Afghan Banking System At Risk Of Collapse

On Monday, the United Nations (U.N.) called for immediate action to prop up Afghanistan’s banking system as it sits on the brink of collapse. In a three-page report issued earlier this week, the U.N. Development Programme (UNDP) warned that rising credit defaults and a worsening liquidity shortage threaten to topple Afghanistan’s financial system in the coming months. The economic and social costs, it said, “would be colossal.”

Afghanistan’s economy was sent into free-fall back in August when President Biden pulled the last US troops out of the country and the Taliban seized control of the government. The abrupt withdrawal of nearly all foreign development and investments has choked the country’s financial markets. To stop a run on bank deposits, the government has been setting weekly withdrawal limits, but this has done little to stem the tide. “Afghanistan’s financial and bank payment systems are in disarray,” the UNDP report said. If current trends continue, 40% of the country’s deposit base will be lost by the end of the year. By 2022, the International Monetary Fund (IMF) predicts that the Afghan economy could shrink by up to 30%.    

The country’s banking system was unstable even before the Taliban takeover, says CNN. Afghanistan’s economy was driven by foreign aid and relied heavily upon a steady inflow of US dollars for conducting transactions. Since the Taliban seized power, Afghan assets have been frozen abroad. The United States and IMF have cut off the Afghan central bank’s access to billions of dollars worth of funds, and other lenders including Germany and the World Bank have followed suit. This has left the new regime with little to keep its banking system afloat. “We are in such a dire situation that we need to think of all possible options,” said Abdallah al Dardari, head of UNDP in Afghanistan. “What used to be three months ago unthinkable has to become thinkable now.”

The way forward is tricky, however. The challenge is to find ways to support the banking sector without supporting Afghanistan’s violent new regime. State Department spokesperson Ned Price agreed, saying that the US is working with the UNDP “to see to it that the people of Afghanistan can take advantage of international support in ways that don’t flow into the coffers of the Taliban.” Yet, with a humanitarian crisis exacerbated by stalled aid funding, there is no time to waste. “Without the banking sector, there’s no humanitarian solution for Afghanistan,” said al Dardari – “Do we really want to see Afghans completely isolated?”

Given their extensive experience with Afghanistan’s financial system, the World Bank and International Monetary Fund must consult on the UNDP’s efforts to provide short-term economic relief. They should offer Afghan citizens deposit insurance and loan repayment delay options to limit defaults so that panic does not drive further collapse. Despite fears that it will benefit the Taliban, these institutions should also unfreeze some foreign assets to the Afghan central bank so it can increase liquidity in financial markets. Otherwise, the potential cost to civilians will far outweigh the potential gain for the Taliban. However, this unfreezing of assets should be contingent on the government spending part of these funds on the purchase of food imports⁠—upon which Afghanistan depends heavily. Without such conciliatory measures, financial collapse will thwart humanitarian efforts and push Afghanistan towards famine, a deepening refugee crisis, and even greater civil unrest.

Caleb Loughrin