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Habib Bank becomes the first bank in history to be

practically ousted from the United States.


What happened at Habib Bank in New York?
and what will happen next, now that HBL has become the first bank
ever to be practically ousted from the United States

The Grand Central Terminal in New York is, by some measures, the largest
train station in the world, covering 48 acres in the heart of midtown
Manhattan, with 44 platforms serving 56 tracks more than any other train
station on the planet. Its main concourse is one of the most filmed locations
in television and movies. Small wonder, then, that nearly 22 million tourists
visit it each year.

As you leave the station from its southwest exit, you will find yourself across
the street from (by New York standards at least) a nondescript building
called One Grand Central Place, a 53-storey structure located on East 42nd
Street. It is in this building, on the fifth floor to be precise, where the New
York branch of Habib Bank Ltd (HBL), the largest in Pakistan, is located.

One Grand Central Place, a 53-storey structure which houses the New York branch of Habib
Bank Ltd (HBL) on its 5th floor.
It is in this anonymous office, on an unremarkable floor of an unremarkable
building in Manhattan, almost 11,671 kilometers from Habib Bank Plaza in
Karachi, that is located the branch office the shady financial dealings of
which resulted in Habib Bank becoming the first bank in history to be
practically ousted from the United States by
the New York State Department of Financial Services (DFS).

How did this happen? What did Habib Bank do wrong? What are the
consequences of this punitive action on Habib Bank and Pakistani banks in
general? And most importantly, will anyone be held accountable for this
national embarrassment?

Before we dig into the accountability debate, however, we would like to give
a little background to those who missed the most significant business news
development of the previous month.

In an order dated August 25, DFS sought to impose a penalty of $630 million
on HBLs New York branch, saying the banks American operations failed to
comply with its Anti-Money Laundering Laws and Bank Secrecy Act, and
booked it in 53 violations of the states rules, regulations, orders, and
agreements committed to by HBL itself since 2006.

Repeated failure, for over a dozen years


The DFS report states that except 2009, violations of laws occurred in every
exam cycle in the last decade. An examination in 2015 demonstrated HBLs
compliance function had deteriorated even further. The bank admitted to
deficiencies in its compliance with the written agreement and notified this to
the Pakistan Stock Exchange. A year later, the DFS conducted another exam
determining that the New York branch continued to suffer from severe
weaknesses in its risk management and compliance with its laws.

The head office screening appears to be as weak as that of the Branch itself
if not even more inadequate, the Department said in its report. For these
reasons, DFS most recent examination determined that the Branch should
receive the lowest possible rating, a score of 5.

Besides repeated warnings, the Bank was given more than sufficient
opportunity to rectify its deficiencies, but it utterly failed to do so, it said.
Indeed, presently the New York Branch is losing key compliance staff due to
resignations, including its chief compliance officer.

The report points towards the banks failure to screen and report transactions
by a Karachi-based cyber criminal who is on the FBIs most wanted list, a
Chinese arms manufacturer, the leader of a Pakistani terrorist organization,
an individual on the Specially Designated Global Terrorist list, and a
politically exposed person all these transactions were cleared by the bank.
But HBLs facilitation of Al Rajhi, the largest private bank in Saudi Arabia,
which accounted for 24 percent of the New York branchs total transactions,
emerged as the most serious compliance failure.

The Branchs deficiencies are all the more alarming given that one of its
largest US dollar clearing accounts has been Al Rajhi Bank, the report said,
adding, for many years, Al Rajhi has been linked through negative media to
Al Qaeda and terrorism financing.
Specifically, Al Rajhi used HBL as essentially its front man to process billions
of dollars of transactions through the United States, masking the identities of
the Al Rajhi clients on whose behalf those transactions were conducted.

HBL appears to have been unaware of who the ultimate beneficial user of
each of those transactions was. But a local television known for its anti-
government stance claimed that the politically exposed person the DFS
report mentioned is no other than former Prime Minister Nawaz Sharif, who
was ousted by the Supreme Court of Pakistan for concealing information
during the investigation of the Panama Gate scandal.

