188. After more than two decades of war and conflict, regional tensions, and endemic security concerns, very little was left of Afghanistan’s financial system when the Taliban departed at the end of 2001. Although six commercial banks still retained banking licenses, none of them was operational. Virtually no loans had been made since 1995 and banks had lost their credibility as deposit-taking institutions. The central bank had been changed into a Soviet-style dirigiste institution, interfering in the allocation of credit and the setting of interest rates, and abrogating its responsibility to undertake the traditional functions of a central bank. Its financial role was subsumed to monetizing successive governments’ fiscal deficits. The banking system could no longer provide a payment system, which was instead taken over by the informal Hawala system.


188. After more than two decades of war and conflict, regional tensions, and endemic security concerns, very little was left of Afghanistan’s financial system when the Taliban departed at the end of 2001. Although six commercial banks still retained banking licenses, none of them was operational. Virtually no loans had been made since 1995 and banks had lost their credibility as deposit-taking institutions. The central bank had been changed into a Soviet-style dirigiste institution, interfering in the allocation of credit and the setting of interest rates, and abrogating its responsibility to undertake the traditional functions of a central bank. Its financial role was subsumed to monetizing successive governments’ fiscal deficits. The banking system could no longer provide a payment system, which was instead taken over by the informal Hawala system.

188. After more than two decades of war and conflict, regional tensions, and endemic security concerns, very little was left of Afghanistan’s financial system when the Taliban departed at the end of 2001. Although six commercial banks still retained banking licenses, none of them was operational. Virtually no loans had been made since 1995 and banks had lost their credibility as deposit-taking institutions. The central bank had been changed into a Soviet-style dirigiste institution, interfering in the allocation of credit and the setting of interest rates, and abrogating its responsibility to undertake the traditional functions of a central bank. Its financial role was subsumed to monetizing successive governments’ fiscal deficits. The banking system could no longer provide a payment system, which was instead taken over by the informal Hawala system.

189. The speed with which Afghanistan’s economy can be rebuilt and sustainable economic growth achieved, and ultimately widespread poverty reduced will depend crucially on a rapid and sound redevelopment of its financial sector.94 For the government to pay the wages of its civil servants, procure goods and services, and undertake investment in infrastructure, for it to collect taxes and customs duties efficiently, and for Afghanistan to make the best use of the substantial donor funds destined for its reconstruction, a rudimentary payment system and basic financial services are essential. It is thus paramount for the Afghani authorities to quickly initiate reforms to move away from cash as the sole medium of exchange and to lay down the enabling framework for an efficient commercial banking system to flourish. And for all this to be done while safeguarding against fraud and bank failure, it will be necessary to rebuild a modern central bank, with a supervisory capacity in line with international standards to oversee the operations of the new banking system as it develops.95

I. After the Taliban: The Financial System at the End of 2001

190. At the end of 2001, there was no functioning banking sector in Afghanistan, notwithstanding the existence of a number of financial institutions with valid banking licenses and a roster of staff on the payroll. Most of what remained of the financial system was based in Kabul. Although not much is known about the state of the financial system in the other provinces, it is not believed to have been extensive, let alone operational. The Afghan financial system comprised, in principle, Da Afghanistan Bank (DAB), a hybrid institution with central banking and commercial banking functions, two state-owned commercial banks, and four state-owned special purpose development banks. In addition, there were about 300 registered money trading entities reportedly operating in Kabul with some 5,000 traders.

191. Assessing the conditions of the financial sector in Afghanistan that prevailed at the end of 2001 proved in itself to be a major challenge. Qualified translators were few and the difficult security situation, particularly outside of Kabul, seriously hampered a systematic and rapid assessment of the financial sector on a nationwide scale. Communication lines with most of the branches of the central bank or commercial banks with their headquarters had mostly broken down. In most cases, there had been no exchanges with correspondent banks abroad for years and accurate information on assets and liabilities, either domestic or external, were unavailable. The books kept at the banks in Kabul were completely out of date, and moreover were prepared according to Soviet accounting systems that were incompatible with internationally accepted accounting standards. At the aggregate level, meanwhile, the databases of international institutions, such as the IMF, on Afghanistan’s financial sector had not been updated for more than a decade. A proper assessment of the informal financial system, the registered money traders, and the rest of the Hawala was by its nature even harder to make. As a result, information collected was often ambiguous or contradictory and it was impossible to properly assess the soundness of the banking sector, let alone to conduct any due diligence of reported data. It thus took considerable time to assess the post-Taliban conditions of the financial sector and even today the assessment remains approximate.

Legal foundations

192. The legal basis for the central bank and for the commercial banks was the Law on Money and Banking, which was enacted in 1994. This law has a number of serious flaws. First, it is designed on the now outdated socialist principle that the purpose of monetary policy is to direct credit. It is therefore unsuitable for a market economy. Second, it involves a number of important conflicts of interest between the government, central bank, and commercial banks. Third, it omits important modern prudential standards and enforcement tools. For most of its life, however, the law was irrelevant in practice, as the Taliban largely ignored it during their rule. In order for the financial sector to develop in Afghanistan within a modern legal framework, it would be impracticable to make amendments to this law. The law needed to be replaced in its entirety by a modern central bank law and modern banking law and new legislation is expected to be enacted soon. Box VI.1 summarizes some of the main issues surrounding the outdated Law on Money and Banking.

The Law on Money and Banking of the Islamic State of Afghanistan1/

1. The old 1994 Law on Money and Banking is a compound law of a central bank law and a banking law. The law is poorly written and at times contradictory. Part I defines the legal tender, the Afghani, and its value, ambiguously both in terms of gold and SDRs. It also defines the minimum reserves DAB has to hold against issued banknotes at 25 percent. It further reserves the right of printing and issuing money to DAB.

2. Part II of the law relates to the DAB, its objectives, responsibilities, and powers, and its organs. It states that DAB is responsible for the implementation of the government’s monetary and credit policy and that it shall maintain the value of the Afghani in order to facilitate banking and commercial transactions. It also empowers DAB to supervise operations of banks and credit institutions and to regulate and carry out foreign exchange operations. It mandates DAB to determine the commercial banks’ interest rates for deposits and loans and to set minima and maxima on their commissions. DAB is also mandated to define liquidity and capital requirements and limits on large loan exposure. However, these provisions are mostly ill-defined and do not comply with international best practice. There are no loan classification or provisioning requirements. Furthermore, the law only empowers DAB to define ratios and to collect information, but no provisions exist on the enforcement of the regulations. Part II further requires DAB to manage government accounts and, if necessary, to finance the government budget deficit, as well as to grant loans to government institutions, agencies, and municipalities. With respect to loans for government projects, DAB is required to check on the projects’ economic and financial efficiency.

3. The final section of Part II defines the composition and the role of DAB’s organs, namely the Supreme Council, the Monetary and Credit Committee, the Executive Board, the Board of Supervisors, and the Banknote Reserves Supervision Board. The highest organ is the Supreme Council composed of nine members: the Prime Minister, the ministers of finance, commerce, planning, mines and industries, agriculture and light industries and food products, the minister without portfolio (advising the Prime Minister on economic affairs), and the governor of DAB. The Supreme Council is supposed to meet at least four times a year and decides on all important matters of DAB or on recommendations made by the other supervisory organs. It notably approves all regulations.

