Twelve foreign banks from Europe, Asia and the Gulf have applied to open branches in Tehran despite the political risks and pariah status of the Iranian government, as they focus on the opportunities of an oil-rich country with a population just of under 70 million, which is not served by its many state banks.
Additionally, some of them may become involved in the estimated $30bn privatisation of four state banks by taking minority stakes in them, as allowed by Iranian law.
“We have had 12 applications from European, Asian and Gulf [banks],” says Mohammad Jafar Mojarrad, vice-governor of the Central Bank of the Islamic Republic of Iran, although bank committees discussing the details of what the formal application process involves have not finalised their work yet – evidence of the high level of interest.
This is even as reports surface that US vice-president Dick Cheney believes that military options should be considered as he doubts the efficacy of the Security Council’s attempts to persuade Iran to suspend uranium enrichment, which could produce nuclear fuel and weapons grade material, while Mohamed El Baradei, head of the United Nation’s nuclear watchdog, spoke recently about “new crazies who want to say ‘let us go and bomb Iran’.”
Disruptive influences
But the US bombing threat is not the only hot issue on the political front. The extreme rhetoric of president Mahmoud Ahmadi-Nejad, the government’s arrest of at least three Iranian-American citizens involved in non-governmental organisation work, and its alleged armed support of Sunni and Shia factions in Iraq, are disrupting Iran’s overseas relations.
Foreign companies face other apparent impediments to doing business. The Iranian economy is labouring under both limited UN sanctions and the Iran Libya Sanctions Act, which requires the US to place sanctions on non-US companies investing more than $20m a year in Iran, although so far this has not been applied.
Nonetheless, oil companies such as Norway’s Statoil, Russia’s Lukoil and France’s Total have a presence, unable to resist the lure of a country with the world’s second largest oil reserves – as are Chinese companies. Additionally, German engineering companies and others are involved.
Now foreign banks may join this group, albeit cautiously, as evidenced by the words of an Iranian-born banker who, after spending most of his professional life abroad, returned several years ago to take advantage of an opening up of the economy.
“When the situation is right – in a few months, in a few years or God knows when – there are tremendous opportunities,” says Parviz Aghili, managing director of Karafarin Bank. “That is why I came back.”
He has already grasped the existing opportunities by building up the third largest private bank in Iran (private banks were only allowed in 2000), which now has more than 1000 employees and total assets of $2bn. There are five other private banks in Iran, which are providing competition to the state banks by giving better service to higher income groups and top companies.
Disadvantages
There are drawbacks to banking – indeed any business – that bankers need to be aware of. They include a diffuse set of power centres that have an influence on economic policy and can lead to some controversial decisions.
Take interest rates. President Ahmadi-Nejad, who was elected on a populist platform, and some Parliamentarians, or members of the Majlis, have pushed for a reduction in interest rates, known as profit or return rates in the prevailing Islamic finance, to below the inflation rate. They believe this will boost lending to the poor, reduce inflation and stimulate investment.
“It is very strange for every economist that the government thinks if lending rates go down then inflation goes down,” says Jalal Rasoulof, chief executive of EN Bank, a private bank. “The government thinks this manipulation is needed [but] it does not benefit poor people.”
Last year, the government succeeded in pushing lending rates down for the private banks from an average of 22% to 17%. For the state banks, the rate was pushed down from an average of 16% to 14%. Inflation was officially 13.6% – although bankers put it at anything between 18% to 25%.
Yet bankers have not suffered unduly. The government was only able to force rates down on non-participatory contracts, which are less than 40% of total loans, says Mr Rasoulof. The measure backfired because bankers focused on selling more of other instruments, which the government cannot interfere with, while overall, lending to business as a percentage of total loans fell.
As The Banker went to press, rates had just been pushed down to 12% for state bank and 13% for private banks, despite central bank governor Ebrahim Sheibany – who voted for a fall in rates last year – vowing to fight any lowering this time (see Karina’s Kolumn, page 24).
