TBY talks to Dr. Mammoud Bahmani, Governor of the Central Bank of Iran.
TBY What measures have been taken by the Central Bank of Iran (CBI) to improve its supervision over the increased number of private banks active in the Iranian finance sector?
MAHMOUD BAHMANI Effective banking supervision is among the major prerequisites for a sound economic system, as well as the stability of the financial system, and the building of confidence in this system by reducing the risks faced by depositors and other creditors. The CBI, according to the Monetary and Banking Law of Iran, approved in 1351 (1972/73), fulfills a supervisory function role, thereby ensuring the sound operation of banks and credit institutions as well as the presence of sufficient capital and reserves to counter risks. Thus, the CBI has moved from “supervision compliance” to “risk-based supervision”. In this regard, the CBI adopted the following measures: restructuring the banking supervision section, formulating prudential regulations, and broadening and expanding the new literature on banking supervision. Therefore, the CBI practices off-site supervision based on the review of the banks’ financial position. As of 1389 (2010/11), the CBI has strengthened its supervisory mechanisms to prepare the ground for on-site supervision, including provincial supervision and inspection by local staff, and to pay more attention to off-site supervision through a careful consideration of prudential ratios.
Therefore, the Money and Credit Council (MCC) set the minimum required capital for the establishment of banks at IR4 trillion, for credit institutions at IR3,500 billion, and for electronic banks at IR2 trillion. Banks and credit institutions that violate capital adequacy ratio (CAR) limits will be downgraded and face restrictions.
At present, the priorities of the supervision section of the CBI for the current year are: preventing the operation of unorganized money market institutions not licensed by the CBI; putting a deposit insurance system into effect; and expanding banking operations in free trade zones.
One of the major banks’ assessments in Iran, as in other countries, is the CAR. The MCC approved a bylaw on capital adequacy in 1382 (2003/04). Based on Article 3 of this bylaw, the minimum CAR for banks and credit institutions was determined at 8% with the stipulation that the CBI could change this ratio for all or some of the banks as need arose.
Moreover, the development of a fair competitive environment, the prevention of banking and credit overexposure, improved financial transparency, and the higher use of IT in the banking system are underlined in Chapter 4 of the Supervisory Policy Package of the Banking System in 1389 (2010/11), approved by the MCC.
What results do you expect to see from the recent regulation lifting the restriction on foreign investment in Iranian banks?
Banks enjoy a high share in the Iranian financial market. Moreover, there are many investment projects in Iran as a developing country in which credits are largely financed through the banking system, creating lots of opportunities for banks to make profits. Certainly, lifting the restrictions on foreign investment in the Iranian banking industry may raise the amount of capital inflows to banks.
Iran is unique in the world with its fully sharia-compliant financial market. It is estimated that the potential of sharia-compliant assets reaches up to $4 trillion globally. What actions are being taken by the CBI to improve the potential of this market?
In light of the soaring oil prices in recent years and investors’ reluctance to put money into Western financial institutions, there is an increased willingness to deposit with Islamic banks in the region. This is mainly due to higher confidence in the system and the higher deposit rates offered by Islamic banks. Thus, with regard to the huge potential of the Islamic financial market comprising Islamic banking, Islamic insurance, Islamic bonds, and Islamic investment funds, the expansion of this market is expected in the future.
The Islamic Banking Sharia Council was established at the CBI in 1388 (2009/10), and it discusses various issues including guidelines for risk coverage arising from exchange rate fluctuations, sharia procedures for the issuance of bonds in foreign currencies, guidelines for the issuance of foreign exchange certificates of deposit, rules on entering into “debt purchase contracts” and “debt repurchase contracts”, designing new instruments for the development of the interbank market, and planning for the approval of sharia-compliant procedures for other types of sukuk. The Islamic Banking Sharia Council tries to resolve sharia concerns, and paves the way in designing new Islamic financial instruments.
The formulation, approval, and declaration of the Law for the Development of New Financial Instruments and Institutions was a major step forward in the expansion of the Iranian capital market. Therefore, the High Council of Securities and Exchange took the issue of financial instruments, i.e. sharia-based instruments, into consideration. The introduction of new financial instruments, namely sukuk, and participation papers issued by the government, municipalities, and investment funds that are transferable on the stock exchange help evolve the capital market and create new opportunities for expanding this market. At present, shares, rights, and corporations’ participation papers are being traded on the capital market. It is expected that the shares of funds will be traded on the stock exchange in the future. Then, it is the turn of debt instruments, in particular sukuk, which would provide a good opportunity for the expansion of the capital market.
Why did Iran need a new Anti-Money Laundering Law and how is the CBI now authorized to curb illegal money laundering activities?
The Anti-Money Laundering (AML) Law was approved by the Parliament in January 2008, and it includes 12 chapters. Upon ratification of this law, the pertinent executive bylaw, comprising 49 articles, was approved and declared in December 2009. According to this bylaw, the CBI, as the supervisory body for banks and credit institutions, shall ensure the proper implementation of the AML’s provisions and the pertinent bylaws for banks and credit institutions.
