The usury-free banking law was approved in September 1983, that is, 25 years ago. On the other hand, the Iranian banking system has been constantly suffering from structural and institutional problems. This paper will try to prove that such problems are mostly due to structural problems of the Iranian economy not conditions imposed by usury-free banking system.

Dr. Seyed Ahmad Mir-Motahari, Economist

Literature on economic development shows that there is meaningful and direct relationship between economic development and financial development. Growth of financial institutions and markets (including banking network) is a precondition for economic development because it provides required financial backbone for the economic development by mobilizing, guiding and allocating financial resources. From this viewpoint, that is, from viewpoint of sustainable economic development, structures which ensure development of financial system constitute a necessary component of this form of development.

Political interventions in decisions made by the banking system via dictating interest rates on bank deposits and facilities, enforcing the policy of credit ceilings, introducing obligatory facilities and credits, and all other forms of government interventions in decisions that pertain to the banking system, on the one hand, and absence of a suitable motivational system for competition and subsequent inattention of banks, especially state-run ones, to establishment of effective mechanisms for analyzing credit risks and market risk and to diversity portfolio of their assets, on the other hand, has rendered the whole domestic banking network relatively ineffective.

The net result of these interrelated trends is reduced share of capital in balance sheet of banks, inefficiency of operational expenses as well as inadequate deposits in comparison to outstanding loans. On the other hand, banking network and, on the whole, the Iranian money market has suffered from a number of structural insufficiencies. A powerful traditional and underground money market, limited number of institutions and instruments in the Iranian money market, as well as inefficient structure of operational expenses and existence of obligatory credits has added to structural woes of the Iranian banking system. Under these conditions, it would be more difficult to supervise performance of money market institutions and, in practice, the Central Bank of Iran has been forced to simply use such direct tools as administrative rates and credit ceilings in order to plan and implement monetary policies.

In this way, if we wanted to classify the existing problems of domestic banking network, some of them would pertain to structure of money market because some institutions which are active and play a determining role in the money market evade supervision and, despite wide range of their activities and their impact on the money market, their operations are not overseen by the Central Bank of Iran. On the other hand, government control over state-run banks has led to such problems as reduced share of capital in balance sheets of banks and increased operational expenses which have, in turn, led to lack of needed diversity in money market tools and active institutions. Meanwhile, the government’s political interventions in bank decisions (such as enforcing policies like credit ceilings, preferential and obligatory facilities, administrative rates of interest rate on deposits and loans, and recent controversies surrounding early output enterprises) and absence of a suitable motivational system to encourage competition among banks, has further weighed down on an ailing banking system.

Therefore, banks do not feel any need to establish an efficient mechanism to analyze market risk as well as credit and management risks and to manage their assets portfolio in such a way as to produce a suitable combination of their assets. All these factors prompt us to emphasize that the Iranian banking system needs structural, institutional, and policy changes. Reforming and correcting financial structure of banks in order to achieve a relatively optimal combination of collections and liabilities; making interest rate and facilities more flexible; decentralization of powers in the banking system; more use of indirect monetary instruments and moving in the direction of eliminating obligatory facilities are major axes of these reforms. However, the main point on which this paper stresses is that the existing difficulties and structural problems are not due to restrictions envisaged by usury-free banking system. The existing banking law has paved the way for presence of a great number of financial institutions and tools which can meet the country’s developmental needs.

However, these factors have caused the Iranian banking system to suffer from structural problems. On the other hand, absence of a suitable motivational system for banks has caused capacities of usury-free banking law to be ignored and inadequate efforts have been made to create needed institutions within the framework of that law. Experiences of other Islamic countries with more developed financial markets, like Malaysia, prove that Islamic financial system will allow creation and establishment of relatively developed financial markets and that restrictions imposed by such a system is no obstacle to development of advanced and modern banking and financial institutions. Sokouk (or Islamic bonds) was a good experience which has successfully supplanted usury-based financial instruments like ordinary bonds.