Iran’s Banking Sector on Path to Recovery Despite Sanction Challenges

The situation Iran’s banks found themselves in over the past decade, cordoned off the global markets by sanctions, would take a toll on any country’s banking sector. But as relationships with the West begin to warm, Agah Group is paving the way towards reintegration with the global banking system. Bonds and Loans talks to Mahdi Goodarzi, one of the financial group’s board members, about some of the steps being undertaken to modernise the country’s banking sector.

Jun 9, 2017 // 10:41AM

How successful and effective has the revamp of Iran’s banking sector been so far?

Over the past four years, officials in the Ministry of Economy and Financial Affair as well as the Central Bank of Iran (CBI) took serious steps to align Iranian banks with their foreign counterparts. In fact, the CBI found out that establishing relations with those banks was subordinate to a collection of internal reforms, having assessed common international banking requirements in the post-JCPOA atmosphere. Due to years of sanctions and therefore, lack of relations with international banks and not upgrading rules and regulations, Iranian banks were left behind their foreign counterparts, which had applied upgrades in their procedures, particularly after the global financial crisis in 2008.

The administration also focused on restructuring the banking system. Banks’ unhealthy structure and postponed/doubtful/non-performing claims had made accounts un-compatible with international standards. Under the 11th administration, the CBI mandated banks to prepare IFRS-based financial statements, since their balance sheets were the first item investigated by foreign counterparts in collaborations.

Additionally, in early 2016, the Iranian Parliament ratified the Anti-Money Laundering/Fighting the Financing of Terrorism Law and declared its commitment to implement an action plan; this finally directed the Financial Action Task Force (FATF) to suspend counter-measures in June 2016 for 12 months while monitoring Iran’s progress in implementing the Action Plan. In this regard, an official expressed hope that Iran would be deemed in compliance by the FATF when the deadline is met, which would stop counter-measures altogether.

Launching the Cash Transaction Report system, the establishment of compliance and risk management units and the formation of committees in regards to Basel standards, KYC issues, and credit risk are among other steps.

However, talking about the CBI’s success seems a little early, since the applied changes have targeted structural reforms, therefore, are in need of more time; classifying banks in terms of their required supervision levels, organizing the unsupervised money market, putting an end to banks’ non-banking activities along with supervising the yield division are among issues addressed by the CBI; a correct but difficult and challenging path ahead. In order to increase its oversight, it also ratified important regulations; for instance, based on the permanent directives in Iran’s development plans (those which have been repeated in the past 5 development plans), establishing any monetary and credit institutes will be possible only after the CBI and the High Council of Money and Credit have issued the permission while it used to be possible via the issuance of permits by the Ministry of Cooperatives, Labour and Social Welfare. This way, we will no longer face the establishment of credit institutes unsupervised by the CBI. All that said, the actual outcome of such measures will come out in due course.

What were the Agah’s main objectives this year and have they been achieved?

As a leading full-service financial group in Iran, Agah Group has made itself familiar with the needs and requirements of foreign clients, including tailor made reports and consultancy services. In fact, it is focused on providing correct and reliable information on Iran’s capital market and launching has been one way to pursue that; in fact, Agah Group website is considered as one of the most popular sources for foreign investors. Besides, foreign companies are looking for a reliable and well-regulated local partner, able to guide and help them in finding the best investment opportunities. Considering the man power, strong and extended network with large and major listed companies, we have attempted to serve foreign parties with useful services. As a result, we have started working with several investment companies and investment funds, injecting millions of dollars into Iran’s capital market.

How is the new bank rating system being implemented in the sector?

Currently, agencies like Moody’s, Fitch and S&P seem unprepared to start activities in Iran any time soon; therefore, as Mr. Hasheminejad, a CBI official, has said, banks’ credit rating is done based on CAMELS, in terms of indices like Capital Adequacy Ratio, Asset Quality and Management Quality.

In the 55th General Meeting of the CBI, President Rouhani addressed the need for credit rating banks owing to the undeniable role they play in the economy in order to raise transparency in compliance with the international banking system. Six months later, CBI officials defined 168 criteria for supervising banking operations and dividing banks into “banks with low level risk”, “banks with moderate level risk” and “banks with high level risk”; this will create a difference between banks’ resource attraction ability in a more competitive environment.

What are the main challenges around implementation, particularly regarding Basel III regulations?

