up business accounts at Kabul Bank. Those businesses that opted for installing Kabul Bank’s ATM’s would get priority when Kabul Bank’s “point of sale” (POS) network was rolled out. The result for Kabul Bank was an increase in customers, deposits, and profits.
Q says that Kabul Bank’s competitors and the central bank were horrified. They were already worried about Kabul Bank’s expanding ATM network but the MasterCard membership was the tipping point. Q adds, “The scare of monopoly was built.” The other banks were complaining to the central bank that there was no longer a “level playing field,” meaning that Kabul Bank had an unfair competitive advantage in Afghanistan.
Actually, Q says that Kabul Bank had a different plan. Sherkhan wanted to start a separate financial services business that would take over Kabul Bank’s switching service, ATM network, and future POS network, then lease them back to Kabul Bank and to any other bank that wanted to use the services, with the exception of Kabul Bank’s chief rival, Azizi Bank.
Many other Afghan commercial and state-owned banks were already inquiring with Kabul Bank as to how they might use its switch and ATMs. The profit potential was staggering. Kabul Bank also wanted to include in the financial service business a partnership with NGOs by offering NGO beneficiaries specially designed debit cards for the distribution of aid.
In April or May of 2009, a U.S. Army task force began approaching Afghanistan’s commercial and state-owned banks individually, about its desire to construct a “national switch” that would enable any proprietary bank card to work everywhere. The idea behind the national switch was to create a separate entity to own and operate the national switch, and the shareholders of the entity would be the Afghan banks themselves.
Afghan banks would connect their ATMs into the national switch, which would be hooked up to the MasterCard/VISA network. Q says while the idea of a national switch for Afghanistan was an American one, Abdul Qadir Fitrat, the central bank’s governor, fully supported it and strongly urged the U.S. Army task force to implement it.
When members of the task force met with Fruzi, they told him that the purpose of the national switch was to provide a level playing field for all banks. They said that the central bank and all commercial and state-owned banks would be the shareholders of the national switch. However, they also told Fruzi that Kabul Bank should dismantle its own switch.
Kabul Bank’s management staff advised Fruzi neither to dismantle the bank’s switch nor to connect the bank’s ATMs to the national switch. They said that the bank had invested too much money and effort into its switch to shut it down. When Azizi Bank and Maiwand Bank learned that Kabul Bank refused to dismantle its switch, they too became emboldened against the U.S. task force. At the time, Azizi Bank and Maiwand Bank were trying to set up their own switches because they understood the profit potential.
That November, the U.S. Army task force and the central bank co-hosted a conference in Dubai for all Afghan banks to discuss the national switch and payment systems. The conference’s goals were to secure a formal commitment from the banks for a national switch and for those with their own switches –or Kabul Bank and AIB- to voluntarily shut them down. However, Q believes that given the fact that many of the banks were instinctively supportive of a national switch because of the benefits it would bring, and given that AIB was non-aggressive with its switch, the true purpose of the conference was actually to get Kabul Bank to agree to dismantle its switch.
In Dubai, the Kabul Bank team told the representatives of the U.S. Army task force that Kabul Bank would support the creation of a national switch, but it would not dismantle its own switch. Kabul Bank would connect its switch to the national switch but its ATM network would operate on Kabul Bank’s switch. Kabul Bank also agreed to accept the propriety debit and credit cards of all other Afghan banks through the national switch. Kabul Bank would benefit from the arrangement because the other banks would still be charged a small fee for using Kabul Banks ATMs.
Q says that the U.S. Army task force agreed with Kabul Bank’s proposal because the national switch would come into existence, which was its primary concern. However, in a private meeting in Dubai between the Kabul Bank team and the U.S. Army task force representatives, the Kabul Bank team told Q that there still needed to be competition among banks because Afghanistan will benefit from it by getting a better product. Competition will force banks to deliver their best.