4. According to the law, the Monetary and Credit Committee is charged with drafting regulations and recommending the level of interest rates to the Supreme Council. This committee is also charged with determining the accounting principles to be used and advising the Supreme Council on monetary, banking, and credit matters. The Monetary and Credit Committee is composed of the following: the Governor and the First Deputy Governor of the DAB, the Treasury Director of the Ministry of Finance (MoF), the Financial and Commercial Director of the Ministry of Planning, the Foreign Trade Director of the Ministry of Trade, the President of the Chamber of Commerce and Industry, two presidents of state commercial banks, one of a private bank, and one of a specialized state bank (all four selected by the president of DAB), and a professor of economics (specialized in banking) from Kabul University. The composition of the Supreme Council and of the Monetary and Credit Committee is highly problematic as it politicizes decisions that should be made on purely technical grounds. DAB thus lacks the necessary independence that a modern central bank should have.

5. The Executive Board consists of the governor and his two deputies. Upon recommendation of the Supreme Council, the governor is to be appointed by the president for three years. The law stipulates that the members of the Executive Board are not allowed, during their tenure of office, to accept any position in any other government or private institution. Finally, a Board of Supervisors with a chairman and two members would supervise DAB’s banking operations and accounting practices, and submit monthly reports to the MoF and quarterly reports to the Supreme Council. This control function has not been fulfilled for years.

6. Part III of the law relates to banking. A bank is defined as an establishment that accepts deposits for the purpose of granting loans or making investments. A special definition is given to “private banks” as institutions whose operations are limited in scope and whose activities consist of “monetary and credit transactions” and the purchase and sale of movable and immovable assets. It defines the conditions for establishing a bank, including its minimum capital requirement and its by-laws. The law further requires banks to use a double entry accounting method and to submit to DAB its annual balance sheet and profit and loss statement within four months following the end of each year, together with an audit report. The law empowers the Supreme Council, upon recommendations of the governor and the Money and Credit Committee, to transfer the management of a bank to DAB, or to take measures for the management of the bank or to close the bank (if, for example, the bank acts against the law or its by-laws). The law allows that liquidation of an insolvent bank would be carried out by a team that could include officials of the failed bank. The involvement of the management of the closed bank is particularly problematic if the bank failed for fraudulent reasons. If a government bank is closed, all outstanding deposits, salaries, and claims of other creditors would be paid by the government. In the case of the closure of a private bank or semipublic bank, the law states that outstanding claims would be paid with the 15 percent of capital the bank deposited with DAB at the time the bank was constituted, without indicating the order of priority.

1/ This box is based on an unofficial translation from Dari into English of the Law on Money and Banking of the Islamic State of Afghanistan. Weaknesses of the law highlighted in this box may stem from an incorrect translation of the Dari version.

193. Other aspects of the legal foundations of the financial system seem, on the face of it, to be less problematic, as they have been derived from Western, market-oriented laws and thus do not bear the communist legacy.96 Afghanistan’s civil code was adopted in the 1960s with assistance of the Egyptian government, and is reported to be almost identical to the civil code of Egypt, originally based on French law.97 The commercial code of Afghanistan, in turn, was received from Turkey where it had been modeled after German law. It covers general company law, transport law, insurance law, and special financial transactions. It also includes provisions on bills of exchange, promissory notes, and checks. Finally, bankruptcy law provisions can be found in both the civil code and the commercial code and apply equally to state-owned and private banks. Bankruptcies are administered by the courts. For these laws to be made operational, however, there needs to be the necessary infrastructure: record-keeping institutions, functioning courts and police, and an impartial and independent judicial system. Given the difficult environment in Afghanistan, many of these elements are either not yet in place or are in a state of substantial disrepair.

Da Afghanistan Bank

194. At the end of 2001, DAB was actively performing two main functions. First, it was cashier to the Ministry of Finance (MoF), and was, in principle, responsible for salary and other budget payments, and receiving government revenues for deposit, across the country. Second, it issued banknotes and managed the stock of cash monies. The bank was also structured around many commercial banking operations that a central bank in a modern two-tier banking system would not normally do, while at the same time it omitted many of the typical central bank functions that a modern central bank should do. DAB was meanwhile fulfilling its tasks with a totally inadequate physical infrastructure and security features (see Box VI.2).

The Physical Infrastructure and Security of Da Afghanistan Bank

1. A critical weakness of DAB was the design of the main office, which was not adequate for a central bank. Most disturbing were the security features associated with the storage of cash. DAB’s main currency reserve stock was held in two major vaults in Kabul. Although there are well established procedures for accessing the vault, requiring two certified key holders and a witness, the vault area was situated near counters to which the general public had access and was not monitored by electronic surveillance or access technology. During banking hours, the security of the premises was entrusted to unarmed guards and armed military personnel. After working hours, the exterior of DAB was patrolled by military personnel. DAB’s lack of suitable vehicles and the poor and insecure road conditions made cash transport to the provinces very difficult and highly risky. In early 2002, DAB had only two trucks, one bus, and one Land Rover. All these vehicles were old and unsuited for cash transport. In Kabul City, even now, branch offices must occasionally transport cash to the main office using private cars. Only exceptionally can DAB benefit from air transport provided by the army to deliver cash to the provinces. As a result, cash delivery is often delayed. This has forced some branches to rely on their local provincial authorities and private sources to transport cash from Kabul to the provinces.

195. On the commercial side, DAB offered commercial banking services, extended long-term loans to banks and enterprises, and accepted deposits from the public. Although most of these operations were discontinued in 1995, a number of DAB accounts (debit and credit) are still current.98 The governor of DAB remains legally the chairman of the governing boards of all the commercial and development banks. This relationship would have involved a substantial and undesirable conflict of interest with the traditional functions of a central bank, in particular with banking supervision, had DAB considered this its duty. As it was, the central banking side of DAB was minimal. DAB did not supervise the banking sector either by issuing prudential regulations or by checking compliance through on and off-site inspections. DAB did not provide or supervise an efficient payment system. Nor did it offer any lender-of-last-resort facility for illiquid but solvent banks. Finally, DAB lacked a meaningful and credible monetary or foreign exchange policy (see Chapter V for a discussion of monetary and exchange rate policy).

196. While best practice in central banking would require that DAB be granted a high degree of autonomy, combined with stringent rules for accountability, DAB is fully controlled by the government. DAB’s ultimate decision making organ, the Supreme Council, as well as the Monetary and Credit Committee, which drafted regulations and governed the operational aspects of DAB, both included representatives from different ministries.

DAB’s organizational structure

197. At the end of 2001, DAB’s organizational structure was based on the soviet mono- bank system, and therefore inappropriate for a modern central bank in a two-tier banking system. Most importantly, crucial departments were missing or did not perform the functions that their name would have suggested. For example, there was no monetary policy department, banking supervision department (see below), or market operations department. The Planning and Research General Department did not conduct any research and the Supervision and Control of Currency Exchange General Department’s main activity was to keep records on the activity of licensed exporters and importers. Finally, DAB had departments that do not belong in a modern central bank, such as the Savings General Department or the Foreign and Domestic Loans General Department. The latter is in charge of keeping the records of defaulted DAB guaranteed loans extended to Afghan entities by foreign banks or governments. The last guarantee was granted 10 years ago, and the last external payment under such guarantees was made in 1997. DAB also had a Pension Department for pensions of the entire financial sector, including commercial banks.

