BY many accounts, the story of KASB bank reads a little like a movie script. It nearly went bankrupt when the crisis of 2008 hit the financial system, sending overnight lending rates skyrocketing and leaving many smaller banks gasping for air. It took an injection from some unnamed Chinese investors to rescue it, and reports were that the State Bank had to play a role in arranging it.

At one point, driven by extreme desperation for business, the bank indulged in opening Letters of Credit with Iran-based parties, disguising its transactions by routing them through middlemen in Dubai. The actions could trigger American sanctions, and inevitably they came to the attention of the US Department of the Treasury which came down like a hammer on the bank. The CEO had to flee the country to avoid serious legal consequences.

Also read: ‘Chinese company not eligible to buy KASB Bank’

Then in late 2014, news came of a senior bank owner who had been placed on the Exit Control List and was turned away from the airport while attempting to leave the country. Matters were turning serious. It turned out the owner was that of KASB.

The bank’s financial difficulties go back a long time, but the SBP prefers to begin the story from 2009, when the bank started “facing severe capital shortfall in terms of both Minimum Capital Requirement (MCR) and Capital Adequacy Ratio (CAR)”. Three other small banks were in the same position, since the SBP had only recently raised its required MCR and CAR for all banks very significantly.

The IMF warned, in every report since then, of the risks arising to the financial system from these undercapitalised banks, always hastening to add that the health of the overall banking system remained sound.

Nevertheless the little bank grew. Its deposits went from Rs35bn in 2008 to Rs63bn in 2013. Shareholders equity plummeted from Rs8.8bn to Rs1.1bn in the same period, as did net advances. But investments, presumably in government securities rose, going from Rs9.5bn to Rs27.7bn. Break-up value per share dropped from Rs12 to Rs0.7.

The extreme volatility of these numbers, and the mixed picture they paint of a bank whose sponsors were withdrawing their equity while deposits were rising, tell the story that ended in tears last November, when the State Bank moved to place KASB under moratorium.

This was not the first search for a rescue. The banks owners had mounted a search of their own in 2010, and brought back a Chinese party called Asia International Financial Limited (AIFL), which had agreed to inject funds into the bank in return for 50pc shareholding, as well as stakes in other companies of the KASB group. That deal lingered for four years, and in 2014 the State Bank disallowed to due changes in the ownership structure of AIFL. But why did it linger for four years in the first place? And what was the State Bank doing during this time, when KASB remained undercapitalised in violation of SBP rules?

In late November, rumours circulated of a Chinese entity that had shown an interest in acquiring a stake in KASB in return for injecting some liquidity into the bank. The SBP turned down the offer and came under some criticism for doing so. But the answers given by SBP for their actions make sense.

“An entity whose beneficial ownership is not clear cannot be entrusted with the licence of a bank” says the SBP, after telling us that the Chinese owner could not answer basic questions like who its owners really are, and from “where funds will be mobilised” to inject into KASB. The new investor failed to pass the test the SBP has to determine the eligibility of any party to own a bank, although senior bankers ask how it is that many current sponsors were able to pass that same test.

Once the SBP began clamping down on KASB, the owners of the other three banks moved quickly and injected the funds required to bring their banks into compliance with SBP regulations on MCR and CAR requirements. In November, the SBP finally moved to place a moratorium on KASB, and forcibly oversee its merger with another bank.

Four banks showed an interest in looking at KASB’s books closely to see if they might be interested, and three of them walked away after examining the numbers. The only one left — Bank Islami — is now set to acquire KASB for Rs1,000, while taking over its liabilities as well as the responsibility to bring it into compliance with MCR and CAR regulations.

In the middle of this, a dramatic new development occurred when the owner of KASB bank told the SBP in late February of this year that they had found another investor willing to inject funds into the bank to lift its capital base. But the SBP says the investor and the owner gave differing numbers for how much money was to be injected, and according to what timeline. The SBP asked the new investor, Cybernaut Investment Group (CIG), to place Rs5bn with KASB in a week, which CIG ignored.

This last ditch effort on the part of the owner also fell through when the SBP declined to entertain the new investor on April 27. The way was cleared for an amalgamation with Bank Islami that left the owner with nothing, his bank gone for a mere Rs1,000.

The story of KASB shows the perils that small and medium banks face in competing on a landscape where the game is rigged to benefit large players. Perhaps it would have been better to have forced these banks to become specialised banks early in the game, concentrating on small and medium enterprise lending, while keeping lower capital adequacy requirements for them. The forcible amalgamation has been disruptive, raising questions about accountability while at the same time causing immense hardship for the 150,000 depositors. Surely there was a cleaner way to get this job done.

Published in Dawn, May 2nd, 2015

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