Iran's Banking Sector Should Be Restructured

By Tahereh Amirzadeh, an Energy/Natural Resources Structured Finance - M&A Professional

Graduated from University of Liverpool in International Management with specialization track in Oil & Gas, from Ecole Polytechnique in Leading International Industrial Projects and from ESSEC Business School in Strategic Management of International Business. Certified in Liquefied Natural Gas from IFP School and in Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) in Banks. 

July 4, 2020

I would like to express my financial analysis of Iran’s banking sector and stress that it is not based on any political opinion but rather on facts and figures. 

The objectives of the Central Bank of Iran (CBI) are to increase the liquidity growth rate (and manage liquidity), stabilize interest rate at low levels (including controlling it on the interbank market) and decrease inflation rate (curb inflation). Unfortunately, Iran is facing several challenges:

-        The international ones: Low oil prices due to overproduction compared to demand and to the Coronavirus epidemic; Increased competition in the oil & gas market including from countries offering similar crude; Shale oil & gas boom in the US although it is currently suffering; and Coronavirus epidemic’s impact on national budgets and on economy, in particular the tourism sector.

-        Those common to developing countries: Growing real estate prices; Deficit in national budgets; Significant inflation; Major gap between the richest and the poorest people; High interest rates; Political clientelism (including for obtaining loans from banks, jobs or winning public tenders), bureaucracy and too big number of civil servants; “Bold corruption” in politics, business, banking, public administration and State-owned companies; and, Embezzlement of public funds. 

-        Those specific to Iran: Dependency on oil & gas sales revenues; US sanctions and its consequences: stop of foreign direct investments (FDI), no new foreign technology, shortage in US dollars (there is no inflow of US dollars), cut of oil & gas sales revenues (which will cause a trade deficit of $18 billion according to the forecasts of the International Monetary Fund), reduction of number of oil & gas customers, oil & gas purchases through barters of overpriced low-quality goods and products, oil & gas sales revenues in frozen bank accounts abroad, the $34 billion-debt of National Iranian Oil Company (NIOC) to Iranian banks and companies, economy entering recession, no significant investment in oil & gas and destruction of the middle class; No significant investments in producing sectors not related to oil & gas: agriculture, industry, mining, etc.; Cold war between Iran and Saudi Arabia with wars against Saudi-backed terror groups in Syria, Iraq and Yemen and financial supports to pro-Iran groups such as Lebanese Hezbollah, the Syrian Baathist regime of Assad, Iraqi Hachd ash-Shaabi and Yemenite Houthis; Three money exchange rates: the official rate, the NIMA rate controlled by CBI, and the floating market rate; Currency’s depreciation (from seventy rials to the dollar in 1979 to 30,000 at the time of the Nuclear Deal in 2015, to 140,000 before Coronavirus and 210,000 rials now) which destroyed the purchasing power of Iranians (their average monthly salary is about 25 million rials: it was fine in 2010 but now with this salary they cannot afford to pay for both their rent and their basic necessities); and, Spending CBI’s liquid foreign exchange reserves to pay Government bills, stabilizing the rial and performing foreign exchange transactions and “financial engineering”. 

After the Islamic Revolution (1979), five new State-owned banks were created: Bank-e Ma’dan wa San’at (Bank of Industry and Mine), Bank-e Maskan (Housing Bank), Bank-e Keshavarzi (Bank of Agriculture), Bank-e Tejarat (Mercantile Bank) and Bank-e Mellat (People’s Bank). At the same time, the first National Bank of Iran (Bank e-Melli), the first Iranian-owned bank to operate in Iran (Bank-e Sepah, initially capitalized with the army pension fund), the workers’ welfare bank (Bank-e Refah-e Kargaran) and the export bank of Iran (Bank e-Saderat Iran) continued their operations under control of the State. In the early 1990s, Export Development Bank of Iran was created. Since 2000, three privately-owned banks, Parsian Bank, the Modern Economy Bank (Eghtesad Novin Bank, EN Bank) and Bank Pasagard (named after the capital of the Achaemenid Empire under Cyrus the Great) were established. 

CBI cannot achieve its objectives because none of the Iranian banks use the accounting methods of the “Big 4”, the world’s top accounting and auditing firms: Deloitte Touche Tohmatsu, EY (Ernst & Young), KPMG and PwC (PricewaterhouseCoopers). Iranian banks are not declared bankrupt because they publish balanced balance sheet using accounting methods which would not be acceptable by international accounting and auditing firms. For long time, they even declared profits and gave dividend to their shareholders. In reality, they have unbalanced balance sheet and are insolvent. Dividend were paid with money of the customer deposits which is owed by the banks to its clients.  

Indeed, on the assets side of the banks, there are overvalued assets and loans without appropriated provisions. These assets have piled up mainly due to shareholders (who sold them to their banks to get cash), impaired loans (assets seized from borrowers who failed to perform their loans), bad debts, settlement of government debts to banks and bad investments. Moreover, banks are unable to recover non-performing loans for many reasons. 

On their liabilities side, there are growing customer deposits. This doesn’t mean that Iran’s economy is improving and people and companies are becoming richer. This is actually caused by high interest rates offered to bank’s clients which then prefer redepositing the interests and not investing in the real economy. CBI’s print of money covers these “profits” but printing money generates more inflation. On the equity side, shareholders capital is also growing. This doesn’t mean that shareholders are investing fresh equity. It rather means that they are adding overvalued assets in the banks as capital-in-kind. These overvalued assets are sometimes intangible assets and could then not be accepted as capital by international and accounting firms. There is a capital inadequacy. 

