Iran’s Capital Market Threatened by High Interest Rates!
By Mahdi Goodarzi & Mojde Rezaee
The Situation now
Taking a look at the Sixth Development Plan, one finds out effective measures for supporting and expanding Iran’s Capital Market, which is now suffering from high interest rates. Considering the agreements reached between banks on lowering this rate to 16%, the current rates revolve around 24%, which is not only a threat to the Iran’s Capital Market but also endangers industries, depriving local companies of competitiveness in international markets.
The current interest rates are up to 30% in private banks and above 20% in state-run ones while such fluctuates at 4% on average in many other countries. Despite attempts to reduce this rate in 2 phases, banks still show resistance; a reason to ditch the Central Bank of Iran’s guidelines is mentioned to be the government’s debt to banks, which has faced them with resources crunch and pushed them towards offering higher rates to attract resources, preventing them from being bankrupted.
According to a banking official, more than 50% of banks’ resources are frozen and the government owes near IRR 1,300,000 bn, equal to 15%, to the sector. It is worth mentioning that lowering this rate might accelerate the escape of deposits from banks and increase the probability of their migration to other parallel markets.
What is the Diagnostic?
The recent strictness taken by the CBI of applying IFRS to their financial statements revealed a more realistic image of banks, which was not desirable especially to shareholders. Among others, the current banking system is now grappling with two major diseases of “being forced by the government to offer facilities by decree” and “the calculation and payment system for interest rates”.
Many experts have discussed the challenges and difficulties caused by the government interference and impositions in the banking system; it is now worse since the estate is now relying on the Iran’s Capital Market as well. This not only distorts the order and balance of the money and markets, but also will save the government of feeling the pain of budget deficit and being in debt, therefore, not taking the issue of its expenditure management seriously enough.
The present article deals with points addressed by Mr. Tahmasb Mazaheri, the former Minister of Economy and Financial Affairs, on the calculation and settlement system for the interest rates.
What is the Tale?
The approval of the usury-free banking operation law in 1983 was interpreted as a huge step in the country’s economic structure; since then, this law has contributed to the basic structure for depositing and offering facilities. This law enjoys two bases:
The first is concerned with the Qarz-al Hasane contract while the second is focused on banking operations in the investment area. The former is free of usury since it deals with offering loans with no interest rate while the latter is formed by signing Islamic contracts on behalf of depositors to invest their funds; therefore, the banks enter into contracts with clients and offer facilities to them and then, receive the yields made by the economic activities; such yields will be returned to depositors after the banks deduct their fees. Having been applied and gone under many changes, this system for calculation and payment for interest rates is faced with challenges below:
- The calculated on account interest rate between the bank and clients does not arise from economic activities. Taking the relation between inflation, bank interest and economic growth into account, it is realized that the current rates are at least twice the inflation rate.
- The credit crunch has pushed banks to offer the on account rates not based on actual income or even estimates, but on competition with other banks and credit institutions, which has resulted in nothing but a price war.
- Based on what was said, the interest rate received on offering facilities and loans will become less than what is paid on absorbing resources. In order to hide it and show healthy financial statements, some managers intervened by balancing and in fact, manipulating figures and ratios to prove they are capable of providing the on account interest rate as well as earnings expected by shareholders. Unfortunately, this occurred by inappropriately using the accrual accounting basis or resorting to fake trades with their subsidiaries.
- The continuance of false accounting and demonstrating unreal earnings in financial statements was put to an end, fortunately, by the CBI forcing banks to apply IFRS in their reports. Although resulted in weak performances and realizing loss in those like Bank Saderat and Bank Mellat, it promised serious supervision of the CBI.
- Banks’ commitment to offer yield to depositors have made them set higher interest rates on facilities, which has raised concerns over banking operations being polluted with usury, which is against Islamic Finance.
- The said price war has provided uncertified credit institutes with a golden chance to announce higher rates to attract resources, adding fuel to the fire of high interest rates and becoming larger both in size and power; this, inevitably, will drag certified institutes to this war.
- The vicious circle of high interest rate on deposits and unreal incomes of banks has added to the volume of deposits and banking receivables; being a constituent element of total liquidity in the society, higher banking deposits will result in higher liquidity and such kind of liquidity will not be able to mobilize and revive the economy, posing the danger of a fake rise in demands for goods and services.
Having submitted the banking sector reform bill to the parliament, the government and the Majlis are currently working on solutions to root this problem out. In the meantime, there are still some measures to be taken to bring peace and order to the banking system suggested by Mr. Mazaheri.
- Facilities must be granted to clients and plans that have gone through a comprehensive credit rating process; unfortunately, only the records of the board member of the applicant company in regards with having any bounced checks along with its financial statements are being investigated. The important point here is the transparency level in those statements and the company’s performance in dealing with the receipt and settlement of credits, which plays a major part in defining the interest rate on the facilities to be offered. Unfortunately, the current system put both healthy and bankrupted applicants through the same filter, granting provisions with same interest rates to them.
- The government must stop forcing banks to offer facilities by decree; besides, resources must be seen in the budget to cover the previously imposed ones within 2 years in order to annually reduce their volume by 25% and settle the whole within 4 years.
- Banks must pay sufficient supervision to how clients spend the received credit and the CBI must also play a stricter supervisory role over banks.
- Banks must stop placing the yield obtained from offering facilities to clients as their revenue; only the banks’ fee must be registered as revenue.
- Finally, the required training and education must be provided for those who are responsible in producing IFRS-compliant financial statements in order to approach Iran to international standards, making attracting foreign investment for the country less challenging.
DISCLAIMER: This report has been prepared and issued by Agah Brokerage Firm on the basis of publicly available information, internally developed data and other sources believed to be reliable. The information contained herein is not guaranteed, does not purport to be comprehensive and is strictly for information purposes only. Agah does not assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions. Any expressions of opinions are subject to change without notice.
To contact reporters: Inter@agah.com