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WorldDecember 1 2011

Sanctions leave Iran's banks short on partners and profits

The Iranian government is insistent that the growing number of sanctions on the country is not having a detrimental effect on the country's economy. Yet, with its banks limited by the financial instruments they can use and the international banks that they can partner, it is proving increasingly difficult for them to remain profitable.
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Sanctions leave Iran's banks short on partners and profits

Economic sanctions are nothing new for Iran. The US imposed sanctions on the country following the Islamic revolution of 1979, when Iranian students stormed the US embassy and took diplomats hostage. In 1995, the then US president Bill Clinton issued executive orders preventing national companies from investing in Iranian oil and gas, or trading with Iran.

The more recent rounds of sanctions by the US and other countries and organisations are aimed at confronting Iran’s alleged nuclear weapons programme. The UN Security Council has imposed four sets of sanctions on Iran over the past five years: in December 2006, March 2007, March 2008 and June 2010.

During that time, both the range of sanctions imposed by the UN and the number of countries imposing additional, unilateral measures has steadily increased, to the point where Iran’s banking system is feeling the strain.

The official line

As is only to be expected, the official government line is to deny that the country’s growing international isolation is having any adverse impact. The truth is that sanctions are very clearly taking their toll on all aspects of the economy. 

The Washington, DC-headquartered International Monetary Fund is forecasting that Iran’s economic growth will remain flat in 2011 due to the combination of sanctions and the phasing out of subsidies. Meanwhile, inflation is predicted to rise to 22.5% – which would be the second highest rate in the world, after Venezuela.

Iran's banking sector has been especially hard hit. Over the years, sanctions have been imposed on many of Iran’s 28 banks and nearly all the state-owned banks. Today, there are eight Iranian banks on the US sanctions list and international efforts to squeeze Iran economically are solidifying.

On November 21, 2011, two European allies signalled their intention to take on the Central Bank of Iran directly. The UK’s chancellor of the exchequer George Osborne announced that the country’s credit and financial institutions had to cease trading with Iran's banks with immediate effect as part of a package of sanctions from the UK, US and Canada. Meanwhile, France urged Western nations to collectively freeze all overseas assets held by the Central Bank of Iran.

The moves follow a recent report published by the International Atomic Energy Agency on November 9, 2011, that suggested Iran was working on a nuclear weapons programme under the guise of a civilian energy project.

This is the first time the UK has used powers created under its 2008 Counter-Terrorism Act to cut off a country's banking sector in this way. The US and Canada are also expected to announce further economic sanctions against Iran at the end of November.

Long way around

As a result of these sanctions, banks are now finding it harder to operate overseas and to transfer money globally – both in terms of the financial instruments they use and the partner banks they work with.

Iran conducted $3bn-worth of trade through letters of credit (LC) in its last calendar year, which covered the period from March 2010 to March 2011. Sanctions have forced banks to conduct financial transactions through small-scale correspondent institutions.

“Iran has had to learn to become self-sufficient. Our business model is to rely on ourselves and untraditional methods of doing business,” says a correspondent banker based in Tehran. “The country can no longer find the financial services it used to utilise but we are finding ways around that. For example, if a bank or exporter in Malaysia is not able to add their confirmation to a transaction then they will approach a third-party bank to silently confirm it.”

But this method of navigating through several banks is far from ideal. Not only is it more time-consuming but it also drives up costs through increased commissions which is weighing down on the profitability of Iranian banks.

Changing direction

With more and more banks closing ranks, Iran has seen a noticeable shift eastwards in its trading partners. “Over the past couple of years, Iran’s trade has shifted from a focus on European countries such as Germany and France to countries such as Turkey and the Far East with whom it is easier to work with,” says Cyrus Razzaghi, president of Tehran-based business consulting group ARA Enterprise.  

“We are now seeing European brands replaced by Asian brands and products. Companies that used to bring in goods from Europe are now bringing in lower-quality goods from Asian countries such as China, where there are more banking options available.”

