Iran’s economic recovery will require an independent central bank
By Steven Terner
On May 25, the Guardian Council narrowed down the field of candidates for Iran’s June 18 presidential election from the several hundred who registered to seven who will be allowed to campaign. The Guardian Council is a constitutional oversight body whose duties include supervising elections and approving presidential candidates. Among those the council approved is Abdolnaser Hemmati, who resigned his post as Iran’s Central Bank (CBI) Governor on May 15 to enter the race. While judiciary chief Ebrahim Raisi is touted in the press as the front-runner, Hemmati is a high profile candidate, and his acceptance by the Guardian Council as a finalist has significant implications for the debate about the Iranian economy during and after the election.
Banking is a campaign issue
Hemmati’s experience as head of the CBI since 2018 and as CEO at Sina Bank and Bank Melli before that is a testament to both his loyalty to the regime and his qualifications as an economist. Both will be critical traits for government officials in the foreseeable future as the Iranian regime struggles to retain popular legitimacy while rebuilding an economy ravaged by Covid, sanctions, and above all, systemic corruption and mismanagement. To be sure, economic recovery is among the more important issues discussed by the campaigns of all presidential candidates.
That being said, Hemmati’s entry into the race will further heighten the debate among the candidates regarding economic issues by pressing other candidates to develop policy strategies to turn the economy around. Furthermore, should Hemmati win, banking regulation and reform will likely become a central issue of his administration given his background. Irrespective of how he fares in the election, however, having an effective central bank will be integral to righting the economic ship. Unfortunately, the CBI as it currently stands is unable to do its job.
An impotent central bank
One of the most important functions of a central bank is to protect its country’s currency. This is done by controlling monetary policies, such as interest rates, in order to, among other things, control the rate of inflation. In Iran, due to the aforementioned combination of negative factors affecting the economy, inflation has risen to its highest level in decades. According to Zahedi and Azadi of the Stanford Iran 2040 Project, historically, high rates of inflation are of relatively little concern to the Iranian government except when they threaten to trigger protests. This might explain why Hemmati has crusaded to stem inflation since becoming the head of the CBI; political unrest in Iran seethed in late 2019 and early 2020.
Unfortunately, as the result of state capture, the CBI does not have the authority to control monetary policy. Rather, this authority belongs to the Money and Credit Council (MCC). The MCC is a group of political appointees without economic bonafides. Monetary policies in Iran are therefore effectively based on political considerations, rather than on the recommendations of independent economists aiming to protect the nation’s currency and ensure a stable economy.
What authority the CBI does have is too little to make a difference. For example, the CBI recently unveiled the Samat System, through which it will oversee loans issued by Iranian banks. With the Samat System, the CBI will collect and store data and information from individuals and businesses in order to verify their credit-worthiness when they request loans from Iranian commercial banks. Although a central bank taking on this role is a topic for considerable discussion on its own, that the CBI will protect banks from issuing risky loans marks a positive step; CBI oversight should reduce the risk exposure of Iranian banks to loan defaults, and therefore decrease the vulnerability of the banking system at-large. However, when banks are limited in how much they can lend at a given time, other lending institutions fill the demand in the market that the banks cannot meet.
Non-bank financial institutions that offer loans are called shadow banks. They include hedge funds, insurance companies, investment banks, private equity firms, and other entities that are not held to the same regulations as commercial banks in terms of how much they are allowed to lend relative to their holdings, or at what rate. Considering the limited availability of reserve capital in Iran due to its dire economic straits, shadow banks will likely play an oversized role in lending when Iran is able to redevelop its economy, which in turn could harm Iran’s economy even further. This has been the case in China, where shadow banks have created significant vulnerabilities in China’s financial sector.
Shadow banks could similarly create problems for Iran. Without regulations put in place to protect an economic system, shadow banks can and do offer high interest rates and at times over-leverage their resources and misrepresent their assets. Take for example the subprime mortgage crisis in the United States in 2007. Although an oversimplification, in that case, the central banking system of the US, i.e. the US Federal Reserve, failed to regulate lending by both commercial banks and shadow banks, leading to the issuance of over-leveraged and highly risky mortgages. As borrowers defaulted on their loans, panic set in and caused a run on the banks. This crashed not only the US economy, but the intertwined global economy along with it. Although the immediate risk in Iran is not a subprime mortgage crisis, if the Iranian economy lacks the oversight and authority of a responsible central banking system, international investors may consider the risk too high to become involved.
Proposed reorganization of authority
The Iranian establishment is aware of the shortcomings of its current setup with the CBI and the MCC. In fact, a bill was discussed on May 24 in the Majles that would create a High Council to supersede the MCC and the Executive Board of the CBI as the supreme banking oversight body, and the one responsible for determining monetary policy. Although the declared intent of the proposal is to ensure independence of the CBI from the executive branch, the High Council would be composed of political appointees with longer terms than elected officials. By design, the council would be beholden to the regime.
Nevertheless, proposing an abrupt replacement of the current banking oversight system with an entirely new one expresses acute recognition of the inability of the CBI to carry out its duties. However, the political appointment of officials on the High Council is not different from the current structure of the MCC. Therefore, despite the evident failures of the CBI and MCC, this remedy would not address any of the systemic problems, and effectively calls for more of the same.
The CBI does not currently function as an independent body. As a result, the monetary policy of the country is in a state of disarray. So far, the regime is sending signals that it intends to maintain the status quo with a weak central bank, but the CBI must be able to function properly for the sake of Iran’s future economic recovery. To do so, Iran’s central bank must be free of state capture, that is to say it must be independent of not only the executive branch but also of the power elite within the regime who wield influence in government institutions and oversight bodies and protect individual and institutional interests at the expense of the country at-large. Abdolnaser Hemmati’s entry into the presidential race adds an interesting bit of intrigue about the prominence of the issue in the minds of the powers-that-be in Iran. That he is on the short list of seven candidates shows some recognition of the problem. Still, even if he wins, not much is likely to change. Although the inability of the central bank to function effectively is widely known throughout the Iranian establishment, the regime remains unable or unwilling to allow the central bank to do its job.