Accounting and control

198. Although there existed an Accounting General Department, this did not in fact perform the required accounting tasks. DAB had no formalized accounting system or a chart of accounts. Its rudimentary accounting rules were incompatible with principles of materiality (the reflection of all items that are material to the financial statements), prudence (valuation at market value or at cost if lower), and substance (over form). Its systems lacked headquarters-branch data reconciliation, a delineation between central bank and commercial operations, and an appropriate valuation and classification of assets and liabilities, and involved confusion between stocks and flows. There was a complete absence of automation and computerization, and of related technology for accounting, financial analysis, and risk management. In short, using a conventional understanding for accounting, the financial information produced by the accounting department was inaccurate and even misleading for disclosure and financial reporting, and thus unsuitable for decision-making.99 While the department did keep records of movements in assets and liabilities, income, and expenses, the old National Cash Registry (NCR) card journal entry posting machine used to do this broke down six years ago. This, together with the Taliban’s disinterest in financial affairs and the long delays in financial reporting by DAB’s branches, meant that DAB had not produced a balance sheet for seven years.

199. DAB also had a Control General Department, which performed preemptive control of every operation recorded by DAB. Authorization of each and every operation required the signature of two representatives of this department. This system led to protracted delays and disruptions in DAB’s day-to-day operations and removed all responsibility from mid-level managers. Yet the system also failed to reduce risks. Ex-post internal control in all of DAB’s departments and Kabul-area branches was meanwhile performed by the Inspection General Department. But the information collected and processed did not conform with the traditional function of an internal audit department.

Banking supervision

200. Before the Taliban regime came to power in Kabul, the Planning and Research Department routinely collected statistics from banks without, however, analyzing them. The staff of the department who purported to be supervisors did not have the necessary understanding or capacity for meaningful supervision. And the data collected were in any case mostly irrelevant, for two reasons. First, similar to the accounting practice in DAB, the accounting rules under which the data were produced in the commercial banks did not correspond to international practice, and therefore the data submitted could not be assessed against prudential benchmarks (see below). Second, much of the data collected (number of employees, their profession and gender, and number of buildings and cars) bore no relation to prudential considerations. Some functions related to supervision were also performed in other departments. For example, money changers were licensed by the Foreign Relations General Department and on-site audit was performed by the Inspection General Department. During the Taliban regime, the Planning and Research Department was closed altogether and no banking data of any kind was collected by DAB during this period. In short, such banking supervision as was undertaken was confused with the functions of auditing and checking the bank’s activities against the rules set out in its charter, and by the end of 2001, even this activity had largely ceased. Banking supervision in DAB therefore needed to be built from scratch.

Branch network

201. In the original design, in addition to its headquarters in Kabul, DAB included 89 branches across the country, six desks in hotels and other public places, and four toll desks on highways. Each of the 30 provinces had a main provincial branch headed by a general director and one or more district level branches headed by a director. The general director in the province oversaw and supported the district branches in that province. As a result of the civil and military upheavals, 24 of 89 branches were closed. This left the provinces of Bamyan, Maidan Shar, Qala E Naw, Zabul, and Nimroz without any functioning branch at all. The provinces of Gardez, Khost, Kapisa, Logar, Ghazni, Kunurha, Qalat, Urazghan, Ghorat, Farah, Badghis, Sar-e-Pol, Baghlan, and Taluqan emerged with only one branch each. Apart from Kabul, which has 15 official branches, the provinces least affected were Nangarhar (with five branches), Kandahar (four), Herat (five), Mazar-i-Sharif (seven), and Kunduz (three). DAB owns 30 branches. The remaining properties belonged to other state institutions and private investors.

202. Although DAB’s branches were supposed to report monthly to the main office on branch activities, most branches stopped sending reports six years ago, reflecting the disruption in transportation and communication and the disinterest of the Taliban rulers.100 As a result, the main office in Kabul no longer knew its current cash holdings in the branches, which the branches were supposed to surrender to DAB headquarters.


203. In mid-2002, despite the low level of activity and the past closure of numerous branches, the staffing level had remained generally unchanged over the years and DAB employed 2,400 staff, of which 1,021 are at headquarters, 1,130 in branches, and approximately 250 at the tolls. A substantial number of staff had no clear responsibility, and many only showed up at work for attendance checks. There was also a conspicuous lack of telephone, telex, and computer operators, reflecting the absence of a modern communication and information system in DAB.

204. Difficulties at DAB’s headquarters in making prompt wage payments in its branches resulted in staff in some provinces turning to local political authorities, to which they became accountable. In some instances, these branch employees were also called upon to perform municipal duties. In Ghazni and Gardez provinces, for example, DAB branch staff also ran the provincial tollbooths. The dependence of some DAB staff on local political authorities was problematic for an effective management of DAB, as their loyalty vis-à-vis the main office was compromised.

The commercial banks

205. It is not surprising that at the end of 2001, after 23 years of military conflict, the financial system in Afghanistan bore little resemblance to a modern western banking system. During the pro-communist and later the Soviet era (1973–89), the banking system was nationalized and soviet-style accounting, financial control, and management systems were introduced. The situation of the banks deteriorated further during the Mujahedin period and the associated civil strife, with continued government interference in bank management, directed lending, and administered interest rates. Finally, during the Taliban period financial institutions were forbidden to charge interest on their loans or pay interest on deposits. The banks’ loan portfolios suffered widespread loan defaults, reflecting the effect of constant warfare and the banks’ inability to recover debt. Deposit mobilization collapsed and the banks discontinued lending. During this same period, the registered money changers and the rest of Hawala system replaced the banks in providing payments and liquidity in the economy, as well as certain deposit and lending services.

206. Box VI.3 provides a summary of each bank’s history and particularities. In summary, the commercial banks may be solvent and even have a positive cash flow, but this situation is due to real estate they own and returns on foreign currency deposits abroad that had been frozen during the Taliban times. However, none of the banks have been effectively engaged in the banking business for many years, nor do they have a management cadre, an accounting framework, or risk management systems that would remotely resemble modern banking. As such, the six banks should probably be characterized as shell banks, that is, institutions which may have assets and a valid banking license, but cannot become operational without a fundamental restructuring of the banks and a substantial improvement of their management.


207. As with DAB, the commercial banks do not operate according to a defined chart of accounts. While most banks are still using outmoded NCR accounting systems (including DAB), others use the manual Cartotek system.101 Neither system is adequate to determine a banks’ true financial condition and is thus not appropriate as a management tool. The banks have no system of headquarters-branch reconciliation. Valuation and classification of assets, liabilities, expenses, and income are misleading and do not correspond to international accounting standards. There are also problems stemming from the lack of adequate financial controls and weak verification procedures and monitoring mechanisms. Two major weaknesses in the current accounting framework are the inappropriate booking of nonperforming loans and the absence of their provisioning. In Afghanistan, nonperforming loans are never written off. Some banks transfer these loans together with accrued interests from “loans” to“receivables” in the balance sheet, where the loan would be kept at a value greater than its face value.102 Certain banks apply some provisioning rules and punitive interest rates for late payment. However, they are insignificant and do not reflect the probability of nonpayment.

