Like everything else in Afghanistan, the formal financial services sector is underdeveloped. This is constraining economic efficiency and growth but also presents an opportunity that investors are already seizing. Several commercial banks have licences to operate, though their range of products and services is curtailed by the absence of supportive regulation and legislation.

Running concurrent to the establishment of a modern banking system, Afghanistan also has an informal, yet highly efficient, money transfer system – hawala – that exists almost entirely outside official channels. Unsurprisingly, Afghanistan lacks an efficient capital market, a further limitation on investors’ in-country capital raising options. For the moment, however, the country benefits from large inflows of donor funding, a portion of which is being directed to the private sector on concessional terms for the purpose of investment in priority sectors and projects.

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Still in infancy

 

The banking system is best described as embryonic. International banking group Standard Chartered, National Bank of Pakistan, Habib Bank (also from Pakistan) and Punjab National Bank of India have opened branches. Other notable names include Afghanistan International Bank, managed by Dutch banking group ING, Kabul Bank and First Microfinance Bank of Afghanistan.

Legislation needed

Aside from banking to the large foreign sector (including aid agencies, non-governmental organisations, embassies and the military) the Afghan banking market is small and financial intermediation is low. At the same time, the absence of key legislation, such as bankruptcy law or mortgage law, inhibits banks’ ability to extend services. Services include basic transactional facilities and offerings such as money transfer; simple credit facilities are slowly being developed.

The country’s financial sector is, in effect, being built from the ground up but this permits the adoption of the latest processes and technology to improve efficiency and reduce costs.

“Because of the war, the financial sector came to an almost complete standstill. The country’s banks survived the period in name only but were not functioning at all. It was only the central bank that was able to carry out limited commercial banking operations,” says Noorullah Delawari, governor of Da Afghanistan Bank, the central bank.

With technical assistance from consultants BearingPoint, the central bank is steadily reforming the country’s financial system. New central bank and commercial banking laws have been enacted, paving the way for ongoing reorganisation of the central bank and the licensing of new commercial banks. Also, a new, fully exchangeable currency – the Afghani – has been unveiled, which has proved stable.

“Mr Delawari has been a good choice of governor,” says Joseph Silvanus, CEO of Standard Chartered. “He comes across as extremely straight-talking and honest about what he can and can’t do. He has promised to lean on the relevant ministers to get the necessary laws passed because the banking system cannot be neglected any further. The financial institutions here can do so much more but they are being held back.”

Project finance

In terms of project financing, investors have a limited range of options but development finance is available. The Rebuilding Agricultural Markets Program (RAMP) is the largest donor initiative in Afghanistan’s agricultural sector. Funded by the US Agency for International Development (USAID) to the tune of $132.5m, this three-year programme (2003–2006) aims to improve the lives of Afghans by increasing food supplies and food security, creating jobs, increasing incomes, and strengthening the competitiveness of agricultural products.

Investors who develop opportunities consistent with these objectives, in areas such as transport and logistics, storage and value-adding processing, can get access to these funds. The Asian Development Bank, International Finance Corporation and private development institutions such as the Aga Khan development network have all invested in private sector projects. The Overseas Private Investment Corporation (OPIC) provides loans to help US businesses of all sizes invest in Afghanistan. This independent agency of the US government has a $100m line of credit available to projects that demonstrate a substantial US participation, promise significant benefits to Afghanistan’s economic and social development and foster competition in its private sector. Preferential consideration is given to projects involving US small businesses.

OPIC has already provided financing to several projects in Afghanistan, including construction of the five-star Hyatt hotel in Kabul and construction of 1200 homes near Kandahar by a small US company.

Development finance is also available to investors for priority projects. Rehabilitation of Afghanistan’s sugar, cotton and olive oil industries have all benefited from development finance.

The presence of aid and development agencies and large volumes of donor funding have been crucial to stimulating the economy, either in the form of equity and debt financing for large-scale investment and reconstruction projects or seed financing for small and micro enterprises. But given the weakness of the banking system and non-existence of a functioning capital market, the most important segment of the economy – the small to mid-sized enterprises that are the true engine of the economy – is underfunded.

Venture capital

ACAP Partners is Afghanistan’s first and only venture capital fund. Founder and managing director Pierre van Hoeylandt reckons there is a gap in the market for funding of between $500,000 and $5m on projects that typically fall outside donor programmes. The $20m fund is close to making its first investments, having considered opportunities as varied as window manufacturing, plastic piping and ice-cream making.