With Iran being under banking sanctions for over 10 years, the international banking network started to apply measures to add to transparency in international transactions and fighting terrorism and Iran had been left out of this circle, sticking with Basel I standards, which allowed Iran to allocate up to 40% of its resources to non-banking activities; as such, foreign banks are now required to apply Basel III standards until 2018.

It seems that the Capital Adequacy Ratio, as the most challenging item among other Basel III standards, which should stand at 13%, mostly hovers around 4% or lower in Iran, although there are healthy banks in the country enjoying a 12% capital adequacy ratio.

Risk management and compliance issue are the next important items, whose investigation calls for independent units in each bank with trained staff.

Last but not least is the corporate governance issue to shield depositors’ interest as well as their trust in banks on one hand and guaranteeing banks’ healthy performance on the other, aimed at creating a balance between the interests of all beneficiaries. In this regard, the CBI had communicated a 14-clause guideline to improve corporate governance in Iran.

It is noteworthy to say that as Dr. Tayebnia, the Minister of Economy and Financial Affairs believes, the method used for quantifying such a ratio must also be in compliance with Basel III standards.

However, it is worth stressing that since it reduces banks’ lending power, Basel III standards application has had its challenges in Europe as well; taking the current credit crunch in Iran into consideration, implementing such standards will face even more challenges in our country.

That said, and referring to the previously issued licenses to credit institutes without the CBI permission, successfully implementing such standards will call for a rigorous investigation of shadow banking in Iran, which is currently done by the CBI.

The banking sector is still cut off from the West due to sanctions. How much stress does it put the local banks under and what are your coping strategies?

In years after the Islamic Revolution, Iranian economic practitioners have always been grappling with various kinds of sanctions, although more tangible and hurtful effects were felt after 2006, when the CBI was put on the black list, accompanied by foreign banks’ blocking Iranian accounts and freezing their assets. At that time, even the previous limited international activities of Iranian banks,  opening limited companies and facilitating Iranian businesses for instance, were becoming even more limited. Sanctions also caused a deep divide between Iranian and foreign banking regulations, making Iran’s supervision capabilities ineffective.

With banks seen as a government arm in implementing development plans in the country, such sanctions have always targeted, both directly and indirectly, the economic development of Iran. In fact, with Iran being a bank-based economy, banking sanctions dented the country’s risk profile, increased the financing costs for producers and manufacturers as well as the cost of goods and services imported by businessmen. Aside from their negative effects on Iran’s foreign exchange reserve account, they raised many concerns over the security of export and business with Iran, too.

Nevertheless, continued negotiations with foreign banks, the establishment of correspondent relations along with re-joining SWIFT and opening LC were among the positives of the JCPOA, to which the re-opening of Iranian banks’ branches abroad must also be added. There is now interest among foreign banks in opening representative offices and branches in Iran as well.

Although transactions are done with less difficulty, there are still a lot of bumps in the road. Many large international banks are refusing to enter into business with Iran, mainly due to their relations with the US and fear of being fined in addition to the gaps in Iranian banking structures.

With Trump elected as president, more ambiguity and concerns were raised in regards to dealing with Iran, which slowed down the speed of Iran’s return to the international markets even more. Doing trades in US dollars is regarded as the most important challenge; despite many negotiations and talks on the part of political and banking officials, it seems it still takes more time and in the meantime, Iranian entities seem to be substituting mostly with euro and local currencies in its trades.

We have seen a drop in non-performing loans this year, but Iran still has 1 quadrillion rial worth of bad debt – how can it deleverage and dispose of distressed assets? What can individual banks do to aid this process?

Determined to settle a part of its debts by securitizing it in the debt market, the government started to issue Islamic Treasury Bills in winter 2015, which continued in 2016 as well. Considering the government being in debt of contractors and contractors themselves’ debt to the banking sector (mostly state-owned banks), the government was granted the permission to use resources equal to IRR450,000bn from the CBI’s Net Foreign Assets allocating IRR200,000bn, IRR150,000bn and IRR100,000bn to raise banks’ capital, settle its debt to the banks and settle the interest on facilities granted to some other businesses, respectively; with many experts for and many against this issue, what is really needed is the injection of fresh money, which seems impossible under the current circumstances. Regarding the second part, it is worth mentioning that disposing of such assets takes more time since most of banks’ assets are in real estate and housing sector, which has been grappling with recession in the past few years, although there has recently been a rise in the number of trades in this industry.

Macro Policy & Government Middle East

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