The sanctions are also distorting Iran’s trade flows in other ways. Without access to much-needed foreign investment and expertise, the country is struggling to reduce the natural decline at its ageing oilfields. Oil profits traditionally comprise about 65% of government revenues in Iran, but despite being the world’s fourth largest producer of crude oil, underinvestment in its energy sector means the country now resorts to importing its main fuel needs.

Over the past couple of years, Iran’s trade has shifted from a focus on European countries such as Germany and France to countries such as Turkey and the Far East with whom it is easier to work with

Cyrus Razzaghi

Iran has already begun eating into its Oil Stabilisation Fund and in January 2010 Iran’s Guardian Council approved a $20bn subsidy cut that will inevitably lead to higher inflation and potentially rising unemployment.

“Iran’s main exports are oil and gas and these are now dwindling,” says a Tehran-based banker. “But Iran is a net importer so the combination of the increase in the price of foreign currencies coupled with the rise in banking sanctions, which is forcing banks to use more expensive trade instruments, is having a very negative impact on the banking sector.”

Currency in meltdown

The sanctions are also having a highly detrimental impact on Iran’s currency market. Since 2001, the central bank has supported the Iranian rial through a managed float system, to help ensure a single rate against hard currencies. However, the gap between the market and official rates has been widening since January – a reflection of the escalating impact of sanctions on Iran’s financial transactions.

The central bank has been trying to close the gap but its efforts have proven unsuccessful. In the past, the Iranian economy has suffered enormously as the result of irregularities inherent in a two-tier foreign currency exchange system. Currency dealers claim the authorities are now trying to prop up the rial by withholding foreign currencies from the market.

The central bank has imposed a stringent limit on the purchase of foreign currency, including US dollars. Iranians who travel abroad can purchase up to $2000 at the official rate after providing their airline tickets as proof of their need for the currencies.

The number of dollar-denominated transactions has fallen dramatically since the US began restricting Iranian banks’ access to the dollar clearing system in 2006. According to the Central Bank of Iran, the proportion of interbank foreign exchange transactions carried out in dollars fell from 65.9% in 2006 to 2007 to just 1.7% in 2008-09. Over the same period, the share of euro transactions rose from 32.4% to 83%, as banks redirected their business to the eurozone instead.

EU cut off

However, the wave of sanctions issued by the EU in July 2010 has now cut off that line of business. Iran’s difficulty in finding correspondent banks that are happy to confirm LCs is leading them to look at alternative trade finance tools.

“International trade instruments, such as LCs, are by far the biggest challenge for Iran’s banking system today,” says the head of a financial advisory company who spoke on condition of anonymity. “Consequently, all banks are resorting to establishing their own foreign exchange operations, a relatively easy and profitable way of catering to their business clients. Instead of inter-banking LCs, they provide flexible terms to clients.”

A banker at one of Iran’s main export finance institutions says: “If you are unable to use international recognised payment systems then you resort to the next best alternative. Banks' foreign exchange departments are now working with bureau exchanges that are domiciled in other countries so the movement of funds is done by proxy. We are also seeing the use of ad-hoc financing instruments such as certificates of deposit or banks issuing debt financing on another bank’s behalf.”  

Bad reaction

Unsurprisingly, the growing chorus from Iran’s financial community is that it is becoming harder, riskier and more expensive to transfer money through unofficial channels. There is no doubt that the latest sanctions on Iran’s banking sector are the toughest it has ever experienced.

For now, the US has stopped short of imposing sanctions directly on the central bank amid fears that it could drive up oil prices and hurt its economy, which in turn would inflict more chaos on global markets. But it is clear that Iran stands to lose the most in this political battle. 

The government’s spate of privatisations over the past decade has revolutionised the Iranian banking sector to the point that it has ranked as one of the best-performing sectors in the country, both in terms of profitability and share price performance. Now its international stance is threatening to undo all that hard work and the banking sector looks set to be the biggest casualty. 

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Read more about:  Middle East , Iran