Iran needs to push through reforms

Published in MEED, 25 June 2017

One of the biggest challenges facing Hassan Rouhani in his second term as president is the reforms needed in Iran’s banking sector. While most sanctions on Tehran were lifted in early 2016, when the nuclear deal came into force, many restrictions on the financial sector remained in place, particularly those imposed by the US. This has severely curtailed Iran’s ability to attract international investment and, in turn, has muted the economy’s growth rate.

The problems are well recognised, but addressing them is not easy. Rouhani vowed to have all sanctions removed if he was re-elected, but given the hostile tone adopted by the White House, that will be far easier said than done.

“We need to have an air of caution,” says Ali Ansari, chair of Middle East studies at the University of St Andrews in the UK. “Rouhani has made several promises. He’s now saying he will try and ensure all sanctions get lifted. I think the international situation at the moment may not be entirely conducive to that.”

The banking sector’s problems do not just stem from international difficulties, however. Years of poor oversight and weak management have left the sector badly under-capitalised.

In its most recent review of Iran, Cyprus’ CI Ratings says the under-capitalised banking system “poses substantial contingent liabilities to the sovereign”. It says asset quality, capital adequacy, liquidity and profitability have all been adversely affected by a combination of sanctions and past government policies.

The Washington-based IMF has made similar observations, noting in a report on Iran published in late February that there is “an urgent need for financial sector reforms to sustain financial stability”. Among other things, the fund has recommended tighter supervision of distressed banks and a review of their asset quality to identify those no longer viable. It has suggested Tehran uses oil revenues to recapitalise the sector.

Now the election is out of the way, the government is expected to push ahead with much-needed reforms, with technical assistance from the IMF. “The issue of the banking reforms became a hot topic in the election campaign, so we think they are going to expedite the reforms of the banking sector,” says Homan Harandian, CEO of Griffon Capital, an asset manager focused on Iran.

New bills covering the banking sector and the Central Bank of Iran (CBI) are due to come before parliament in the coming months, which should lead to tighter supervision. The authorities have already asked banks to retain their profits and raise more capital.

This year, banks have also had to adhere to international financial reporting standards when drawing up their accounts. This has prompted disappointing results. Shervin Shahriari, chief investment officer of the local Turquoise Investments – an investment manager that notably avoids making any investments in the domestic banking sector – points out that in January, banks downgraded their aggregate earnings projections for the fiscal year ending March 2017 from $2bn to less than $1bn. The government has also been pushing to improve anti-money laundering measures and to implement an action plan set by the Paris-based Financial Action Task Force (FATF) in 2016. Officials in Tehran say they are hoping to be taken off the FATF blacklist in June.

There has been progress in other areas too. The number of correspondent banking relationships rebounded to 238 by the end of 2016, according to the IMF. That is still lower than the 306 in place before sanctions were tightened in 2012, but better than the four Iran had in 2014. Most of these relationships are with small and medium-sized banks, but some large foreign banks are now active in Tehran, including Japanese lenders such as Bank of Tokyo-Mitsubishi UFJ, Sumitomo Mitsui Banking Corporation and Mizuho Bank.

And Iranian banks are starting to open up branches overseas. CBI governor Valiollah Seif visited Oman in May for talks with Hamoud al-Zadjali, executive president of Oman’s central bank. They agreed to “reactivate” the Omani branches of Bank Saderat and Bank Melli Iran.

The weakness of Iran’s banking system is likely to lead to mergers, which could cut costs and should improve efficiency. Seif was quoted by local media in May as saying “any decision for consolidations would first be made by the shareholders of the banks, but this option is present in the CBI’s roadmap for banks”.

Clearly, there is much to be done, but the planned reforms should support the wider economy, if they are pushed through in a reasonable time frame.

“If [the government] manages to get this done correctly then the economy will continue to grow and inflation will remain in check,” says Harandian. “However, if they delay some of the things they’re supposed to do then the positive economic moves made over the past four years might start to disappear.”