Restructuring Banking System

Restructuring Banking System Restructuring Banking System

Recently the banking system of Iran has been sharply criticized because of the embezzlement of US$1bln, high interest rates on loans - more than 25% to SMEs, large number of defaults by its debtors, and the acquisition of firms active in businesses other than banking. Albeit the government regulates the banking industry to ensure the soundness of the financial system, to run the economy smoothly and efficiently, and to increase the availability of information, the industry needs structural reforms to surmount its shortcomings.

In the developed banking systems, the principal financial intermediaries fall into three categories of depository institutions, contractual saving institutions and investment intermediaries. That is, commercial banking is separated from investment banking.  Commercial banks and other depository institutions are not allowed to engage in risky ventures associated with the securities industry because 1) security prices experience substantial fluctuations and 2) banks have the incentives to invest in risky assets to gain higher earnings when they pay off, leaving depositors and creditors with the loss when they do not. Hence, if a large bank wants to actively participate in the securities industry, one of its investment intermediaries, such as investment bank and mutual fund, will accomplish the mission while capital flow from commercial bank to investment segment is prohibited. 

The inception of global financial crisis has reinforced this separation through passing legislations in some European parliaments and cabinets. For example, in the UK, the government says banks have to ring-fence their operations by 2019 to ensure taxpayers will not have to bail them out and to make the system safer.

 Details of the ring-fence are expected to be finalized by 2015, with the banks then being given a further four years to implement them.  In Iran, the Central Bank of Iran intends to restrict banks from engaging in risky activities by ordering them to decrease their involvement in the stocks market and the ownership of firms to less than 40% of their capital, during a time period of 3 years.  Currently, the average amount of banks’ investments in their subsidiaries and affiliated firms is approximately 51% of the banks’ capital and the Ayendeh Bank has the highest rate of 380% amongst the Iranian banks.

Although this decree does not separate two main sectors of the banking industry, it is a step forward to curb the insatiable appetite of banks for having more firms and investing in securities.  

Amir Moradi is a PhD candidate in finance at France Business School and an independent financial consultant. amir.moradi@france-bs.com