The program host showed on his screen details of transactions he claimed


were made by Sharif from his account in Al Rajhi bank that routed through
New York to the former premiers account in Standard Chartered Bank,
Lahore. The host publicly challenged HBL and the former premier to prove
him wrong, but an expert told Profit the details he revealed were transcripts
of Society for Worldwide Interbank Financial Telecommunication (SWIFT)
cables, which do not prove money laundering. Firstly, all dollar transactions
have to be routed through New York and second, they were made from
Sharifs account and were not anonymous, the expert said. That politically
exposed person can be former presidents Asif Ali Zardari or General Pervez
Musharraf or even Afghanistans Hamid Karzai, but we dont know unless the
details are made public, he added.

After HBL and DFS ended the matter in a settlement, those details may
never be public, that is at least what we learn from an article by Robert Kim
of Bloomberg BNA, a website that writes about legal, tax, compliance, and
government affairs.
There may be revelations far more interesting than anything publicly
released up to now in an enforcement action, Kim wrote in his article on
September 6, before the settlement. He was of the view, if HBL contested
the case, the hearing would likely be conducted in a federal court requiring
the regulator to reveal all the details relating to those transactions.

In DFSs Statement of Charges, the only indication of these remarkable


events is the short and formulaic phrase politically exposed person activity,
he said. Sharif and others involved in such actions will not like the exposure
that they receive at the hearing, he added.

DFSs Public Affairs Department, too, denied comment. We cannot comment


on the details of our negotiations and discussions with our regulated
entities, they wrote in an email to Profit.

However, the report reveals that the volume of transactions involved was not
small. HBLs New York branch handled $287 billion in correspondent banking
transactions in the calendar year 2015, of which nearly $69 billion was on
behalf of Al Rajhi.

The problem, according to analysts who cover the stock (but wished to
remain anonymous for the purposes of this article), is that HBL never felt
that investing in the technology to automatically detect money laundering
and other fraudulent activity was worth it for a branch that only produced
total profit of $10 million over the past decade or less than 1% of the banks
total profits during that period.

According to the analyst, the compliance cost for DFSs 2015 Order would
have been too expensive to have been borne by the relatively small New
York operations. So instead of deploying an automated detection system, the
bank chose to do it through human analysis. To make screening easier, they
reduced the volume of transactions monitored by capping it at $150 billion
per year, far lower than the $206 billion the regulator required from them.
Though risky, the decision was based on cost benefit analysis, he said.
HBL management made three major mistakes, said the analyst. They
preferred human analysis over automation, they turned down DFS when it
offered a settlement on a significantly lower amount earlier this year, and
they didnt wind up US operations in 2015 when they received a serious
warning.

For these violations of the US law, the state regulator initially announced that
it would seek to impose a $630 million penalty. By settling the dispute with
DFS, and by agreeing to shut down its New York branch, HBL was able to get
that penalty reduced to $225 million (Rs23.5 billion), equal to earnings of
last three-quarters.

HBL had been operating its New York branch since 1978, and was one of only
three Pakistani banks to have a presence in the United States (the other two
being the National Bank of Pakistan and the United Bank Ltd). With the
closure of its branch, HBL will now rely on banks like JPMorgan, Deutsche
Bank and others for its correspondent banking needs.
By offering to close its New York branch and as a result paying a reduced
$225 million penalty, HBL may have done away with a stringent regulator,
but that doesnt solve the main issue: its failure to adequately monitor for
money laundering and terrorist financing.
Whether it is the lack of banks cyber readiness or monitoring of money
laundering, the State Bank of Pakistan seems to be sleeping, said one bank
compliance expert. How come the FBIs most wanted cyber criminal was
able to open and run multiple accounts with HBL in violation of the SBPs KYC
requirements? he said. Some Pakistani banks are doing money laundering
presently and we are also bringing in Chinese money, the expert said.