Six Licensed Banks in Afghanistan1/

1. The Banke Millie Afghan (BMA) was established in 1933 as a private bank by a prominent Afghan businessman for trade financing. It is the oldest and largest commercial bank in Afghanistan. Until the establishment of the central bank, DAB, in 1939, BMA is believed to have undertaken some core central banking activities. During the first 40 years, the bank expanded aggressively both domestically and internationally. Until 1994, it maintained six branches abroad in Berlin, Peshawar, Chaman, London, and Panama City. The first six branches in Afghanistan were located in Herat, Kandahar, Andkhol, Mazar-i-Sharif, Gazni, and Agcha. BMA was nationalized in 1974, and since then has been fully owned and managed by DAB. Since its nationalization, the bank has suffered from political interference and consequently weak corporate governance and management structures. Its financial condition deteriorated significantly, and in 1992 it ceased all forms of financial intermediation. In 2002, BMA had five foreign branches (the Hamburg branch has recently been closed), 10 branches in Kabul, and 13 in the provinces, and employed 800 staff. The latest Profit and Loss Statement was prepared in March 1997. BMA owns shareholdings in Pashtany Tejaraty Bank (3.31 percent), in the Industrial Development Bank of Afghanistan (13.57 percent), in the Agricultural Development Bank (0.43 percent), and in the Mortgage and Construction Bank (6.40 percent). Its books show investments in 21 companies in the areas of textiles, insurance, oil, carpets, and the national airline, Ariana.

2. The Pashtany Tejaraty Bank (PTB) was set up in 1955 mainly to provide financial services to the growing trade business community. Although the bank was majority owned by the government through DAB, the MoF and the Ministry of Commerce (together with 58.3 percent of shareholdings), its 12 member board had an equal representation from both the private sector and the government. Until its full nationalization in 1974, the bank performed relatively well. Thereafter, the shrinking private sector reduced lending opportunities, and political interference made the bank entirely dependent on DAB for policy directions and operational instructions. By the early 1990s, the bank’s operations were limited to receiving payments of government utilities and small value deposits. PTB currently employs 564 staff in its headquarters and 17 branches, of which six are in Kabul, eight in the provinces, and three Pakistan. Despite its branch network, PTB cannot perform payment services as it lacks basic telecommunication facilities. The latest available audited balance sheet is for the fiscal year ending March 20, 1998.

3. The Agricultural Development Bank (AgBank) was established 1954 as the Agricultural and Handicraft Bank by the MoF (with 69.67 percent of shareholdings), DAB (30.03 percent), and Banke Millie Afghan (0.30 percent), and has not changed its ownership structure since then. The bank’s objective was to provide financial services to small farmers and handicraft producers. After an unsuccessful start, the bank was reorganized and renamed in 1969. In line with an agreement between the government, UNDP, and IDA, the restructured bank refocused its business on financing the agricultural supply chain from producers through to processing and export. At the same time, AgBank received an IDA technical assistance and a credit facility of $34 million for re-lending and appointed a German general director. AgBank subsequently experienced a period of high growth providing a wide spectrum of short to long-term loans for working capital and investments. During the soviet period, the management changed and put under control of DAB and its Soviet advisors. The bank’s activities declined, concentrating on importing and selling Russian equipment, providing fertilizer and financing operating expenses. After the Soviets left in 1989, the bank became inoperative apart from two brief periods of directed loan activity. AgBank has a Board of directors consisting of the governor of DAB as chairman, the deputy ministers of finance, agriculture, and planning, a member of the Farmer’s Cooperative Society, the chairman of the Cooperative Society, and the president of the AgBank. Of the once 28 branches throughout the provinces, only eight remain and are situated in Kabul, Jalalabad, Herat, Mazar-i-Sharif, Kondoz, Helmand, Parwan, and Farah. The last audited balance sheet dates 1994. Once employing as many as 1,350 persons, the bank now employs only 230 persons.

4. Established in 1976 by MoF on behalf of a “retirement fund” under its administration (80 percent of shareholdings), the Chamber of Commerce (10 percent), the Cooperation for Development for Raisins (3.3 percent), the Cooperation for Karakul (3.3 percent), and the Cooperation for Rugs (3.3 percent), the Export Promotion Bank (EPB), despite its name, mainly financed import letters of credit. Apart from trade finance, no other loans were offered. The bank has two branches, one in Mazar-i-Sharif and one at the general Chamber of Commerce in Kabul. A third branch in Herat was closed in the early 1990s. The bank’s operations continued during the Soviet period, but they fell back drastically after 1992 and were effectively suspended under the Taliban regime. The EPB still employs 250 staff.

5. The Industrial Development Bank of Afghanistan (IDBA) was founded in 1973 as a private financial institution by 203 domestic shareholders (60 percent of shareholdings) and six foreign investors, including Chase Manhattan Bank, First National City Bank of New York (predecessor of Citicorp), the International Finance Corporation of the World Bank Group, National Westminster Bank of London, Ltd., Industrial Bank of Japan, Ltd., and Credit Lyonaise of France. The bank provided short and long-term loans to the private sector, state-owned enterprises and joint private-government enterprises, both secured and unsecured loans. Most projects financed were for production in Kabul of alcohol, carpets, shoes, medical products, and textiles. With its nationalization in 1977, its new owners became DAB, the MoF, Pashthany Tejaraty Bank, Bank Millie Afghan, and the Afghanistan Chamber of Commerce. Its activities were disrupted during the Soviet and Mujahedin period and totally halted with the arrival of the Talibans in 1996. Of the original 400 staff, the bank has retained 37 (18 professional and 19 support staff). It has closed its only two branches in Mazar-i-Sharif and Kabul. IDBA is the only bank to have a project appraisal manual, although it is outdated. The last bank balance sheet was prepared in 1997.

6. Mortgage and Construction Bank (MCB) was established in 1948 to finance residential and commercial construction in Afghanistan. From its inception, the bank was majority state-owned. The composition of the private shareholders who control the residual 49 percent of shareholdings is not known as the bank’s records were destroyed in a fire during the 1992–96 war. After nationalization in 1974, the bank’s share structure was divided between DAB (40 percent ownership), the Afghan Chamber of Commerce (30 percent), MoF (20 percent), and Bank Millie (10 percent). MCB has a Board of directors consisting of the governor of DAB, a representative of the ministries of finance, public works, and mines and industry, and a representative of the Kabul municipality, Chamber of Commerce, Banke Millie Afghan, and MCB. Initially, the bank employed 360 persons. This number was reduced to 80 persons during the Taliban regime. The two branches in Herat and Mazar-i-Sharif have been closed and MCB extended its last loan in 1995. Loans typically covered 70 percent of the property value and had maturities of three to five years. Today, MCB’s main activity is to collect rents of repossessed buildings and interest rates on some 300 loans, the principal of which had already been collected during the Taliban regime. MCB’s last financial statements dates from 1997.

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1/ Information in this box is based on interviews in February and July 2002 and May 2003, and on diagnostic studies conducted by the World Bank.

