Banking system reform is under way: true reform or cosmetic changes?
- This weekend the Iranian media reported on the launch of the “banking reform program”. Initiated by the government several years ago, the program is intended to advance a series of reforms in Iran’s banking system, which include increasing the Central Bank’s oversight of commercial banks, reinforcing the principles of Islamic banking, improving public access to banking services, and expanding e-banking services. The current stage of the banking reform is intended to fight the problem of bounced checks, which has become much more widespread in recent years.
- The launch of the first stage of the reform may reignite the debate on how effective it will be. In May 2012, a periodical issued on behalf of the Central Bank published an article on the proposed reform and its limitations. Hamid Zamanzadeh, a top expert at the Central Bank’s Monetary and Banking Research Institute, said in the article that the reform will not solve the fundamental problems of the banking system as long as it does not address its problematic interrelationship with the government. Zamanzadeh noted that, while top economic officials put the emphasis mostly on the internal structural problems plaguing the banking system, most of its weaknesses are the result of excessive government intervention in the functioning of the Central Bank, which undermines its independence and powers. Accordingly, the reform needs to focus on reducing government involvement while the changes pertaining to the internal conduct of the banking system, such as increased privatization, changes in legislation, and enhancement of e-banking, should be second on the priority list.
This weekend the Iranian media reported on the launch of the “banking reform program”. Initiated by the government several years ago, the program is intended to advance a series of reforms in Iran’s banking system, which include increasing the Central Bank’s oversight of commercial banks, reinforcing the principles of Islamic banking (“no interest economy”), improving public access to banking services, and expanding e-banking services.
The need for increased Central Bank oversight of commercial banks was made particularly clear by the exposure of the massive embezzlement scandal in Iran’s banking system last year. The embezzlement, considered the largest in the history of Iranian banking, involved the theft of around 3 billion dollars that were used to purchase government assets. It was masterminded by businessman Amir Mansoor-Arya Khosravi, who used his connections with top Saderat Bank officials to fraudulently take over government bonds and later sell them to private banks.
ISNA News Agency reported this weekend that the current phase of the banking reform is intended to combat the problem of bounced checks, which has become much more widespread in recent years. As part of the current phase of the reform, the Central Bank has imposed a series of restrictions on commercial banks in order to reduce the extent of the problem. Among other things, banks are now prohibited from providing various banking services—such as opening checking accounts, issuing checkbooks, and providing e-banking services—to customers with a history of bounced checks. In addition, banks will be able to recover the debt of customers who bounce checks from other accounts they hold, while bank systems will be required to provide information on the banking and economic history of the customers (ISNA, November 29).
The new instructions that have come into force as part of the first phase of the banking reform are intended to curtail the ongoing increase in the number of bounced checks in Iran, which accounted for over 12 percent of all the checks that were traded last year. The daily Donya-ye Eqtesad (“World of Economy”) reported in April 2012 that, in the first 11 months of the year 1390 (March 21, 2011 – February 19, 2012), 6 million checks bounced out of the total 46 million checks traded in the banks. The figure represents an increase of nearly 25 percent in the number of bounced checks compared to the previous year (Donya-ye Eqtesad, April 21).
In light of the growing severity of the problem, a top official at the Central Bank announced this past June that the Central Bank imposed restrictions on the provision of banking services to those writing bounced checks. Amir-Hossein Amin Azad, a Central Bank official in charge of bank instructions and the fight against money laundering, said at a press conference that the Central Bank looked into ways to impede the spread of the phenomenon and decided that account owners who bounce a check will be denied access to banking services for seven years. They will also be denied access to loans and foreign currency, prohibited from opening new bank accounts, and prevented from receiving bank credit and bank guarantees. Commercial banks were also instructed to take various measures intended to make sure that the bank accounts of customers who pay by checks have sufficient funds to cover the checks that they write. The new instructions also prevent customers from holding more than a single bank account with any one bank, and require banks to confirm with the Interior Ministry the address given by a person opening a new bank account, to make sure that the address is real.