The cost of managements failure will now be borne by all shareholders, an


official said adding such mistakes are not expected of a leadership that has a
vast work experience in large American financial services firms and are
familiar with Americas regulatory environment the CEO, Dar has spent 18
years in Bank of America and also served Citibank while Manochere Alamgir,
Country Manager for NY branch, has worked with JPMorgan Chase Bank for
more than 28 years.
The market reaction
Shortly after the damning report had hit the market, HBLs stock came
crashing down.
Habib Banks shares have had their worst two days in nine years dropping
by its limit after reports that NY regulator wants to fine them, Bloomberg
correspondent Faseeh Mangi tweeted on August 29. The banks shares were
sold at about 20 percent below the market price in off market trades, he
said.

With analysts yelling sell and investors heeding to their shouts, HBLs stock
has witnessed its worst two weeks ever. After hitting its lower cap (5 percent
of opening rate) for six consecutive sessions, it lost another 4.6 percent to
settle at Rs152.94 per share its lowest level in three years, at the close of
market on Thursday last. This translates to an almost 30 percent decline
from Rs218.11 its price before the DFS damning report went public.

The market reaction clearly indicated investors were losing confidence in


Pakistans largest private bank that sits atop Rs2.5 trillion worth of assets (as
of December 2016). And just when talks regarding the top managements
accountability started doing the rounds, HBL eked out a settlement with the
Department.

Perhaps HBLs offer to close down its US operations helped The New York
State regulator to agree to a reduced fine of $225 million still the highest
ever imposed on a Pakistani bank late last Thursday. DFS will not tolerate
inadequate risk and compliance functions that open the door to the financing
of terrorist activities that pose a grave threat to the people of this State and
the financial system as a whole, it said.
The news of a reduced penalty came as a relief to the shareholders and HBL
stock hit its upper cap at Rs160.58 per share minutes after the trade opened
last Friday morning. Given it has 5.4 percent weight in the benchmark KSE-
100 Index, an upward movement in HBLs stock quite understandably lifted
the pall of gloom from the market in early morning trade. The index
heavyweight dragged an already bearish market further down, contributing
more than half (947 points) to the index, which shed 1700 points between
August 28 and September 7.

A difficult to live down moment


We received a mixed response from analysts over the latest development.
Some were pleased, other seem disappointed. Surprisingly for people who
get paid to state their opinions about publicly listed companies, none of them
was willing to be quoted. It is a moment of shame, not relief, said one
analyst adding that even the much-reduced fine is still humongous
especially if one considers that timely action by the management could have
averted things coming to such a sorry pass.

Most analysts have estimated that the fine will have an impact of Rs16.3 per
share in the ongoing calendar year, or 70 percent of last years earnings.
And thats only the immediate aftermath. In order to maintain its Capital
Adequacy Ratio above 11 percent as required by the central bank, HBL will
have to reduce its dividend or might not even pay one for a whole year. The
banks CAR ratio is expected to settle at 13.4 percent at year end, down from
15.4 percent of June.

Besides stripping shareholders of all the capital gains they accumulated on


the stock since July 2013, the one-time payment will also result in a 6
percent lower earnings per share on average for the four-year period ending
December 2021, if analysts estimates turn out to be accurate.

Besides, experts say there is also an intangible cost of this development. HBL
had to surrender the New York State license for dollar transactions. Even if
one ignores the meagre profit of an average of $1 million a year it earned
from its New York operations, losing this legacy business would mean HBL is
back in the same league as other banks.

Some senior bankers and experts we spoke to questioned as to why HBL


could not avoid a penalty, which was inevitable as evident from the details of
the August 25 order and the recent actions of the Department against large
global banks who had failed to comply with its laws.

The bank had received repeated warnings about the deficiencies in its New
York operations and was under constant scrutiny by the regulator, which was
penalizing global banks right left and center.

Since its creation in 2011 by New York Governor Andrew Cuomo, through the
merger of the New York State Insurance and Banking departments into a
single financial services regulator, the Department of Financial Services
(DFS) has extracted more than $8 billion in fines from some of the worlds
largest banks, making headlines for its rigorous enforcement of anti-money
laundering laws.