At first the idea of a venture capital fund in Afghanistan sounds incongruous – the country lacks the legal framework to protect investors, or a capital market to facilitate profitable exit from the business. But Mr Van Hoeylandt sees it differently, arguing that it is exactly Afghanistan’s high risk, high reward climate that suits the country to venture capital. He sees first-mover advantage in a number of sectors, such as construction materials and agribusiness, as well as import substitution opportunities.

He also believes the most profitable opportunities are small to medium-sized investments, offering fast growth and quick returns. In the near term, the fund’s exit strategy is built around management buyouts, utilising the by-then strong cash flows of the business to fund the deal.

Good proposition

Mr Van Hoeylandt and his team, who have experience in other post-conflict environments such as Somalia and Rwanda, recognise an opportunity when they see it: recent establishment of peace and general stability; a large injection of donor funding; government reforms towards private sector development; the return of skilled workers to the country; and the pursuant economic growth all make for a compelling proposition.

However, despite positive intentions, Afghanistan’s risks – real and perceived – remain a serious barrier to building up liquidity. Recognising this, the Afghanistan Investment Guarantee Facility (AIGF) was established in 2004 to bridge the gap between investors’ desires to tap business opportunities in the country and concerns about political risks. This facility, administered by the Multilateral Investment Guarantee Agency (MIGA), will mitigate key risks for foreign investors by providing political risk guarantees (insurance) for their investments.

The AIGF provides long-term political risk insurance to foreign investors from MIGA’s member countries, and to foreign financial institutions, located abroad or in Afghanistan, who make loans to local businesses. Insurance coverage includes transfer restriction, where losses arise from an investor’s inability to convert local currency (capital, interest, principal, profits, royalties, or other monetary benefits) into foreign exchange for transfer outside the host country; expropriation; wars and civil disturbance; and breach of contract.

AIGF can cover new investments into Afghanistan originating from any of MIGA’s member countries. New investments associated with the expansion, modernisation, or financial restructuring of existing projects are also eligible, as are acquisitions that involve the privatisation of state enterprises. Investments by Afghans who reside either overseas or in the Islamic Republic of Afghanistan are also eligible, provided the investment originates from outside Afghanistan.

Eligible forms of foreign investment include equity, shareholder loans and loan guaranties issued by equity holders, provided the investment has a term of at least three years. Other eligible forms of investment include movable assets, management contracts, and franchising and licensing agreements, provided they have terms of at least three years and the investor’s remuneration is tied to the project’s operating results.

Smaller investments

Although AIGF can operate in all sectors, the facility is designed primarily to facilitate small and medium-sized investments. In addition, in view of MIGA’s objective of promoting economic growth and development, investment projects will be selected on the basis of their contribution to economic development and must be financially, economically, and environmentally sound.

Coverage from AIGF is available for up to seven years. Longer tenors may be obtained through co-insurance provided by MIGA or arranged by MIGA from other public and private providers of political risk insurance.

In each risk category, MIGA may insure equity investments for up to 90% of the investment contribution, plus up to an additional 450% of the initial investment amount to cover earnings directly attributable to the investment. In the case of loans and loan guarantees, MIGA may insure up to 95% of the principal, plus an additional 135% of the initial principal amount to cover interest that will accrue over the term of the loan. For other forms of equity investments, MIGA may insure up to 90% of the total value of the investment. Regardless of the nature of the project, an investor is required to remain at risk for the uninsured portion of any covered loss. OPIC also provides political risk insurance, mainly to US investors.

 

 

 

 

THE HAWALA SYSTEM

Despite commercial banks opening their doors to business, many Afghans and even some foreign aid workers still prefer to use the hawala system. In its most basic form, money is transferred via a network of hawala brokers.

A customer approaches a hawala broker in one city and gives a sum of money to be transferred to a recipient in another, usually foreign, city. The hawala broker calls another hawala broker in the recipient’s city, gives disposition instructions of the funds (usually minus a small commission), and promises to settle the debt at a later date.

The unique feature of the system is that no promissory instruments are exchanged between the hawala brokers – the transaction takes place entirely on an honour system. As it does not depend on the legal enforceability of claims, it can operate even in a defunct legal and judicial environment, hence its appeal in Afghanistan.

Hawala is attractive to customers because it provides a fast, convenient and safe transfer of funds, usually with a far lower commission than that charged by banks. Authorities, however, take a dim view of it because transfers are informal and cannot be effectively regulated by governments.