Kabul Bank Fraud, Governance, Clean-up The International Consulting Economists Association July 16 th 2014 John Francies The facts in this talk are taken.

Kabul Bank

Fraud, Governance, Clean-up

The International Consulting Economists Association

July 16th 2014

John Francies

The facts in this talk are taken from the “Report of the Public Inquiry into the Kabul Bank Crisis” 2012 and other public sources. The

opinions are those of the speaker.

1 Background

2 The fraud

3 Governance

4 Clean-up

5 Privatisation of New Kabul Bank

6 Lessons

Contents

1.1 Background – Afghanistan

•A young country – 50% under 15 + literacy•Agriculture 27% Services 48% Industry 21%• Fastest growing economy c 7% p.a.• GDP 2002/3 - $210• GDP 2011/12 - $715

•Construction + 13%•Mining + 32%•An ancient trading nation – silk route

A Central Bank (DAB)• Set up 1939 • Licensing, regulation, supervision• Banking• Low capacity to enforce• Influence of “politically connected persons”

Banking laws adequate – Reform delayedAll banks post 2001 Taliban exit• 2 SOE, 16 others – strong/weak

1.2 Background – Banking sector

KB set up 2004 by a “wanted criminal”

The largest bank – Bakht accounts$1.3bn depositors from >1m customers

112 branches – managed GoA payroll2,300 employees34% of total bank assets at its height60% of inward remittances through KB

After “run” $500m depositors remained

1.3 Background – Kabul Bank

The fraud planned by and for the benefit of 12 92% of $861m shared by 19 benefitting 128% legitimate lending $74m

A Ponzi scheme – Dubai property crash / press

IMF assisted with loan of $850m + conditions

Chairman $270.3m - CEO $94.3m

10 individuals $43.1m to $1.7mConnected companies $210m

1.4 Perpetrators & Beneficiaries

“Loans”

False documents

Accounting firms created forgeries

Proxy/real borrowers linked in Dubai annex

“Loans” “repaid” by issuing new “loans”

2 The Fraud – the loan-book scheme

2.1 The fraud – Shaheen Exchange/Other

The Shaheen Exchange (a halawa)

Security costs, branch office rents, payroll

Inflated salaries, bonuses, expenses

Fictitious: assets

Spending

3 Governance – the regulatory framework

Corporate governance

Sector Regulator - DAB

Other central governance entities FT&RAC - HOO – NDS

InternationalInterpol – FATF

Law enforcementPolice - AGO

3.1 Governance – Corporate Governance

Shareholders

Supervisory Board

Deputy CEO (acting)

Audit committee

Internal audit

External audit

DAB and bank sector growth

Licensing and reporting

Supervision and enforcement

Some shortcomings identified

3.2 Governance - DAB– S

3.3 Governance – Central

NationalFinancial Transactions & Reports Analysis Centre

High Office of Oversight

National Directorate of SecurityInternationalInterpol

Financial Action Task Force

3.4 Governance – Police and AGO

Police: appeared to have taken no action

AGO:Reputedly taking orders from a High CommitteeLong delays before any actionAction only against 2 of the 19 beneficiariesStrong action against junior staff in DAB and KB“Generally un-cooperative”The Serious Organised Fraud Squad (UK)Gave limited assistance very late

3.5 Governance – Subverted

Corporate governance• Criminal founder – selected key staff

DAB• No resources for growth - licensing• Staff suborned? – failed to spot fraud

FTR&AC, HOO, NDS• Independence?• Poor coordination

Interpol / FATFFailure at licensing stage (Interpol)

LEGAL SYSTEM – independence?

4 Clean up - Approach

Conservatorship (Administration)

Receivership of Kabul Bank

Report on fraud and responsePrivatisation of New Kabul Bank

Action against perpetrators

Cash recovery - $168m (costs >$50m)

5 Privatisation – Good Bank: Bad Bank

Bad Bank Good Bank

With Receiver New Kabul Bank

As at Aug 12 $m Assets $m

    Cash 443

    Claim v R 100

KB Assets 935 Fixed Ass 17

Recovered -128 Rec'able 22

  807   582

Claim -MoF -925 Liabilities $m

    Deposits 560

    Payables 22

      582

5.1 Privatisation - start

• IMF / Government agree conditions

• IMF benchmarks

•Accounts – transfer to NKB

•Would privatisation succeed?

5.3 Privatisation – institutional arrangements

PrivatisationBoard

ImplementationOffice

Cabinet

Privatisation Steering Committee

Chair – NKB ChairMoF, DAB, NKB, MoJ

Advisors

The Public& Media

PotentialInvestors

Cabinet

5.4 Privatisation – strategy

What, how, how much, to who, when?

What - Pre-sale restructuring – lessons• Debt absorption has no net effect• Downsize labour• Improving efficiency fails• Cancel investment programmes• Replace CEO if non-cooperative• Delays come at a cost

5.5 Privatisation – Sell 100%?How much – 100%• GOA already has two SOE banks• Separation of roles – Regulator / O&M• Encourage foreign investment• Maximum incentive to invest more• Maximisation of proceeds • High cost of second sale / value problem• Reduce admin burden on Government• Reduce risk of loss of future failure• Government intention clear – no interference• Problem of when to sell a retained %• Partially privatised banks perform less well

5.6 Privatisation – Sell to whom?

To whom•Not connected with KB shareholders•Not black - listed by FATF (Iran and North Korea)•Not over 20% Government-owned•But:•Any local bank (almost)

When•IMF – GoA deadlines agreed

Tender documents•IM, valuation, financial & legal due diligence

5.7 Privatisation – tender process

1 Expressions of interest2 Investor due diligence3 Submit bids – to PSC and DAB4 Evaluation & award5 Post-award – DAB license6 Handover – Gap filled, payment

Outcome of first tenderOutcome of second tenderCurrent position

6 Lessons – JAC 1

Governance •OmbudsmanRegulation•Institutes of directors & accountants•Law re political party financing•Protect whistle-blowers / Publish annual acsSupervision and enforcement•FTRAC & DAB to cooperateInvestigation and law enforcement•AGO to consider action v KB fraud perpetrators

6 Lessons – JAC 2

Implement benchmarks agreed with IMF:Reform bank lawsImprove DAB supervisionEnhance KB recoveriesWhat permitted the fraud are society failures:IncapacityNepotismEntitlementPolitical interferenceImpunity

THE BIG LESSON

IF AFGHANISTAN WANTS STRONG GOVERNMENT UNDER THE RULE OF

LAW,IMPUNITY MUST END AND THOSE

GUILTY OF PERPETRATING THE FRAUD AND BENEFITTING FROM IT MUST BE

BROUGHT TO JUSTICE