Some of those fined are global banking giants, the likes of Standard
Chartered Bank, HSBC, BNP Paribas, and Deutsche Bank. Why didnt the see
it coming and what were they thinking? said a banker who requested not to
be identified.

Profits queries to HBLs management and the boards Chairman Sultan Ali
Allana of Agha Khan Fund for Economic Development also the single-
largest shareholder with 51 percent stakes remained unanswered. The
State Bank of Pakistan did not respond to our email either. We also tried to
reach out to some senior bankers but most of them denied comments while
those who spoke to us requested their names remain confidential.

So will anyone be held accountable? On that score, there appears to be


cause for pessimism.

A culture of impunity
And on the eighth day, God looked down on his planned paradise and said,
I need someone who can flip this for a quick buck. So God made a banker,
Marketwatch columnist Brett Arends wrote on February 6, 2013.

I need someone who doesnt grow anything or make anything but who will
borrow money from the public at 0 percent interest and then lend it back to
the public at 2 percent or 5 percent or 10 percent and pay himself a bonus
for doing so

I need someone who will take money from the people who work and save,
and use that money to create a dotcom bubble and a housing bubble and a
stock bubble and an oil bubble and a commodities bubble and a bond bubble
and another stock bubble, and then sell it to people in Poughkeepsie and
Spokane and Bakersfield, and pay himself another bonus

So God made a banker


So God made a banker Arendss dripping-with-sarcasm post was actually
a Wall Street parody of popular radio broadcaster Paul Harveys 1978 speech,
So God made a farmer.

Harveys speech was a heartfelt tribute to Americas hardworking farmers


whom he considered caretaker of Gods planned heaven. By contrast, the
Marketwatch columnist took a jibe at bankers implying the latter make quick
money by doing nothing.

Arends was criticized for his article, which many commentators said was
based on mere assumptions as opposed to facts apparently with some
reason. Banking is the engine of economic growth after all, and an economy
like the United States can collapse if big banks fail. Or why else would
Federal Reserve bail them out in times of crisis?

His post also earned many endorsements and sparked a fresh debate on
what remains a topic of much discussion globally: are top bankers who
receive insanely inflated pay cheques along with a host of other executive
benefits accountable vis a vis their performance?

The question is even more relevant in the Pakistani context, where banks
have long been making risk-free spreads through investment in government
securities instead of lending to private sector (An issue Profit has already
featured in a separate report). Given they sit on a huge pile of deposits,
making money from government securities is a no-brainer, still bank
presidents remain the highest-paid, some say overpaid, executives in
corporate Pakistan.

Bank CEOs are at the helm of for-profit organizations, with assets running
into hundreds of millions of rupees. I dont find it surprising at all that their
remuneration is relatively higher than that of their counterparts in other
sectors of the economy, a bank president said speaking to Kazim Alam for a
2012 article in Express Tribune.

The banker went on to say shareholders hold executives accountable and can
fire them for bad performance and we couldnt agree more.

However, that claim sounds hollow when it is belied in the case of HBLs
reaction thus far to the DFS fine and its departure from the US market.

A singular lack of accountability


Market analysts argue HBL is one of the best-run banks in the country and
one would have to agree as long as one ignores customer service issues at
the branch level operations.

HBL offered 18 percent return on equity, highest among the big five banks in
2016. Foreign investors are in love with this stock, owning 29 percent, as of
December 2016. Based on financials for the last five years, HBL is Pakistans
best-performing bank according to an independent study by Profit. In fact, it
is the only large bank of its size in the country where management faces no
intervention from the board other than legal requirements a strategy it is
widely praised for.

One would argue that rewarding the top management for a good financial
performance is justified, but that is only one side of the story.

Is maximizing profits the only job of a CEO, a senior banker who wished to
remain anonymous asked. The CEO is also responsible for compliance, he
said in the same breath. This was an absolute management failure, he said.
And equity analysts, including those bullish on the stock, agreed, saying
there were no two opinions about it.

