The Raisi administration has prepared a plan of action in which reforming the banking sector is a key priority.
In the plan published in the local media, the government of President Ebrahim Raisi said the reform plan is expected to result in “complete realization of the Islamic banking system, a stronger national currency, less inflation and a significant reduction in bank debt to the central bank.”
In enforcing the reform agenda, banks are expected to diversify financing methods, restore discipline to lending practices and ease manufactures and households access to banking resources (loans and credits) on the basis of “equality and justice.”
The plan also includes guidelines to improve transparency in the ailing banking system, enhance capital adequacy, reduce NPLs, improve balance sheets, increase profitability and curb banking operations suspected of money laundering.
The government wants the Central Bank of Iran to rewrite its function and move away from plugging deficits in fiscal budgets and balance sheets of banks to a strong, transparent, responsible and accountable institution.
Under the overhaul plan, the banking sector should emerge from conventional norms to a system governed by and premised on innovation and digital technology.
To help tame runaway inflation, the CBI is expected to replace the currency peg as the nominal anchor with “inflation targeting”, i.e. specifying inflation rate as a goal and adjusting monetary policy to achieve that rate.
A nominal anchor is a variable policymakers use to tie down the price level. Currency peg is a nominal anchor central banks use to control inflation. A currency peg is a policy in which a government sets a specific fixed exchange rate for its currency with a foreign currency or basket of currencies.
Five Challenges
The plan compartmentalizes the mountain of banking problems into five areas and offers solutions.
High and rising inflation and sharp volatility in prices is seen as one of the main challenge, which the government said is caused mainly by “flaws in monetary policymaking” and “funding government deficit from CBI resources -- directly or otherwise.”
Under the plan, the government says it wants to promote the CBI as an “authoritative policymaker” with the help of fundamental changes to its managerial structure.
To mitigate the impact of the government’s fiscal policies on inflation, the plan states that the CBI should not be overloaded with demands to fund the government’s unending needs.
One reform measure is getting rid of years of legal requirements that compel the CBI to buy the government’s petrodollars or its overseas revenue and give it the rial equivalent.
Iran’s forex assets overseas are blocked due to the US sanctions and the practice (paying rials to the government for the forex that is inaccessible) has expanded the monetary base and given rise to hyperinflation.
As per procedures, the CBI pays the government the rial equivalent of the foreign currency and receive the forex in lieu. However, because Iran’s forex revenue is locked overseas and there is no likelihood of unfreezing it in the foreseeable future, the CBI has to keep its printing presses running 24/7 to be able to pay the government, causing monetary base to increase.
Under the overhaul plan, the CBI can operate as the government agent in selling currency along with state banks. Obliging the CBI to change the inaccessible currency and pay the rial equivalent to the government is prohibited.
Improving Access to Loans
The government singled out limits on manufacturers and households access to loans as another challenge in the banking system and called for “providing sustainable finance” by diversifying financial instruments and developing supply chain finance methods.
To this end, the CBI has already initiated its SCF program to help businesses. The SCF is a set of solutions that aim to lower financing costs by automating transactions and tracking invoice approval and settlement processes, from initiation to completion. Under this paradigm, buyers agree to approve suppliers' invoices for financing by a bank or other outside financier.
Financial instability and dysfunctional banks is another major challenge in the banking industry mentioned in the government overhaul plan.
Incompatibility of the banking system with Islamic rules and principles and lack of robust financial interaction with the outside world are other challenges that the government wants to address.
In line with its measures to restore financial discipline to the banking system, the CBI has imposed tough monetary restrictions on some financially disabled banks as part of efforts to “control money issuance” by banks.
Economists say overexpansion of broad money supply is partly linked to the poor performance of banks. The CBI has recently enforced disciplinary measures to control bank balance sheets.
As per a bylaw issued by the CBI, the monthly growth of specialized bank assets must not exceed 2.5%. Likewise, commercial banks are not allowed to increase assets in their balance sheets beyond 2%.
