Sanctions relief to ease pressure on banks

Iran’s banking sector will benefit from the relaxation in sanctions, but will remain in a state of near-crisis over the coming quarters, a report has forecast.

Lending growth will pick up in line with an improving economy, but a weaker rial and elevated inflation will weigh on deposit growth, Business Monitor International said in its fourth quarter on Iran’s commercial banking report.

“Our expectation for an easing of sanctions on Iran’s banks will bolster the outlook for the sector. However, huge risks will remain over the coming quarters,” the report said. “The unwinding of sanctions will take some time and be contingent on Iran meeting the West’s demands, but by the beginning of 2016 we expect numerous banking sanctions to have been suspended.”

According to the report, while this will help stabilize the sector, a boom in lending or deposit growth is still a long way off.

“We forecast economic growth in Iran to pick up from an estimated 0.5% contraction in 2014 to positive expansion of 0.6% and 2.9% in FY2015 (fiscal year running from March 21, 2015 to March 20, 2016) and FY2016, respectively, which will improve the backdrop for the banking sector.

“Inflationary pressure will moderate slightly. We forecast consumer price index (CPI) inflation to fall from 22% in FY2014 to 15% in FY2016,” it added.

Elevated price pressure has dramatically decreased the attractiveness of bank deposits in Iran over the past few years. Deposit growth averaged 2.1% in 2014, from a 5.6% decline in 2013.

BMI projected deposit growth of 3% in real terms in FY2015, and 5% in FY2016.

High base effects, improving macroeconomic conditions and the government’s efforts to tackle inflation will lead to gradually declining price pressure over the medium term, and consequently rising real rates. As a result, Iranians will likely be more willing to deposit money in banks over the next few years, the report said.

However, it projected real interest rates to remain in negative territory until 2018, which will continue to dampen profitability for banks even as international sanctions on the industry are lifted.

Risks Remain
The issuance of bad loans remains a key source of risk to the industry, BMI predicted.

According to the Central Bank of Iran, the proportion of non-performing loans stood at 14% in April, although unofficial estimates put the figure closer to 20-25%.

Previously, the central bank managed this via injections of capital, a tactic that has been bolstered by the recent agreement on the nuclear program, whereby Tehran will get access to $4.2 billion in oil revenue held in foreign banks.

“That said, we believe the current status quo is unsustainable and will lead the government to implement reforms of the banking segment over the coming years. In particular, we believe that the executive will seek to diminish the influence of the state in a banking sector dominated by public entities.”

According to available data, the 17 existing private banks in Iran have a total of 2,780 branches in the country, fewer than the number operated by one of the giant state-owned banks. Such move would allow the CBI to eliminate its role in supporting financial institutions and lead to a more efficient allocation of capital across the economy.

“We reiterate our view that structural reforms are unlikely to take effect any time soon, which will ensure that the industry will remain in a crisis over the coming quarters.”

The unfreezing of Society for Worldwide Interbank Financial Telecommunication (SWIFT) transactions as part of the sanctions relief will be key, the report said.

The system, which provides the network for the majority of global bank-to-bank transactions, abandoned the Iranian economy, with the banking sector virtually cut off from the global financial system. Banks are, therefore, currently unable to undertake international transactions, raise capital in the international bond market or expand their presence abroad.

President Hassan Rouhani has pledged to undertake a series of reforms to the economy, including liberalization measures, introduction of tighter controls over growing money supply and increase in the independency of CBI from government’s interference.

BMI forecast that the executive will implement reforms to the banking sector to diminish the influence of the state in the decisions of private banks and alleviate systemic risk in the industry.

Previously, banks were encouraged to lend to specific sectors, regardless of the profitability of such operations.

According to CBI Governor Valiollah Seif, approximately 40% of the liquidity in the industry have been forcibly directed toward a large-scale housing project over the past four years. This has elevated systemic risks in the banking sector and will be one area Rouhani’s reforms are likely to target.

By Financial Tribune