• Official figures put Iranian banks’ non-performing loans (NPLs) at around $35bn, but the real figure could be double
  • Low impaired loan coverage means Iranian banks are in poor financial health
  • Lifted sanctions could lead to frozen assets being used to recapitalise banks

Lifting sanctions against Iran’s banking sector would improve its health considerably, according to US-based Moody’s Investors Services.

Iran’s banking system has a non-performing loan (NPL) ratio of 14.4 per cent according to the Central Bank. This would imply approximately $35bn in NPLs across the system.

Moody’s predicts the real figure is much higher. One former banking official put the figure as high as $70bn.  

“The official non-performing loans ratio is already high, but we suspect ‘true’ NPL levels are a lot higher than reported,” says Constantinos Kypreos, a vice-president and senior credit officer at Moody’s. “Some restructured and rescheduled loans may not have been recognised as NPLs. There was probably some regulatory forbearance following the distress that the economy and the banking system has gone through due to sanctions being imposed.”

Access to foreign reserves and international banking networks, prevented by sanctions would reduce the vulnerability of the system. This would boost trade and the wider economy, allowing more loans to be serviced. The Washington-based Institute of International Finance (IIF) projects annual GDP growth could accelerate to 6 per cent in fiscal years from 2016, driven by an exports and private investment boom.

Moody’s also predicts that domestic banks will benefit from renewed infrastructure spending even if foreign banks take the lead.

But Iranian bank’s balance sheets mean they are very vulnerable. Only 36 per cent of NPLs are covered by provisions, and the capital adequacy ratio (CAR) is just 6.8 per cent, around half of the ratio for GCC banks.

“Taking into account our view that NPLs levels are higher than what is officially reported, the actual capital adequacy ratio is a lot lower,” says Kypreos. “Iranian banks are undercapitalised compared to other banks in the region.”

The IIF estimates that Iran has $92bn in official reserves, of which half are inaccessible under sanctions.

A significant part of this could be used to invest in infrastructure and recapitalise state-owned banks. Private banks can go to their shareholders, or in the medium term, look for outside investment.

“Foreign banks can take an equity interest of up to 40 per cent in local banks, but whether they invest depends on how the economic and political situation plays out,” says Kypreos. “It is impossible to say how much money is needed to recapitalise the banks without knowing the true financial position of the banks, but it will be a substantial amount.”

In the longer term, the Central Bank will also need to improve its supervision of the financial sector and strengthen risk management practices and accounting standards. Iran still uses Basel I regulatory framework, as the rest of the world upgrades to Basel III. Anti-money laundering regulations also need updating.