Reform and Regulation of Economic Institutions in Afghanistan: Formal and Informal Credit Systems

Taliban's return to power in August of 2021 caused everyone to ask why the two decades of institution building in Afghanistan failed. This book investigates the root causes of failed reforms in an important area of reform: trade and credit institutions. It explains why the efforts to reform and regulate the economic institutions in Afghanistan failed and what we can learn from their failure. It draws on more than eighty interviews with Afghan merchants, business leaders, money dealers, and government officials in five major provinces of Afghanistan to identify the barriers to access to credit and to understand the performance of formal institutions (banks) and their informal counterparts. This book finds that Afghan merchants were often unable to benefit from the offerings of formal institutions for three reasons: a highly volatile business climate, uncertain contract enforcement, and an unsupportive property rights system. Several informal institutions have emerged that alleviate some of the credit constraints on Afghan merchants. These informal institutions include risk-sharing trade credit operations, money dealers’ short-term working capital loans, Gerawee, and Sar qufli. Although these informal institutions have helped Afghan merchants survive, they are unable to support economic growth. This book argues that countries like Afghanistan should solve their institutional dilemma by adopting an approach which the author calls "Grounded Institutional Reform." Using this approach, a country would formalize existing informal institutions, a development that would vastly increase their effectiveness. While this book focuses on credit and trade in Afghanistan, the analysis of "formalizing the informal" can easily be extended to solve other types of economic problems in similarly situated countries. This book should be of great interest to scholars, policymakers, and development workers in the field of law, finance, and development.

Table of Contents:
Acknowledgement Preface Introduction Broader theoretical landscape and the case of Afghanistan Overview of the book’s organization and summary of its argument Methodology and Definitions Grounded Theory Sampling and Data Collection Definitions 1. Background on the Economy and the Problems of Credit Transacting in Afghanistan A General Picture of Afghanistan’s Economy under the Islamic Republic Main Types of Actors in Afghanistan’s Credit Economy An Analysis of Businesses in Afghanistan Business Registry Data on Business Registry and Initial Capital Investment in Five Major Provinces The Business Survey Data on Business Establishments in Afghanistan An Overview of the Social Context of Afghanistan’s Economy A Brief Overview of Institutional Context of Afghanistan’s Economy Fundamental Problems of Credit Transactions in Afghanistan Afghanistan Has a Volatile Business Climate Formal Property Rights in Afghanistan Formal Commercial Dispute Resolution in Afghanistan 2. Informal Financial and Dispute Resolution Institutions in Afghanistan Supply Chains and Trade Credit Market Competition and Provision of Trade Credit Weekly Payment System (Ugraee) How Businesses Come to Trust Credit Sales in Afghanistan Trade Credit versus Bank Loans Sources of Initial Capital to Start a Business Prevailing Institutions in Afghanistan Disincentivize Destructive Innovation and Creative Destruction Agency Costs Limit Business Expansion Family Businesses in Afghanistan Trade Credit from Suppliers Located Outside Afghanistan Is the Solution Curbing Credit Sales? Sarrafs and Sarrafi Markets Deposit-keeping Domestic Money Transfer (Hawala) International Money Transfer (Hawala) Currency Exchange Speculative Trade in Currencies (Sita) and Public Auctions (Booli) Sarraf’s Checks Short-Term Working Capital Loans Medium and Long-Term Sarrafi Loans Equity Financing The Case of Balkh’s Sarrafi Market Religious Prohibition of Interest and Access to Finance Regional Variations within Sarrafi Markets Gerawee Size of Gerawee Market Gerawee and its variations Important Characteristics of the Gerawee Market Bay’ al-Wafa: Sale with a Right of Repurchase Gerawee in Fatwas issued by the Afghan Muftis Status of Gerawee under Afghan Civil Code of 1977 Gerawee cases before Afghan Courts Sar qufli What is Sar qufli? Recognition of Sar qufli by Commercial Courts The Contrast between Judicial Treatment of Sar qufli and Gerawee Informal Dispute Resolution Institutions in Afghanistan: Who Uses Them and Why? Afghan Merchants Prefer Informal Dispute Resolution Institutions Who Uses Formal and Informal Dispute Resolution Institutions in Afghanistan Why Merchants Use Informal Dispute Resolution Variation in the Effectiveness of Informal Dispute Resolution Institutions Informal Dispute Resolution and Pashtun Culture The Use of Force to Resolve a Commercial Dispute 3. Afghanistan’s Formal Financial Institutions Formal Financial Intermediaries in Afghanistan: Are Sarrafs Included? Formal Regulations of Sarrafs What Is Wrong with the Sarrafi Regulation? Banks in Afghanistan Trust in Banks Banks’ Total Assets Banks’ Total Deposits Banks’ Loans Government Strategic Policies Aimed to Improve Access to Credit during the Islamic Republic Afghanistan National Peace and Development Framework (2017-2021) Ministry of Economics’ Afghan Government Economic Plan (National Economic Plan) (2013) Ministry of Commerce and Industries Strategic Plan (Commerce Strategy) (2016-2020) Afghanistan Central Bank Strategic Plan (Banking Strategy) (2017-2021) Ministry of Justice Strategic Plan (Justice Strategic Plan) (2014-2018) Analysis of Afghan Government Strategic Policies 4. A Critique of the Approach to Institutional Reform in Afghanistan, and a Proposal for a New Approach: Grounded Institutional Reform Grounded Institutional Reform: A Revised Approach for the Countries with Poor Infrastructure, Limited Market Expansion Opportunities, and a Willing Government Rationales for Anti-Informal Institutions Positions: The Problems of Formalizing Informal Institutions in Afghanistan Theoretical Underpinning of Anti-Informal Institutions in Afghanistan Practical Problems of Absorbing Informal Institutions in Afghanistan What Would Reforms Based on Grounded Institutional Reform Look Like in Afghanistan? Conclusions and Recommendations Bibliography Appendix I Appendix II