Iran's banking crisis to worsen as US sanctions continue to roil economy

US sanctions on Iran and their growing impact on the local economy are aggravating the country's banking crisis, forcing Iran to choose between deep reforms or preserving short-term financial stability of its liquidity-deficient financial institutions. Significant liquidity and solvency problems are posing a "growing risk" to Iran's financial stability, according to a policy brief by the Peterson Institute for International Economics (PIIE). The banking system's problems also stem from the heavy-handed role of the state, banks' often "corrupt" relations with some semi-official corporations and the Central Bank of Iran's ineffectiveness in regulating lenders, it added. "A substantial portion of banks' assets is impaired and their capital positions are very weak," Adnan Mazarei, non-resident senior fellow at PIIE and former deputy-director at the International Monetary Fund, said. The US administration in November last year moved to reimpose sanctions on Tehran, leading to significant inflation and pressure on the country's economy as crude exports, the main source of income for Iran, fell sharply. Iranian banks, some of the state-related entities and the government officials, were also subject to US sanctions. Earlier in 2018, the US administration announced unilateral withdrawal from the Joint Comprehensive Plan of Action (JCPOA), signed by world powers to restrict Iran's nuclear programme in exchange for economic relief. The US move led to pressures on the Iranian rial even prior to the sanctions taking effect. Iran's economy contracted by 3.9 per cent at the end of last year and the IMF expects a further 6 per cent contraction in its gross domestic product in 2019. Mr Mazarei said, Iran's "precarious" banking system is expected to increase the economy's vulnerability to external factors. "A worsening of the banking crisis can probably be avoided in the short run, but banking distress will continue to mount, making the system more vulnerable to an external shock - especially if Iran’s oil exports are completely halted or if there is a major military confrontation with the United States - which could lead to much higher inflation and further financial difficulties," he explained. With reimposed US sanctions the liquidity in the banking system is expected to deteriorate, prompting more capital injections from the Central Bank, the PIIE noted. Iran now faces a choice between either implementing deeper reforms to correct the banking system or preserving short-term financial stability. Structural reforms, however, would be challenging given the complexity and size of the problem, the policy paper said. "Given the difficult economic conditions, fragile confidence in the banking system, and the complexity and costs of cleaning up the banks, the authorities are unlikely to pursue deep reform and will instead continue to focus on self-preservation with a bias toward short-term financial stability," Mr Mazarei said. Even if a short-term collapse of the banking sector could be avoided, the worsening economic fundamentals will likely lead to "further decay" in banks' balance sheets, making them more vulnerable to weakened confidence in the system, according to the policy paper. Asset quality is a major issue for the Iranian lenders with official data indicating non-performing loans climbing to about 11 per cent. However, unofficial figures suggest the impairment ratio could be as high as 50 per cent, the PIIE said. The lenders' capital position is weak, with capital adequacy reaching 4.9 per cent as of June 2017, below the Basel 1 minimum requirements of 8 per cent, it added. The Central Bank has bailed out lenders in the past by providing large capital injections over the years as banks face chronic liquidity problems and their holdings of real estate and equity assets are making them more vulnerable to shifts in local economy. "With or without sanctions, the situation is not sustainable for Iran's banking system," Mr Mazarei said.

Iran's banking crisis to worsen as US sanctions continue to roil economy

A substantial portion of Iranian banks’ assets are impaired and their capital positions are 'very weak', new study shows