Financial situation

208. In the absence of reliable data and an audit, the banks’ financial situation at the end of 2001 can only be guessed at. The banks’ main assets consist mainly of foreign currency deposits held abroad, which were frozen during the Taliban regime because of UN sanctions, and real estate, including repossessed houses and the banks’ office and branch network. Because of the arrival of many embassies and aid organizations, including the United Nations, the value of real estate has increased rapidly in Kabul since the end of the war, and this has likely raised the value of the banks’ asset base accordingly. Most of the banks’ other assets were substantially eroded by inflation and/or can probably be written down to zero. For example, most of the banks’ loan portfolio is past due by 7 to 15 years and many borrowers are either dead or have disappeared. While some bankers claimed that some of their loans were still recoverable, they conceded that, because of corruption or inefficiency in the court system, they would not attempt to enforce loans but rather negotiate a settlement of the debt. On the liability side, the deposit base has been eroded substantially by the high inflation rates that prevailed until the end of the war, and deposits would now likely represent only a small claim on the asset base. Banks were not aware of substantial outstanding debts, except for defaulted debt on letters of credits. These were, however, mostly insignificant with the exception of the Export Promotion Bank that reports an outstanding debt of $5 million. The income situation differs between banks. Some banks generate sufficient income from rents and interest on deposits abroad to cover their overhead and administrative expenses, and fixed and variable costs of their liabilities. Other banks, however, such as the Industrial Development Bank, depend on loans from DAB to cover their expenses. For banks as a whole, collections on nonperforming loans account for less than 1 percent of total income.

Management and employment

209. The banks’ management had not been managing their banks in a modern commercial sense for years. Managers were instead entrusted with executing instructions from the government in line with its many social, political and developmental objectives. Interference in commercial decisions was either made directly through the manager or through the bank’s governing board, which is chaired by the governor of DAB. Furthermore, bank managers were appointed on political grounds leading to situations in which banks were run by people lacking any banking experience. Interest rates were first set by a governmental committee independently of the underlying risk of the projects and later were prohibited altogether under the Taliban regime.

210. Staff, management, and board members lack basic banking and operational experience, even in their own assigned areas, and their job descriptions, including responsibilities and accountability, are ill-defined. Operationally, banks do not have any policies, procedures, and well defined communication lines in place to guide management and staff. Banks were lacking any modern automation and information technology. Employees are mostly unfamiliar with computers and have little or no understanding of automation technology, risk assessment, elements of profit and loss, financial flows and stocks, branch management and operations, accounting, lending, deposit mobilization, and general banking operations. There has been no training for many years. Staff were regularly turned over with each political upheaval. It is estimated that the six commercial banks together employ nearly 2,000 staff.

The payment system

211. With the decline of the commercial banking system to a near moribund state at the end of 2001, most domestic and international payments in Afghanistan came to be undertaken by the money dealers (see Box VI.4). As the only viable payment system, this informal financial network had become crucial for the functioning of the Afghani economy. But it is also vulnerable to money laundering, drug trafficking, and terrorist financing.103 And at the end of 2001, there was an urgent need for a formal payment system for payments by the government and by the donor community, which for a variety of reasons was not best suited to the Hawala payment system. Not only did the central government need to immediately make salary and other budgetary payments to and collect customs revenues from the provinces, but the success of the currency conversion critically depended on being able to reactivate DAB’s branch system for the conversion to take place nationwide. In the absence of a functioning banking system, therefore, the responsibility fell to DAB to provide leadership in the reform and development of the formal national payment system.

II. Modernizing the Financial Sector in Afghanistan

A new legal framework

212. As explained above, the existing Law on Money and Banking is not compatible with a modern two-tier banking system and needs to be replaced by a completely new central bank law and a banking law, properly defining the separate roles of the central bank and commercial banks. The early enactment of a modern central bank and banking law will be crucial for the development of a sound and resilient private banking sector and more generally for macroeconomic stability and growth in Afghanistan. The laws will also be crucial if foreign banks, with their much-needed technology and management know-how, are to be attracted into Afghanistan. For such banks, investing in Afghanistan offers potentially lucrative opportunities, but—given the low institutional development—with substantial risks. It is therefore very important that potential investors are given transparent, predictable, and sound “rules of the game.” At the same time, the central bank needs to have the proper tools to regulate and supervise the banking system without government and political interference. This would help to restore the confidence of the public in the banking system and serve to regenerate the deposit base that banks need to be able to extend credit. Toward this end, drafts of central bank and banking laws, prepared with the help of the IMF and benefiting from comments of a number of international organizations, law firms, and consulting firms, have been extensively discussed with senior officials in the Afghan government and are now ready to be enacted as presidential decrees.

The Money Dealers in Afghanistan1/

1. There are approximately 5,000 money traders in Kabul, of which some 300 have shops and are licensed by the Supervision Department of DAB.2/ This department licenses money changers for a fee, but does not regulate or supervise them. Some of the unlicensed money traders are affiliated to shops, which typically have two to five traders. Most traders, however, work independently and thus without a license. In provincial towns, there are on average around 80–150 licensed money traders with shops and about 500 traders. Although the Kabul market has existed for only 80 years, the Afghan people have relied on this informal sector for hundreds of years. The money transfer system is usually referred to as the Hawala System.3/ Since the Islamic revolution, when most foreigners left Afghanistan, the money exchange market has been dominated almost entirely by Afghan nationals.

2. Funds can be transferred within 6 to 12 hours from Peshawar, Dubai, or London to Kabul, and with improving communication, the transfer time continues to diminish. Transfers to provinces usually take a little longer. While regional money dealers are mostly located in provincial cities, from where they organize the distribution to villages through their local offices or representatives, the international dealers are mainly based in Kabul. For international transfers, the traditional counterparts are situated in Iran, Pakistan, India, Saudi Arabia, Qatar, the United Arab Emirates, and Oman. Rather than transacting in cash, some clients wire funds to a correspondent account in Peshawar or Dubai, and upon confirmation of receipt of funds, the counterpart is released immediately at the desired destination. Some 10 to 15 of the larger traders have correspondent accounts with banks abroad. Affiliated traders can also benefit from this network. Reputable customers can cash checks or require receipt of the counterpart prior to making the corresponding wire. Such services are usually negotiated at a higher cost. Depending on the amount, destination, financial relationship, the currency of exchange, and security environment, the cost for making international transfers varies between 0 and 2 percent of the amount transacted. Domestic transfers are typically more expensive with an additional charge of ½ to 1 percent. In exceptional circumstances, such as immediately after September 11, 2001 and until early 2002, the fees have been as high as 4 percent. In principle, money transfers operate on a netting system with other traders in the provinces or abroad. Physical transfer of cash, or at times in legal or illicit goods, is only made when a trader has no representation in a particular town, or where a net position needs to be settled. Outstanding balances are usually settled between two dealers on a weekly or monthly basis, but at times, when the volume of transactions is high, settlement of accounts are made daily.

3. Besides the transfer of funds, the other main financial service provided by the money dealers is foreign exchange dealing, mainly in U.S. dollars, Pakistani rupee, and Iranian rial. Virtually any currency can be traded. The 30 largest traders cover about 70 percent of all transactions and roughly half of their trading consists of transactions in U.S. dollars. Daily trade volumes in the Kabul foreign exchange market reportedly run to several millions of U.S. dollars, and most of this is transacted in cash. There are no limits on transaction volumes. Traders have reported that buying or selling $1 million in cash can be accommodated easily. The main market place is in Kabul. It is located close to the gold and silver bazaars and includes shops and operates as an open-cry currency exchange. At the end of each day, dealers store their excess currency and working capital in vaults located in their shops until the next working day.

