Friday
Feb192010
Iran: Are The Banks Failing?
Friday, February 19, 2010 at 0:01 
Jahangir Amuzegar, who was Finance Minister in Iran's pre-1979 government, sifts through the rumours and realities of Iran's banking sector. Originally published in Foreign Policy:Rumors have recently spread among Iran's jittery populace regarding the state of their country's banking system. Although these rumors happen to be nothing but a false alarm, the financial sector really is, and has been, in crisis for a number of different reasons.
The current spate of rumors began on Jan. 28, when Iran's commercial banks were ordered by the central bank to limit each depositor's daily cash withdrawal to 150 million rials (about $15,000). The order was explained by authorities as a means of implementing the anti-money-laundering legislation just passed by the Majlis, Iran's parliament, and combating what the finance minister called "financial terrorism."
This announcement coincided with an unrelated statement by President Mahmoud Ahmadinejad two days earlier regarding the elimination of "three zeros" from the currency, due to its drop in value, and the government's intention to restore the Iranian currency to its "real value." These dual developments aroused widespread suspicions among the traditionally cynical rank and file, who were already rightly skeptical of the often exaggerated and frequently contradictory economic statistics coming out of Tehran over the past five years. Sporadic news reports about the banking system's undercapitalization and the rising number of its nonperforming loans added to mounting anxieties.
Within a few hours, Facebook and Twitter messages spread and amplified rumors about a run on banks, customers rushing to withdraw their savings, and street clashes among depositors. Two of the largest state-owned commercial banks -- Mellat and Melli -- were said to be on the verge of declaring bankruptcy. Neither the vigorous denials by the two banks, nor the government's solemn assurances regarding the banking system's solid financial position, managed to quash the false alarms, and there were reports of ugly encounters in some provincial bank branches.
Curiously enough, the obvious absurdity of the bankruptcy rumors was missed even in some quarters that should have known better. Commercial banks facing liquidity problems in any modern state can always resort to the central bank's "open window" to borrow needed funds. And the central bank, with a printing press at its disposal, can never run out of money to lend. The bankruptcy of a state central bank, and by implication the failure of state banks, is a theoretical as well as existential impossibility. Depositors in state banks never lose their savings overnight through bank failures, but only through a hidden tax called inflation. Although the Islamic Republic has never established formal deposit insurance, as in the United States, all state bank deposits are de facto guaranteed by the full faith and credit of the central government.
The real problems faced by the Iranian state banking system are rooted in a host of other shortcomings. The banking sector is the most laggard area of the Iranian economy. Iran's state-owned banks suffer from high overhead costs -- too many branches, too many employees, and poor management -- with operating costs estimated at four times the world average. Furthermore, the Majlis and government-dictated loans to state entities and public projects at below-inflation rates make them highly unprofitable.
Finally, Iran's state banks suffer badly from enormous nonperforming assets. These unrepaid loans -- estimated at $48 billion, or 2½ times the banks' own capital -- have increased sevenfold in the last five years. To put that figure in perspective, Iranian banks accumulated less than $4 billion in nonperforming assets during the previous hundred years of Iranian banking history! These loans constitute nearly 20 percent of total bank assets -- compared with a world average of 3 to 5 percent. Around half of the arrears are owed by state-owned corporations. Seventy percent of the total is owed by only 1,000 entities (including some "shell," or nonexisting, paper corporations). Some $23 billion is owned by four state banks -- Melli, Mellat, Saderat, and Tejarat -- with Melli carrying the largest burden.
Borrowed funds are not paid back on time for several reasons. Ahmadinejad's administration limited the banks' annual lending interest rate to 12 percent -- in an economy that is experiencing much higher inflation rates, reaching 29.5 percent in September 2009 -- a heaven-sent incentive for borrowers to renege on their obligations and postpone repayment for as long as possible. The difference between the state banks' borrowing rate on the one hand, and informal bazaar rates on the other, create what economists call an intrinsic "rent" element. That is, the unsupervised funds, borrowed from an Iranian state bank at 12 percent, may be re-lent in the bazaar at rates up to 30 to 45 percent -- or even placed in other banks as long-term savings deposits, accruing 18 percent interest. As a result, borrowers rationally decide to forego the "late payment" penalty of six percent and postpone repayment as long as they can.
The Islamic Republic's endemic cronyism and flawed policies represent a constant impediment to the profitability of Iran's financial sector. Influential and well-connected borrowers -- state entities connected with the Islamic Revolutionary Guard Corps, siblings and grandees of clerical leadership, and clever apparatchiks -- easily manage to borrow large amounts without sufficient guarantees for repayment. One single borrower is reported to have obtained $100 million! These politically connected debtors often refuse to pay back their loans, and suffer no penalties. Under one government project, hundreds of small businesses promising to create jobs have managed to receive funds without proper scrutiny of their projects and are now unable to service their debts due to causes that range from the recession to their own incompetence. The sanctions imposed by the United Nations and the United States, and the poor performance of the Iranian economy -- GDP growth was just 1 percent last year, even with rising oil prices -- has dealt another blow to Iran's banking sector. An estimated 6,700 businesses were unable to service their financial obligations last year and received a one-year grace period by their banks.
