Call for Preventing the Return of Shadow Banks

Organizing the unlicensed credit and financial institutions is among the government's biggest achievement, President Hassan Rouhani announced in a recent TV interview.

Rouhani noted that it had to spend 115 trillion rials ($2.48 billion) to reimburse the depositors hit by the bankruptcy of these rogue players in the monetary market.  

However, the fallout from the operations of these institutions continues to reverberate in the financial sector–at least as far Majlis Research Center, the influential  parliamentary  in-house think tank is concerned.

In its latest economic analysis, MRC has for the first time forayed into shadow banks, elaborating on their rise and fall and the enormous adverse economic, financial and social repercussions they have bequeathed.

Attributing the catastrophe to a complicated chain of events going back to the past decades, many of which are linked to the unique socioeconomic features of Iran, the body makes suggestions to totally rid the economy of these players.

At the top of these recommendations is an enhanced supervisory role for the Central Bank of Iran to act as the financial market's sole regulator.

In the Beginning

As the research center notes, shadow banks operated in the country based on laws passed before the Islamic Revolution in 1971 and after the revolution in 1991. They spawned out of small credit institutions among guilds and state agencies and expanded gradually.

The first three major ones were created in the religious hub Khorasan region–comprising three provinces–and extended their tentacles all over the country. However, they thrived with impunity in the booming 1990s.

MRC emphasizes that the expansion of "informal monetary market" as it is referred to is in fact the byproduct of a supervisory vacuum that prevailed during these years.  It noted that although CBI passed a law in 2004 to monitor all credit institutions, such a moment did not occur until 2016 when these institutions controlled 25% of the liquidity.

Later, due to CBI's frenzied efforts, that figure dropped lower than 10% by 2017.

Another major factor acting as a tailwind for these companies has been the regulator's decision to keep interest rates down in the face of rising inflation, presenting these entities with the opportunity to offer high interests on deposits and thereby entice the depositors.

At present, MRC notes, out of the 31 active banks, only one (Mehr Eqtesad) has yet to receive an official operating license and of the nine operating credit institutions, four lack CBI's authorization.

Further enumerating the root of the exponential growth of shadow banks, MRC names the weak performance of law enforcement body—which even issued licenses for these institutes in the past–in dealing with them, the anemic response of other legally responsible agencies due to "expedient" considerations, the complacent response of the judiciary and the collusion of some legitimate banks in working with these entities.

However, "above all was the political influence that the founders of many of these shadow banks wielded", which obstructed any effort to counter them.  

This influence peddling, MRC reckons, is what led to nationwide street protests in the weeks and days leading to the presidential elections in August 2017 to undermine the incumbent Hassan Rouhani in his reelection bid.

Obstacles & Suggestions

Although the Rouhani administration launched a drive to settle the affairs of the shadow banks, this has come at a great cost and, as MRC notes, several tough challenges remain.

Among these are the underdevelopment of the country's monetary and banking system, lack of strong CBI supervision, inefficiency of M&A laws, weakness in identifying these illegal lenders, lack of a clear CBI roadmap to regulate the informal market and the influence peddling by the powerful owners of these entities.

As to how to address these flaws, MRC suggests, among other things, that CBI use utmost vigilance when granting permits to banking institutions, pass legislation to fill the legal vacuum, order all banks and agencies (both private and state-run) to stop working with shadow banks and create an asset management company to protect the rights of depositors without dipping into the coffers of CBI.