The quality of the assets affects liquidity and then the currency’s value and its effect on inflation. This prevents CBI to achieve its objectives and banks to play their role of lending institutions supporting the economic sectors and growth. In August 2019, Governor of CBI Abdolnasser Hemmati said that he has been working hard “to reform the banking system long grappling with mismanagement and financial indiscipline”. Because of the lack of liquidity and the depreciation of rial, the loan-to-deposit ratio in the banks has been of the descending order.

Since October 2019, CBI and Government took several decisions: 

-        Imposing restrictions on ownership of banks’ shares (ownership of more than 33% of a bank’s shares by one person is prohibited and owning 10-33% of a bank’s shares is subject to approval from CBI); 

-        Calling the banks to reduce their branches (10,000 of more than 22,000 are extra and most of them belong to State-owned banks);

-        Lowering interest rates for customer deposits to encourage bank’s clients seeking higher returns by using their savings (and even sometimes to borrow money from the banks) to buy overvalued – even after discount – bank assets (real estate properties, lands, factory units, livestock production units, etc.) and overvalued – even after discount – shares of State-owned companies (such as the Social Security Investment Company, SHASTA, and insurance companies Alborz and Amin), banks (loss-making banks Mellat, Tejarat and Saderat), pension funds, institutions, and assets (such as oil refineries, mining, steel, metal and petrochemicals plants and car manufacturers) for sale on the Tehran Stock Exchange to generate respectively cash reserves for the banks (officially for the banks to then lend for the country’s productive sector in order to create jobs) and cash to cover deficit for the State (this process is called “privatization” by some officials) at the citizen’s expense as most of the investors are only seeing short profits in a Stock Exchange manipulated by insider players collecting their cash like in a casino where most of the investors will end up losing big and becoming poorer (as mentioned on their Twitter accounts by Ali Khezrian and Ahmad Naderi, two members of the Parliament from Tehran, also worried about “social and security consequences in the near future: riots bigger than those in 2017 and 2019”): many small investors have invested on the stock exchange market which has grown of 200% in a year, this is rising concerns of a bursting bubble (as even stated in the newspaper Vatan-e Emroz on May 4, 2020);

-        Cutting part of the borrowing of the banks from CBI including the principal and interest on credit lines, overdrafts and CBI deposits with banks (instead, banks are meeting their need for liquidity from the interbank market but the challenge is that they all need for liquidity and they cannot print money to cover the interests – they have to pay each other – which are then pumped from the customer deposits since they don’t make enough earnings from their banking activities);

-        Merging five banks and credit institutions, namely Ansar Bank, Bank Hekmat Iranian, Mehr Eqtesad Bank, Ghavamin Bank and Kosar Credit Institution, will merge with Sepah Bank and cut branches by 10%;

-        Supporting rial by intervening through CBI’s affiliated moneychangers, by knocking off four zeros and issuing a replacement currency (the toman) although the two last are more cosmetic like we saw in Turkey (in 2005) and in Venezuela (in 2018);

-        Selling debt securities for plugging the national budget deficit, avoiding the print of money, controlling inflation and fixing balance sheets of banks: this, however, means banks and investors subscribe to bonds funding national budget deficit without knowing if the government will be able to reimburse them (if not then it would be a debt restructuring with an haircut for the bank depositors); and,

-        Using funds of the National Development Fund of Iran (NDFI, Iran’s Sovereign Wealth Fund, SWF) to revamp funding needs of the overstretched health care system and the unemployment insurance fund.

Iran’s rentier economy relying on a Ponzi or Pyramid financial and banking scheme should stop before collapsing and a restructuring of its banking sector should be made immediately as follows:

-        Forensic audit of CBI, all the banks and all entities and assets going IPO as per the accounting and auditing methods of the “Big 4” to understand their real financial situations (balance sheet) and performance (income statement, profit & loss, P&L);

-        Capital increase through fresh equity from current or new shareholders, receivables, accumulated profits, cash flow and currency exchange as suggested by Farhad Hanifi, CBI’s vice governor for banking supervision affairs;

-        Bank consolidations and mergers; 

-        Bail-ins that shrink banks’ liabilities (consisting mainly of deposits) by converting a portion of deposits into bank equity (those of large depositors, small depositors will have to be protected); 

-        Creation of a deposits recovery fund in which money recovered from corruption and embezzlement of public funds will be injected in to repay the money owed by the banks to the depositors;

-        Write-off of the current shareholders of the banks (the wipe-out of the shareholder capital) who invested badly the liquidity (coming from depositors); 

-        Current shareholders and managers to be hold accountable because they are responsible of mismanagement;

-        Change of all the top managers of the banks and appointment of new ones based on competence criteria, not clientelism; 

-        Creation of a “national bad bank” to support asset sales and establish normal banking activities quickly and consisting of the banks’ non-performing loans or toxic assets;

-        New banking licenses to new investors; and,

-        Shares of NDFI given to the banks under new shareholding structure and new management. 

The sooner the better the above practical steps should be taken in order to avoid total financial and economic collapse, a crime which will benefit to no Iranians no matter their political opinion.