Attention is turning to how Iran’s banks and financial system will fare when a bevy of western sanctions are lifted in the wake of the Iran nuclear deal. So far, large part of the country’s financial sector appears unbankable.

The Tehran Stock Exchange recently capped a month-long rally on heavy trading volume. The nuke deal’s announcement, however, left the benchmark index essentially flat for the year on news that the easing of major sanctions will be delayed until early 2016. The UN, after that date, could lift banking prohibitions including connection to the SWIFT global payments network. Chinese and Indian institutions are poised to be among the first to resume correspondent and local banking relationships. Chinese and Indian bankers have also led delegations calling on Iranian business and government representatives in recent months.  However, their enthusiasm has been muted, as credit and capital markets despite nominal access remain subject to pervasive official control. The Chinese and Indians may also be put off by estimates that the cumulative hole on the balance sheet of Iranian banks may already exceed the $100 billion frozen in Iran’s international accounts.

President Rouhani convened a national conference early this year to debate approaches for the huge bad loan ratio of Iranian banks which is pegged at 20-25% of the total if normal accounting standards are applied. Oversight and resolution gaps have been regularly cited in IMF reports, and the central bank lacks independence as it is just one voice on Iran’s Monetary and Credit Council setting policy.

The overall economic picture is also far less than encouraging. Iranian economic growth was 2% in the latest quarter with inflation more than halved at 15% from 2014’s 40%. With relative currency stability, the difference between the formal and parallel exchange rates narrowed to average 30,000 rial/dollar, and unification is still a near-term goal.  “Profit rates” for borrowers, to be followed by all 30 state and private institutions in the no-interest Islamic system, were recently reduced 2% to 20%, and reserve requirements fell to 13.5%. The government-run giants include Melli, Industry and Mine, Agriculture, Sepah and specialized Housing and other units, while private competitors like Saderat and Pasargad often have official ties as part of wider family business conglomerates. Non-performing assets are concentrated in real estate, where a large buyer subsidy program began under the Ahmedijad administration, while manufacturing is operating at only 60% capacity. According to the central bank, most commercial lending is for immediate cash flow rather than longer-term investment.

A list of 600 individual and corporate defaulters has been compiled as an important step in addressing problems and reported in the media including the new English-language Financial Tribune. However, they are politically-protected names and workout procedures are undeveloped. Banks have also been ordered to divest non-core activities like property speculation which supported the bottom line amid credit woes. Meanwhile, they are locked in to previous high-yield deposits at 30% plus rates which prevailed under runaway inflation. A task force is exploring setup of a single disposal agency for overdue debts and recapitalization needs, which together may amount to one-quarter of the system’s $500 billion size, as earnings for banks listed on the stock market declined 7% for the quarter ended in March.

The Tehran exchange has been touted by frontier enthusiasts as a longstanding financial sector channel, in contrast with the absence of this facility in post-embargo Burma and Cuba. Since the 1990s Tehran has been member of the Istanbul-based Federation of Euro-Asian Exchanges, a technical body which works to harmonize infrastructure and regulation and also includes archenemy Israel. Modern brokerage and electronic capacity support trading and settlement, and price-earnings ratios are in low single digits for the hundreds of companies offered at over $100 billion in combined capitalization. The biggest weightings are in telecoms and petrochemicals, and IPOs and small stake privatizations have been staples for retail punters.  Foreign investors can in principle acquire majority ownership with permission, and Gulf buyers in particular were active before sanctions.

True availability is limited as the free-float is only around $30 billion with shareholding dominated by government institutions like pension funds, the Revolutionary Guard, municipalities, and religious foundations. Along with average citizens, they received non-payment transfers in the past under Iranian-style privatization. Despite their preponderance and failure to exercise traditional corporate governance, international fund joint ventures such as between Tehran’s Turquoise Securities and the UK’s Charlemagne Capital have been launched with promises of quick value cultivation.  However banking and equity markets remain choked by decades of underbrush that will not be cleared even if anti-nuclear intentions are laid out in the rapprochement’s preliminary operational phase.

Gary N. Kleiman is an emerging markets specialist who runs Kleiman International in Washington, D.C.

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