NH-2016-q2
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COUNTRY FOCUS<br />
NEWHORIZON Shawaal 1437 to Rabi al awwal 1438<br />
The Challenges Facing Islamic Banking in Iran<br />
Background<br />
Prior to the 1979 revolution Iran had a thriving economy including a vibrant, modern financial sector with about 36 banks,<br />
a mix of state, private, joint venture and foreign entities. World Bank statistics for the years 1960 to 1977 show that Iran<br />
enjoyed a real rate of growth of 9.6% per annum. While there were many improvements for the people of Iran in those years,<br />
e.g. education, health and the reduction of absolute poverty, there was no narrowing of the gap between rich and poor and<br />
therefore no popular support for the regime of the Shah. The conditions were ripe for regime change.<br />
The Immediate Aftermath of<br />
the 1979 Revolution<br />
In the wake of the revolution Iran’s<br />
banking system was in real danger of<br />
collapse. This situation was a function of<br />
the revolution itself-the physical assets<br />
of many banks had been damaged or<br />
destroyed; customers had lost confidence<br />
and withdrew deposits creating a run on<br />
the banks and many of the professional<br />
bankers had simply left the country. The<br />
chosen solution was nationalisation,<br />
which was particularly actively promoted<br />
by a strong Marxist element among the<br />
successful revolutionaries. The existing<br />
banks were, therefore, re-organised and<br />
merged to form six commercial and<br />
three specialised banks, all under state<br />
control.<br />
While some moves were made to<br />
control levels of interest in relation<br />
to borrowings and savings (the word<br />
interest was replaced by ‘minimum,<br />
guaranteed profit’ for depositors and<br />
‘maximum service fees’ for borrowers),<br />
full Islamisation of the banks did not<br />
take place until 1983. By this time the<br />
Marxist-leaning revolutionaries had lost<br />
influence.<br />
The Usury-Free Banking Act of 1983<br />
meant that from early 1984 the entire<br />
financial system had to operate in<br />
accordance with Shari’ah. This created<br />
the single, largest Islamic banking<br />
system in the world and Iran could<br />
be considered one of the pioneers of<br />
modern Islamic finance. According to<br />
Dubai government statistics in 2014<br />
Iran’s Islamic banking assets were<br />
estimated to be in the region of<br />
$482 billion. This is more than the<br />
combined Islamic banking assets of<br />
Saudi Arabia, Malaysia and the United<br />
Arab Emirates, all of which have a<br />
mixed system with both conventional<br />
and Islamic banks.<br />
The experiment was not successful,<br />
again for a variety of reasons. There<br />
was no experience of Islamic banking<br />
in Iran at that time; the people who ran<br />
the banks were chosen on the basis of<br />
‘party loyalty’ rather than for financial<br />
experience; the government dictated<br />
to whom the banks should lend; loans<br />
to approved organisations were on an<br />
on-demand basis and there was heavy<br />
central bank interference in day-to-day<br />
operations. There was also no template<br />
for how the system would work; the<br />
law simply stated that banking should<br />
support a just economic system; that<br />
it should promote the objectives of<br />
the Islamic Republic and that it should<br />
protect the national currency. Some<br />
commentators have even suggested<br />
that it was Islamic in name only and<br />
that it continued to charge and pay<br />
interest under euphemistic titles<br />
such as ‘minimum expected rate of<br />
profit under granted facilities’ and<br />
‘provisional rate of profit’.<br />
By the late 1990s it would not be an<br />
exaggeration to say the Iranian<br />
banking system was in crisis and<br />
for many ordinary Iranians the only<br />
financial resource available was<br />
unregulated, underground money<br />
lenders. The banking system had<br />
become inefficient; it had a limited<br />
range of products; asset portfolios<br />
were either non-performing or<br />
producing very low returns and there<br />
were a number of embezzlement<br />
scandals. Something had to be done.<br />
Easing the Grip of<br />
Nationalisation<br />
Changing the banking system was not<br />
going to be easy. The Iranian Constitution<br />
and the 1983 Usury-Free Banking Act<br />
meant private banks and conventional<br />
banks were not an option. In 1997<br />
the Central Bank found an opening<br />
and licensed three ‘non-bank credit<br />
institutions’. They also permitted private<br />
and foreign banks to operate in Iran’s<br />
Free Trade Zone. These banks then<br />
began to lobby for full bank status and<br />
in 2000 another opening was found in<br />
the Constitution and they were allowed<br />
to operate as private commercial banks,<br />
provided they were 100% Iranian owned.<br />
In 2006 Iran began the process of<br />
privatising or part privatising a whole<br />
range of state-owned enterprises, including<br />
banks. This came as a result of an<br />
Executive Order from the Supreme Leader<br />
in July 2006. Somewhat problematically<br />
the Iranian government retains significant<br />
shareholdings in many of these<br />
banks, either directly and/or through<br />
government-controlled organisations. It<br />
is estimated by some sources that only<br />
5% of the ownership of state-owned<br />
organisations has been truly privatised. So,<br />
ostensibly banks are being privatised; the<br />
reality may be rather different.<br />
The Banking System Today<br />
Today there are 29 banks in Iran – 19 are<br />
partly or wholly privately owned and there<br />
are three state-owned commercial banks,<br />
five specialised state-owned development<br />
banks and two state-sponsored banks<br />
focusing on charitable projects. Iran<br />
controls 40% of the world’s Islamic<br />
banking assets compared to 18.5% for<br />
Saudi Arabia and 9.6% for Malaysia. (Iran<br />
36 IIBI<br />
www.islamic-banking.com