ILIA Corporation Expertise on the Iranian Banking Sector
Banking Industry Iran: current status, opportunities and threats
Managing and Founding Partner of ILIA Corporation
Q: How has the Iranian banking sector evolved during the past decades?
SHN: Since the Islamic Republic came into power, Iran’s banking industry has developed significantly from a local perspective.
Around 15 years ago, private banks started operating and the quality of services steadily increased. Ever since, the nature of customer service has gotten a true meaning here locally. In the private banks, the customers are the kings – they can easily choose another service provider, for free, without limitations. This makes the competition between the banks tough, and customer service the key differentiating factor.
Q: How big was the impact of the sanctions on the Iranian banking sector? What is the situation like now in regards to the Iran Banking sanctions?
SHN: Sanctions on both the Iranian Central Bank and the banking sector more broadly had some notable impacts on the entirety of Iran’s banking industry. Whilst some argue the sanctions acted as a positive force (conveying many lessons towards self-sufficiency, which is also correct), in actuality it should be acknowledged that the main damage was caused to the banking infrastructure, mainly by cutting it off from the international banking network.
From a legal perspective, under the JCPOA, Iran is again linked and connected to the international banking system with the exception of the United States. This means all transactions between Iranian banks and international banks are allowed except through the US system or with US banks. All financial sanctions imposed by the EU and the UN on the financial systems of Iran have been lifted however some legacy US sanctions from a trade embargo in 1995 remain in place.
Q: In that case, what is preventing international banks from operating in Iran?
SHN: It is true that after the lifting of the sanctions one can wonder why international banks are so reluctant to set foot in Iran. Anecdotally we hear “you can work with Iranian banks; opening accounts for Iranian banks is ok”, “transferring and handling Iranian orders/transactions is fine”, and “opening LC’s for Iranian clients is possible.” These are statements that American authorities have been repeating in recent weeks. They emphasize that under the JCPOA framework, collaborations with Iranian banks are allowed and also encouraged.
Notwithstanding this, we believe there are several key reasons why foreign banks are not rushing to Iran:
As I mentioned one of the issues facing banks post the lifting of the sanctions, is that the US still has restrictions and sanctions on Iran, dating back to the 1990’s which are yet to be lifted. Therefore, before any non-US bank – which has a subsidiary on US soil – can facilitate any financial transaction, they must ensure that the Iranian person or company is not directly or indirectly working with an entity remaining on the US sanctions list.
This of course can be clarified, via Customer Due Diligence (CDD). However, getting this wrong can be costly. There is a long history of significant and punitive fines enforced by the US Justice Department for “illegal” dealings with Iranian entities, which will keep banks cautious in the near term as they continue to clarify the United States intentions and expectations going forward.
By way of example, in 2014, BNP agreed to pay nearly USD9bn in fines for violating US sanctions involving Iran (as well as Cuba and Sudan).
Q: So the main problem is not with the UN, but with the US authorities?
SHN: Well, even after the JCPOA has been signed US citizens and entities are still prohibited from directly or indirectly providing services to Iran. Therefore the key question becomes what does “providing indirect services” actually mean? In the JCPOA and its clarification manual the terminology is not defined. The American authorities have stated that any questions around this ambiguity can be clarified with them. International banks will not start working with Iran until such matters are clearer as the risks of misinterpretation remains to great. They need to know definitively what they can and cannot do. Even more importantly, in the event they fail to comply, what risks are they exposing themselves to? This too is not clear or defined. We would not expect any international bank with a subsidiary on US soil to start working with Iran until both these issues are resolved.
Moreover and as mentioned, despite the lifting of the sanctions against Iran’s nuclear program, there are other US claims and some established sanctions are still in place, such as those against alleged human rights violations and terrorism support. This creates an ambiguous environment and grey zones for big banks, thus Iran remains as a sensitive area on their banking system radar.
Q: What are potential solutions to those issues?