The real problems facing Iran's state banks -- poor management, undue political interference, and the incongruity of mixing seventh-century Islamic finance principles (the foundation of the Iranian banking system) with the exigencies of the highly complicated world of modern international finance -- should inspire Iranians to keep a wary eye on their economy's bottom line.
Reader Comments (7)
"And the central bank, with a printing press at its disposal, can never run out of money to lend. The bankruptcy of a state central bank, and by implication the failure of state banks, is a theoretical as well as existential impossibility."
Take a look at the Zimbabwe Reserve Bank. There is a limit to mhow much money a central bank can print.
Although Zimbabwe is a smaller country than Iran, it has features in common: dependence on natural resources for export, and a large diaspora (departure of the competent).
"...Furthermore, the Majlis and government-dictated loans to state entities and public projects at below-inflation rates make them highly unprofitable."
In the US there was the whole Fannie Mae/Freddie Mac fiasco. The government(Rep. Barnie Frank, Sen.Christopher Dodd) forced the banks to issue sub-prime mortgages to people who could not pay them back. The wild lending inflated the price of housing. The inflated value of houses were used as collateral.
The banks bundled the bad mortgages with good mortgages and sold them as packages that were given high ratings by wall street rating organizations. Wall Street created complicated derivative instruments that were also sold in packages. These bonds were sold world wide. The effect of this was that a lot more money was being lent then could be justified by the low level of assets backing it.
The faith in the US dollar as a world currency seemed on the verge of collapse until Greece started a crisis for the Euro.
The Obama administration is trying very hard to bring on a second Great Depression by raising taxes and demonizing business.
Our government issues false economic data like Iran.
The stimulus projects are corrupt. Seems similar to what's being described for Iran. Fortunately, in the US, democracy may allow for corrections. And for now, the world still invests in the US[buys bonds(lends us money){which we re-lend to poor countries(even though we have no money)}]... almost seems as if the US is being paid to be world managers based on ideas & engineers with less and less tangible materials -- all professors,scientists and managers and no workers. A writer gets paid although he produces no material product, but he can write a letter asking for a car, or write a mortgage derivative document, or write a loan agreement for a business that will eventually make stuff for him... so I suppose we could have a nation of "writers" who just order stuff with rules written by politicians the king "writers", and of course sports figures as Gladiators. Quite a Roman Circus.
(If the truth be known) So here we are: a coming world Great Depression and World War 3.
We're making great progress: the games are becoming more elaborate and more deceitful. It is a subtlety that will kill us all. And of course, everyone on all sides is morally justified as they see it.
Boom times are here again...
Just wondering what kind of "boom"
Everything is fine. The UK, Zionists, and the Great Satan are trying to provoke a run on the banks. Seventh-century Islamic finance principles provide a moral grounding to tame the cowboy-Capitalism of the Western world. The EU and its Euro currency are like the Camel's Nose under the tent. Our President, Mahmoud Ahmadinejad, states it well http://enduringamerica.com/2010/02/18/latest-on-iran-18-february-watching-on-many-fronts/comment-page-1/#comment-28230" rel="nofollow">LINK
Salamalakum to all... Doug first of all go read more. I used to say the same to liberals until I realized both sides actually don't read. are you one of them who believes the net neutrality law was a take over of the internet by the Obama admin? or that we are all going to lose our gun rights? that Obama was not born in a citizen? or that Obama has more czars than bush did? do you totally forget the oil crisis we had? and the greed of the (credit) companies and banks ARM's ect. I agree with your derivatives statement, wall street became a casino on other casinos backed up by other casinos betting for and against other casinos. as far as economy goes go listen to Mish Shedlock if you don't already have him in your favorites. The banks could have helped save themselves from greed by allowing modifications to the people who were suddenly losing jobs which started from high oil prices. All that said Khamenei knows when he's ready to go into exile if he becomes any more brutal. If america is the great satan then who is the great Mousavi? oh and back to american jobs lets not forget NAFTA, CHINA, and loose regulation allowing american companies to go over seas. In our small town alone we lost 6 canneries or factories between 97-05 last one left from high oil cost. So instead of you calling everyone hitler and stallin lets come up with some ideas not conspiracies.
chauvin,
An abuse by the Wall Street "Casino's" does require regulatory reform but doesn't justify radical change to a Socialist government. The Keynesian economics approach doesn't appear to be working. Why not reduce taxes?
RE: "...net neutrality law was a take over of the internet by the Obama admin? or that we are all going to lose our gun rights? that Obama was not born in a citizen? or that Obama has more czars than bush"
Do I believe. Ans: No, no, no, and no.
However, his Czars have radical roots... admire Mao etc. and have socialist agendas.
You are right about the Adjustable Rate Mortgages. That was an immoral trap, and a terrible abuse
NAFTA, CHINA: I agree with you that those countries abuse their workers and unfairly compete with us...
What's wrong with : Cut taxes, drill for oil off our coasts. Find alternate sources for rare earth elements so we don't have to depend on China to abuse their people to dig and produce it cheaply for our computers.
And could I assume you agree that despite everything, our banks are much more dependable and trustworthy and in no danger of collapsing unlike Iran's whose condition no one can really knows?
Don Cox,
It could be like Zimbabwe. It's hard to tell.
As you say:
"...dependence on natural resources for export, and a large diaspora (departure of the competent)..."
That's a good point. The IRGC has taken over a lot of companies but they are incompetent. A nasty inflation has begun....
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