Iran’s Banking System Welcomes
its New Oversight Plan
By mahdi Goodarzi & Mojde Rezaee
Playing an active part in financial markets, banking business will cause instability if left unsupervised; Iran’s Banking System is not an exception. In addition to goals like supporting depositors and shareholders, the financial supervision is to establish stability first at the level of institutions and then, the whole financial system.
In addition to the complexity of banks’ business models in comparison with other economic institutions, the Central Bank of Iran (CBI) Governor, Valiollah Seif believes that the gap between Iran banking system and the international banking regulations due to sanctions has turned the traditional supervision format ineffective. Lack of a systematic approach in supervision, outdated supervision methods, similar supervision methods for un-similar banks, weak relationship with professional supervisory bodies such as independent auditors and lack of an alert system are mentioned as the defects of the current supervision model.
This pushed the CBI towards finding a method made up of data on financial statements, experts’ insights and international comparative studies. In February 2017, the Central Bank of Iran eventually delivered its promise of applying changes and reforms to the banks supervision model. The new system is said to change the banking system, leading to the improvement and stability of its health. Although details of this oversight plan have not been released yet, its major approaches have been introduced by banking authorities in Tejarat-e Farda Magazine, which will be discussed below.
Nearly 2.5 years ago at the beginning of the project, concerns were raised over the recognition and distribution of unreal returns by the project management team, headed by Ahmad Badri, an advisor the CBI Governor, forcing the CBI supervisory body to put an end to distributing such returns in the general meetings held at the end of FY ended 19 March 2016.
Following the research conducted on the re-designing of the CBI oversight plan and taking advantage of potentials in the monetary and banking regulations as well as the 5th Development Plan, the new financial statements of banks were formulated with 3 characteristics of adaptability with Iran’s banking law (16 items), improvement of disclosure and transparency levels (100 items) plus compatibility with IFRS (53 items) and communicated to the country’s banking system in Jan-Feb 2015; this is interpreted as a milestone in Iran’s banking system financial reporting.
Aimed at improving efficiency of the banking system, this project eventually managed to detect the most fundamental problems of the system, a target which would not be accomplished by foreign experts since banking in Iran is different from that of Islamic countries and the rest of the world, although their experience played a huge part in this process.
How It Started
The idea for this oversight plan firstly came from “Model 2015” of the European Central Bank to supervise the banking system, adopting a business plan approach, which has been domesticated for Iran. The input for this model was also taken from the Basel Committee guidelines, banking supervision structures and regimes of about 50 countries, banking rules and regulations of 12 countries, Iran’s information structure and banking system specifications, the current oversight system as well as the rules and regulations governing the banking system.
Being designed in 8 areas, with 43 criteria and 187 measures, as Ali Divandari, the Head of the Monetary and Banking Institute has said, this model follows 7 important characteristics; the areas and characteristics are briefly introduced below:
- the first area deals with the banks’ main business, i.e. acting as a financial intermediary, which might be threatened by high level of overdue claims, insufficient reserves and a large number of debtors;
- the second area is concerned with banks’ business ownership, which deals with non-optimal allocation of resources, taking non-common risks and low transparency levels;
- the third area is the banks’ ability to meet their commitments, which can be threatened by low liquidity and capital adequacy ratios;
- the fourth area pays attention to assets quality, investigating non-producing and frozen assets;
- the fifth part is focused on return and its quality as well as the artificial trades, which have caused ambiguity in banks’ balance sheets;
- the sixth item deals with banks’ minimum profitability in order to be able to guarantee the repayment of depositors;
- the seventh part concentrates on the corporate governance issue, which is taken very much seriously in international economic institutions for which there exist auditing committees and compliance units; and
- the eighth item is focused on the non-transparent reports submitted to the CBI.
The said model is
- a domestic design suitable for Iran’s baking business atmosphere;
- adaptable; it is adaptable with different supervisory areas, criteria, measures and strategies usable at any time;
- flexible; it is implementable with any kind of data available and has the capacity to take the supervisors’ opinions;
- reducing systematic risk;
- group- oriented; it means that the supervision domain has expanded from the bank level to the level of a group of banks;
- regulation-oriented; it means that being Sharia-compliant as one principle has been considered; and finally
- acting as an alert system, i.e. it detects critical measures in banks’ critical areas and results in a special performance on the part of the supervisor.
This new oversight plan is governed by 29 principles of Basel Committee supervision model as its basis; considering the governance of the usury free banking framework, the “supervision over Sharia-based operations” principle has also been added to include the Sharia considerations of the banking industry.
Another important feature of this new oversight plan, as Farshad Heydari, the CBI Deputy for Supervisory Affairs has stated, is the division of banks into 4 categories, which each calls for particular actions:
- banks with no tangible risk, which will only need basic supervision;
- banks with low level risk, which must be supervised more carefully;
- banks with moderate level risk, which require obligatory reforms; and
- banks with high level risk, which call for overall restructuring.
Based on this model, the supervisor is to annually release the report of its activities. However, banks’ grade will be disclosed at the CBI discretion. It is worth mentioning that this plan will only apply to certified banks and uncertified ones are not basically taken into account; however, all authorities agree that the necessary decisions concerning such institutions must be soon made.
The question that arises here is as the supervisory body, how will the CBI conduct actions which will address such broad areas up to banks’ restructuring and will the current regulatory infrastructure allow it to do so? Past experience has proven lacks and defects in the legal infrastructure of the country. As an instance and as a solution to restructuring banks, mergers and acquisitions can be named. Despite being mentioned in Iran’s trade law for several decades, the specifications concerning mergers have not been outlined; besides, other rules and regulations have dealt with it in a superficial manner. As the result, there are questions on the mechanisms for implementing mergers, those who will be allowed to make decisions or the rights and obligations of different beneficiaries.
It is worth mentioning that neither have the CBI banking regulation and its usury free banking rules nor the new oversight plan addressed the interaction between the money market and the capital market on one hand and financial market and the real economy on the other as well as the possibility of the risk being transferred from one to the other along with the necessary measures to deal with them; being now known as a key point, this matter has been considered in developed countries in the recent years, which, under the current circumstances, calls for the presence of the necessary supervisory bodies and regulations in the country.
After the financial crisis in the previous decade, banking supervisors in foreign countries have learned that banking standards and supervision methods must be different for each bank while they were similar for all before the financial bubble burst; although, it should be mentioned that the new model divides banks into different categories based on their risk level and not their systemic importance and it is not the supervising standards that are different from one bank to another; rather, it is the supervisory actions towards banks which will be taken differently for each one. Considering its importance, now, this is the CBI determination, which will turn this new oversight plan into an effective one, moving the country one step forward to approach international standards.
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