Reform Iran’s Banking System;
The Three Labours
By Mahdi Goodarzi & Mojde Rezaee
The current article, whose first part was published here, deals with the main three items to be corrected in order for the mentioned reform plan in Iran’s banking system to take place, which is hoped to eventually result in prosperity in Iran’s Economy.
The Road Map
Cash flow and toxic assets crisis in banks, as a short-term to midterm problem in Iran’s banking system, is the result of structural and organizational conditions, whose sustainable solution takes time; until then, they may negatively affect the banking system for a while, adding to its instability. Consequently, it is important to first bring about a temporary improvement in this system using new policies and then, start implementing a comprehensive reform plan. In line with fundamental actions to rebuild the banking system along with attempts to restructure their balance sheets, quick measures must also be taken to solve banks’ cash flow problem. Considering the current conditions, this preliminary reform plan for the banking system must have the following features:
- it should not impede the achievement of one-digit inflation rate;
- it should reduce the real interest rate to neutralize the effect of banks’ unhealthy competition in the market;
- it should alleviate the credit crunch consequences through lowering the interest rate, increasing access to and volume of facilities; and
- it should not cause turbulence at the macroeconomic level.
The banking system reform plan has been designed to be implemented in two phases. The first is aimed at improving the banking system health, the relationship between banks and the government plus strengthening the regulatory role of the CBI and its policy making authority. The results of such attempts are first expected to gradually lower interest rate, increase banks’ lending power and alleviate the destructive consequences of the credit crunch phenomenon. The second phase, then, is to apply structural reforms which are expected to eventually improve the efficiency of the economy through enhancing banking functions.
The Structural Reform Plan
The first phase, which is the focus of the current article, is concentrated on cash flow and toxic assets problem, organizing the government debts and raising banks’ capital.
The reform plan is to strengthen the regulatory and monetary policy making role of the CBI. Empowering the CBI with sufficient authority will act as a major part in removing this problem, for which the following has been set by the CBI:
- applying adjustments to improve the legal requirement ratio in commercial banks;
- credit rating banks and monitoring behaviors of weaker banks;
- raising capital in non-governmental banks;
- properly dealing with NPL problem in banks;
- merging, reforming, restructuring, settling or dissolving [problematic/uncertified] credit institutes and banks, and
- improving effective supervision over banks activities.
Indirectly, the CBI intends to resort to instruments to establish a stable environment to reduce the interest rate through the market mechanism. It is also focused on putting an end to the destructive competition between financial institutions and banks to adjust the interest rate with the inflation in a limited period. Since sustainably lowering the interest rate will not happen by decree, it is necessary for the CBI to employ instruments for encouraging or penalizing banks to respect those standards and pay special attention to their health indices, stop this bad rivalry and neutralize its consequences. In this regard, schemes like credit rating banks and supervising unhealthy ones plus applying adjustments to improve the legal requirement ratio in commercial banks have been designed.
Besides, as an example on the CBI’s direct role, it is also worth mentioning that this summer, some banking tickers went through many ups and downs plus delays in holding their general meetings mainly due to the CBI obliging them to release their financial statements based on IFRS. Eventually, banks were allowed to hold their meetings for this period with their accounting principle-based (ordinary) reports and after that, they were obliged to submit their future statements respecting IFRS measures.
The capital raise plan for non-governmental banks has also been defined to improve the banking system health, preventing instability in banks and increasing their lending power. Successful implementation of this plan is in need of the following:
- approving the required law and regulation by the Majlis;
- the government fully supporting the CBI in supervising and penalizing unhealthy financial institutions; and
- securitizing debts and issuing such debt securities.
Organizing the Government Debts
Comparing the government debt size with other countries directs attention to the potential of government regulated borrowing in Iran. It seems that introducing a new instrument can help the government maintain and implement policies to kick out recession and balance the effect of shocks. Securitizing the government debts can raise the government credit and properly help apply monetary policies and continue the lowering of inflation rate, which provides the government with new resources for its future borrowings. The following will be of the goals sought by implementing such a plan:
- strengthening monetary policies: issuing debt securities can help the real interest rate be found in economy and end in its discovery through the market mechanism, replacing policies by decree;
- the CBI granting credit based on collateral: opening credit lines by the CBI for banks can not only decrease cost and systematize banks’ financing, but also will manage excess resources withdrawals; and
- organizing the government debt;
It is worth mentioning that recently several capital market players have complained over the yield offered in the debt market on Islamic Treasury Bills, saying that such rates will push investors further and further away from the equity market. Experts, on the other hand, believe that it is the macroeconomic conditions of a country as a reliable measure for issuing such bonds and not the capital market status, rejecting such complaints. Below, you can find the current status of Islamic Treasury Bills Market.
Raising Banks’ Capital
Based on banking principles and Bassel Committee rules and regulations, aimed at controlling risk taking ratio among banks’ managers using the public deposits, banks are required to provide themselves with a minimum level of risk coverage through shareholders’ capital.
On raising the capital of state-run banks, it is worth mentioning that a part of this plan will inject new cash into the banks, increasing their lending power, in addition to guaranteeing their health; another part is merely aimed at correcting their balance sheets, which will improve their risk coverage ratio and is of great importance especially with regard to developing banks’ international relations. Below are methods and sources which might be used to fulfill this goal:
- using the potentials in the budget law for 2016/17 to raise capital;
- raising capital through divesting government shares in banks and insurance companies;
- releasing Musharaka sukuks; and
- raising capital using Tose’e Melli Fund resources
Requirement for Successful Implementation of the Plan
The interrelated nature of communication between the financial market players turns the correctional actions into a set of related factors whose incomplete or non- implementation can endanger the banking system health even more quickly.
Furthermore, applying the structural reforms in the banking field without rebuilding the government financial sector and the capital market will not exert the expected positive effect on improving the country’s financial system and it demands the cooperation and collaboration of all organizations.
Correcting the banking system also requires a more active financing role by the capital market in the economy, a hike in attracting foreign resources, launching a deeper debt market for sovereign bonds, organizing the government debt to the banking system and regulating the government’s financial behavior and necessitates the implementation of comprehensive plans by the corresponding authorities. All in all, the success of this plan calls for a harmony in different parts of monetary, financial, foreign exchange and commercial policies.
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