EghtesadOnline: The Majlis Research Center has called on the government and monetary regulators to boost the capital buffers of banks to help them cope with recession that observers predict will afflict the economy.
In an analytical report, MRC said liquidity in the past five years is high enough to show its inflationary effects. Since 2014, liquidity has grown buy an average 28% annually and reached 16,930 trillion rials ($145 billion) last October, which according to the think tank created the grounds for galloping inflation.
This was exacerbated by the overall decline in investments that together with falling private sector consumption forebode an economic recession in the near future.
Add to this the need of the production sector for import of raw material, heavily affected by forex rate volatility, which will ultimately lead to higher production costs, according to Financial Tribune.
Moreover, producer inflation (measured by producer price index) in fact downgrades the real value of banks’ loans. “Therefore, in order to maintain the working capital for enterprises, the loans should be increased nominally,” the think tank believes.
To weather the storm and the expected recession, MRC called for meaningful support for the banking system, warning that failure to do so will have detrimental to macroeconomic variables.
“Lack of derivative financial instruments, widespread government intervention in pricing procedures and the sanctions are but a few dark spots in the key production sector that enhance the sector’s need for bank loans and credits.”
MRC warns that banks aversion to support businesses would increase the cost of recession much higher.
It recalled that CBI monetary policy and controlling money creation has little to do with budget planning while budgetary decisions can go a long way in boosting the lending power of banks.
The report points to perennial obstacles of bankers, namely capital inadequacy, as an issue that indeed determines to a large extent their lending capability. Capital adequacy ratio is a measure of banks’ capital divided by their risk-weighted assets. Thus, to be able to augment lenders’ CAR their capital should increase.
MRC further argues that private banks’ policies are less concerned with curbing inflation and coping with recession and worry more about caps on lending during recession, fearing borrowers’ inability to repay debt. Therefore, the burden falls on public lenders.
“Boosting banks’ capital is essential simply because their role in improving economic conditions is critical,” it said.
Review of Lenders’ Capital
Pointing to the regulator’s penalties in banks whose CAR is below 8%, the MRC said CAR of some banks is currently below standard.
According to CBI rules, banks whose CAR falls between 5 to 8% are required to propose their plan for capital increase within 15 days otherwise they will face restrictions.
Similarly, bankers with 3%-5% CAR are banned from participating in the interbank market plus face some restrictions on paying interest to shareholders and making big loans. Banks with CAR below 3% must increase their capital within 90 days or face insolvency procedures.
The influential Majlis think tank points to the capital boost for public banks in fiscal 2017-18 sourced mainly from revaluation of foreign assets and budgetary allocations, arguing that given the economic circumstances, more support seems a must.
$1.7b Capital Boost
The MRC proposes two main avenues for boosting banks’ capital: transferring banks debts to the CBI to the government’s debt to the CBI and issuing Islamic bonds.
Total debt of public banks to CBI amounted to 507 trillion rials ($4.3 billion) by Oct. 22 which is mainly held by Bank Maskan (410 trillion rials/$3.5 billion). In the next fiscal budget bill, the government has proposed 50 trillion rials ($431 million) capital boost for the main home lender to be sourced by transferring the lenders’ debt to the CBI.
According to the MRC, the boost can increase the banks’ CAR to 17%, which will strengthen its lending power and by extension bring prosperity to the struggling real estate sector.
It called for extending the initiative to all public banks and suggested that the capital of other banks increase by 100 trillion rials ($860 million).
The body also proposed issuing Islamic bonds worth 100 trillion rials as Plan B to help strengthen the lending power of banks. It points out that government bonds should increase the CAR of banks largely due to their low risk.
Additionally, bonds can be traded as part of the CBI Open Market Operation in which lenders can either sell the bonds to the CBI to increase their reserve requirement or offer it as collateral to the regulator and (then) borrow from it to address their shot-term liquidity needs.