Economy, Business And Markets

Sanctions Relief to Ease Pressure on Banks

Sanctions Relief to  Ease Pressure on Banks Sanctions Relief to  Ease Pressure on Banks

Iran’s banking sector will benefit from the removal of sanctions at the start of 2016 and lending growth will pick up in line with an improving economy, but a weaker rial and elevated inflation will weigh on deposit growth, according to a report by the Business Monitor International.

The report anticipates, however, that Iran’s banking sector will remain in a state of near-crisis over the coming quarters and expects Iran’s banking sector to benefit from a removal of sanctions, most likely at the start of Q2 of 2016, which will see lending growth pick up. However, as it will take months for banking sanctions to be unwound the impact in the near term will be marginal.

“The removal of sanctions will help stabilize the Iranian banking sector, but a boom in lending or deposit growth is still a long way off but the key benefit from an unwinding of sanctions on the Iranian banking sector will be returning access to the Society for Worldwide Interbank Financial Telecommunication (SWIFT) transactions,” BMI maintains.  

SWIFT – which provides the network for the majority of global bank-to-bank transactions - has isolated the Iranian economy leaving the banking sector virtually cut off from the global financial system. Banks are therefore currently unable to undertake international transactions, raise capital in the international bond market, or expand their presence abroad.

Although the exact timing is unclear, BMI expects Iranian banks to have access to non-US dollar denominated SWIFT transactions around the start of Q2 of 2016. US dollar transactions will come later, most likely at the start of 2017.

 Decline in CPI Inflation

On the back of sanctions relief, the report forecasts economic growth to pick up from an estimated 0.5% contraction in 2014 to 0.6% and 2.9% growth in FY2015 (fiscal year running from March 21, 2015 to March 20, 2016), and FY2016, respectively, which will improve the backdrop for the banking sector. Inflationary pressures will moderate slightly and consumer price index (CPI) inflation is expected to fall from 22% in FY2014 to 15% in FY2016.

High base effects and price pressures will weigh on deposit growth over the coming quarters. While deposit growth averaged 2.1% in 2014, from a 5.6% decline in 2013, BMI analysis projects deposit growth of 3 % in real terms in FY2015, and 5 % in FY2016.

Lending growth will show a similar trend to deposits, with growth in the coming months bolstered only slightly by sanctions relief. BMI forecasts real lending growth of 4.2% in FY2016 as the economic expansion accelerates, though the issue of non-performing loans (NPLs) remains pressing. The NPL ratio for commercial banks is currently at 15.6%. This has resulted from government’s lending directives to support failing enterprises and the depreciation of the rial in 2014, which is expected to continue.

“The practice of forcing banks to lend has declined during the current administration of President Hassan Rouhani, and we expect banks to be cautious as the macroeconomic situation improves only slightly,” says the report.

Capital injections by the central bank will contribute to reducing systemic risks in the Iranian banking sector. Iran will receive access to around $ 30-50 billion in assets frozen under the nuclear deal. While not nearly enough to support growth of an economy heavily reliant on oil sales and given competing demands from other sectors, this will go some way towards bolstering the central bank’s firepower, especially given how leveraged the banking sector is.

 Gov’t Pledges

Given systemic risks in the banking sector, profitability of commercial banks will be minimal in 2015 and 2016. Bad loans will oblige banks to put aside large sums to shield against non-repayment, and the dominance of state-owned banks in the financial system will reduce room for restructuring and diversifying income streams.

President Hassan Rouhani, however, has pledged to undertake a series of reforms to the economy, including liberalization measures, introducing tighter controls over the growing money supply and increasing the independency of the Central Bank of Iran from government interference.

“We believe that the executive will seek to implement reforms to the banking sector as well, in a view to diminish the influence of the state in the decisions of private banks and alleviate systemic risk in the industry,” BMI reports states.

Previously, banks were also encouraged to lend to specific sectors, regardless of the profitability of such operations. For instance, according to the CBI’s governor Valiollah Seif, approximately 40% of the liquidity volume in the industry was forcibly directed towards a large-scale housing project—known as Mehr-- over the past four years. This has elevated systemic risks in the banking sector and will be one area where Rouhani’s reforms are likely to target.

The report concludes that expectation for sanctions to be unwound on Iran from Q3 of 2015 will provide a significant boost to the country’s economy. “On the back of this, we forecast Iran’s economy to return to growth in 2015, following three years of recession.”

In addition, lower oil prices will play a key role in limiting the impact of the unwinding of sanctions. The report forecasts oil prices to average $53/bbl in 2015 and $57/bbl in 2016 as a result of global oversupply. This will ensure government spending and private consumption growth will be relatively low. Fixed investment and exports will become increasingly important growth drivers, though this will be a slow process as opposed to a sudden jump once sanctions are eased.