Q says that the U.S. Army task force representatives agreed about the need for competition and divulged that Governor Fitrat was urging them behind the scenes to establish the national switch as soon as possible in order to make a level playing field. In lay terms, Fitrat wanted the national switch set up quickly to prevent Kabul Bank from running away with any more market share.
After the meeting in Dubai, Kabul Bank was the first to sign the formal document which outlined the modalities for establishing the national switch. Moreover, Kabul Bank committed itself financially to help establish the national switch.
The second episode in 2006 that led Kabul Bank to conclude that its success prompted backlash from its competitors, the central bank, and other detractors, was the government salary disbursement contract. In the years following the toppling of the Taliban government, Afghan government employees struggled to receive their salaries on time and in full.
Salaries were being paid late and many supervisors were skimming, or keeping a portion of staff salaries for themselves. The average government monthly salary is about 20,000 Afghani ($400) paid once at the end of every month. Moreover, the MoF, which paid all Afghan government salaries, did not have a computerized employee database. It was using handwritten and outdated registers.
The IMF and USAID advised the MoF to fix the corruption problem by contracting government salary disbursements to a bank. Consequently, the MoF requested salary disbursement proposals from interested banks. Foreign banks operating in Afghanistan, such as Standard Charter and Punjab National Bank, were not interested in submitting proposals and Afghanistan’s state banks were not fully computerized to properly handle the task. That left Afghanistan’s private, or commercial banks, to compete and three of them submitted proposals: Kabul Bank, Azizi Bank, and BRAC Bank. BRAC later withdrew from the bidding process and was replaced by Maiwand Bank.
Kabul Bank’s salary distribution proposal contained the following eight steps:
- Each government ministry was required to collect its employees’ data in a Microsoft Excel spreadsheet and to scan a photo and a signature from each employee.
- The employee data and the scans were to be copied to a disk and sent to Kabul Bank.
- Kabul Bank would upload the employee information into its system and open the account, but keep it in a suspended or a restricted state so that no activity could yet be performed in the account.
- For each government employee, Kabul Bank would printout a form for opening a Kabul Bank account and a Kabul Bank ID card.
- Kabul Bank would send the account opening forms and the ID cards to the MoF.
- Government employees would complete the account opening process, by signing the printed account opening forms, and by receiving their bank ID cards.
- The MoF would return the signed account opening forms to Kabul Bank.
Sherkhan Farnood is pictured here playing poker. Q says that Sherkhan is “addicted” to poker. Photo used with permission by PokerNews.com.
- Kabul Bank would lift the restriction/suspension on each account thereby making them operational.
From start to finish, Kabul Bank projected it would take a maximum of 48 hours to register a new applicant. In contrast, Azizi Bank’s proposal took one week. For a test run, the MoF gave Kabul Bank the responsibility for paying the salaries of the MoF’s “Control and Audit Office.” Q says that to the MoF’s surprise, Kabul Bank’s salary disbursement scheme worked flawlessly.
In the end, the MoF awarded the salary disbursement contract to all three competing banks and each bank was authorized to register new accounts according to its own proposal. In addition, each ministry was granted the flexibility to chose the bank it wanted to and to switch between banks if the first one’s service was unsatisfactory. The latter policy stoked competition between the banks because if one of them performed poorly then it risked losing its salary accounts to its competitors. To make matters more fluid, most ministries gave their employees the liberty to chose which bank they wanted.
The ministries of defense (military), interior (police), and education (teachers) are Afghanistan’s three largest ministries accounting for roughly 70% of all government employees. The ministries of interior and education permitted their employees to choose among any of the three banks. Q says that at first most of these employees chose either Kabul Bank or Azizi Bank, but later, those that chose Azizi Bank switched to Kabul Bank on account of its superior service. The Ministry of Defense chose Azizi Bank, but did not allow its employees to choose between banks, likely because it would be easier to deal with a single bank since many soldiers are deployed to desolate places across the country.
