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Asad A.

• A. Jafre

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Agenda

Background to FSI Vision Project Issues facing the banking industry Financial Market Development Pillars of the FSI Vision

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Background to FSI Vision Project

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Concerns regarding the financial services industry

• Is the banking sector adequately serving the needs of the real

economy to spur growth?

• Does the banking sector have adequate financially stability?
• Is there sufficient financial inclusion with access to financial

services across Iran, including disadvantaged and low income segments?

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Concerns regarding the financial services industry

• Does the banking sector have adequate technology to serve

its customers efficiently and provide reliable reporting to the CBI?

• Are financial statements reliable and based on international

standards?

• Are banks in Iran ready and prepared to be part of the global

financial system now sanctions have been suspended?

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Background to the FSI Vision

• The financial services industry in Iran can be an engine for

economic growth.

• We look to a time when Iran’s Financial Services Industry is

recognised as effectively serving the economy and population.

• That opportunity is being articulated in the FSI vision.

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An IMF study showed that Iran had the highest NPL ratio in the peer group

As put by Gholam-Hossein Mohseni-Ejei, the judiciary spokesman, bad loans amount to $72.2 billion (at the official exchange rate). According to Akbar Torkan, a top adviser to Rouhani, the overdue loans have exceeded 2,200 trillion rials ($80.5 billion at the official exchange rate)….

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Poor macroeconomic conditions lead to high NPLs with significant implications to the economy

Increase in losses for enterprises in real economy Increased inability of enterprises to service debt High level of NPL in banking sector Limits on ability of banks to continue lending Reduced lending to real economy Reduced production

• f goods and

services Reduced employment in economy Reduced capital adequacy Increased provisions and write offs for banks Reduced demand for goods and services Reduced cash flows for banks

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Iran’s banking sector has also suffered from low interest rate spreads for over 5 years

2.4% 0.4%

• 1.3%
• 1.1%

0.1%

• 0.2%

0.0%

• 2.0%

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 2004 2005 2006 2007 2008 2009 2010 2011 2012

Interest rate spread (lending rate minus deposit rate, %)

Azerbaijan Egypt, Arab Rep. Iran, Islamic Rep. Iraq Jordan Kuwait MENA (developing only) Oman Pakistan Qatar

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The IMF has raised concerns in relation to the capital adequacy of Iran’s banks

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Iran’s collateral and bankruptcy laws are deemed weak and do not facilitate the expansion of credit

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Iran, Islamic Rep. Egypt, Arab Rep. Saudi Arabia Turkey Brazil Russian Federation India China

Strength of legal rights index (0=weak to 12=strong) - 2013 Strength of legal rights index measures the degree to which collateral and bankruptcy laws protect the rights of borrowers and lenders and thus facilitate lending. The index ranges from 0 to 12, with higher scores indicating that these laws are better designed to expand access to credit.

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Iran’s resolving insolvency ranking is very low as is the recovery rate on defaults

163 138 137 126 109 65 55 53

Saudi Arabia Iran, Islamic Rep. India Egypt, Arab Rep. Turkey Russian Federation Brazil China

Resolving Insolvency Rank out of 189 countries

28.7 19.5 25.7 26.6 27.9 43 25.8 36

Saudi Arabia Iran, Islamic Rep. India Egypt, Arab Rep. Turkey Russian Federation Brazil China

Recovery rate (percent)

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These factors have contributed to lower credit to the private sector and reduced GDP Growth

Domestic credit to private sector (% of GDP) GDP growth rate

33.46% 11.39%

• 1.9%

3.94%

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Projected growth for Iran – Institute of International Finance (IIF)

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Projected growth for Iran – ICAEW

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Financial sector reforms

"Ultimately, if mild reforms are implemented the sanctions relief will have only a moderate positive impact on the economy. If, on the other hand, more assertive and deeper reforms along the lines outlined above are carried out, the boost to confidence and investment inflows would put Iran’s economy on a significantly higher growth trajectory."

