The Afghan financial system is staring at a collapse within months as it reels from a worsening cash liquidity crunch and a spike in bad loans, a new report by the United Nations Development Programme (UNDP) said on Monday.

The UN body called for urgent "prompt and decisive" action, warning that the economic cost of a collapse and the resulting social fallouts would be "colossal."

Afghans have been facing an acute cash shortage since the Taliban's takeover of Kabul in August that led to international sanctions. The latter saw the country's international reserves frozen and most foreign grants suspended. The liquidity crunch forced the Taliban regime to cap weekly bank deposit withdrawals.

Abdallah al Dardari, head of UNDP in Afghanistan, said the collapse of the financial system was slowing down the fast-diminishing economic activity in the country and could undermine international aid efforts as "banking is also one of the most important connectors of the country to the outside world."

"Without the banking sector, there's no humanitarian solution for Afghanistan," he said in a statement. "Do we really want to see Afghans completely isolated?"

Banking system in 'disarray'

Total banking system deposits in the country fell to 194 billion afghanis (€1.8 billion, $2 billion) in September from 268 billion afghanis at the end of 2020, the report found. The deposits are expected to fall further to 165 billion afghanis by the end of 2021, a drop of about 40% from last year.

Bad loans have also been climbing in what is a relatively small credit market. Nonperforming loans soared to 57% in September from around 30% at the end of 2020.

The current crisis has prompted banks to stop extending new loans, worsening the predicament, especially for smaller firms.

"In addition to the decline in economic activity, problems in the banking system will further reduce MSMEs' [Micro, Small & Medium Enterprises) probability of survival, which is critical for the Afghan economy and people," the report said.

The International Monetary Fund (IMF) expects the Afghan economy to shrink by up to 30% this year.

"The Islamic Emirate [of Afghanistan] must open the accounts of businessmen. If the bank accounts of traders are not opened and exports and imports do not take place, normal people will be faced with problems, Mir Dawlat, a Kabul resident told DW's media partner in Afghanistan, ToloNews.

Risking two decades of progress

The Afghan financial system, while still underdeveloped, had been growing steadily since the ouster of the Taliban in 2001 when the banking sector had virtually collapsed.

The banking sector has 12 commercial lenders, including six private commercial banks, one private Islamic bank, three state-owned banks and two foreign bank branches. Private domestic banks accounted for roughly two-thirds of overall banking sector assets at the end of 2020.

The majority of the banks' over 400 branches are in the capital Kabul, Herat and Mazar-e-Sharif.

The banking system is heavily reliant on dollars, with about 60% of bank deposits made in foreign currencies.

While the Taliban have ordered banks to reopen after weeks of closure following the Taliban's victory, the lenders are struggling to find enough cash to service their customers as dollar inflows have stopped and worried Afghans stash cash for even worse times.

"I had come to get my money from the bank. There are cash issues here. I have a dollar account, but when I try and withdraw cash, they tell me that they would give the money in the local afghani currency. The exchange rate they offer is very low compared to the market," Mohammad Emal, another Kabul resident, told ToloNews.

Al Dardari told Reuters news agency that of the $4 billion worth of afghanis in the economy only about $500,000 worth is in circulation.

"The rest is sitting under the mattress or under the pillow because people are afraid," he said.

Preventing a collapse

Among measures to prevent a collapse of the Afghan banking system, the UNDP has proposed a deposit insurance scheme, adequate liquidity for the banking system to meet both short- and medium-term needs and credit guarantees plus loan repayment delay options.

"The longer the delay in the full restoration of the financial and banking systems, the longer the recovery period, due to the subsequent lack of confidence by international markets," the UNDP report said. "This erosion is hard to repair and could take decades."

Edited by Hardy Graupner