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Swimming against the tide

August 1, 2002

Swimming against the tide: Iran’s central bank governor is facing his toughest challenge yet–taking banking into the private arena.

Article from: The Banker
Article date: August 1, 2002
Author: Dinmore, Guy ; Ostrovsky, Arkady

It has been an eventful year for Mohsen Nourbakhsh, governor of Iran’s central bank. Overcoming internal opposition as well as Washington’s hostility the US-educated banker last month steered the Islamic republic into international capital markets for the first time since the 1979 revolution, with its debut Eurobond.

The successful [euro]500m issue followed a more important development for Iran’s domestic economy however. With the start of the Persian New Year on March 21, Iran scrapped the two-tier exchange rate for the rial and established what Bank Markazi (the central bank) describes as a “managed float” system, with the national currency effectively pegged to the US dollar.Politically controversial, exchange unification was a longstanding goal of Mr Nourbakhsh and is widely seen as the most important single economic reform since the revolution.

But with another economic milestone — privatising and restructuring the behemoth of the state banking system — Mr Nourbakhsh appears to have run into a wall of opposition.

“Privatisation of state banks is off the agenda for now,” the governor admitted to The Banker in London during the Eurobond roadshow. “Now there are no plans to privatise banks. But we do want to promote private banks.”

Just last month, Bank Saderat, founded in 1952 and nationalised after the Islamic revolution, repeated its intention to return to the private sector. A similar application was made more than a year ago and given the green light by the central bank, only to be blocked by higher authorities. Sharif Razavi, its chairman and managing director, resigned shortly afterwards.

His comments appear to be an acceptance of defeat. Just two years ago, the central bank’s quarterly reports spoke of offering 49% of the shares of the commercial and specialised banks to the public “to enhance competition and deepen the banks’ ownership base”. The latest report, summarising policies of the current five-year plan (ending March 2005), makes no such mention.

A banking official says privately that Saderat’s latest bid to float shares on the Tehran Stock Exchange was likely to meet a similar fate.

Saderat dominates

Saderat has the largest network in Iran of the 10 main state banks, with some 3300 branches and the most private depositors. In its last reported fiscal year, to March 2001, Saderat returned a 41% rise in pre-tax profit of IR622bn ($77m).

Like the other state banks, Saderat has enjoyed the benefits of recapitalisation by the state and a reassessment of its property assets that has seen its world ranking leap dramatically between 2000 and 2001.

Iran’s Bank of Industry and Mines rose 496 places to be ranked 304 by capitalisation, the largest rise of any bank. One banking expert said, however, that its sudden growth may also have been due in part to its takeover of several other state enterprises. (The bank declines to comment.)

Recapitalisation costs

Mr Nourbakhsh said the central bank had already spent the equivalent of $1bn to recapitalise state banks and planned to inject another $1bn to help banks meet capital adequacy ratios set by the Bank for International Settlements. Economists say much of the money was raised through issues of domestic bonds, while some was probably drawn from the oil stabilisation fund set up two years ago to manage surplus revenues from sales of crude oil.

Saderat was also involved in recent mergers and restructuring of overseas branches in London of several Iranian state banks. Western bankers in Tehran claim the mergers were forced on Bank Markazi by the UK Financial Services Authority which was concerned about inadequate supervision. The new banks were also recapitalised.

Saderat International was formed when Saderat bought out the three shareholders (banks Mellat, Melli and Industry and Mines) of the Iran Overseas Investment Bank. Bank Tejarat and Bank Mellat merged their London branches to form Persia Bank.

In a strange twist of the privatisation saga, the central bank last month agreed that state banks could privatise their branches. Bankers, however, are rather baffled by the concept, describing it as a “piecemeal reform”.

Speaking in London, Mr Nourbakhsh stressed the importance of Iran’s newly created private banks, which he hoped would eventually match the state banks in size. Economists and western bankers in Tehran say such ideas are unrealistic.

Three very small private banks have started operations this year — Bank Karafarin, Bank Parsian and Bank Eqtesad-e-Novin — while a fourth has acquired a licence but has yet to open a branch. In the murky world of who owns what in Iran, some bankers believe only Karafarin can be called truly private.

“Compare their handful of branches with the 20,000 branches of state-owned banks,” says the Tehran representative of a major western bank. “They are just too small to be an agent of change.”

Akbar Karbassian, a lecturer at the Iran Banking Institute, agrees. He is blunt in his criticism of the efforts by Mohammad Khatami, Iran’s moderate president, to reform the state sector, which accounts for some 80% of the oil-dominated economy.

“Government-owned banks are operating extremely inefficiently, with widespread corruption under weak supervision,” he says. “Reforms in state banks can only mean one thing and that is privatisation.”

Bank Markazi’s role

Mr Karbassian also advocates more independence for Bank Markazi, saying: “At the moment the central bank of Iran is just another state-owned bank that provides loans to cover the state budget, which generates inflation.

This main role of the state banking sector — to channel loans to floundering state-owned enterprises — lies at the root of the problem. Latest official figures show a sharp rise in banking system claims on the public and private sectors, totalling more than IR 355,000bn. Meanwhile, public sector deposits with the banking system have halved.

Mr Khatami’s administration is generally tagged “reformist” on political issues. But when it comes to the economy, his loose coalition is essentially socialist in nature and fearful of the impact of privatisation, especially at a time of mounting unemployment and a decline in the administration’s popularity.

The more conservative establishment, dominated by the ayatollahs, also has powerful business interests that would be threatened by a dismantling of the state banking sector. The same clerics are deeply suspicious of Mr Nourbakhsh, whom they see as responsible for running up unsustainable foreign debts and devaluing the rial when he was finance minister in the 1990s.

According to local press reports, several state banks are involved in high-profile court cases as a result of an anti-corruption campaign launched by the conservative supreme leader, Ayatollah Ali Khamenei, last year. It is well known that some hardline clerics would also like to bring Mr Nourbakhsh to court, and the central bank has become adept at dismissing rumours of the governor’s impending appearance.

But for the sake of stability, at a crucial juncture in the slow process of economic reform, Mr Nourbakhsh’s presence is sorely needed.

Unification of the exchange rates for the rial in March (at close to the black market rate of about IR8000 to the dollar) was a controversial measure that had failed when attempted 10 years earlier. This time the central bank is convinced it has the adequate reserves to keep the rial stable after three years of robust current account surpluses.

But to make up for the abolition of the official exchange rate of IRI 750, the government increased the state budget by a massive 54% to IR693,000bn ($87bn). Some $4bn of this will be drawn from the oil stabilisation fund, a blow to Mr Nourbakhsh, who had advocated greater fiscal prudency.

Inflation worries

With M2 liquidity rising by an annual 30% or so, the central bank is clearly worried about inflation and plans to issue its own domestic bonds as a sterilisation measure. There has been much confusion over interest rates in recent weeks, but so far Mr Nourbakhsh has resisted pressure from Tahmasb Mazaheri, the finance minister, to reduce yields on bank deposits, which give a one-year return of 13%.

Mr Karbassian, the banking lecturer, says the five-year economic plan contains a blueprint for economic development but adds: “Unfortunately, most of its targets will not be achieved due to distractions, deviations or delays by the authorities.”

Of Mr Nourbakhsh, he says: “He is probably the best person for this job under the present circumstances. In a city of the blind, a one-eyed man is king.”

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