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First step into a private world

October 1, 2001

Article from: The Banker
Article date: October 1, 2001
Author: Dinmore, Guy

Iran has given authorisation to its first private bank since the 1979 revolution. Guy Dinmore, in Tehran, examines the background and likely progress of banking privatisation in the Islamic state

FINGERING HIS PRAYER BEADS, dressed in a well-worn suit without tie and speaking of Islamic principles, Farid Ziaolmolki comes across as a religious man. He is the chairman of Iran’s first private bank since the 1979 Islamic revolution. Under the reforms pursued by President Mohammad Khatami’s administration, which is starting its second four-year term after his landslide re-election victory in June, Iran’s banking sector is undergoing a small revolution of its own.On August 25, Bank Eqtesad-e-Novin won the race of more than 30 applicants to become the first privately owned bank to receive an operating licence from Bank Markazi, the central bank. Several more authorisations are in the pipeline. And Sharif Razavi, chairman and managing director of Bank Saderat, Iran’s second largest commercial bank, told THE BANKER he had formally asked the the country’s new finance minister, Tahmasb Mazaheri, for the go-ahead to return the bank to the private sector after more than 22 years of state ownership.

Privatisation movement

The concept of private banks had been years in the making, even before Mr Khatami swept to office in 1997. However, much political manoeuvering was needed, including the sensitive reinterpretation of article 44 of the Islamic Republic’s constitution, which asserts state control over key sectors of the economy, including banking.

All of Iran’s banks, some of them partly foreign owned, were nationalised after the revolution. Bringing back private banks, albeit on a small scale, is part of a wider package of reforms that is backed by the US-educated central bank governor, Mohsen Nourbakhsh. The reforms will lead to the restructure of the 10 state-owned banks, some of them behemoths of an earlier age.

Analysts say there is a legal argument for privatising Saderat on the grounds that the establishment of private banks has already been approved. But, given Saderat’s size with reported assets of lR61,500 ($7.7bn), it would take a major political decision to allow it to rejoin the private sector.

Iran is endeavouring to adhere to the core principles set out by the Basle committee and set the minimum capital requirement at IR200bn.

Bank Eqtesad-e-Novin’s operations should begin within two months. It aims to set up home and internet banking, using foreign or domestic software, within one year.

Share issue raises cash

The bank raised IR125bn through a share issue to the public that was quickly sold out. An equal amount was raised by Behshahr Industrial Development Corp and Iran construction Industry Investment company, both quoted on the Tehran Stock Exchange and holding 30% and 20% of the new bank’s share capital respectively.

“The government has no share in this bank,” says Mr Ziaolmolki. He dismisses suggestions that the state could try to exercise some control over the bank through indirect minority stakes held in the two founding companies by investment funds operated by state-owned banks.

One of those banks is Bank Melli, for which Mr Ziaolmolki worked for more than 30 years, becoming a board member and general director of investment affairs and loans before retiring at the age of 55.

Bank Eqtesad-e-Novin has already applied to list its shares on the Tehran Stock Exchange — one of the world’s best performing but least transparent markets last year — and eventually to find a foreign partner, a change in Iranian laws permitting. “There is a good climate for private banks,” says Mr Ziaolmolki. “People are not very satisfied with the services offered by state-owned banks. We want to carry out non-usury Islamic banking in the true sense of the word.”

Islamic prohibition of usury

In theory, Iran’s banks follow Islamic principles that prohibit usury, setting “profit rates” rather than interest rates on deposits and “expected rate of profit on facilities” on loans. In practice, the central bank had kept the same interest rates for several years before lowering them by 1% in May. A one-year term deposit now gains 13%, just above the official inflation rate, offering a real rate of return for investors for the first time since the revolution. One of the achievements of the pro-reform administration is to have brought inflation down to manageable levels.

But Mr Ziaolmolki believes Bank Eqtesad-e-Novin can offer more favourable rates to lenders and borrowers, especially because, unlike state-run banks, it can set its own rates. Banks in the state sector are also hamstrung by rigid government directives on labour, aimed at employing as many people for as long as possible.

