Monetary and Capital Market Exclusive, March 2004

Monetary and Capital Market in Iran

Credit and Monetary Markets in Iran

The range of profit rate changes in the Iranian monetary market is very wide

Seyed Ali Milani, Chairman & Managing Director of Bank Tejarat

The monetary market in Iran has a special structure as a result of being owned and governed by the state. Government’s control over most monetary activities, on the one hand, and generalizing Islamic banking to the whole banking system as the main pillar of the monetary market, on the other hand, have imparted a different structure to the Iranian monetary market.

Generally speaking, the money and credit market in Iran can be divided into two parts. One part comprises of monetary market activists which operate under supervision of the country’s monetary authorities (the Central Bank of Iran), which is known as the ‘regulated monetary market’. The market currently includes 10 public banks (six commercial banks, three specialized banks and one developmental bank), four private sector banks, two private credit institutes, one cooperative fund and three funds (Employment Support Fund, Electronic Industries Support Fund, and Mines Support Fund) supported by the government.

Most of this market is controlled by the government and a small portion of it is run by private sector banks and credit institutes. Of course, private banks are still in their initial stages of formation and are expected to increase their share of the market during the upcoming years. In general, the country’s regulated market holds more than 90% of the private sector’s liquidity while the liquidity circulating in the public sector is managed by the state-run banks.

Another part comprises of activists that operate unsupervised by the Central Bank of Iran in an unorganized manner (some of them like interest-free funds and credit cooperatives are organized, but are not supervised by the Central Bank of Iran). Leasing companies, credit cooperatives and Qard-al-hassaneh funds, (interest-free funds), which include more than 6,000 funds, are examples in this regard. Unorganized elements of this part include commodity installment sales markets, housing mortgage market and money-lenders.

Although, share of this market of the country’s total monetary market is meager, activities made by them during recent years have caused fears as to the expansion of the market and its negative impact on the country’s economic system.

Estimates indicate that only 6,000 Qard-al-hassaneh funds (with about 18,000 branches nationwide) are in Iran. That is, branches of interest-free Qard-al-hassaneh funds are approximately equal to the number of official and regulated bank branches. The main threat posed by these funds is creating money and increasing liquidity (outside the supervision of the Central Bank) as well as unwanted money laundering. Since those funds are not supervised by banking authorities, and do not observe regulations related to money laundering, people owning dirty money use these funds to launder their money.

Another element of the unofficial monetary market is credit cooperatives, which are less active than Qard-al-hassaneh funds. For this reason, they pose fewer problems, though they may cause the same problems as mentioned for Qard-al-hassaneh funds. The unofficial monetary market includes commodity installment sales market, housing mortgage market and money-lending market, which has been very active during the recent years. Due to partially high inflation rates, on the one hand, and inadequacy of facilities granted by governmental banks and the red tape involved in granting such facilities, on the other hand, the unofficial, unorganized market has been very active.

The range of profit rate changes in the Iranian monetary market is very wide. It varies from 7% per annum, for the obligatory credits and facilities provided by the banking system, to 84% per annum on the unofficial monetary markets and money-lenders.

In the organized banking system, specialized banks consider profit rates on their facilities ranging from 7% to 24% for various sectors and activities. This figure for state-owned commercial banks is between 13% and 24%. The minimum expected profit rates offered on deposits by the public sector banks is between 7% (for short-term deposits) and 17% (for five-year, long-term deposits). At times, banks pay final profit rates of up to 4% higher than the announced levels depending on their annual performance.

The expected profit rate on credits and facilities provided by the private sector banks and credit institutes ranges from 24% to 36%. The ex-ante profit rates on their deposits would vary from 10% to 24% per year.

In the unofficial market, the profit rates for money are much higher than the official markets. Profit rate in many Qard-al-hassaneh funds and credit cooperatives are more than 30% (of course, there are Qard-al-hassaneh funds that grant facilities free of interest to meet people’s needs whose number is limited).

The profit rate at unorganized commodities related financial markets are still much higher than the organized, and even the unofficial monetary markets. The interest rate is at least 36% in commodity installment sales market and the housing mortgage market. This figure is higher in the money-lending market and varies from a minimum of 48% to a maximum of 84%.

