Banking Sector: Stability Remains At Risk


BMI View: The crisis in Iran's banking sector will continue for the remainder of 2013 , with profitability set to decline further. Although incoming President Hassad Rouhani will seek to liberalise the sector , we do not expect major reform being implement ed over the short term.

Total assets in Iran's commercial banking sector declined 11.8% y-o-y in real terms in December 2012 - having shrunk by an average of 7.7% in 2012. Deposits fell 1.3% y-o-y in real terms in the same month, posting an average of 3.6% decline in 2012, while loan growth fell 19.0%, having shrunk 9.8% in 2012. Despite the lack of recent data on the industry coming out of the country, it is clear that the crisis is continuing, and we expect this to remain the case in the coming months.

Improving Slowly In 2013
Iran - Deposits, IRRtn (LHS) and % chg y-o-y (RHS), nominal terms

Deposit Growth Accelerating Modestly In 2013...

According to official data, consumer price inflation (CPI) increased 34.0% y-o-y in June. We forecast CPI averaging 28.0% in FY2013/14 (fiscal year beginning on March 21 2013), only slightly lower than our estimate of 28.5% in FY2012/13, and believe that the rial will remain weak over the coming quarters. Although deposit growth will remain slow as a result, the pace of expansion is set to modestly increase. Iranians have continued to withdraw cash from banks in order to exchange it for gold or foreign currency, or invest in the real estate sector. However, as a result of new US sanctions which came into effect on July 1, foreign financial institutions that conduct or facilitate significant transactions related to the purchase or sale of Iranian rials, including derivatives, swaps, or maintaining significant accounts denominated in Iranian rials, are subject to sanctions. As a result, it will be more difficult for Iranians to find ways to deposit their money in foreign banks. In addition, the United States recently banned the transfer of precious metals to Iranian state and private institutions, as well as to Iranian citizens. As a result, we believe that Iranians will have more difficulties pulling money out of the banking sector. We forecast client deposits to increase 29.0% and 22.0% in FY2013/2014 and FY2014/15 in nominal terms, respectively, which amounts to growth in real terms of 1.0% in FY2013/14 and 4.0% in FY2014/15, based on our inflation forecasts.

Credit Growth To Continue Contracting
Iran - Loans, IRRtn (LHS) and % chg y-o-y (RHS), nominal terms

... While Lending Will Decline Further

Following the victory of moderate cleric Hassad Rouhani in presidential elections in June, we have revised upward our GDP growth forecasts for the Islamic Republic ( see 'Rouhani's Election Bodes Well For Growth', July 2). We project the economy contracting 2.0% in real term in 2013, from our previous forecast of a 2.3% contraction, and see growth of 2.8% in 2014, compared to our previous projection of 2.4% growth. That said, credit growth will likely remain slow over the coming quarters. With the economy remaining in crisis, few creditors will be able to repay their debts, adding to banks' reluctance to ramp up lending. Indeed, over a quarter of bank loans are non-performing according to official data, and reports suggest that such figure could be much higher. Indeed Yahya Al-e Es'haq, the director of the Tehran Chamber of Commerce, Industries and Mines, said on July 22 that Iran's manufacturing sector owes approximately IRR800trn (US$24.2bn based on the dollar price in the black market) to domestic banks. Given the dire state of the manufacturing sector, we would not be surprised if a significant amount of such debt was not paid back. Finally, given our view that price pressures will remain elevated, banks will remain reluctant to extend credit as the value of repayments is eroded by inflation. We project client loans expanding 23.0% and 21.0% in FY2013/2014 and FY2014/15 in nominal terms, respectively, which amounts to a contraction in real terms of 5.0% in FY2013/14 and growth of 3.0% in FY2014/15.

Economy Still In A Crisis
Iran - Components of GDP (IRRtr) & Real GDP Growth

Elevated Systemic Risks

Iran's banking sector is poorly-positioned to deal with a prolonged period of instability. International sanctions are making it virtually impossible for Iranian banks to raise capital in international bond markets, a situation which we expect to continue over the coming quarters ( see 'Presidential Election: Improved International Climate', June 17). Moreover, although Tehran will likely continue to intervene with capital injections to the banking sector, its policy to force banks to provide cheap loans to the economy will only worsen the crisis. The government currently instructs banks on how to allot credit and which borrowers and sectors must be regarded as "priorities". For instance, banks were recommended to allocate 80% of their increase in deposits to priority sectors in FY2010/11 - 37% to manufacturing and mining, 25% to agriculture, 20% to construction and housing, 10% to trade, and 8% to export. Although the remaining 20% of the increase in deposits could be used freely, sub-limits existed on credit for consumer durables or home improvement. More recently, outgoing president Mahmoud Ahmadinejad's administration instructed the banking sector to allocate IRR650trn trillion to plans to stimulate job creation in FY2013/2014, compared to only IRR270trn reserved for job creation by the executive during the 2006-12 period.

Rouhani has pledged to undertake a series of reforms to the economy, including liberalisation measures, introducing tighter controls over the growing money supply and increasing the independency of the Central Bank of Iran from government's interference. We believe that the executive will seek to implement reforms to the banking sector as well, in a view to diminish the influence of the state in the decisions of private banks and alleviate systemic risk in the industry. That said, we do not expect structural reforms to the banking sector being implemented anytime soon, and expect the industry to remain in a crisis situation over the coming quarters.

This article is tagged to:
Sector: Country Risk
Geography: Iran