“The state-owned banks are compelled to grant huge loans to government projects, which are not necessarily a good source of income, so the banks cannot pay a profit rate above inflation. Whereas private banks will not have loan decisions forced on them and our hands are free to select our clients. By earning more profits we will be able to offer higher profit rates.”

Mr Ziaolmolki is realistic about the prospects for his bank, given its small size. “We are not a threat to state-owned banks but we will make them more competitive and, eventually, they will change into private banks. State-owned banks have more than 15,000 branches, a huge investment. We cannot catch up with them for a long time,” he says.

Part of reform package

One of the officials overseeing the changes is deputy governor Mohammad Mojarrad. “Private banks are part of the reform of the financial system along with the restructuring of the financial position of state banks, so that we can see more efficiency and competition,” he says.

In future, state banks will have more discrepancy over the loans they give and more authority over employment policies. “The whole idea is to let state banks restructure and compete with the new private banks,” says Mr Mojarrad.

What condition the state-owned banks are in is a matter of controversy. Although it is well accepted that many state-owned enterprises – which control some 80% of the economy – are bankrupt, the concept of non-performing loans does not appear to exist in Iran. The lack of transparency has also led to corruption scandals in the banks, which have not yet been resolved by the courts.

Mr Mojarrad says loans from state-owned enterprises are guaranteed by the government. “These loans might be revolving but they are not considered as non-performing loans. We are not concerned about government debts to the banking system. What is important is the government share of bank credits, which is 35%. This is the maximum.”

According to central bank data for fiscal 2000/2001, ending March 21, total outstanding credits to the public sector amounted to IR122,400bn. Helped by surplus oil revenues and the healthiest foreign reserves since the revolution, the government has allocated IR5bn to increase the capital of five commercial and two specialist banks this year, and has resolved to pay back IR2300bn of its debt to the state banking sector.

Western bankers believe these steps are inadequate and more drastic measures are needed to recapitalise and consolidate the state banks. A private business consultancy, Atieh Bahar, has compiled a comprehensive report on the banking sector, which concludes: “Iran’s government banks will keep their dominant position in Iran’s financial markets with a market share of more than 90%. In their present more or less bankrupt state, it is not expected that any private investor will be interested in participating in the privatisation of these banks.”

Foreign operators

Nonetheless, the central bank’s eventual aim is to allow foreign banks to operate in Iran, probably first as minority shareholders in the private banks to be. For the moment, they have the latitude to open branches in the country’s small free trade zones, the two Persian Gulf islands of Kish and Qeshm and the mainland port of Chabahar. No foreign bank has yet taken up the offer, although several, including HSBC, are carrying out feasibility studies.

“We expect that, once competition is established on the mainland, we could consider the entry of foreign banks. This is the process of reform,” says Mr Mojarrad.

About 30 foreign banks have representative offices in Tehran. One western banker, who asked not to be identified, is sceptical about the new reforms but concedes that they are moving in the right direction. “Private banks are not a significant initiative,” he says, noting their tiny capitalisation. “Banking is not a profitable business in Iran. Banking today is all about technology but it is expensive. How will they do it?”

With more than 3 million people unemployed and more than 1 million newcomers entering the job market each year, the government’s focus is on employment and pumping money into state enterprises. The purpose of a state bank in the soviet-style banking system, says the western banker, is not to be an efficient financial institution. “Foreign banks will not be allowed in for five to 10 years. They might allow a foreign bank to have a minority share holding in a private bank but would any foreign bank want to make this commitment to Iran? I doubt it.”

Eurobond issue

The international banking community’s view of the risk element in Iran could become clearer later this year if the government goes ahead with its planned launch of a five-year, [euro]300m eurobond, its first foray into the international capital market since the revolution. The central bank has commissioned Standard & Poor’s to carry out a sovereign credit rating of Iran ahead of the issue, and 10 foreign banks submitted their proposals last month in a bid to be named as lead manager. Commerzbank and Paribas are considered as front-runners.

“Iran’s view of itself and the world’s view of Iran are quite different,” says the western banker. “Their view of their own risk is that people should be more interested than they are. This will become clearer with the eurobond issue that will act as a benchmark.”

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