The country’s banking system plays a central role in financing development projects and working capital of the various economic activities by directing the surplus funds in the society towards productive investments. The outstanding balance of facilities granted to the private sector by the banking systems exceeded 265,000 billion rials by the end of 1381 (20 March 2003) where, more than 50% of the facilities were allocated for capital formation (for establishing economic units).

Sectoral distribution of granted facilities to the private sector shows that during most of the years in that period (1999-2002), the majority of facilities were allocated to the industries and mines sector with an average share of about 30% as well as the housing sector (especially buildings) with an average share of about 29%. They were followed by commerce, service and agriculture sectors.

Since most domestic banks are state-run, to support special and infrastructural sectors, create jobs and achieve other social goals, the government has obliged banks to pay obligatory facilities. During the 2000-2002 period, the majority of disbursed obligatory facilities belonged to the non-governmental sectors, so that, during this period, the non-governmental sectors’ share of these facilities was more than 60% on average.

A goal of disbursing obligatory facilities is job-creation. Therefore, share of obligatory facilities granted for job-creation from 1999 to 2000 of total obligatory facilities was 45% on average. With regard to total jobs created through such facilities, one can single out facilities of Article 56. Out of 9,000 billion rials facilities granted from the said Article by the end of the Iranian calendar year 1381 (2002 - March 2003), creation of about 300,000 jobs opportunities throughout the country were planned.

Major steps have been taken with regard to monetary and credit policies of the country during the recent years, especially with regard to giving more latitude to banks and monetary institutes. In this regard, the average rate of legal deposits of banks has decreased from 24% to 16%. On the other hand, to curtail government’s monopoly on the country’s financial system and increasing competition in the state-run sector, the grounds were provided for the activity of private banks, so that, there are currently private banks in the country. Also, to increase competitiveness and latitude of state-run banks, the banks were allowed to distribute 35% of the increase in balance of facilities granted to the non-governmental sector outside the determined sectoral quotas according to monetary and credit policies adopted during the recent years.

New grounds have been opened up during the recent years. The domestic monetary market, however, still faces challenges, the most important of which would include:

• Lack of independence of monetary and credit policies and especially the monetary market, from financial and budgetary policies of the government;

• Increased liabilities of the government and state-owned enterprises to domestic banking system and suspension of such facilities;

• Growing trend of increased number of unofficial monetary institutes (not supervised), especially Qard-al-hassaneh funds that create money;

• Lack of a comprehensive plan for privatization of banks;

• Imposing obligatory facilities on the country’s banking system;

• Imposing sectoral distribution on the country’s banking system;

• Determining profit rate on deposits and facilities for the country’s banking system.

On the contrary, the above challenges also help the country’s banking system to be more efficient, the following suggestions could be helpful:

• For better planning of sources and funds of the state-owned banks, it is suggested that facilities granted from trusted funds of the government should replace obligatory facilities;

• Since a major problem facing the banking system is delayed repayment of granted facilities, especially those granted to government and public sector companies as well as regular expansions considered for some facilities granted to these companies, the government must take action for the repayment of delayed claims of banks by determining a specific time period (for example two years);

• Although sectoral distribution of facilities and determining rate of return on facilities could be a temporary remedy, continued use of that policy by the government would lead to economic rents in supported activities or sectors with the ensuing corruption and bureaucracy. It is proposed that firstly, determination of profit rates on facilities within framework of monetary policies approved by Money and Credit Council should be done by banks and financial institutes and government’s support for certain sectors such as agriculture should be carried out in the form of direct subsidy on profit rate. Secondly, sectoral divisions of facilities should be canceled and banks should allocate credits on the basis of market demands;

• To organize unofficial monetary markets, especially Qard-al-hassaneh funds, it is suggested that any kind of bank operations by legal and real entities without receiving permit from the Central Bank should be banned and establishments as well as institutes active in banking operations, which have permits from other bodies should adapt to the approved policies of the Money and Credit Council as well as monetary and banking laws of the country as soon as possible.

• Since the country’s banking community—with a work-force of more than 200,000 people and controlling more than 90% of liquidity in the economy—lacks a well defined system to defend its rights; it is suggested that an association of domestic banks should be formed to inform the public of the activities of the banking system, promote healthy competition and provide financial services comparable to global standards.