• Mr. Cerisola, IMF after concluding the 2015 Article IV Consultation

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Issues facing the banking industry

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The major issues facing the banks are shown below

4.5 6.0 6.6 6.8 7.1 7.1 7.1 7.3 7.6 7.6 7.9 8.8 8.9 9.1

Sharia interpretation Corruption / fraud Priv sect access to finance CG Economy Technology Regulation CBI Power Foreign perception CG FSI Credit institutions SME & Consumer finance Skills Debt capital market NPL

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Biggest single factor facing the banking industry

Regulation NPL CBI Power Skills

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The three biggest issues facing banks

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NPL Skills Debt capital market

Banking problems These three issues had the highest scores showing they were the most problematic, they all had the same range (between 7 & 10) but the problem related to skills had a higher concentration of results than the other two problems cited

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Financial Market Development

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The low Financial Market Development has constrained growth in Iran

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The WEF corporate survey highlights the most problematic factors for doing business

0.2 0.5 0.7 1.5 1.8 2.0 3.5 4.0 5.6 7.3 7.9 10.6 11.5 13.0 13.0 16.9

Poor public health Government instability/coups Crime and theft Insufficient capacity to innovate Tax regulations Tax rates Inadequately educated workforce Poor work ethic in national labor force Restrictive labor regulations Foreign currency regulations Corruption Inadequate supply of infrastructure Inefficient government bureaucracy Inflation Policy instability Access to financing

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World Bank Financial Market Development measurement

FINANCIAL INSTITUTIONS DEPTH

Private credit to GDP Financial institutions’ assets to GDP M2 to GDP Deposits to GDP Gross value-added of the financial sector to GDP

ACCESS

Accounts per thousand adults (commercial banks) Branches per 100,000 adults (commercial banks) % of people with a bank account % of firms with line of credit (all firms) % of firms with line of credit (small firms)

EFFICIENCY

Net interest margin Lending-deposits spread Non-interest income to total income Overhead costs (% of total assets) Profitability (return

• n assets, return on equity)

Boone indicator (or Herfindahl or H-statistics)

STABILITY

Z-score (or distance to default) Capital adequacy ratios Asset quality ratios Liquidity ratios Other (net foreign exchange position to capital etc.)

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WB Financial depth: Private credit by deposit money banks to GDP (%)

118.1 104.4 100.8 50.3 45.5 44.8 42.1 41.2 38.5 33.2 29.9 28.7 24.6 24.4 21 18 China Vietnam Korea, Rep. Brazil India Saudi Arabia Russian Federation Bangladesh Turkey Egypt, Arab Rep. Nigeria Philippines Iran, Islamic Rep. Indonesia Pakistan Mexico

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WEF: Availability of financial services

5.2 5.2 5.0 4.9 4.9 4.5 4.4 4.3 4.2 4.2 4.1 4.1 4.0 3.9 3.4 2.9 Brazil Turkey Philippines Indonesia Saudi Arabia China Russian Federation Mexico India Pakistan Bangladesh Nigeria Korea, Rep. Vietnam Egypt, Arab Rep. Iran, Islamic Rep.

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WB: Financial Access - Account at a formal financial institution (%)

93 73.7 63.8 57.6 55.9 48.2 46.4 39.6 35.2 29.7 27.4 26.6 21.4 10.3 9.7 5.6 Korea, Rep. Iran, Islamic Rep. China Turkey Brazil Russian Federation Saudi Arabia Bangladesh India Nigeria Mexico Philippines Vietnam Pakistan Egypt, Arab Rep. Indonesia

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WEF: Ease of access to loans

3.9 3.9 3.7 3.6 3.6 3.5 3.0 2.9 2.7 2.6 2.6 2.4 2.4 1.9 1.6 1.6 Indonesia Korea, Rep. China India Saudi Arabia Philippines Russian Federation Turkey Brazil Pakistan Vietnam Bangladesh Mexico Egypt, Arab Rep. Iran, Islamic Rep. Nigeria

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WEF: Affordability of financial services

5.1 5.0 4.9 4.9 4.8 4.4 4.1 4.1 4.0 3.9 3.9 3.7 3.6 3.5 3.3 3.1 Saudi Arabia Brazil Indonesia Turkey Philippines China India Russian Federation Pakistan Bangladesh Korea, Rep. Mexico Vietnam Nigeria Egypt, Arab Rep. Iran, Islamic Rep.

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WB: Financial Efficiency – Bank lending- deposit spread (%)

33.1 8.8 6 5.2 5.2 4.9 4.5 4.4 3.1 2.8 2.4 1.8 0.1 Brazil Nigeria Pakistan Bangladesh Russian Federation Egypt, Arab Rep. Philippines Mexico China Indonesia Vietnam Korea, Rep. Iran, Islamic Rep. India Saudi Arabia Turkey

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WB: Interest rate spread

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WB: Financial stability - Bank Z-score

40.2 39.9 37.9 22.8 21.9 21.2 19.4 18.6 14.1 13.4 10.2 8.1 7 5.8 0.1 India Egypt, Arab Rep. Indonesia Philippines Mexico Brazil China Vietnam Saudi Arabia Pakistan Korea, Rep. Bangladesh Russian Federation Turkey Nigeria Iran, Islamic Rep.