The contract was delivered to the banks in steps beginning around February 2006. Priority was given to government workers located in Kabul, followed by their representatives in the provinces. Afghanistan has two tiers of government: state and traditional (or tribal). (The U.S., in contrast, has three levels of government: federal, state, and local governments.) The Afghan state government is the Western-styled government based in Kabul. The governments in Afghanistan’s 34 provinces are merely extensions of the Kabul government. The Afghan president appoints the provincial governors. The various government ministries (called “departments” in the U.S.), such as defense, interior, education, etc, have their representatives in the provinces.
While each bank had its own method to setting up its salary disbursement accounts, the MoF had a three-step process for delivering to the banks the money to pay the salaries. The steps are worth noting because problems arising in step one often resulted in payment delays to a fraction of the government employees. As late as April 2010, Kabul Bank was forced to delay payment to about 2,000 to 3,000 government employees each month. Azizi Bank and Maiwand Bank also complained about payment delays. A U.S. Embassy cable, reported by Wikileaks, mistakenly blamed Kabul Bank for the payment delays. The MoF’s process to transfer the salary money to the banks was as follows:
- The MoF sent a soft (digital) and a hard (paper) copy of the salary details for each employee to the participating bank. The hard copy was necessary because it contained the physical signature of each employee’s supervisor. Since Afghanistan does not have laws recognizing digital signatures (or digital certificates), the hard copies had to be sent to the banks. Unfortunately, sometimes the name of the government employee, or even his or her account number on the soft and hard copies, did not match. When that happened there was a payment delay.
- The MoF instructed the central bank to transfer money to the participating banks. This money was transferred to the accounts that these banks held at the central bank, which earned interest.
- Once the money arrived in the accounts that these banks held at the central bank, the banks had 72 hours to process the salaries (to transfer the money into the government employees’ bank accounts).
For the first year, the MoF paid the three banks a fee of 50 Afghani (about $1) for processing a single salary. Afterwards, under pressure from the IMF and USAID, the MoF renegotiated the salary disbursement contract and the 50 Afghani fee was cut to 25 Afghani. Q says that the U.S. agencies were unhappy with the fee because they argued that the banks were making an indirect profit in interest from the salaries and further compensation through a fee was unnecessary. However, Q says that Kabul Bank never made more than $3 million a year in interest paid by the central bank.
While $3 million a year earned in earned interest for disbursing government salaries may seem substantial, it is not. $3 million a year comes out to $250,000 a month. At the end of 2009, Kabul Bank was disbursing about 520,000 government salaries a month, thus making about 48 cents per salary. Q asks what U.S. bank would agree to manage salary disbursements fee free for American government employees?
Working against the interest earned on the salary money at the central bank was the fact that Afghan government employees tended to withdraw their salaries quickly and in their entirety, leaving little time for the salaries to sit in the bank and earn interest. Q explains that a $400 a month salary in Afghanistan is quickly spent, and other external factors, such as insecurity and the relatively few banking branches and ATMs across Afghanistan, encouraged government employees to withdraw their monthly salaries all at once and as soon as the money was released.
Q says that shortly after the initial tranche of salaries was given, the ministries that received their salaries from Azizi Bank began complaining about the service they received from Azizi Bank. As a result, most government employees that signed with Azizi Bank left and signed with Kabul Bank. Azizi Bank even lost its exclusive relationship with the MoD. By 2009, or the same year that Kabul Bank received its MasterCard associate membership, Azizi had lost most of its salary disbursement accounts to Kabul Bank. In 2010, media reports alleged that Kabul Bank dominated the salary disbursement contract due to its political connections; however, Q insists that while the bank was well connected, the truth is that it simply outperformed its competitors.
According to Q, Azizi Bank began bribing the ministries that had signed with it in order to stem the loss of salary disbursements to Kabul Bank. By passing bribes to these ministers and other senior ministry officials, Azizi Bank hoped that those people would use their influence to keep their employees signed on with Azizi Bank. When Kabul Bank got word that Azizi Bank was bribing ministries, it too bribed some of the same individuals to counter Azizi’s bribes. Q says that Sherkhan and Fruzi were “too happy” at any given moment “to destroy Azizi Bank.”
