August 2011, No. 60

Banking

Low Interest Rate on Bank Deposits and Idle Capitals

When financial markets are stagnated and investing in banks produces lower than inflation profit, people should find a suitable place for their capital in order to avoid taking their money to pyramid companies.

The Iranian year 1389 (March 21, 2010-March 21, 2011) was an unfortunate year for pyramid companies.

A great number of them were identified by the intelligence forces and the police and were shut down. Figures produced by officials show that more than four million people have been working with these companies which are now facing more than 2 million lawsuits with the Iranian judiciary.

Emergency plans carried out by the police in that year and information through the mass media were influential in reducing membership in those activities. The main point, however, which was ignored, was why people were willing to work with them. Attention to root causes will be more influential than any other means in curbing the activities of such companies.

The work in pyramid companies is such that members are promised high return rates on their capital in a short time. Although there is a high risk entailed, but the promise is too tempting to be resisted by many people. Why such companies have mushroomed in recent years? What has been the relationship between the country’s economic situation and growth of such companies?

First a review should be made of Iran’s economic situation in the past few years. Since 1995, the oil price has increased followed by a parallel rise in liquidity. The rise in liquidity was accompanied with concurrent fall in the stock exchange indices. As a result, psychological consequences of presidential polls in 2005 led to severe decline in the indices of the stock market which was just a beginning for five-year stagnation. The results of the expansion of liquidity in 2005 and more severe expansion of liquidity in 2006 were reflected in high inflation rates of the following years. The inflation kept rising from 2006 and reached a 10-year high in 2008; that is 26 percent. In addition to the above three phenomena; that is, high oil prices, expansion of liquidity, and stagnation in the stock market, interest treat of bank facilities were kept at a fixed level as a result of which the rate fell down to 13 percent.

Under those inflationary conditions with high liquidity in the market and in the absence of enough capacities in the capital market to take on that liquidity, people were naturally looking for high-profit investments. Steep rise in housing prices in those years was just an outcome of those economic conditions. In addition to flow of liquidity into the housing market, there were small amounts of idle capital which could not be invested in housing. As a result, pyramid companies offered a very attractive opportunity for these capitals. Thus, inflationary conditions in addition to increased liquidity and stagnation of financial markets were major reasons for growth of pyramid companies. When financial markets are stagnated and investing in banks produces lower than inflation profit, people should find a suitable place for their capital in order to avoid taking their money to pyramid companies.

This issue is of high significance to the existing economic conditions in Iran and there are many lessons to be learned here. The current economic situation is no dissimilar to conditions in 2005. The oil price is increasing and developments in the Middle East promise more price hikes in the near future. The interest rate for 2011 has been reduced and paying cash subsidies to families in addition to high oil revenues will increase liquidity. Under these circumstances, new phenomena may take place for pyramid companies in order to attract small capitals and this may lead to outflow of capital. Therefore, we better learn from the experience of pyramid companies which took more than 80,000 billion rials out of the country. We must formulate suitable economic policies such as reducing interest rate on bank deposits and introducing new tools such as bonds with a logical interest rate in order to pave the way for attraction of small idle capitals whose mobilization may spurt the economic growth of the country.