Aug. 29 (Bloomberg) -- When Michael Eggleton arrived in Kazakhstan in 2009 after three banks defaulted on about $20 billion in debt, he thought something drastic had to be done.
So the former Merrill Lynch & Co. and Credit Suisse Group AG banker, who had been appointed chief executive officer of Almaty-based Eurasian Bank JSC, flew a polygraph machine into the Central Asian country to bolster client trust.
The bank, Kazakhstan’s 10th largest, was losing money, and Eggleton’s predecessor, Zhomart Yertayev, had been arrested on suspicion of embezzlement in connection with $1.1 billion in losses at Alliance Bank, which he led from 2002 to 2007. Yertayev, who denied wrongdoing, was convicted in 2011.
“We had just come through one of the biggest economic crises in the world, and I had just arrived in a new country,” the 44-year-old, U.S.-born Eggleton said in an interview in Almaty in July. “There was no confidence in the banks. I was trying to address concerns of the market, and internally I saw it was going to be a war collecting money back from people.”
Kazakhstan, with about 3 percent of the world’s proven oil reserves and 1 percent of its gas, ranks 133rd out of 176 nations on Transparency International’s 2012 Corruption Perceptions Index, behind Uganda and Nicaragua. Graft is pervasive in banking, with every seventh borrower saying they paid a bribe to secure a loan, according to a poll conducted last year by Sange Research Center in Almaty.
Eurasian Bank’s owners, Alexander Machkevitch, Alijan Ibragimov and Patokh Chodiev, also control London-based mining company Eurasian Natural Resources Corp. The ferrochrome, iron ore and aluminum producer is under investigation by the U.K.’s Serious Fraud Office for alleged bribery in Kazakhstan and the Democratic Republic of Congo. The firm said this month that it will “cooperate fully” with the probe.
The polygraph -- a laptop computer with wires and sensors that connect to a subject’s hands, arms and chest -- has led to a drop in theft, including kickbacks for lending, Eggleton said, declining to provide figures. The bank was the third-least corrupt among 24 commercial lenders in the February 2012 Sange poll, which asked 500 Kazakh businessmen and mortgage borrowers whether bank employees had sought payments to facilitate credit.
Eurasian Bank’s average return on equity rose to 25 percent this year compared with 2.2 percent in 2010 and a loss in 2009.
Eggleton started using the polygraph on a routine basis in January 2010, the same year he hired actor Gerard Depardieu to appear in advertisements for the bank. While the test is voluntary, employees who decline to take it aren’t eligible for bonuses or promotions, he said.
“I have a problem with someone who has failed the test or who won’t take it and is making decisions worth millions and millions of dollars,” said the U.S.-born banker, who submits to a polygraph exam once a year. “If they are not taking it, that’s fine and I won’t be penalizing them, but I won’t be making them chairman of a credit committee.”
More than 600 people left Eurasian Bank the first year the lie detector was in use, reducing the number of employees at the corporate and retail lender to 2,010, the company said. The workforce is now more than 5,700.
“A polygraph is an extreme measure, but large global institutional investors that we talk to are increasingly concerned about the effects of bribery on businesses, especially in frontier markets like Kazakhstan where corruption is a serious problem,” said Hugh Wheelan, managing editor of Paris- based Responsible Investor magazine.
BTA Bank JSC, Kazakhstan’s biggest lender before it was taken over by sovereign-wealth fund Samruk-Kazyna four years ago, has sued former Chairman Mukhtar Ablyazov, claiming he embezzled more than $5 billion using fake loans, backdated documents and offshore companies. Ablyazov, arrested in France last month, has denied accusations of theft and money laundering, saying the lawsuits are politically motivated.
Banks, including BTA, Alliance Bank and Temirbank, restructured about $20 billion in debt after defaulting in 2009.
Nurbek Ayazbayev, Eurasian Bank’s deputy CEO, said he was “shocked, thinking they don’t trust me” when first asked by e- mail to submit to a polygraph. He said he changed his mind after learning that Eggleton had taken the test, and he answered questions for 30 minutes in a dark room about whether he had received any kickbacks for providing banking services or loans.
The polygraph is a useful tool for improving discipline, Ayazbayev said, because “you know that one day big brother will come and find out who you are.”
Eurasian Bank isn’t the only lender using polygraphs. Kazkommertsbank, the country’s biggest bank by assets, began testing some employees in 2003. The practice was introduced by former law enforcement officers, according to spokesman Sergey Chikin, who said the exams are used “to control and improve the bank’s processes as well as a preventive measure.”
The Kazakh unit of Russia’s largest lender, OAO Sberbank, began polygraph testing last year, according to a spokeswoman.
