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Iranian Banks Under Sanctions: Government Looking Towards Foreign Banks

07/07/10 By Ardalan Sayami, Rooz Online

As international sanctions curtail the operations of Iranian banks, there were reports this week that restrictions on foreign bank operations in Iran have been lifted. The root of these reports was the regulations that the government passed which ordered the executive branch to implement a law passed by the Majlis. In the meantime, because of the UN Security Council resolutions bilateral cooperation between Iranian and foreign banks has for all practical purposes suspended.

By ordering the implementation of an amendment to article 5 of the law that defines the high level policies of the Islamic republic (known as  the Fourth Development Plan), as is required by article 44 of the constitution, the chief executive lifted the operational restriction that existed in bringing foreign banks into Iran.

The debate about the presence of foreign banks in Iran heightened in 2008 when the Central Bank's Monetary and Credit Council draft an act in this regard and sent it to the Majlis to be passed as law. According to this law foreign banks are permitted to open branches in Iran. Among other provisions of the act are the approval to create banks with joint foreign and Iranian capital, and the taking possession of Iranian shares by foreign investors.

With this move, the groundwork was laid for the creation of the first foreign (European) bank in Iran. It is called the Iranian-European Bank. Foreign banks could operate in Iran's free trade zone areas for many years and there are currently three such banks on Iran's Kish Island in the Persian Gulf. But, as explained by banking experts, the permission to allow foreign banks to operate on the Iranian mainland is a major change in the country's banking system. The second foreign bank to be created in Iran was the joint Iranian-Venezuelan bank.

But despite this, there are other obstacles for the presence of foreign banks in Iran. There are growing signs now that the administration and the Majlis are working to remove these as well. According to Iran's ILNA labor news agency, because of the existence of restrictions on foreign banks which is defined in article 5 of the Fourth Development Plan, the administration in May presented an amendment act to the law to the Majlis that when passed would remove these obstacles.

According to this amendment, the ceiling on taking possession of the shares of private banks and financial and credit organization and government banks whose shares are available to the public, has been set at 10 percent for individuals and 5 percent for corporations.

Also according to the new provisions, the limitations on joint banks in Iran are removed. According to the new rules, only the Iranian government has the authority to form join banks with foreign entities. Under the same provisions, foreign individuals and entities that have at least 51 percent Iranian ownership shall be considered Iranian companies. These provisions were passed into law in the Majlis in June 2009 and approved by the Guardians Council on June 9th and then instructed by the Majlis to the executive branch on June 16. Ahmadinejad last week issued the executive order to the ministry of economy to implementation the law (June 28, 2010).

The authorization to establish and operate foreign banks in Iran comes after a 26 year ban. In 1984 the Fourth Development Plan contained provisions for this and the seventh Majlis approved this opening. But the actual implementation of the law required more than just its passage. The BBC on May 5, 2007 quoted the then minister of economy as saying that the restriction on foreign banks in Iran had been resolved. The governor of Iran's Central Bank Tahmaseb Mazaheri confirmed this opening when he said that there were no legal restrictions on foreign banks in Iran. He did add that there were some considerations in establishing foreign banks which requires that the Central Bank had to monitor their activities.

Iran's ISNA student news agency in 2007 wrote of a number of proposals for creating foreign banks in Iran and reported, "It is hoped that the necessary work will be done in a logical manner regarding this. Reciprocal trust provisions have been included for foreign banks in this regard so that the conditions for expanding the country's banking system with the presence of foreign banks will be carefully provided."

But the executive order that Ahmadinejad issued this week after three years demonstrates that the problem has nothing to do with the statements and interviews given by government officials. The first problem in this regard is the deep gap between Iranian banking and international banking. The Iranian system operates on the principle of no interest and therefore lacks the modern mechanisms that are normal under international banking. There are also restrictions on Islamic contracts which are also not in line with foreign banking operations.

Experts view the biggest difference between Iranian and foreign banks to be the control of banks by the government in Iran. Ever since banks in Iran were nationalized by the government and brought under its direct control, the executive branch sees it as its right to intervene in the most detail aspects of banking operations while those who deposit money into banks and constitute its main donors, do not have any rights in electing bank managers. The result is the absence of independence of the Central Bank from the executive branch of government.

Absence of competition is another difference between the two systems. Iranian banks cannot compete with each other while the presence of foreign banks in Iran took the first step in creating such competition. Today, private banks acquired 11 percent of the whole money market in a relatively short period.

Other issues that highlight the differences are the government's interference in determining interest rates, the rentier method of providing credit, and the complex bureaucratic operations of the banking system because of government ownership.

Conditions Not Right

Dr Mohammad Jamsaz, told Farikhtegan newspaper, "One should generally discard this notion that foreign banks enter a dangerous area without an investigation and specific expectations. Banks consider such factors as political stability, economic security, the presence of a legal foundation for investment, the potential financial market of the country, etc." "Foreign banks open branches in places where they believe they can derive a profit and where great potential for returns exist. This means there are no regulations that prevent conventional banking practices or such operations. If in their studies foreign investors conclude that investment conditions are not present, this means that the Iranian economy is not in a state to encourage their presence," he added.

Jamsaz then explained that despite the presence of the right regulations and even the existence of foreign banks on Kish Island, the very fact that foreign banks end their operations and relations with Iranian banks and the foreign branches of Iranian banks are closed, these are indicative of the impact of economic sanctions which come from the economic sanctions against Iran. Under such circumstances, foreign capital does not flow to Iran, and, "In my belief, the conditions currently do not exist for foreign banks to come to Iran," he said.

Some economists have said that there is an opportunity for foreign banks to come to Iran for banking operations and this can improve the quality of banking operations of government banks in Iran because of the competition that will follow. But they also say that when Iranian banks are under various foreign sanctions it is not clear what will the presence of foreign banks in Iran accomplish. They too point out that the biggest problem in Iran is that banking operations are driven by orders from the government and do not follow the laws of demand and supply. The government pressures banks to take measures that promote its policies and provide the banking resources to the government, even when the banks do not believe such investments to be wise and prudent economically. The other issue is the interest rate charged between banks which the government sets. This too has been a serious issue for the last four years.

Ahmadinejad's administration had promised right from the start to reduce inter-bank rates annually, but the Monetary and Credit Council of the Central Bank has been avoiding this as its measure to control inflation. Such differences and pressures can cause headaches to foreign banks operating in Iran. 

Iran's fourth development plan only allowed the establishment of banking offices in Iran, while not allowing any banking operations. The ban related to provisions in a law that was passed in 1984.  With the new provisions however, this restriction has been lifted. Iran's Central Bank is the institution designated to regulate the activities of foreign banks in Iran.

Until now, foreign banks in Iran have acted as the bridge between foreign companies from the same mother country in the host country. Foreign companies learned of Iran's economic and investment opportunities through these foreign banks in the country.

So even though regulations may allow foreign banks to engage in banking operations in Iran, it is far from clear whether foreign capital will come to the country through these foreign banks because of the international environment against Iran and also the domestic rules and regulations and specific banking operations.

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