Mohammad Alipour, member of the Majles Economic Committee, discussed the restrictions imposed under the banking reform in an interview given to the daily Tehran Emrooz. Alipour had praise for the measures which the Central Bank decided to take, saying that, even though the growing incidence of bounced checks is mostly the result of macro-economic problems and government performance, there needs to be more oversight of issuing checkbooks and restrictions on customers who bounce checks. Alipour added that the banking system is in need of a reform, expressing his hope that the coming reforms will be for the benefit of all Iranians (Tehran Emrooz, December 1).
The launch of the first stage of the reform may reignite the debate on how effective it will be. In May 2012, the economic periodical Tazehaye Eghtesad (“Recent Trends in Economy”), issued on behalf of the Central Bank, published an article on the proposed reform and its limitations. Hamid Zamanzadeh, a top expert at the Central Bank’s Monetary and Banking Research Institute (MBRI), said in the article that the reform will not solve the fundamental problems of the banking system as long as it does not address its problematic interrelationship with the government and the excessive government intervention in the functioning of the Central Bank.
In his article, Zamanzadeh reviews the background for the banking system reform, which is part of an overall economic reform program approved during the previous Ahmadinejad government. In 2007, a team set up by the Central Bank suggested a series of measures intended to improve the functioning of the banking system. The team addressed various issues, including oversight of the activity of commercial banks, loan policy, and e-banking. The implementation of the banking reform was delayed due to the launch of the subsidy policy reform. In 2010 the government announced its plans to implement the banking reform after the completion of the first phase of the subsidy reform. The Majles Economic Committee held several meetings to discuss the issue with the minister of economy, the governor of the Central Bank, and other Central Bank officials in attendance. The team decided to separate long-term reforms, which require making changes in Iran’s constitution, from short and medium-term changes pertaining to loan policy and the activity of commercial banks.
According to the author of the article, Iran’s banking system is plagued by several weaknesses that can be clearly seen in the inflation crisis and the economic instability, the lack of proper management of the banking system’s financial sources, and the crisis of deferred loans that have not been paid back to the banks. These weaknesses are the result of two main factors: the interrelationship between the government and the banking system and the internal structure of the banking system.
The interrelationship between the government and the banking system is characterized by the government’s excessive intervention in the monetary functions of the Central Bank, which severely undermines its independence and powers. The government makes widespread use of the Central Bank to guarantee its financial needs while blatantly intervening in its monetary conduct. It does not provide the Central Bank with sufficient powers to direct the financial system and makes it strongly dependent on the government to guarantee its financial sources. When oil prices were low, the government borrowed significant sums of money from the Central Bank. When oil revenues were high, the government sold foreign currency and had the Central Bank convert it to rials. This kind of behavior by the government has not allowed the Central Bank to conduct itself independently and fulfill its missions in maintaining the stability of Iran’s economy.
Zamanzadeh pointed out two main areas of excessive government intervention in the functioning of the Central Bank: setting the interest rate and the loan policy. The interest rate has a considerable influence on many areas of day-to-day economic conduct, and the government’s regulation of the interest rate has made the Central Bank substantially weaker, particularly given the fact that the interest rate is not real and does not match the inflation rate. The loan policy, too, has been dictated to a great extent by the government, which has in fact turned the banks into a money distribution network with no regard for economic sense. This has led to the deferred loan crisis—these loans have not been paid back to the banks and severely hit their revenues.
In addition to weaknesses resulting from government intervention in the functioning of the banking system, it is also plagued by internal structural problems. Most of these problems stem from the fact that the banking system is still largely under government control, despite the increase in the number of banks and the privatization of some government banks. Other internal problems in the banking system have to do with the problematic implementation of banking laws, lack of transparency in banks, and insufficient progress with e-banking. Zamanzadeh does stress, however, that while top economic officials focus mostly on the internal structural problems of the banking system, most of its weaknesses are the result of its interrelationship with the government. As long as the government does not change the way it deals with banks, reforms in the internal structure of the banking system will lead to no improvement in its functioning. The reform needs to focus on removing pressure and reducing government involvement, while the changes pertaining to the internal conduct of the banking system, such as increased privatization, changes in legislation, and enhancement of e-banking, should be second on the priority list (http://www.ensani.ir/storage/Files/20120504171053-9021-40.pdf).