Economy, Business And Markets

Banking on Banks!

Banking on Banks!Banking on Banks!

Iran’s financial system is dominated by banks. With a small and undeveloped stock market, the only way firms can raise money is through borrowing from them. This slaves the economy and businesses to lenders. The reliance showed its fault when sanctions and bad lending practices crippled banks in the past years, inevitably having a spill over to the real economy.

Banks were too big to fail in bastions of free market economy in 2008. In Iran and its state controlled economy, the story takes an even darker shade. With the absence of developed equity markets, the bond markets in embryonic stage, and high business risk, savers are left with only one logical option: deposits. The reliance on banks as the sole conduit for turning savings into business investments bloats their role. Thus, dealing with a bank in financial distress becomes a nightmare.

But having a turgid function in the economy is not the only pitfall of Iran’s banking system.

Because Iran’s major lenders are all state-owned and even some private ones are controlled by state affiliated entities, the government gets too much say in how they are run. Considering the government doesn’t shy away from meddling in their corporate affairs, little is left for the banks to decide when it gets to strategy and policy. Recently, chief executive of Bank Melli -- Iran’s largest lender -- criticized the parliament for interfering in the bank’s governance and budget planning, citing it as the main reason for its poor performance. Thus, Iranian lenders have become levers of state control, and states have rarely succeeded in running businesses.

Blatant government intrusion in how the banks are run not only reduces their efficiency, but also endangers the financial system and with it, the entire economy. “Compulsory facilities” – loans state-owned lenders were forced to pay at low rates to fund government initiated schemes – have piled up bank balance sheets with at least $938 trillion rials ($33.1 billion at official exchange rate) of bad debt. The number becomes terrifying when you consider that clients borrowed 3.2 quadrillion rials ($95.2 billion at market exchange rate) from Iran’s commercial lenders during the Persian year ending March 21.

State-owned banks still have had to provide “compulsory facilities” at low interest rates, while paying upward of 22 percent on one-year deposits. To cover lost revenue, they raised lending rates and embarked on running risky enterprises. Lax oversight by the regulator, legal loopholes and corruption abetted the banks in this regard. Now, the government is trying to solve the mess it and its predecessor made, regrettably with the same method: heavy-handed intervention.

Though financing is not the only reason behind meager business activity, it plays a prominent role. Until Iran’s financial markets grow to adequate size to take their place in the financing cycle, banks will continue to be the plausible source of funding. In their current state, that is not a task they are up to in their current conditions.

Unsurprisingly, the solutions are hard and time-consuming to implement. The state should change its culture of interference. The central bank has to break away from the government and increase its supervision on the banking system. Bankruptcy laws must be revised and bank charters changed accordingly. It takes a lot to fix what’s broken.