Sanctions
Sanctions are another drawback to banking in Iran. One large state bank, which is implementing a major technological change, is forced to use middle-men in entrepots such as Dubai and Frankfurt to gain access to the US hardware and software it needs.
Meanwhile, a private bank that spent two years implementing a Singapore software company’s state-of-the-art customer relationship management system is extremely worried because the company has been taken over by a US company.
The bank is as yet unsure about what this means for after-sales service. “If we hit a snag, who is going to solve the problem?” asks the CEO, who did not wish to be named. “If we didn’t have this political problem, what we could have on offer would be as good as Wells Fargo.”
The sanctions have also affected the dollar business of the banks, and are preventing some foreign banks from doing business there. Executives from Credit Suisse, for instance, reportedly told their Iranian banking clients that the Zurich-headquartered bank could no longer do business with them as its US business was much too important to jeopardise.
A spokesman from Credit Suisse did not deny the story but said that at the end of 2005, the bank took the decision to withdraw from all possible Iranian business and not enter into any new business on the back of increased political and financial risk.
Global behemoth HSBC is an obvious candidate to open branches in Iran due to its large operations in the region, its expertise in Islamic finance and its ownership of the Imperial Bank of Persia from the last century. It currently has a five-person representative office there and private bankers fly in to do offshore banking. HSBC denies it is one of the 12 banks interested in asking for a full banking licence; it has extensive US operations.
Standard Chartered, another bank with emerging market and Middle East expertise, denied it was planning to expand its representative office in Tehran.
Privatisation
But for banks without big US business arms, there are good opportunities to make profits in a country that saw its gross domestic product grow 5.5% in the year ending March 20, 2007, according to provisional numbers from the Central Bank. Agriculture grew 7% and the non-oil sector, mainly services, manufacturing and mining, grew 6%.
This is despite the short-term nature of the government’s economic policy. The high oil price has allowed it to indulge in subsidies of about $5.5bn in basic commodities and about $29.5bn in energy last year. These are aimed at keeping the voters who put president Ahmadi-Nejad in power happy. They are due at the polls twice in the next two years.
Meanwhile, the lack of investment in projects such as increasing the country’s low refining capacity, and using the funds from the Oil Surplus Fund for long-term projects, has been highlighted by an open letter from 60 local economists, who accused the government of “putting short-term welfare above long-term sustainable development”.
In a bid to boost the growth rate, increase revenue and provide jobs for the unemployed – officially 12% but estimated by economists at close to 20% – the government is now privatising huge swathes of the economy, including four big banks, an additional opportunity for foreign banks.
The impulse behind this move is itself an indication of the different centres of power, as are the mechanics behind it. Grand Ayatollah Ali Khamenei, Iran’s supreme leader, issued an executive order in July 2006 for the wide-scale privatisations. He is seen as the prime mover, along with the more technocratic elements in the government, including Heidari Kord Zangeneh, deputy minister of economic affairs and chairman of the Iranian Privatisation Organization, the body charged with managing the $130bn privatisation.
Other power centres in Iran, whether religious, legislative or governmental, are reportedly less enthusiastic about privatisation on ideological grounds, as well as practical ones involving the loss of patronage.
However, the political force behind the sale of state assets appears stronger, and even more so than in 2004/05, when there was an aborted attempt to sell some state assets.
Mr Kord Zangeneh, who was about to go on a privatisation road show to France and Malaysia when interviewed by The Banker in Tehran, estimates that Bank Saderat, Bank Mellat, Bank Tejarat and Bank Refah are worth $30bn. He was in Germany three months ago as part of the road show.
There is confusion about the exact stakes available to foreigners. The central bank’s Mr Sheibany says 40% has been discussed and approved. Mr Kord Zangeneh says each foreign bank can buy up to a 10% stake in every bank being privatised.
Meanwhile, Hamid Borhani, chairman and managing director of Saderat – the first bank due to be privatised – says there are ongoing discussions and a foreign bank could possibly end up with 40%.
Whether one would want to get involved in a bank blacklisted by the US government is another matter (for full interview see below).
