Can Iran’s private banks make a difference?

Experts agree that the Iranian private sector will be the critical element in driving the country’s economy out of its current stagflation. At the same time, private businesses are in dire need of modern and functioning banking and financial services. While still small compared to giant public banks, Iran’s private banks could be the missing link in the country’s business services; however, they need to look for new ways to take advantage of their more dynamic nature. 

Iran started liberalizing its state-dominated banking system in the late 1990s, initially by introducing private “savings and loans” institutions and later allowing the establishment of private banks in 2000. A number of genuinely private banks have been established in the past decade. In addition, shares of formerly state-owned banks such as Tejarat, Mellat and Saderat have been offered on the Tehran Stock Exchange. However, in their management and operation, all the privatized banks are still under government control — a fact that is clearly documented in the appointment of managing directors of these banks by the government. 

All public and private banks as well as savings and loans institutions are subject to supervision and regulation by the Central Bank of Iran (CBI) under the Monetary and Banking Act. CBI supervision is conducted through regular reporting requirements as well as by on-site inspection. In recent years, especially following a number of major embezzlement and corruption cases, the CBI has increased its supervisory capacity and revised existing regulations in areas such as large exposures and connected lending. One of the principal threats to the banking and financial system has always been the weak supervision of the large state-owned banks, reflecting the lack of appropriate infrastructure to collect data. As such, smaller private banks are subject to greater scrutiny by the CBI as their data infrastructure is modern and can follow the reporting requirements.

A recent report by the regulatory body assessing the performance of the country’s private banks indicates that the 17 existing private banks in Iran (Eqtessad Novin, Ansar, Iran Zamin, Ayandeh, Parsian, Pasargad, Hekmat Iranian, Saman, Day, Sarmaye, Sina, Shahr, Karafarin, Tourism, Ghavamein, Mehr Eqtesad and To’see) have a total of 2,780 branches in the country (fewer branches than those of one of the giant state-owned banks). It should be noted that a number of these banks are positioned in the semi-governmental sphere of foundations and military organizations. In fact, Sina is owned by the Mostazafan Foundation, Shahr is owned by the Municipality of Tehran, Hekmat Iranian by the army, Day by the Martyrs Foundation, Ansar by the Cooperative of the Revolutionary Guard, Ghavamein by the Law Enforcement Organization and Mehr Eqtesad by the Basij Mostazafan Organization. This means that the real private sector banks only number 10, some of which are also controlled by other conglomerates and organizations with ties to the government (such as Eqtessad Novin, owned by the Behshahr Group and Parsian, part owned by the Iran Khodro Group). Nonetheless, it is these banks that are generating new competition for banking services, and they could help fill the gaps in the banking sector.

The report indicates that as of November 2013, these banks had extended a total of 1,144 trillion rials ($46.1 billion at the current exchange rate) in loans to individual and commercial customers. This is a significant amount in the Iranian economy; however, the report also identifies some 220 trillion rials ($8.9 billion) of these loans (or about 20% of the total facilities) as “bad debt” — a growing phenomenon in the Iranian economy and a consequence of the poor economic conditions. In fact, the bad debts of private banks have increased by 57% in the 12 months ending in November 2013. According to the CBI's governor, the total amount of bad debt in the country’s banking sector totals 780 trillion rials ($31.5 billion). This means that about 30% of the economy’s bad debt is held by private banks, even though these banks only have a 15% market share in the banking industry. 

Another indicator that shows the weak position of the private banks is the ratio of loan facilities to deposits. Private banks show a ratio of 0.76 while government-owned banks have a ratio of 1.36. Despite the existence of laws for “Islamic [Sharia-compliant] banking,” Iranian banks essentially work with fixed interest rates that are termed “profit sharing” in order to comply with Islamic rules. Considering the spread between interests paid on deposits and fees charged on loan facilities, one can imagine the potential upside for public banks that have a high ratio of extending loans to customers (mainly state-owned enterprises). However, the fact that such banks are loss-making entities points to the existing inefficiencies in state-owned banks. 

Private banks have a lower ratio of converting deposits to loan facilities and also a higher ratio of bad debt, but most of them are profit-making enterprises. On a positive note, in the past few months, private banks have also managed to reduce their debt to the CBI, which indicates a new financial discipline as a result of the emergence of a new government and also a new CBI governor.

The report also indicates that the performance of private banks in the fields of letters of credit and bank guarantees, which are a reflection of their services to businesses, is negligible. This suggests that private banks have not managed to become the vehicles of choice for key businesses in Iran. Evidently, external banking sanctions have hit the private banks more severely, as they do not have the resources to deal with the related operational challenges. Another reason is their size — most businesses in a cash-based economy like Iran require banks with a large number of branches so that they can operate in the entire country. Consequently, private banks will continue to play a limited role as long as their branch networks remain small. However, some of the private banks have managed to penetrate niches such as online or mobile banking, which are preferred by a number of new businesses.

All in all, private banks are a small, but growing phenomenon in the Iranian economy. They have the potential to fill the existing gaps in the country’s financial sector, especially if they develop new concepts to respond to the needs of the business community. To do so, they have to come out of the shadow of the public sector and attract deposits in a more efficient and creative way. However, here they are at the mercy of the CBI and the government’s monetary and financial policies. Considering the inflationary environment in Iran, it can be expected that there will be a downward push on interest rates, which will shift deposits away from banks toward speculative markets such as the stock exchange. 

Consequently, private banks will need to focus on the existing gaps for the private economy to be able to grow their business away from the areas of competition with larger state-owned banks. For example, they are more equipped to combine diverse financial services (such as banking, insurance and brokerage services). Furthermore, should banking sanctions be lifted, Iran’s private banks would be ideal vehicles for collaboration with international banks in the Iranian and regional markets. To position them for such a role, the government will also have to support private banks, especially in the face of the challenge of bad debt in the economy. In fact, the government may have to bail out some of these banks in order to facilitate their role in the growth of private enterprise in the economy. There is no doubt that the health of private banks will be interdependent on the growth of private businesses in Iran and by extension, on the economy’s success in creating needed jobs and economic impetus.