HBL is a publicly-listed company and has a responsibility towards public


(depositors), shareholders, the regulator and the market, a senior banker
said. When you are not able to perform well, you step down and let
someone else do the job, which helps gain investors confidence, he added.

Far from being laid off, the top management was not only able to retain their
positions but also walked away with increments, bonuses and stock options
in the years the bank was being investigated for money laundering and other
compliance issues.

HBLs President and CEO Nauman Karamat Dar, who is one individual with
the ultimate responsibility for operational risk and compliance, received
notable increments during the period the bank was under scrutiny. This was
in addition to other benefits and stock options offered to him during the
period.

It is difficult to calculate the exact compensation of the CEO but based on


publicly available data, Dars annual remuneration increased by 120 percent
to 81.3 million compared to Rs36.84 million of 2013. This does not include
another Rs60 million the board showered on him in long-term benefits during
2015 and 2016. Moreover, the CEO was given stock-options for purchasing
373,800 shares in 2014 and another 107,054 shares in 2015.
The bank had a huge team, the senior banker said, adding the entire top
management including directors is responsible for this negligence and failure.
The DFS gives you a warning long before knocking at your door. But when
they come to you, they have done their work already, he said questioning
why the management did not act in time to avoid the penalty. They [top-tier
executives] earned bonuses while the inquiry was going on, he added.

In the year ending December 2016, the directors remuneration increased to


Rs37.2 million, up 18.4 percent from Rs31.4 million in 2015. In the same
period, another Rs1.13 billion was paid to the key management personnel in
shortterm benefits.

Whether a group of top executives deserves to be rewarded as richly as


those of HBLs for their failure to comply with risk management shall best be
answered by the boards chairman. But the display of such largesse, say
experts, can send negative signals to shareholders and investors who worry
about corporate governance and senior managements accountability when
they fail.

No heads roll
Its perfectly reasonable for people to ask for accountability from the current
leadership. However, one important aspect that seems to be missing from
the debate is the accountability of the former leadership that is responsible
for all the suspicious transactions processed at their time, said Barrister
Zahid Jamil, an expert on banks anti-money laundering laws. It should be
transparent, bringing out in the open who those people are, because they
may currently be providing consultancy or advisory services to other banks
or even the government, he said.

In September 2012, Dar had replaced Zakir Mahmood who had joined HBL as
president and chief executive officer in 2005. After leaving the banks
presidency, Mahmood continued to serve on the banks board of directors
until March 2015, according to the banks financial reports.
The companys board should fire the president and file damages suit against
all other officials responsible for this penalty, said one senior banker. The
New York branch compliance officer, the country head, the legal head should
all be questioned by the board, he said. By doing so, the board can
demonstrate to shareholders that there is accountability, which will help
restore investors confidence in the bank, he said, adding it will also show the
regulator that the bank is taking it seriously.

Shareholders may wish for the accountability, but no one from the top
management had resigned, nor did HBLs board of directors fire any
executive, as of the filing of this report. In fact, the banks handling of the
matter implies it is not even thinking along those lines.
The bank was not charged with any criminal wrongdoing, said HBL CEO
Nauman Dar at a press conference and at analyst briefings. The penalty was
a consequence of the banks outdated clearing system as a result of which its
soundness and safety were compromised, and the DFS decision to impose
such a big fine [the unrevised $630 million] came as a surprise.

Dar admitted that the banks system was still using human analysis as
opposed to an automated system to analyse transactions. He acknowledged
the bank made mistakes but objected to the size of the fine, saying it was
disproportionate. Though he hinted the bank would pay the fine if it was
reasonable, Dar told the media that the bank would vigorously contest the
penalty in American courts.

The hearing of HBLs case was scheduled for September 27, but HBL signed
the Consent Order for a settlement at $225 million on September 7.

The management has not fired anyone so far. Meanwhile, some of the
market analysts who invest in HBLs stock seem to throw their weight behind
Dar.

The US is a high-risk market and such fines are imposed on big banks every
now and then. It is business as usual, said one analyst. It is a good bank
and it will continue to perform well in future.
Edited by Farooq Tirmizi in New York