The government has stated that 21 million of the poorest Iranians will be given justice shares in these privatisations, equal to a 40% stake in each of the companies being privatised. Mr Kord Zangeneh does not see this as an impediment to foreign or local companies taking stakes.
“We are going to establish an over-the-counter (OTC) market for them to sell their shares,” he says, adding that he expects these shares ultimately to end up in the hands of private sector players. One hundred percent of the four banks’ shares will be sold, he says, although Mr Borhani of Saderat says the government is planning to keep 20% of his bank’s shares.
Potential buyers
Potential investors in the banking privatisations are both foreign and domestic.“Iran is viewed as one of the last great emerging markets,” notes Steve Austen, managing director of Dubai-based fund management company Mehr, which is seeking to raise a €300m First Persia Equity Fund to invest in the stock market and in privatisations. The fund, a joint venture between Mr Austen, who has been doing business with Iran for more than two decades, and Bank Melli Iran, recently completed a road show through the Gulf Cooperation Council states and Europe.
Mr Austen says emerging market fund managers and hedge fund managers were quite interested. He notes that the Tehran Stock Exchange is much more diverse than other regional markets, as it includes automotive companies, mining and technology, rather than only real estate companies and banks.
The government is also looking to bring back some of the capital that has left the country in recent years, amid increased political tension and reported comments by president Ahmadi-Nejad comparing the stock market with gambling.
Dubai’s Iranian Business Council estimates there is $400bn of Iranian assets in the United Arab Emirates (UAE), Iran’s biggest trading partner, and another $900bn in the West. The president visited the UAE in May and called on expat Iranians to invest in the privatisation programme. There are an estimated 350,000 Iranians living in Dubai.
Iran’s six private banks are also potential investors. One top private banker said the government was pressuring them to set up investment companies to buy shares, but that he was not planning to do so. Instead, his bank was creating an investment bank to place privatisation shares with both foreign and local institutions.
“I expect more interest from foreign [ones],” he said. The government needs to appeal to foreign interest if it hopes to make a success of the privatisations, since the estimated $130bn price tag for all the companies being privatised would overwhelm local capital. Additionally, says Mr Kord Zangeneh, there is a draft law in Parliament to limit to 10% the stakes that each pension fund and foundation – organisations that are linked to the government – can buy. The law also seeks to limit to 20% in total the shareholding of all government institutions. This is to avoid back-door nationalisation or influence.
Domestic interest
But that doesn’t mean domestic banks aren’t interested. Mr Rasoulof of EN Bank, the second largest private bank with $4bn in assets, is expecting to hear in the near future whether private banks will be allowed to own stakes in the state banks being divested and says there is a need for mergers between state and private banks to create strong international banks, although the comparative size of the two sectors is an impediment. Bank Saderat, for instance, the first bank scheduled for privatisation, has $28bn in assets.
An attraction will probably be the price. Private banks on the Tehran Stock Exchange are on price/earnings ratios of only five to six times, notes Mr Borhani of Saderat, “so it is possible the price will be very low”.
Rule confusion
Investing in Iran is not straightforward. The rules that are being elaborated, whether on establishing foreign bank businesses or investing in privatised banks, are unclear. Both foreign and domestic investors with experience of the country say that this is not just the result of the current regime’s different centres of power with different priorities but is also, interestingly, an historic Persian trait which is the exact opposite of the exactness of the Anglo-Saxon culture.
But uncertainty is a peril in many emerging markets. The return of a number of Iranian-born bankers, the opening up of the economy, plus the fact that Iran has a large population and an underdeveloped banking sector, all point to an interesting opportunity.
The political risks, though, are large. On the positive side, at least the US and Iran are talking, although supposedly only about the situation in Iraq. On the negative side, tension about the nuclear problem is on the rise and the sanctions issue could extend beyond Bank Saderat and Bank Sepah.
The question is whether potential profits outweigh risks. This is something bankers will have to decide for themselves. What is obvious is that already some Gulf, Asian and European banks look willing to put their feet into the water.