Thus, based on the road map prepared by the Anti-Money Laundering High Council (consisting of the Minister of Commerce, Minister of Intelligence, Minister of the Interior, and the CBI Governor), 11 instructions were prepared by the CBI. The Minister of Economic Affairs and Finance presides over the High Council. The CBI issues the AML-related instructions and circulars, and supervises their proper implementation.
The CBI recently adjusted the reserve ratios for the banks. Was this part of an attempt to ease the supply of credit to the private sector?
The CBI reduced the reserve requirement ratios of banks to raise the share of banks’ long-term deposits and strengthen the sustainability of bank deposits. The free reserves of banks, after lowering the reserve requirements, will be used in priority order for the payment of bank debt to the CBI, financing the working capital of productive units and incomplete projects, investment for productive units, interbank loans, and the Mehr Housing Project. On the other hand, the reduction in the reserve requirement ratios increases the money multiplier (considering other variables remain constant) in line with CBI policy on controlling and restricting monetary base growth as well as raising the money multiplier.
What is the current policy of the CBI regarding inflation? What monetary policy actions need to be taken to sustain the decreasing inflation rate trend?
The CBI aims at curbing broad money growth, with an emphasis on controlling monetary base growth. Banks’ indebtedness to the CBI as a component of monetary base growth, which surged in 1386 (2007/08), decreased through controlling measures adopted by the CBI such as setting the 34% penalty of overdraft facilities on central bank reserves, and banks’ obligation to extend loans commensurate with their accessible funds. Thus, the continued rise in banks’ indebtedness to the CBI was reduced in 1387 (2008/09), followed by a further decrease in banks’ outstanding debts to the CBI in 1388 (2009/10). This reduction in line with directing banking facilities to priority sectors helped prevent obstacles to financing the real sector.
Other CBI measures, besides controlling the monetary base, include curbing inflationary expectations as well as adopting effective and efficient supervision over banking operations to extend facilities for their true purposes and prevent the involvement of banks’ facilities in speculative activities, all of which play a key role in curbing inflation. Moreover, the CBI may utilize participation papers to reduce monetary base growth if necessary.
How would you assess the confidence of the public in the banking system? Does Iran need a deposit insurance system to encourage higher saving ratios in the banking system?
At present, the banks enjoy public trust due to their performance in previous years. Of particular note is that despite such events as the Revolution and the Imposed War, Iranians have never faced any difficulties in withdrawing their deposits from the banking system.
It is worth mentioning that the deposit insurance system is underlined in the Law for Usury (Interest) Free Banking as well as Chapter 2 of the pertinent bylaw of the mentioned law. According to Article 4 of the Law for Usury (Interest) Free Banking, banks are obliged to pay the principal of Gharz-al-hasaneh (savings and current) deposits and may undertake and/or insure the principal of term investment deposits.
Banking deposits must be insured by an independent entity such as the Deposit Guarantee Fund. The deposit insurance system shall be implemented in cooperation with the money market supervisory body and all agent banks. Therefore, one chapter of the new Banking Law is devoted to the establishment, administration, financing and operation of the Deposit Guarantee Fund.
What steps are being taken on the fiscal side to reduce government debt to more comfortable levels?
In order to improve the government fiscal position during the Fourth Five-Year Development Plan (FYDP) period, tax revenues and non-oil resources increased while expenditures decreased.
Table 1 shows that the highest change in tax revenues (excluding tax on oil performance) was related to 1388 (2009/10) and the lowest to 1384 (2005/06). Moreover, the biggest change in non-oil resources occurred in 1386 (2007/08) and 1388 (2009/10). On the other hand, during the Fourth FYDP, growth in government expenses remained relatively unchanged. Government expenses for the years 1386 (2007/08) and 1388 (2009/10) increased by merely 4.2% and 15.5%, respectively.
Moreover, according to Article 2 of the Fourth FYDP Law, and to establish fiscal and budgetary discipline during the course of the FYDP, the following measures were taken:
1 The government was obliged to increase the share of expenses financed through government non-oil revenues in a way that by the end of the plan government expenses could be financed entirely through tax and other non-oil revenues.
As shown in Table 2, during the Fourth FYDP years, the share of expenses in non-oil resources constantly increased, except for the year 1387 (2008/09), with the highest share related to 1388 (2009/10) (the last year of the FYDP) by 76.3% and the lowest to 1384 (2005/06) (the first year of the FYDP) by 51.7%.
2 Based on Paragraph (b), Article 2, Fourth FYDP Law, financing the budget deficit through borrowing from the Central Bank and the banking system is prohibited. During the implementation years of the Fourth FYDP Law, there was no borrowing from the Central Bank or the banking system (for financing budget deficit). Moreover, during the course of the Fourth FYDP, measures were taken to privatize state-owned companies. Table 3 summarizes the performance of the Iranian Privatization Organization (IPO) during 1384-88 (2005/06-2009/10).
The receipts of the Treasury General of the Ministry of Economic Affairs and Finance from privatizing state-owned companies were respectively IR1,786.6 billion, IR818,6 billion, IR32,956.9 billion, IR10,959.3 billion, and IR62,936.2 billion during 1384-88 (2005/06-2009/10), with the highest amount related to 1388 (2009/10).
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