4. Other financial services include deposit taking, granting of short-term loans, trade finance, and microfinance. However, money traders extend loans or accept deposits only to and from people they personally know and trust. Most of the loans are between traders and are made on an intra-day basis. The money dealers also offer some auxiliary nonfinancial activities, including telephone (GSM and satellite) and fax services, regional and international trade services, and internet access.

5. The money traders operate without standard documentary requirements and usually design and maintain their own documentary policies and procedures. Transactions usually involve comprehensive and detailed records for the entire process of remittance and settlement of each money transfer. The documentation is kept at least until the entire transaction and its settlement is completed. Customers are provided with a document containing a money transfer number or code, which is needed for the purpose of customer identification, payment, and settlement. Some dealers require secondary identification from clients collecting the transferred funds in addition to the transfer number or code. Others maintain a rudimentary “know your customer” policy, requesting photocopies of customer identity such as passports, or identity cards from hospitals or the army. They also record the date of the transaction, the name and address of the sender and recipient, identity card number, transaction number or code, and the name of the transaction counterpart dealer. For regular customers, dealers keep customer files containing invoices and quotations, copies of receipts, transaction contracts, and agreements. Upon request, mostly from established organizations and NGOs, the dealers also deliver receipt and payment confirmation documents to the sender. The (larger) traders keep daily records of the volumes and rates traded and balance their books at the end of each day. Communications with the banks abroad are via fax and satellite phone. The money market is not subject to any reporting requirements or supervision. It is fully based on reputation and trust, but also benefits from self-regulation by the Money Dealers Association formed by the 20–30 leading traders. This association is directed by an Executive Committee, that consists of an executive director and three assistants, and it meets regularly. The Association has unwritten rules of conduct and practices. Traders not respecting these rules can be expelled from the market.

1/ This box draws extensively on a study conducted by the World Bank (Maimbo (2003)), on El Qorchi et al. (April 2003), and on meetings held with money changers in February and July 2002 and May 2003.2/ Until early 2003, money traders were licensed by the Foreign Relations Department of DAB.3/ The term Hawala is used throughout the Middle East and means transfer. Equivalent informal transfer systems exist in other countries under a different terminology: fei-ch’ien (China), hui kuan (Hong Kong), hundi (India), padala (Philipines), and phei kwan (Thailand).

213. The draft central bank law includes provisions that give DAB the overriding responsibility to achieve and maintain price stability, and grants it full autonomy in seeking this objective. In order to mark the clear departure from its socialist legacy, the law would also specify that DAB shall act in accordance with the principle of an open market economy with free competition. It would further entrust DAB with the tasks of defining, adopting, and implementing Afghanistan’s monetary and foreign exchange policy, issuing banknotes and coins, holding and managing the official foreign exchange reserves, acting as advisor to and as fiscal agent to the government, and licensing, regulating, and supervising institutions engaging in banking business. The law would prohibit financing the government budget deficit, thereby closing one important channel through which macroeconomic instability and high inflation might otherwise emerge. DAB would also be prohibited from providing loans to commercial banks. The one exception to this rule is to permit DAB to act as a lender of last resort and to extend short-term liquidity support to solvent but illiquid banks, especially in the event of a systemic liquidity crisis.

214. Under the draft law, DAB would be granted complete legal, operational, and administrative autonomy from the state and any other person or authority in the pursuit of its objectives and the performance of its tasks. Independence requires accountability, and this is also stipulated in the law. Accountability would be achieved by a clear mandate and by reporting requirements to Parliament and to the public on DAB’s financial condition, and on the achievement of its objectives and on the performance of its task. Accountability would also be enhanced by prohibiting DAB senior officials from holding other government positions and by excluding them from engaging in other tasks incompatible with their duties, and which could put them into conflict of interest. The governor, first deputy governor and members of the Supreme Council of DAB would be appointed, remunerated, and dismissed in accordance with the procedures and conditions specified by law.

215. The law would also stipulate DAB’s right to be consulted on any proposed legislative or public administrative act of the government in DAB’s field of competence. This provision would ensure that the overall legal framework of the financial system continues to be consistent and coherent. Finally, in consideration of the difficulties involved in passing several laws at the same time, the current draft of the central bank law includes specific issues that under normal circumstances could have been covered by separate laws, including currency, cash payments, payment system issues, and securities services and securities transfer systems. Furthermore, DAB would have the powers to issue regulations for the Hawala dealers as nonbank providers of money and payment services.

216. The main features of the draft banking law would include a precise definition of a bank as an entity engaged in the business of accepting deposits or other repayable funds from the public and using such funds either for extending loans or for making investments for its own account. The law would introduce a two-stage process for applications of banking licenses with only essential information to be submitted in the first stage. It would further give DAB the mandate to issue regulations to further specify the necessary conditions for obtaining a banking license. The draft law stipulates that before an application is considered, DAB would need to apply a fit and proper test to future owners, board members, and senior managers of the bank. The draft law defines the banking activities that banks are allowed to pursue, as are further detailed in their banking licenses.104

217. The law would include the standard rules of a modern banking system with sound management, prudent risk management, and transparent and adequate accounting. Specifically, the law would include provisions related to the banks’ corporate governance and on DAB’s powers to review changes in bank ownership, as well as the board and senior management level. The law would also include requirements of credit documentation, risk management, as well as provisions that banks should maintain their accounts in accordance with international accounting standards (IAS). Furthermore, banks would be subject to specific auditing requirements, including the establishment of an audit committee. DAB’s oversight role would be strengthened through the conduct of on-site examinations. The last part of the law would be dedicated to specify DAB’s enforcement measures to address infractions by banks and situations where a bank’s capital declines. It defines a graduated system of prompt corrective actions to be imposed by DAB, including the power to order the removal from office of board members or senior managers of banks, and explicit provisions for dealing with banks having solvency problems. Finally, the law would grant DAB the exclusive authority to revoke a license and to initiate insolvency proceedings, with comprehensive explicit provisions for the resolution of insolvent banks under the oversight of a financial service tribunal.

A modern central bank in a two-tier banking system

218. In the first 18 months since the end of the war, DAB has made important progress in a number of areas. Most importantly, it successfully implemented the currency exchange and has gained control over the issuance of currency which is a prerequisite for an effective monetary policy (see Chapter V). It has also created a banking supervision department and thereby addressed one of the key weaknesses of DAB. And, as noted above, it is poised to achieve the passage of the central bank law and commercial bank law. Progress in other areas, in particular the restructuring of the central bank, has been slow.

219. Basic training in the business of banking will be a crucial prerequisite for a successful financial sector reform. At the end of 2001, there existed a fundamental misunderstanding by both the banks and the supervisors regarding the role that banks and banking supervision had to perform. In the future, supervisors will be concerned about the safety of the banks’ depositors, rather than about any social, political, or developmental agenda. Bank managers, in turn, will be concerned about proper pricing of risk, risk management, and return on equity.

