Economy, Business And Markets

Banking Sector Troubles: Int’l Policies, Experiences

The Iranian banking system has been accumulating problems over the past 15 years.
The Iranian banking system has been accumulating problems over the past 15 years.

By coming into line with the Central Bank of Iran’s attempts to implement IFRS standards, the Iranian banking sector’s structural issues have delivered a painful blow to investors on equity markets. 

Since December 2016, banks listed on Tehran Stock Exchange were obliged by CBI to adjust their reported profit for the Iranian fiscal year March 2016-17 according to IFRS standards. This involved taking higher reserves and lower profits, triggering losses of 11% in banking sector index (rial terms) in January 2017. 

The Iranian banking system has been accumulating problems over the past 15 years, which intensified with sanctions and a lack of collective consensus to resolve them. High non-performing loans, investment in illiquid assets such as real estate and lack of proper risk investment measures and regulations are key factors that have contributed to this mountain of troubles. 

According to Masoud Nili, the president’s economic advisor, the future of banking sector, specifically how the government will be able to resolve the issue of troubled banks, remains the government’s top economic priority and the main topic of debate among financial experts. 

In this overview, we examine the policies and actions of other countries that tackled their own troubled banking systems. 

We look at two examples of advanced economies: the United States and Sweden, and one emerging market, Turkey.

  US Bailout Plan (2008–9)

Overinvestment in the US housing sector started in early 2006 and led to a rapid expansion of housing and stock prices relative to historical norms. Thus, the subprime crisis started from the banks and financial institutions in the US and their major international peers. 

Excessive risk-taking by the private sector, inadequate or inappropriate regulation, and lack of credibility of rating agencies are known as key factors that contributed to the financial crisis in 2008.

In September 2008, the US Treasury secretary announced a major new government intervention in the US economy. Under the bailout plan, the Treasury started to buy the troubled assets of domestic financial institutions. In addition, the Treasury proposed using taxpayer funds to purchase equity positions in the country’s largest banks. Causing a worsening of the global economy and further sharp declines in US markets, the Federal Reserve and other central banks pursued a range of rescue efforts, including cutting interest rates, expansion of deposit insurance and further purchase of equity positions in banks. 

Many analysts and academic studies examined whether these bailout efforts were the best policy that the US government could have pursued. What were the alternatives? 

According to a study by Harvard University, instead of bailing out banks, US policymakers would have been better off allowing the standard process of bankruptcy to operate. 

According to their findings, allowing bankruptcy of the banks would not prevent the crisis, but it would cost less relative to the bailout cost. The study concluded the bankruptcy approach would have reduced the likelihood of future crises. It suggested the US government was better off not bailing out private risk-takers avoiding conflicts stemming from moral hazard. 

For example, many taxpayers would argue that they should not have to pay for the bailout to cover losses that originated from risk-takers who took excessive risks with their investments in many private banks. In economics, moral hazard occurs when one person takes more risks because someone else bears the cost of such risks.

  The Swedish Model (1991-92)

Similar to the US subprime mortgage crisis, Sweden experienced a credit crunch in 1991-92. But Sweden adopted different policy from what implemented by the US Treasury. 

In 2008, Swedish officials shared their experience of their own nightmare with the US government.

The Swedes forced banks to write down their losses and issue warrants to the government in exchange for giving the government ownership. After distressed assets were sold, the profits went to a taxpayers’ government fund and the government could recover more money later by selling its shares through public offerings.

“If I go into a bank,” said Bo Lundgren, who was Sweden’s minister for fiscal and financial affairs at the time, “I’d rather get equity so that there is some upside for the taxpayer.”

The country spent 4% of its GDP. However, the final cost to Sweden ended up between 0% and 2% of GDP, depending on calculations of the rate of return. 

In summation, banks had materialized the actual amount of their losses and only then did they issue an ownership interest (common stock) to the government. 

The government announced the state would guarantee all bank deposits and creditors of the nation’s 114 banks and formed a new agency to supervise institutions that needed recapitalization or had to sell off their assets, mainly real estate.

  Turkey’s Experience (2000-1)

The heavy reliance of Turkish economy on foreign investment throughout the 1980s and 1990s, and a lack of financial means to support growth stemming from foreign inflows resulted in a banking crisis in Turkey. 

During the 90s, the government sold high interest bonds to banks due to its budget deficit and banks started to invest heavily in these high-yield bonds. 

While Turkish banking system suffered from lack of proper regulation and supervision for many years, in November 2000, international banks closed their interbank credit lines with some vulnerable Turkish banks following rising concerns over the health of the Turkish banking system. These concerns triggered fears among foreign investors who withdrew funds by selling off treasury bills and equities. 

Losses from state banks grew from 2% of GNP in 1995 to nearly 11% of Gross National Product in 2000 and non-performing loans increased to 18% of GNP in 2001.

To tackle this crisis, the government started to borrow $30 billion from the IMF to stabilize the Turkish lira and bring down interest rates to restore confidence in the market. 

Due to their significant losses, banks were taken over by the Savings Deposit Insurance Fund, a government body responsible for insuring saving deposits and strengthening and restructuring banks, if necessary. 

Although confidence returned to the economy and markets, public debt rose from 38% of GDP in 2000 to 74% in 2001. The economy started to recover and GDP grew 5.7% in 2002. Nevertheless, unemployment rose from 6.5% in 1999 to 10.4% in 2002.

At the same time, the regulatory and supervisory framework was strengthened by serious amendments to banking laws, in line with international best practices. 

To minimize financial risks, capital adequacy ratios for Turkish banks were raised to 12%, while international regulations required only 8%. Futures, option contracts and other derivative products were introduced to limit overall exposure to counterparties.

Add new comment

Read our comment policy before posting your viewpoints