Iran: Interest Rates and the Battle for Deposits

Saturday was the implementation day for the Central Bank of Iran’s latest major directive on bank interest rates, which has already created a momentum in the banking system as lenders are scurrying to absorb the maximum number of deposits.

As per the directive, banks and credit institutions were obligated to refrain from paying high interests–that went up to 23%–after September 2, and cap their interests on one-year deposits at the previously set 15% while paying a maximum interest of 10% to short-term deposits.

The directive was issued more than 10 days ago, meaning that the banks were effectively given a legal deadline to retain their status as the most attractive place for making deposits by offering higher interests for one more year. And that is exactly what happened.

Lenders embarked on a frenzied campaign and sent text messages to micro depositors. By directly contacting the macro depositors, they tried to maintain their base and attract more customers.

What is more, firsthand media reports indicate that a number of banks even kept their overcrowded branches open until late Friday–a holiday in which they were supposed to be closed–not to miss out on any potential deposits.

A query by the Financial Tribune from a number of banks both state-owned and private found inconsistencies in adhering to the CBI directive.

While a majority of them said they will not open new deposit accounts with higher interest rates in line with the directive, some of them said they will. For instance, one lender said outright it currently offers 18% interest on deposits higher than 500 million rials ($13,000).

But more importantly, the real getaway loophole to the interest rate crackdown seems to be the investment funds owned by banks and credit institutions.

Even though the eight-part CBI directive clearly states that “deposits made in investment funds” belonging to banks and credit institutions are “also subject to the fixed interest rates devised as part of this directive”, lenders seem to be telling a different story.

Asked by Financial Tribune, a general air of uncertainty presented itself in the way the banks look at the operations of their investment funds, as they claim they are still allowed to and will pay higher interest rates.

However, they add that this might be subject to later changes, if the CBI were to decree it.

  Deposits Stay in Banks

As to the immediate implications of the directive for the banking system, CBI Governor Valiollah Seif has expressed confidence that “we are not worried that deposits will exit the banks”.

“Even deposit rates set at 15% remain attractive for the people as the inflation rate currently stands at 10%, meaning that deposits will not flow into other markets,” he added in a late-night television interview.

Ali Khosroshahi, a senior asset management and investment analyst at Amin Investment Bank, concurs that the deposits are highly unlikely to find their way to the capital market.

“At least in the short-term, deposits will not be moved to the capital market because the customers of the capital and money markets are vastly different and people will not risk their money in the capital market as they are not familiar with it,” he told Financial Tribune.

The only feasible way by which deposits made in the banking sector might enter the capital market in the short term is if previous macro investors who had moved their money to the banks may find stocks more attractive again.  

However, Khosroshahi believes that people may opt to spend their money in other parallel markets such as gold coin, foreign exchange and housing markets.

  Effects of Rate Cuts on Inflation

While there is a general consensus on the necessity of reducing deposit and interest rates among officials, parliament, private sector and pundits, the real effectiveness of rate cuts and the influence of trying to reduce them on other macroeconomic indicators are also of paramount importance.

“I believe that as a result of recent CBI measures, we will witness a rise in the monetary base and see inflation rates in the double digits again by the end of the current year [in March],” Pouya Jabal Ameli, a senior economic analyst, tells Financial Tribune.

As he sees it, the recent directive is aimed at helping the general state of the economy and boosting growth rather than instilling major banking reforms.

“The first aspect of the directive, which is to directly reduce interest rates, will prove to be largely null and ineffective at the end of the day,” he adds, while the second aspect, which is turning the overdrafts made in the interbank market by banks into cheaper credit lines with 18% interest rates, will prove more beneficial.

But even those benefits will help reduce the rates in the short term because two major problems will prevent meaningful and long-lasting rate cuts.

“As a result of the lenders’ capital shortage and major issues in their balance sheets, this decrease in bank interest rates will be short-lived,” Jabal Ameli predicts.