In 2009, panicking at the loss of salary disbursement accounts to Kabul Bank, Azizi Bank informed the MoF that it would disburse government salaries free of charge. Q says that the MoF initially was not interested in Azizi Bank’s offer but was under pressure from USAID to take action. The MoF approached Kabul Bank and asked if it would also disburse the government salaries fee free. The MoF’s demand set off intense debate within Kabul Bank’s senior management.
Most of the management team advised Fruzi, to end Kabul Bank’s salary disbursement service. They argued that disbursing the salaries for free threatened the bank’s return on investment and encouraged competitors to bring the bank to its knees in the future. Q says that after much discussion, Fruzi made the decision to continue disbursing the government salaries without the fee. Fruzi calculated that the earned interest still made it worth Kabul Bank’s time and effort. Moreover, other benefits to disbursing government salaries included boosting Kabul Bank’s public profile and encouraging those government employees with Kabul Bank accounts to use the bank’s other services.
Q raises an additional point about the salary disbursement contract that is worth noting. Kabul Bank’s requirement of getting ministries to collect their employees’ data in a spreadsheet facilitated the creation of a digital database of government employees for the MoF. The database contained the name of each employee, their date of birth, address, photo, and more. It was a giant leap forward from the handwritten registers that were operational beforehand.
However, the digital database was also a mechanism that could have been expanded to include the entire Afghan population. By adding digital fingerprints, the database could have been used to issue a “smart ID card” to replace the tazkira (the Afghan ID). A smart ID card could help to prevent the kind of fraud that brought down Kabul Bank, specifically the practice of creating shell companies to hide where the bank’s money really went.
A smart ID card would have a number attached to it. The same number would be used to register new businesses. By entering a smart ID card number into the government’s computer system, one could instantly view every legally registered company associated with that number.
Q argues that a smart ID card could also help to reduce the kind of rampant fraud witnessed in Afghan presidential and parliamentary elections. A person would have to show their smart ID card to vote, then their number would be checked off after voting. No one could vote again with that same smart ID number and no one could vote without a smart ID number.
Q says that in early 2006 members of Kabul Bank’s Management Board privately contacted (without Sherkhan’s knowledge) the IMF, World Bank, and various embassies in Kabul to recommend the creation of the smart ID card. Several individuals showed interest in the project. The South Korean embassy even suggested that it might be interested in helping to finance the project. Q thinks that the project would have cost about $100 per person, a sensible and worthwhile investment considering the benefits it would bring.
The smart ID card never got off the ground. According to Q, it was not in the interest of the Karzai administration, some Afghan powerbrokers, Pakistan, and perhaps certain Western countries. If the smart ID card could help eliminate business fraud then the benefactors of such fraud would not be inclined to support it. Likewise, if the smart ID card could prevent election fraud then a northern presidential candidate like Abdullah Abudullah, who lost against President Karzai in 2009, might just have a chance at the presidency.
Kabul Bank was about one man’s dream to become very wealthy through the establishment of so-called “blue chip” companies. Kabul Bank was strategic for Sherkhan because it was the funding instrument for multi-million dollar companies. Pamir Airways is one example of the strategy at work.
It was in Sherkhan’s interest, therefore, that Kabul Bank be successful. He was not trying to kill his bank despite the theft and profligate spending. It was just the opposite. The more successful that Kabul Bank was, the more deposits would flow into the bank, and the more money Sherkhan would have to invest –through illegal loans- in his businesses and those of his associates.
Steps that Sherkhan took to ensure Kabul Bank’s success included Kabul Bank setting up its own ATM network and switching service, obtaining a MasterCard associate membership, establishing Internet and mobile banking, becoming a principal agent in Afghanistan for Western Union, and dominating in the disbursement of government salaries. He also expanded the shareholding from 2006 to bring in numerous business associates, the two first brothers, and Khaliullah Fruzi.
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