THE CHALLENGE FACING SADERAT
How do you privatise a bank that has been blacklisted by the US government for allegedly funding ‘terrorist’ groups? That is the challenge facing the Iranian government with Bank Saderat Iran, the second largest bank in the country with assets of $28bn, 3400 branches and 42 million accounts.
The first of the four state banks due for sale, Saderat has traditionally been the most internationally minded. It has the largest network of foreign branches among Iranian banks, as well as holding strategic investments in London-based Bank Saderat plc and stakes in two joint-venture banks, Future Bank in Bahrain and Arian Bank in Afghanistan.
The blacklisting by the Office of Foreign Assets Control, a department of the US Treasury, asks all countries to cut operations with Saderat. As a result, says Hamid Borhani, Saderat chairman and managing director, profits from foreign operations were 30% in the year to December 2006 when they might have been much higher. In 2004, they were 19% of total profits and in 2005, 26%.
In a speech in mid-June, US Treasury secretary Hank Paulson reiterated the reasoning behind the sanctions: “At around the same time, in September 2006, Treasury cut Iran’s state-owned Bank Saderat off from any direct or indirect access to the US financial system, and publicly disclosed some of the information underlying that decision, including that the Central Bank of Iran was sending money through Bank Saderat to Hizballah. We also disclosed evidence that Bank Saderat was providing financial services to other terrorist groups such as the Palestinian Islamic Jihad and Hamas. Almost immediately, financial institutions around the world began to adjust their business with all Iranian state-owned banks and with Bank Saderat, specifically.
“The private sector, when presented with our solid evidence, is able to act much more quickly than governments who often lack the necessary authority or the political will to take action on their own.”
(Mr Paulson went on to point out that US intelligence found out that state-owned Bank Sepah, the fifth largest bank by assets, was allegedly providing financial services to Iranian missile firms, and following US actions against it in January, the UN Security Council then blacklisted it a few months ago. As a result, its assets have been frozen.)
Bank Saderat, as well as the Central Bank, has written to international bodies such as the Bank for International Settlements and the Financial Action Task Force, asking to see evidence of the allegations and insisting on Saderat’s innocence. Mr Borhani, interviewed in his bank’s modern Tehran headquarters, was preparing to send his third letter with documentation to Stuart Levey, undersecretary for terrorism and financial intelligence in the US. Despite this, the bank had a profitable year. Mr Borhani says deposits grew 38%; audited accounts for the Iranian year to March 20, 2007 will be ready in a few months,
The government has played a large role in the banking sector through its ownership of the banks, but Mr Borhani denies it is as large as mooted.
“The government may say ‘lend to SMEs’ but we decide who and whether to give loans to,” he says; 14% of the loan portfolio is dedicated to agriculture, less than the 17% it is obliged by law to dedicate, notes an auditors report.
In the year to March 2006, the bank reported net profit of $459m and posted a return on equity of 18.2%, which Mr Borhani says rose to 20% in 2007, which he believes can be improved on through the bank’s strategy of investing in technology. Currently, more than 80% of Saderat’s branches are connected to each other in real time and by the end of the year all of them will be.
The bank is issuing local credit cards and has distributed 24,000 points of sale (PoS). By the end of the year, the target is to have 150,000 PoS, with the aim of reducing customers’ dependence on holding large amounts of cash – foreign credit card companies do not operate in Iran due to the sanctions.
Saderat started offering internet banking at the end of 2006 and is setting up hundreds of ‘virtual branches’ with no staff, whereby the customer gains access to an information kiosk and internet banking with a bank-issued card. The bank expects to offer mobile banking to clients in the near term.
Mr Borhani, a 35-year veteran of the banking industry who is visibly excited by the notion of becoming the head of private bank, notes that Saderat was a private bank before the revolution and nationalisation and has retained an impetus towards profitability.
An international bank taking a strategic stake could provide a lot of value-added. “I, as a banker, look for such a shareholder. The rules and the regulations of the country will change and permit such an investment – investors with a seat on the board bringing technology and knowhow,” he says. “There are some international banks [that have] already showed their interest,” he adds.