Among the country’s six biggest banks, only Halyk Savings Bank, controlled by Kazakh President Nursultan Nazarbayev’s son- in-law, and ATF Bank JSC, which Italy’s UniCredit Spa sold at a 2 billion-euro ($2.7 billion) loss this year, don’t use or have any plans to introduce lie-detector tests.
“As is well-known, the polygraph is not a perfect system, and there are often cases of mistakes,” Vyacheslav Abramov, a spokesman for ATF Bank, wrote in an e-mail.
The tests are 80 percent accurate, according to Eggleton, who said he hadn’t been aware that Kazkommertsbank was using a polygraph when he began his program.
“It was one of the ideas I had seen from TV serials, and I had heard examples of it used in companies and banks but not as an actual systematic practice,” Eggleton said. “It’s like having a video camera, which offers a bit of protection if people are doing their jobs.”
The U.S. banned private employers from forcing workers to take polygraph exams in 1988 because of their unreliability. The Employee Polygraph Protection Act doesn’t apply to government agencies, such as the Federal Bureau of Investigation.
In Kazakhstan, a polygraph can be used if the employee agrees and if questions don’t involve religious or political matters, or inquire about membership in organizations such as trade unions, according to the Prosecutor General’s Office. The answers can be of an “orienting character” and don’t have any legal force, a spokesman for the office said by e-mail.
“It’s an unusual thing to require an employee to do anywhere,” Tim Johnson, founder of London employment and labor- law firm Tim Johnson/Law, said of Eggleton. “But the fact that it’s voluntary covers him and means it’s not unlawful.”
Eggleton, who graduated from the University of San Diego and has a Master of Science degree in business from San Diego State University, started his career as a certified public accountant and took a job in Russia with PricewaterhouseCoopers LLP 20 years ago.
Credit Suisse hired him as head of fixed income in Moscow, where he was on the desk in 1998 when the Ministry of Finance defaulted on a 719 million ruble ($22 million) interest payment as part of a $40 billion sovereign default.
Merrill Lynch recruited Eggleton in 2004 as head of emerging markets in London and Moscow. Two years later he became CEO of Trust Investment Bank, a former unit of Yukos Oil Co., after the Moscow-based lender bought out owners, including jailed former billionaire Mikhail Khodorkovsky.
Eggleton joined the board of Eurasian Natural Resources Corp. as an independent director in 2007, after the company’s $3 billion initial public offering in London, and was named CEO of Eurasian Bank two years later.
“When I got here, I wanted to define what corruption was going on,” Eggelton said of his arrival in Almaty. “It’s not just taking money but also hiring someone who is not right for the job, and it’s also lending money that you may or may not get back. It’s the same mentality I saw in Russia, Ukraine and it probably applies to most other markets in the world.”
Members of Eurasian Bank’s management board, branch heads and executives on credit and procurement committees are asked to take the test. Some employees take more than one exam a year because it gives them “comfort and confidence” to do their job, Eggleton said.
The bank is highlighting its crime-busting tool in marketing to bond investors for a planned debut $300 million Eurobond sale this year, according to Eggleton. In its annual report last year, the company said it introduced voluntary polygraph testing in a region “where bank employees have not always adhered to their fiduciary duties to their employer.”
Under Eggleton, Eurasian Bank’s net interest margin increased to 6.9 percent at the end of last year from 1.9 percent in 2009, and its cost-to-income ratio improved to 55 percent from 106 percent, the company said. Asset quality is now above the Kazakhstan average, according to Moody’s Investors Service, with the level of impaired loans falling to 10.5 percent at the end of 2011 from 16.2 percent for 2010.
Standard & Poor’s upgraded the bank’s outlook to “positive” from “negative” on July 16, citing improved profitability, capital and market share.
“Management has been successful in cleaning up the balance sheet, repositioning the business and recovering problem assets,” said Annette Ess, a Frankfurt-based credit analyst at S&P. “We are aware of the use of the lie-detector machine, and we think its impact is marginal and we will only see its effects in a few years when existing loans mature.”
Jason Hurwitz, an analyst at Alfa Bank in Moscow who worked at Almaty-based investment bank Visor Capital JSC from 2006 to 2010, said Eggleton’s use of lie-detector tests set a standard for banks in Kazakhstan that others have been forced to follow.
“Somebody has a neat idea, and then it gets copied, so it’s a kind of flattery,” said Hurwitz, who tracks Kazakh as well as Russian lenders. “When you are the only one not using it, maybe the liars will start flocking to work for you.”
--Editors: Robert Friedman, Frank Connelly