F ew would contest the charge that Iran’s banking industry is not up to the mark. Confluence of bad loans, mismanagement plus the mountain of government debt has, to name a few, called into serious question the solvency of many banks. As the need for AMCs is being felt more urgently than ever before, lenders’ woes took a turn for the worse after nuclear-related sanctions hit the banking system in 2012. The government now says it has a banking reform plan to fix the incompetent system. However, the complexity of the situation calls for innovative measures. Asad Jafree is an analyst who has done extensive research on the financial services industry in Iran. Financial Tribune caught up with him in an interview in his office in Tehran. Excerpts:
What do you think are the core issues of the banking industry?
Jafree: Iran’s banks suffer from high level of NPLs and low liquidity which limits their ability to lend to the real economy and help spur growth rates. Banks ability to recover overdue loans depends on the legal framework, bankruptcy and foreclosure laws which are ineffective. Another important structural problem is the lack of sufficient treasury securities or corporate bonds. Then there is the need to develop the debt capital market. Another factor is the weak corporate governance with specific problems including excessive related party loans, weak accounting and auditing and lack of skilled human resources.
Can you prioritize the problems?
The solution has to be multifaceted and should be done simultaneously. If we increase liquidity without restructuring the banks, then they lend to special interest groups or invest in speculative areas. For example, some ministries have historically borrowed directly from banks. There is no single data at the government level of all of the total public debt owed to the banking system. If we try to get the record straight, we will probably find miss-match accounts of banks and the relevant ministries.
If injecting cash will not help, what will?
Government debt is one aspect of the financial sector reform plan that President Hassan Rouhani mentioned on July 4. The plan calls for reforms in the banking sector, development of capital markets and management of public sector debt to improve fiscal discipline. It excludes three other important factors, namely the insurance sector, pensions industry and the national development funds. These are all intertwined and the next phase of financial sector reforms should include these sub-sectors.
After the global financial crisis some economists said financial stability is as important as having an inflation target. What about in Iran?
I think both are crucial but unfortunately in Iran neither has been upheld in the past. Iran hasn’t had an explicit inflation rate targeting regime like in many countries. Part of the reason is that changes in money supply depend on oil exports. Financial stability has not been a core objective within the central bank rules. However, now the government is aware of these structural problems that could be addressed by strengthening the independence and autonomy of the central bank.
What has contributed to the reported declining rates in inflation? Is it the good practices of the CBI or the government?
Both the government and CBI have placed lower inflation on their priority list. However, the sanctions have also had an impact as have the steep fall in international oil prices that have limited the creation of new money within the economy.
Can banks get rid of their bad assets? How can the CBI help?
The Central Bank of Iran can consider creating an Asset Management Company which manages the collection of overdue loans on behalf of banks. There are cases when counterparties are unable to repay due to weak economic conditions and also situations when they are unwilling to repay. World Bank data shows that Iran’s recovery rate on overdue loans is very low at approximately 19.5%. By establishing the AMC with specialized courts, we can expect the recovery rates to improve.
As for public sector debt, the government can consider repaying its debts with government debt securities. These securities need not be sold. The banks can use these instruments for their CBI reserve requirements or as collateral to borrow from the CBI which would improve their liquidity.
Many believe the current bank interest rates are very high. Do you agree?
Yes and no. High interest rates make it difficult for companies to repay debts that in turn curbs growth. However, at the same time, depositors need a real return. A reason for the high interest rates is the unregulated credit institutions which offer services to the underserved segments of the economy. These segments (consumers, SMEs and private firms) then borrow from credit institutions that often charge higher rates and are therefore able to offer higher rates on deposits. This puts pressure on banks to (also) deliver higher deposit rates.
Some foreign banks want to work in Iran. Is the industry ready for new comers?
In my meetings with CEOs of some regional banking groups, they said they are interested in acquiring a local bank in Iran. If foreign banks are able to raise deposits overseas and lend domestically, it will be good for the economy as this will mean increased credit in the banking system which would help the economy grow. This will also lead to an increase in banking skills. However, opening up of the banking industry should be done in a controlled manner as local banks are restructured and local regulations updated.
What would be the optimal number of foreign banks?
It is very difficult to reflect on the issue at this point in time. But what can be deduced is the optimal level of credit needed for economic growth. What matters is the vision of the CBI governor and the government who take these things very seriously. I think now is the time to address key banking issues. With the removal of sanctions, the isolated banking sector can benefit from better ties and links with international institutions such as the World Bank, the Basel Committee and the IMF.
