Going The Wrong Way
Banks’ assets in real estate and investments in “non - bank subsidiaries” is a recent economic phenomenon in our country which is referred to as “the paradox of liquidity”. Despite an abundance of liquidity at macro - level, providing “working capital” is posing major problems for banks and other financial institutions.
DONYA-E-EGHTESAD: Banks' assets in real estate and investments in "non-bank subsidiaries" is a recent economic phenomenon in our country which is referred to as "the paradox of liquidity". Despite an abundance of liquidity at macro-level, providing "working capital" is posing major problems for banks and other financial institutions. The structure of banking system, banks management, regulations and improper monetary policies led to the distortion of banking system.
Banks start to invest in real estate for the purpose of nominal coverage of their losses caused by imposed policies and regulations. This results in an unhealthy balance sheet and a deepening stagnation. That would also cause disruption to financing and consequently shock in price of goods and services. In an analytical report "Donya-e-Eghtesad" studies the roots of these measures in banking system and the role of "toxic assets" in the current economic downturn and assesses the risk of such assets to Iran's banking and credit system.
Toxic assets and stagnation
Former head of Iranian accountants association believes that "toxic assets" in banks' balance sheets has deepened the stagnation. According to Gholamreza Salami Iran's economy is confronted with "the paradox of liquidity"; despite an abundance of liquidity at macro-levels, manufacturing plants face shortage of working capital issues. He adds that "assets being frozen" and "poor function of banks as financial intermediaries" are the leading causes of the current situation. He further mentions that banks show profits in their balance sheets by investing in real estate and branch expansion. This has resulted in high "Fixed Assets to Total Assets Ratio". On the other hand it won't be possible for banks to sell those assets at their book value (BV).
Banks and stag-exit
"Exit from stagnation" and the role of the banks have recently come into sharp focus. Banking system has attracted a lot of criticism. Abbas Akhoundi Iran's Minister of Roads and Urban Development emphasized the issue of "assets" in banks' balance sheets and referred to them as "toxic assets". According to him, this has almost disabled banks to function as financial intermediaries.
Several weeks ago in an interview with "Tejarat-e-Farda" Mr. Gholamreza Salami highlighted the fact that banks are not lending out their reserves and deposits are mostly invested internally and turned into assets. This had a major impact on the flow of capital. These toxic assets include "real estate" and investments in "non-bank subsidiaries".
Creation of toxic assets
According to Gholamreza Salami, a considerable portion of bank deposits has been taken out of economic cycles. It is worth noting that the central role of banks in economy is to create money as financial intermediaries. Increasing "money multiplier" is the mechanism of providing liquidity services. A significant portion of monetary assets (with the exception of coins and paper money in the hands of public) belongs to banks. Generally, 80% to 90% of bank deposits are turned into loans and return to economic circles. Mr. Salami points out that a bank is just like the heart of economic structure and the provided capital is its blood. As long as blood is in circulation, the organs will remain sound and healthy. According to him, toxic assets pose three major risks to banks functionality as intermediaries:" non-performing assets", "assets in real estate" and "investments in non-bank subsidiaries".
Experts believe that malfunction of banking system as financial intermediaries is due to a number of factors including "non-performing assets" in banks' balance sheets as a crucial factor. These assets do not produce income and are actually "frozen". According to Mr. Salami, toxic assets pose serious risks to banking system and the economy. The financing mechanism is malfunctioned and capital turns into stagnant water.
Assets in real estate
Investments in real estate sector and branch expansion strategies gave rise to difficulties for the banking system. "Unreal reporting book value of these assets show nominal profits in balance sheets, yet since these assets are typically very sensitive to economic conditions, decline in inflation poses a challenge to these book profits" Gholamreza Salami said. He emphasized the crucial importance of fixed assets ratio. "There is a standard for fixed assets ratio and, unfortunately, this ratio is above the normal standard in Iranian banks" he added. Nonetheless banks are under Central Bank's pressure for capital increase in order to reduce liquidity risk and strengthen the lending power. It has been said that capital requirement regulations and standards defined by Basel Committee on Banking Supervision (BCBS) have not been implemented in Iran.
"According to Basel Committee, physical assets cannot be utilized to increase capital and the increase should be in cash." Mr. Salami said. He then added that liquidation value of banks' physical assets such as real estate would be less than their book value, nevertheless, banks have no option but to sell their fixed assets which, of course, represents challenges.
Figures show that in the previous year, investments in non-bank subsidiaries exceeded 50% of the capital base which is higher than benchmarks. "As a matter of fact, a portion of banks' deposits are turned into fixed assets by the banks themselves which is relatively high in our country. This and other reasons such as imposed policies and government regulations, lack of credit rating agencies, economic instability and ambiguity and uncertainty in exchange rates and inflation have disabled banks as financial intermediaries" said the former head of Iranian Accountants Association.