Banking supervision

220. One of the most important improvements in DAB took place with the initial steps in establishing effective banking supervision. Since the end of 2001, a new Supervision Department has been created, a number of prudential regulations and manuals have been drafted, and the training of supervisors has been initiated. In the first phase, staff received training in the basic balance sheet analysis and concepts of prudential ratios. More recently, and under the supervision of a foreign expert, the staff has been conducting “real life” off-site supervisions of the operating banks and on-site supervision of Bank Millie Afghan.

221. The licensing of money traders has been shifted from the Foreign Relations Department to the new Supervision Department. In November 2002, all licensed money traders had to renew their licenses, a process that had been enforced with the help of the police. The department has now started, as a first step, to improve collection of personal data on the licensed money traders.


222. With the exception of the new supervision department, there has been slow progress in the reorganization of DAB, which still runs under its original organizational chart and which continues to employ a large number of unqualified staff with no assignments. Although there has not yet been an overall reorganization, parts of some departments are being restructured individually into what corresponds to a Monetary Policy Department, Payment Systems Department, Accounting Department, Banknote Operations Department, and Banking Supervision Department with foreign experts in each of these departments.

223. The work of the foreign experts has initially focused on the key outputs of these departments by training (and hiring new) personnel, while leaving the remaining departments untouched. The strategy is to recruit national staff from within or outside DAB to perform tasks that should be performed by DAB’s staff. This allows hired staff to be better paid and thus motivated, while being under direct supervision of the foreign experts. The objective is to reintegrate these local employees into DAB once DAB’s reorganization, including the pay scale, has been implemented.

Accounting reform

224. On the accounting side, DAB is in the process of introducing a new chart of accounts, as well as computerizing the function to include a general ledger software package that will ultimately enable DAB to produce its balance sheet on a regular basis. However, the reform agenda in the accounting area is still substantial. Accounting regulations still need to be drafted, together with operating manuals and procedures, and staff need to be trained. Furthermore, the consolidation of financial accounts will also depend on the speed of reforms made in DAB’s branches. An ambitious project has been initiated to improve the connectivity of DAB’s branches with the main office (see below). Improvements have also been made in data collection with the production of a simple quarterly Economic and Statistical Bulletin. Some essential monetary and fiscal statistical data have been collected and work has been initiated for analytical reports.

Commercial operations

225. DAB has also made notable progress in the efficiency of its commercial services. Almost all banking activities for the international organizations and for many of the NGOs in Afghanistan are currently being conducted by the commercial arm of DAB. Although DAB’s services include opening of accounts, deposits, and international money transfers, this is solely to facilitate international payments for international organizations, including USAID, World Bank-funded programs, NGOs, as well as the U.S. army. The efficiency of the payment service has substantially improved with the introduction of SWIFT. Improvements in the commercial area include the development and introduction of procedures that expedite the opening of letters of credit by the MoF under grant programs. New current accounts can only be opened by money changers, NGOs, or international organizations, but not by the general public.105 With the exception of two recent small loans, one to the Ministry of Defense and another to the Industrial Development Bank, DAB has ceased to extend loans. DAB’s commercial arm has been expanding rapidly over the last couple of months. Although these commercial operations do not belong in a central bank, the current vacuum in the banking system leaves DAB with little option but to fill the gap, at least until commercial banks have resumed operations in Afghanistan. When that time comes, DAB intends to divest itself of all the commercial bank activities it now undertakes as soon as possible and no later than end-2004. A conscious effort is being made to develop the commercial activities in such a way that they can be easily split off from the core operations of DAB at a later stage.

Domestic payment system and connectivity of DAB’s branches with the main office

226. Developments in the payment area by commercial banks will likely be very limited for many months if not years. Meanwhile, DAB has reconnected 35 of its main provincial branches to DAB’s head office in Kabul. These branches have been connected by laptops with Immarsat connections, and by end-September 2003 they will be able to report to the center their balances and account movements, with the capacity to do so on a daily basis.106 Bank branches in Kabul are already reporting to the head office on a daily basis under the existing communication system. In the near future they will be connected by a computer network. The next step will be to identify the branches that need to be rehabilitated to meet the necessary security standards. The decision on which branch to re-open or to rehabilitate will need to be taken based on a needs assessment and on the estimated reflow of refugees and internally displaced people. The disbursement of government salaries, the main expenditure item in the provinces, would probably require fewer operational provincial branches than existed in the past.107 DAB would further need to develop a physical distribution system with some regional cash centers from where the distribution of cash could be made. This would also include the introduction of a software system for the management of the currency inventory and the purchase of an armored fleet or use of an aircraft suited to the important yet risky task of transporting cash within and outside the city. For the medium term, with the emergence of a commercial banking system, DAB plans to implement two payment systems that will represent the core of the National Payment System. The payment systems will provide the clearing and settlement of both high and low value credit payments, using a Real Time Gross Settlement (RTGS) system and a Direct Giro Credit (GC) system.

Other changes

227. With the assistance of a foreign expert, DAB is also unblocking and consolidating existing DAB accounts in international banks and is improving the management of its foreign reserves. Tasks for the future include the removal from the DAB balance sheet of all assets and liabilities held by both the Foreign and Domestic Loans General Department and the Foreign Trade General Department, together with all records associated with them, and their transferal to a public agency designated to settle these balances. DAB will also need to address the pension department, which is responsible for the pensions of employees of both DAB and the commercial banks. Options would include transferring them to an outside private agency or to a national pension system.

Seeking the renaissance of commercial banks

228. Since the end of the Taliban era, several of the licensed banks claim to have received a small number of new deposits and loan repayments, and to have extended some new loans. But management practices of the licensed banks have not changed. Commercial banks still do not function in a manner consistent with a market economy. Despite the reemergence of some limited banking transactions, therefore, the commercial banking sector in Afghanistan remains dysfunctional. A fundamental restructuring of the currently licensed banks, together with a substantial improvement in their management, will be necessary if these banks are to become modern and efficient banking institutions.

229. The development of an effective banking sector will need to be based on three important pillars: competition, good corporate governance, and strong banking supervision.108 The enactment of the draft central bank and banking laws will be the first major step toward this new structure. But the passing of new laws will not be a sufficient basis for the redevelopment of the banking system without improved contract enforcement and well defined property rights. Reforms will be needed simultaneously on a number of different fronts, including accounting reform and training in commercial banking and risk assessment.

230. A good number of reforms can be imported into the banking system by opening it up to foreign banks. Such banks could be expected to have modern management and risk assessment techniques. In-house rules would require them to apply international accounting standards. A number of international banks have already made formal applications for banking licenses, pending the passage of the draft central bank and banking laws. But foreign banks cannot provide all the answers. To begin with, foreign banks will most likely limit their operations both to the larger cities, starting with Kabul, and to certain type of customers, namely international organizations, NGOs, the diplomatic corps, and the largest corporations, leaving small and medium-size enterprises and rural areas unbanked. Most banks will likely also focus their operations initially on facilitating payments and few can be expected to engage in significant domestic-lending at the outset. This indicates that there remains an important role for DAB, microfinance institutions, and a rehabilitated domestic banking sector to deliver financial services outside of Kabul and to a client basis not served by the international banks.

