Top managers of private and state-owned banks eventually agreed last week to set the deposit rate ceiling at 20% (for one-year deposits), down from 22%. The decision is yet to be finalized by the Monetary and Credit Council in a matter of days; however, critics believe that two main issues must first be addressed if the deposit rate cut is to be effective.
The first issue is the rising number of non-performing loans (NPLs) and the second is the loose supervision of banks and other financial institutions, which violate the deposit rate ceiling.
Although cutting the deposit rate ceiling has been pursued by the Central Bank of Iran (CBI) since January 2014, it was brought into the spotlight when the Rouhani administration managed to reduce inflation to about 16 percent from once 40 percent.
By narrowing the gap between inflation and lending rates, the suggested plan aims to encourage investment by decreasing the cost of financing from the banking system to provide producers (loan applicants) with low-cost loans.
The decline in deposit rates is expected to result in a drop in loans’ interest rate, leading to higher loan demands, and accordingly, investment and economic growth. However, the problem which most banks are struggling with is lack of financial resources.
NPLs
The NPLs held by commercial banks stood at 938 trillion rails in the month ending Nov. 21, 2014, though independent experts believe the figure could be twice. Bad debts are a serious challenge banks are dealing with to replenish their resources.
“A large part of banking resources has been blocked as bad debts,” Ahmad Hatami Yazd, an advisor to the chairman of Bank of Industry and Mine, said, as quoted by news website Bina.
“As long as banks fail to resolve this major problem any decision to cut the interest rate or deposit rates is considered a political gesture only,” the economist added.
To shore up financial resources, Economy Minister Ali Tayebnia has recently announced that the government intends to pay its debt to the banks, a move that could increase their lending power. Banks are also urged to sell their excess assets to raise more capital.
Supervision
For effective supervisory over banks and other credit institutions, which should comply with the deposit rate ceiling of 20 percent, is the second necessity that should be highlighted.
If some institutions violate the ceiling and offer higher rates, they would absorb more deposits compared to others, rendering the ceiling policy ineffective and encouraging rent-seeking.
Critics believe that the government needs to maintain strict control of banks’ activity. They argue that if the decrease in deposit rates is implemented gradually, it would benefit the money market and help curb inflation.
Banks need more time to lower the ceiling they are now offering on one-year deposits, Hatami Yazd said.
The MCC is expected to meet in a week or so to address the interest rate issue. If the new decision by the Coordination Council of Banks is approved, all commercial banks and financial institutions will have to comply as of May 5.