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WEF: Soundness of banks

6.1 6.0 5.7 5.6 5.5 5.1 5.0 4.8 4.8 4.3 4.2 4.2 4.0 3.9 3.8 3.5 Brazil Saudi Arabia Turkey Mexico Philippines Indonesia China Nigeria Pakistan India Bangladesh Egypt, Arab Rep. Russian Federation Korea, Rep. Iran, Islamic Rep. Vietnam

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Financial market development

When we then consider all four aspects of Financial Market Development for Iran’s Financial Institutions, Iran scores low for all of these (after adjusting appropriately for Financial Access and Efficiency).

4.7 4.5 4.4 4.3 4.3 4.3 4.2 4.1 4.1 4.0 3.8 3.8 3.8 3.5 3.2 3.0

WEF FMD score, 2014-15

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Pillars of the FSI Vision

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Pillars of the FSI Vision

The Vision for the Financial Services Industry focuses on the aspirations and objectives in ten mutually reinforcing areas. These objectives will be achieved given the current state of the Financial Services Industry through a Financial Sector Development Plan to cover the relevant sub sectors of the Financial Services Industry. The objectives in the FSI Vision are:

• 1. Support Economic Growth: Iran to have a more resilient,

competitive and dynamic financial system to support sustainable economic growth. This will require increased access to credit to sectors and segments of the economy that will contribute most to economic growth, offering products and services that meet the needs of the economy, increasing the ability of customers to mitigate the risks they face and facilitating increased investment into the economy

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Pillars of the FSI Vision

• 2. Financial Inclusion: Implement a financial inclusion program for

financial intermediaries to meet the needs of underserved economic subsectors, including outreach programs to meet the requirements of the agriculture, housing, SME, consumer and microfinance sectors. Deepen financial intermediation by developing not only the banking sector but also non-bank credit institutions and the capital markets.

• 3. Strong & Independent regulators: Strengthen the powers of CBI &

SEO to maintain monetary and financial stability, updating the associated Legal Framework in accordance with IMF recommendations and other leading international practices for central bank & regulatory independence, accountability, power, transparency and governance.

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Pillars of the FSI Vision

• 4. Financial Stability: Strengthen and consolidate the Financial Services

Industry by raising governance and risk management standards, higher capital requirements and the orderly resolution of unviable financial

• intermediaries. Introduce a framework for the consolidated supervision

and reorganize the regulatory architecture to allow better regulation and supervision of financial groups and conglomerates. Develop a financial safety net for the protection for small depositors, clearly structured lender of last resort facilities, update the framework for market exit and the resolution of unviable financial intermediaries, and coordination arrangements between regulators and the government for dealing with systemic crises.

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Pillars of the FSI Vision

• 5. Corporate Governance: Implement corporate governance standards
• and. Standards will be implemented initially in the banking sector and

capital markets and then work with the government to roll out this out to all sectors including public sector entities and other large corporates, strengthening the Board of Directors, in particular the Audit Committees and further separate management and Boards.

• 6. Products & Services: Work with the industry to assess current

products and services from the perspective of customer & industry needs and leading practices. Where products & services fall short, rectify the shortcomings through effective product programs and roll these out efficiently across the industry for all sub-sectors.

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Pillars of the FSI Vision

• 7. Inclusion within the global financial system: As the Iranian

government has successfully negotiated with the P5 + 1 on the suspension of sanctions, work internally with the financial industry to prepare for the integration of the Financial Services Industry for inclusion within the global financial system.

• 8. Efficient markets: Ensure all investors have consistent access to all

investment opportunities at fair, accurate and transparent market

• prices. This will also require the provision of reliable liquidity for the

range of assets and a well-functioning transaction execution process.

• 9. Reliable payments system: Ensure the payment systems are safe &

low-cost with reliable infrastructure to make payments for goods & services and to transfer money domestically and internationally.

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Pillars of the FSI Vision

• 10. Islamic finance: Develop an approved set of products that are

demonstrably sharia compliant with consistent product programs and

• contracts. Establish country level sharia boards for each sub sector to

ensure consistency in the manner that each sector and its financial intermediaries offer their products and services.

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Pillars of the FSI Vision

Economic growth Financial inclusion Financial stability Products & services Efficient markets Payments system Islamic banking Global inclusion

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Inter-related pillars

Financial Inclusion Economic Growth Strong regulators Financial Stability Products and services Efficient markets Islamic Finance Payments system Integration with global FS industry Corporate governance

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Financial sector development plan

Time Effectiveness

• f FSI

Current state Future Vision

FSDP

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A Vision to inspire the whole nation