231. Afghanistan needs a comprehensive medium to long-term financial sector development strategy, possibly including a strategy to rehabilitate part of the current domestic banking system. Such a strategy would likely require an experienced and competent management team to make a detailed diagnostic and action strategy with voluntary retrenchment plans, training of remaining staff, and introduction of modern banking technology. Domestic bank restructuring will only bear dividends if qualified and experienced people are assigned board and management positions; if the organization and corporate governance is well restructured; if the operating systems, management tools, and operating policies and procedures are strengthened and automated; if the duties, responsibilities, and scope of authority at all levels of management and staff are well-defined; and if the bank is sufficiently capitalized after full due diligence and after financial, management, and operational audits have been performed on the banks being restructured. Institutions which are unable to perform should ultimately be liquidated.

Money changers and the Hawala system

232. Even with the emergence of a modern banking system, the informal Hawala system will likely continue to exist, as is the case in many other countries in the Middle East. Given the need to counter untransparent, undocumented, and adverse practices, DAB will need to evaluate the options available to partly regulate and supervise this market without pushing it underground.109 In this context, simply extending banking regulations and supervision practices with respect to licensing requirements, customer identification, suspicious activity reporting, and record-keeping to the money dealers is not a viable option. It would not be feasible to regulate in this manner, given the huge number of traders involved, and this level of regulation would probably push the activity underground and further into the dark. But two alternative options might instead be envisaged. First, the Hawala dealers could, at least as an interim solution, subject themselves to self-regulation and supervision. This market already benefits from an association enforcing a number of unwritten rules. The association could be encouraged to draft written rules and regulations.110 Second, recognizing the distinct features of the Hawala system would justify the development of special regulations and supervision techniques, which would mainly attempt to increase the level of transparency in the business while keeping intact the characteristics that made this market so efficient. Such regulations could include the requirement of registration but not licensing of the Hawala dealers, the requirement to be able to identify customers and to keep records on their identity, and the requirement to cooperate in investigations if the need arises. The latter would also include the right of DAB to enter and inspect the money dealers’ premises where there is a reasonable suspicion of a committed offence. Finally, through information campaigns, DAB could seek to educate the money dealers about their responsibility to report suspicious activities.


  • Asian Development Bank, 2003, National Payments System for the Islamic Republic of Afghanistan, (draft (B) issued August 19), Final Report TA 3874-AFG, prepared by Schlumberger Sema.

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  • Bokros, Lajos, 2001, “Banking Sector Reform in Central and Eastern Europe,” in A Decade of Transition: Achievements and Challenges, ed. by Havrylyshyn Oleh and Seleh M. Nsouli (Washington: International Monetary Fund).

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  • El Qorchi, Mohammed, Samuel Munzele Maimbo, John F. Wilson, 2003, Informal Funds Transfer: An Analysis of the Hawala System, IMF Occasional Paper No. 222 (Washington: International Monetary Fund).

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  • Holden, Paul, and Vassili Prokopenko, 2001, “Financial Development and Poverty alleviation: Issues and Policy Implications for Developing and Transition Countries,IMF Working Paper 01/160 (Washington: International Monetary Fund).

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Prepared by Felix Fischer.


See Holden and Prokopenko (2001) for a literature review on the linkages between the financial sector growth, economic growth, and poverty. See also Levin et al. (2000) for an econometric analysis showing the positive link between financial intermediation and growth. The study also confirms that legal and accounting reforms that strengthen creditor rights, contract enforcement, and accounting practices can boost financial development and accelerate growth.


Banking supervision does not necessarily have to be performed by a central bank. Some countries have chosen to set up a separate institution for this purpose.


However, a detailed assessment of the old legal framework would be necessary to determine the adequacy and mutual consistency of the laws. Given the variety of origins the legal framework has been built on it is not unlikely that at least parts of the laws could be contradictory or incompatible.


Based on the very rudimentary information available, the property law and the law of obligations could in principle be adequate for supporting banking transactions in Afghanistan. Again, a more thorough review of the laws would be necessary to determine its adequacy for banking activities.


In DAB’s headquarters there were only 5,000 active accounts out of a total of 100,000 accounts (35,000 of which had a zero balance). In the first 30 branches assessed in May 2002, less than 6,000 accounts were found to be active. Active accounts are defined as those that had any movements since the beginning of the year or that had a customer who declared an interest for his or her account.


Conventional central banks have both financial and management accounting. With financial accounting, central banks produce financial statements that reflect the “true and fair value” of their accounts, as well as the profitability of their operations. It further allows for financial control, cost accounting, and information to be made public. Under the management accounting, internal forward-looking financial statements are produced, based on which management derives its information, monitors the financial health of the organization, and, most importantly, takes strategic decisions, including budgeting and planning.


In early 2002, a major and constant problem for the connectivity of the main office with the branches or with DAB’s customers was the lack of communication. Urgent messages from the main office to the branches outside the city were sent via telegram to the provinces of Mazar-i-Sharif, Farab, Jowzjan, Farah, and Kandahar. DAB itself had one direct telephone line, a set of analogue phones for telephone calls within Kabul only, and eleven digital lines, which allow calls within Kabul and to the regional centers in Herat, Mazar-i-Sharif and Kandahar. The situation was even worse with respect to computer hardware and software. DAB had only three older model computers in its main office, but none in the entire branch network. Data processing in DAB has so far been manual and old-fashioned typewriters were virtually the only equipment in use.


The Cartotek accounting system is a double-entry manual bookkeeping system, in which entries are booked separately for stocks (balance sheet) and flows (profit and loss statement). The data are then transposed into line items in the balance sheet and profit and loss statement.


A commonly applied accounting rule in many developed countries prescribes that loans which are nonperforming for a year would be written down in the balance sheet to a value of zero. At the same time, a charge in the income statement of the same amount would be imputed under “provisioning,” thereby reducing the profit of that year by the amount of the nonperforming loan. However, the client’s liability would still remain vis-à-vis the bank, which would enforce the loan contract if necessary through the court system.


Afghanistan remains the largest opium producer in the world. See Chapter II (Annex for an account of opium production in Afghanistan.


The draft law also provides DAB with the powers to specify by regulation additional activities for banks to the extent not specifically restricted by law.


In early 2002, DAB has also resumed the payment of interest on the savings accounts.


As the volume of transactions increases, it is planned that the Immarsat connections would be replaced by a VSAT network.


Facilitating the Ministry of Rural Development’s scheme to make grant payments to 7,000 villages commencing end-September 2003 using the DAB branch network outside Kabul represents one of DAB’s biggest immediate tasks. As regards the MoF individual salary payment requirements, this is still in the planning stage by a taskforce at the ministry. Retail salary payments in Afghanistan are currently made by cash payments at the employees’ place of work in the municipalities, rather than by bank transfer to commercial banks (which is not possible) or through individual payments at DAB’s branches around the country. However, the number of DAB branches required to undertake this operation is limited by the fact that, after the money has been sent to the local DAB branch, provincial payments are thereafter the responsibility of the local representative of the MoF (Moustoufi).


For experience gained in banking sector reform in Central and Eastern Europe, see Bokros (2001).


For a detailed discussion of regulatory options for the Hawala system, see Maimbo (2003).


The disadvantage of self-regulation is that it risks becoming self-serving with a high degree of regulatory forbearance.