IRANIAN banks are being given a dose of shock therapy in a bid to raise standards to international levels. If the reformers have their way, far more radical moves to modernise the Islamic banking system could be in store that would overshadow anything attempted so far.
Iran's banks were nationalised after the 1979 revolution and were formally Islamicised in 1984. They seemed to get through the upheavals in relatively good shape, but the true state of their finances became something of a mystery and, in recent years, the banks have played only a limited role in the economy.
A major uncertainty was created by the revaluation of the banks' fixed assets in the 1990s. Thanks to soaring property prices, some banks declared a 10-fold increase in their capitalisation overnight. This was greeted with scepticism and experts have long expressed reservations about the true value of the banks' investments and their pre-tax profits.
Concern grew when the banking system was shaken by a series of corruption scandals involving hundreds of millions of dollars in the mid-1990s. The scandals, suggesting that significant parts of Iran's banking operations were out of control, shocked the authorities, and became a major concern at the IMF in Washington.
With technical help from the IMF, the banks are now busy revising their basic reporting systems to bring them into line with international norms. Controls are also being improved with the introduction of off-site supervision - a novelty for Iran.
'Our banks are financially sound,' insists a senior banker in Tehran. He defends the capital revaluation as 'necessary' because inflation had not been taken into account for decades, adding that 'profitability figures are more realistic' than they were in the 1980s.
Much of the hard work to bring reporting up to international standards was carried out during the first quarter of the Iranian year which started on 21 March. '[Now] anyone, anywhere can glance at our accounts and know exactly what the situation is,' says an official at Bank Markazi (central bank).
More importantly, official supervisors will be able to monitor the banks more closely. Some 30 personnel were selected by the IMF recently for advanced training in the US, but their programme was disrupted when they were denied visas to enter the US. However, the completion of a $100 million satellite computer system within the next 12 months, which will link the central bank and all the banks into a network, should simplify the task of supervision. It should also reduce the number of skilled personnel needed to police the sector.
Iran's banks are already having to adapt to a new system of supervision involving the off-site inspectors. The introduction of off-site supervision follows two years of preparation with the help of the IMF. The IMF has conducted four training sessions for Iranian bankers since 1995, each lasting two-three weeks. The sessions were videotaped by the Iranians and have been used for further training.
Such technical changes, significant though they are, pale in comparison to the far-reaching reforms reportedly being contemplated by a growing number of officials. These reforms would entail a modification of Islamic rules and possible privatisation. A senior banker in Tehran says that privatisation would require an amendment of the country's constitution, but the other changes could be effected through 'the ingenuity of our people'.
'What we need is the introduction of a sound monetary policy and instruments of this policy that would involve payment of profit to depositors that is at par with inflation,' he says. 'We also need to charge users of financial facilities at a price that is closer to the rate of return that they expect.'
In essence, what the banks want is to be able to set their own rates and charges, as well as to be allowed to choose their own mix of investments.
At the moment, rates are announced by the government at the end of the fiscal year, and there is usually such a big gap between bank returns and inflation that smart investors put their money into more speculative enterprises.
On the other side of the equation, Iran's banks are required to distribute their investments according to social and development criteria determined by the government. In 1995/96, for example, banks that were focusing on lending for trade and services were not allowed to allocate more than 12.5 per cent of their total investment to such activities. They were obliged to devote about 25 per cent of their investment to agriculture, regardless of its likely profitability. The quota for industry and mining was a promising 33.5 per cent in 1995/96, but the choice of industries is often dictated by the government.
Local bankers say change will come, but slowly. 'Things have improved over the past decade, but we still have a long way to go,' says one. Some bankers predict that merchant banking, non-existent at present, could be a reality in Iran within the next five-six years. However, its emergence will depend to a great extent on the evolution and sophistication of the Tehran Stock Exchange. A form of merchant banking was introduced in the 1990s, with the use of floating bonds by municipalities and other bodies to raise money to build shopping malls or similar large commercial ventures. The biggest of these projects was the Navvab scheme in west Tehran, which the banks underwrote for the municipality and then offered to the public as fixed-rate bonds, covered by a buy-back guarantee.
Privatisation is a more complex issue because of the constitutional requirement that all banks should be under state control. Bankers claim that the political leadership realise that those who framed the constitution in 1979 had unrealistic expectations, but that 'no one wants to be the first to
propose a constitutional amendment'.
They also say that the Rafsanjani government has in the past floated fresh ideas to gauge their acceptability before easing some of the restrictions that stifle innovation in the sector. Permission has been granted for private 'financial institutions', and permits have even been issued for several such banks. 'But nothing has happened on the ground, because these institutions would not be able to take deposits,' says one banker. The only way of ensuring change would be to amend the constitution. 'And, of course, allowance has to be made for foreign banks.'
Instead of competition from the private sector, the commercial state banks now face the possibility of a rival state network emerging through the Post Office. 'We may soon have to compete with what we call the 'Post Bank' which we think is unfair and which will degrade general banking standards,' says another banker.
Ultimately, it is the quality of management executed by officialdom that will determine the standard of banking in the future. A key element in this, say outside experts, is to decide which agency has ultimate responsibility for the banks. At the moment, this is diffused among Bank Markazi, the Finance & Economy Ministry and the General Accounting Office.
Some observers are very critical of the ministry's performance in recent years, which has obliged Markazi and the General Accounting Office to step in and take on more of the burdens. The accounting office became more interventionist after the recent bank scandals.
Improvements in the banking system may also involve a higher cost to the government in the short term. Capital adequacy levels are being raised and non-performing assets could weigh heavily on the government's budget.
From the sidelines, the IMF has offered support and wholesome praise for Iran's efforts, particularly in the past two years. IMF experts also think Iran has no time to lose. This year's Article IV mission has been delayed for four months, until October, to allow the new government that will take over from President Rafsanjani in Augustto appoint all its key economic and banking personnel. Bankers hope the new administration means business.
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