SHN: First of all, keeping good diplomatic relations is another step to further improvements of Iran’s ties with the global economy. One potential solution would be to have US and EU authorities establish a publicly available Q&A checklist on the Iranian banking sanctions status, and whenever an issue is raised and clarified the answer would apply to all other banks as well, which could then be the basis for further steps. This checklist could be maintained and updated until the status is clarified. It would encourage knowledge sharing amongst other banks, enabling them to work with Iran.
A second solution would be to request from banks that when an Iranian person or organization comes to them requesting financial services they would be asked if they are working with sanction listed individuals or companies. If the verbal and written answer is “no”, then it would not be the banks responsibility to investigate the matter further anymore. A similar approach was taken by the EU on Russian banking sanctions, and there is no reason that the same cannot be applied to Iran’s case.
To complete this it would also be suitable to have a publicly available list of the people and entities who are still on the sanction list, clearly mentioning that these people are not to be worked with – any other person or entity would then be considered a reliable business partner.
Q: Are there any other issues you are seeing at the moment?
SHN: Yes. There is another bottleneck between the Iranian and the international banking system, namely the conversion non-floating currencies vs the Iranian Rial. This is related to the U-turn sanction still in place for Iran. Let me clarify this as follows:
A U-turn transaction, generally speaking, is a banned financial transaction done by a bank in country A (example: USA) for the benefit of a bank in country B (example: Iran) through an offshore bank (example: Switzerland). This loophole is used by Iranian banks to avoid U.S. sanctions for their US dollar based transactions. The phrase “U-turn” applies because the funds are transferred to a U.S. bank and instantly turned back as dollars to a European bank.
Many of the transactions internationally are done in USD. However, most of Iran’s assets outside the country as well as their reserves in Iran are in non-USD currencies. This is the result of sanctions on Iran, where Iran has had to exchange its assets into non-USD currencies (mostly into Chinese and other Asian currencies). Many of these currencies are not actively traded, as compared to the Euro or USD, and therefore when Iran needs to exchange its local currency or any of the non-floating currencies, it has to wait until it finds a buyer and negotiate an exchange rate (i.e. the market for Rial/Renminbi is extremely illiquid). The pricing and additional charges create a significant issue.
Therefore, even after the implementation of the JCPOA, many challenges remain for the Iranian Banking industry. It is our strong belief that come the beginning of 2017, this situation will be normalized. Some European and Asian banks will be offering full services to their Iranian customers and some of the governmental and private Iranian banks will be open and operational in Europe and Asia. The banking industry of Iran is going to grow at a fast pace, but certain challenges need to be dealt with.
Iran’s FinTech scene is receiving a lot of attention lately because of Iran’s large FinTech friendly market and low-competitive business environment. Strong local banking infrastructure, high debit card and smartphone penetration rates, combined with Iran’s young and well educated population of nearly 80m people, make this market an attractive prospect for FinTech entrepreneurs.
Iran’s FinTech ecosystem is still very much in a grassroots stage, however it has the potential to become one of the Middle East’s leading hubs in the near future.
The number of FinTech startups operating in Iran is currently at just under 50 (August 2016), with many new start-ups emerging every few weeks across a variety of platforms. FinTech offerings currently cover online payments, mobile wallets, financial management applications and p2p payment systems.
For international payments, the European VC-backed Turkish payment startup Iyzico has signed contracts with one of Parsian Banks’ subsidiaries to provide services to Iranian debit card holders. This will enable Iranians to use local debit cards in Turkey. San Francisco based Paymentwall is also partnering with CBI’s Shetab network.
According to the Digital Finance Institute, a Canadian Fintech Think-Tank, the opportunity for FinTech in Iran are enormous:
“Iran, the only Muslim country besides Sudan where the entire financial industry is obliged to be consistent with the principles of sharia law, accounts for more than 40% of the world’s total Islamic banking assets. Trailing far behind is Saudi Arabia with 18.5%, Malaysia with 9.56%, and the UAE with 7.36%. As a result, FinTech in Iran means that it will be poised to lead in Islamic FinTech globally and this has implications for the rest of the world’s banks that are far behind in understanding and catering to Islamic finance customers.”
NOTE: ILIA Corporation has recently successfully facilitated one of the largest (if not the largest ever) seed financing round of an emerging startup in the FinTech arena of Iran.